Financialmanagementworkbook 121105064928 Phpapp01

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WORKBOOK
Financial Management

2005 The Icfai University Press. All rights reserved.

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system, used in a spreadsheet, or transmitted in any form or by any
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ISBN : 81-7881-969-4
Ref. No. FMWB 11200502
For any clarification regarding this book, the students may please write to us giving the above
reference number of this book specifying chapter and page number.
While every possible care has been taken in type-setting and printing this book, we welcome
suggestions from students for improvement in future editions.

Preface

The ICFAI University has been upgrading its study material to make it more beneficial to the
students for self-study through the Distance Learning mode.
We are delighted to publish a workbook for the benefit of the students preparing for the
examinations. The workbook is divided into three parts.

Effective from April, 2003, the examinations for all the subjects of DBF/CFA (Level-I) consist of
only multiple choice questions.

Brief Summaries of Chapters
A brief summary for each of the chapters in the textbook is given for easy recollection of the
topics studied.

Part I: Questions on Basic Concepts and Answers (with Explanatory Notes)

Students are advised to go through the relevant textbook carefully and understand the subject
thoroughly before attempting Part I. In no circumstances should the students attempt Part I without
fully grasping the subject material provided in the textbook.
Frequently used Formulae
Similarly the formulae used in the various topics have been given here for easy recollection while
working out the problems.

Part II: Problems and Solutions

The students should attempt Part II only after carefully going through all the solved examples in
the textbook. A few repetitive problems are provided for the students to have sufficient practice.

Part III: Model Question Papers (with Suggested Answers)

The Model Question Papers are included in Part III of this workbook. The students should attempt
all model question papers under simulated examination environment. They should self score their
answers by comparing them with the model answers. Each paper consists of Part A and Part B.
Part A is intended to test the conceptual understanding of the students. It contains 40 questions
carrying one point each. Part B contains problems with an aggregate weightage of 60 points.

Please remember that the ICFAI University examinations follow high standards that demand
rigorous preparation. Students have to prepare well to meet these standards. There are no short-
cuts to success. We hope that the students will find this workbook useful in preparing for the
ICFAI University examinations.

Work Hard. Work Smart. Work Regularly. You have every chance to succeed. All the best.

Contents

PAPER I

Brief Summaries of Chapters 1
Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 10
Frequently Used Formulae 101
Part II: Problems and Solutions 108
Part III: Model Question Papers (with Suggested Answers) 333
PAPER II

Brief Summaries of Chapters 467
Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 480
Frequently Used Formulae 560
Part II: Problems and Solutions 570
Part III: Model Question Papers (with Suggested Answers) 749

Detailed Curriculum
Paper I
Introduction to Financial Management: Objectives, Functions and Scope, Evolution, Interface of
Financial Management with Other Functional Areas, Environment of Corporate Finance.
Indian Financial System:
a. Financial Markets: Money Market, Forex Market, Government Securities Market, Capital
Market, Derivatives Market, International Capital Markets.
b. Participants:
i. Financial Institutions: IDBI, IFCI, ICICI, IIBI, EXIM Bank, SFCs, SIDCs
ii. Insurance Companies: LIC, GIC
iii. Investment Institutions: UTI, Mutual Funds, Commercial Banks; Non-Banking
Financial Companies; Housing Finance Companies; Foreign Institutional Investors.
c. Regulatory Authorities: RBI, SEBI, IRA.
Time Value of Money: Introduction; Future Value of a Single Cash Flow, Multiple Flows and
Annuity, Present Value of a Single Cash Flow, Multiple Flows and Annuity.
Risk and Return: Risk and Return Concepts, Risk in a Portfolio Context, Relationship between
Risk and Return.
Leverage: Concept of Leverage, Operating Leverage, Financial Leverage, Total Leverage.
Valuation of Securities: Concept of Valuation, Bond Valuation, Equity Valuation: Dividend
Capitalization Approach and Ratio Approach, Valuation of Warrants and Convertibles.
Financial Statement Analysis: Ratio Analysis, Time Series Analysis, Common Size Analysis, Du
Pont Analysis, Funds Flow Analysis, Difficulties associated with Financial Statement Analysis.
Financial Forecasting: Sales Forecast, Preparation of Pro forma Income Statement and Balance
Sheet, Growth and External Funds Requirement.
Paper II
Sources of Long-Term Finance: Equity Capital and Preference Capital, Debenture Capital, Term
Loans and Deferred Credit, Government Subsidies, Sales Tax Deferments and Exceptions, Leasing
and Hire Purchase.
Cost of Capital and Capital Structure Theories: Cost of Debentures, Term Loans, Equity
Capital and Retained Earnings, Weighted Average Cost of Capital, Systems of Weighting,
Introduction to Capital Structure, Factors affecting Capital Structure, Features of an Optimal
Capital Structure, Capital Structure Theories: Traditional Position, MM Position and its Critique
Imperfections.
Dividend Policy: Traditional Position, Walter Model, Gordon Model, Miller & Modigliani
Position, Rational Expectations Model.
Estimation of Working Capital Needs: Objectives of Working Capital (Conservative vs.
Aggressive Policies), Static vs. Dynamic View of Working Capital, Factors affecting the
Composition of Working Capital, Interdependence among Components of Working Capital,
Operating Cycle Approach to Working Capital.
Financing Current Assets: Behavior of Current Assets and Pattern of Financing, Accruals, Trade
Credit, Provisions, Short-Term Bank Finance, Public Deposits, Commercial Paper, Factoring,
Regulation of Bank Credit.
Management of Working Capital:
a. Inventory Management: Nature of Inventory and its Role in Working Capital, Purpose of
Inventories, Types and Costs of Inventory, Inventory Management Techniques, Pricing of
Investments, Inventory Planning and Control;
b. Receivables Management: Purpose of Receivables, Cost of Maintaining Receivables, Credit
Policy Variables (Credit Standard, Credit Period, Cash Discount, Collection Program), Credit
Evaluation, Monitoring Receivables;
c. Treasury Management and Control;
d. Cash Management: Meaning of Cash, Need for and Objectives of Cash Management, Cash
Forecasting and Budgets, Cash Reports, Factors and Efficient Cash Management.
Capital Expenditure Decisions: The Process of Capital Budgeting, Basic Principles in Estimating
Costs and Benefits of Investments, Appraisal Criteria: Payback Period, Average Rate of Return,
Net Present Value, Benefit-Cost Ratio, Internal Rate of Return, Annual Capital Charge,
Infrastructure Decisions and Financing.
Current Developments.

Introduction to Financial Management
The financial goal of any firm including public sector firms is to maximize the wealth of the
shareholders by maximizing the value of the firm.
The objective of financial manager is to increase or maximize the wealth of owners by
increasing the value of the firm which is reflected in its earning per share and market value of
the firm.
Function of finance manager includes mobilization of funds, deployment of funds, control
over the use of fund, and balancing the trade-off between risk and return.
The advantages of sole proprietorship are (i) easy and inexpensive set up. (ii) few
governmental regulations and (iii) no firm tax. Partnership firm is a business owned by two
or more persons. They are partners in business and they bear the risks and reap the rewards of
the business. A partnership firm is governed by the Indian Partnership Act, 1932. Hence
it is relatively free from governmental regulations as compared to the joint stock
companies. A group of persons working towards a common objective is a company. It
represents different kinds of associations, be it business or non-business.
Corporate investment and financing decisions are circumscribed by a government regulatory
framework. The important elements of these framework are: (i) Industrials policy
(ii) Industrial licensing provisions and procedure (iii) Regulation of Foreign Collaborations
and Investment (iv) Foreign Exchange Management Act (v) Companies Act and (vi) SEBI.
Indian Financial System
The economic development of a country depends on the progress of its various economic
units, namely the Corporate Sector, Government Sector and the Household Sector.
The role of the financial sector can be broadly classified into the savings function, policy
function and credit function.
The main types of financial markets are: money market, capital market, forex market and
credit market.
The financial markets are further sub-divided into the Primary market and the Secondary market.
A market is considered perfect if all the players are price takers, there are no significant
regulations on the transfer of funds and transaction costs, if any, are very low.
The accounting equation: Assets =Liabilities, can be altered as
Financial Assets +Real Assets =Financial Liabilities +Savings.
The main types of financial assets are deposits, stocks and debt.
While designing a financial instrument, the issuer must keep the following in mind: cash
flows required, taxation rules, leverage expected, dilution of control facts, transaction costs to
be incurred, quantum of funds sought, maturity of plan required, prevalent market conditions,
investor profile targeted, past performance of issues, cost of funds to be borne, regulatory
aspects to abide by.
While investing in a financial instrument, the investor must keep the following in mind: risk
involved, liquidity of the instrument, returns expected, possible tax planning, cash flows
required and simplicity of investment.
Various financial intermediaries came into existence to facilitate a proper channel for
investment. The main ones are: stock exchanges, investment bankers, underwriters,
registrars, depositories, custodians, primary dealers, satellite dealers and forex dealers.

2
Time Value of Money
Additional compensation required for parting with say Rs.1,000 now is called interest.
There are two methods by which the time value of money can be taken care of compounding
and discounting.
Under the method of compounding, we find the Future Values (FV) of all the cash flows at
the end of the time horizon at a particular rate of interest.
Under the method of discounting, we reckon the time value of money now i.e. at time zero on
the time line. So, we will be comparing the initial outflow with the sum of the Present Values
(PV) of the future inflows at a given rate of interest.
To determine the accumulation of multiple flows as at the end of a specified time horizon, we
have to find out the accumulations of each of these flows using the appropriate FVIF and sum
up these accumulations.
Annuity is the term used to describe a series of periodic flows of equal amounts.
To determine the present value, we have to first define the relevant rate of interest.
Risk and Return
The risk associated with a common stock is interpreted in terms of the variability of its
return. The most common measures of riskiness of security are standard deviation and
variance of returns.
Unsystematic risk is the extent of the variability in the securitys return on account of the
firm specific risk factors. This is also called diversifiable or avoidable risk factors.
Systematic risk refers to factors which affect the entire market and hence the firm too. This is
also called non-diversifiable risk.
If a portfolio is well diversified, the unsystematic risk gets almost eliminated. The
non-diversifiable risk arising from the wide movements of security prices in the market is
very important to an investor. The modern portfolio theory defines the riskiness of a security
as its vulnerability to market risk. This vulnerability is measured by the sensitivity of the
return of the security vis--vis the market return and is called beta.
The concept of security market line is developed by the modern portfolio theory. SML
represents the average or normal trade-off between risk and return for a group of securities.
Here the risk is measured typically in terms of the beta values.
Application of Security Market Lines:
The ex post SML is used to evaluate the performance of portfolio manager; tests of
asset-pricing theories, such as the CAPM and to conduct tests of market efficiency.
The ex ante SML is used to identify undervalued securities and determine the consensus,
price of risk implicit in the current market prices.
Depending upon the value of alpha, using SML it is possible to estimate whether the scrip is
underpriced (it is then eligible to be purchased) or overpriced (it is then eligible to be sold).
Valuation of Securities
Value of any security can be defined as the present value of the future cash streams i.e., the
intrinsic value of an asset should be equated to the present value of the benefits associated
with it.
Book value is an accounting concept. Assets are recorded at historical costs and they are
depreciated over years. Book value includes intangible assets at acquisition cost minus
amortized value. The book value of debt is stated at the outstanding amount. The difference
between the book value of assets and liabilities is equal to shareholders funds or net worth
(which is equal to paid-up equity capital plus reserves and surplus).
Replacement Value is the amount that a company would be required to spend if it were to
replace its existing assets in the current condition.

3
Liquidation Value is the amount that a company could realize if it sells its assets after having
terminated its business. It is generally a minimum value which a company might accept if it
sells its business.
Going Concern Value is the amount that a company could realize if it sells its business as an
operating one. Its value would always be higher than the liquidation value, the difference
accounting for the usefulness of assets and value of intangibles.
Market Value of an asset or security is the current price at which the asset or the security is
being sold or bought in the market.
Face Value: This is the value stated on the face of the bond and is also known as par value. It
represents the amount of borrowing by the firm which it specifies to repay after a specific
period of time i.e., at the time of maturity. A bond is generally issued at face value or par
value which is usually Rs.100 and may sometimes be Rs.1,000.
Coupon Rate or Interest: A bond carries a specific rate of interest which is also called as the
coupon rate. The interest payable is simply the par value of the bond Coupon Rate. Interest
paid on a bond is tax deductible for the issuer.
Maturity: A bond is issued for a specific period of time. It is repaid on maturity. Typically
corporate bonds have a maturity period of 7-10 years whereas government bonds have a
maturity period up to 20-25 years.
Redemption Value: The value which a bondholder gets on maturity is called redemption
value. A bond may be redeemed at par, at premium (more than par value) or at discount (less
than par value).
Market Value: A bond may be traded in a stock exchange. Market value is the price at which
the bond is usually bought or sold in the market. Market value may be different from Par
Value or redemption value.
One Period Rate of Return: If a bond is purchased and then sold one year later, its rate of
return over this single holding period can be defined as rate of return.
Current Yield measures the rate of return earned on a bond if it is purchased at its current
market price and if the coupon interest is received.
Coupon rate and current yield are two different measures. Coupon rate and current yield will
be equal if the bonds market price equals its face value.
Yield-to-Maturity (YTM): It is the rate of return earned by an investor who purchases a bond
and holds it till maturity. The YTM is the discount rate which equals the present value of
promised cash flows to the current market price/purchase price.
Based on the bond valuation model, several bond value theorems have been derived which
state the effect of the following factors on bond values:
I. Relationship between the required rate of return and the coupon rate.
II. Number of years to maturity.
III. Yield-to-maturity.
When the required rate of return (k
d
) is equal to the coupon rate, the value of the bond is
equal to its Par Value.
i.e., If k
d
=Coupon Rate;
then value of a bond =Par Value.
d
) is greater than the coupon rate, the value of the bond is
less than its par value.
If k
d
>coupon rate; then value of a bond <par value.
d
) is less than the coupon rate, the value of the bond is
greater than its par value.
i.e., if k
d

<coupon rate; then value of a bond >par value.

4
d
) is greater than the coupon rate, the discount on the bond
declines as maturity approaches.
d
) is less than the coupon rate, the premium on the bond
declines as maturity approaches.
A bonds price is inversely proportional to its yield to maturity.
For a given difference between YTM and coupon rate of the bonds, the longer the term to
maturity, the greater will be the change in price with change in YTM.
Given the maturity, the change in bond price will be greater with a decrease in the bonds
YTM than the change in bond price with an equal increase in the bonds YTM. That is, for
equal sized increases and decreases in the YTM, price movements are not symmetrical.
For any given change in YTM, the percentage price change in case of bonds of high coupon
rate will be smaller than in the case of bonds of low coupon rate, other things remaining the
same.
A change in the YTM affects the bonds with a higher YTM more than its does bonds with a
lower YTM. A warrant is a call option to buy a stated number of shares.
The exercise price of a warrant is what the holder must pay to purchase the stated number of
shares.
A convertible debenture, as the name indicates, is a debenture which is convertible partly or fully,
into equity shares. If it is partially converted, it is referred to as partly convertible debenture and if
the debentures are converted into equity shares at the end of maturity fully, it is referred to as fully
convertible debentures. The option of conversion is either at the discretion of the investor, i.e.,
(optional) or compulsory (if it is specified).
The conversion ratio gives the number of shares of stock received for each convertible
security. If only the conversion ratio is given, the par conversion price can be obtained by
dividing the conversion ratio multiplied by the face or par value of the convertible security.
The conversion value represents the market value of the convertible if it were converted into
stock; this is the minimum value of the convertible based on the current price of the issuers
stock.
Intrinsic value is the value of a stock which is justified by assets, earnings, dividends, definite
prospects and the factor of the management of the issuing company.
According to the dividend capitalization approach, which is a conceptually sound approach,
the value of an equity share is the discounted present value of dividends received plus the
present value of the resale price expected when the equity share is sold.
The E(P/E) ratio is formed by dividing the present value of the share by the expected
earnings per share denoted by E(EPS).
Financial Statement Analysis
A financial statement is a compilation of data, which is logically and consistently organized
according to accounting principles.
Financial Statement Analysis consists of the application of analytical tools and techniques to
the data in financial statements in order to derive from them measurements and relationships
that are significant and useful for decision making.
The financial data needed in the financial analysis come from many sources.
The important tools of analysis:
1. Ratio Analysis
Comparative Analysis
Du Pont Analysis
2. Funds flow Analysis.

5
The analysis of a ratio can disclose relationships as well as bases of comparison that reveal
conditions and trends that cannot be detected by going through the individual components of
the ratio. The usefulness of ratios is ultimately dependent on their intelligent and skillful
interpretation.
Financial ratios fall into three groups:
1. Liquidity Ratios
2. Profitability or Efficiency Ratios
3. Ownership Ratios
Earnings Ratios
Dividend Ratios
Leverage Ratios
a. Capital Structure Ratios
b. Coverage Ratios.
Liquidity implies a firms ability to pay its debts in the short run.
Current Ratio:
The liquidity ratio is defined as:
CurrentAssets
CurrentLiabilities

Current assets include cash, marketable securities, debtors, inventories, loans and advances,
and pre-paid expenses. Current liabilities include loans and advances taken, trade creditors,
accrued expenses and provisions.
Quick Ratio Quick-test (also acid-test ratio) is defined as:
=
QuickAssets
CurrentLiabilities
=
QuickAssets Inventories
CurrentLiabilities

Bank Finance to Working Capital Gap Ratio =
Short termbankborrowings
Workingcapital gap

where Working capital gap is equal to current assets less current liabilities other than bank
borrowings.
Accounts receivable turnover ratio =
Netcreditsales
Averageaccountsreceivable

Average collection period =
360
Averageaccountsreceivableturnover

=
Averageaccountsreceivable
Averagedailysales

Inventory turnover =
Costof goodssold
Averageinventory

The Gross Profit Margin Ratio (GPM) is defined as:
GrossProfit
NetSales

Where net sales =Sales Excise duty.
The Net Profit Margin ratio (NPM) is defined as:
NetProfit
NetSales

Asset turnover ratio is defined as:
Sales
Averageassets

6
Earning power is a measure of operating profitability and it is defined as:

Earning before interest and taxes
Averagetotal assets

Return on Equity
The Return on Equity (ROE) is an important profit indicator to shareholders of the firm. It is
calculated by the formula:
Netincome
Averageequity

Ownership ratios are divided into three main groups. They are:
1. Earnings Ratios
2. Leverage Ratios
Capital Structure Ratios
Coverage Ratios
3. Dividend Ratios.
The earnings ratios are Earnings Per Share (EPS), price-earnings ratio (P/E ratio), and
capitalization ratio. From earnings ratios we can get information on earnings of the firm and
their effect on price of common stock.
Earning Per Share (EPS) =
Netincome(PAT)

Numberof outstandingshares
Price earnings multiple =
Marketpriceof theshare
Earningspershare

Capitalization rate =
Earningspershare

Debt equity ratio =
Debt
Equity

Debt-Asset ratio =
Debt
Assets

Interest coverage ratio =
EBIT
Interestexpense

Fixed charges coverage ratio
Earning before depreciation, debt interest and lease rentals and taxes
=
Debt interest +Lease rentals +
Loanrepayment installment Preference dividends
(1 taxrate) (1 taxrate)
+

Debt Service Coverage Ratio
=
P

AT Depreciation Othernon cashcharges Interestontermloan
Interestontermloan Repaymentof thetermloan
+ + +
+
Dividend Pay-out Ratio
This is the ratio of Dividend Per Share (DPS) to Earnings Per Share (EPS)
Divident yield =
Dividendpershare

Different types of comparative analysis are:
1. Cross-sectional analysis
2. Time-series analysis
a. Year-to-year change
b. Index analysis
3. Common-size analysis.

7
Cross-sectional analysis is used to assess whether the financial ratios are within the limits,
they are compared with the industry averages or with a good player in normal business
conditions if an organized industry is not there.
A comparison of financial statements over two to three years can be undertaken by
computing the year-to-year change in absolute amounts and in terms of percentage changes.
When a comparison of financial statements covering more than three years is undertaken, the
year-to-year method of comparison may become too cumbersome.
In the analysis of financial statements, it is often instructive to find out the proportion that a
single item represents of a total group or subgroup. In a balance sheet, the assets, the
liabilities and the capital are each expressed as 100%, and each item in these categories is
expressed as a percentage of the respective totals. Similarly, in the income statement, net
sales are set at 100% and every other item in the statement is expressed as a percentage of net
sales.
Analyzing return ratios in terms of profit margin and turnover ratios, referred to as the
Du Pont System.

Funds Flow Analysis
A funds flow statement is a statement which explains the various sources from which funds
are raised and the uses to which these funds are put.
The major difference, however, between a true funds flow statement and a balance sheet lies
in the fact that the former captures the movements in funds, while the latter merely presents a
static picture of the sources and uses of funds.
A funds flow statement would enable one to see how the business financed its fixed assets,
built up the inventory, discharged its liabilities, paid its dividends and taxes and so on.
Similarly, it would enable one to see how the business managed to meet the above capital
or revenue expenditure.
The simplest funds flow statement for a period is the difference between the corresponding
balance sheet items at the beginning and the end of the period, such that all increases in
liabilities and decreases in assets are shown as sources of funds and all decreases in liabilities
and increases in assets are shown as applications of funds.
FFS can also be prepared with the help of the two balance sheets (opening and closing) and
the profit and loss statement of the intervening period. Such a funds flow statement defines
funds as total resources and the sources of funds will always be equal to the uses of funds.

8
A funds flow statement may be so prepared as to explain only the change in the working
capital (current assets and current liabilities) from the beginning of a period to the end of the
period.
Sources of funds that increase cash are:
A net decrease in any asset other than cash or fixed assets.
A gross decrease in fixed assets.
A net increase in any liability.
Proceeds from the sale of equity or preference stock.
Funds from operations.
Uses of funds which decrease cash include:
A net increase in any asset other than cash or fixed assets.
A gross increase in fixed assets.
A net decrease in any liability.
A retirement or purchase of stock.
Cash dividends.
Gross changes in fixed assets is calculated by adding depreciation for the period to net fixed
assets at the ending financial statement date. From this figure, the net fixed assets at the
beginning of financial statement date is deducted.
An increase in a current asset results in an increase in working capital.
A decrease in a current asset results in a decrease in working capital.
An increase in a current liability results in a decrease in working capital.
A decrease in a current liability results in an increase in working capital.
Leverage
Leverage is the influence which an independent financial variable has over a dependent/
related financial variable.
Operating leverage examines the effect of the change in the quantity produced on the EBIT
of the company and is measured by calculating the Degree of Operating Leverage (DOL).
A large DOL indicates that small fluctuations in the level of output will produce large
fluctuations in the level of operating income.
DOL is a measure of the firms business risk. Business risk refers to the uncertainty or
variability of the firms EBIT. So, every thing else being equal, a higher DOL means higher
business risk and vice-versa.
The financial leverage measures the effect of the change in EBIT on the EPS of the company.
Financial leverage refers to the mix of debt and equity in the capital structure of the
company. The measure of financial leverage is the Degree of Financial Leverage (DFL)
If the management decides to finance a part of the total investment required of through debt
financing, the following two factors are important: The proportion of total investment which
the management decides to finance through debt (Debt Equity Ratio the firm aspires to) and
the interest rate on borrowed funds.
The greater the tax rate, the more is the tax shield available to a company which is financially
leveraged.
As the company becomes more financially leveraged, it becomes riskier, i.e., increased use of
debt financing will lead to increased financial risk which leads to: Increased fluctuations in
the return on equity and increase in the interest rate on debts.
The greater the use of financial leverage, the greater the potential fluctuation in return
on equity.

9
As the interest rate increases, the return on equity decreases. Even though the rate of return
diminishes, it might still exceed the rate of return obtained when no debt was used, in which
case financial leverage would still be favorable.
A combination of the operating and financial leverages is the total or combined leverage.
Thus, the Degree of Total Leverage (DTL) is the measure of the output and EPS of the
company. DTL is the product of DOL and DFL
There is a unique DTL for every level of output. At the overall break-even point of output the
DTL is undefined. If the level of output is less than the overall break-even point, then the
DTL will be negative. If the level of output is greater than the overall break-even point, then
the DTL will be positive. DTL decreases as the quantity of sales increases and reaches a
limit of one.
DTL measures the changes in EPS to a percentage change in quantity of sales.
DTL measures the total risk of the company since it is a measure of both operating risk and
total risk.
Financial Forecasting
Financial forecasting is a planning process with which the companys management positions
the firms future activities relative to the expected economic, technical, competitive and
social environment.
There are three main techniques of financial projections. They are proforma financial
statements, cash budgets and operating budgets.
Proforma statements are projected financial statements embodying a set of assumptions about
a companys future performance and funding requirements.
Cash budgets are detailed projections of the specific incidence of cash moving in and out of
the business.
Operating budgets are detailed projections of departmental revenue and/or expense patterns,
and they are subsidiary to both proforma statements and cash flow statements.
Sales Budget can be prepared by making a sales forecast, sales forecast can be made from
subjective and objective methods.
Subjective methods use the judgments or opinions of knowledgeable individuals within
the company, ranging from sales representatives to executives.
Objective methods are statistical methods which range in sophistication from relatively
simple trend extrapolations to the use of complicated mathematical models. More and more
companies are relying on computers to predict causal relationships.

Part I: Questions on Basic Concepts
1. The financial goal of a public sector firm fully owned by the government is to
a Maximize the book value per share
b. Maximize the profits earned by the firm
c. Maximize the present value of stream of equity returns
d. Maximize the return on equity
e. Both (a) and (d) above.
2. Which of the following is not an objective of financial management?
a. Maximization of wealth of shareholders.
b. Maximization of profits.
c. Mobilization of funds at an acceptable cost.
d. Efficient allocation of funds.
e. Ensuring discipline in the organization.
3. Which of the following is not a function of a finance manager?
a. Mobilization of funds.
b. Deployment of funds.
c. Control over use of funds.
d. Manipulate share price of the company.
e. Maintain a balance between risk and return.
4. The market value of the firm is the result of
a. Dividend decisions
b. Working capital decisions
c. Capital budgeting decisions
d. Trade-off between cost and risk
e. Trade-off between risk and return.
5. Which of the following is related to the control function of the financial manager?
a. Interaction with the bankers for arranging a short-term loan.
b. Comparing the costs and benefits of different sources of finance.
c. Analysis of variance between the targeted costs and actual costs incurred.
d. Assessing the costs and benefits of a project under consideration.
e. Deciding the optimum quantity of raw materials to be ordered for procurement.
6. The minimum number of persons required to form a private limited company and a public
limited company respectively are
a. 2 and 5
b. 5 and 7
c. 2 and 7
d. 7 and 2
e. None of the above.
7. Which of the following is an advantage of a sole proprietorship?
a. Life of a firm is limited to the life of the owner.
b. Fund raising from outside is easy.
c. Limited personal liabilities.
d. Easy and inexpensive to set-up.
e. Expansion of Business is possible.
Part I
11
8. Which of the following is an advantage of partnership firms?
a. The life of the firm is perpetual.
b. Personal liabilities of the partners are limited.
c. Its ability to raise funds is virtually unlimited.
d. It is relatively free from Governmental regulations as compared to joint stock
companies.
9. The objective of financial management is to
a. Generate the maximum net profit
b. Generate the maximum retained earnings
c. Generate the maximum wealth for its shareholders
d. Generate maximum funds for the firm at the least cost
e. All of the above.
10. Which of the following statements represents the financing decision of a company?
a. Procuring new machineries for the R&D activities.
b. Spending heavily for the advertisement of the product of the company.
c. Adopting state of the art technology to reduce the cost of production.
d. Purchasing a new building at Delhi to open a regional office.
e. Designing an optimal capital structure by using suitable financial instruments.
11. The amount that can be realized by a company when it sells its business as an operating one
is termed as
a. Going concern value
b. Market value
c. Book value
d. Replacement value
e. Liquidation value.
12. Which of the following functions of the financial system facilitates conversion of investments
in stocks, bonds, debentures etc., into money?
a. Savings function.
b. Liquidity function.
c. Payment function.
d. Risk function.
e. Policy function.
13. The objective of financial management to increase the wealth of the shareholders means to
a. Increase the physical assets owned by the firm
b. Increase the market value of the shares of the firm
c. Increase the current assets of the firm
d. Increase the cash balance of the company
e. Increase the total number of outstanding shares of the company.
14. Which of the following is a function of the finance manager?
a. Mobilizing funds.
b. Risk return trade off.
c. Deployment of funds.
d. Control over the uses of funds.
12
15. A financial asset should necessarily have
a. A claim to a payment in the form of an instrument
b. An underlying asset, with a charge over it
c. Parting of money today with an expectation that it will be returned in future with some
addition to it
d. Both (a) and (c) above
e. All of (a), (b) and (c) above.
16. Which is/are the essential feature(s) of a Call Money Market?
a. Maturity periods of 1-15 days.
b. Market determined interest rates.
c. Low liquidity.
d. High agency costs.
e. Both (a) and (b) above.
17. The apex financial institution in India that promotes housing finance is
a. Housing & Urban Development Corporation (HUDCO)
b. Housing Development Finance Corporation Ltd. (HDFC)
c. Cooperative Housing Finance Society
d. National Housing Bank (NHB)
e. LIC Housing Finance Limited.
18. Single Window Lending refers to
a. An arrangement by which the lead bank in a consortium of banks releases the initial
requirements of the borrower
b. Loans given by commercial banks to the agricultural sector, which are subject to
efinance from NABARD
c. A specialized cell set up in scheduled banks exclusively for the purpose of industrial
loans
d. Priority sector lending by nationalized banks
e. Loans given by NBFCs to some sectors to which nationalized banks are not allowed to
give.
19. The difference(s) between Commercial Paper (CP) and Certificate of Deposit (CD) is/are
a. CP is secured while CD is unsecured
b. CPs can be issued by private sector companies while CDs can be issued by scheduled
banks
c. CP is sold at a discount and redeemed at face value whereas for CD the principal and
interest are payable upon maturity
d. Both (b) and (c) above
20. The money lent in money market for a period of 2 to 15 days is referred to as
a. Call money
b. Demand loan
c. Term loan
d. Notice money
Part I
13
21. Which of the following are feature(s) of Gilt-edged securities?
a. Only repayment of principal is secured.
b. They are issued by non-governmental service organizations.
c. They are issued by government entities.
d. The repayments of both principal and interest are secured.
e. Both (c) and (d) above.
22. Which of the following provides liquidity to money market instruments by creating a
secondary market where they can be traded?
a. Discount and Finance House of India.
b. National Securities Depository Limited.
c. State Bank of India.
d. Reserve Bank of India.
e. Over the Counter Exchange of India.
23. Which of the following is an example of non-fund based activity of an NBFC?
a. Bill discounting.
b. Leasing.
c. Issue management.
d. Hire purchase.
e. Inter-corporate loans.
24. The minimum maturity period for a Certificate of Deposit is
a. Fifteen days
b. One month
c. Three months
d. Six months
e. No specific time limit is prescribed.
25. Statutory Liquidity Ratio (SLR) refers to the
a. Percentage of secret reserves which acts as a cushion for nationalized banks
b. Percentage of reserves banks are required to park with instruments approved by RBI
c. Ratio between current account and fixed account deposits of banks
d. Percentage of reserves banks are required to utilize only for forex transactions
e. Percentage of reserves meant for priority sector lending.
26. Public debt in the Indian economy is being managed by
a. SBI on behalf of Government of India
b. Ministry of Finance
c. RBI
d. All nationalized banks and term lending institutions
e. Ministry of Commerce and Trade.
27. In which of the following instances bought-out deal is more appropriate?
a. Companies do not wish to disclose information by way of public issue.
b. Promoters do not want to dilute their stake by going public.
c. Small projects require funds but costs of public issue are substantially high.
d. Foreign Institutional Investors offload their shares when market is down.
e. Board for Industrial and Financial Reconstruction (BIFR) offers a sick unit to existing
blue chips in that industry.
14
28. Which of the following is/are not a feature(s) of National Stock Exchange?
a. NSE was promoted by FIs at the bentest of GOI.
b. The trading is on-line in national network.
c. The volume of trading in it is less than that of BSE.
d. It has a debt market segment.
e. The weights to the stocks on NIFTY are based on total share holding.
29. Which of the following is/are not true in respect of PSU bonds?
a. There is no secondary market.
b. Market lot for trading purposes is minimum of Rs.10 crore.
c. They come under approved investments by RBI.
d. Both (a) and (b) above.
30. Unit banking refers to the system
a. With a single bank having units at different places
b. With the overall operations of a bank conducted from a single office
c. Which deals with the units of UTI
d. Which deals with the units in small-scale sector
e. Either (a) or (b) above.
31. Which of the following is not a function performed by a financial system?
c. Risk function.
d. Social function.
e. Policy function.
32. The maturity period of a Certificate of Deposit (CD) issued by a bank is
a. Not less than 1 month and not more than 6 months
b. Not less than 2 months and not more than 9 months
c. Not less than 15 days and not more than 12 months
d. Not less than 4 months and not more than 12 months
e. Not less than 1 month and not more than 12 months
33. If in an order to buy/sell shares from a stock exchange is limited by a fixed price it is called
a. Limit order
b. Limited discretionary order
c. Stop loss order
d. Best rate order
34. Gilt edged securities are the bonds issued by
a. Big corporates
b. Multinational corporates
c. Global corporations
d. Central government
e. Financial institutions.
Part I
15
35. Medium dated government securities have maturities ranging from
a. 1 to 3 years
b. 1 to 5 years
c. 3 to 5 years
d. 3 to 10 years
e. 5 to 10 years.
36. Which of the following maturity of T-Bills does not have a provision?
a. 30-day.
b. 91-day.
c. 182-day.
d. 364-day.
37. In secondary spot capital market, the delivery and payment is completed
a. On the same day of the date of contract
b. On the next day of the date of contract
c. Within four days from the date of contract
d. Within 2 days from the date of contract
e. Beyond fourteen days from the date of contract.
38. The primary capital market
a. Imparts liquidity and marketability to long-term financial instruments
b. Helps companies to raise funds to finance their projects
c. Provides an auction market for long-term securities
d. Operates through the medium of stock exchanges
e. Both (a) and (c) above.
39. In a private company maximum number of members permissible is
a. 5
b. 10
c. 25
d. 50
e. 100.
40. Banks borrow in call money market to
a. Give loans
b. Invest in high yielding securities
c. Meet the Cash Reserve Ratio (CRR)
d. Meet sudden demand for funds arising due to large payments and remittances
41. Which of the following is not a feature of Commercial Paper (CP)?
a. Purely secured instrument.
b. Maturity varies between 15 days and a year.
c. Buy-back facilities are available.
d. Negotiable by endorsement and delivery.
16
42. Which of the following is not a money market instrument?
a. Treasury bills.
b. Certificate of deposits.
c. Debentures.
d. Call money.
43. Private placement of shares can be made out of
a. Mutual funds quota
b. Promoters quota
c. Public quota
d. Financial institutions quota
44. An order to sell shares, where brokers are given a particular limit for sustenance of loss is
known as
a. Limited discretionary order
b. Limit order
c. Cancel order
d. Stop loss order
e. Best rate order.
45. Which of the following is not true with regard to commercial paper?
a. It is issued in multiples of Rs.5 lakhs.
b. The minimum amount to be invested by a single investor is Rs.20 lakhs.
c. The maturity period cannot exceed 1 year.
d. These are unsecured promissory notes.
e. The issuing company must have a high credit rating.
46. Which of the following enables a company to increase its paid-up share capital without
receiving any payment from the recipients of the shares?
a. Public issue.
b. Bonus issue.
c. Private placement.
d. Bought-out deal.
e. Rights issue.
47. In which of the following types of orders the members of stock exchange are not given any
price or time limit by the client for execution of order?
a. Limit order.
b. Best rate order.
c. Immediate or cancel order.
d. Limited discretionary order.
e. Open order.
48. Which of the following statements is false?
a. All scheduled banks except co-operative banks and regional rural banks are eligible to
issue CDs.
b. CDs can be issued to individuals.
c. CDs are issued at a discount to face value.
d. The maturity period of CDs issued by banks varies from 15 days to one year.
e. CDs are issued in multiples of one lakh subject to the minimum size of each issue of
Rs.50 lakh.
Part I
17
49. Which of the following methods of issuing additional shares does not result in an increase in
the net worth of the company?
a. Public issue.
b. Rights issue.
c. Bonus issue.
d. Private placement.
e. Bought-Out Deal.
50. The major categories of investors in primary market of government securities include
a. Reserve Bank of India
b. Financial institutions
c. Foreign financial institutions
d. Commercial banks
51. Which of the following is an asset of a bank?
a. Balances with other banks.
b. Savings deposits.
c. Demand and time deposits from other banks.
d. Refinance from NABARD.
52. The National Housing Bank extends refinance on housing loans to
a. Scheduled commercial banks
b. Co-operative banks
c. Housing finance companies
d. Apex cooperative housing finance societies
53. According to the guidelines of Money Market Mutual Funds, the minimum lock in period of
an investors investment is
a. Nil
b. 15 days
c. 30 days
d. 45 days
e. 60 days.
54. One of the important functions of a well developed money market is to channel savings into
productive investments like working capital. Which of the following is not a money market
instrument?
a. Corporate debentures.
b. Call money.
c. Treasury bills.
d. Commercial paper.
e. Certificate of deposits.
55. Which of the following is not a feature of a commercial paper?
a. They are transferable by endorsement and delivery.
b. They are issued in multiples of one lakh.
c. Their maturity varies from 15 days to one year.
d. They are unsecured in nature.
e. They normally have buy-back facility.
18
56. Which of the following is not an advantage of a bought out deal?
a. The promoters are assured of immediate funds.
b. The time consuming and costly public issue can be avoided.
c. It is easier to convince the wholesale investor rather than the general public.
d. The shares issued via bought out deal can be bought back by the company at any time.
e. It is the cheapest and quickest source of finance for small to medium sized companies.
57. If a company wants to raise funds through commercial paper market, the minimum fund
based working capital limit should be
a. Rs.1 crore
b. Rs.2 crore
c. Rs.3 crore
d. Rs.4 crore
e. Rs.5 crore.
58. In a Bought-Out Deal
a. Companies issue shares to the public
b. Companies issue shares to the existing shareholders
c. Mutual funds buy out a part of promoters share
d. A part of the equity of an unlisted company is bought by a sponsor/merchant banker
e. Financial institutions buy out a significant portion of share capital of a listed company.
59. Which of the following is not a financial asset?
a. Secured premium notes.
b. National defence gold bond.
c. Capital investment bond.
d. Bullion.
e. Special bearer bond.
60. Bills rediscounting facility is offered by
a. All public sector banks
b. Some co-operative banks
c. IDBI
d. All SFCs
61. Which of the following statements is/aretrue?
i. A cash credit is a running account.
ii. Cash credits may become long-term loans due to repeated roll-overs.
iii. Overdrafts are allowed only against the security of inventories.
a. Only (i) above.
b. Only (ii) above.
c. Only (iii) above.
d. Both (i) and (ii) above.
e. All of (i), (ii) and (iii) above.
a. Treasury bill.
b. Commercial paper.
c. Convertible debenture.
d. Certificate of deposit.
e. Both (b) and (c) above.
Part I
19
63. Which of the following statements is true regarding issuance of Commercial Paper (CP)?
a. Corporates need prior approval of RBI for CP issue.
b. Underwriting of a CP issue is not mandatory.
c. Minimum size of a CP issue is Rs.10 lakhs.
d. CPs have to be backed by a bank guarantee.
e. CPs are issued in multiples of Rs.1 lakh.
64. Which of the following statements is/are true regarding the call money market?
a. Surplus funds of banks constitute a major component.
b. Major corporates participate as lenders.
c. Banks often borrow from it for maintenance of SLR and CRR.
65. Which of the following statements is/are true regarding 91-day Treasury Bills?
a. They are also referred to as PSU bonds.
b. They are issued through auctions conducted by RBI.
c. They are risky instruments as their interest rates fluctuate widely.
d. They cannot be rediscounted with RBI.
66. CRISIL
a. Rates, Debentures and fixed deposits.
b. Was set up by the Industrial Development Bank of India.
c. Gives the highest rating of P1 to short-term instruments.
d. Does not consider non-financial factors while valuing a companys securities.
a. Call Loans.
b. Commercial Papers.
c. Certificates of Deposit.
d. Treasury Bills.
68. Which of the following is a form of direct assistance by All India Financial Institutions?
a. Underwriting.
b. Subscribing to a companys shares.
c. Bills Rediscounting.
d. All of the above.
69. Which of the following statements is not true?
a. The Industrial Credit and Investment Corporation of India has merged with ICICI bank.
b. The Industrial Development Bank of India is the apex term lending financial institution.
c. The Industrial Finance Corporation of India is an All India term lending financial
institution.
d. The Industrial Reconstruction Bank of India is the central agency for rehabilitation of
Industrial units declared sick by BIFR only.
20
70. Which one of the following was not an objective of Nationalization and greater
governmental control over major banks?
a. Achieving wider spread of bank credit.
b. Preventing misuse of resources of banks.
c. Reducing the influence of business houses on banks.
d. Bringing larger income to the government.
71. Private Banks
a. Should not be registered as public limited companies
b. Need not adhere to capital adequacy norms determined by RBI
c. Are covered by the Banking Regulation Act, 1949
d. Should not be listed on any stock exchanges
72. Which of the following are the reasons for low profitability of the Commercial Banks?
a. High incidence of bad debt.
b. Inefficient procedures.
c. Overstaffing.
d. Priority sector lending.
73. Gilt-edged securities
a. Have fairly active secondary market
b. Have low interest rates
c. Are subscribed mainly by commercial banks, provident funds and other institutional
investors
d. Are held by banks to satisfy their SLR requirements
74. Which of the following is not true?
a. There has been a general down trend in the nominal interest rates in the past few years.
b. Term finance rates have been higher than the working capital finance rates.
c. Interest rates in the organized sector in India are fixed by the government.
d. Interest rate policy of the government is designed to mobilize substantial savings.
e. Interest rate policy of the government is designed to facilitate government borrowing
cheaply.
75. Certificates of Deposits (CDs)
a. Are freely transferable by endorsement and delivery
b. Are issued at a discount stipulated by RBI
c. Are issued by RRBs
d. Have no fixed maturity
e. Have an active secondary market.
76. Which of the following statements is true?
a. IDBIs deep discount bonds are zero coupon bonds.
b. When a company wants to raise a given amount of capital through a rights issue, the
subscription price should ideally be higher than the current market price.
c. Regional stock exchanges are unrecognized.
d. The rupee is convertible on the capital account.
e. The alpha () of a security measures the return on the market portfolio.
Part I
21
77. The changes in the banking structure through nationalization has resulted in
a. Deeper penetration into rural areas
b. Increase in deposits
c. Channelization of bank credit
d. Lower operational autonomy for banks
78. The following indirect financial assistance is extended by the financial institutions to help the
industrial units
a. Underwriting
b. Guarantee for foreign currency loans
c. Deferred payment guarantee
d. All of the above
79. Money market deals with
a. Mortgage loans
b. Certificate of deposits
c. Deposits with RBI under CRR
d. Fixed Deposit Receipts
80. In a well-functioning capital market, shareholders will vote for the goal of
a. Modifying the investment plan of the firm to help shareholders achieve a particular time
pattern of investment
b. Making shareholders as wealthy as possible by investing in real assets with positive net
present values
c. Inviting shareholders and giving them costly articles in annual general meetings
d. Having employees as shareholders
e. Choosing high or low risk projects to match shareholders risk preferences.
81. Capital markets differ from money market in that
a. Capital markets are regulated while money markets are not
b. The maturity of securities in the capital are long-term while in the money market it is
short-term
c. Limited companies which operate in capital markets cannot operate in money markets
d. Unorganized money markets are larger than unorganized capital market
82. Which of the following members would you not find in the secondary stock market?
a. Investors.
b. Stock Exchanges.
c. Stock Brokers.
d. Companies.
e. Underwriters.
83. In terms of the maturity of assets issued, which of the following markets have the shortest
maturity period?
a. Call Money Market.
b. Commercial Paper Market.
c. Treasury Bills Market.
d. Certificates of Deposit Market.
22
84. Which of the following is true regarding the issuance of commercial paper?
a. The minimum net worth of Rs.10 crore is required.
b. The maximum discount rate is 16%.
c. The minimum credit rating required is P1.
d. Prior approval of RBI for the issue is required.
e. Minimum investment by an individual is Rs.5 lakh.
85. The minimum maturity of treasury bills is
a. 14 days
b. 28 days
c. 45 days
d. 60 days
e. 90 days.
86. Which of the following statements is/are true regarding call money market?
i. Financial institutions and mutual funds can participate only as lenders in this market.
ii. The interest on call loan is regulated by Reserve Bank of India.
iii. The maximum maturity of notice money is 3 days.
a. Only (i) above
b. Only (ii) above
c. Both (i) and (ii) above
d. Both (i) and (iii) above
e. Both (ii) and (iii) above.
87. Which of the following is true regarding a Bought-Out Deal?
a. It involves direct selling of securities to a limited number of institutional or high net
worth individuals.
b. The costs involved in a bought-out deal are generally higher than the costs of a public
issue.
c. The company proposing to place its securities through this route can price its securities
to reflect the intrinsic value.
d. The procedural complexities are very high.
e. New companies cannot make bought-out deals.
88. The maximum number of persons in a private limited company is
a. 1
b. 2
c. 3
d. 7
e. 50.
89. The service of which of the following entities is generally not useful to the retail investors for
raising funds?
a. Merchant Banks.
b. Commercial banks.
c. Hire purchase finance companies.
d. Housing finance companies.
e. Nidhis.
Part I
23
90. Which of the following is not traded in the money market?
a. Commercial papers.
b. Certificate of deposits.
c. Treasury bills.
d. 6 months term deposits.
91. Which of the following is a function of the primary capital market?
a. To allow the Foreign Institutional Investors (FIIs) to invest in the Indian capital markets.
b. To allow the companies to raise funds to meet their short term funds requirements
through new securities.
c. To provide a market for trading with the outstanding long term securities.
d. To provide a market for trading with the existing short term securities.
92. In which of the following types of issue, new securities are offered to the existing
shareholders of the company on a pro rata basis?
a. Public issue
b. Rights issue
c. Bonus issue
d. Private placement
93. Which of the following is a disadvantage of Bought-Out Deals?
a. It is difficult to convince a wholesale investor.
b. The promoters of the company do not get the funds immediately.
c. It is a very time consuming procedure.
d. The issue expenses are more than that of a public issue.
e. Sponsor may exploit the situation.
94. Which of the following companies generally provide risk capital to the technology oriented
and high-risk business entities?
a. Lease finance companies.
b. Venture capital funding companies .
c. Commercial banks.
d. Hire purchase finance companies.
e. Insurance companies.
95. Which of the following is/are the characteristics of the money market instruments?
a. Long term maturity.
b. High liquidity.
c. Highly secured.
d. Issued by the Governments only.
e. Both (b) and (d) above.
96. Which of the following situations leads to the greatest increase in volatility in the call money
market?
a. Reduction in cash reserve ratio
b. Prepayment of term loans by a large number of borrowers
c. Entry of the financial institutions (FIs) into the market
d. Payment of large amount of advance taxes by the banks and FIs
e. Decrease in the demand for loanable funds in the economy.
24
97. Which of the following is/are correct with respect to the act(s) of the arbitrageurs in the
derivatives market?
a. To protect ones position in the spot by taking suitable instrument(s) in the derivatives
market.
b. To protect ones anticipated position in the spot by taking suitable instrument(s) in the
derivatives market.
c. To make profit from the subsequent price movements of any particular instrument in the
derivatives market.
d. To make risk free profits by simultaneously buying and selling different instruments in
different markets.
98. Which of the following results in a public limited company to have a significant advantage
over a proprietorship firm?
a. Limited liability.
b. Difficulty of transfer of ownership interest.
c. Limited life.
d. Inability to mobilize a lot of funds.
99. Which of the following is not a marketable instrument?
a. Commercial Paper.
b. Certificate of Deposit.
c. Inter Corporate Deposit.
d. Preference Shares.
e. Treasury Bills.
100. Which of the following functions is/are served by the primary capital market of an economy?
a. It allows the corporate houses to raise the long term capital by issuing new securities.
b. It offers a market to trade for the outstanding long term securities.
c. It offers a market to trade for the outstanding short term securities.
d. It offers an excellent exit route for the venture capital funding companies.
101. Which of the following functions of the financial system channelises the savings from the
savers to the producers in the economy?
a. Financial Intermediation function.
d. Risk function.
e. Policy function.
102. In which of the following markets, are the outstanding long-term financial instruments
traded?
a. Money market.
b. Forex market.
c. Primary capital market.
d. Secondary capital market.
e. Call money market.
Part I
25
103. Corporate investment and financing decisions are limited by a governmental regulatory
framework which seeks to
a. define avenues of investment available to business enterprises in different categories,
ownership and size-wise
b. Induce investment along certain lines by providing incentives, concessions and reliefs
c. Specify the procedures for raising funds from financial markets
e. All of (a), (b) and (c) above
104. Which of the following entities issues the Gilt edged securities?
a. Multinational companies.
b. Reputed domestic companies.
c. Private sector enterprises.
d. Small scale companies.
e. Central and state governments.
105. Long dated government securities have maturities ranging from
a. Up to 1 year
b. 1 to 5 years
c. 5 to 8 years
d. 8 to 10 years
e. 10 to 30 years.
106. What is the maximum limit on the number of members in a private limited company?
a. 5.
b. 8.
c. 15.
d. 50.
e. Unlimited.
107. Which of the following regulations no more relevant in todays business environment?
a. Foreign Exchange Regulation Act, 1973.
b. Monopolies and Restrictive Trade Practices Act, 1969.
c. Companies Act, 1956.
d. Income Tax Act, 1961.
e. SEBI Act, 1992.
Time Value of Money
108. Which of the following statement(s) is/are true for given values of i and n?
a. Present Value Interest Factor is the reciprocal of Future Value Interest Factor.
b. Future Value Interest Factor Annuity is the reciprocal of Present Value Interest Factor
Annuity.
c. Capital recovery factor is a product of Future Value Interest Factor and reciprocal of
Future Value Annuity Factor.
d. Both (a) and (c) above.
109. The product of PVIF, FVIF, FVIFA and Capital Recovery Factor is
a. FVIF
b. PVIFA
c. PVIF
d. FVIFA
26
110. The nominal rate of interest is equal to
a. Real Rate +Risk Premium Inflation
b. Real Rate +Risk Premium +Inflation
c. Real Rate Risk Premium +Inflation
d. Real Rate Risk Premium Inflation
e. Real Rate.
111. The accurate doubling period n given a rate of return R can be calculated by
a. (1 +R)
n
=2
b. 72/R
c. 0.35 +69/R
d. All of the above
e. None of the above
112. The inverse of sinking fund factor is given by
a.
n
1 (1+k)
k

b.
n
1
(1+k)
k

c.
n
(1+k) 1
k k

d.
n
k
(1+k) 1

e.
n
(1+k) 1
.
k

113. If P =principal amount, i =interest rate per annum, m =frequency of compounding per year,
n =number of years and A =accumulation at the end of the year n, then which of the
following expressions is correct?
a. A =P(1 +i/n)
mn
b. P =A(1 +i/m)
mn

c. A =[P(1 +i/m)
m
]
n
d. A =P(1 +i/m)
mn
114. If k is the rate of interest and n the number of years, then the capital recovery factor is
given as
a.
n
n
1+k)
(1+k) 1
k(

b.
n
n
(1+k) (k)
(1+k) +1

c.
n
n
(1+k) 1
k(1+k)

d.
n
n
(1+k) (1+k)
(1+k) (k)

e.
k
n
(1+k) (n)
.
(1+k) 1

Part I
27
a. The more frequent the compounding, the higher the future value, other things being equal.
b. For a given amount, the greater the discount rate, the less is the present value.
c. Capital recovery is the inverse of FVIFA.
d. PVIFA =
n
n
(1+k) 1
k(1+k)

116. An interest rate that has been annualized using compound interest is termed as
a. Simple interest rate
b. Annual interest rate
c. Discounted interest rate
d. Effective annual interest rate
e. Compounded interest rate.
117. When an investment pays only simple interest rate, this means
a. The interest rate is lower than on comparable investments
b. The future value of investment will be low
c. The interest earned is non-taxable to the investor
d. Interest is earned only on the original investment
e. Interest is earned on previously earned interest.
118. Cash flows occurring in different periods should not be compared unless
a. Interest rates are expected to be stable
b. The flows occur no more than one year from each other
c. High rates of interest can be earned on the flows
d. The flows have been discounted to a common date
e. Interest rates are expected to increase over a period of time.
119. Sinking fund factor is the reciprocal of
a. Future value interest factor
b. Present value interest factor
c. Future value interest factor of annuity
d. Present value interest factor of annuity
e. Capital recovery factor.
120. The present value interest factor of annuity is equal to
a.
n
n
+k) 1
k(1+k)
(1

b.
FVIFA (k,n)
FVIF (k,n)

c. FVIFA(k,n) x PVIF(k,n)
d. Reciprocal of sinking fund factor for k% and n years x PVIF (k,n)
a. Increased frequency of compounding reduces the effective rate of interest.
b. According to Rule of 72, the period within which the amount will be doubled can be
obtained by dividing 72 by the interest rate and adding 0.35 to the value arrived at.
c. Effective interest rate is always more than or equal to the nominal interest rate.
d. An annuity is a lump sum payment.
e. A project is financially viable if the present value of the future cash inflows is positive.
28
122. Money has time value because
a. The individuals prefer future consumption to present consumption
b. A rupee today is worth more than a rupee tomorrow in terms of its purchasing power.
c. A rupee today can be productively deployed to generate real returns tomorrow
d. The nominal returns on investments are always more than inflation thereby ensuring
real returns to the investors
123. Which of the following equations is correct?
a. PV =FV
n
x FVIF(k, n)
b. PV =FV
n

(1 +k)
n
c. PV =FV
n
PVIF(k, n)
d. FV
n
=PV (1 +k)
n

e. FVA
n
={(1 +k)
n
1} k.
a. The Present Value Interest Factor for an Annuity (PVIFA) is equal to the product of the
future value interest factor for annuity and the present value interest factor.
b. The inverse of PVIFA factor is called the capital recovery factor.
c. The nominal rate of interest is equal to the effective rate of interest when the interest is
compounded annually.
d. The present value of cash flow stream of any periodicity can be calculated using FVIFA
tables.
e. The sinking fund factor is used to determine the amount that must be deposited
periodically to accumulate a specified sum at the end of a given time period.
a. The inverse of PVIFA factor is called the capital recovery factor.
b. The nominal rate of interest is equal to the effective rate of interest when the interest is
compounded annually.
c. The present value of interest factor for annuity is equal to the product of the inverse of
future value interest factor for annuity and the present value interest factor.
d. The present value of any cash flow stream can be calculated using PVIFA tables.
e. The sinking fund factor is used to determine the amount that must be deposited
periodically to accumulate a specified sum at the end of a given period at a given rate of
interest.
126. With an increase in the frequency of compounding
a. The nominal rate of interest becomes greater than the effective rate
b. The effective rate of interest increases at an increasing rate
c. The nominal rate of interest becomes equal to the effective rate of interest
d. The effective rate of interest increases at a decreasing rate
127. Sinking fund explains
a. The maturity value in year t for an amount deposited in year 1
b. The amount to be deposited annually to accumulate a predetermined sum in year t
c. The discounted value in year zero for an uneven series occurring in several years in future
d. The amount to be deposited in year zero for a periodical withdrawal in future for a
specified period
e. The effective rate of interest.
Part I
29
128. Which of the following statements is/are true?
i. The inverse of the PVIFA factor is sinking fund factor.
ii. The product of PVIF and FVIFA factors is PVIFA factor.
iii. The present value of a perpetuity is infinity.
a. All (i), (ii) and (iii) of the above.
b. Both (i) and (ii) of the above.
c. Only (i) of the above.
d. Only (ii) of the above.
e. Only (iii) of the above.
129. The nominal rate of interest
a. Is lesser than the effective rate of interest under inflationary conditions
b. Is equal to the effective rate of interest minus inflation
c. Does not consider risk premium
d. Is the real rate of interest plus inflation plus risk premium
e. Is also referred to as the prime lending rate.
130. When compounding of interests is done at intervals which are less than a year
a. The effective rate of interest will be the same as the nominal rate of interest
b. The effective rate of interest will be lesser than the nominal rate
c. The nominal rate of interest will be lesser than the effective rate
d. There is no difference between the effective and nominal rates in the first year
e. It cannot be ascertained as to which rate is more unless the frequency of compounding
is known.
131. If any investment (P) has to be doubled at an interest rate of k, then the doubling period n is
exactly equal to
a. 72/k
b. 0.35 +69/k
c. Log2/log (1 +k)
d. 2
132. Which of the following is/are true?
a. Inverse of FVIF is PVIF.
b. Inverse of FVIFA is PVIFA.
c. Inverse of capital recovery factor is FVIFA.
d. PVIFA is the product of inverse of FVIFA and PVIF
133. The relationship between effective rate of interest (r) and nominal rate of interest (i) is best
represented by
a. i =
m
r
1+ 1
m

b. r =
m
i
1+ 1
m

c. i =
n
r
1+ 1
n

d. r =(1+m)
i
1
e. i =(1+r)
m
1.
30
134. If compounding is done twice in a year, the effective rate of interest is equal to
a. 2 nominal rate of interest
b. Nominal rate of interest/2
c. (1 +nominal rate of interest/2)
2
1
d. ((1 +nominal rate of interest)/2)
2
e. (1 +nominal rate of interest/2) 2.
a. FVIF is the reciprocal of PVIF.
b. Product of FVIF and PVIFA is equal to FVIFA.
c. FVIFA is the reciprocal of PVIFA.
136. Time value of money considers
a. The preference of the individuals for future consumption to present consumption
b. Increase in purchasing power of rupee with the passage of time
c. The uncertainty of the future
d. The productivity of money to earn real returns over time
137. Which of the following statements is/are true with respect to Present Value Interest Factor of
Annuity (PVIFA)?
i. The cash flow is assumed to occur at the end of the period under consideration
ii. The cash flow is assumed to occur at the start of the period under consideration
iii. It is reciprocal to capital recovery factor.
a. Only (i) above.
b. Only (ii) above.
d. Both (ii) and (iii) above.
e. Both (i) and (iii) above.
138. Which of the following may be considered as the correct reason for money having time
value?
a. It is the legal tender for carrying out any type of transaction.
b. In India, it is guaranteed by the union government.
c. Its purchasing power increases with the passage of time due to inflation.
d. Money can be productively invested to generate real returns over a period of time.
Risk and Return
139. A risk-free stock has a beta of
a. 1
b. Zero
c. 0.5
d. 1
e. Infinity.
Part I
31
140. Which of the following is not an assumption under CAPM?
a. Investors make their investment decisions on a single period horizon.
b. If the perceived risk is high, a risk-averse investor expects higher return.
c. The investor is not limited by his wealth and price of the asset.
d. Assets can be bought at the going market price.
e. CAPM is based on all the above assumptions.
141. If the slope of the Security Market Line is zero, which of the following is/are true?
a. Risk-free return =Market return.
b. Market return =Expected return.
c. Expected return =Risk-free return.
142. Which of the following is not a non-diversifiable risk?
a. Lock-out in a company due to workers demanding a wage hike.
b. Slump in the industry.
c. Lack of strategy for the management in a company.
d. A change in the tax-structure for corporates in the Union Budget.
143. The amount of risk reduction depends on
a. Degree of correlation
b. Number of stocks in the portfolio
c. The market index movement
d. Both (a) and (b) above
144. Which of the following is diversifiable risk?
a. Inflation risk.
b. Interest-rate risk.
c. Market risk.
d. Business risk .
145. If a person holds a diversified portfolio the risk a security adds would be
a. Specific risk
b. Systematic risk
c. Portfolio risk
d. Liquidity risk
e. Diversifiable risk.
146. Portfolio Beta
a. Is the risk of a diversified portfolio
b. Is the weighted average of individual security betas, weights being the proportions of
individual returns
c. Is the weighted average of individual security beta, weights being the proportions of the
investments in the respective securities
32
147. Which is true regarding k
j
=r
f
+ (k
m
r
f
)?
a. r
f
can be the rate of return earned on gilt-edged securities.
b. will be >1 if the security is volatile.
c. Lower would give a low risk premium.
d. There is a possibility that a zero beta exists.
148. The slope of the security market line denotes
a. The expected return by the investors
b. The market volatility
c. Beta of the security
d. The influence of unsystematic risk
e. The risk premium required.
149. If the securitys return plots below the SML, then, it can be said that
a. It is overpriced
b. The required rate of return is much lower than the actual rate of return
c. The investors would try to buy more of the security
d. It is a defensive security
150. A security is said to be aggressive when it
a. Has a beta of >1
b. Plots on the upper part of SML
c. Gives below average returns
151. Which of the following is not a non-diversifiable risk?
a. Interest rate risk.
b. Purchasing power risk.
c. Operating risk.
d. Market risk.
e. Political risk.
152. Risk-return trade-off implies
a. Increasing the profit of the firm through increased production
b. Not taking any loans which increases the risk of the firm
c. Not granting credit to risky customers
d. Taking decisions in such a way which optimizes the balance between risk and return
e. Minimizing all risks.
153. Which of the following is a specific risk factor?
a. Market risk.
b. Inflation risk.
c. Interest rate risk.
d. Financial risk.
Part I
33
154. Security Risk premium in the Capital Asset Pricing Model (CAPM) is given by
a. R
f
b. k
m
R
f
c. (k
m
R
f
)
d. K
m
e. ( R
f
k
m
).
155. The risk arising due to uncertainty about the time element and the price concession in selling
a security is called
a. Price risk
b. Market risk
c. Trading risk
d. Liquidity risk
e. Financial risk.
156. Standard deviation as a measure of risk is preferred because
a. Standard deviation considers every possible event and assigns each event equal weight
b. Standard deviation is a measure of dispersion around the median value
c. Standard deviation is a familiar concept and many calculators and computers are
programmed to calculate it
d. Standard deviation considers every possible event and assigns each event a weight equal
to its probability
157. Which of the following is not a diversifiable or specific risk factor?
a. Company strike.
b. Bankruptcy of a major supplier.
c. Death of a key company officer.
d. Unexpected entry of new competitor into the market.
e. Industrial recession.
158. Which of the following statements is true of beta?
a. Beta of a security is the slope of the Security Market Line (SML).
b. Beta of a security is a measure of the diversifiable risk of a security.
c. High beta of a security assures high return.
d. Beta of a security can never be negative.
e. Beta of a security is a measure of systematic risk of a security.
159. Which of the following is not an assumption of Capital Asset pricing Model (CAPM)?
a. Investors are risk-averse and use the expected rate of return and standard deviation of
return as appropriate measures of return and risk respectively.
b. Investors make their investment decisions based on a single period horizon i.e. the next
immediate time period.
c. Transaction costs in financial markets are low enough to ignore and assets can be
bought and sold in any unit desired.
d. Taxes do not affect the choice of buying assets.
e. Investors make their investment decisions based on multi-period horizon.
34
160. Ceteris Paribus, a security is to be bought if.
a. The required rate of return is less than expected rate of return
b. The required rate of return is greater than the expected rate of return
c. Security has a beta greater than one
d. The security has beta of less than one
e. The security has a large amount of floating stocks in the market.
a. If one portfolios variance exceeds that of another portfolio, its standard deviation will
also be greater than that of the other portfolio.
b. For investment horizons greater than 20 years, long-term corporate bonds will
outperform common stocks.
c. Due to their short maturity, the average real rate of return for treasury bills
approximately equals their average nominal rate of return.
d. When inflation is expected to be low, the nominal risk premium on common stocks is
expected to be low.
e. Market risk can be eliminated in a stock portfolio through diversification.
162. Real rates of return are typically less than nominal rates of return due to
a. Inflation
b. Capital gains
c. Dividend payments
d. Deflation
e. Recession.
163. Real rates of return will be positive as long as
a. The nominal return is positive
b. The inflation rate is positive
c. The nominal return exceeds inflation rate
d. Inflation rate exceeds the real return
164. The major benefit of diversification is to
a. Increase the expected return
b. Increase the size of the investment portfolio
c. Reduce brokerage commissions
d. Reduce the expected risk
e. Increase the expected return over and above the risk-free rate of return.
a. Interest rate risk is the variability in a securitys return resulting from changes in interest
rates.
b. Market risk refers to the variability of returns due to a wide range of factors exogenous
to the securities themselves.
c. Inflation risk is the loss of purchasing power due to inflation.
d. As inflation rate increases the interest rate risk decreases.
e. Business risk is the risk of doing business in a particular industry.
Part I
35
166. What is the cost of a debenture if it is issued at face value of Rs.100. The coupon is 13%, the
maturity is 6 years, redemption is at 6% premiumand realizable amount is Rs.97.50 and
Tax =Rs.38%.
a. 9.25%
b. 9.56%
c. 9.13%
d. 9.31%
e. 9.49%
a. Interest rate risk refers to the variability of returns due to fluctuations in the securities
market.
b. Market risk refers to the reduction in purchasing power.
c. The interest rates on securities tend to go up with inflation.
d. Business risk refers to the risk due to debt financing.
e. Financial risk is associated with the secondary market in which a particular security is
traded.
168. Financial risk arises due to the
a. Reduction in purchasing power of the assets employed by the firm
b. Variability of returns due to fluctuations in the securities market
c. Changes in prevailing interest rates in the market
d. Leverage used by the company
e. Liquidity of the assets of the company.
169. The diversifiable risk includes the risk due to
a. Inflation
b. Industrial recession or slow down
c. Natural calamities
d. Strike in the company
e. Changes in economic policy.
170. Which of the following would reduce the applicability of Capital Asset Pricing Model
(CAPM)?
a. Investors having different time horizons for investments.
b. The presence of high transaction costs in the market.
c. The influence of taxes on the choice of assets.
d. The different expectations of the investors regarding the risk and return associated with
various securities.
171. Which of the following is a diversifiable risk factor?
a. An increase in inflation rate.
b. Unexpected entry of a new competitor in the market.
c. A change in economic policy of government.
d. Industrial recession.
e. Increase in international oil prices.
36
172. If a security is less risky than the market portfolio, then its beta would be
a. Negative
b. More than market beta
c. Equal to Zero
d. Less than 1
e. More than 1.
a. Expected returns and ex post returns are same.
b. There are only two types of returns i.e., realized returns and historical returns.
c. Risk is a motivating force for an investor.
d. The objective of any investor is to maximize his returns as well as risk.
e. The investor compensates for the uncertainty in returns by requiring an expected return
that is sufficiently high to offset the risk or uncertainty.
174. Which of the following types of risks is/are not systematic risk?
a. Credit risk.
b. Interest rate risk.
c. Purchasing power risk.
d. Market risk.
175. The security market line shows the relationship between the
a. Expected rate of return and diversifiable risk
b. Realized rate of return and beta
c. Required rate of return and unsystematic risk
d. Expected rate of return and beta
e. Realized rate of return and systematic risk.
176. The risk that arises due to change in the purchasing power is called
a. Financial risk
b. Interest rate risk
c. Business risk
d. Market risk
e. Inflation risk
177. The risk aversion of an investor can be measured by
a. Risk-free rate of return
b. Market rate of return
c. Variance of the return from a security
d. The difference between the market rate of return and the risk-free rate of return
178. The risk of a portfolio of two securities increases if there is _______ between their returns.
a. Perfect positive correlation.
b. Perfect negative correlation.
c. Moderate positive correlation.
d. Moderate negative correlation.
e. Both (a) and (c) of the above.
Part I
37
179. Which of the following types of risk is not a diversifiable risk?
a. Business risk.
b. Financial risk.
c. Credit risk.
d. Purchasing power risk.
e. Technology risk.
180. Market portfolio contains
a. Frequently traded securities in the stock market
b. All the securities in proportion to their market capitalization
c. All securities listed in the specified group of a stock exchange
d. The securities having large volumes in terms of number of transactions and market
capitalization
181. Security market line shows the relationship between return on the stock and
a. Return on market portfolio
b. Risk-free rate of return
c. Standard deviation of the stock returns
d. Beta of the stock
e. Variance of the stock returns.
182. If a securitys return plots above the Security Market Line (SML), it means
a. Security is overpriced
b. Security is underpriced
c. Securitys beta is more than one
d. Securitys beta is less than one
e. Securitys beta is equal to zero.
a. The Capital Asset Pricing Model (CAPM) establishes the relationship between an
assets return and its systematic risk.
b. The above relationship can be graphically plotted as the Security Market Line.
c. An undervalued security is a very desirable asset to own.
184. Characteristic line is the relationship between return on stock and
a. Return on market portfolio
b. Risk-free rate of return
c. Return on Government bond
185. In booming (share) market, the companies are to be selected with Beta ()
a. =0
b. >1
c. <1
d. =1
e. Beta is not relevant.
38
186. Which of the following is not an assumption of CAPM?
a. Capital markets are perfect.
b. Lending rate is more than borrowing rate.
c. No individual is capable of affecting market.
d. Homogenous expectations.
e. All the above are assumptions.
187. Systematic Risk Factor(s) involved in investing in bonds
a. Purchase-Power risk
b. Interest rate risk
c. Yield risk
188. The slope of the Security Market Line (SML) changes with
a. Change in risk-free rate of return
b. Change in risk attitude of investors
c. Change in inflation
d. All of the above
189. The relationship between of a security and required rate of return is represented by
a. Characteristic line
b. Security market line
c. Capital market line
d. All of the above
190. If investors expect the inflation rate to fall in future and they expect themselves to become
less risk-averse then
a. SML shifts up and the slope increases
b. SML shifts up and the slope decreases
c. SML shifts down and the slope increases
d. SML shifts down and the slope decreases
e. SML does not change as the above changes offset each other.
191. The return from an investment is calculated by using the formula
a.
t t t 1
t
d +(P P )
P 1

where d
t
=dividend in year t; P
t1
and d
t
=prices in the years t and

t1
respectively
b.

where k
j i
n
k p
i =1
i
=ith possible rate of return; p
i
=Probability associated with the
occurrence of the ith rate of return
c. R
f
+ (R
m
R
f
) where R
f
=Risk-free rate of return; =Beta coefficient of the
security; R
m
=Return from the market portfolio
e. All of (a), (b), and (c) above.
Part I
39
192. The required rate of return calculated as per Capital Asset Pricing Model (CAPM)
a. Is the minimum return required by the investor
b. Is the same as expected rate of return under equilibrium conditions
c. Depends on returns of market portfolio and risk-free rate of return
d. All of the above
e. CAPM does not define required rate of return.
193. Which of the following does not contribute to systematic risk?
a. Change in the interest rates.
b. Change in the level of government spending.
c. Emergence of a new competitor.
d. Change in the industrial policy.
194. Security Market Line (SML) cuts the Y-axis at
a. Expected rate of return on the market portfolio
b. Expected rate of return on individual security
c. Expected rate of inflation
d. Real rate of return on risk-free securities
e. Nominal rate of return on risk-free securities.
195. An equity share with beta greater than unity would be called
a. A defensive stock, because it is expected to decrease more than the market increases
b. An aggressive stock, because it is expected to increase more than the market increases
c. A defensive stock, because it is expected to increase more than the market decreases
d. An aggressive stock, because it is expected to decrease more than the market increases
e. A stock moving against the market.
196. Riskiness of a portfolio is a function of
a. Proportions invested in the components
b. Riskiness of the components
c. Correlation of the returns on the component securities
d. All of the above
e. Only (b) and (c) of the above.
197. Which of the following will cause an increase in the required rate of return?
a. Decrease in inflation.
b. Decrease in risk-free rate.
c. Increase in interest rate.
d. Decrease in risk aversion.
198. The Security Market Line
a. Is also referred to as the Characteristic Line
b. Is a graphical representation of the Capital Asset Pricing Model
c. Has beta as its slope
d. Manifests the relationship between returns on the market and returns on the security
e. Measures the behavior of returns overtime.
40
199. If the slope of Security Market Line (SML) =0, which of the following is/are true?
a. Expected rate of return is more than the market return.
b. Expected return is equal to risk-free rate of return.
c. Risk-free rate of return is equal to zero.
d. Expected return shall be beta times of the risk aversion.
e. Both (a) and (b) of the above.
200. Diversification can eliminate risk if the securities of a portfolio are
a. Perfectly positively correlated
b. Perfectly negatively correlated
c Weakly positively correlated
d. Weakly negatively correlated
e. Not correlated.
201. Systematic risk of a security is measured by
a. Standard deviation
b. Variance
c. Covariance
d. Beta
e. Correlation coefficient.
202. Which of the following instances relating to ABC Ltd., do not represent unsystematic risk?
a. An open offer for takeover of the company.
b. Workers declare strike in the company.
c. Company makes a breakthrough in process innovation.
d. Introduction of Minimum Alternative Tax.
e. Raid on the company for tax evasion.
203. If there is zero correlation among the securities in a portfolio, the resulting graph will be a(n)
a. Straight line with a slope of 45 degrees
b. Straight line with a negative slope of 45 degrees
c. Scattered
d. Ellipse
e. Hyperbola.
204. Which of the following is an example of systematic risk?
a. Risk of non-availability of a major raw material to a company making aluminium bars.
b. Death of the finance manager of a company providing financial services.
c. Unexpected entry of a multi-national company in the tea industry.
d. Reduction of tax rate by the government.
e. Sudden strike called by the workers of a jute manufacturing company demanding for the
wage revision.
205. Which of the following statements does not involve risk-return trade-off decision?
a. To increase the sales revenue through an aggressive advertisement campaign.
b. To improve the paying habit of the customers by framing an attractive credit terms.
c. To maximize profits by ensuring the maximum usage of the production facilities.
d. To maximize the profit by resorting to debt financing.
Part I
41
206. If a securitys return is plotted above the security market line, then
a. The risk free rate is equal to the required rate of return on the security
b. The securitys rate of return is more than the return on the market portfolio
c. The securitys beta is less than one and hence a conservative security
d. The security is said to be overvalued
e. The security is to be bought immediately.
207. Which of the following is/are an assumption(s) of CAPM?
a. Investors use the expected return and standard deviation of returns as the appropriate
measures of return and risk of the portfolios.
b. Investors are risk averse.
c. Investors agree with each other on the nature of return and the risk associated with each
instrument where investment may be made.
d. The assets can be bought and sold in any unit as desired by the investors.
208. If the rates of return from a security move perfectly in tandem with respect to the market
returns, then the beta for that security will be
a. Equal to 1
b. 0
c. Between 0 and 1
d. Greater than 1
e. Less than 1.
209. Which of the following is an example of non-systematic risk to a firm?
a. Volatility of interest rates.
b. Sudden increase in the rate of inflation.
c. The possibility of the imposition of surcharges by the government to reduce fiscal
deficit.
d. Sudden scarcity of cement in the market.
e. Non-availability of sufficient power supply to overall business sector.
210. If the return on a security lies below the security market line, then
a. The security is conservative security
b. The security is aggressive security
c. The risk free rate of return is more than the expected return from that security
d. The security is over priced
e. The security is under priced.
211. Which of the following relationships is represented by the Characteristic Regression Line
(CRL)?
a. The return from an equity share and the variance of its returns.
b. The return from an equity share and the return from the market index.
c. The return from an equity share and its beta.
d. The return from an equity share and the risk free rate of return.
e. The return from an equity share and the market risk premium.
42
212. What is the significance of the beta coefficient with respect to the risk of a security?
a. It indicates the unsystematic risk of the security.
b. It indicates the systematic risk of the security.
c. It indicates the total risk of the security.
d. It indicates the operating risk of the company that has issued the security.
e. It indicates the financial risk of the company that has issued the security.
213. Which of the following is an assumption of CAPM?
a. The investors are risk lovers.
b. The assets can be sold or bought in the lots of 100 units.
c. Transaction costs and taxes are of a significant amount.
d. Expectations of one investor is not same as that of the another in relation to the
expected returns from a security and the risks associated with it.
e. The investors considers the expected return and the standard deviation of returns as the
criteria for making investment.
214. Which of the following is/are not feature(s) of bonds issued by a government agency?
a. They are secured.
b. They are issued at discount and redeemed at the face value.
c. The interest rate can be changed before the maturity of the bond if government wishes so.
215. If a 2-year redeemable bond is purchased and held till maturity, the rate of return earned is called
a. Coupon rate
b. Required rate of return
c. Yield to maturity
d. Current yield
e. Either (b) or (d) above.
216. When the required rate of return is equal to the coupon rate, value of the redeemable bond is
equal to its
a. Market value
b. Face value
c. Present value of the stream of interest inflows
d. Average of par value and maturity value
217. When the coupon rate is less than the required rate of return the discount on the bond ____ as
maturity approaches.
a. Decreases
b. Increases
c. Does not change
d. First decreases and then increases
e. First increases and then decreases.
Part I
43
218. Given the maturity, an increase in bonds yield causes a price decrease that is ___ the price
increase caused by an equal size decrease in yield.
a. Higher than
b. Smaller than
c. Equal to
d. Greater than or equal to
e. Smaller than or equal to.
219. A change in YTM affects those bonds with a higher YTM ____ it affects bonds with a lower
YTM.
a. Less than
b. More than
c. Same as
d. Either of (a) or (c) above
e. Either of (b) or (c) above.
220. An investor would buy a bond if
a. The intrinsic value is lower than the market value
b. The intrinsic value is higher than the market value
c. The current market value is lower than the redemption value
d. The current market value is less than the face value
e. The required rate of return is equal to coupon rate of interest.
221. Nadir Shah purchases a bond today and sells 6 months before its maturity. The yield realized
is known as
a. Holding period return
b. Current yield if coupon interest is received
c. Yield to maturity
222. For abond held to maturity, YTM is not affected by
a. Annual interest payment
b. Discount rate
c. Redemption value
d. Number of years to maturity
e. Current market price of the bond.
a. The required rate of return determines the premium or discount on the bond value.
b. If the YTM increases the bonds market price decreases.
c. The coupon rate affects the YTM.
d. If the market price and face value are equal then coupon rate is more than YTM.
224. If the coupon rate of bond X is greater than bond Y with the same YTM and maturity
a. The bond Xs price will change more than Y for a change in YTM
b. The market price of bond Y is more than that of X
c. The current yield of both the bonds would be same
d. The bond Ys price would change more than that of X for a change in YTM
44
225. The price of the share will increase if
a. The dividend decreases
b. The required rate of return increases
c. The growth rate increases
226. Prabhasa Constructions Ltd., is showing a low dividend yield and high price earnings ratio.
Then,
a. Price of its share is high
b. There is growth in the company
c. The investors in this share can expect capital gains
227. The book value approach is criticized because
a. It can be established easily
b. It values the firms share without any future projections
c. It is based on accounting figures which can be manipulated
228. The factor(s) which affect(s) P/E ratio is/are
a. Growth rate
b. Debt proportion
c. Retention ratio
d. Quality of management
e. All of (a), (c) and (d) above.
229. The coupon rate on a bond is set equal to
a. Its yield to maturity
b. A percentage of its market price
c. A percentage of its maturity value
d. A percentage of its par value
e. A percentage of its issue price.
230. The amount a company can realize if it sold its business as an operating one is called
a. Market value
b. Book value
c. Replacement value
d. Liquidation value
e. Going concern value.
a. Ceteris Paribus, as the expected growth in dividend increases, the expected return
depends more on the capital gain yields, and less on dividend yield.
b. Ceteris Paribus, the price-earnings ratio increases as the expected growth rate in
dividend increases.
c. High dividend yield and low price-earnings ratio imply limited growth prospects.
d. Low dividend yield and high price-earnings ratio imply low growth prospects.
e. Low dividend yield and high price-earnings ratio imply considerable growth prospects.
Part I
45
a. When required rate of return (k
d
) is equal to coupon rate (k
c
), the value of bond (V) is
equal to its par value (F).
b. When k
d
is greater than k
c
, V is less than F.
c. When k
d
is greater than k
c
, the discount on bond declines as maturity increases.
d. When k
d
is less than k
c
, the premium on the bond declines as maturity approaches.
a. Market value is the amount that a company could realize if it sold its assets after
terminating its business.
b. Replacement value is the amount required to replace its existing assets in the current
condition.
c. Going concern value is the amount that a company could realize if it sold its business as
an operating one.
d. Book value is an accounting concept.
e. The difference between the book value of assets and liabilities is equal to shareholders
funds.
234. Which of the following is true?
a. The book value of a company is equal to the historic value of its assets.
b. Intangible assets cannot form part of the book value of a company.
c. The book value of debt is equal to the outstanding amount of debt.
d. The difference between book value of shareholders funds and the liabilities is equal to
the book value of the firm.
e. Book value is also known as liquidation value.
a. A change in YTM affects a bond with a higher YTM more than a bond with lower YTM.
b. For a given difference between YTM and coupon rate, bonds with longer term to
maturity will have greater price change.
c. A bonds price moves inversely proportional to YTM.
d. For any changes in YTM, the percentage price change in case of bonds of high coupon
rate will be smaller than bonds with low coupon rate.
236. If the maturity of a bond increases, the
a. Volatility of the bond decreases
b. Volatility of the bond increases
c. Volatility remains unaffected
d. Change in volatility depends on the required rate of return
237. When the required rate of return on a bond is less than the coupon rate, then
a. The value of the bond is equal to its par value
b. The discount on the bond declines as maturity approaches
c. The premium on the bond increases as maturity approaches
d. The value of the bond is greater than its par value
e. The value of the bond is less than its par value.
46
a. The intrinsic value of a stock is equal to the discounted value of the stream of future
earnings per share.
b. The intrinsic value of a stock is equal to the present value of earnings per share plus the
net present value of future growth opportunities.
c. The intrinsic value of a stock is equal to the present market price per share less the
purchase price per share.
d. The intrinsic value of a stock is equal to the discounted value of the stream of future
dividends per share.
e. The intrinsic value of a stock is equal to the market capitalization divided by the number
of outstanding shares.
239. Which of the following statements is/are true regarding changes in bond prices?
a. The shorter the term to maturity the greater would be the price change with change in
yield to maturity.
b. With a change in YTM the percentage change in bond prices would be lower in case of
high coupon bonds than in the case of low coupon bonds.
c. The changes in bond prices move inversely to change in yield to maturity.
d. Both (b) and (c) above.
240. If maturity of bond lengthens, what happens to the volatility of bond?
a. Volatility increases.
b. Volatility decreases.
c. Volatility sometimes increases, sometimes decreases.
d. Volatility remains unchanged.
a. When the expected price earnings ratio exceeds the actual price earnings ratio of a
stock, the stock is overpriced.
b. When the expected rate of return is equal to the required rate of return, the stock is
correctly priced.
c. An overpriced stock should be purchased as it is undervalued.
242. When the required rate of return on a bond is greater than the coupon rate
a. The premium on the bond declines as maturity approaches
b. The discount on the bond declines as maturity approaches
c. The value of the bond is greater than its par value
d. The greater is its price change, in response to a given change in the required rate of return
243. In an ever changing scenario of interest rates in the bond market, if discount bonds and
premium bonds are sold at the same price, it indicates that
a. The bonds have approached maturity
b. The YTM =Coupon rate
c. The bonds are having the same coupon rate, same maturity value and same face value
d. The investors cost of funds are approximately equal
Part I
47
244. Coupon yield is equal to current yield, if and only if
a. The market interest rates are regulated
b. The market price of the bond is equal to the face value of the bond
c. The bonds are highly volatile
d. The market price is more than the par value
e. The face value is more than the market value.
245. What is the value of Beta when the required rate of return is 21.4%, the risk free rate is 6%
and the market return is 17%?
a. 1.2.
b. 0.8.
c. 1.3.
d. 1.4.
e. 1.5.
246. Which of the following is true regarding the value of a share?
a. The value of a share equals the discounted stream of future earnings per share.
b. The value of a share equals the present value of earnings per share plus the net present
value of future growth opportunities.
c. The value of a share is equal to the present market price per share less the purchase
price per share.
d. The value of a share equals the discounted stream of future dividends per share.
e. The value of a share equals the market capitalization divided by the number of
outstanding shares.
247. Which of the following is false regarding the value of a bond?
a. The value of a bond varies inversely with the interest rate.
b. Bonds of short maturity have less interest rate risk compared to the bonds of long maturity.
c. Bonds of high coupon have high interest rate risk compared to small coupon bonds.
d. The value of the bond will be equal to face value if the coupon rate is equal to the YTM.
e. The discount on the bond decreases as maturity approaches if the coupon rate is less
than the interest rate.
248. Yield to maturity of a perpetual bond is equal to
a. Interest/Face value
b. Interest/Market price
c. Interest/Average of face value and market price
d. Interest rate
e. (Interest +Annual Redemption)/Average Investment.
249. Which of the following statements is/are true regarding bond value theorems?
i. When the required rate of return is greater than the coupon rate, the premium on the
bond increases as maturity approaches.
ii. For a given difference between yield to maturity and coupon rate, the longer the term to
maturity, greater will be the change in price with the change in yield to maturity.
iii. The effect of a change in yield to maturity on the price of the bond is more in case of
lower yield bonds than in bonds with higher yields.
a. Only (i) above.
b. Only (ii) above.
c. Both (i) and (ii) above.
48
250. Which of the following is most likely to result in a higher P/E ratio for a firm, other things
being equal?
a. Lower growth rate in dividends.
b. Reduction in the stocks required rate of return.
c. Lower dividend yield.
d. Lower stock price.
e. Higher cost of insolvency.
251. Which of the following statements is correct regarding cash dividends on common stocks?
a. Dividend payments are guaranteed.
b. Dividends are the only form of return on investment.
c. Low dividend yields indicate out of favor stocks.
d. Dividend yields are based on current stock price.
252. The value of common stock is likely to decrease if
a. Investment horizon decreases
b. The growth rate of dividends increases
c. The discount rate increases
d. Dividends are discounted back to present
e. Dividends pay-out ratio remains constant.
253. The g in the constant-growth dividend discount model refers to
i. The annual growth rate of dividends
ii. The annual growth rate of stock price
iii. The annual growth rate of earnings per share
a. Only (i) above.
b. Only (ii) above.
d. Both (i) and (iii) above.
254. Which risk is associated with a particular security traded on the secondary market?
b. Market risk.
c. Liquidity risk.
d. Financial risk.
255. Given the difference between YTM and coupon rate
a. The longer the term to maturity the lesser will be the change in price with change in
YTM.
b. The shorter the term to maturity the greater will be the change in price with change in
YTM.
c. The longer the term to maturity the greater will be the change in price with change in
YTM.
d. The term to maturity does not influence the change in price for any change in YTM.
e. The term to maturity influences the change in price for any change in YTM in an
unpredictable manner.
Part I
49
256. Which of the following is an external factor that influences the intrinsic value of a stock?
a. Earning power and profitability of the operations.
b. Dividends paid and payable in future.
c. Growth in earnings over time and expectations of the same in future.
d. Quality of management.
e. Growth rate of the industry to which the company belongs.
257. Current yield of a bond equals
a. Coupon rate when the price of the bond is greater than the face value of the bond
b. Coupon rate when the price of the bond is less than the face value of the bond
c. Coupon rate when price of the bond is equal to the face value of the bond
d. Yield to maturity (ytm) when the price of the bond equals the face value of the bond
258. Other things being equal, which of the following will cause an increase in the value of a
bond?
a. Decrease in the term to maturity.
b. Increase in the required rate of return on maturity.
c. Decrease in the discount on the bond on issue.
d. Increase in the premium on maturity of the bond.
e. Decrease in the coupon rate of the bond.
259. Which of the following is/are false when the required rate of return on a bond is more than
the coupon rate?
i. The discount on the bond decreases as the maturity approaches
ii. The market value of the bond is less than its par value
iii. The premium on the bond decreases as the maturity approaches
a. Only (i) above
b. Only (ii) above
c. Only (iii) above
d. Both (i) and (ii) above
260. Which of the following is not true with regard to the warrants issued by a company?
a. It is a call option to buy certain number of shares of the company that issued the same.
b. The warrant holder is entitled to receive dividends.
c. The warrant holder may sell the warrant at any point of time prior to the exercise date.
d. Warrants are generally issued with an objective to sweeten the public offer.
e. All are the above.
261. Which of the following is not true with regard to the multi period valuation model of equity
shares?
a. There is a pre-specified maturity period.
b. The value of an equity share is equal to the present value of its entire dividend stream.
c. The model can be applied to the instances of constant dividends and constant growth in
dividends.
d. The model can also be applied in case of variable growth in dividends.
e. The cost of equity of the company can vary from time to time.
50
262. Which of the following factors, other things remaining the same, will decrease the bond
value?
a. Increase in coupon rate.
b. Decrease in the yield of the bond.
c. Increase in maturity premium.
d. Increasing the term of the bond.
e. Increase in the yield of the bond.
263. The amount that a company may realize if it sells its business after having terminated the
same is called
b. Book value
c. Market value
d. Liquidation value
e. Replacement value.
264. Which of the following statements is true, if the required rate of return from a bond is more
than the coupon rate?
a. The intrinsic value of the bond is more than the par value of the bond.
b. The intrinsic value of the bond is less than the par value of the bond.
c. The discount on the bond increases as the maturity approaches.
d. The discount on the bond decreases as the term to maturity increases.
e. The premium on the bond decreases as the maturity approaches.
265. Which of the following factors are to be considered in the valuation of the equity shares of a
company through price-earning ratio approach?
a. Book value of the assets of the company.
b. Liquidation value of the assets of the company.
c. Growth rate of the earnings.
d. Number of equity shareholders.
e. Whether preference shares have been issued by the company.
266. Long-term solvency is indicated by
a. Liquidity Ratio
b. Debt-equity Ratio
c. Interest Coverage Ratio
d. Return on Capital Employed
267. Current ratio is chiefly used to assess the
a. Effective utilization of capital
b. Application of debt
c. Liquidity position
d. Levels of inventory piled up in different forms
e. Prompt payment of long-term liabilities.
Part I
51
268. Which of the following indicates the Debt-Service Coverage Ratio (DSCR) of 1.5 of a firm?
a. The total obligations (i.e. interest plus repayment on the long-term loan) of the firm are
1.5 times its PBDIT.
b. The total obligations are 1.5 times its PAT.
c. The post-tax cash earnings are 1.5 times its total obligations.
d. The post-tax earnings after depreciation are 1.5 times its total obligations.
e. The total obligations are 1.5 times the equity earnings.
269. Which of the following is/are false statement(s) regarding common-size analysis?
a. It is used for comparing performance of a company in one year with that of another year.
b. The industry average is compared with the performance of a company.
c. All items in the financial statements are expressed as percentages of the respective totals.
270. A fixed charges coverage ratio of 4 signifies
a. Pre-tax operating income is 4 times all fixed financial obligations
b. Post-tax income plus depreciation is 4 times all financial obligations
c. Pre-tax income before lease rentals is 4 times all fixed financial obligations
d. Post-tax income less preference dividends is 4 times all fixed financial obligations
e. Post-tax income plus debt interest and lease rentals is 4 times all fixed financial
obligations.
271. Which of the following statement(s) is/are true?
a. Average collection period evaluates all aspects of credit policy.
b. All other things remaining the same, issue of new shares for cash will improve the
current ratio.
c. Ratio analysis is technique of planning and control.
272. If a firm has realized its debtors and has paid-off its creditors to the same extent then
a. The current ratio will increase if it was less than 1 previously
b. The current ratio will decrease if it was more than 1 previously
c. The current ratio will increase if it was equal to 1 previously
273. Receivables turnover ratio of 10 means
a. The net credit sales for the year are 10 times the average receivables
b. Receivables are generated 10 times during the year
c. It takes 36 days to collect credit sales on an average
274. If the realized collection period is more than the terms of trade, it can be said that
a. The collection job is poor
b. The quality of debtors is poor
c. The average daily sales are low
52
275. Low assets turnover may indicate
a. Low assets
b. High costs of maintenance
c. Idle assets
d. Higher sales
276. A gross profit margin ratio may not indicate
a. Earning power
b. The efficiency of production
c. The efficiency of pricing
d. The gap between net sales and cost of goods sold
e. The balance left to meet the administration and financing expenses.
277. The long-term solvency positions are measured by
a. Coverage ratios
b. Earnings ratios
c. Structural ratios
278. Dividend Pay-out Ratio is
a. A ratio between dividend paid and the number of equity shares
b. DPS divided by EPS
c. A ratio between PAT and the dividend paid
d. The percentage of equity earnings over EBIT
e. EPS divided by DPS.
279. Which of the following would affect the dividend yield directly?
a. Retention ratio.
b. Book value per share.
c. Face value of a share.
d. The cost of equity capital.
e. Debt-equity ratio.
280. While doing the time series analysis you found that the ROE is decreasing. Which of the
following may be a probable reason?
a. The net profit margin is increasing.
b. Assets turnover is decreasing.
c. The debt assets ratio is decreasing.
281. Which of the following is/are the problem(s) encountered in financial statement analysis?
a. Development of benchmarks.
b. Window dressing.
c. Price level changes.
d. Interpretation of results.
Part I
53
282. Equity multiplier is defined in Du Pont Analysis as
a. EPS/Market price of shares
b. EPS/Book value of shares
c. PAT/Net worth
d. Average assets/Average equity
a. The income statement of a firm shows the value of its assets and liabilities over a
specified period of time.
b. The difference between the current and quick ratio is that inventory has been subtracted
from current liabilities.
c. The net working capital of a firm will increase when accrued wages are paid with cash.
d. The lower the times interest coverage ratio, the lower is the interest expense.
e. Other things being equal, a decrease in average accounts receivable will increase the
firms return on assets.
284. A common size balance sheet portrays the firms accounts as a percent of the
a. Industrys assets
b. Firms net income
c. Firms total assets
d. Strongest competitors assets
e. Current assets.
285. An assets liquidity measures
a. Its potential for generating a profit
b. Its usefulness to the corporation
c. Its ease and cost of being converted into cash
d. Its proportion of equity financing
e. Its proportion of debt financing.
286. The current ratio is the ratio of
a. Current assets to total assets
b. Current liabilities to total liabilities
c. Current assets to current liabilities
d. Current liabilities to equity
e. Current assets to fixed assets.
287. If the current ratio is less than 1 then it can be definitely said that
a. The net working capital is negative
b. The net working capital is positive
c. The inventories are inadequate
d. The current assets other than inventories are inadequate
e. Cash in hand is inadequate.
54
288. 1 year =365 days. The expression
AverageReceivablex365
isknownas
Annual CreditSales

a. Receivables turnover ratio
b. Average collection period
c. Quick ratio
d. Current ratio
e. Leverage ratio.
289. If the debt-equity ratio of a company is 2:1 then it can be understood that for every
a. 2 rupees of equity there is 1 rupee of debt
b. 2 rupees of total assets there is 1 rupee of equity
c. 3 rupees of total assets there is 1 rupee of debt
d. 3 rupees of total assets there are 2 rupees of debt
e. 3 rupees of debt there are 2 rupees of equity.
a. Liquidity implies a firms ability to pay its debt in the long run.
b. Working capital gap is equal to current assets plus total current liabilities.
c. The number of days it takes to collect accounts receivables is known as average
collection period.
d. Lesser the inventory turnover ratio, higher the efficiency of inventory management.
e. PE ratio is one of the most important profitability ratios.
291. How does financial statement analysis help in understanding financial statements?
a. Window dressing.
b. Price level changes.
c. Correlation among ratios.
d. Differences in accounting policies.
292. Working capital gap
a. Shows the degree of the firms reliance on long-term bank finance
b. Shows the degree of the firms reliance on shareholders funds
c. Is equal to current assets less current liabilities other than bank borrowings
d. Is equal to the total current assets
e. Is equal to current assets less current liabilities plus bank borrowings.
293. Which of the following is an efficiency ratio?
a. Asset turnover ratio.
b. Fixed charges coverage ratio.
c. Accounts receivable turnover.
d. Price-earnings ratio.
e. Debt-service coverage ratio.
294. Capitalization rate is calculated as
a. Total assets-to-debt ratio
b. Market price of the share to earnings per share
c. Earning per share to book value of the shares
d. Earning per share to market price of the shares
e. Total assets-to-equity ratio.
Part I
55
295. An interest coverage ratio of 2.25 indicates that
a. EBIT is 2.25 times the interest payable
b. EBT is 2.25 times the interest payable
c. EAT is 2.25 times the interest payable
d. Retained earnings are 2.25 times the interest payable
296. Which of the following is a liquidity ratio?
a. Debt-equity ratio.
b. Dividend pay-out ratio.
c. Net profit margin.
d. Interest coverage ratio.
e. Acid test ratio.
297. Which of the following is/are not a liquidity ratio?
a. Current ratio.
b. Quick ratio.
c. Average collection period.
d. Bank finance to working capital gap ratio.
e. Both (c) and (d) of the above.
298. Earnings Per Share (EPS) is equal to
a. Profit before tax/No. of outstanding shares
b. Profit after tax/No. of outstanding shares
c. Profit after tax/Amount of equity share capital
d. Profit after tax/Net worth
e. Profit after tax less equity dividends/No. of outstanding shares.
299. Current ratio indicates
a. Amount of cash with the company
b. Amount of current assets out of total assets of the company
c. Capacity to meet current liabilities
d. Ability to repay debt installments
300. Which of the following is not considered while determining the appropriate P/E ratio for a firm?
a. Industry growth rate.
b. Book value to earnings per share ratio.
c. Stability of earnings.
d. Size of the company.
e. Dividend pay-out ratio.
301. Which of the following is/are true regarding common size analysis?
a. It states items in the balance sheet as percentages of total assets.
b. It expresses items in balance sheet as an index relative to the base year.
c. It is the same as time series analysis.
d. It is done to find the intrinsic value of the companys stock.
56
302. Days Sales Outstanding
a. Is the ratio of receivables outstanding to average daily sales
b. Is similar to the Average Collection Period
c. If higher, indicates an efficient credit policy
303. A high inventory turnover ratio
a. Could mean that inventory could have increased even when net sales remained constant
b. Is generally an indicator of efficient inventory management
c. Could also be an indicator of over trading
d. All of the above
e. Only (b) and (c) above.
304. When current assets and current liabilities increase by the same amount
a. The current ratio remains the same
b. The current ratio increases, if it is greater than 1
c. The current ratio decreases, if it is greater than 1
d. The current ratio becomes 1:1
305. The basic ratio for measuring the firms ability to meet its interest charges is the
a. Cash flow coverage ratio
b. Interest coverage ratio
c. Debt service coverage ratio
d. Acid test ratio
306. The starting point of Du Pont chart is
a. Return on equity
b. Return on investment
c. Return on total assets
d. Return on fixed assets
307. Return On Investment (ROI) and Return On Equity (ROE) are exactly 0.25. This indicates that
a. ROE has been calculated wrongly
b. ROI pertains to the previous year
c. The firm has no debt in their capital structure
d. The firm does not pay income taxes
e. Both (c) and (d) of the above.
308. The market value to book value ratio is 2. This indicates that
a. The book value is understated
b. There is heavy speculation in the market
c. The firm has doubled the wealth of the shareholder
d. The net wealth of shareholder is reduced to half
e. Accounts are not being maintained properly.
Part I
57
309. In the Du Pont chart the left apex term is
a. Earnings Per Share (EPS)
b. Return on equity
c. Net profit to total assets
d. Operating profit before interest and taxes to total assets
e. Net profit margin.
310. The use of debt in a project increases ROE if the firm
a. Has more outside liabilities than equity
b. Has more assets than equity
c. Pays more taxes than interest
d. Has an asset turnover more than 2
e. Earns higher return than the rate of interest on debt.
311. Interest coverage ratio of 6 indicates
a. Sales are 6 times of interest
b. Profit after tax is 6 times of interest
c. Profit before tax is 6 times of interest
d. Earning before interest and taxes is 6 times of interest
e. Profit after tax is equal to 1/6 th of interest.
312. In the context of financial statements analysis, cross-sectional analysis involves comparison
between
a. Two divisions of a company
b. Historical and current data
c. A company and its competitor
d. A company and the industry
313. Earning Power measures the
a. Profitability of equity funds invested in the firm
b. Operating performance of the firm
c. Efficiency of production as well as pricing
d. Efficiency of fixed assets employed
e. Efficiency of total assets employed.
314. The current ratio and quick ratio of BCC Ltd. are nearly the same. This suggests that
a. The company has got a sizeable investment in inventory
b. The liquidity position of the company is unclear
c. The company has got a low investment in inventory
d. The quick assets of the company are low
e. The company is a highly profitable one.
315. The leverage ratio used in ROE analysis is
a. Sales ratio
b. Profit margin
c. Total assets to net worth
d. Tangible net worth to total assets
e. Long-term debt to equity ratio.
58
316. Which of the following is/are true with respect to earning power?
a. It measures operating profitability of the firm.
b. It measures the efficiency of the capital employed.
c. It is not influenced by the financial structure of the firm.
d. All of (a), (b) and (c) above.
317. Earnings per share divided by book value is equal to
a. Net worth
b. Return on equity
c. Net profit
d. Net worth/Net profit
e. Reciprocal of return on equity.
318. For assessing the future market value of a company, it is best to depend on
a. Turnover ratios
b. Earnings ratios
c. Efficiency ratios
d. Profitability ratios
e. Liquidity ratios.
319. Dividend yield is equal to
a. Dividend Rate
b. Dividend per share/Face value of the share
c. Dividend per share/Earnings per share
d. Dividend per share/Retained earnings per share
e. Dividend per share/Market value per share.
a. Return on equity.
b. Return on investment.
c. Acid-test ratio.
d. Debt-equity ratio.
e. Debt-asset ratio.
321. In common size analysis the items in the income statement are expressed as percentage of
a. Total assets.
b. Net sales.
c. Total expenses.
d. Gross sales.
e. Total fixed assets.
322. Which of the following ratios indicates the capital structure?
a. Debt-assets ratio
b. Inventory turnover ratio
c. Total asset turnover ratio
d. Return on equity
e. Return on assets.
Part I
59
323. Which of the following ratios indicates the ability of a firm to service the financial charges?
a. Dividend pay-out ratio.
c. Net profit margin ratio.
d. Inventory turnover ratio.
e. Acid test ratio.
324. In which of the following situations, price earnings ratio is applied?
a. To determine the financial risk of a business entity.
b. To determine the expected market value of the shares of a company.
c. To assess the earning potential of a company in the near future.
d. To examine the operational efficiency of a company.
e. To check how efficiently the assets are utilized by a firm.
325. How can a company lower its debt-to-total assets ratio in its capital structure?
a. Borrowing more funds from the market by issuing debentures.
b. Using short-term funds against the fixed assets of longer life.
c. Using long-term funds against the current assets of the company.
d. Planning for a rights issue.
e. Borrowing more funds from the financial institutions.
326. The reserves and surplus at the base year is set at 100 percent whereas for the subsequent
years, it may be less than or more than 100 percent. Which types of analysis is supposed to be
carried out?
a. Cross-sectional analysis.
b. Year-to-year change analysis.
c. Index number trend analysis.
d. Common size analysis.
e. Expected annual income analysis.
327. A cement manufacturing company has a debt-to-equity ratio of 1.6 compared with the
industry average of 1.4. This means that the company:
a. Will never experience any difficulty with its creditors
b. Has more borrowing capacity than the other companies in the industry
c. Will be viewed as having high creditworthiness
d. Has greater than average financial risk when compared to companies in the same
industry
e. Has a better ability to meet its financial commitments towards its stakeholders.
328. High asset turnover ratio indicates
a. Large amount of investment in the fixed assets
b. Large amount of investment in the current assets
c. Large amount of sales value in comparison to total assets
d. Inefficient utilization of the assets
e. High debt-equity ratio.
329. A 15% debenture of face value Rs.100 of 8 years to maturity is trading at a premium of 9%.
Realized amount Rs.95 and tax rate is 40%. What is the yield?
a. 10.21%.
b. 10.44%.
c. 10.76%.
d. 10.54%.
e. 10.12%.
60
330. Which of the following methods of financial statement analysis is based on the inter-
relationships among various components of the financial statements?
a. Common size analysis.
b. Time series analysis.
c. Index analysis.
d. Du Pont analysis.
e. Cross-sectional analysis.
331. In which of the following methods of financial statement analysis, the items in the income
statement are expressed as percentages of total sales?
a. Common size analysis.
b. Time series analysis.
c. Index number trend analysis.
d. Du Pont analysis.
e. Cross-sectional analysis.
Funds Flow Analysis
332. The meaning of fund in funds flow statement is
a. Cash
b. Net working capital
c. Gross working capital
d. Profit
e. Either (a) or (b) above.
333. Which of the following change(s) does/do not appear in a Cash Flow Statement?
a. Issue of equity shares.
b. Conversion of all FCDs into equity shares.
c. Bonus issue of equity shares.
334. Which of the following is true with respect to sources and uses of funds?
a. Depreciation and decrease in NWC are sources of funds.
b. Depreciation and decrease in NWC are uses of funds.
c. Depreciation is a source of fund but decrease in NWC is a use of fund.
d. Depreciation is a use of fund but decrease in NWC is a source of fund.
e. Depreciation and increase in NWC are uses of funds.
a. Depreciation is a use of funds.
b. Increase in liability is a source.
c. Decrease in an asset, other than cash is a use.
d. Increase in bills payable is a use.
e. Increase in equity is a use.
336. Which of the following items represent potential use of funds?
a. Sale of land and building at loss.
b. Dividend proposed and not yet declared.
c. Sale of trade marks and patent rights.
d. Net loss from operations.
e. Amortization of goodwill.
Part I
61
337. Which of the following represents cash from operations?
a. Net profit +non-cash expenses.
b. Net profit +decrease in current liabilities.
c. Net profit +increase in current assets.
d. Net profit.
e. Earnings before interest, depreciation and tax +decrease in current assets.
338. Which of the following is/are true regarding funds flow statement?
a. Amortization of preliminary expenses is a use of funds.
b. Increase in provision for taxation decreases working capital.
c. Cash or credit sales at a profit increases the working capital.
339. Which of the following is a source of fund?
a. Increase in cash.
b. Increase in accrued expenses.
c. Decrease in reserve.
d. Dividend payment.
340. Which of the following is not a use of funds?
a. Increase in Fixed Assets.
b. Buy-back of shares.
c. Decrease in working capital.
d. Increase in depreciation.
e. Both (c) & (d) only.
341. Which of the following is not a benefit of funds flow statement analysis for an organization?
a. Detection of imbalances.
b. Divisional performance appraisal.
c. Evaluation of firms financing.
d. Evaluation of the quality of firms top management.
e. Planning of future financing.
342. Which of the following is not a method of sales forecasting?
a. J ury of Executive Opinion.
b. Sales force estimate.
c. Trend analysis via extrapolation.
d. Ratio analysis.
e. Regression analysis.
343. Which of the following assumptions is true while calculating the external funds requirements?
a. The assets of the firm will increase proportionately to cost of goods sold.
b. Net profit margin will increase at a constant rate.
c. Dividend pay-out ratio and debt-equity ratio will remain constant.
d. External issue of equity will be resorted to.
e. Net profit margin will increase at an increasing rate.
62
344. Which of the following is a source of working capital in a funds flow statement drawn on
working capital basis?
a. Net Income.
b. Dividends.
c. Taxes.
d. Increase in short-term loans.
e. Decrease in receivables.
345. Which of the following is a source of cash in a funds flow statement drawn on cash basis?
a. Dividend payment.
b. Increase in fixed assets.
c. Increase in receivables.
d. Repayment of short-term bank loan.
e. Depreciation.
346. Which of the following is not an item of current liabilities?
a. Sundry creditors.
b. Hire purchase dues.
c. Fixed deposit made for 18 months.
d. Unclaimed dividends.
e. Advances from customers.
347. Which of the following is not a source of funds?
a. Increase in owners equity.
b. Decrease in plant and machinery.
c. Payment of dividends.
d. Decrease in debtors.
e. Sale of investments.
348. Which of the following will not result in an increase in net working capital?
b. Decrease in creditors.
c. Decrease in bank borrowings.
d. Decrease in inventory.
e. Decrease in bills payable.
349. Which of the following is not a source of fund?
a. Increase in share capital.
b. Increase in working capital.
c. Increase in a long-term liability.
d. Increase in profits.
e. Increase in depreciation.
350. An increase in which of the following is considered as a source of funds while preparing
funds flow statement on a working capital basis?
a. Issue of share capital.
b. Increase in working capital.
c. Repayment of a term loan.
d. Purchase of fixed assets.
Part I
63
351. Which of the following appears as a use in a funds flow statement?
a. Taxes.
b. Increase in equity.
c. Increase in long-term loans.
d. Decrease in fixed assets.
e. Decrease in working capital.
352. Which of the following is a use of funds?
a. Decrease in current liabilities.
b. Increase in current assets.
c. Increase in cash.
e. Both (a) and (c) of the above.
a. Increase in profits.
b. Increase in liabilities.
c. Increase in share capital.
d. Increase in assets.
354. Which of the following sources/uses of funds is not considered while preparing funds flow
statement on a working capital basis?
a. Issue of share capital.
b. Payment of dividend.
c. Depreciation.
d. Purchase of fixed assets.
e. Purchase of raw materials.
355. Which of the following increases the cash flow from operations?
a. Increase in debtors.
b. Increase in inventory.
c. Decrease in prepaid expenses.
d. Decrease in income tax paid in advance.
356. Which of the following alternatives result(s) in an increase in working capital?
a. Issue of bonus shares.
b. Issue of equity shares.
c. Conversion of debentures to equity.
357. Which of the following can be considered as a use of cash?
a. Increase in provisions.
b. Increase in prepaid expenses.
c. Increase in taxes due, but not paid.
d. Decrease in investments.
e. Decrease in current assets.
64
358. Which of the following is not shown by a funds flow statement on cash basis?
a. The sources of cash.
b. The uses of cash.
c. Decrease in cash .
d. The net change in working capital.
e. Increase in cash.
359. Which of the following is true with respect to funds flow statement of a company?
a. It helps to judge the quality of management.
b. It shows whether the ownership pattern of the business entity has been changed.
c. It cannot be manipulated by the unscrupulous promoters.
d. It fails to identify the operational ineffectiveness in a business entity.
e. It identifies whether short-term fund is used for the procurement of long-term asset.
360. Which of the following statements shows the source of funds while making funds flow
analysis on total resources basis?
a. Retirement of high cost debt.
b. Installation of a capital asset.
c. Conversion of debentures into equity shares.
d. Selling an old car today in order to buy a new one after three months.
e. Buying back the equity shares.
361. Which of the following is not a source of fund in a funds flow statement on cash basis?
a. A gross decrease in fixed assets.
b. A gross increase in fixed assets.
c. A net increase in current liabilities.
d. Sale of any fixed asset.
e. Funds from the operations.
362. Which of the following is not a use of funds flow analysis for an organization?
a. Planning for the future financing strategy.
b. Identification of imbalances with respect to the sources and uses of funds.
c. Divisional performance appraisal.
d. Assessment of the firms financing.
e. Assessment of the market leadership for the products of the company.
363. Which of the following statements is/are true with respect to funds flow statement?
a. It shows the changes in the ownership patterns of the company.
b. It shows the sources and uses of funds at any particular date in a year.
c. It can be considered as a snapshot picture for the operations of the business.
d. It cannot be manipulated by means of window dressing.
e. It indicates how the business financed its fixed assets.
364. A funds flow statement is also known as
a. Balance sheet
b. Profit and loss statement
c. Income statement
d. Proforma statement
e. Statement for the changes in financial position.
Part I
65
Leverage
365. Degree of total leverage can be applied in measuring change in
a. EBIT to a percentage change in quantity
b. EPS to a percentage change in EBIT
c. EPS to a percentage change in quantity
d. DFL to a percentage change in DOL
e. Quantity to a percentage change in EBIT.
366. DFL becomes zero when
a. The firm does not have to pay any tax
b. EBIT is just equal to the sum of interest and dividend components
c. The firm does not earn any operating profit
d. The interest component equals the preferred dividend
e. DFL will never become zero.
367. The firm is now operating at the BEP. Then
a. The DTL will increase if the quantity produced increases
b. The DTL will be negative if the quantity increases
c. The DTL will start decreasing as the quantity increases
d. The DTL will not be affected by quantity unless the fixed costs also change
e. The DTL at the BEP is undefined.
368. The measure of business risk is
a. Operating leverage
b. Financial leverage
c. Total leverage
d. Working capital leverage
e. Debt-equity ratio.
369. The value of EBIT at which EPS is equal to zero is known as
a. Break even point
b. Financial break even point
c. Operating break even point
d. Overall break even point
370. Which of the following is not a leverage ratio?
a. Debt-asset ratio.
b. Debt-equity ratio.
c. Debt service coverage ratio.
d. Fixed charges coverage ratio.
e. Bank finance to working capital gap ratio.
371. Degree of financial leverage is a measure of relationship between
a. EPS and EBIT
b. EBIT and quantity produced
c. EPS and quantity produced
d. EPS and sales
e. EPS and interest payment.
66
372. Operating leverage examines
a. The effect of the change in the quantity on EBIT
b. The effect of the change in EBIT on the EPS of the company
c. The effect of the change in output to the EPS of the company
d. The effect of change in EPS on the output of the company
e. The effect of change in EPS on the EBIT of the company.
a. Each level of EBIT has a distinct DFL.
b. DFL is undefined at financial breakeven point.
c. DFL will be negative when the EBIT level goes below the financial breakeven point.
d. DFL will be positive for all values of EBIT that are above the financial breakeven point.
e. DOL (Degree of Operating Leverage) is undefined at level of output below the financial
breakeven point.
374. Which of the following is the expression for operating leverage?
a. Contribution/EBIT.
b. EBT/Contribution.
c. Contribution/EAT.
d. Quantity/EBIT.
e. Contribution/Quantity.
375. Which of the following statements regarding Degree of Financial Leverage is false?
b. DFL is undefined at financial break-even point.
c. DFL is negative when EBIT is below financial break-even point.
d. DFL starts declining as EBIT increases.
e. With the help of DFL one can understand the impact of the change in output on EBIT of
the company.
a. Degree of Total Leverage (DTL) measures the changes in EPS to a unit percentage
change in EBIT.
b. DTL measures the total risk of the company.
c. DTL measures the variability of EBIT for a given error in forecasting the total quantity sold.
d. The sum of operating and financial leverage is called total leverage.
e. The DTL is equal to one at the overall break-even point of output.
377. If the degree of operating leverage is 2 and the degree of financial leverage is 1.5, it means that
a. 1% change in sales will result in 1.5 percent change in EBIT
b. 1% change in EBIT will result in 2% change in EPS
c. 1% change in EPS will be caused by 3.5% change in sales
d. 1% change in EPS will be caused by 3% change in EBIT
e. 1% change in sales will result in 3% change in EPS.
378. If DOL represents degree of operating leverage and DFL represents degree of financial
leverage, degree of total leverage can be defined as
a. DOL +DFL
b. DOL DFL
c. DOL DFL
d. DOL/DFL
Part I
67
379. Which of the following statements is false about financial leverage?
a. It measures the effect of change in EBIT on the EPS.
b. Each level of EBIT has a distinct DFL.
c. At financial break even point DFL is zero.
d. If EBIT is less than the financial break even point, DFL will be negative.
e. If EBIT is more than the financial break even point, DFL will be positive.
380. Which of the following statements is true if the Degree of Financial Leverage (DFL) of a firm
is zero?
a. The firm does not pay preference dividend.
b. The firm does not pay taxes.
c. The firm does not pay interest.
d. The EBIT of the firm is zero.
381. Which of the following is/are true regarding the Degree of Operating Leverage (DOL)?
a. Each level of output has a unique DOL.
b. DOL is undefined at operating break even point.
c. DOL is positive beyond the operating break even point.
382. If we observe the behavior of DOL, in general, we find the following
a. Unique DOL for each level of output.
b. DOL is well defined at operating break even point.
c. DOL is positive beyond the operating break even point.
383. Operating Leverage is the response of changes in
a. EBIT to the changes in sales
b. EBIT to the changes in selling price
c. EPS to the changes in EBIT
d. Production to the changes in sales
384. Operating Leverage
a. Exists because of the presence of fixed expenses like interest payments
b. Measures the responsiveness of earnings per share to variability in earnings before
interest and taxes
c. Is undefined at the operating break even point
d. All of the above
385. The operating break even point
a. Is that point below which the degree of financial leverage is negative
b. Is that quantity produced and sold at which the profit after tax is zero
c. Is that value of earnings before interest and taxes at which earnings per share is zero
d. Is that quantity produced and sold at which the profit before interest and taxes is zero
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386. The use of preference share capital as against debt finance
a. Reduces DFL
b. Increases DFL
c. Increases financial risk
d. Has no effect on either financial risk or financial leverage
387. Which of the following is true of the Degree of Operating Leverage (DOL)?
a. DOL is negative beyond the operating break even point, implying that an increase in the
quantity sold leads to a decrease in EBIT.
b. DOL is positive beyond the operating break even point and as the level of quantity
increases, DOL will also increase.
c. DOL is undefined at the operating break even point.
388. When the firm changes the technology leading to increase in fixed costs, it
a. Increases DOL
b. Decreases DOL
c. Decrease operating break even point
d. Loses all abandonment value
e. Decreases DFL.
389. The Degree of Financial Leverage (DFL)
a. Measures financial risk of the firm
b. Is zero at financial break even point
c. Increases as EBIT increases
d. Is undefined below financial break even point level
390. Operating leverage measures the sensitivity of the ____________ to changes in quantity.
a. Earnings per share
b. Profit after tax
c. Earnings before interest and taxes
d. Profit before tax
e. Dividend per share.
391. If Degree of Financial Leverage (DFL) becomes zero, then
a. The firm does not pay preference dividend
b. The firm does not pay taxes
c. The firm does not pay interest
d. The firm does not earn any operating profit
392. The degree of operating leverage below the operating break even point will be
a. 1
b. 0
c. Less than zero
d. Either (b) or (c)
e. Undefined.
Part I
69
393. If the output is less than the operating break-even point, then the degree of operating leverage
will be
a. Greater than 1
b. Less than 1
c. Equal to Zero
d. Less than Zero
394. Which of the following is true with regard to the Degree of Operating Leverage (DOL) for a
company?
a. Irrespective of the level of output, DOL of a company remains same.
b. DOL of a company is positive above the operating break-even point.
c. DOL of a company is positive below the operating break-even point.
d. DOL of a company is negative above the operating break-even point.
e. DOL is zero at the operating break-even point.
395. Which of the following is true with regard to the Degree of Financial Leverage (DFL)?
a. DFL helps to measure the business risk of any corporate entity.
b. DFL can be used to analyze the implications of retiring debts by using the proceeds of
preference capital.
c. DFL is applied by a corporate house for its production and sales planning.
d. DFL is used to estimate the revised EPS following a change in sales volume.
e. DFL is used assess the change in EBIT owing to any change in sales volume.
396. At operating break-even point, which of the following is true?
a. Sales revenue just covers the fixed cost.
b. Sales revenue is just equal to the variable cost.
c. Fixed cost is same as that of the variable cost.
d. EBIT is zero.
e. EBIT is positive.
397. Other things remain the same, what will be the impact on the Degree of Operating Leverage
(DOL) of a firm, if it issues equity shares in lieu of debentures?
a. DOL will increase.
b. DOL will decrease.
c. DOL will remain the same.
d. DOL will become zero.
e. Cannot be predicted.
398. Which of the following results from the early repayment of the debenture capital by a firm?
a. The degree of operating leverage increases.
b. The degree of operating leverage decreases.
c. The degree of financial leverage increases.
d. The degree of financial leverage decreases.
e. The degree of total leverage remains unchanged.
70
399. If the degree of total leverage of a firm is zero, then which of the following statements will
always be valid?
a. The firm does not produce and sale any output.
b. The firm does not have any interest burden in a strict sense.
c. The firm has never issued any preference share.
d. The firm does not bear any fixed cost burden.
e. The contribution is zero.
400. Which of the following is true with respect to the Degree of Operating Leverage (DOL)?
a. DOL is same for any level of output of the firm.
b. DOL is well defined at the operating break-even point.
c. DOL measures the business risk of a company.
d. DOL assesses the impact on the profitability of the company against the changes in the
interest rate.
e. Using the concept of DOL, one may judge the possibility of committing default by a
company with respect to the payment of interest.
401. If a company appoints a number of skilled managers with a very high amount of
compensation package, which of the following conditions may occur immediately after the
appointment?
a. The operating break-even point of the company will come down.
b. The company will be able to reach the financial break-even point easily.
c. The degree of operating leverage will be zero.
d. The degree of total leverage will reduce to zero.
e. The degree of total leverage will increase.
402. What will be impact on the operating leverage of a firm, if it proceeds for additional borrowings?
a. It will increase.
b. It will decrease.
c. It will remain unchanged.
d. It will increase or decrease depends on the cost of borrowings.
e. Cannot be analyzed.
403. The major assumption in trend analysis via extrapolation is
a. The erratic movements which occurred in the previous years will reoccur in the coming years
b. Sales for the coming period will increase by the average growth rate of the concerned
industry
c. Sales for the coming period will change to the same degree as sales changed from the
prior period to the current period
d. Sales in the coming period will increase by the general economic growth rate, after
adjusting for the erratic events
404. Sustainable growth rate refers to the rate
a. Which can be maintained without resorting to external finance
b. The firm uses for its internal purposes like project appraisal, etc.
c. Which can be maintained only with external borrowing
d. By which the firm expects its sales to increase in the coming years
e. By which the assets of the firm have been increasing in the past several years.
Part I
71
405. The credit extended by the suppliers of goods and services is
a. Long-term sources of finance
b. Short-term sources of finance
c. Spontaneous source of finance
406. The starting point of the financial forecasting exercise is the
a. Sales forecast
b. Forecast of labor cost
c. Forecast of material cost
d. Forecast of operating expenses
e. Cash flow statement.
407. The percent of sales method of financial forecasting assumes that
a. The future relationship between the manufacturing costs only and sales will be similar
to their historical relationship
b. The future relationship between the selling and administrative costs only and sales will
be similar to their historical relationships
c. All the cost elements change by the same percentage as the change in sales
d. All the cost elements will bear the same relationship with sales as in the past
e. Only the variable cost elements will bear the same relationship with sales as in the past.
408. The starting point in the preparation of pro forma income statement is the projection of
a. The amount of sales for the next year
b. The amount of raw material to be purchased in the next year
c. The quantum of product to be manufactured in the next year
d. Anticipated EPS for the next year
409. Which of the following is not an objective method of sales forecasting?
a. Sales force estimates.
b. Extrapolation and trend analysis.
c. Regression analysis.
d. Sustainable growth rate.
410. Which of the following is/are objective method(s) of sales forecasting?
a. J ury of executive opinion.
c. Market survey.
d. Regression analysis.
411. Given that all the other factors are constant, the external funds requirement is
a. Directly related to growth rate of sales
b. Inversely related to growth rate of sales
c. Inversely related to dividend pay-out ratio
d. Directly related to net profit margin ratio
e. Cannot be determined with certainty.
72
412. The basic assumption in percent of sales method for preparation of pro forma income statement is
a. Similar relationship between future costs and sales to their historical relationship exists
b. Cost elements are unchanged
c. Sales increase by ten percent
413. Which of the following methods is preferred to prepare pro forma income statement?
a. Percent of sales method.
b. Budgeted expense method.
c. Combination of above two methods.
d. Time series projection method.
414. Which of the following is not a subjective model of sales forecasting?
a. Trend analysis.
b. Sales force estimates.
d. (a) and (c) only.
415. Growth with internal equity will increase with the
a. Increase in debt ratio
b. Decrease in dividend pay-out ratio
c. Decrease in profit margin
d. Increase in assets to sales ratio
416. The growth rate of sales that can be sustained by a firm without raising external equity
increases with
a. An increase in net profit margin
b. A decrease in the debt to equity ratio
c. A decrease in the retention ratio
d. An increase in the assets to sales ratio
417. Which of the following is not an assumption for estimating the sustainable growth rate?
a. The assets of the firm will increase proportionately with the increase in sales .
b. The company will maintain the same capital structure.
c. The profitability of the company will remain same.
d. The company will pay the same amount of dividend.
418. While preparing proforma financial statement by using budgeted expense method,
a. The method of extrapolation is applied to assess the total expenses of the company in
proportion to increase in sales
b. The items related to various expenses are projected on the basis of the anticipated changes
c. The future cost-sales ratio is assumed to be prevailed as per historical relationship
d. A regression equation may be framed to project the costs during the future years
e. All the expenses are increased by a fixed percentage.
Part I
73
419. Which of the following is/are subjective method(s) of sales forecasting?
c. Regression Method.
d. Time Series Projection Method.
420. Calculate the DTIL from the following information
Quantity sold =6,000 Units
S.P/Unit =Rs.500
Variable Cost/unit =Rs.200
Fixed Expenses =Rs.8,00,000
Interest =Rs.80,000
Preference Dividend =Rs.60,000
Tax rate =40%
a. 2.119
b. 3.416
c. 2.195
d. 2.519
e. 2.159.
421. In relation to the preparation of the proforma income statement by using budgeted expense
method,
a. The future relationship between various costs to sales is assumed to follow historical
relationship
b. The estimation of the various items are made on the basis of the expected developments
c. A extrapolation using trend analysis is always made to assess the total expenses of the
company
d. A regression equation is always modeled to project the amount of future expenses

Part I: Answers on Basic Concepts (with Explanatory Notes)
1. (c) The financial goal of any firm including public sector firms is to maximize the wealth of
the shareholders by maximizing the value of the firm.
2. (e) Ensuring discipline in the organization is a function of human resource management.
3. (d) The objective of a finance manager will be to maximize the wealth of the owners by
increasing the value of the firm which is reflected in the Earnings Per Share (EPS) of the firm
and the market price of the shares. He does not manipulate the share price of the company.
4. (e) Decision making in order to achieve the objectives in all areas of management including
financial management involves the balancing of the trade-off between risk and return.
5. (c) Analysis of variance between the targeted costs and the actual costs incurred is related to
control because it helps management to take timely corrective action to ensure the planned
results are achieved.
6. (c) According to Section 3(1)(iii) of Companies Act, 1956 the minimum number of persons
required to form a private and public limited company are 2 and 7.
7. (d) The advantages of sole proprietorship are (i) easy and inexpensive set up. (ii) Few
governmental regulations and (iii) no firm tax.
8. (d) Partnership firm is a business owned by two or more persons. They are partners in
business and they bear the risks and reap the rewards of the business. A partnership firm is
governed by the Indian Partnership Act, 1932. Hence it is relatively free from governmental
regulations as compared to the joint stock companies.
9. (c) The objective of financial management is to increase the wealth of the owners by
increasing the value of the firm, which is reflected in the EPS of the firm and the market
price of the shares.
10. (e) An optimal capital structure can satisfy the return expectations of the stakeholders at a
lower cost that will result in share price of the company to a healthier one. It is a financing
decision. While the cases mentioned in the other alternatives are the investment decisions as
these may bring return to the company over a period of time.
11. (a) The amount that a company can realize if it sells its business as an operating one is called
going concern value. Replacement value indicates the value that a company would be
required to spend if it were to replace its existing assets in the present situation. Liquidation
value is the amount that a company could realize by selling its assets following the
termination of its business. Market value of an asset is the current market price at which it
may be sold or bought in the market.
12. (b) The liquidity function of the financial system facilitates conversion of investment in stocks,
bonds etc., into money. Savings function leads to the flow of savings from the savers to the
consumers of an economy while payment function facilitates the payment of dues in an easy
and convenient way. Risk function provides the required tools for the protection against life,
health and income risks whereas policy function enables the regulating authorities of a country
to take suitable policy measures to influence the policy variables in the macro-economy.
13. (b) According to the objective of financial management to increase the wealth of the
shareholders means to increase in the market value of the shares issued by the firm. Increasing
the physical assets or current assets of the company may not provide adequate returns to the
shareholders, if it is done through incremental borrowing. Increasing cash balance imparts more
liquidity to a company but decreases the returns on investments. Increase in the total number of
outstanding shares of the company does not make any impact on the total value of the firm.
14. (e) All the functions as specified in the given options are the salient functions of a finance manager.
15. (e) Financial assets represent a claim to the payment of a sum of money sometime in the
future and/or periodic payment in the form of interest or dividend.
16. (e) The call money loans are of short-term in nature with maturity period of 1-15 days. Any
amount can be lent or borrowed at a convenient interest rate, which is acceptable to both the
borrower and the lender. These loans are highly liquid, as they are repayable on demand.
Part I
75
17. (d) The National housing bank is set up in J uly, 1988 as an apex level housing finance
institution as a wholly owned subsidiary of the RBI.
18. (a) Single window lending refers to an arrangement by which the lead bank in a consortium
of banks releases the initial requirements of the borrower and also takes documentation on
behalf of all the banks.
19. (b) Commercial paper is an unsecured, short-term promissory note issued mainly by
companies, mostly on the discount basis whereas certificate of deposit is a title to a time
deposit with a commercial bank, which can be negotiated. All the scheduled banks, other
than regional rural banks and scheduled co-operative banks are eligible to issue CDs.
20. (d) The money that is lent for one day in call money market is known as call money and if it
exceeds one day (but less than 15 days) is referred as notice money.
21. (e) Gilt-edged securities are securities issued by the Government of a country for which
repayments of principal as well as interest are totally secured, being first charge on the
nations purse.
22. (a) DFHI was established as a company under the Companies Act 1956, to provide liquidity
to money market instruments by creating a secondary market where they can be traded.
23. (c) Issue management is a function related to issue of securities and does not involve any
fund-based activity.
24. (a) The minimum maturity period for a certificate of deposit is 15 days.
25. (b) Statutory Liquidity Ratio is the percentage of reserves banks are required to maintain
specified reserves in the form of government securities, specified bonds and approved
securities.
26. (c) Public debt in the economy is being managed by RBI.
27. (c) In a bought out deal a company, initially places its equity shares, with a sponsor/
merchant banker who in turn offloads the shares at the appropriate time, by offering to the
public at a later date. Bought out deals come to the rescue of promoters of small projects.
28. (c) The Volume of trading is more than that of BSE.
29. (d) There is a fairy large secondary market for PSU bonds. The market lot for PSU bonds for
the purposes of trading is a minimum of Rs.5 crore. Such investments come under approved
investments.
30. (b) In unit banking system, the bank conducts its overall operations from a single office.
31. (d) The functions performed by a financial system are savings function, payment function,
liquidity function, risk function and policy function.
32. (c) The maturity period for the certificate of deposits issued by a bank is not less than 15 days
and not more than 12 months.
33. (a)Limit order is an order fixed by a fixed price. It may or may not include brokerage.
34. (d) Securities issued by the central Government are usually referred to as `gilt-edged
securities as repayments of principal as well interest are totally secured, being first charge on
the nations purse.
35. (e) Long dated Government securities have maturities exceeding 10 years from the issue date,
medium dated securities have maturities ranging from 5-10 years.
36. (a) There are 5 types of T-bills based on the maturities. 14 days, 28 days, 91 days, 182 days,
364 days. However, at present (since May, 2001) there are only two types of treasury bills
issued by the government, 91 days and 364 days.
37. (d) Presently, in the secondary capital market, delivery and payment has to take place within
two days from the date of contract.
38. (b) Primary market creates long-term instruments through which corporate entities borrow
from capital markets. Companies in order to meet the financial requirements of its projects
raise capital through issue of securities in the primary market.
39. (d) According to Section 3 of Companies Act, 1956 the min and max members permissible in
a private company are 2 and 50 respectively.
76
40. (e) Banks borrow in call money market to:
i. Fill the temporary gaps, or mismatches that arise, as the banks normally lend out
the deposits they mobilize.
ii. Meet the cash reserve ratio requirements, which they should maintain with the RBI.
iii. Meet sudden demand for funds, which may arise due to large payments and
remittances.
41. (a) Commercial papers are short-term, unsecured promissory notes issued at a discount to
face value by well-known companies that are financially strong and carry a high credit rating.
42. (c) Debentures are long-term instruments which are issued in the capital markets.
43. (b) Private placement market financing is a direct sale by a public limited company or a
private limited company of its securities to a limited number of sophisticated investors like
UTI, LIC, GIC, etc., through investment bankers. Private placement can be made out of
promoters quota but it cannot be made with unrelated investors.
44. (d) In stop loss order a particular limit is given for sustenance of loss. If the price falls below
that, broker is authorized to sell immediately to stop further occurrence of losses.
45. (b) The minimumamount to be invested by a single investor is Rs.5 lakh in a commercial paper.
46. (b) Bonus shares are shares issued by companies to their existing shareholders in the ratio of
existing shares from profits in lieu of dividends. The shareholders do not have to make any
additional payment for these shares.
47. (e) When the client does not fix any time or price limit for execution of order, it is called an
open order.
48. (e) CDs are issued in multiples of 1 lakh subject to the minimum size of each issue of
Rs.5 lakh.
49. (c) Bonus shares are shares issued by companies to their existing shareholders in the ratio of
existing shares from profits in lieu of dividends. The shareholders do not have to make any
additional payment for these shares.
50. (e) All the given alternatives are major categories of investors in primary market of
government securities.
51. (a) Savings deposits, demand and time deposits from other banks and refinance from
NABARD liabilities of a bank as the bank owes to somebody.
52. (e) The National housing bank is set up in J uly, 1988 as an apex level housing finance
institution as a wholly owned subsidiary of the RBI. It extends refinance to all the above.
53. (a) As per the new guidelines on money market mutual funds, the minimum lock-in period is
reduced to nil from 15 days (earlier 30 days).
54. (a) Call money, Treasury bills, Commercial paper, Certificates of deposits are all money market
instruments where the function of money markets is to channel savings into short-termproductive
investments like working capital. A corporate debenture is a capital market instrument.
55. (b) Commercial papers are issued in multiples of 5 lakh.
56. (d) In a bought out deal a company, initially places its equity shares, which are offered to the
public at a later date to a sponsor/ merchant banker who in turn offloads the shares at the
appropriate time. Bought out deals come to the rescue of promoters of small projects. They
cannot be bought back by the company.
57. (d) As per the latest guidelines, if any private or public sector company wants to raise money
through CP market, its fund based working capital limit should not be less than 4 crore, and
tangible net worth not less than 4 crore as the latest audited statement.
58. (d) In a bought out deal a company, initially places its equity shares, which are offered to the
public at a later date to a sponsor/ merchant banker who in turn offloads the shares at the
appropriate time. Bought out deals come to the rescue of promoters of small projects.
59. (d) Financial asset represents a claim to the payment of a sum of money sometime in the
future/or periodic payment in the form of interest. Bullion is not a financial asset as it does
not meet the above requirements.
60. (c) IDBI finances industries directly and also support State Financial Corporations and State
Industrial Development corporations by providing refinance and through the bills
rediscounting scheme.
Part I
77
61. (d) Cash credits and overdrafts are running accounts, from which the borrower can withdraw
funds as and when needed up to a credit limit sanctioned by his banker. Cash credit is given
against the security of commodity stocks, ODs are allowed on personal or on joint current
accounts.
62. (c) Convertible debenture is a capital market instrument.
63. (b) No prior approval of RBI is needed for CP issues; minimum size of CP issue is 5 lakh.
CPs are purely unsecured as they are backed by the credit of the issuing company; they are
issued in multiples of 5 lakhs. Underwriting of CP is not mandatory.
64. (e) The call money market forms a part of the national money market, where day-to-day
surplus funds, mostly of banks are traded.
65. (b) Treasury bills are short-term instruments issued by the government to tide over short-term
liquidity shortfalls. The RBI acts as an agent for issuing the T-bills and it issues them either
by tender or by tap.
66. (a) CRISIL is a rating agency, which rates equity, debentures and fixed deposits. Equity
rating has not picked up in India.
67. (e) Call loans, Commercial papers, Certificates of deposits, Treasury bills are all short-term
money market instruments.
68. (b) Direct assistance is provided All India financial institutions by subscribing to the
companys shares.
69. (b) The Industrial Development bank of India is an apex financial institution to coordinate the
functioning of all other financial institutions.
70. (d) Options (a) to (c) were objectives of Nationalization of Banks but not option (d).
71. (c) As per the guidelines laid by the RBI a private bank will be governed by the provisions of
RBI Act, 1934, and the banking regulation Act, 1949 and other relevant statutes.
72. (e) All the given alternatives are reasons for low profitability of commercial banks.
73. (e) Securities issued by the Central Government are called Gilt-edged securities.
74. (c) The RBI fixes interest rates in the organized sector, based on the market.
75. (a) CDs are freely transferable by endorsement on delivery, they are issued at discount rate
freely determined by the issuing bank and the market, or carry a coupon rate, they are issued
by scheduled banks excluding RRBs, they have fixed maturity ranging from 15 days to
1 year for banks 1-3 years for financial institutions and they have no secondary market.
76. (a) A deep discount bond does not carry any coupon rate but is issued at a steep discount over
its face value. It is also referred to zero coupon bond. The Industrial Development Bank of
India issued deep discount bonds in 1996 which have a face value of Rs.2 lakh and a maturity
period of 25 years. The bonds were issued at Rs.5,300.
77. (e) The changes in the banking structure through nationalization has resulted in all the above.
78. (d) The financial institution provides indirect financial assistance to industrial units by
providing underwriting facility, guarantee for foreign currency loans, guarantee for deferred
payment, etc.
79. (b) Money market deals with short-term instruments with the objective of meeting the
working capital requirements. Certificate of deposit is a money market instrument.
80. (b) Investing in real assets with positive net present values is an optimum decision in well
developed capital markets.
81. (b) Money market deals with all transactions in short-term instruments with a period of
maturity of one year or less whereas capital markets deal market deals with transactions
related to long-term instruments with a period of maturity of above one year.
82. (e) The role of underwriters is restricted to only the primary market.
83. (a) Call money market is a very short-termmarket with maturity period ranging from1-15 days.
84. (e) As per the latest audited statement corporates, primary dealers, satellite dealers and all
India Financial Institutions are eligible to issue commercial paper. The minimum net worth
required is Rs.4 crore, the minimum credit rating is P-2 and there is no maximum discount
rate prescribed.
78
85. (a) There are 5 types of T-bills based on the maturities. 14 days, 28 days, 91 days, 182 days, 364
days. However, only 91 days and 364 days treasury bills are issued in India since May, 2001.
86. (c) The interest rate on call loan is largely subjected to be influenced by the forces of supply
and demand for funds. The money that is lent for one day in call money market but not for
more than 15 days is referred as notice money.
87. (c) In a bought out deal a company initially places its equity shares, which are to be offered
to the public at a later date, to the sponsor / merchant banker, who in turn offloads the shares
at the appropriate time. A company proposing to place its securities through this route can
price its securities to reflect the intrinsic value.
88. (e) The maximum number of persons can form a private limited company are 50.
89. (a) Merchant banks are generally engaged in several services like, management, underwriting
and marketing of new issues; project promotion services and project finance; syndication of
credit and other facilities; leasing including project leasing; corporate advisory services; etc.
These services are generally not useful for the retail investors. While the other entities as
mentioned in the other alternatives generally deal with the retail investors for raising funds
from them as well as for lending to them.
90. (d) A term deposit made by a depositor is held for a specific term or maturity with a bank as
mutually agreed by both the parties; it is not marketable. All other instruments as mentioned
in the other alternatives are marketable instruments in the money market.
91. (a) Primary capital markets help in the creation of new long term securities. These long term
securities are issued by the companies to raises funds for meet their long term financing
requirements. It neither helps for trading with the outstanding long term as well as the short
term securities. But it allows the FII to invest in the Indian capital markets.
92. (e) In rights issue as well as bonus issue, new securities are offered to the existing
shareholders of the company on the ratio of existing shares held by the investors i.e. on a pro
rata basis. But in public issue, the shares are directly issued to the general public while in
private placement; the securities are issued to few selected entities as decided by the
management of the company.
93. (e) Since, in a bought-out-deal, the shares are initially offered to the sponsor and the sponsor
has the discretion to offload the shares to the public at an appropriate time in future as per the
discretion of the sponsor. The sponsor may exploit the situation where the promoter of the
company may be in the dire need for funds by offering a substantially low price and may also
misuse its discretion to divest the shares in favor of the public. All these facts may affect the
interests of the promoters of the company. The points as stated in the other options are not
correct with respect to bought out deals.
94. (b) Venture capital funding companies generally provide risk capital to the technology
oriented and high risk business entities. Lease finance companies allows their customers to
use the capital as per the terms of the leases while hire purchase companies allows their
clients to procure the capital assets against the payment of the regular hire rentals.
Commercial banks are engaged in the business of raising funds mainly through deposits and
lending the same while insurance companies undertake the pure risks of their clients against
the payment of the upfront premium.
95. (b) The characteristics of the money market instruments are the short term maturity and easy
liquidity. These are generally issued by the government union as well as the state, Public sector
enterprises, banks and financial institutions, reputed corporate entities fromthe public sector as
well as the private sector, etc. The CPs issued by the private companies are not at all secure one.
96. (d) The volatility in the call money market increases with the reduction of the liquidity in the
market. It generally comes down with the following reasons:
Increase in Cash Reserve Ratio (CRR)
Larger amount borrowed by several borrowers following an increase in demand for the
loanable funds
Withdrawal of funds by the banks and financial institutions suddenly to meet their
respective corporate requirements
Payment of a large amount of advance taxes by the banks and FIs will lead to the reduction in
liquidity in the system thereby increases the volatility in the call money market. Hence, the
option (d) is the answer.
Part I
79
97. (d) The options (a) and (b) represent the acts of hedgers who are interested to minimize their
risk in a volatile market. The option (c) represents the act of the speculators who wants to
make profits from the price movements in a volatile market through speculation. The option
(d) represents the act of the arbitrageurs who take the opportunity of improper pricing in
different markets and imparts a better efficiency in the system.
98. (a) A public limited company is said to be in a significant advantage owing to its limited
liability. If the company turned to an insolvent one, the members dont have any further
liability to bail out whereas in a proprietorship firm, the liability of the owner is unlimited.
However, for a public limited company, the ownership can be easily transferred and
resources can be mobilized with a unlimited life. But for a proprietorship company, these
advantages are not available to a proprietorship company
99. (c) Inter Corporate deposits are not traded in the market. The instruments as mentioned in the
other options are traded in the respective financial markets.
100. (a) Primary market allows the corporate houses to raise long term funds by issuing new
securities like, shares equity and preference as well as debentures. The venture capital
funding companies generally dilute their stakes in a company by selling their holdings in any
company to the investors through secondary capital market route.
101. (a) Financial Intermediation function encourages the household sector to save money through
the various channels in the financial system like, banks, insurance companies, capital
markets, etc. These funds are ultimately channelised to the productive sector that needs
money. The other functions do not play any role in this context.
102. (d) The long term financial instruments equity shares, preference shares and debts - are
traded in the secondary market that have been issued earlier. Primary capital market allows
the corporate houses to raise the long term capital by issuing new securities. Money market
and forex market deal with the short term debt instruments and the transactions related to the
foreign exchange respectively. So, the option (d) is the answer.
103. (e) All of (a), (b) and (c) are included in the regulatory framework.
104. (e) The word Gilt edged securities signifies the government securities that can be issued
only by the government central as well as state.
105. (e) Long dated government securities have maturities ranging from 10 to 30 years
106. (d) In a private limited company, the maximum number of members is limited to 50 only.
107. (a) Foreign Exchange Regulation Act, 1973 has been replaced by Foreign Exchange Management
Act, 2000 in order to facilitate the external trade and payments as well as to promote an orderly
maintenance of the foreign exchange market in India. So, the option (a) is correct.
Time Value of Money
108. (d) The future value of a single cash flow compounded annually is given as FV =PV (1 +k)
n

and the present value of a sum (FV
n
) receivable after n years at a rate of interest k is given as
PV =FV
n
/(1+k)
n
. Hence present value interest factor is the reciprocal of future value
interest factor.
Capital recovers factor
FVIF x
1
PVIFA
=(1 +k)
n
x
n
k
(1+k) 1
=
n
n
k(1+k)
(1+k) 1
=
1
PVIFA

109. (a)
PVIF =
n
1
(1+k)

FVIF =(1 +k)
n

FVIFA =
n
(1+k) 1
k

80
CRF =
n
n
(1+k)
(1+k) 1

Product of the above
n n
n
n n
1 (1+k) 1 k(1
x(1+k) x x
k (1+k) (1+k) 1

+k)

=(1 + k)
n
=FVIF.
110. (b) Nominal or market rate of interest =Real rate of interest +Expected rate of inflation +
Risk premiums to compensate for uncertainty.
111. (a) The accurate doubling period n given a rate of return R, of an amount A will be
A x FVIF
(r, n)
=2A =(1 +R)
n
=2.
112. (e) Sinking fund represents the amount that has to be invested at the end of every year for a
period of n years at the rate of interest k, in order to accumulate Re.1 at the end of the period.
It is given by k/(1 +k)
n
1.
113. (d) The generalized for shorter compounding periods is given as
FV
n
= PV (1 +k/m)
mxn

Where,
FV
n
= future value after n years
PV = cash flow today
k = nominal rate of interest
m = number of times compounding is done during a year
n = number of years for which compounding is done
114. (a) Manipulating the relation between PVA
n
, A, k and n we get the equation:
A =PVA
n
{k (1 +k)
n
/ (1 +k)
n
1}
Where {k (1 +k)
n
/(1 +k)
n
1} is known as the capital recovery factor.
115. (c) Capital recovery factor is the inverse is PVIFA.
116. (d) Effective rate of interest is the rate of interest per annum under annual compounding that
produces the same result.
117. (d) When an investment pays only simple interest, it means that interest is paid only on the
original investment as simple interest is calculated as a percentage of rate of interest on the
original amount.
118. (d) Cash flows obtained in various periods can be compared only after discounting each one
to a common date.
119. (c) The expression k / (1 +k)
n
1 is called the sinking fund factor which is the reciprocal of
the future value interest factor annuity.
120. (e) The present value of annuity A receivable at the end of every year for a period of n years
at a rate of interest k is equal to
PVA
n
=A x PVIFA

k, n
Where, PVIFA is called the present value interest factor annuity and is given as
{(1 +k )
n
1/ k ( 1 +k )
n

}.

n
n
FVIFA (1 k) 1 1
x PV
FVIF k (1 k)
+
= =
+
IFA
FVIFA x PVIF =
n n
n n
(1 k) 1 1 (1 k) 1
x P
k (1 k) k(1 k)
+ +
= =
+ +
VIFA
FVIFA x PVIF =PVIFA
Part I
81
121. (c) The general relationship between effective and nominal rate of interest is given by
r =(1 +k/m)

m
1
Where,
r =effective rate of interest
k =nominal rate of interest
m =frequency of compounding per year
Hence effective interest rate is always more than or equal to nominal interest rate.
122. (e) Money has time value because in an inflationary period, a rupee today has a higher
purchasing power than a rupee in the future, money can be employed productively to
generate real returns and since future is characterized by uncertainty, individuals prefer
current consumption to future consumption.
123. (e) Only e is correct. For alternatives (b), (c) and (d), the effective result is a, where a is
the amount.
124. (d) The present value of cash flow stream of any periodicity can be calculated by using
PVIFA tables.
125. (c) The present value interest factor for annuity is equal to the product of the future value
interest factor for annuity and the present value interest factor.
126 (d) The general relationship between effective and nominal rate of interest is given by
r =(1 +k/m)
m
1
Where,
r = effective rate of interest
k =nominal rate of interest
m =frequency of compounding per year
With an increase in m the effective rate of interest increases but at a decreasing rate.
127. (b) Sinking fund represents the amount that has to be invested at the end of every year for a
period of n years at the rate of interest k, in order to accumulate Re.1 at the end of the period.
128. (d) (i) The inverse of FVIFA is sinking fund factor.
Therefore (i) is false

n
n
n
n
1 (1+k) 1
x
k (1+k)
(1+k) 1
= =PVIFA
k(1+k)

Therefore (ii) is true.
(iii) PV of perpetuity =
value of perpetuity
interestrate
.
Hence it is not infinity. Therefore (iii) is false.
129. (d) Nominal or market rate of interest =Real rate of interest +Expected rate of inflation +Risk
premiums to compensate for uncertainty.
130. (c) When compounding is done more than once in a year the effective rate of interest is
greater than the nominal rate of interest.
131. (e) The doubling period is the time taken for the amount invested to be doubled for a given
rate of interest. The doubling period can be calculated approximately by using rule of 72
according to which doubling period is 72/rate of interest or by using rule of 69 according to
which doubling period is 0.35 +69/rate of interest.
82
132. (a)

n
1 1
PVIF = =
FVIF (1+k)

n
(1+k) 1
FVIFA=
k

1
PVIF =
n
(1+k)

n
n
1 k
xPVIF = x(1+k)
FVIFA (1+k) 1

=
n
n
k(1+k) 1
=
PVIFA (1+k) 1

PVIFA =
n
n
(1+k) 1 1
k (1+k)

PVIFA is product of FVIFA and PVIF.
Inverse of capital recovery factor is PVIFA, and inverse of IVIFA is sinking fund.
Therefore only (b), (c) and (d) are false. (a) is true.
133. (b) The general relationship between effective and nominal rate of interest is given by
r =(1+i/m)
m

1
where,
r =effective rate of interest
i =nominal rate of interest
m =frequency of compounding per year.
r =(1 +k/m)
m
1
where,
m = frequency of compounding per year
When compounding is done twice a year
r =(1 +k/2)
2
1.
135. (d) FVIF = (1 +k)
n
=
1
PVF

PVIFA =
n
n
(1+k) 1
k(1+k)

FVIF x PVIFA =
n
(1+k) 1
=FVIFA
k

only (a) and (b) are true.
Part I
83
136. (e) Individual preference of present consumption to future consumption, gradually decreasing
purchasing power of money, uncertainty of the future and the possibility of the productive
deployment of money to generate real returns in future are the factors behind the time value of
money. Hence, the alternatives (c) and (d) both are correct and so the option (e) is the answer.
137. (e) For the calculation of the present value interest factor of an annuity (PVIFA), it is
assumed that the cash flow will occur at the end of the period under consideration. PVIFA is
also reciprocal to the capital recovery factor. Hence, the option (e) is the correct one.
138. (d) Being a legal tender and having the government guarantee do not have any role in relation
to the time value of money. The purchasing power of money gradually decreases due to
inflation and so the individuals prefer to spend money, rather than saving the same without
any suitable incentives. But money may be productively invested to generate higher returns
in future. Hence the option (d) is the correct one.
Risk and Return
139. (b) measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. It is the measure of non-diversifiable or systematic
risk of an asset relative to that of the market portfolio. A risk-free stock has a of zero.
140. (c) CAPM is based on one of the assumption that the investor is limited only by his wealth
and the price of the asset.
141. (e) The graphical representation of the CAPM models is the SML. The SML equation is given by
E (r) =R
f
+
j
(R
m
R
f
). The SML intersects the vertical axis at the risk-free rate of return R
f
and (R
m
R
f
) is the slope of the SML. When the slope of SML is zero then
Risk-free rate =Expected return and risk-free rate =Market return.
Hence all the given statements are true.
142. (e) Non-diversifiable risks are those risks which cannot be managed or reduced.
Lockout in a company due to workers demanding a wage hike and lack of strategy for the
management in a company can be managed and hence are diversifiable risks. Slump in the
industry and change in the corporate tax structure are non-diversifiable risks as they cannot
be managed or diversified.
143. (d) The amount of risk depends on (i) degree of correlation-the lower the degree of positive
correlation, the greater is the amount of risk reduction that is possible and (ii) number of
stocks in the portfolio as the number of stocks increases, the diversifying effect of each
additional stock diminishes.
144. (d) Business risk is the risk of doing business in a particular industry or environment and
hence can be diversified.
145. (b) If a person holds a diversified portfolio the unsystematic risk is diversified, and the only
risk a security adds would be systematic risk i.e the non-diversifiable risk which is a part of
total risk from various sources like interest rate risk, inflation risk, financial risk, etc.
146. (e) Beta measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. Hence it is a risk of diversified portfolio and is the
weighted average of individual security beta, weights being in proportions of the investments
in the respective securities.
147. (e) The equation represents the CAPM which establishes a linear relationship between the
required rate of return of a security and its systematic or undiversifiable risk or beta. Hence
all the above statements are true.
148. (e) SML intersects the vertical axis at the risk free rate of return R
f

and K
m
R
f
, i.e., risk
premium is the slope of the SML.

149. (a) If the securitys return plots below the SML, it is said that it is overpriced and unattractive
because it is expected to produce a return lower than stock with similar betas.
150. (d) The securities with beta >1 and plotting on the upper part of the SML are classified as
aggressive securities, and those with beta <1 and plotting on the lower part of SML are
classified as defensive securities.
84
151. (c) Operating risk is the risk of doing business in a particular industry or environment and it
gets transferred to the investors who invest in that business. Hence it is a diversifiable risk.
152. (d) Trade off between risk and return implies taking decisions in such a way which optimizes
the balance between risk and return.
153. (d) Financial risk is the risk arising from the use of debt capital and hence a specific risk factor.
154. (c) The CAPM is represented by
k
j
=R
f
+
j
(k
m
R
f
)
Explicit measures of security risk premium is the product of beta for a particular security j
and the market risk premium K
m
R
f
.
Hence risk premium =
j
(K
m
R
f
)
155. (d) A security which can be bought or sold quickly without significant price concession is
considered liquid. Hence the risk arising due to uncertainty about the time element and the
price concession in selling a security is called liquidity risk.
156. (e) Standard deviation considers every possible event and assigns each event a weight equal
to its probability. It is a very familiar concept and many calculators and computers are
programmed to calculate it. It is a measure of dispersion around the expected (or average)
value. Standard deviation is obtained as a square root of the sum of squared differences
multiplied by their probabilities. This facilitates comparison of risk as measured by standard
deviation and expected returns as both are measured in the same costs. This is why standard
deviation is preferred as a measure of risk.
157. (e) Industrial recession cannot be attributed to a specific risk factor. It is related to the general
economy. Hence is a non-diversifiable risk.
158. (e) Beta measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. Hence it is a measure of systematic risk of a security.
159. (e) CAPM assumes that investors make their investments based on single period horizon, i.e.
the next immediate time period.
160. (a) To gain from a security it has to be bought only when the required rate of return is less
than the expected rate of return.
161. (a) Variance =(Standard deviation)
2

Hence if one portfolios variance exceeds another portfolio, its standard deviation will also be
greater than that of the other portfolio.
162. (a) Nominal rate of return =Real rate of return +Inflation
Hence real rates of return are typically less than nominal rates of return due to inflation.
163. (c) Nominal rate of return =Real rate of return +Inflation.
Hence when nominal rate of return is more than inflation, real rate of return is positive and when
nominal rate of return is less than inflation, real rate of return will be negative.
164. (d) Through diversification the loss arising from one security is compensated by a gain
arising from some other security. Hence the expected risk can be reduced.
165. (d) Interest rates go up with inflation as inflation is directly related to interest rates.
166. (d) K
d
=
(106 97.50)
13(1 0.38)
6
106+97.50
2
+
=0.0931
K
d
% =9.31%.
167. (c) Interest rate is directly related to inflation hence interest rates of securities tend to go up
with inflation.
168. (d) Financial risk arises from the use of debt capital or leverage used by the company. The
more the company resorts to debt financing, the greater is the financial risk.
Part I
85
169. (d) Strike in the company is specific to the company and can be diversified.
170. (e) The CAPM model assumes that investors have single period time horizon, low transaction
costs in the market, taxes do not affect the choice of buying assets and that all investors agree
on the nature of return and risk associated with each investment. Hence all the statements
would reduce the applicability of CAPM.
171. (b) Unexpected entry of a new competitor in the market is risk specific to a particular
industry and hence diversifiable.
172. (d) Beta measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. Hence, if a security is less than the market
portfolio, then its beta would be less than 1.
173. (e) Realized return is ex-post return, the two types of returns are realized or historical return
and expected return, the objective of any investor is to maximize his returns and minimize
risk, return is the motivating factor for an investor. The investor compensates for the
uncertainty in returns by requiring an expected return that is sufficiently high to offset the
risk or uncertainty.
174. (a) Systematic risk is non-diversifiable risk. Credit risk is diversifiable.
175. (d) The SML equation is
E(r) =R
f

+
j
(k
m
R
f
)
It shows the relationship between the expected rate of return and beta.
176. (e) With rise in inflation there is reduction of purchasing power, hence inflation risk is also
referred to as purchasing power risk and affects all securities.
177. (d) Because investors are risk averse they will expect a risk premium to compensate them for
the additional risk assumed in investing in a risky asset.
Risk premium =Required rate of return Risk-free rate.
178. (a) When there is perfect positive correlation the loss in one security cannot be compensated
by a gain in another. Hence, the risk of a portfolio of two securities increases if there is
perfect positive correlation.
179. (d) With a rise in inflation there is reduction of purchasing power, this is referred as
purchasing power risk. It is related to the general economy and cannot be diversified.
180. (b) Market portfolio contains all the securities in proportion to the market capitalization.
181. (d) The graphical representation of the CAPM model is the SML. The SML equation is given
by E(r) =R
f
+
j
(k
m
R
f
)
Hence it shows the relationship between return on the stock and beta of the stock.
182. (b) When a security plots above the SML it means the security is undervalued or priced too
low because its average rate of return is inappropriately high for the level of risk it bears.
183. (d) All the given alternatives are true.
184. (a) The CRL i.e. the characteristic regression line is a graphic representation of the market
model. It is given as k
j

=
j
+
j
km +e
j
. This explains the relationship between return on
stock k
j
and return on market portfolio.
185. (b) Beta measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. In a booming market the share prices tend to be on
a rise. Hence those companies whose >1 are to be selected.
186. (b) CAPM assumes that individuals can borrow and lend freely at a risk less rate of interest.
187. (d) Systematic risks are risks which cannot be diversified. Purchasing power risk and interest
rate risk are undersifiable risk whereas yield risk can be diversified.
188. (a) The graphical representation of the CAPM model is the SML. The SML equation is given
by E(r) =R
f
+
j
(k
m
R
f
).
Where (k
m
R
f
) is the slope of the SML. Hence it changes with change in the risk-free rate of
return.
86
189. (b) The graphical representation of the CAPM model is the SML. The SML equation is given
by E(r) =R
f
+
j
(k
m
R
f
). Hence the relationship between beta of the security and the
required rate of return is represented by the security market line.
190. (d) If investors expect the inflation rate to fall in future and they expect themselves to become
less risk averse then SML shifts down and the slope decreases.
191. (e) All the given alternatives are used to calculate the return from an investment.
192. (d) As per CAPM model the required rate of return =Risk-free rate +Risk premium.
Hence all the above statements are true.
193. (c) Emergence of a new competitor is a unsystematic risk which can be diversified as it can
be attributable to that particular industry. Hence it does not contribute to systematic risk.
194. (e) As per the CAPM assumptions, any individual securitys expected return and beta
statistics should lie on the SML. The SML intersects the vertical axis at the risk-free rate of
return R
f
=236.

195. (b) As per the CAPM assumptions, any individual securitys expected return and beta
statistics should lie on the SML. Those with beta greater than one and plotting on the upper
part of the SML are classified as aggressive securities as they earn above average returns with
higher risks.
196. (d) Riskiness of a portfolio is the function of all the above factors.
197. (c) Prices of security move inversely with the interest rates. Hence, increase in interest rate
will cause an increase in the required rate of return.
by E(r) =R
f
+
j
(k
m
R
f
).
It shows the relationship between return on the stock and beta of the stock.
by E(r) =R
f
+
j
(k
m
R
f
).
The SML intersects the vertical axis at the risk free rate of return R
f
and (k
m

R
f
) is the slope of
the SML. Hence when SML =0, the expected rate of return is equal risk-free rate of return.
200. (b) When the securities in the portfolio are negatively correlated the loss in one security can
be offset by a gain in another security. Hence by diversification we can eliminate risk.
201. (d) Beta measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. It is a measure of systematic risk of a security.
202. (d) Introduction of minimum alternative tax cannot be diversified. Hence it does not represent
unsystematic risk.
203. (c) When there is zero correlation between the securities in a portfolio it means that there is
no relationship among the different securities. Hence the graph will be scattered.
204. (d) Reduction of tax rate by the government will affect all the companies in the market and so
can be considered as a systematic risk. While the factors mentioned in the other options will
affect a particular company or the companies belonging to a particular industry. Hence, these
factors may be termed as non-systematic risk.
205. (c) A finance manager is required to examine whether the opportunity is worth more than the
cost thereafter he must take a decision by duly balancing the risk and return associated with
that decision. An aggressive advertisement campaign may increase the sales revenue but
improper appeal may cost a company too for the advertisement cost. An attractive credit term
may improve the sales turnover but may inability to implement the same may cost the
company in some other way. A borrowing firm enjoys tax shield against the payment of
interest to its lenders but a risk of failure to make such payment may result in the risk of
insolvency. But to maximize profit through maximum usage of the production facilities is not
a risk, as it leads to the reduction in cost per unit of production, to the finance manager of any
manufacturing company.
Part I
87
j
e
206. (e) If a securitys return plots above the Security Market Line (SML) then the return on the
security is more than the required rate of return on the security according to the SML. A
greater return means a lesser price of the security than its intrinsic value that implies the
security is under priced and hence that should be bought immediately to book profit in future
as its price increases.
207. (e) The assumptions of CAPM are as follows:
Investors use the expected return and standard deviation of returns as the appropriate
measures of return and risk of the portfolios
Investors are risk averse
Investors agree with each other on the nature of return and the risk associated with each
instrument where investment may be made
The assets can be bought and sold in any unit as desired by the investors
Hence, the option (e) is the correct choice.
208. (a) Beta of security represents the relationship between the rates of return from a security as
well as from the market. It shows the responsiveness of the security to the general market and
indicates how extensively the return of the security will vary with the changes in the market
return. As the rates of return from a security move perfectly in tandem with respect to the
market returns, then the beta for that security will be equal to unity.
209. (d) Volatility of interest rates, sudden increase in the rate of inflation, the imposition of
surcharge and the non-availability of electricity affect the profitability of all the companies in
the market almost in the same manner. But a sudden scarcity of cement affects only those
companies, which use cement as one of their inputs like; construction companies, housing
sector, etc.
210. (d) As the return on a security lies below the security market line, the security is over priced
as the expected return is less than the required return. The statements as stated in the options
(a), (b) and (c) are not related to the security market line.
211. (b) The equation for the Characteristic Regression Line (CRL) is given as:
j j j m
K k = + +
The CRL is plotted by plotting K along the Y-axis and K along X-axis.
j m
212. (b) The beta coefficient of a security indicates the systematic risk of a security while the
unsystematic risk is estimated by deducting it from total risk i.e. variance of returns from that
security. The total risk and financial risk of a company, not for a security, is measured by the
total leverage and financial leverage of the company at a certain level of operations. There is
no measurement called the operating risk of a company.
213. (e) The salient features for the assumptions of CAPM are:
The investors are risk averse
The assets can be sold or bought in any small number of units
Transaction costs and taxes are negligible
Expectations of one investor is same as that of the another in relation to the expected
returns from a security and the risks associated with that
The investors consider the expected return and the standard deviation of returns as the
criteria of investment. Hence, the option (e) is correct.
214. (c) The bonds issued by the government are secured. T-Bills are issued at a discount and
redeemed at a face value and Government buy term bonds carry a coupon rate of interest.
Interest rate cannot be changed before the maturity of the bond.
215. (c) The rate of return earned by an investor, who purchases a bond and holds it till maturity,
is called the yield to maturity.
88
216. (b) This is the theorem showing the effect on the bond values influenced by the relationship
between the required rate of return and the coupon rate. When the required rate of return is
equal to the coupon rate, the value of the bond is equal to its par value.
217. (a) This is a bond theorem showing the effect of the number of years to maturity on the bond
values. When the coupon rate is less than the required rate of return the discount on the bond
decreases as maturity increases.
218. (b) This is the theorem showing how YTM determines a bonds market price and vice versa,
as bonds price will fluctuate in response to the change in market interest rates. For equal
sized increases and decreases in the YTM, the price movements are not symmetrical.
219. (b) This is the bond theorem showing how YTM determines a bonds market price. A change in
YTM affects those bonds with a higher YTM more than it affects bonds with a lower YTM.
220. (b) When the intrinsic value or the present value of a bond is higher than the market value, it
implies that the bond is under priced. Hence, an investor would buy a bond.
221. (a) The rate of return earned by an investor who purchases a bond and does not hold till
maturity is called the holding period return.
222. (e) For a bond held to maturity YTM is the discount rate which equals the present value of
promised cash flows, and hence is not affected by the current market price of the bond.
223. (d) Bonds price moves inversely proportional to its yield to maturity. When market price and
face value are equal, the coupon rate is equal to the YTM.
224. (d) Since coupon rate of bond Y is relatively less, the bond Ys price would change more
than that of X for a change in YTM.
225. (c) The price of theshareis given by P =D/k g. Other things being equal as the expected growth in
dividends increases, the expected return increases.
226. (e) Low dividend yield and high price earnings ratio imply considerable growth prospects.
High dividend yield and low price earning ratio imply limited growth prospects.
227. (e) The book value per share is the net worth of the company (paid-up equity capital plus
reserves and surplus) divided by the number of outstanding equity shares. This approach is
criticized because it values the firms share without any future projections and it is based on
accounting figures which can be manipulated.
228. (e) The factors which effect the P/E ratio are growth rate, stability of earnings, size of the
company, quality of management, dividend pay-out ratio and debt preperation.
229. (d) The interest rate payable on a bond =Par value x Coupon rate. Hence the coupon rate is
set on equal to a percentage of its par value.
230. (e) The amount a company can realize if it sold its business as an operating one is called
going concern value.
231. (d) Low dividend yield and high price earnings ratio imply considerable growth prospects.
Hence the statement given is not true.
232. (e) All the given statements are true.
233. (a) Market value of an asset or security is current price at which the asset or the security is
being sold or bought in the market. The amount that a company could realize if it sold its
assets after terminating its business is liquidation value.
234. (c) Assets are recorded at historical costs and they are depreciated over years, book value
may indicate intangible assets at acquisition cost minus amortized value. It is stated as
outstanding amount. The difference between the book value of assets and liabilities is equal
to shareholders funds or net worth.
235. (a) This is a bond theorem showing how YTM determines a bonds market price. A change in
the YTM affects the bond with a lower YTM more than it does bonds with higher YTM.
Hence statement (a) is false.
236. (b) Longer the maturity of the bond , the greater its price change in response to a given
change in the required rate of return. Hence if the maturity of the bond increases, the
volatility of the bond increases.
237. (d) This is the bond theorem showing the effect on the bond values influenced by the relationship
between the required rate of return and the coupon rate. When the required rate of return on a
bond is less than the coupon rate then the value of the bond is less than the face value.
Part I
89
238. (d) The intrinsic value of a stock is equal to the discounted value of the stream of future
dividends per share. It is given by
P
0
=D
1
/(1 +g) +P
1
/(1 +k
e
)
Where,
D
1
is the expected dividend a year hence,
P
1
is the expected price of the share
K
e
is the required rate of return.
239. (d) All the statements are related to the bond value theorem showing the how YTM
determines the prices of the bonds. Statement (d) is false because the longer the term to
maturity, the greater will be the change in price with change in YTM.
240. (a) Longer the maturity of the bond, the greater its price change in response to a given change
in the required rate of return. Hence if the maturity of the bond increases, the volatility of the
bond increases.
241. (b) When the expected rate of return is equal to the required rate of return the value of the
bond is equal its par value. Hence it is rightly priced.
242. (b) When the required rate of return on a bond is greater than the coupon rate the discount
then the value of the bond is less than the par value. This discount on the bond declines as
243. (a) The discount or premium on a bond declines as maturity approaches. Hence if discount
bonds and premium bonds are sold at the same price, it indicates that the bonds have
approached maturity.
244. (b) When the required rate of return is equal to the coupon rate, the value of the bond is equal
to its par value.
245. (d) k
e
=R
f
+ (R
m
R
f
)
=
e e
f m
k R 21.4 6
=
R R 17 6

=1.40.
246. (d) The value of a share is its economic value as a going concern, taking into account its
characteristics, the nature of its business and the investment environment. The value of the
share equals the present value of earnings per share plus the net present value of future
growth opportunities.
247. (c) Interest rate risk is the variability in a securitys return resulting from changes in the level
of interest rates. Bonds with low coupon rate have high interest rate risk as the return on the
bond is less than the actual interest at that period.
248. (b) Yield to maturity of a perpetual bond i.e., bonds with no maturity is equal to the interest
divided by the market price.
249. (b) When the required rate of return on a bond is greater than the coupon rate the discount then
the value of the bond is less than the par value. This discount on the bond declines as maturity
approaches. For a change in YTM, the percentage price change in case of bonds of high coupon
rate will be smaller than in the case of bonds of low coupon rate. Hence only (ii) is true.
250. (c) P/E =MPS/EPS.
When there is low dividend yield the EPS decrease and hence the
P/E ratio tend to increase.
251. (d) Dividend yield = Dividend paid/Current market price. Thus, we can conclude that
dividend yield is based on current stock price.
252. (c) The value of common stock increases with increase in growth rate of dividend. The value
of common stock decreases with increase in investment horizon. If dividend pay-out ratio
remains constant the value of the stock would also remain the same. The value of common
stock, other thing remaining same, decreases with the increase of discount rate.
90
253. (a) The value of a share when dividend increase at a constant, compound rate is given by
P
0
=D
1
/k g
Where,
P
0
is the current market price of the equity share
D
1
is the expected dividend a year hence
D
1
=D
0
(1 +g) where D
0
is the last paid dividend
k is the expected rate of return or the required rate of return
g =annual growth rate.
254. (e) A security traded in the secondary market in subject to market risk and liquidity risk.
255. (c) For a given difference between YTM and coupon rate of the bonds, the longer the term to
maturity, the greater will be the change in the price with change in YTM. This is because, in
case of long maturity bonds, a change in YTM is cumulatively applied to the entire series of
the coupon payments and the principal payment is discounted at the new rate for the entire
number of years to maturity; whereas in case of short-term maturity bonds, the new YTM is
applied to comparatively few coupon payments and also the principal payment is discounted
for only a short period of time.
256. (e) Growth rate of the industry to which the company belongs is an external factor that
influences the intrinsic value of a stock.
257. (e) Current yield measures the rate of return earned on a bond if it is purchased at its current
market price and if the coupon interest is received. Coupon rate and current yield will be
equal if the bonds market price equals its face value. Yield to maturity and current yield will
be equal when price of the bond equals the face value.
258. (d) Intrinsic value of bond =C x PVIFA(k,n) +F x PVIF(k,n)
where, C is the coupon payment on the bond, F is the amount payable at maturity, k is the
discount rate or the required rate of return and n is the number of years of maturity to the bond.
From the above expression of the intrinsic value of a bond, we can see that other things being
equal if the amount payable at maturity (F) increases, the value of bond also increases
correspondingly. While decreasing the term to maturity and the coupon rate of the bond as
well as increasing the required rate of return on the bond will decrease the intrinsic value of
the bond. The discount on the bond at the time of issue does not have any role to play in this
context. Hence, the alternative (d) is correct.
259. (d) When the required rate of return on a bond is more than the coupon rate the intrinsic value
of the bond is less than its par value; hence the bonds are sold at a discounts on its par value.
The amount of discount on the bond decreases as the maturity approaches. The question of
premium on the bond price does not arise in this case. Hence, the alternative (c) is true.
260. (b) The warrant holder is not at all entitled to receive any dividend from the company that
issued the same. While the features as stated in the other alternatives are the regular features
of the warrants generally issued by the companies. Hence, the option (b) is the correct choice.
261. (a) The salient features of the multi-period valuation model are as follows:
Cash flows to the investors in the formof dividends over an infinite duration are considered.
The value of an equity share is equal to the present value of its entire dividend stream
over an infinite duration
The model can be applied to the instances of constant dividends and constant growth in
dividends
The model can also be applied in case of variable growth in dividends
It assumes that the cost of equity of the company will remain constant.
Hence, the option (a) is the answer.
Part I
91
262. (e) If the market interest rate increases, the value of the bond will also be adjusting itself in
such a way that the yield of the bond matches with the market interest rate. Hence as the
interest rate increases, the value of the bond will also decreases correspondingly in order to
keep in pace with that of the new rate of interest. The factors as mentioned in the other
options increase the value of the bonds
263. (d) In going concern value, the assets of the company are sold as the operating assets and
their values are generally higher than any other criterion of measurement. Book value is an
accounting concept that is historical cost minus depreciation. Market value of any asset is the
value at which that is generally bought and sold in the market. Replacement value is the
amount that a company is required to spend if it decides to replace the existing assets by new
one. But liquidation value is the amount that a company may realize by selling the assets on
terminating its business.
264. (b) If the required rate of return from a bond is more than the coupon rate the value of the
bond will be less than the par value of the bond as the bond value adjusts itself against the
movement of the interest rates. The discount rate on the bond decreases as maturity
approaches, if the required rate of return from a bond is more than the coupon rate. The
premium on the bond decreases as the maturity approaches, if the required rate of return is
less than the coupon rate.
265. (c) In the valuation of the equity shares of the company through price-earning ratio approach,
the growth rate of the company is considered only. Book value and the liquidation value of
the company do not have any role in this context. Maturity of the debentures and issue of
preference shares do not affect the valuation process for the company under this method.
266. (b) Debt equity ratio indicates the relative contributions of creditors and owners, which
indicate the long-term solvency.
267. (c) Liquidity implies a firms ability to pay its debts in the short run. This ability can be
measured by the use of current ratio.
268. (c) Debt service coverage ratio =PAT +Depreciation +Other non-cash charges +Interest on
term loan/Interest on term loan +Repayment of the term loan 1.5 indicates that the firm has
post-tax earnings which are 1.5 times the total obligation (interest and loan repayment) in the
particular year to the financial institution.
269. (d) The common size analysis is used for inter company comparison because the financial
statements of a variety of companies can be recast into the uniform common size format
regardless of the size of individual companies. In the balance sheet, the assets as well as the
liabilities and capital are each expressed as 100 percent and each item in these categories is
expressed as a percentage of the respective totals.
270. (a) Fixed charges coverage ratio measures debt servicing ability comprehensively. The fixed
charges coverage ratio of 4 signifies that its pre-tax operating income is 4 times all fixed
financial obligation.
271. (b) The current assets increase as a result of increase in cash balance, hence the current ratio
increases.
272. (c) Current ratio =Current assets/Current liabilities
The firms current assets are converted into cash to provide funds for the payment of current
liabilities. So CA will not change while CL will decrease.
273. (e) The receivable turnover ratio shows how many times accounts receivable (debtors) turn
over during a year. It is defined as Net credit sales/Average accounts receivable.
274. (d) If the realized collection period is more than the average collection period it would reflect
that collection job is poor, customers are facing financial problems, and in spite of careful
collection efforts there is difficulty in obtaining prompt payments.
275. (c) Assets turnover ratio highlights the amount of assets that the firm used to produce its total
sales. Low ratio indicates idle or improperly used assets.
276. (a) Gross profit margin =Gross profit/Net sales
This shows the profit relative to sales. It may be used as an indicator of the efficiency of the
production operation and the relation between production costs and selling prices.
92
277. (d) Coverage ratios give the relationship between the financial charges of a firm and its
ability to serve them. Structural ratios measure the long term solvency of a firm.
278. (b) Dividend pay out ratio is the ratio of DPS to EPS. It indicates what percentage of total
earnings is paid to the shareholders.
279. (a) Dividend yield exists for only those firms which declare dividends. Hence the retained
earnings directly affect the dividend yield.
280. (e) ROE =Net income/Average equity.
281. (e) All the given alternatives are problems encountered in financial statement analysis.
282. (d) According to the Du Pont Analysis
Equity multiplier =(Average assets/Average equity) =1/1 (Debt to assets ratio).
283. (e) The accounts receivable is used in the evaluation of liquidity of receivables. Other things being
equal, a decrease in the average accounts receivable will increase the firms return on assets.
284. (c) A common size balance sheet portrays the firms accounts as a percent of the firms total assets.
285. (c) Liquidity of an asset implies the speed at which it can be converted into cash. It measures
the ease and cost of being converted into cash.
286. (c) Current ratio =Current assets/Current liabilities. It is a measure of a firms liquidity.
287. (a) The net working capital =Current assets Current liabilities.
A current ratio of less than 1 implies that the firms current liabilities are more than the current
assets. Hence, a current ratio of less than 1 implies that the net working capital is negative.
288. (b) Average collection period =Average accounts receivable/Average daily sales
=Average accounts receivable x 365/Average credit sales
Average collection period indicates the speed of collections.
289. (d) The total assets comprises of debt and equity. If the debt equity ratio is 2:1 then the total
assets will be 3. Hence, for every 3 rupees of total assets there is 2 rupees of debt and 1 rupee
of equity.
290. (c) Liquidity implies a firms ability to pay its debt in the short run. Working capital gap is
equal to current assets less total current liabilities other than bank borrowings. Higher the
inventory turnover ratio higher the efficiency of inventory management. PE ratio is one of the
most important ownership ratios. Only statement (c) is true.
291. (c) Financial statement analysis helps to know the correlation among ratios.
292. (c) Working capital gap is equal to the current assets less current liabilities other than bank
borrowings.
293. (a) Asset turnover ratio highlights the amount of assets that the firm used, to produce its total
assets. It measures the efficiency of the firms activities and its ability to generate profits.
294. (d) Capitalization rate =Earning per share/Market price of the share
295. (a) Interest coverage ratio =EBIT/Interest expense
It is the measure of a firms ability to handle financial burdens. An interest coverage ratio of
2.25 indicates that the EBIT is 2.25 times the interest payable.
296. (e) Acid test ratio or quick ratio =Quick assets/Current liabilities
It is a measure of liquidity of a firm.
297. (c) Average collection period is a turnover ratio Average collection period is defined as the
number of days it takes to collect accounts receivable.
298. (b) Earnings per share =Profit after tax/Number of outstanding shares
299. (c) Current ratio =Current assets/Current liabilities. It is a measure of a firms liquidity, i.e.,
the ability to pay its debts.
300. (b) In determining the appropriate PE ratio for a firmthe factors to be considered are growth rate,
stability of earnings, size of the company, quality of management and dividend pay-out ratio.
301. (a) In common size analysis, each item in the balance sheet is expressed as a percentage of
their respective totals.
302. (a) Days sales outstanding is the ratio of receivables outstanding to average daily sales.
Part I
93
303. (e) Higher the inventory turnover ratio, greater the efficiency of inventory management. Since
inventory turnover ratio is a measure of the adequacy of goods available to sell in comparison to
the actual sales orders a high inventory turnover ratio may indicate over trading.
304. (c) When current ratio is greater than one, a similar increase in current assets and current
liabilities will result in the decrease in current ratio.
305. (b) Interest coverage ratio measures the firms ability to handle financial burdens. This ratio
tells how many times the firm can cover or meet the interest payments associated with debt.
Interest coverage ratio =EBIT/Interest expense.
306 (c) Analyzing return ratios in terms of profit margin and turnover ratios, referred to as the
Du Pont system. The starting point of Du Pont chart is return on total assets.
307. (e) Return on equity =Net income/Average equity
Return on investments =EBIT/Total assets
Hence it means that the firm does not have any debt in its capital structure as average
equity =Total assets and that the firm does not pay taxes as EBIT =Net income.
308. (c) The ratio of market value to book value indicates the contribution of a firm to the wealth
of the society. Hence Market value =2 x Book value, indicates that the firm has doubled the
wealth of the shareholder.
309. (e) Analyzing return ratios in terms of profit margin and turnover ratios, is referred to as the
Du Pont system. In the Du Pont chart the left apex term is net profit margin.
310. (e) Debt is used in the capital structure only when the interest paid on such debt is less than
the return. Such use of debt increase. Return on equity if the firm earns higher return than the
rate of interest on debt.
Return on equity =Net income/Average equity
311. (d) Interest coverage ratio measures the firms ability to handle financial burdens. This ratio
tells how many times the firm can cover or meet the interest payments associated with debt.
Interest coverage ratio =EBIT/Interest expense. Hence interest coverage ratio of 6 indicates
EBIT is 6 times of interest.
312. (d) In the context of financial statement analysis, cross sectional analysis involves
comparison between a company and an industry. The industry averages or the standard
players averages are used as benchmarks.
313. (b) Earning power =EBIT/Average total assets
It is a measure of the operating business performance which is not affected by interest
charges and tax payments.
314. (c) Current ratio =Current assets/Current liabilities
Quick ratio =Current assets Stock/Current liabilities
Hence when the current ratio and quick ratio are nearly the same it means that the company
has got low investment in inventory.
315. (c) According to the Du Pont analysis
Return on Equity =Net profit margin x Asset turnover ratio x Asset Equity ratio
Leverage ratios measure the long-term solvency of a firm. Total assets to net worth is the
leverage ratio used in ROE analysis.
316. (d) Earning power is a measure of operating profitability and it is defined as Earnings before
interest and tax/Average total assets. It does not consider the effect of financial structure and
tax rate.
317. (b) ROE =Net income/Average equity or ROE =EPS/ Book value.
318. (b) Earning ratios helps in getting the information on earnings of the firm and their effect on
price of common stock. Hence for assessing the future market value of the company, it is best
to depend on earnings ratio.
319. (e) Dividend Yield =dividend per share/Market price per share. It gives current return on
investment.
94
320. (c) Debt-equity ratio and debt-asset ratio are leverage ratios for a company. Return on equity
and return on investment represents the profitability ratios of a business entity. Acid test ratio
indicates the liquidity status of a company.
321. (b) In common size analysis the items in the income statement are expressed as percentage of
net sales.
322. (a) Debt asset ratio indicates the capital structure of a company. Inventory turnover ratio and
total asset turnover ratio are the turnover ratios that indicate how efficiently the assets are
utilized by a company. While return on equity and return on assets are the profitability ratios
of a business entity.
323. (b) Dividend pay out ratio indicates the amount of dividend paid out of net profit earned by
the company. Net profit margin represents the amount of profit as a percentage of total sales.
Inventory turnover ratio implies how efficiently the inventories are used by a company while
acid test ratio shows the liquidity status for a company. But fixed chares coverage ratio
represents the ability of a firm to meet its financial obligations to make service the debts as
well as to pay the lease rentals.
324. (b) The financial risk of a firm may be estimated by using the leverage and coverage ratios
while the earning potential of a company may be evaluated through the profitability ratios.
The operational and the level of efficiency in utilizing the assets may measured by using the
turnover ratios. But price-earnings ratio is used to determine the expected market price per
share of the company. One may project the EPS of a company for the next few years and
thereafter by assuming the continuity of the same P/E multiple, the future market price per
share may be calculated.
325. (d) If the company resorts to external borrowings by issuing debentures or from the financial
institutions, the debt-to-total assets will go up. Using short-term funds for the long-term
purposes and vice-versa does not serve the purpose and may lead to the liquidity mismatch.
However, further issue of the equity shares through rights issue will increase the share capital
that may be used to retire the old debt partially or wholly thereby reducing the debt-
equity ratio.
326. (c) In index number trend analysis, every figure for the first year is considered as 100 percent
while the corresponding figures for the subsequent years are mentioned as a percentage of the
first year figure. In cross-sectional analysis, the relevant figures are presented for more than
one companies while in year-to-year change analysis, the respective ratios or data as
required, are presented without making any change. In commonsize analysis, every element
in the balance sheet is presented as a percentage of the total asset or total liabilities whereas
the figures of the income statement are presented as a percentage of the sales value. There is
no analysis called as expected annual income analysis.
327. (d) As the debt-equity ratio of the company is higher than the other companies in the same
industry, the company can be termed to have a higher than average financial risk in
comparison to the other companies in the same industry for the higher debt burdens. So, its
borrowing capacity is less compared to its peers. It has the higher probability to experience
some difficulties with its creditors in future. The creditworthiness of the company is at low
level owing to the higher interest burden and also its ability to meet the financial
commitments towards its stakeholders.
328. (c) Asset turnover of a company is defined as the ratio between the sales value and total
assets. High asset turnover is possible only when a company can generate a high sales
volume in comparison to the amount invested in the fixed assets and current assets.
329. (d) K
d
=
109 95
15(1 0.40)
8
109 95
2
+
+
=0.1054
K
d
=10.54%
330. (d) In Du Pont analysis, the return on equity (ROE) is expressed as the product among net
profit margin (NPM), total assets turnover ratio (TATR) and the equity multiplier (EM). But
in the other cases, the interrelationships among three ratios are not observed.
Part I
95
331. (a) In commonsize analysis, the income statement is expressed as a percentage of total sales.
In index number trend analysis, every figure for the first year is considered as 100 percent
while the corresponding figures for the subsequent years are mentioned as a percentage of the
first year figure. In cross-sectional analysis, the relevant figures are presented for more than
one company while in year-to-year change analysis, the respective ratios or data as required,
are presented without making any change. In Du Pont analysis, the return on equity of the
company is analyzed.
Funds Flow Analysis
332. (e) Funds in funds flow statement represent either net working capital or cash.
333. (d) Conversion of all FCDs into equity shares, and bonus issue of equity shares does not
result in any inflow or outflow of cash. Hence they do not appear in the cash flow statement.
334. (a) Depreciation is an appropriation of profits hence it is a source of funds. Decrease in net
working capital may be because of the increase in current liabilities; hence it is a source of fund.
335. (b) Increase in liability results in inflow of cash through loan or credit. Hence it is a source of
fund.
336. (d) Net income from operations is a source of funds whereas net loss from operations is a use
of funds.
337. (a) Cash from operations is obtained by adding all non-cash expenses like depreciation the
profit after tax or the net profit.
338. (e) Increase in provision for taxation results in increase in current liabilities and cash or credit
sales at a profit increase the current assets.
339. (b) Increase in accrued expenses result in increase in current liabilities which is a decrease in
working capital, hence a source.
340. (e) Decrease in working capital is a source of fund. Increase indepreciation is also a source of
fund.
341. (d) Funds flow statement is a statement which explains the various sources from which funds
were raised and the uses to which these funds were put. Hence evaluation of the quality of
firms top management is not a benefit of funds flow statement analysis.
342. (d) Ratio analysis is a tool for financial analysis.
343. (c) The following assumptions are made will calculating the external fund requirement
The assets of a firm will increase proportionately to sales.
Net profit margin is constant.
Dividend pay-out ratio and debt equity ratio will remain constant.
External issue of equity ratio will remain constant.
344. (a) The net income increases the cash balance, and hence is a source of working capital as an
increase in current asset increases the working capital or vice versa.
345. (e) Depreciation is an appropriation made to profits. It is a non-fund expenditure, and it is a
source of internal finance.
346. (c) Current liabilities includes liquid items of duration less than a year. Hence fixed deposit
made for 18 months is not an item of current liabilities.
347. (c) Payment of dividend is a use of fund.
348. (d) Decrease in inventory result in decrease in current assets and hence will not result in an
increase in net working capital.
349. (b) Increase in working capital is a use of fund.
350. (a) Issue of share capital results in inflow of cash or funds in the form of capital, hence it is a
source of funds.
351. (a) Taxes result in outflow of cash. Hence it is a use of fund.
96
352. (b) Decrease in current liabilities is a source of funds and increase in current assets is an
applications of funds.
353. (d) Increase in asset is because of use of some source to purchase then asset, hence it is a use
of fund.
354. (c) Depreciation is a source of long-term internal finance which can be used for purchase of a
new asset. It is not considered while preparing funds flow statement on a working capital basis.
355. (d) Decrease in prepaid expenses result in decrease of Current Assets and decrease in income
tax paid in advance result in increase of in cash available for business operations.
356. (b) Issue of equity shares result in inflow of capital in the form cash and the current assets
increase resulting in an increase of net working capital.
357. (b) Increase in prepaid expenses is an application of cash.
358. (d) A funds flow statement on cash basis does not show the net change in working capital.
359. (e) Funds flow statements are not helpful for the judgements of the following matters:
The quality of management
The ownership pattern of the company
The operational efficiency of the company
It also may be manipulated by the unscrupulous managers of any corporate entity. However, it
may be used to detect whether short-termfund is used for the procurement of the long termasset.
360. (d) Retirement of high cost debt, the installation of a capital asset and buy back of the equity
shares are the examples of the uses of funds by a business entity. Conversion of debentures
into equity shares is a matter of capital restructuring that does not lead to any financial
transaction. But selling an old car today to buy a new one after three months leads to the
inflow of cash to a company that may be used for the next quarter which may be considered
as a source of funds to the company.
361. (b) A gross increase in fixed assets is not considered as a source of fund, but as an use of
funds while making funds flow analysis on cash basis. The conditions mentioned in the other
options increase cash balance of a company and hence can be termed as the source of funds
for the company.
362. (e) Funds flow analysis can be studied in order to detect the imbalances in regards to the
sources and uses of funds as well as for the planning for the future financing strategies. But
the assessment of the market leadership for the products of the company are not reflected in
the funds flow statements.
363. (e) The features related to the funds flow statements are as follows:
It does not show the changes in the ownership patterns of the company
It does not show the sources and uses of funds at any particular date in a year, that is
shown in the balance sheet of the company
It cannot be considered as a snapshot picture for the operations of the business
It can also be manipulated by means of window dressing. Hence, the option (e) is correct.
364. (e) A funds flow statement is known through different terms one of them is mentioned in the
given option (e). A balance sheet states the financial position of a company as on a particular
date while profit and loss statement or income statement shows the financial performance of
a company during a year or a particular time period. Proforma statements are prepared to
project the financial position (proforma balance sheet) of a company and the financial
performance (proforma income statement) of a company in future.
Leverage
365. (c) Degree of total leverage is a combination of the operating and financial leverages. Thus, it is a
measure of the output and EPS of the company.
DOL =% Change in EBIT / % Change in output
DFL =% Change in EPS / % Change in EBIT
Hence DTL =DOL x DFL =% Change in EPS / % Change in output.
Part I
97
366. (c) DFL is use to know the impact of a change in EBIT on EPS of the company. DFL is zero
when the firm does not earn any operating profits.
367. (e) When the firm is operating at BEP, DTL is undefined.
368. (a) Greater the DOL, the more sensitive is EBIT to a given change in unit sales, i.e. the
greater is the risk of exception losses if sales become depressed. DOL is therefore a measure
of the firms business risk.
369. (b) Financial Break Even Point is the level of EBIT at which EPS of the company is zero and
DFL is undefined.
370. (e) Leverage ratios measure the long-term solvency of a firm. Bank finance to working
capital gap ratio shows the degree of firms reliance on short-term bank finance for financing
the working capital gap. It is a liquidity ratio.
371. (a) DFL =% Change in EPS/% Change in EBIT.
372. (a) Operating leverage examines the effect of the change in the quantity produced on the
EBIT of the company.
DOL =
EBIT
Output

373. (e) DOL is negative at the level of output below the operating breakeven point.
374. (a) Operating leverage examines the effect of the change in the quantity produced on the
EBIT of the company. Operating leverage =Contribution/EBIT
375. (e) With the help of DFL one can understand the impact of the change in EBIT on EPS of the
company.
376. (b) DTL is the product of DOL and DFL and hence measures the total risk of the company.
377. (e) DTL =DOL x DFL or % Change in EPS/% Change in output =1.5 x 2 =3.
i.e., one percent change in output will lead to 3% change in EPS.
378. (c) The combination of operating and financial leverages is the total or combined leverage.
The degree of total leverage is the measure of output and EPS of the company.
379. (c) At financial break even point DFL is undefined, i.e., it is equal to infinity.
380. (d) EBIT
DFL =
EBIT
EBIT I D (I t)
P

EBIT I D
p
/(1 t) x DFL =0
If DFL is zero then EBIT must be zero.
381. (e) Operating leverage examines the effect of the change in the quantity produced on the
EBIT of the company. All the above are true regarding the degree of operating leverage.
382. (e) By calculating the DOL for various levels of output we find that there is unique DOL for
each level of output, DOL is positive beyond the operating break even point, DOL is
undefined at the operating break even point.
383. (a) DOL =% Change in EBIT/% Change in output.
384. (c) By calculating the DOL for various levels of output we find that there is unique DOL for
385. (d) The operating BEP is that quantity which is produced and sold at which EBIT is zero.
386. (b) EBIT
DFL =
EBIT
EBIT I (D )/(1 t)
P

If preference share capital increases then the D
p
increases, which in turn increases the DFL.
98
387. (c) By calculating the DOL for various levels of output we find that there is unique DOL for
388. (a) Q (S V) =contribution
DOL =
Q(S V)
Q(S V) F

Increase in fixed costs then DOL increases.
389. (a) Financial leverage refers to the mix of debt and equity in the capital structure of the
company. As the company becomes more financially leveraged, it becomes riskier, i.e
increased use of debt financing will lead to increased financial risk.
390. (c) DOL =% Change in EBIT/% Change in quantity
Operating leverage measures the sensitivity of the earnings before interest and tax to change
in quantity.
391. (e)
DFL =
EBIT
EBIT I (D )/(1 t)
P

When DFL is zero EBIT is also zero. Hence the firm does not earn profits, so tax liability is
zero.
392. (c) The degree of operating leverage below the operational break even point will be negative.
393. (d) If the output is less than the operating break even point, then DOL will be negative.
394. (b) The following statements are correct with respect to the Degree of Operating Leverage
(DOL) for the operations of a company:
Each level of output has a distinct DOL
DOL is always negative below the operating break even point
DOL is always positive above the operating break even point
DOL is undefined at the operating break even point.
Hence, the option (b) is the answer.
395. (b) The following points are true with respect to the DFL of a company:
DFL helps to measure the financial risk of any corporate entity
DFL can be used to analyze the implications of retiring debts against the proceeds of the
issue of the preference capital.
DOL is applied by a corporate entity for its production and sales planning
DFL is used to relate the percentage change in EPS against every percentage change in
EBIT.
Hence, the option (b) is the correct choice.
396. (d) At the operating break even point, the EBIT is zero i.e. the sales revenue of the company
just covers the fixed and variable costs incurred by the company. Hence, the operating break
even point can be expressed in quantity of sales or value of sales.
397. (c) The DOL of a company depends on the contribution margin, sales quantity and the fixed
costs. It is not at all related to the interest expenses of the company. Hence, the issue of
equity shares in lieu of debentures will not affect the DOL of a company.
398. (d) If a firm retires its debentures prematurely, its interest burden will come down that will
decrease the financial leverage and total leverage of the company. It does not have any
impact on the operating leverage of the company. So, the option (d) is correct.
Part I
99
399. (e) As the degree of total leverage for the firm is zero, the contribution received by the firm
by selling its product will also be zero or the EBIT for the firm is zero. So the option (e) is
the answer. The conditions mentioned in the other options are not true, as any of such
conditions cannot make the DTL to zero.
400. (c) DOL measures the business risk of the company by assessing the change in EBIT owing
to a change in the level of production and sales volume. DOL has a distinct value at every
level of output of a firm while it is undefined at the operating breakeven point. The concept
of the degree of financial leverage is used to assess the conditions as mentioned in the option
(d) and (e). So, the option (c) is correct.
401. (e) Appointment of the managers at a very high compensation package will increase the fixed
cost of the company thereby decreasing the denominator of the DOL, DFL and DTL. As a
result of this, these leverages will go up. So, the operating break-even point and the financial
breakeven point will increase. So, the option (e) is correct
402. (c) If a firm goes for additional borrowings, its operating leverage will not be changed as the
degree of operating leverage does not depend on interest expenses.
403. (c) In the trend analysis via extrapolation, the past trend in sales is identified and this trend is
projected into the future. Hence, it is assumed that sales for the coming period will change to
the same degree as sales changed from the prior period to the current period.
404. (a) Sustainable growth is the rate which can be maintained without resorting to external
finance.
405. (e) The credit extended by the suppliers of goods and services is short-term source of finance
or spontaneous source of finance.
406. (a) Financial forecasting is a planning process with which the companys management
positions the firms future activities relative to the expected economic, technical, competitive,
and social environment. Sales forecast provides the basis around which the firms planning
process is centered.
407. (d) The percent of sales method assumes that the future relationship between various
elements of costs to sales will be similar to their historical relationship.
408. (a) The starting point in the preparation of pro forma operating statement is a projection of
the unit and rupee volume of sales.
409. (a) Objective methods are statistical methods which range in sophistication from relatively
simple trend extrapolations to the use of complicated mathematical models. Sales force
estimates is not based on the above. It is a subjective model.
410. (d) Objective methods are statistical methods which range in sophistication from relatively
simple trend extrapolations to the use of complicated mathematical models. Regression
analysis is more objective than any other model.
411. (a) EFR = A/S (S) L/S (S) mS (1 d)
This equation highlights that the amount of external financing depends on the firms
projected growth in sales.
412. (d) The percent of sales method assumes that the future relationship between various
elements of costs to sales will be similar to their historical relationship and the cost elements
remain unchanged.
413. (c) To prepare the pro forma income statement the percent of sales method is used in the
estimation of cost of goods sold and budgeted expense method is used for estimating the
value of various items on the basis of expected developments in the future period.
414. (d) The methods which use the judgments or opinions of knowledgeable individuals within
the company are called the subjective methods. Regression analysis and trend analysis are
objective methods of financial forecasting.
100
415. (b) g =
m(1 d)A/E
A/SO m(1 d)A/E

The above equation depicts the rate of growth without resorting to external financing. When
there is decrease in the dividend payout ratio then the growth increases.
416. (a) g =
m(1 d)A/E
A/SO m(1 d)A/E

The above equation depicts the rate of growth without resorting to external financing.
When the net profit margin increases the growth rate also increase.
417. (d) The assumptions for the sustainable growth rate are as follows:
The assets of the firm will increase proportionately to sales
Net profit margin is constant
Dividend pay-out ratio, not the amount of dividend and debt-equity ratio will remain
constant
External issue of equity will not be resorted to
Therefore, the alternative (d) is the correct choice.
418. (b) The trend analysis, through the method of extrapolation and regression analysis are used
for the projection of sales volume of the company. The future relationship between various
costs to sales is assumed to follow historical relationship in case of percent of sales method.
But in budgeted expense method, the estimation of the various items is considered on the
basis of the expected changes to be happened in the market for the preparation of the
proforma income statement. Hence, the option (b) is the answer.
419. (e) In J ury of Executive opinion method, the personal judgements of many senior executives
from different fields are taken into account while in sales force estimates method, the
personal judgement of the sales personnel operating at the ground level are considered. But
mathematical tools and techniques are applied in the methods mentioned in the options (c)
and (d). Hence, the option (e) is answer.
420. (c) DTL =
( )
p
Q(S V)
D
Q(S V) F I
1 t
=
( )
6000(500-200)
60,000
6000(500-200) 8,00,000 80,000
1-0.40

=2.195.
421. (b) The future relationship between various costs to sales is assumed to follow historical
relationship in case of percent of sales method. But in budgeted expense method, the
estimation of the various items are considered on the basis of the expected developments in
the context of the preparation of the proforma income statement. Trend analysis and
regression analysis are used for the projection of sales volume of the company. Hence, the
option (b) is the answer.

Frequently Used Formulae
Time Value of Money
1. Nominal interest rate = Real rate of interest or return + Expected rate of inflation + Risk
premiums to compensate for uncertainty.
2. Future Value of a single cash flow = FV
n
= PV(1 + k)
n
Where FV
n
Future Value of the initial flow n years hence
PV Initial cash flow
K Annual rate of interest
n Life of investment.
3. Doubling Period
(i) Rule of 72: 72/number of years
(ii) Rule of 69: 0.35 +
69
interest rate

4. Future value for shorter compounding periods
FV
n
= PV
mxn
k
1
m

+

m number of times compounding is done during a year
n number of years for which compounding is done.
5. Relationship between Effective and Nominal rates of interest:
r =
m
k
1
m

+

1
r Effective rate of interest
k Nominal rate of interest
m Frequency of compounding per year.
6. Future value of Annuity FVA
n
=
n
(1 k) 1
A
k

+

A = Amount deposited/invested at the end of every year for n years.
K = Rate of interest
n = Time horizon
FVA
n
= Accumulation at the end of n years.
7. Sinking Fund Factor =
n
k
(1 k) 1 +

8. Present Value of a single flow
PV =
n
n
FV
(1 k) +

9. Present value of an annuity
PVA
n
= A
n
n
(1 k) 1
k(1 k)

+

+

102
10. Capital Recovery Factor =
n
n
K(1 k)
(1 k) 1
+
+

11. Present value of Perpetuity
.
k,
P A x PVIFA

=
Risk and Return
1. Standard deviation = =
1
n
2
2
it i
t 1
1
(r r )
(n 1)
=

2. Variance =
2
3. Covariance = =
12
1 1 2 2
(x x )(x x )
(n 1)

4. Coefficient of correlation = =
12
12
1 2
x

5. Variance of portfolio =
2
p
=
n n
2 2 2 2
i i j j ij i j
i=t j=t
W + W +2 Cov W W

6. Systematic risk of a security =
2 2
i m

7. =
im
2
m

8. Unsystematic risk =
2 2
i im
(1 ).
1. V
0
(or P
0
) =
1 2 n
1 2
C C C
..
(1 k) (1 k) (1 k)
+ + +
+ + +
n
=
n
t
t
t 1
C
(1 k)
=
+

Where,
V
0
= Value of the asset at time zero
P
0
= Present value of the asset
C
t
= Expected cash flow at the end of period t
k = Discount rate or required rate of return on the cash flows
n = Expected life of an asset.
2. Instrinsic value or the present value of a bond:
V
0
(or P
0
) =
n
t n
t 1 d d
1 F
(1 k ) (1 k )
=
+
+ +

V
0
= I + F
d
(k , n)
(PVIFA )
d
(k , n)
(PVIF )
Where,
V
0
= Intrinsic value of the bond
P
0

= Present value of the bond
I = Annual interest payable on the bond
F = Principal amount (par value) repayable at the maturity time
n = Maturity period of the bond
k
d
= Cost of Capital.

103
3. The bond values with semi-annual interest
V
0
=
2n
t 2n
t 1 d d
I / 2 F
(1 k / 2) (1 k / 2)
=
+
+ +
d
(k / 2, 2n)
(PVIFA ) = I/2 +

d
(k / 2, 2n)
F(PVIFA )

Where,
V
0
= Value of the bond
I/2 = Semi-annual interest payment
F = Par value of the bond payable at maturity
k
d
/2 = Required rate of return for the half-year period
2n = Maturity period expressed in half-yearly periods.
4. One period rate of return
=
Pr ice gain or loss Coupon int erest
during holding period (if paid)
Purchase price at the beginning of
the holding period

+

5. Current Yield =
Coupon interest
Current Market Price

6. P
0
=
n
t n
t 1 d d
1 F
(1 k ) (1 k )
=
+
+ +

7. As trial and error method calculations are too tedious the following approximation formula
can be employed to find out the approximate YTM on a bond.
YTM
I (

F P) / n I (F P) / n
or
0.4F 0.6P (F P) / 2
+ +
+ +
Where,
YTM = Yield to maturity
I = Annual interest payment
F = Par value or redemption value of the bond
P = Current market price of the bond
n = Years to maturity.
8. Conversion value = Conversion Ratio x Stocks Current Market Price.
9. The value of convertible is determined as follows:

n
n
t n
t 1
(P ) x Conversion ratio C
(1 r) (1 r)
=
+
+ +

Where,
C = Coupon
r = Required rate of return
P
n

= Expected price of equity share on conversion
n = Number of years to maturity.

104
10. According to single period valuation model
P
0
=
1 1
e e
D P
(1 k ) (1 k )
+
+ +

Where,
P
0
= Current market price of the share
D
1
= Expected dividend a year hence
P
1
= Expected price of the share a year hence
k
e
= Required rate of return on the equity share.
11. According to multi-period valuation model
P
0
=
1 2
1 2
e e e
D D D
...
(1 k ) (1 k ) (1 k )
+ + +
+ + +
=
t
t
t 1 e
D
(1 k )
=
+

Where,
P
0
= Current market price of the equity share
D
1
D
2
= Expected dividend two years hence
= Expected dividend at infinite duration D
k
e
= Expected rate of return or required rate of return.
12. Valuation with Constant Dividends
Assume that the dividend per share is constant year after year, whose value is D, then value
of share is determined as follows:
P
0
=
1 2
e e
D D D
...
(1 k ) (1 k ) (1 k )
e

+ + +
+ + +

The above on simplification becomes
P =
e
D
k

13. Valuation with Constant Growth in Dividends
It is assumed that dividends tend to increase over time because business firms usually grow
over time. Therefore, if the growth of the dividends is at a constant compound rate than:
D
t
= D
0
(1 + g)
t
Where,
D
t
= Dividend for year t
D
0
= Dividend for year 0
g = Constant compound growth rate.
The valuation of the share where dividend increases at a constant, compound rate becomes

2
1 1 1
0
2 3
e e e
D D (1 g) D (1 g)
P .....
(1 k ) (1 k ) (1 k )
+ +
= + + +
+ + +

On simplification

1
0
e
D
P
k g
=

14. Valuation with Variable Growth in Dividends
Some firms have a super normal growth rate followed by a normal growth rate. If the
dividends move in line with the growth rate, the price of the equity share of such firm would be

105

n 1 n 1 2
1 a 1 e 1 n n
0
2 n n 1 n 2
e e e e e
D (1 g ) D (1 g ) D D (1 g ) D
P .....
(1 k ) (1 k ) (1 k ) (1 k ) (1 k )

+ +
+ + + +
= + + + + +
+ + + + +
n n
(1 g )

Where,
P
0
= Price of the equity share
D
1
g
a
= Super normal growth rate of dividends
g
n
= Normal growth rate of dividends.
15. Book Value = Net worth (Paid-up equity capital + Reserves + Surplus)
Number of outstanding equity shares.
16. Liquidation value per share is equal to:

Value realized from liquidating Amount tobe paid to all the
all the assets of the firm Creditors and preference shareholders
Number of outs tan ding equity shares

17. P/E Ratio = Expected earnings per share x Appropriate price Earnings ratio
The expected earnings per share is:

Expected PAT Pr eference dividend
Number of outs tan ding equity shares

18. E(P/E) =
PV per share
E(EPS)

19. E(P/E) =
D 1 D/ E(EPS)
or
k g E(EPS) (k g)

Ratios Definition
LIQUIDITY
Current Ratio
Current Assets
Current Liabilities

Quick Ratio
Current Assets Inventor
Current Liabilities

Inventory Turnover
Cost of GoodsSold or Sales
Average Inventory

LEVERAGE
Debt-equity Ratio
Total Debt
Net worth

Debt-asset Ratio
Total Debt
Total Assets

Interest Coverage Ratio
EBIT
Interest

PROFITABILITY
Gross Profit Margin
Gross Pr ofit
Net Sales

106
Net Profit Margin
Net Pr ofit
Net Sales

Return on Equity
Net Income
Average Equity

Earning Power
EBIT
Average Total Assets

Assets Turnover
Sales
Average Assets

Leverage
1. LY/LX =
Y/ X
X/ X

Where,
LY/LX Measure of the leverage which dependent Y has with independent X
Change in X X
Change in Y Y

X
X
Percentage change in X

Y
Y
Percentage change in Y.
2. Total Revenue = Quantity Sold(Q) x Selling Price (S)
Hence,
EBIT = Q x S Q x V F = Q(S V) F
EPS = [(EBIT I) (1 T) D
P
]/N =
P
[Q(S V) F I] (1 T) D
N

Where,
N = Number of Equity Shareholders.
3. DOL = Percentage change in EBIT / Percentage change in Output
=
EBIT/ EBIT
Q/ Q

EBIT = Q(S V) F
Substituting for EBIT, we get
DOL = [Q(S V)] / [Q(S V) F].
4. DFL = (Percentage change in EPS) / (Percentage change in EBIT)
DFL = ( EPS/EPS) / ( EBIT/EBIT)
Substituting Eq.(ii) for EPS we get
DFL =
P
EBIT
D
EBIT 1
(1 T)

107
5. DTL = % change in EPS / % change in output
= ( EPS / EPS) ( Q/Q)
DTL = DOL x DFL
= {[Q(S V)]/[Q(S V) F]} x {[Q(S V) F]/ Q(S V) F I [D
p
/1T)]}
=
P
Q(S V)
D
Q(S V) F I
(1 T)

6. The overall break even point is that level of output at which the DTL will be underfined and
EPS is equal to zero. This level of output can be calculated as follows:
Q =
P
D
F 1
(1 T)
(S V)
+ +

1. EFR =
1
A L
( S) ( S) mS (1 d)
S S

Where,
EFR = External financing requirement
A/S = Current assets and Fixed assets as proportion of sales
S = Expected increase in sales
L/S = Spontaneous liabilities as proportion of sales
m = Net profit margin
S
1
= Projected sales for next year
d = Dividend pay-out ratio.
2.
0
m(1 d)A/ E
g .
A/ S m(1 d)A/ E
=

Part II: Problems
1. If 182-day T-Bills are issued at a discounted price of Rs.96.52, then the yield is
a. 6.98%
b. 7.13%
c. 7.23%
d. 7.58%
e. 8.05%.
2. If 364-day T-bills of face value Rs.100 are issued at a yield of 11.50%, then the issue price is
a. Rs.88.50
b. Rs.89.69
c. Rs.89.71
d. Rs.89.78
e. Rs.89.88.
3. If the bid received by RBI from a bank for a 364-day T-Bill having a face value of Rs.100 is
Rs.88.24, and the bank calculates yield based on 365-day year, the yield to the bank will be
a. 11.760%
b. 11.792%
c. 13.291%
d. 13.327%
e. 13.364%.
4. Mr. B purchases a 91-day T-bill on 12.06.99 at Rs.98.12. The bill has a maturity of 61 days.
The yield realized by Mr. B by holding the bill till maturity is
a. 5.87%
b. 6.10%
c. 7.54%
d. 7.69%
e. 11.46%.
Time Value of Money
5. X deposited Rs.1,00,000 on retirement in a bank which can be withdrawn Rs.16,274 annually
for a period for 10 years. What is the interest rate?
a. 14%.
b. 20%
c. 10%
d. 8%.
e. 18%.
6. Vision Ltd., an NBFC offers car loans with two schemes. Scheme A offers 10% discount on
cash payment. Scheme B asks for a down payment of Rs.18,000 and Rs.4,100 per month for
5 years.
If the cost of the car is Rs.2.5 lakhs and the required rate of return is 9%, which of the
following represents the present value of cash inflows of both the Schemes?
a. Rs.2,50,000; Rs.2,17,000.
b. Rs.2,25,000; Rs.2,17,000.
c. Rs.2,25,00;Rs.2,17,182.
d. Rs.2,25,0000; Rs.2,17,582.
e. Rs.2,35,000; Rs.2,17,500.
Part II
109
7. Mr. Rohit is considering two options for investing Rs.5,000 for 4 years. In the first option, he
will get an assured return of Rs.7,000 plus percentage gain on the sensex at the end of 4th
year over todays closing index. The second option assures him an interest rate of 15% p.a.
compounded annually. Todays closing index =4000, Sensex at the end of 4th year =5000.
What amount will Rohit receive at he end of 4th year, if he is considering, the two options
independently?
a. Rs.8,250; Rs.8,545.
b. Rs.8,250; Rs.8,745.
c. Rs.8,545; Rs.8,745.
d. Rs.8,645; Rs.8,845.
e. Rs.8,745; Rs.8,845.
8. Which of the following alternatives gives the highest return assuming an interest of 14% per
annum?
a. Rs.1,00,000 now.
b. Rs.2,00,000 after 6 years.
c. Rs.15,000 p.a. in perpetuity
d. Rs.1,000 per month for a year and Rs.95,000 at the end of the year.
e. Rs.18,000 per year for the next 10 years.
9. How much amount should be deposited today in order to receive Rs.5,000 next year, and
which grows at the rate of 4% forever? Assume that the discount rate is 14% per annum.
a. Rs.50
b. Rs.500
c. Rs.5,000
d. Rs.50,000
e. Rs.5,00,000.
10. Hi-tech Ltd., offers a scheme under which an investor has to deposit Rs.1,500 per year for a
period of 10 years. After he can get back Rs.23,905 at the end of 10th year. What is the
irrelevant interest rate.
a. 10%
b. 12%
c. 13%
d. 14%
e. 20%
11. Ms. Sunita needs Rs.1,00,000 after 10 years. She can receive the required amount at the
desired time under two schemes. Under scheme A, she has to invest Rs.10,000 at the end of
every year for the first four years. Under scheme B, she has to invest Rs.5,000 at the end of
every year for the first 8 years. What are the implied interest rates in both the schemes?
a. 12.69%, 16.87%.
b. 12.85%, 16.79%.
c. 12.36%, 16.61%.
d. 12.69%, 16.97%.
e. 12.41%, 16.54%.
12. Ms. Kusum has retired recently. She received Rs.5 lakh as her retirement benefits, which she
had invested in a bank at 15% rate of interest. If she expects to live independently for another
15 years, how much money she can withdraw at the end of every year so as to leave a nil
balance in her account at the end of maturity?
a. Rs.40,65,040.
b. Rs.85,514.
c. Rs.61,448.
d. Rs.10,509.
e. Rs.4,064.
110
13. Mr. Amol wants to have an annual income of Rs.60,000 starting from the 11th year, which
should increase to Rs.90,000 from the 16th year and should continue till perpetuity. At 15% rate
of interest, how much should he invest amount annually for 10 years to get the desired returns?
a. Rs.24,592.
b. Rs.99,486.
c. Rs.14,687.
d. Rs.5941.4.
e. Rs.1,23,411.
14. Mr. Rajan Lal requires a sum of Rs.10 lakh at the end of 5 years from now for his sons
education. He is considering the following alternatives to accumulate the funds required:
i. Deposit a fixed sum in bank at the beginning of every year for five years, which will
fetch him on maturity an amount equal to Rs.10 lakh. Bank pays him interest at the rate
of 12% p.a.
ii. Buy a plot now by borrowing the amount required to buy it and sell it after 5 years so
that it realizes Rs.10 lakh. He has identified an area in which the market price is expected
to grow at the rate of 24% per annum. The purchase price is repayable in 5 equal
installments at the beginning of each year, the first installment being paid now. The loan
carries interest at the rate of 18% p.a.
What is the outflow of funds required for Mr. Rajan Lal under both the options?
a. 1.00 lakh; 0.90 lakh.
b. 1.41 lakh; 0.92 lakh.
c. 1.42 lakh; 0.95 lakh.
d. 1.45 lakh; 0.95 lakh.
e. 1.47 lakh; 0.97 lakh.
15. Mr. Chandramouli Singh is considering to take a life insurance policy of LIC for 20 years.
The insurance agent is advising him to take a money back policy. The scheme offers money
back at the end of 5th, 10th, 15th and 20th year to the extent of 25%, 25%, 25% and 25% of
the insured amount. The premium he will have to pay is Rs.62 annually for every Rs.1,000
insured. The insurance agent also, informs him that he will get a minimum bonus to the
extent of 40% at the end of the insurance term. Mr. Singh is of the opinion that the premium
for the money back policy is on the higher side. If the banks are offering a rate of 11% on the
long-term deposits, what is the effective return (K) on the policy and advise Mr. Singh.
a. K =2.56% and it is advisable for Mr. Singh to go for policy
b. K =2.56% and it is advisable for Mr. Singh to go for policy
c. K =2.56 % and it is not advisable for Mr. Singh to go for policy
d. K =2.56% and it is not advisable for Mr. Singh to go for policy
16. Mr. Farooq is considering to purchase a commercial complex that will generate a net cash
flow of Rs.4,00,000 at the end of one year. The future cash flows are expected to grow at the
rate of 4% per annum. Mr. Farooqs required rate of return is 12%. How much sould Mr. Farooq
pay for the complex if it produces cash flows forever.
a. Rs.20,00,000
b. Rs.50,000
c. Rs.5,00,000
d. Rs.50,00,000
e. Rs.2,00,000.
Part II
111
17. Mr. Prasad is considering to purchase a commercial complex that will generate a net cash
flow of Rs.4,00,000 at the end of one year. The future cash flows are expected to grow at the
rate of 4% per annum. Mr. Prasads required rate of return is 12%. Mr. Prasad would be
willing to pay the amount of ________ for the complex if he wishes to sell it at the end of
four years at Rs.40 lakh, net of transaction costs.
a. Rs.49,58,921
b. Rs.38,26,958
c. Rs.1,56,13,927
d. Rs.1,61,51,256
e. Rs.1,82,77,509.
18. Modern Textiles Ltd., has to redeem debentures worth Rs.1 crore by paying Rs.30 lakh at the
end of 8th year, Rs.30 lakh at the end of 9th year and Rs.40 lakh at the end of 10th year
from now. How much amount should the firm deposit in a sinking fund account at the
end of every year for 7 years in order to meet the aforementioned payments? (Assume that
the interest rate earned on the deposit account is 8% per annum).
a. Rs.49,73,803
b. Rs.4,97,380
c. Rs.9,55,410
d. Rs.95,541
e. Rs.9,550.
19. The present value of cash flows of Rs.950 per year forever at an interest rate of 8% and 10%
are _________ and _____________ respectively.
a. Rs.9,375 and Rs.7,500
b. Rs.8,500 and Rs.9,670
c. Rs.11,875 and Rs.9,500
d. Rs.7,345 and Rs.9,450
e. Rs.9,150 and Rs.8,965.
20. The present value of Rs.4,500 receivable in 7 years at a discount rate of 15% is __________.
a. Rs.975
b. Rs.1150
c. Rs.1692
d. Rs.1890
e. Rs.1555.
21. The present value of an annuity of Rs.8,000 starting in 7 years time lasting for 7 years at a
discount rate of 10% is ______
a. Rs.16,000
b. Rs.21,964
c. Rs.24,750
d. Rs.16,875
e. Rs.15,700.
22. The present value of an annuity of Rs.550 starting after 1 year for 6 years at an interest rate of
12% is ______.
a. Rs.5,435
b. Rs.4,712
c. Rs.2,261
d. Rs.2,795
e. Rs.5,195.
112
23. The present value of an annuity of Rs.1,300 starting immediately and lasting until 9th year at
a discount rate of 20% is _______
a. Rs.5,755
b. Rs.4,586
c. Rs.6,798
d. Rs.6,288
e. Rs.5,915.
24. The present value of a perpetuity of Rs.800 starting in the beginning of year 3 at a discount
rate of 18% is ___
a. Rs.24,160
b. Rs.2,796
c. Rs.3,191
d. Rs.2,831
e. Rs.1,794.
25. _____ is the present worth of operating expenditures of Rs.4,00,000 per year which are
assumed to be incurred continuously throughout in 8 year period if the effective annual rate
of interest is 12%.
a. Rs.15,75,000
b. Rs.19,87,200
c. Rs.14,27,995
d. Rs.15,67,813
e. Rs.18,27,500.
26. Kiran Automobiles purchases a machinery for Rs.8,00,000 by making a down payment of
Rs.1,50,000 and remainder in equal installments of Rs.1,50,000 for six years. The rate of
interest to the firm is ______.
a. 10% approximately
b. 11% approximately
c. 8% approximately
d. 14% approximately
e. 6% approximately.
27. Ten years from now Mr. X will start receiving a pension of Rs.8,000 a year. The payment will
continue for sixteen years. If his interest rate is 10%, now the worth of pension is ______.
a. Rs.24,160
b. Rs.18,760
c. Rs.21,365
d. Rs.23,414
e. Rs.20,775.
28. Assume that a deposit is to be made at year zero into an account that will earn 8%
compounded annually. It is desired to withdraw Rs.6,000 after three years from now and
Rs.7,000 after six years from now. The size of the year zero deposit that will produce these
future payments is _______.
a. Rs.8,400
b. Rs.9,650
c. Rs.11,000
d. Rs.9,174
e. Rs.8,120.
Part II
113
29. _______is the minimum amount which a person should be ready to accept today from a
debtor who otherwise has to pay a sum of Rs.4,000 today Rs.5,000, Rs.7,000 and Rs.8,000
and Rs.10,000 at the end of year 1, 2, 3 and 4 respectively from today. The rate of interest
may be taken at 14%.
a. Rs. 29,540
b. Rs. 28,409
c. Rs. 25,000
d. Rs. 18,750
e. Rs. 25,088.
30. The present value of the investment Rs.7,500 due in 10 years discounted @10 percent annual
rate is _______.
a. Rs.1,009.10
b. Rs.2,038.95
c. Rs.2,891.57
d. Rs.3,195.80
e. Rs.6,610.75.
31. The fixed deposit scheme of ICICI Bank offers the following interest rates.
Period of deposit Rate per annum
58 days to 187 days 12.0%
188 days to <1 year 12.5%
I year and above 13.0%
An amount of Rs.1,00,000 invested today will grow in 3 years to __________
a. Rs.1,55,000
b. Rs.1,44,200
c. Rs.1,67,500
d. Rs.1,52,000
e. Rs.1,45,000.
32. What is the doubling period according to the Rule of 69 if the interest rate is 18%?
a. 4.45 yrs.
b. 4.90 yrs.
c. 5.67 yrs
d. 5.28 yrs.
e. 4.18 yrs.
33. If you deposit Rs.10,000 today at 12% rate of interest, in how many years does this amount
grow to Rs.80,000 (Use Rule of 72)?
a. 6 years
b. 12 years
c. 18 years
d. 14 years
e. 24 years.
34. What is the future value of Rs.20,000 invested now for a period of 5 years at an interest rate
of 8%?
a. Rs.29,380.
b. Rs.41,350.
c. Rs.30,710.
d. Rs.20,700.
e. Rs.28,000.
114
35. What is the future value of the following series of payments @ 5% rate of interest at the end
of 5 years?
At the end of 1st year =Rs.2,000
2nd year =Rs.3,000
3rd year =Rs.4,000
4th year =Rs.5,000
5th year =Rs.6,000
a. Rs.14,750.
b. Rs.12,516.
c. Rs.21,559.
d. Rs.16,041.
e. Rs.15,000.
36. The present value of Rs.20,000 to be received after five years from now assuming 6% time
preference for money is ______.
a. Rs.14,940
b. Rs.16,776
c. Rs.12,551
d. Rs.11,500
e. Rs.20,740.
37. The present value of the following cash flows assuming a discount rate of 8% is _______
Year Cash flows
1 Rs.30,000
2 Rs.20,000
3 Rs.10,000
4 Rs.10,000
a. Rs.60,210
b. Rs.35,165
c. Rs.41,210
d. Rs.50,500
e. Rs.46,785.
38. Mr. A has to receive Rs.9,000 per year for 6 years. The present value of the annuity is
______, assuming that he can earn interest on his investment @12% p.a.
a. Rs.22,750
b. Rs.15,650
c. Rs.36,999
d. Rs.18,975
e. Rs.32,515.
39. The amount of equal annual payment to be made for a loan of Rs.4,00,000, taken for a period
of 4 years @10% rate of interest is _________.
a. Rs.64,009.60
b. Rs.63,091.48
c. Rs.71,568.10
d. Rs.1,26,183
e. Rs.1,76,000.
40. A company offers to pay you Rs.4,025 annually for 8 years if you deposit Rs.20,000 today with
the company. The interest rate earned will be ______.
a. 13%
b. 16%
c. 18%
d. 12%
e. 22%.
Part II
115
41. An investment company offers to pay Rs.25,959 at the end of 10 years to investors who
deposit annually Rs.1,000. The implied interest rate is __
a. 12%
b. 14%
c. 16%
d. 18%
e. 20%
42. If you deposit Rs.20,000 today at 12% rate of interest, in how many years will this amount
grow to Rs.80,000 using rule of 72.
a. 10 years
b. 12 years
c. 14 years
d. 16 years
e. 18 years.
43. Payment of a 9-years annuity of Rs.10,000 will begin 7 years hence. The value of this
annuity now if the discount rate is 12%?
a. Rs.44,315.
b. Rs.27,000.
c. Rs.35,675.
d. Rs.13,400.
e. Rs.22,975.
44. X deposits Rs.1,00,000 on retirement in a bank which pays 10% annual interest. How much
can be draw annually for a period of ten years if PVIFA @10% is 6.145.
a. Rs.16,273.79
b. Rs.18,797.10
c. Rs.20,000
d. Rs.11,567.15
e. Rs.15,850.
45. At the time of his retirement Mr. Swamy is given a choice between two alternatives.
i. An annual pension of Rs.20,000 as long as he lives.
ii. A lump sum payment of Rs.1,50,000. If Mr. X expects to live for 15 years and rate of
interest is 15%, which alternative should he select.
a. Option (i) only.
b. Option (ii) only.
c. Both (a) and (b) above
d. Either (a) or (b)
46. A person can save Rs. ________ annually to accumulate Rs.4,00,000 by the end of 10 years,
if the saving earns an interest of 12 percent.
a. 22,795
b. 18,500
c. 25,700
d. 21,350
e. 19,475.
116
47. Ram expects to receive Rs.1,000 annually for 3 years, each receipt occurring at the end of the
year. What is the present value of this stream of benefits if the discount rate is 10%?
a. Rs.3,568.50.
b. Rs.2,486.85.
c. Rs.3,541.19.
d. Rs.2,796.71.
e. Rs.3,119.18.
48. Andhra Bank has opened a scheme to all individuals/firms. A lump sum deposit is remitted
and the principal is received with interest at the rate of 12 percent p.a. in 12 monthly
installments. The interest is compounded at quarterly intervals. The amount of initial deposit
to receive a monthly installment of Rs.1000 for 12 months is _________.
a. Rs.19,709
b. Rs.21,756
c. Rs.18,494
d. Rs.11,256
e. Rs.10,764.
49. A intends to invest Rs.600 at the end of each of the next eight years at an interest rate of 11
percent. Determine the amount A will have at the end.
a. Rs.7,384
b. Rs.7,304
c. Rs.7,117
d. Rs.6,957
e. Rs.6,845.
50. On a contract, there are two options.
Option 1: Receiving Rs.25,000 six years fromnow
Option 2: Receiving Rs.50,000 twelve years hence.
What is the implied discount rate that equates these two amounts?
a. 10.3%.
b. 11.3%.
c. 12.25%.
d. 13.52%.
e. 13.75%.
51. The present value of the wages receivable for the next thirty years for C is Rs.400000. If C
saves 10% of his salary and invests the same at an interest rate of 12% what is the value of
the savings after 30 years.
a. Rs.11,18,375
b. Rs.12,00,020
c. Rs. 9,85,645
d. Rs.11,98,400
e. Rs. 9,69,725.
52. An asset appreciating at 10 percent approximately doubles in 7 years. Calculate the
approximate present value of an asset that pays Rs.1 a year in perpetuity beginning from year 8.
a. Rs.6
b. Rs.7
c. Rs.5
d. Rs.8
e. Rs.4.
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117
53. If an insurance firm X uses an interest rate of 5% in its calculations, what must Mr.Cohen
pay at the outset for an annuity providing him Rs.10,000 per year? (Assume annual payments
are at the end of each of the 15 years). What would be the purchase price if the interest rate
were 10%?
a. Rs.1,10,679; Rs.76,050.
b. Rs.1,10,967; Rs.75,060.
c. Rs.1,03,800; Rs.76,061.
d. Rs.1,03,880; Rs.75,071.
e. Rs.1,04,760; Rs.76,070.
54. Mr. X wants to buy a house which would cost him Rs..8, 00,000. SFCL has offered to
provide 90% finance for a period of 8 years. Mr. X has to bring in 10% of the cost of the
house at the time of purchase. He will borrow the amount of his contribution from one of his
relatives and will pay back his relative Rs.40,000 and Rs.50,000 (which include the amount
borrowed and the interest) at the end of the first year and the second year respectively. The
amount borrowed from SFCL has to be repaid along with interest in equated monthly
installments of Rs.12,800 each, payable at the end of every month over a period of 8 years. If
Mr. X borrows 90% of the purchase price from SFCL Ltd., and the rest from his relative, the
effective rate of interest per annum involved is
a. 15.36%
b. 16.75%
c. 17.89%
d. 18.00%
e. 18.75%.
55. If the interest rate is 10 percent calculate the present value of an asset that pays Rs.10 a year
in perpetuity, and the approximate present value of an asset paying Rs.1 every year for each
of the next seven years.
a. Rs.100 and Rs.5
b. Rs.100 and Rs.50
c. Rs.10 and Rs.50
d. Rs.10 and Rs.5
e. Rs.100 and Rs.7.
56. Mr. Prakash deposits Rs.100 at the beginning of every month in the recurring deposit scheme
of Hyderabad Bank for five years. If the bank offers an interest rate of 12 percent per annum
compounded monthly, the amount accumulated by the end of five years is (round off your
answer to the nearest integer)
a. Rs.7,624
b. Rs.6,121
c. Rs.8,167
d. Rs.8,249
e. Rs.8,538.
57. In order to buy a car woth Rs.5,00,000, you are planning to take loan of Rs.400,000 from a
Commercial Bank. The loan is to be repaid along with interest in equated monthly
installments of Rs.9,000 within a period of 5 years, payable at the end of every month.
However, the margin money of Rs.100,000 is to be borrowed from a local money lender that
is to be repaid with interest at a rate of 20 percent by the end of the year. What is the implicit
cost of your borrowed funds?
a. 12.41%.
b. 12.91%.
c. 13.31%.
d. 13.71%.
e. 14.11%.
118
58. The money invested in Kisan Vikas Patra today doubles in eight years and six months. What
is the approximate rate of interest per annum as per the Rule of 69?
a. 8.08%.
b. 8.23%.
c. 8.47%.
d. 8.53%.
e. 8.68%.
59. Setwin Corp Ltd., has taken a loan of Rs.5 lakh from Secbad Bank at 12 percent per annum
compounded annually. If the loan is to be repaid along with interest in 5 equated annual
installments (where the first installment is to be paid after one year from today and the
interest is calculated on the diminishing balances), what should be the amount of installment?
(Round off your answer to the nearest Rs.100).
a. Rs.1,47,400
b. Rs.1,38,700
c. Rs.1,55,300
d. Rs.1,23,800
e. Rs.1,25,300.
60. In order to buy a car, on January 1, 2007, presently available at a price of Rs.2,50,000, you
started to deposit your money in the monthly recurring deposit scheme of a bank from January
31, 2004. The bank offers a rate of interest of 12 percent per annum compounded monthly. If
the car price is expected to go up by 4 percent per annum, how much amount should you
deposit every month in that scheme? (Round off your answer to the nearest integer)
a. Rs.5,828
b. Rs.6,178
c. Rs.6,528
d. Rs.6,670
e. Rs.7,028.
61. If the rate of return from a security is 6 percent per annum, what is the doubling period under
the Rule of 72?
a. 11.85 years.
b. 11.87 years.
c. 12 years.
d. 13 years.
e. 15 years.
62. The nominal rate of interest is 6 percent per annum. What is the effective rate of interest, if it
is compounded quarterly?
a. 6.00%.
b. 6.06%.
c. 6.14%.
d. 6.24%.
e. 6.36%.
63. If long term rate of interest offered by a bank is 6.19 percent per annum. What is the doubling
period under the Rule of 69?
a. 11.15 years.
b. 11.50 years.
c. 11.85 years.
d. 12.15 years.
e. 12.50 years.
Part II
119
64. You are planning to buy a car after 5 years that is presently available at a price of
Rs.2,50,000. If the price is expected to go up by 20 percent by that time, how much amount
should you deposit at the beginning of every year at a rate of 6 percent per annum in order to
make your plan a success?
a. Rs.71,225.
b. Rs.67,193.
c. Rs.53,220.
d. Rs.50,207.
e. Rs.45,038.
65. Hyderabad Finance Ltd., offers a deposit scheme where the investor is required to deposit
Rs.100 at the end of every month for a period of 4 years 2 months in order to get an amount
of Rs.7,500 at the end of 5 years. What is the effective rate of interest?
a. 11.30%.
b. 12.30%.
c. 13.30%.
d. 14.30%.
e. 15.30%.
66. Mr. Sadhu plans to buy a house for a price of Rs.5 lakh. State Bank of India offers loan at a
rate of 9 percent per annum quarterly compounded for 80 percent of the purchase price of the
house. How much will be the equated monthly installments, if Mr. Sadhu plans to repay the
loan with interest in the next ten years?
a. Rs.5,041.
b. Rs.5,142.
c. Rs.5,242.
d. Rs.5,342.
e. Rs.5,442.
67. If a loan of Rs.3,00,000 is to be repaid in 6 annual installments with a coupon rate of 12% p.a.
then the equated annual installment will be
a. Rs.71,967
b. Rs.72,975
c. Rs.74,005
d. Rs.75,995
e. Rs.76,004.
68. A person took a loan of Rs.10,000 on J anuary 1, 2003. At the end of every month he has to
pay Rs.1,000 for 12 months so that his loan will be totally repaid by December 31, 2003. The
implied interest rate per annum is (approximately)
a. 20%
b. 25%
c. 28%
d. 30%
e. 35.1%.
69. The difference between the effective rate of return of a bond with a coupon rate of 12%
when compounded monthly and quarterly is
a. 0.03%
b. 0.10%
c. 0.13%
d. 0.19%
e. 0.45%.
120
70. If the annual cash inflow for a bond is Rs.200, the present value of the bond, if the inflows
continue for 5 years at a required rate of 11%, is
a. Rs.639
b. Rs.739
c. Rs.839
d. Rs.869
e. Rs.939.
71. The fixed deposit scheme of Nagarjuna Bank offers 10% interest for a three-year deposit. If
the compounding is done semi-annually, then effective annual interest rate is
a. 10.00%
b. 10.25%
c. 10.38%
d. 10.50%
72. An income stream provides Rs.2000 for first three years and Rs.3000 for next three years, if
interest rate is 14%, then the present value of income stream is
a. Rs.8650.85
b. Rs.8860.50
c. Rs.9403.20
d. Rs.9624.25
e. Rs.9345.00.
73. Mr. Naresh deposited Rs.1000 every month in a bank for five years, if the interest rate is 12%
p.a. compounded monthly, then the accumulated amount he will get after 5 years is
a. Rs.44,955
b. Rs.67,200
c. Rs.81,600
d. Rs.83,264
e. Rs.96,000.
74. Tripti Foods Ltd., had taken a loan of Rs.500 lakh from a bank. The loan is to be repaid in ten
equal annual installments. If the annual interest rate is 16%, then each installment is
a. Rs.102.78 lakh
b. Rs.103.46 lakh
c. Rs.111.43 lakh
d. Rs.113.50 lakh
e. Rs.132.13 lakh.
75. Mr. Pandit expects to receive from his friend an amount of Rs.2000 per annum for 10 years.
If his required rate of return is 12% p.a. what is the present value of these cash inflows?
a. Rs.20,000.
b. Rs.15,000.
c. Rs.11,300.
d. Rs.10,500.
e. Rs.10,000.
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121
76. If a bank agrees to pay 9 percent per annum for a certain sum of money deposited with it, and
if the interests are paid semi-annually, then the effective rate of interest is
a. 18.00% p.a.
b. 9.00% p.a.
c. 9.20% p.a.
d. 10.00% p.a.
e. 12.00% p.a.
77. A loan of Rs.5,00,000 is to be repaid in 10 equal annual installments. If the loan carries a rate of
interest of 12% p.a., the equated annual installment is
a. Rs.75,000
b. Rs.80,000
c. Rs.88,496
d. Rs.95,496
e. Rs.1,00,000.
78. If the effective annual rate of interest is 17.87%, then on a debt that has quarterly payments,
what is the nominal annual rate?
a. 16.78%.
b. 18.92%.
c. 20.93%.
d. 21.00%.
e. 22.36%.
79. If a share of a stock provided a 19.5% nominal rate of return while the real rate of return was
14%, then the inflation rate was
a. 4.83%
b. 7.18%
c. 8.54%
d. 10.12%
e. 26.24%.
80. If a borrower promises to pay Rs.20,000 eight years from now in return for a loan of
Rs.12,550 today, what effective annual interest rate is being offered?
a. 1.59%.
b. 5.00%.
c. 6.00%.
d. 7.00%.
e. 7.42%.
81. Rs.10,000 is borrowed to be repaid in four equal annual payments with 8% interest.
Approximately, how much principal is amortized with the first payment?
a. Rs.800.
b. Rs.2219.
c. Rs.2500.
d. Rs.3281.
e. Rs.3300.
122
82. If the nominal rate of interest is 10% p.a. and the frequency of compounding is 4 times a year
then the effective interest rate is
a. 10.38%
b. 10.40%
c. 10.42%
d. 10.44%
e. 10.46%.
83. The future value of a regular annuity of Re.1.00 earning a rate of interest of 12% p.a. for
5 years is equal to
a. Rs.6.250
b. Rs.6.353
c. Rs.6.425
d. Rs.6.538
e. Rs.6.625.
84. Rs.100, 180-day T-bills is currently selling at Rs.95. The yield on the bills, assuming 365-day
year is
a. 10.00%
b. 10.50%
c. 10.67%
d. 10.88%
e. 11.25%.
85. What real rate of return is earned by a one year investor in a bond that was purchased for
Rs.1000, has a 12% coupon and was sold for 980 when the inflation rate was 6%?
a. 2%.
b. 4%.
c. 6%.
d. 10%.
e. 16%.
86. The amount that has to be invested at the end of every year for a period of 6 years at a rate of
interest of 15% in order to accumulate Rs.1000 at the end of 6 years is equal to
a. Rs.112.42
b. Rs.114.24
c. Rs.114.42
d. Rs.112.44
e. Rs.112.24.
87. If rate of interest is 16% and maturity period of a loan is 15 years, the sinking fund factor will
be equal to
a. 0.01558
b. 0.01935
c. 0.9735
d. 1.0667
e. 1.9357.
88. If the nominal rate of interest compounded quarterly is 18%, then the effective rate of interest
will be equal to
a. 16.6%
b. 16.7%
c. 16.8%
d. 16.9%
e. 19.25%.
Part II
123
89. The present value of Rs.10,00,000 receivable after 60 years, at a discount rate of 10% is
a. Rs.3,284
b. Rs.6,898
c. Rs.18,649
d. Rs.39,440
e. Rs.48,376.
90. If the interest rate on a loan is 1.5% per month, the effective annual rate of interest is
a. 18%
b. 18.63%
c. 18.79%
d. 19.15%
e. 19.56%.
91. According to the Rule of 69, doubling period of an investment at an interest rate of 16% is
a. 4.2 years
b. 4.5 years
c. 4.7 years
d. 5.0 years
e. 5.2 years.
92. If the return on a security is 6%, then what is the doubling period according to the Rule of 69
for investments in that security?
a. 5.75 years.
b. 11.50 years.
c. 11.58 years.
d. 11.85 years.
93. If the interest rate is 12% p.a., the amount to be invested today to earn an annuity of Rs.1,000
for five years commencing from the end of first year is
a. Rs.6,353
b. Rs.5,672
c. Rs.4,037
d Rs.3,605
e. Rs.3,037.
94. If the rate of interest is 10%, the amount that should be deposited now so that a constant
annual income of Rs.10,000 can be withdrawn indefinitely is
a. Rs.9,00,909
b. Rs.1,10,000
c. Rs.1,00,000
d. Rs.90,000
e. Cannot be determined.
95. If the nominal rate of interest is 16% and compounding is done quarterly, the effective rate of
interest will be
a. 17.52%
b. 16.99%
c. 16.00%
d. 15.12%
e. 12.49%.
124
96. M/s. Lee Ltd., has Rs.10,00,000 worth of debentures to be redeemed after five years from
now. If the interest rate is 14% p.a., the amount that has to be invested every year in a sinking
fund to retire the above bonds is
a. Rs.6,61,010
b. Rs.3,43,308
c. Rs.2,91,284
d. Rs.1,51,284
e. Rs.1,34,330.
97. ICI Ltd., promises to double your investment in 4 years 9 months. The rate of interest
promised by ICI according to the Rule of 69 is
a. 13.14%
b. 13.53%
c. 14.53%
d. 15.16%
e. 15.68%.
98. As per the Rule of 72, in how many years will the amount deposited today at an interest rate
of 16% double?
a. 4.50 years.
b. 4.60 years.
c. 4.62 years.
d. 4.95 years.
99. The amount that should be deposited now so that a constant monthly income of Rs.1,000 can
be withdrawn indefinitely, if the rate of interest is 12% p.a. is
a. Rs.90,000
b. Rs.1,00,000
c. Rs.1,15,000
d. Rs.9,00,900
e. Insufficient information.
100. The amount to be invested today to earn an annuity of Rs.1000 for five years commencing
from the end of two years from today if the interest rate is 12% per annum is
a. Rs.3,219
b. Rs.5,993
c. Rs.2,874
d. Rs.3,873
e. Rs.4,873.
101. How much is a Rupee worth today, if you can expect to receive it a year from now, with no
risk of default?
a. Less than Re.1.
b. Re.1.
c. More than Re.1.
d. Zero.
e. Data insufficient.
Part II
125
102. As per Rule of 69 in how many years will the amount deposited today at an interest rate of
15% become double?
a. 4.62 years.
b. 4.60 years.
c. 4.95 years.
d. 4.49 years.
103. The IDBI deep discount bond offers investors Rs.2,00,000 after 25 years, for an initial
investment of Rs.5,500. The interest rate implied in the offer is
a. 14.8%
b. 15%
c. 15.5%
d. 16.5%
e. Not possible to determine from the given data.
104. Mr.Dhanasekhar borrows from Sind Bank Limited Rs.5,00,000 to be repaid within five years
at an interest rate of 15% per annum on the opening balances of every year. The equated
annual payment to be made by him, so that by the end of five years the entire amount of
principal and interest would be repaid, is
a. Rs.1,25,000
b. Rs.1,75,000
c. Rs.1,49,165
d. Rs.1,00,000
e. Rs.2,48,633.
105. Ms. D Positor has placed a deposit of Rs.5000 with Acceptor Ltd., at 15% p.a. interest
compounded semi-annually. In three years her investment will grow to
a. Rs.7,250
b. Rs.7,344
c. Rs.7,500
d. Rs.7,604
e. Rs.7,716.
106. How much should a company invest at the beginning of each year at 14% so that it can
redeem debentures of Rs.10 lakhs at the end of year 10?
a. Rs.45,363.
b. Rs.48,195.
c. Rs.51,714.
d. Rs.65,236.
e. Rs.71,535.
107. The probability that stock X will rise by 25% is 30% and the chance that it declines by 5% is
70%. The expected return and standard deviation of stock X are ________ and ________,
assuming return on X and Y is 1% currently.
a. Expected return =4%, standard deviation =13.75%
b. Expected return =4%, standard deviation =13.75%
c. Expected return = 4%, standard deviation =13.75%
d. Expected return =11%, standard deviation =93.1%
e. Expected return =11%, standard deviation =93.1%.
126
108. There is a 40% chance that stock A will rise by 20% and the probability for it decline by 8%
is 60%. The expected return and standard deviation of stock X are ________ and ________,
assuming return on X and Y is 1% currently.
a. Expected return =4%, standard deviation =13.75%
b. Expected return =3.0%, standard deviation =19.02%
c. Expected return =3.2%, standard deviation =13.72%
d. Expected return =3.0%, standard deviation =19.02%
e. Expected return =4%, standard deviation =19.02%.
109. The standard deviation of stock X and Y are 13% and 13% respectively. If the correlation
coefficient between X and Y is 0.5% then the covariance is ________.
a. 0.0084
b. 0.0090
c. 0.0087
d. 0.0088
e. 0.01.
110. For XYZ Ltd., if the market and stock returns are 0.5 and 6.83, with beta value as 0.584
then value of alpha from the equation of characteristic line is _____.
a. 7.22
b. 7.02
c. 7.02
d. 7.22
e. 7.12.
111. Given the risk-free rate is 12% and the expected return on the market portfolio is 18%. The
following are the expected returns for three stocks with their betas:
Expected return (%) Expected beta
Stock I 19 1.5
Stock II 18.5 0.75
Stock III 22 1.4
Based on these expectations, which of the following statements is true?
a. Stock I and II are overvalued whereas stock III is undervalued.
b. Stock I is overvalued whereas stock II and III are undervalued.
c. Stock I and II are undervalued whereas stock III is overvalued.
d. Stock I and III are undervalued whereas stock II is overvalued.
e. Stock I, II and III are undervalued.
112. The standard deviation of Greaves Ltd. stock is 24% and its correlation coefficient with the
market portfolio is 0.5. The expected return on the market is 16% with a standard deviation
of 20%. If the risk-free return is 6%, the required rate of return on Greaves Ltd., scrip is
________.
a. 12%
b. 12%
c. 11%
d. 11.5%
e. 11%.
Part II
127
113. Mr. Ramesh has the following scrips in his portfolio:
Industries Beta Proportion (%) of investment
Ballarpur Industries 0.95 15
GE Shipping 1.1 20
SBI 1.25 30
Ahmedabad Electric Co. 0.8 5
BSES 1.05 20
Bombay Dyeing 0.7 10
The required rate of return (%) on his portfolio is ______, if risk-free return is 4% and return
on market is 14%.
a. 14.575
b. 14.570
c. 14.575
d. 14.757
e. 14.857.
114. The risk-free return is 10% and the market return is 15%. Stock A has a beta of 1.2 and is
currently selling for Rs.30. If the expected dividend on the stock is Rs.4, then the growth
rate of the company is ______.
a. 2.16
b. 2.11
c. 2.33
d. 2.67
e. 2.70.
115. The shares of Sumanta Ltd. are expected to provide the following returns in different scenarios:
Scenario Probability Expected Return
Recession 0.3 10%
Low growth 0.4 5%
High growth 0.3 20%
The standard deviation is:
a. 11.0%
b. 11.0%
c. 11.62%
d. 11.62%
e. 12.0%.
116. Consider stock P and Q. The expected return on stock P and stock Q are 10% and 20%
respectively. If standard deviation of stock P is 2% and stock Q is 5%, the expected return
and standard deviation of a portfolio combining these two stocks in equal proportion are
_____ if their correlation coefficient is 0.4.
a. E(r) =15% and standard deviation is 3.04%
b. E(r) =11% and standard deviation is 2.76%
c. E(r) =18.5% and standard deviation is 5.31%
d. E(r) =16.0% and standard deviation is 4.75%
e. E(r) =14.8% and standard deviation is 2.98%.
117. ______ is the equilibrium price of a share for which beta is 1, current dividend is Rs.2.5 per
share, growth rate is 6%, risk free return is 9% and return on market is 18%.
a. Rs.22
b. Rs.21.01
c. Rs.22.08
d. Rs.44
e. Rs.44.02.
128
118. ABC Ltd., has following dividend per share and the market price per share for the period
2002 and 2003.
Year DPS Market Price
2002 1.53 Rs.37.25
2003 1.53 28.75
The annual rate of return for year 2003 is _____.
a. 18.7%
b. 18.7%
c. 28.7%
d. 28.7%
e. 27.1%.
119. Surana Industries has following dividend per share and the market price per share.
Year DPS Market Price
2002 2.00 200.00
2003 2.00 280.00
The annual rate of return for the year 2003 is ___.
a. 58%
b. 41%
c. 58%
d. 56%
e. 41%.
120. The following information of Ram and Co. Ltd., is available in respect of the return from
security X under different economic conditions:
Condition Economic Return Probability
Good 18% 0.1
Average 15% 0.4
Bad 12% 0.3
Poor 5% 0.2
The expected return of the security and the risk associated with that are ______ and
_________.
a. 18% and 7.8%
b. 14% and 8.6%
c. 15% and 7.9%
d. 19% and 6.4%
e. 12.4% and 4.1%.
121. The market price of the share of ABC Ltd., and XYZ Ltd., are Rs.200 each. The total annual
return expected under different economic condition are as follows:
Condition
Economic
Probability ABC Ltd
Rs.
XYZLtd
Rs.
Good 0.3 200 250
Average 0.4 210 230
Bad 0.2 220 190
Poor 0.1 240 160
Using the above data the expected return and standard deviation are _________ and ______
in case of 10 shares of ABC Ltd.
a. Rs.2200 and120.35%
b. Rs.2120 and 116.62%
c. Rs.2050 and 89.75%
d. Rs.2100 and 110%
e. Rs.2360 and 135.45%.
Part II
129
122. Using the data of problem 121, the expected return and standard deviation are _______ and
__________, in case of 10 shares of XYZ Ltd.
a. Rs.2365 and 136.98%
b. Rs.2200 and 128.71%
c. Rs.2210 and 291.38%
d. Rs.2400 and 250.41%
e. Rs.2760 and 215.75%.
123. Assume R
f
is 7%, K
m
is 16% for a security X and has a beta factor of 1.4, the required return
of the security is _________.
a. 21.6%
b. 20.0%
c. 17.4%
d. 19.6%
e. 23.2%.
124. A security Y has a beta factor of 1.0 and R
f
is 9% and K
m
is 15%, then the required return of
the security is __________.
a. 17%
b. 16%
c. 18%
d. 14%
e. 15%.
125. If a security Z has a beta factor of 2.3 and R
f
is 11% and K
m
is 17%, then the required return
of the security is _________.
a. 33.12%
b. 20.61%
c. 24.80%
d. 25.8%
e. 27.6%.
126. The risk-free rate is 8% and the required return on the market portfolio is 18% of security A.
The required return of security A is ________ if the Beta is 2.6.
a. 39.2%
b. 28.76%
c. 34.0%
d. 41.3%
e. 25.55%.
127. The standard deviation of return of security Y is 15 and of market portfolio is 10. The beta of
Y is _________ if Cor
ym
=0.25.
a. 0.375
b. 0.375
c. 0.295
d. 0.295
e. 0.475.
128. From the following data beta of security x is ___.

x
=15,
m
=12 and Cor
xm
=+0.72.
a. 1.00
b. 0.88
c. 0.73
d. 0.90
e. 1.06.
130
129. An investor is seeking the price to pay for a security, whose standard deviation is 4.00
percent. The correlation coefficient for the security with the market is 0.8 and the market
standard deviation is 3.2 percent. The return from the government securities is 6.2 percent
and from the market portfolio is 9.8 percent. The investor knows that, by calculating the
required return, he can then determine the price to pay for the security The required return on
security is _________.
a. 11.57%
b. 10.21%
c. 12.31%
d. 9.8%
e. 12.56%.
Based on the following information, Answer Questions 130 to 133.
The expected return on the market portfolio and the risk-free rate of return are estimated to be
15% and 11% respectively. XYZ Ltd., has just paid a dividend of Rs.3 per share with annual
growth rate of 9%. The sensitivity index of XYZ Ltd., has been found to be 1.2.
130. The equilibrium price for the shares of XYZ Ltd., is Rs.__________.
a. 31.47
b. 48.08
c. 26.39
d. 39.41
e. 34.57.
131. If the risk Premium further increases by 2%, then the change in price is Rs.________.
a. 25.00
b. 29.50
c. 35.54
d. 24.32
e. 26.00.
132. If the expected growth rate in dividends increases to 12%, then the new price is Rs._______.
a. 61.50
b. 88.42
c. 57.90
d. 62.35
e. 60.15.
133. The change in price is Rs._____ if market sensitivity index of XYZ Ltd., becomes 1.5.
a. 31.57
b. 48.72
c. 35.44
d. 29.72
e. 40.87.
134. The following data relate to two securities, A and B
A B
Expected return 32% 27%
Beta factor () 1.5 0.7
Assume: R
f
=20% and K
m
=28%.
Find out whether the securities, A and B are correctly priced?
a. Only security A is not correctly priced.
b. Only security B is not correctly priced.
c. Both security A and B are not correctly priced.
d. Both Security A and B are correctly priced.
e. Data provided is insufficient.
Part II
131
Based on the following information Answer Questions 135 to 137.
Following information is provided concerning the returns on the shares of Zeenath Ltd., and
on the market portfolio, according to the various conditions of the economy.
Condition of
economy
Prob. of condition
occurring
Return on
Zeenath Ltd.
Return on market
(1.) 0.2 10% 5%
(2.) 0.4 15% 16%
(3.) 0.4 20% 18%
135. The current risk-free interest rate is 9 percent. The coefficient of correlation between the
returns on Zeenath Ltd., is __________.
a. 1.02
b. 0.86
c. 0.65
d. 0.89
e. 0.31.
136. The beta factor for Zeenath Ltd., is _________.
a. 0.81
b. 0.75
c. 0.94
d. 0.69
e. 1.02.
137. Is Zeenath Ltd., efficiently priced according to the CAPM and the information given above?
a. Share price is lower and not efficiently priced.
b. Share price is higher and efficiently priced.
c. Share price is equal to expected return.
d. Share price is higher and not efficiently priced.
e. Share price is lower and efficiently priced.
The following are the different state of economy, the probability of occurrence of that state
and the expected rate of return from security M and N in these different states:
State Probability Rate of return
Security M Security N
Recession 0.20 0.25 0.30
Normal 0.50 0.30 0.40
Boom 0.30 0.70 0.50
138. The expected returns for these two securities are ___________ and _____________
a. 31%, 41%
b. 27%, 35%
c. 35%, 27%
d. 30%, 32%
e. 24%, 29%.
139. The standard deviations for Security M and Security N are ________ and ________.
a. 28%, 10%
b. 22.4%, 9%
c. 32.92%, 7%
d. 25.1%, 8%
e. 23.2%, 7.5%.
132
140. The following in available in respect of securities X and Y.
Security Expected return
X 2.8 42.00%
Y 2.6 40.40%
Are these securities correctly priced?
a. Both securities are not correctly priced.
b. Both Securities are correctly priced.
c. Security X is correctly priced.
d. Security Y is correctly priced.
e. Data provided above is insufficient.
141. A certain equity stock consists of following information:
Price at the beginning of the year Rs.60.00
Dividend paid at the end of the year Rs. 2.40
Price at the end of the year Rs. 69.00
Then, the rate of return on this stock is _______
a. 15%
b. 16%
c. 17%
d. 18%
e. 19%.
142. The following information in provided for security A R
f
=8%, =1.4, K
m
=14%, if last paid
dividend is Rs.2.00, current purchase price is Rs.14 and growth rate is 9% then the
equilibrium price is __________
a. 27.11%
b. 29.46%
c. 30.93%
d. 19.21%
e. 32.77%.
143. Security X expects an income of Rs.18.5 when market purchase price is Rs.64. What is the
expected return is?
a. 28.9%.
b. 26.4%.
c. 25.2%.
d. 21.8%.
e. 19.7%.
144. If Correlation coefficient between X and Y is 0.9, standard deviation of X and Y are 0.17 and
0.18 respectively, then the covariance between stocks X and Y is ___________
a. 0.021
b. 0.027
c. 0.015
d. 0.017
e. 0.020.
Part II
133
145. Ms. Annie has the following scrips in his portfolio
Beta Proportion of investment (%)
Reliance 0.75 20
Satyam 0.9 25
GE 1.2 30
Raymonds 1.1 25
The expected return on his portfolio is _____ if risk free return is 6% and return on market is 15%.
a. 13.5%
b. 12.9%
c. 15.09%
d. 12.4%
e. 13.9%.
146. The risk-free return is 20% and market return is 25%. Stock A has a beta of 1.4 and is
currently selling for Rs.40. If the expected dividend on the stock is Rs.10, the growth rate of
the company is _______.
a. 0.02%
b. 0.2%
c. 2%
d. 20%
e. 1.2%.
147. There are two stocks A and B, about which the following information is given:
Expected return on stock A =15%
Expected return on Stock B =25%
Standard deviation of Stock A =3%
Standard deviation of Stock B =6%
The expected return and standard deviation of a portfolio combining these stocks in equal
proportion are _________ and ___________, if their correlation coefficient is 0.6.
a. 20% and 4.08%
b. 19% and 5%
c. 23% and 7%
d. 16.5 and 3%
e. 18.9 and 5.55%.
148. __________ is the equilibrium price of a share for which:
Beta =2
Current dividend =Rs.4.5 per share
Growth rate =9%
Risk free return =13%
Return on market =16%
a. Rs.42.75
b. Rs.37.95
c. Rs.36.95
d. Rs.49.05
e. Rs.35.07.
134
149. If an investor is contemplating an investment in a security X which has the following
probability distribution of possible return then find
i. The expected value of return
ii. Standard deviation of return
Probability 0.1 0.2 0.4 0.2 0.1
Possible Return 10% 5% 20% 35% 50%
a. 18% ; 15.33%
b. 20% ; 16.43%
c. 21% ; 15.43%
d. 21% ; 16.43%
e. 22% ; 16.34%.
150. The beta of a security of SK Ltd., is 1.77. The variance of the securitys returns is 23.43(%)
2
.
The market return has the following probability distribution:
Projected Market Return Probability
15% 30%
12% 40%
8% 30%
The value of the correlation coefficient between market return and the securitys return is
a. 0.996
b. 0.812
c. 0.723
d. 0.123
e. 0.191.
151. Portfolio Z has an expected return of 15 percent and a standard deviation of 16 percent.
Treasury bills are risk free offering an interest of 5%. If you borrow at the treasury bill rate
an amount equal to your initial wealth and invest everything in portfolio Z, calculate the
expected return and the standard deviation of the investment.
a. 10% and 8%
b. 25% and 32%
c. 20% and 30%
d. 20% and 16%
e. 22% and 28%.
152. If the following pairs are the only available alternatives to a rational investor which one will
he choose in each pair for investing purposes?
Rate of return Standard deviation
A 18 20
B 14 20
C 15 18
D 13 8
E 14 16
F 14 10
a. A, D and E
b. A, C and F
c. A, Cant say and F
d. A, C and Cant say
e. A, Cant say Cant say.
Part II
135
153. There are two firms S and T in the stock exchange each accounting for half of the market
portfolio having an expected rate of return of 23% and 13% respectively. Likewise the
standard deviations of returns on their stocks are 40% and 24% with a correlation of 0.80.
Calculate the expected rate of return and the standard deviation of the return on the market
portfolio.
a. 17% and 29.5%
b. 20% and 32%
c. 18% and 30.5%
d. 19% and 32.5%
e. 17% and 31.5%.
154. For the current year, Alpha entertainment Inc. paid a dividend of 19 percent on its equity
shares which have a face value of Rs.10 and are being quoted for Rs.20. The risk free rate of
return is 8 percent, return on market portfolio is 10 percent and beta of the stock of the
company is 1.2. What is the return required by equity holders?
a. 12.00%.
b. 9.60%.
c. 10.40%.
d. 12.40%.
e. 13.20%.
155. What is the expected yield on the market portfolio at a time when treasury bills yield 5% and
a stock with a beta of 1.25 is expected to yield 14%?
a. 7.2%
b. 9.0%.
c. 10.8%
d. 12.2%
e. 17.5%.
156. An investor is supposed to get Rs.40,000 as maturity proceeds after nine years from now
against an investment of Rs.20,000 made today. What is the effective annual interest yield?
a. 5.00%.
b. 6.00%.
c. 7.00%.
d. 8.00%.
e. 9.00%.
157. The net worth and total debt (carrying an average interest rate of 8 percent) of Subsonic
Industries Ltd. amount to Rs.150 lakh and Rs.250 lakh respectively. The net profit of the
company after deducting a marginal tax rate of 20 percent is 24 lakh. The return on
investment of Subsonic Industries is
a. 3.00%.
b. 5.00%.
c. 12.50%.
d. 20.00%.
e. 33.33%.
136
158. The stocks of Suburban Travellers Ltd., are currently trading at Rs.50 per share and are
expected to pay a dividend of Rs.2.00 per share in this year. The stock price expected one
year hence has the following probability distribution:
Probability 0.35 0.40 0.25
Price (Rs.) 52 56 62
Ignoring the time value of the dividend income, the expected return from that stock for a
holding period of one year is (round off your answer to the nearest integer)
a. 12%.
b. 13%.
c. 14%.
d. 15%.
e. 16%.
159. The projected returns from the equity shares of Suburban Traders Ltd. for the next one year
are as follows:
Projected Returns 10 percent 16 percent 20 percent
What is the expected risk (in terms of standard of deviation) for the equity shares of
Suburban Traders Ltd.?
a. 3.16%.
b. 3.36%.
c. 3.56%.
d. 3.76%.
e. 3.96%.
160. The correlation coefficient between the returns on the equity shares of Surya Rashmi Ltd.,
and the market return is 0.90. The variance of return on equity shares of the company is 49%
2

and the same for the market is 36%
2
. Presently the government securities are traded at a
return of 5.5 percent while the market return is 12 percent. What is required rate of return
from the equity shares of the above company?
a. 5.50%.
b. 6.50%.
c. 6.83%.
d. 12.00%.
e. 12.33 %.
161. The expected returns for the next one year from the shares of Eastern Sugars Ltd. (ESL) vis--
vis the returns from the market portfolio under different situations are projected as follows:
ESL Share 12 16 22
Market Portfolio 10 12 20
What should be the Beta coefficient for the equity shares of ESL?
a. 0.875
b. 1.000
c. 1.125
d. 1.250
e. 1.375.
Part II
137
162. If the risk-free rate of return is 6 percent, the beta of a share is 1.25 and the difference
between the return on market portfolio and the risk free rate is 8 percent, then according to
the CAPM approach, the required rate of return on the share is
a. 8%.
b. 10%.
c. 15%.
d. 16%.
e. 20%.
163. For a company, the net profit margin is 12 percent, debt-equity ratio is 2.00 and the total asset
turnover is 1.67. What is the return on equity for that company?
a. 3.34%.
b. 20%.
c. 24%.
d. 30%.
e. 60%.
164. If the retention ratio is 40% and the P/E ratio is 10, the dividend yield for the company is
a. 4%.
b. 6%.
c. 10%.
d. 12%.
e. 15%.
165. The price of the equity shares of Nectar Systems is expected to appreciate from Rs.25 to
Rs.28 during the coming year. The dividend expected by the end of the year is Rs.3 per share.
The expected return from that stock is:
a. 12.00%.
b. 15.00%.
c. 20.00%.
d. 24.00%.
e. 28.00%.
166. If the beta of a stock is 1.50 while the standard deviation of the return on the market index is
12 percent, then the covariance of returns of the stock and the returns on the market index is
a. 144%
2
b. 180%
2

c. 216%
2

d. 252%
2

e. 288%
2
.
167. The shares of SMS Ltd., are presently trading at a price of Rs.20 per share. The expected
dividend by the end of the year is Rs.1.00 per share while the price appreciation is projected
by the analysts as follows:
Price (Rs.) 21 23 25
What is the expected return from the shares of SMS Ltd.?
a. 10%.
b. 15%.
c. 20%.
d. 25%.
e. 30%.
138
168. On September 30, 2003, the BSE sensex was at 3700 points. With the expectation of a bullish
trend in the near future, an analyst projected the expected value of sensex by the end of next
six months as:
Sensex 3978 4163 4348
What is the expected annualized return from the market? (Round off your answer)
a. 15%.
b. 20%.
c. 25%.
d. 30%.
e. 35%.
169. The shares of Saboo Ltd., are presently trading at a price of Rs.30 per share. The expected
dividend by the end of the year is Rs.1.00 per share while the price appreciation is projected
by the analysts as follows:
Price (Rs.) 32 35 38
What is the standard deviation of return from the shares of Saboo Ltd.?
a. 5.75%.
b. 7.75%.
c. 9.75%.
d. 11.75%.
e. 13.75%.
170. The shares of SMS Ltd., is presently trading at a price of Rs.10 per share. The expected
dividend by the end of the year is Rs.1.00 per share while the appreciations of the share price
of SMS vis--vis the BSE sensex (Presently at 3800) are projected by the analysts as follows:
Price (Rs.) 10 11 12
Sensex 4370 4750 5130
What is the beta value for the shares of SMS Ltd.?
a. 0.50.
b. 1.00.
c. 1.25.
d. 1.50.
e. 1.75.
171. The present market price of a security which paid a dividend of Rs.5 is Rs.50. If the required
rate of return is 15% the price expected after one year is
a. Rs.52.50
b. Rs.55.00
c. Rs.57.50
d. Rs.62.50
e. Rs.67.50.
172. If the expected rate of return on a portfolio consisting of two securities is 18.8% and the return on
one security, which constitutes 30% of the portfolio is 16%, the return on the other security is
a. 17%
b. 18%
c. 19%
d. 19.8%
e. 20%.
Part II
139
173. If the coefficient correlation between x and y is 0.4, the covariance between them is 0.8 and
standard deviation of y is 0.2, variance of x would be
a. 0.01
b. 0.1
c. 1
d. 10
e. 100.
174. The stock of Golden Technologies Ltd., is currently quoting at Rs.80 per share in the market.
The expected stock price for the next year is as follows:
Probability 0.20 0.50 0.20 0.10
Price 120 140 160 180
The expected return from investing in the stock is
a. 50%
b. 60%
c. 70%
d. 80%
e. 100%.
175. If the covariance of returns of a stock and market is 514.92(%)
2
and standard deviation of the
return on the market is 16.25%, then the Beta of the stock is
a. 0.80
b. 1.00
c. 1.25
d. 1.63
e. 1.95.
176. If a share of Reliance is purchased for Rs.5,000 at the beginning of the year and company
paid a dividend of Rs.15 per share for the year, and it is sold at the end of the year at
Rs.6,000, the yield on such an investment is
a. 20.30%
b. 21.30%
c. 21.89%
d. 21.95%
e. 22.30%.
177. The covariance of returns of security A and market is (+) 177.85(%)
2
and the variance of
market returns is 121(%)
2
, then the beta of A is
a. 1.30
b. 1.41
c. 1.47
d. 1.53
e. 1.60.
178. Study the following table:
Probability 0.25 0.35 0.25 0.15
Return on ABC% 15 18 20 13
The expected return from ABC stock is
a. 17.00%
b. 18.00%
c. 19.00%
d. 19.76%
e. 20.15%.
140
179. Mr. Anil purchased 100 stocks of Futura Informatics Ltd., for Rs.21 on March 15, and sold
for Rs.35 on March 14 next year. If the company paid a dividend of Rs.2.50 per share, then
Anils holding period return is
a. 11.90%
b. 45.40%
c. 66.70%
d. 78.60%
180. The 182-day annualized T bills rate is 9% p.a., the return on market is 15% p.a. and the beta
of stock B is 1.5. The required rate of return from investment in stock B is
a. 17% p.a.
b. 18% p.a.
c. 19% p.a.
d. 20% p.a.
e. 24% p.a.
181. If a stock is purchased for Rs.120 per share and held for one year, during which time Rs.15
per share dividend is paid and the price decreases to Rs.115, the nominal rate of return is
a. 6.33%
b. 8.33%
c. 9.33%
d. 10.33%
e. 11.00%.
182. Consider the following data:
Probability 0.25 0.35 0.20 0.1 0.1
Return (%) 19 12 18 20 24
The expected return is
a. 15.00%
b. 15.15%
c. 16.00%
d. 16.15%
e. 16.95%.
183. The risk-free rate of return is 8%; the expected rate of return on market portfolio is 15%. The
beta of Ecoboards equity stock is 1.4. The required rate of return on Ecoboards equity is
a. 15.4%
b. 16.8%
c. 17.2%
d. 17.8%
e. 23.0%.
184. If the covariance of return from a stock and the market is (+)221(%)
2
and the variance of
return from market is 121(%)
2
, the beta of the stock is
a. 1.62
b. 1.82
c. 1.92
d. 2.00
e. 2.10.
Part II
141
185. If a security generates a cash flow of Rs.6.25 at the end of a holding period of 1 year, the
price of the security at the beginning of 1 year was Rs.125 and the price of security at the end
of 1 year is Rs.150 then the rate of return from the security is
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%.
186. Following is the probability distribution of rates of return of a stock:
Return (%) 10 15 20 25
Probability 0.20 0.10 0.50 0.20
The expected rate of return from the stock is
a. 12.5%
b. 15.8%
c. 16.6%
d. 18.5%
e. 19.2%.
187. If the risk-free rate of return, market return and the required rate of return by investor are 8%,
15%, 18% respectively, the beta of the corresponding security will be
a. Less than one
b. One
c. 1.429
d. More than one
e. Cannot be determined with the above data.
188. The probability distribution and corresponding rates of return for a company are given below:
Probability 0.2 0.25 0.25 0.3
Rate of Return (%) 10 12 15 18
The expected return is equal to
a. 13.41%
b. 13.70%
c. 13.75%
d. 14.15%
e. 14.25%.
189. If the expected return on a stock is 18%, risk-free rate is 6% and return on the market
portfolio is 12%, then the beta of the stock is
a. 0.5
b. 1.0
c. 1.2
d. 1.5
e. 2.0.
190. The covariance of the return from a stock with the return from the market is 7.40 and the
variance of the market portfolio is 4.80. What is the beta of the stock?
a. 1.54.
b. 3.40.
c. 4.80.
d. 6.10.
142
191. If R
f
=8%, =1.5, R
m
=12%, then the expected rate of return E(r) according to CAPM is
equal to
a. 10%
b. 14%
c. 18%
d. 24%
e. 26%.
192. If the return on a stock increases by 8% when the return on market increases by 12%
increases, then the beta of the stock is
a. 1.50
b. 1.20
c. 0.80
d. 0.75
e. 0.67.
193. If risk-free rate of return is 10%, return on market portfolio is 14% and return on a stock is
16%, then the beta of the stock is
a. 0.80
b. 1.00
c. 1.20
d. 1.30
e. 1.50.
194. If the covariance between the market return and the return on the stock is 225(%)
2
and the
variance of return on the market is 200(%)
2
, then the beta of the stock is
a. 0.89
b. 0.98
c. 1.125
d. 1.215
e. 1.521.
195. The return on a share varies by 20% when the return on market portfolio varies by 10%. The
beta () of the share is
a. =0.2
b. =0.1
c. =0.5
d. =2.0
e. Cannot be determined. More information is required.
196. The current market price of a security is Rs.75. If the probability that the market price a year
hence would be Rs.85 is twice the probability that it would be Rs.90, what is the expected
rate of return on the security? (Ignore dividends)
a. 12.55%
b. 15.53%
c. 20%
d. 20.55%
e. 17.55%.
Part II
143
197. A financial institution issues two types of bonds with one and three years maturity
respectively. The first, which pays Rs.10,000 a year hence, is now selling for Rs.8,929. The
second, which pays Rs.100 next year, Rs.100 after two years and Rs.1,100 at the end of third
year is now offered at Rs.997.18. The implied interest rates of these two bonds are _______
and _______.
a. 12.0%, 10.1%
b. 10.1%, 12.0%
c. 12.1%, 10.0%
d. 10.0%, 12.1%
e. 10.0%, 12.0%.
198. SPIC Ltd., currently pays a dividend of Rs.3 per share which is expected to grow at an annual
rate of 14% for 3 years and 11% p.a. for next 3 years after which it will grow at 4% p.a.
forever. What amount should be paid for the stock, if the rate of return required by the equity
investors is 16%?
a. Rs.16.51.
b. Rs.52.58.
c. Rs.21.56.
d. Rs.38.09.
e. Rs.6.31.
199. The profit after tax for a firm is Rs.20,000. The dividend pay-out ratio is 50%. If the growth
rate of the earnings is 4% and the scrip trades at 2.5 times its EPS in the market, the required
rate of return by equity shareholders is ________, if the number of outstanding shares is
5000.
a. 26.0%
b. 24.8%
c. 24.0%
d. 45.6%
e. 45%.
200. A bond with a face value of Rs.100 provides 12% annual return and pays Rs.105 at the time
of maturity, which is 10 years from now. If the investors required rate of return is 13%, at
what price should the company issue the bond?
a. Rs.634.84.
b. Rs.34.55.
c. Rs.96.087.
d. Rs.573.27.
e. Rs.130.63.
201. The shares of Zenith Ltd., are currently priced at Rs.25. The risk-free rate of return is 8%,
while the market return is 20%. With the company having paid Rs.2 as the current dividend
and the company having a growth rate of 8%, then what is value of the share ________, if its
beta is 0.7.
a. Rs.25.71
b. Rs.22.0
c. Rs.25.77
d. Rs.19.5
e. Rs.43.1.
144
202. A company is offering a bond with the issue price Rs.100, coupon rate (annual payment) of
12% with maturity period 5 years. If the bond is to be redeemed at par and the investor faces
a 30% tax on income and a 10% capital gains tax, the effective yield to maturity for the
investor is ________.
a. 8.22%
b. 8.40%
c. 8.0%
d. 8.11%
e. 6.70%.
203. A company has paid Rs.3 as the current dividend. The growth rate of dividend paid by the
company is 8%, if the cost of equity is 12%, the price of the companys share three years
hence, is _______.
a. Rs.100
b. Rs.118.01
c. Rs.110.01
d. Rs.102.04
e. Rs.120.
204. Mr. Ramchandran is thinking of investing in the equity shares of Duplex Pharma Ltd. The
face value of the shares is Rs.10. He requires a return of 25% on his investment. Duplex
Pharma Ltd., declared a dividend of Rs.5.00 per share for the current year and it is expected
that the dividends of the company will grow at the rate of 30% for the next five years and
after that at 20% forever. The maximum price at which Mr. Ramachandran may buy the
shares of the company is _______.
a. 117.04
b. 98.88
c. 159.23
d. 102.44
e. 174.17.
205. An AAA rated bond of face value Rs.1,000 is currently quoting in the market at Rs.1,062.
The coupon rate of the bond is 14% payable semi annually. The remaining maturity of the
bond is five years and the principal is repayable at two equal installments at the end of the 4th
and 5th year from now. The yield to maturity of the bond is ________.
a. 10%
b. 12.16%
c. 16.08%
d. 6.08%
e. 14.20%.
206. Mr. Rajan Tiwari is planning to invest in the equity stocks of Xerox India Limited. The
current share price is Rs.150 per share. Xerox has declared a dividend of Rs.10 per share for
the current year. Mr. Tiwari is of the opinion that the dividend per share will remain at the
same level for the next two years, after which it will grow at the rate of 25% per annum in the
third and fourth years. From the fifth year onwards, dividends are expected to grow at a
normal rate of 12% per annum. If the required rate of return of Mr. Tiwari is 14% per annum,
do you suggest him to purchase the share at the current price.
a. Intrinsic value of the stock is Rs.551.98 and it is recommended to purchase the share
b. Intrinsic value of the stock is Rs.551.98 and it is not recommended to purchase the share
c. Intrinsic value of the stock is Rs.517.83 and it is recommended to purchase the share
d. Intrinsic value of the stock is Rs.517.83 and it is not recommended to purchase the share
e. Intrinsic value of the stock is Rs.150 and it is recommended to purchase the share.
Part II
145
207. The current price of a Boeing share is Rs.50. The company is expected to pay a dividend of
Rs.2.50 per share increasing with an annual growth rate of 5%. If an investors required rate
of return is 12%, advice the person whether he should buy the share or not.
a. Return provided by the share investment is 14 % as against the required rate of return of
12%. Therefore, the investor can buy the share.
b. Return provided by the share investment is only 10% as against the required rate of
return of 12%. Therefore, the investor need not buy the share.
c. Return provided by the share investment is only 11% as against the required rate of
d. Return provided by the share investment is only 10.5% as against the required rate of
return of 12%. Therefore, the investor can buy the share.
e. Return provided by the share investment is only 15 % as against the required rate of
208. Vishnu Ltd., has just paid a dividend of Rs.16 per share. As a part of its major reorganization
of its operations, it has stated that it does not intend to pay any dividend for the next two
years. In three years time it will commence paying dividend at Rs.12 per share and the
directors have indicated that they expect to achieve dividend growth at 14% p.a. thereafter.
If the reorganization does not take place, dividend will be paid in the next two years and the
expected dividend growth will remain at the present level of 8% p.a. The firms cost of equity
is 18% (i.e., the return expected by the equity investors) and will be unaffected by the
reorganization. The value of firms shares in both the situations are_______and________.
Moreover, advice the directors to which process they should adopt for?
a. Rs.114.83 and Rs.166.67. Hence, the price in the proposed situation is higher and so the
directors may adopt the reorganization process.
b. Rs.172.8 and Rs.215.45. Hence, the price in the proposed situation is higher and so the
c. Rs.172.8 and Rs.3.00. Hence, the price in the proposed situation is higher and so the
d. Rs.114.83 and Rs.119.70. Hence, the price in the proposed situation is higher and so the
e. Rs.114.83 and Rs.119.70. Hence, the price in the proposed situation is higher and so the
directors should not adopt the reorganization process.
209. Zoom Technologies Ltd., had paid dividend at Rs.4 per share last year. The growth of the
dividends from the company is estimated to be 5% p.a. The estimated market price of the
equity share is_____, if the estimated growth rate of dividends rises to 8%. Given that, the
required rate of return of the equity investors is 18.5%.
a. Rs.25.10
b. Rs.41.1
c. Rs.31.1
d. Rs.37.8
e. Rs.33.33.
210. Broom Technologies Ltd., had paid dividend at Rs.4 per share last year. The estimated
growth of the dividends from the company is to be 5% p.a. The estimated market price of the
equity share is_______, if the estimated growth rate of dividends falls to 3%. Given that, the
required rate of return of the equity investors is 18.5%.
a. Rs.12.30
b. Rs.35.8
c. Rs.26.58
d. Rs.24.67
e. Rs.10.45.
146
211. Kotak Ltd., has provided following information.
Equity share capital (Rs.20 each) Rs.80,00,000
Reserves and Surplus Rs.15,00,000
15% Secured loans Rs.45,00,000
12.5% Unsecured loans Rs.20,00,000
Fixed assets Rs.50,00,000
Investments Rs.15,00,000
Operating profit Rs.35,00,000
Tax rate 50%
P/E ratio 17.5
The value of equity shares from the above information is __________.
a. Rs.5
b. Rs.55.1
c. Rs.45.87
d. Rs.56.35
e. Rs.25.48.
212. Vishaka Mining Companys iron ore reserves are being depleted and its cost of recovering a
declining quantity of iron ore are raising each year. As sequel to it, the companys earnings and
dividends are declining, at a rate of 6% per year. If the previous years dividend (D
0
) was Rs.10
and the required rate of return is 7.5%, the current price of the equity share of the company
is_________.
a. Rs.57.5
b. Rs.45.41
c. Rs.69.6
d. Rs.40.55
e. Rs.44.21.
213. Septuple Ltd., has been growing @20% per year and this trend is expected to continue for 5
more years. Thereafter, it is likely to grow @10%. The investors expect a return of 12%. The
dividend paid by the firm per share for the last year (D
0
) corresponding to period 0 (T
0
) is
Rs.5. The price at which an investor may be ready to buy the shares of the company at the
end of period T
0
(i.e., now) is_______.
a. Rs.361.86
b. Rs.394.30
c. Rs.418.84
d. Rs.428.22
e. Rs.464.16.
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147
Based on the following information, Answer Questions 214 and 215.
Sundaram Finance Ltd. has an investment opportunity available which will involve a capital outlay
in each of the next 2 years and which will produce benefits during the following 3 years. A
summary of the financial implications of this investment is given below:
Year Cash flow
(Rs. 000)
1 (2,000)
2 (2,000)
3 200
4 2,300
5 4,100
Sundaram Ltd., currently has 1,00,000 shares in issue. The dividend just paid was Rs.25 per share.
In the absence of the above investment, dividends are expected at this level for the next 3 years,
but will then demonstrate perpetual growth of 15 percent p.a. Sundaram Finance Ltd. is currently
all equity financed and the required rate of return of the equity investor is estimated to be 18
percent. The only possible way of financing the investment is, therefore, to reduce the dividend
payments made in the next 2 years. Cash received form the new investment is therefore, to reduce
the dividend payments made in the 10% will also be maintained because of other operations.
214. The present market price is _________.
a. Rs.909.33
b. Rs.731.22
c. Rs.797.95
d. Rs.506.25
e. Rs.637.95.
215. The market price after the investment has been accepted is______, assuming the market knows
the dividend changes that will result from the investment using a dividend valuation model.
a. Rs.156.21
b. Rs.109.25
c. Rs.117.06
d. Rs.637.14
e. Rs.125.61.
216. A software company is currently paying a dividend of Rs.5.00 per share. The dividend is
expected to grow at a 16% annual rate for three years, then at 11% rate for the next three
years, after which is expected to grow at a 6% rate forever. The present value of the share
is______if the capitalization rate is 9%.
a. Rs.260.2
b. Rs.243.5
c. Rs.211.89
d. Rs.200.67
e. Rs.254.45.
217. Vimta Labs, a chemical company has been expected to grow at 12% per year for the next 4
years and then to grow indefinitely @6%. The required rate of return on the equity shares is
12%. Assume that the company paid a dividend of Rs.2 per share last year (D
0
=2). The
market price of the shares today is_______.
a. Rs.62.10
b. Rs.34.56
c. Rs.43.18
d. Rs.58.21
e. Rs.39.54.
148
218. A Pharmaceutical company has been growing at a rate of 15% per year in recent years. This
abnormal growth is expected to continue for another 4 years; then it is likely to grow at the
normal rate (g
n
) of 8%. The required rate of return on the shares of the investment community is
12%, and the dividend paid per share last year was Rs.6 (D
0
=Rs.6). At
price as an
investor, be ready to buy the shares of this company now (t =0).
a. Rs.205.95
b. Rs.120.11
c. Rs.177.77
d. Rs.200.05
e. Rs.210.89.
219. An automobile company recently paid a dividend of Rs.3.00 per share and it is a fairly risky
company with a cost of equity of 25%. A summary of dividends and earnings per share is
given below:
Years Dividends Earnings
2002 Rs.3.00 Rs.5.50
2001 2.80 4.50
2000 2.70 5.00
1999 2.40 4.00
1998 2.30 3.50
Any new investment by XYZ Ltd., is expected to yield a return comparable to the cost of
equity. The estimation of growth rate g based on dividends is________.
a. 6.00%
b. 6.86%
c. 6.20%
d. 6.26%
e. 6.36%.
220. An automobile company recently paid a dividend of Rs.3.00 per share and it is a fairly risky
company with a cost of equity of 45%. A summary of dividends and earnings per share is
given below:
Years Dividends Earnings
2003 Rs. 3.00 Rs. 5.50
2002 2.80 4.50
2001 2.70 5.00
2000 2.40 4.00
1999 2.30 3.50
Any new investment by XYZ Ltd. is expected to yield a return comparable to the cost of equity.
The estimation of growth rate g and share price based on earnings are_______and_______.
a. 10%, Rs.12.90
b. 13.2%, Rs.15.35
c. 20.45%, Rs.14.72
d. 12.8%, Rs.24.01
e. 14.21%, Rs.21.55.
Part II
149
221. Ms. Sheetal has invested her savings in a company from whom dividends are expected to
grow @20% for 15 years and thereafter @7% forever. The value of the equity share
is____. Given that the current dividend per share is Re.1 and present value during next
15 years @9% required rate of return is Rs.34.96.
a. Rs.250.78
b. Rs.261.70
c. Rs.233.33
d. Rs.167.54
e. Rs.189.31.
222. If Gemini Ltd., is foreseeing a growth rate of 12% per annum in the next 2 years. The growth
rate is likely to 10% for the third and fourth year. After that, the growth rate is expected to
stabilize at 8% per annum. Given that, the present value of dividend stream for first 2 years
is Rs.3.08 and for next 2 years is Rs.3.11. If the last dividend paid was Rs.1.50 per share and
the investors required rate of return is 10%, the intrinsic value per share of Gemini Ltd., as
of date________.
a. Rs.90.20
b. Rs.20.89
c. Rs.16.87
d. Rs.28.70
e. Rs.15.77.
223. The Star Company is contemplating a debenture issue on the following terms:
Face value =Rs. 100 per debenture
Term to maturity =7 years
Coupon rate of interest:
Years 1-2 = 5% p.a.
3-4 =13% p.a.
5-7 =16% p.a.
The current market rate of interest on similar debentures is 15% p.a. The company proposes
to price the issue so as to yield a (compounded) return of 16% p.a. to the investors. The issue
price is_______. Assume the redemption on debenture at a premium of 10%.
a. Rs.82.3
b. Rs.115.67
c. Rs.108.21
d. Rs.69.06
e. Rs.78.23.
224. A Rs.5000 bond matures in 20 years and offers a 10% coupon rate. The required rate of
return is 11%. The bonds value is________.
a. Rs.4601.5
b. Rs.4000.21
c. Rs.5655.45
d. Rs.3897.25
e. Rs.5675.4.
150
225. A bond of Rs.15,000 with a 20% coupon rate matures in 8 years and currently sells at 75%. Is
this bond a desirable investment for an investor whose required rate of return is 11%?
a. Bond is available at a price higher than its present value of returns, the investment in
bond is not desirable.
b. Bond is available at a price lower than its present value of returns, the investment in
bond is desirable.
c. Bond is available at a price higher than its present value of returns, the investment in
bond is desirable.
d. Bond is available at a price lower than its present value of returns, the investment in
bond is not desirable.
226. A Bharat companys iron ore reserves are being depleted and its cost of recovering a
declining quantity of iron ore are raising each year. As sequel to it, the companys earnings
and dividends are declining, at a rate of 6% per year. If the previous years dividend (D
0
) was
Rs.14 and the required rate of return is 18%, the current price of the equity share of the
company is____.
a. Rs.51.09
b. Rs.54.83
c. Rs.53.61
d. Rs.57.55
e. Rs.54.21.
227. The profit after tax for a firm is Rs.10,000. The dividend pay-out ratio is 25%. If the growth
rate of the earnings is 2% and the scrip trades at 1.5 times its EPS in the market share. The
required rate of return by equity shareholders is ____________, is the number of outstanding
shares in 2500.
a. 18.0
b. 18.5
c. 19.0
d. 19.5
e. 20.0.
228. A bond with a face value of Rs.50 provides 8% annual return and pays Rs.75 at the time of
maturity, which is 10 years from now. If the investors required rate of return is 12%, at
______ price should the company issue the bond.
a. Rs.39.43
b. Rs.46.75
c. Rs.40.37
d. Rs.31.41
e. Rs.48.29.
229. The shares of Enron Ltd., are currently priced at Rs.50. The risk free rate of return is 10%,
while the market return is 15%. With the company having paid Rs.2 as the current dividend
and the company having a growth rate of 10%, then the share value is______, if its beta is 0.7
a. Rs.55.54
b. Rs.51.24
c. Rs.46.09
d. Rs.48.89
e. Rs.62.85.
Part II
151
230. A textile company is offering a bond with the following features:
Issue Price =_______________
Coupon rate (annual payment) =15%
Maturity =5 years
If the bond is to be redeemed at par and the investor faces a 45% tax on income and a 11%
capital gains tax, 11% is the effective yield to maturity for the investor.
a. Rs.89.79
b. Rs.85.00
c. Rs.85.70
d. Rs.86.00
e. Rs.87.25.
231. A company has paid Rs.5 as the current dividend the growth rate of the company is 10%. If
the cost of equity is 15%,_______will be the price of the companys share three years hence.
a. Rs.146.4
b. Rs.155.06
c. Rs.187.44
d. Rs.208.09
e. Rs.171.05.
232. A companys share 5 years hence is Rs.157.45. It has paid Rs.2 as the current dividend. The
growth rate of the company is 16%. The cost of equity is___________.
a. 19.75%
b. 27.03%
c. 18.75%
d. 25.54%
e. 19.09%.
233. Ms. Meena Gupta is planning to invest in the equity stocks of Reliance India Limited. The
Current share price is Rs.250 per share. Reliance has declared a dividend of Rs.20 per share
for the current year. Ms. Meena is of the opinion that the dividend per share will remain at
the same level for the next two years, after which it will grow at rate of 25% per annum in the
third and fourth years. From the fifth year onwards dividends are expected to grow at a
normal rate of 14% per annum. If the required rate of return of Ms. Meena is 16% per annum,
do you suggest her to purchase the share at the current price?
a. Rs.1048.62 per share and recommended.
b. Rs.1100 per share and not recommended.
c. Rs.986.97 per share and not recommended.
d. Rs.587.54 per share and not recommended.
e. Rs.698.31 per share and recommended.
234. A bond of face value Rs.1,000 is currently quoting in the market at Rs.1062. The coupon rate
of the bond is 14% payable semi-annually. The remaining maturity of the bond is five years
and the principal is repayable at two equal installments at the end of the 4th and 5th year
from now. The yield to maturity of the bond is 12.16%. what would be the new price of the
bond, if the YTM for similar type of bonds increases by 2% .
a. Rs.1,000
b. Rs.1,015.67
c. Rs.995.29
d. Rs.1,078.52
e. Rs.955.54.
152
235. Beta Company has provided following information
Earning per share =Rs.6.5
Dividend payout ratio (D/P) =25%
No. of outstanding shares =1000
Then the Dividend per share for the Beta Company is___________.
a. Rs.2.015
b. Rs.2.530
c. Rs.1.451
d. Rs.1.625
e. Rs.1.110.
236. _________ is the value of an asset if the annual cash inflow is Rs.1,000 per year for the next
5 years and the discount rate is 15%
a. Rs.2,500
b. Rs.3,500
c. Rs.3,352
d. Rs.2,481
e. Rs.3,705.
237. Mr. Rajath Sharma purchased Rs.1,000 per value bond for Rs.950. The coupon payment on
this bond is Rs.90 i.e., 9% one year later be sells the bond for Rs.900. The rate of return of
Mr. Rajath for this one year period is______________.
a. 4.21%
b. Rs.4.21%
c. 3.48%
d. 3.48%
e. 14.7%.
238. XYZ Company has provided following information
Annual interest payment =Rs.60
Par value of the bond =Rs.995
Current market price =Rs.700
Years to maturity =5 years
The approximate YTM on a bond is ________
a. 13%
b. 13.5%
c. 14%
d. 14.5%
e. 15%.
239. Mahindra Company Ltd., is expected to grow at the rate of 8.9% per annum and dividend
expected a year hence is Rs.4.00. If the rate of return is 15%, the share price of today is_____
a. Rs.60.49
b. Rs.67.86
c. Rs.65.57
d. Rs.71.23
e. Rs.54.37.
240. A pharmaceutical company has provided the following information:
No. of outstanding shares =10,000
Preference dividend =7,500
Present value per share =Rs.27.85
Growth rate =10%
Expected PAT =Rs.25,500
Part II
153
The expected price earning ratio is ________
a. 15.47
b. 20.18
c. 18.24
d. 25.56
e. 15.89.
241. Mr. X is planning to buy an equity share, hold it for 2 years and then sell it. The expected
dividend at the end of year 1 is Rs.8 and Rs.9 at the end of year 2. The expected selling price
of the share at the end of year 2 is Rs.180. The value of the share today taking 10% discount
rate is ______________.
a. Rs.189.11
b. Rs.170.12
c. Rs.124.55
d. Rs.163.470
e. Rs.175.24.
242. A company is presently paying dividend of Rs.9 per share and is expected not to deviate from
this in future. The value of the share is _______, if the required rate of return is 15%.
a. Rs.6
b. Rs.60
c. Rs.600
d. Rs.0.6
e. Rs.0.06.
243. A Firm X presently pays a dividend of Rs.1.6 per share and the market price per share is
Rs.30. The company expects the dividend to increase at a 20% annual rate the first 4 years, at
a 13% rate the next 4 years and then grow the dividend at a 7% rate there after. This phased
growth pattern is in keeping with the expected life cycle of earnings. What is the stock's
expected return on investment?
a. 13.22%.
b. 14.44%.
c. 15.28%.
d. 15.48%.
e. 16.95%.
244. Delphi Products Corporation currently pays a dividend of Rs.2 per share and this dividend is
expected to grow at a 15% annual rate for 3 years then at a 10% for the next 3 years, after
which it is expected to grow at a 5% rate forever.
(i) What value would you place on the stock if an 18% rate of return were required?
a. Rs.32.52.
b. Rs.22.02.
c. Rs.32.70.
d. Rs.22.64.
e. Rs.35.00.
245. A firm is currently all financed by common stock, but intends to issue 5% risk free debt
substituting half of the existing equity. The expected return is 10 percent with P/E of 10 and a
Beta of 1.0. If the operating profit of the company is expected to remain constant what is the
increase (percentage) in EPS and the revised P/E ratio?
a. 25% and 10.
b. 50% and 10.
c. 40% and 3.3.
d. 50% and 6.67.
e. 75% and 3.3.
154
246. The market price of a share is Rs.10 per share and the total outstanding shares are 2,50,00,000.
Common stock is to repurchased through the issue of Rs.160 million debt. What is the
increase/decrease in the market price of the stock and what is the market value of the firm?
a. Increase by Rs.2 and Rs.410 million.
b. Decrease by Rs.3 and Rs.160 million.
c. Unchanged and Rs.410 million.
d. Unchanged and Rs.250 million.
e. Increase by Rs.5 and Rs.250 million.
247. For K Inc., dividends are estimated to grow by 5% every year up to and including year 4.
From the fifth year onwards all of its earnings will be paid out as dividends. Calculate the
existing stock price if the market capitalization rate is 8% and the succeeding years dividend
is Rs.10. Assume EPS of Rs.15.
a. 223.05
b. 227.91
c. 213.12
d. 203.05
e. 232.91.
248. A multinational corporation is expected to pay a dividend of Rs.20 per share at the end of the
year. Consequently if the stock is expected to sell at Rs.125, determine the current share price
with the capitalization rate being 10%
a. 145.92
b. 131.82
c. 128.72
d 135.92
e. 133.82.
249. For F Inc., dividends are estimated to grow by 5% every year. If it were to distribute all of its
earnings as dividends, it can maintain a dividend stream of Rs.18 per share. Calculate what is
the market paying per share for growth opportunities if the market cap rates is 8% and the
succeeding year's dividend is Rs.10.
a. 109.63
b. 145.83
c. 122.93
d. 102.73
e. 333.33.
250. Silicon Wafer Company presently pays a dividend of Re.1. This dividend is expected to
grow at a 20% rate for 5 years and at 10% per annum thereafter. The present market price per
share is Rs.20. Using a dividend discount model approach to estimate capital costs, what is
the company's expected, or required, return on equity?
a. 17.56%.
b. 18.10%.
c. 18.59%.
d. 19.00%.
e. 19.38%.
Part II
155
251. A financial analyst tracking an MNC manufacturing white goods has developed the following
estimates:
Dividend in the current year Rs.6
Dividend Growth Rate
First Four years 20%
Next Four Years 13%
Afterwards 7%
Current Market Price Rs.30
What is the expected return on the stock?
a. 12.85%.
b. 20.00%.
c. 32.57%.
d. 38.97%.
252. The following information is given with respect to Foren Kapital Services Ltd.
Current dividend =Rs.2.00 per share
Constant rate of growth in dividends =5 percent
Expected return from the market index =12 percent
Beta of the stock =1.50
Risk free rate of return =6 percent
The present market price per share will be approximately equal to
a. Rs.14
b. Rs.16
c. Rs.20
d. Rs.21
e. Rs.30.
253. The salient features of the bonds of Saranya Capital Services Ltd., are as follows:
Face value Rs.100
Current market price Rs.114
Coupon rate 12 percent
Maturity period 5 years
The current yield of the bonds is
a. 10.53%.
b. 10.83%.
c. 11.33%.
d. 13.68%.
e. 12.00%.
254. If the dividend payout ratio is 0.30 and capitalization rate is 8.00 percent, then the dividend
yield is
a. 2.40%.
b. 2.67%.
c. 3.75%.
d. 5.00%.
e. 26.67%.
156
255. Consider the following data for the deep discount bonds issued by a financial institution:
Face value and maturity value = Rs.1,00,000
Maturity Period = 20 years
The approximate yield to maturity = 8 percent.
The issue price of the bond is
a. Rs.21,455
b. Rs.22,565
c. Rs.23,675
d. Rs.24,785
e. Rs.25,945.
256. If 91-day T-bills (Face value Rs.100) are issued at a price of Rs.98.48, then the percentage
yield is
a. 5.2%.
b. 5.6%.
c. 6.0%.
d. 6.2%.
e. 6.5%.
257. Bright Metals Ltd., issued fully convertible debentures with a face value of Rs.100 each. The
coupon rate is 9 percent and the interest is payable half yearly over a period of three years. After
three years, each bond will be converted into 10 equity shares of face value Rs.10 per share
which is expected to fetch a dividend of Rs.1.00 per share every year. Presently, the yield on
the risk-free securities is 5 percent per annum. The bondholders of the company need 3
percent more as the risk premium while the expected return to the equity shareholders will go
up by an additional risk premium of 4 percent. The intrinsic value of these fully convertible
debentures is: (Round off your answer to the nearest integer).
a. Rs.83
b. Rs.98
c. Rs.118
d. Rs.129
e. Rs.136.
258. The bonds of Charity Company are presently selling at a premium of 8 percent against its
face value as well as the maturity value of Rs.100. The current yield on these bonds is 8.33%.
The coupons are paid semi-annually. If the bonds are to mature 3 years hence, what should be
the annualized yield to an investor of today by the approximation method?
a. 5.58%.
b. 5.88%.
c. 6.18%.
d. 6.48%.
e. 6.78%.
259. AG Corporation recently paid a dividend of Rs.2.00 per share that is expected to grow at a rate
of 15 percent per annum for the next three years and thereafter, the dividend amount is expected
to remain constant. If your expected rate of return is 10 percent, how much amount are you
ready to pay to buy a share of this company? (Round off your answer to the nearest integer)
a. Rs.17
b. Rs.22
c. Rs.26
d. Rs.29
e. Rs.35.
Part II
157
260. The following figures are collected from the annual report of Mardin Clothes Ltd.:
Return on investment = 12 percent
Number of outstanding equity shares = 1,00,000
Net worth = Rs.25 lakh
Total debt = Rs.40 lakh
Average cost of debt = 9 percent
Applicable tax rate = 40 percent
The earning per share for Mardin Cloths Ltd., is
a. Rs.2.00
b. Rs.2.26
c. Rs.2.52
d. Rs.2.73
e. Rs.2.99.
261. The issue price of the savings bonds of a bank, is Rs.5000 and the maturity value is Rs.7,000
after a period of 5 years and 4 months. What is the effective yield from those bonds?
a. 6.01%.
b. 6.31%.
c. 6.51%.
d. 6.71%.
e. 6.91%.
262. Round Table Ltd., recently paid a dividend of Rs.2.50 per share that is expected to grow by a
constant rate of 8 percent in each year. If the investor needs a return of 16 percent, what is the
intrinsic value of the equity share?
a. Rs.15.63.
b. Rs.31.25.
c. Rs.33.75.
d. Rs.40.00.
e. Data Insufficient.
263. Super Cement Ltd., issued debentures at a coupon rate of 12 percent per annum that are
presently selling at 8 percent premium on the face value. What is the current yield of these
debentures?
a. 8.00%.
b. 11.11%.
c. 12.00 %.
d. 13.34%.
e. 15.00%.
264. RBI sold a 91day T-bill of face value Rs.100 at a yield of 6 percent. What was the issue price?
a. Rs.94.34.
b. Rs.96.15.
c. Rs.97.46.
d. Rs.98.53.
e. Rs.100.00.
265. The perpetual preference shares of Magnum Ltd., were issued at a coupon rate of 10 percent
that is presently selling at 25 percent premium to the face value. If the required yield
increases by one percent, at what premium or discount to the face value will the preference
shares be traded? (Round off your answer)
a. Premium of 43%.
b. Premium of 25%.
c. Premium of 11%.
d. Discount of 5%.
e. Discount of 11%.
158
266. Supersonic Industries Ltd. recently paid Rs.4.00 per share as dividend for the last year. Its
dividend is expected to grow by 15 percent every year for the next three years, thereafter it
will continue a normal growth rate of 6 percent per annum. If the required rate of return is
16 percent, what is the intrinsic value of the equity share of Supersonic Industries Ltd.?
a. Rs.35.
b. Rs.41.
c. Rs.47.
d. Rs.53.
e. Rs.59.
267. The bonds of Supreme Industries Ltd. (issued at a coupon rate of 10 percent) are presently
selling at 5 percent discount on the face value. These bonds will be redeemed after a period
of five years and six years in two equal installments. SIL has an effective tax rate of 40
percent. What is the realized yield to an investor as of now?
a. 10.73%.
b. 11.00%.
c. 11.28%.
d. 11.54%.
e. 11.81%.
268. Khadi Group issued bonds having a maturity premium of 10 percent and a coupon rate
of 9 percent. The bonds are presently trading at par. The yield to maturity of the bond
to an investor as of now, by approximation method, is 12 percent, what will be the
approximate maturity period for the bonds?
a. 2.78 years.
b. 3.78 years.
c. 4.78 years.
d. 5.78 years.
269. If the expected price earnings ratio and earnings per share are 33.3 and Rs.7.5 respectively
and the required rate of return and current dividend are 15% and Rs.20 respectively, the
growth rate of the stock is
a. 3.75%
b. 4.25%
c. 6.47%
d. 8%
e. 8.2%.
270. If the current yield on a bond is 9% and its face value is Rs.1,000 with a coupon rate of 7%
its current market price is
a. Rs.700
b. Rs.778
c. Rs.845
d. Rs.1,175
e. Rs.1,285.
271. Price of a 10% debenture of face value Rs.1000 with five years to maturity if the market
interest for similar type of debenture is 12% is
a. Rs.927.50
b. Rs.981.50
c. Rs.1,000.00
d. Rs.1,075.50
Part II
159
272. A Rs.100 par value bond quoting at the market at Rs.87.52 will mature after 7 years. If the
discount rate is 15%, the coupon rate on the bond is
a. 10%
b. 10.5%
c. 11.5%
d. 12%
e. 12.5%.
273. The equity stock of X Ltd., is currently selling for Rs.20. The next expected dividend is
Rs.2.00. The investors required rate of return on the stock is 14%. The expected dividend
growth rate for X Ltd., is
a. 3.25%
b. 4.00%
c. 5.00%
d. 5.75%
e. 25.00%.
274. A Rs.1000 face value bond bearing a coupon rate of 12% will mature after 3 years. If the
discount rate is 10%, the value of the bond is
a. Rs.948.23
b. Rs.984.56
c. Rs.1,049.44
d. Rs.1,072.21
275. If the stock of Fasttrack Ltd., is trading at the market at Rs.70, the next expected dividend is
Rs.3.50 and required rate of return on the stock is 20%, then the expected growth rate in
dividend is
a. 8%
b. 10%
c. 12%
d. 15%
e. 20%.
276. Stock of XYZ company has declared a dividend of Rs.10 per share. Its dividends are
expected to grow at 10% per annum, if the required rate of return is 15%, the intrinsic value
of XYZ company shares is
a. Rs.180.00
b. Rs.73.33
c. Rs.220.00
d. Rs.230.00
e. Rs.400.00.
277. The coupon rate on a bond of face value Rs.1,000, presently trading at Rs.900, is 15%. The
current yield on the bond is
a. 15.00%
b. 15.79%
c. 16.67%
d. 17.89%
160
278. If the current dividend for a security is Rs.3.00 per share, current price is Rs.41.25 per share
and the rate of return required by the shareholders is 18%, then the expected growth rate of
the security will be equal to
a. 8.00%
b. 9.25%
c. 10.00%
d. 10.50%
e. 10.73%.
279. An investor purchases a 8% bond having a face value of Rs.1000, and maturity of 5 years
for Rs.900. An year later he sells it for Rs.960 in the market. The holding period gain of the
investor is
a. 6.67%
b. 8.88%
c. 14.00%
d. 14.58%
e. 15.55%.
280. A perpetual preference share pays an annual dividend of Rs.15.00 on a face value of Rs.100
and the rate of return required by investors on such investments is 20%. What should be the
market price of the preference share?
a. Rs.15.00.
b. Rs.20.00.
c. Rs.47.50.
d. Rs.75.00.
281. If the next years expected dividend is Rs.2.60, growth rate of dividend is 10% and required
return on the stock is 18%, then the intrinsic value of the stock will be
a. Rs.24.00
b. Rs.30.50
c. Rs.32.50
d. Rs.36.00
e. Rs.52.50.
282. A bond of face value Rs.1000 and remaining maturity 3 years pays 15% interest annually. If
the yield to maturity is also 15%, then the market price of the bond should be
a. Rs.977.90
b. Rs.1,000.00
c. Rs.1,023.30
d. Rs.1,072.30
283. If current years dividend is Rs.2.40, growth rate for the company is 10% and the required
return on the stock is 16%, then the intrinsic value of the stock will be
a. Rs.44.00
b. Rs.40.00
c. Rs.24.00
d. Rs.16.50
e. Rs.15.00.
Part II
161
284. The issue price of a deep discount bond having a face value of Rs.1,00,000 and maturity of
25 years at an effective yield of 15% p.a. is, approximately
a. Rs.2,500
b. Rs.2,700
c. Rs.3,000
d. Rs.3,200
e. Rs.3,300.
285. If the current dividend ( )
0
D of ABCs share is Rs.2.00 and the growth rate of dividends is
8%, then the value of ABCs share at the required rate of return of 15% is
a. Rs.16.00
b. Rs.26.80
c. Rs.28.57
d. Rs.30.86
e. Rs.40.00.
286. If the current yield of a bond bearing interest at 12.00% is 15.00%, the price is
a. Rs.80
b. Rs.85
c. Rs.97
d. Rs.112
e. Rs.115.
287. A bond has face value of Rs.100, maturity period of 4 years, coupon rate of 15% payable
annually, and redemption at 5% premium on maturity. At a required rate of return of 18%,
what would be the market price of the bond?
a. Rs.94.53.
b. Rs.96.75.
c. Rs.98.35.
d. Rs.94.60.
e. Rs.94.45.
288. What is the price of stock of company XYZ Ltd., that pays Rs.10 as annual dividends, having
a required rate of return of 20% and zero growth rate in dividends?
a. Rs.10.
b. Rs.15.
c. Rs.50.
d. Rs.200.
e. Rs.250.
289. How much should be paid for a Rs.1000 bond with 10% coupon per annum and five years to
maturity if the current interest rate is 12%?
a. Rs.927.50.
b. Rs.981.40.
c. Rs.1000.00.
d. Rs.1075.82.
e. Rs.1100.00.
162
290. What constant growth rate in dividends is expected for a stock valued at Rs.32 if the next
years dividend is forecast at Rs.2.00 per share and the appropriate discount rate is 13%?
a. 5.00%.
b. 6.25%.
c. 6.75%.
d. 7.25%.
e. 15.38%.
291. If a Rs.1000 par value bond with a coupon of 12% p.a. is currently yielding 14%, with five
years to maturity, the price of the bond is
a. Rs.920.00
b. Rs.930.50
c. Rs.931.00
d. Rs.1,000.00
e. Rs.1,120.00
292. The following information pertains to the shares of Sky Lark International Ltd.:
Dividend expected a year hence =Rs.3.20
Expected rate of return on the equity shares =12%
Growth rate in dividends = 4%
The current market price of the shares is
a. Rs.36
b. Rs.38
c. Rs.40
d. Rs.42
e. Rs.44.
293. For a bond which is now trading at 10% discount to its face value of Rs.1000, with a coupon
of 10% p.a., the current yield is
a. 11.11%
b. 12.00%
c. 9.00%
d. 10.00%
e. 13.00%.
294. If the current stock price is Rs.154, the dividend last declared is Rs.15 and the growth rate in
dividend is 10%, the required rate of return is (assume the stock is correctly priced)
a. 18.76%
b. 19.02%
c. 20.71%
d. 21.00%
e. 22.00%.
295. Sigma Ltd., has equity of Rs.8,40,000 and retained earnings of Rs.12,60,000. The face value
of its shares is Rs.10 and the current market price is Rs.20. It has preference share capital of
Rs.6,00,000 at 15%. If it had a profit after tax of Rs.9,00,000 this year and paid Rs.3,36,000
by way of equity dividends, which of the following represents the dividend yield and
return on equity respectively for Sigma Ltd.?
a. 0.05%, 2.65%.
b. 20%, 38.6%.
c. 4%, 40%.
d. 10.5%, 32.1%
e. 0.25%, 1.11%.
Part II
163
296. In the above question, consider that, if a person has bought the share of Sigma Ltd. last year
at Rs.18, the one-year holding period yield on this stock is _______ .
a. 100%
b. 11%
c. 33.3%
d. 18%
e. 20%.
297. Siekay Ltd., provided the following information:
Net credit sales = Rs.2,00,000 Net profit margin = 10%
Collection
period
= 180 days Gross profit margin = 25%
Stock turnover
ratio
= 1.25 Net profit to investment = 4%
Receivables
Turnover ratio
= 2
Fixed assets
turnover ratio
= 0.9 Debt assets ratio = 0.5
Face value of
each share
= Rs.10
Additional information:
Long-term debt =2,00,000
Short-term debt =50,000
Using the above information of Siekay Ltd. What is earning per share of the company?
a. Rs.0.75.
b. Rs.0.80.
c. Rs.0.85.
d. Rs.0.90.
e. Rs.1.00.
298. The following details are given of a manufacturing organization:
Capital turnover (cost of goods sold to equity) = 2 times
Debtors collection period = 2 months
Inventory turnover = 6 times
Creditors payment period = 73 days
Fixed assets turnover = 4 times
Gross profit margin @20% = Rs.60,000
Reserves and surplus = Rs.20,000
Long-term liabilities = Rs.60,000
Other current assets = Rs.81,500
Opening stock is Rs.5,000 less than closing stock
What are the current assets of this firm? (Assume that all sales are credit sales)
a. Rs.80,000.
b. Rs.81,000.
c. Rs.1,74,000.
d. Rs.82,000.
e. Rs.82,500.
164
299. In response to complaints about high prices, a supermarket runs the following advertisement
campaign: If you pay your child Rs.7.50 for a milk chocolate and cajole him to buy Rs.25
worth of groceries, your child makes twice as much on the trip as we do. You have collected
the following information about the supermarket for latest financial year:
Sales Rs.225.00 lakh
Net income Rs.33.75 lakh
Total assets Rs.40,00 lakh
Total debt Rs.17.00 lakh
Which of the following statements is true?
a. The claim is incorrect.
b. The claim is correct.
c. Data is insufficient.
d. Depends on different individual perceptions.
e. False complaint.
300. The summarized financial statements of Max Value Co. Ltd., for year 1 and year 2 are given
below:
Profit & Loss A/c
Year 1 Year 2
(Rs.) (Rs.) (Rs.) (Rs.)
Sales: Cash 50,000 40,000
Credit 4,10,000 4,60,000 5,54,000 5,94,000
Cost of Sales 3,54,000 4,50,000
Gross Profit Margin 1,06,000 1,44,000
Expenses: Administration 32,050 40,000
Selling 20,000 22,500
Interest 17,500 25,000
Taxes 10,950 80,500 15,800 1,03,300
Net Profit 25,500 40,700
Balance Sheet
Year 1 Year 2
(Rs.) (Rs.) (Rs.) (Rs.)
Fixed Assets (Net) 1,49,300 2,15,000
Current Assets:
Stock 95,000 1,25,000
Debtors 70,000 97,000
Cash 12,000 14,000
1,77,000 2,36,000
Less: Current Liabilities 67,000 96,000
Net Current assets 1,10,000 1,40,000
Total Assets 2,59,300 3,55,000
Share Capital 80,000 80,000
Reserve & Surplus 31,300 72,000
Long-term Debt 1,48,000 2,03,000
Total Liabilities 2,59,300 3,55,000
You are required to comment on the liquidity and profitability position of the company.
a. Liquidity and profitability performance of the company are poor.
b. Liquidity position is increasing greatly and profitability is constant.
c. Liquidity of the company is being adversely affected and profitability position indicates
improving performance.
d. Liquidity and profitability performance of the company are improving.
e. Liquidity of the company indicates improving performance and profitability position is
being adversely affected.
Part II
165
301. Following are the financial highlights of ABC Industries Ltd.
(Amount in Rs.)
Particulars Year 3 Year 2 Year 1
Sales 14,553 13,404 8,730
Total income 15,161 13,740 9,020
Earnings Before Depreciation Interest and Tax (EBDIT) 3,318 2,887 2,233
Depreciation 855 667 410
Interest 728 503 300
Profit after tax 1,704 1,653 1,323
Equity dividend (%) 37.5 35 65
Dividend pay-out 350 327 299
Equity share capital (par value Rs.10) 933 932 458
Long-term debt 10,577 8,311 7,413
Net worth 12,369 11,983 8,471
Gross fixed assets 22,088 19,918 14,665
Net fixed assets 15,396 14,973 11,173
Total assets 28,156 24,388 19,536
Market capitalization 12,176 16,518 14,395
Number of employees 16,640 17,375 16,778
Based on the data given above, identify the correct statement.
a. The reducing interest coverage ratio during 2nd and 3rd year indicates that financial
burden has been increased whereas return on net worth remains unchanged in second
and third year.
b. The increasing interest coverage ratio during 2nd and 3rd year indicates that financial
burden has been increased whereas return on net worth remains unchanged in second
and third year.
c. The reducing interest coverage ratio during 2nd and 3rd year indicates that financial
burden has been increased whereas return on net worth is also increasing in second and
third year.
d. The reducing interest coverage ratio during 2nd and 3rd year indicates that financial
burden has been decreased whereas return on net worth remains unchanged in second
and third year.
e. The increasing interest coverage ratio during 2nd and 3rd year indicates that financial burden
has been increased where as return on net worth is also increasing in second and third year.
302. Consider the data given below and advice, if it is profitable for the company to issue 16%
debentures of Rs.2,00,000 with a ten year maturity.
Year 1 2
EBIT 53,950 81,500
Interest 17,500 25,000
Debt 1,48,000 2,03,000
Equity 1,11,300 1,52,000
a. Considered risky to invest in the debentures of the company
b. Considered highly profitable to invest in the debentures of the company
c. Considered less profitable to invest in the debentures of the company
d. Neither profitable nor risky to invest in the debentures of the company
e. Risky and profitable.
166
303. Universal Bank Ltd., provided the following information:
(Amount in Rs.)
Net profit 80.13 Cr
Proposed dividend 18.72 Cr.
Tax on dividend 3.43 Cr.
Number of equity shares outstanding 10.4 crore
Current market price Rs.28.00
Industry PE ratio 4.60
Expected growth rate of dividend 22%
Rate of return expected by equity investors 24%
Reserves and surplus 137.73
Calculate the intrinsic value of the bank shares using:
i. Dividend capitalization approach
ii. PE ratio approach.
a. 129.70, Rs.54.22
b. 109.79, Rs.34.12
c. 111.89, Rs.16.33
d. 100.79, Rs.21.61
e. 94.67, Rs.19.50.
304. Consider the following balance sheet and income statement of Sarkar & Sarkar Company.
Balance sheet
Liabilities Amount Assets Amount
(Rs.000)
Share Capital 1,400Net Fixed Assets 3,320
Reserves and Surplus 2,040
Long-term Debt @10% 2,000
Current Liabilities: Current Assets:
Accounts payable 320 Cash 400
Accruals 260 Accounts Receivable 1,300
Short-term Loans 1,100 1,680Inventories 2,100 3,800
7,120 7,120
Income Statement
(Rs.000)
Net sales:
Cash Sales 2,540
Credit Sales 10,140 12,680
Cost of Goods Sold 8,450
Gross Profit 4,230
Depreciation 480
Selling, General and Administrative expenses 2,230
Interest Expenses 460
Profit before Taxes 1,060
Taxes 318
Profit after Taxes 742
Which of the following represents the (i) Acid test ratio, (ii) Earning power and (iii) Debt
service coverage ratio, of the company? A loan repayment of Rs.200,000 is to be made.
a. 1.12, 21.0% and 2.95.
b. 1.112, 11.35% and 5.55.
c. 1.010, 23.35% and 5.05.
d. 0.012, 2.31% and 4.55.
e. 1.012, 21.35% and 2.55.
Part II
167
The Balance sheet and the income statement for Liberty shoes Ltd., for the years 2003 and
2004 are given below. Answer question 305 and 306 based on the given data.
Rs.
2003 2004
Cash 2,00,000 1,60,000
Sundry debtors 3,20,000 4,00,000
Temporary investments 2,00,000 3,20,000
Stock 18,40,000 21,60,000
Prepaid expenses 28,000 12,000
Total current assets 25,88,000 30,52,000
Total assets 56,00,000 64,00,000
Current liabilities 6,40,000 8,00,000
Loans 16,00,000 16,00,000
Capital 20,00,000 20,00,000
Retained earnings 4,68,000 8,12,000
Statement of Profit for the Current Year
Rs.
Sales 40,00,000
Less cost of goods sold 28,00,000
Less interest 1,60,000
Net Profit 10,40,000
Less taxes @ 50% 5,20,000
Profit after taxes 5,20,000
Profit distributed 2,20,000
305. From the above information the return on total assets, return on capital employed, return on
equity funds for the year 2004 are ___________, __________ and _____________
respectively.
a. 8.12%, 27.20%, 18.5%
b. 13.6%, 8.12%, 18.5%
c. 18.5%, 8.12%, 13.6%
d. 8.12%, 18.5%, 13.6%
e. 8.12%, 18.6%, 18.5%.
306. Current ratio, acid test ratio of Liberty Shoes Ltd., for the year 2004 are ___________ and
____________ respectively.
a. 4.20, 1.0
b. 3.56, 1.4
c. 4.01, 1.2
d. 3.81, 1.1
e. 3.14, 1.5.
168
307. The Aditya Textiles provides the following information:
Long-term debts Rs.16,00,000
Equity funds Rs.28,12,000
EBIT Rs.12,00,000
Interest charge Rs. 1,60,000
Temporary investments Rs. 2,00,000
The debt equity ratio and interest coverage ratio are________ and _______.
a. 0.57, 7.5 times
b. 0.42, 6.7 times
c. 0.67, 8.6 times
d. 0.33, 7.1 times
e. 0.71, 5.9 times.
308. The following information is extracted from Kotari Ltd., financial statements:
Cost of goods sold Rs.28,00,000
Sales Rs.40,00,000
Average Debtors Rs. 3,60,000
Average Stock Rs.20,00,000
Average assets Rs.60,00,000
Net profit Rs.10,40,000
Activity ratios such as debtors turnover, stock turnover and total assets turnover are
_________, ___________ and ___________ respectively.
a. 12.0 times, 1.3 times, 0.67 times
b. 11.1 times, 1.4 times, 0.67 times
c. 11.1 times, 1.2 times, 0.63 times
d. 12.0 times, 1.3 times, 0.74 times
e. 12.5 times, 2.2 times, 0.12 times.
The balance sheet of Aditi Enterprises company is given below.
Liabilities Amount
(Rs. in lakh)
Assets Amount
(Rs. in lakh)
Equity share capital 250 Fixed assets 400
General reserve 280 Investment 50
P&L A/c (current year) 30 Stock 460
Secured loans- long term 300 Debtors 460
Secured loans-short term 360 Cash in hand 10
Creditors 150 Misc. expenditure
(not written off)
20
Other liabilities 30
1400 1400
i. FromProfit and Loss Account Rs.90 lakh was transferred to general reserve during the year.
ii. Interest cost amounted to Rs.120 lakh.
iii. Taxation @40%.
Part II
169
309. The debt equity ratio and interest coverage ratio of the XYZ company are _______ and ____.
Consider long-term loans are the only constituent of debt.
a. 0.22, 2.10
b. 0.54, 2.66
c. 0.67, 2.12
d. 0.12, 2.08
e. 0.11, 3.00.
310. The current ratio of the company is __________.
a. 1.45
b. 1.89
c. 1.76
d. 1.54
e. 1.67.
311. From the following information of XYZ company, the P/E ratio is ________________.
Rs.
Equity share capital
( Rs.20 each)
50,00,000
Reserves and surplus 5,00,000
Secured loans at 15% 25,00,000
Unsecured loans at 12.5% 10,00,000
Fixed assets 30,00,000
Investments 5,00,000
Operating profit 25,00,000
Income tax rate 50%
Market price/share 50
a. 0.08
b. 12.5
c. 12.0
d. 11.0
e. 11.5.
312. From the following information the market price of share of Mahati Film distributors
is ____________.
Profit after tax = 1,50,000
Number of shares = 50,000
P/E ratio = 8
Current ratio = 1.5
a. Rs.21
b. Rs.20
c. Rs.12
d. Rs.24
e. Rs.14.

170
Sahiti Enterprises capital structure is as follows:
7% Preference shares, Re.1 each Rs. 6,00,000
Ordinary shares, Re.1 each Rs. 16,00,000
Rs. 22,00,000
The following information is relevant as to its financial year just ended:
Profit after taxation at 50% Rs.5,00,000;
Ordinary dividend paid 20%;
Depreciation Rs.1,20,000;
Market price of ordinary shares Rs.4;
Capital commitments Rs.2,40,000.
313. What are the earning yield and net cash flow of the company?
a. 7.16%, Rs.2,58,000.
b. 8.7%, Rs.6,42,000.
c. 6.8%, Rs.3,42,000.
d. 4.97%, Rs.3,00,000.
e. 5.7%, Rs.6,42,000.
314. What are the dividend yield on the ordinary shares and price/earnings ratio?
a. 5%, 12.0.
b. 5%, 13.97.
c. 4%, 19.3.
d. 4%, 13.7.
e. 5%, 14.5.
315. What are the long-term debt and total assets of Vishwa Fabricators Ltd., based on the
following data?
Owners equity Rs.1,00,000
Current debt to total debt 0.40
Total debt to owners equity 0.60
Fixed assets to owners equity 0.60
Total assets turnover 2 times
Inventory turnover 8 times
a. 1,00,000, 1,60,000
b. 84,000, 1,60,000
c. 32,000, 1,84,000
d. 40,000, 1,50,000
e. 36,000, 1,60,000.
316. The net sales of Apex Co., are Rs.15 crore. The EBIT of the company as a percentage of
sales is 12%. The capital employed of the company comprises of Rs.5 crore of equity, Rs.1
crore of 13% preference shares and Rs.3 crore of 15% debt capital. The companys profit is
subject to tax at 40%. The return on equity for the company is __________________.
a. 13.0%
b. 12.0%
c. 12.6%
d. 13.6%
e. 12.4%.
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171
317. Mayuri Distributors has made plans for the next year. The sales are expected to be
Rs.7,20,000It is estimated that the company will employ total assets of Rs.8,00,000, 50% of
the assets being financed by borrowed capital at an interest rate of 16% 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 profit after tax is Rs.48,000. The goods will be sold to customers at 150%
of the direct costs. Income tax rate is assumed to be 50%. The net profit margin and assets
turnover are __________ and ________________:
a. 6.0 %, 0.7 times
b. 6.7%, 0.9 times
c. 5.4%, 1.0 times
d. 4.9%, 0.7 times
e. 6.2%, 0.5 times.
318. The return on assets and return on owners equity are ___________ and _______________.
a. 6%, 12%
b. 3%, 12%
c. 4%, 10%
d. 5%, 25%
e. 6%, 20%.
319. Kashyap Electricals has furnished the following details:
Current ratio 1.80
Liquid ratio 0.60
Fixed assets to proprietary fund 0.80
Bank overdraft Rs.1,20,000
Working capital Rs.2,40,000
There was no long-term loan or intangible asset.
What are other current Assets and Other Current liabilities of this firm?
a. Rs.1,40,000; Rs.1,80,000.
b. Rs.1,80,000; Rs.1,80,000.
c. Rs.1,80,000; Rs.3,00,000.
d. Rs.1,80,000; Rs.1,20,000.
e. Rs.1,20,000; Rs.1,80,000.
320. A company is presently working with Earnings Before Interest and Taxes (EBIT) of Rs.15
lakh. Its present borrowings are
Rs. in Lakh
15% term loan 50
Borrowing form bank @20% 33
Public deposit @14% 15
The sales of the company are growing and to support this the company proposes to obtain
additional borrowings of Rs.25 lakh. The increase in EBIT is expected to be 20%. Which of
the following statements is true?
a. The interest coverage ratio will fall and hence revised proposal is not desirable.
b. The interest coverage ratio will rise and hence revised proposal is not desirable.
c. The interest coverage ratio will rise and hence revised proposal is desirable.
d. The interest coverage ratio will fall and hence revised proposal is desirable.
e. There is no change in interest coverage ratio and hence revised proposal is not desirable.
172
The capital of Growfast Co. Ltd. is as follows:
10% preference shares of
Rs.10 each
Rs.50,00,000
Equity shares of Rs.100 each 70,00,000
1,20,00,000
Profit after tax (at 50%) 15,00,000
Depreciation 6,00,000
Equity dividend paid 10%
Market price per equity share 200
321. Using the above information the earning per share and price earnings ratio of Growfast Co. Ltd.
are ___ and_____.
a. Rs.13.50, 15 times
b. Rs.14.50, 12 times
c. Rs.14.29, 14 times
d. Rs.13.50, 15 times
e. Rs.12.00, 12 times.
322. Using the information in above question find the following:
i. Cover for the preference and equity dividends, and
ii. Net funds flow of Growfast Co. Ltd., are______and________ respectively.
a. (i). 1.20 times (ii). Rs.20 lakh
b. (i). 1.05 times (ii). Rs.11 lakh
c. (i). 1.21 times ii. Rs.21 lakh
d. (i). 1.25 times ii. Rs.21 lakh
e. (i). 1.14 times ii. Rs.14 lakh.
323. Following is the information relating to movement of inventory in three firms. Which of the
following is true regarding the Inventory Turnover Ratio (ITR)?
Firm A Firm B Firm C
Average inventory 10,00,000 15,00,000 20,00,000
Cost of goods sold 60,00,000 75,00,000 80,00,000
Expenses of management 5,00,000 7,50,000 10,00,000
a. ITR indicates that Firm A is having highest inventory turnover ratio. This Firm A able
to make relatively higher sales with lower inventories and thus making efficient use of
its working capital.
b. ITR indicates that Firm B is having highest inventory turnover ratio. This Firm B able
c. ITR indicates that Firm C is having highest inventory turnover ratio. This Firm C able
d. ITR indicates that both Firm A and C are having highest inventory turnover ratio. They
are able to make relatively higher sales with lower inventories and thus making efficient
use of their working capital.
e. ITR indicates that both Firm B and C are having highest inventory turnover ratio. They
are able to make relatively higher sales with lower inventories and thus making efficient
use of their working capital.
Part II
173
324. Following is the information relating to movement of inventory in three firms. Which of the
following is true regarding the average collection period?
(Rs.)
Credit sales 66,00,000 83,25,000 89,60,000
Average receivables 13,20,000 24,97,500 35,84,000
Expenses of management 5,00,000 7,50,000 10,00,000
a. Firm C is following a relatively sound credit policy whereas Firm B and C are following
a liberal credit policy.
b. Firm B is following a relatively sound credit policy whereas Firm A and C are
following a liberal credit policy.
c. Firm A is following a relatively sound credit policy whereas Firm B and C are
d. Firm A and B are following a relatively sound credit policy whereas Firm C is
e. Firm B and C are following a relatively sound credit policy whereas Firm A is
325. The profitability ratios of company X are given in comparison with the industry norms.
Which of the following statements are true?
Industry Standard Company X
Net Profit Ratio 3.3% 2.1%
Net Profit on Total Assets Ratio 6.6% 3.0 %
Net Profit on Net Worth 10.7% 4.8%
a. Profitability ratios indicate higher cost of production, assets are not properly managed
of the firm and the firm is not a leveraged firm.
b. Profitability ratios indicate lower cost of production, assets are properly managed of the
firm and the firm is a leveraged firm.
c. Profitability ratios indicate average cost of production, assets are not properly managed
of the firm and the firm is a leveraged firm.
d. Profitability ratios indicate no cost of production, assets are not properly managed of the
firm and the firm is a leveraged firm.
e. Profitability ratios indicate lower cost of production, assets are not properly managed of
the firm and the firm is not a leveraged firm.
326. Liquidity ratios of company X are given below. Comparison with the industry norms. Which
of the following statements are true?
Current ratio 2.4 2.67
Debtors turnover ratio 8.0 10.00
a. The ratios indicate that the firm is in worst liquidity position and is following stringent
credit policy.
b. The ratios indicate that the firm is in better liquidity position and is following liberal
credit policy.
c. The ratios indicate that the firm is in better liquidity position and is following stringent
credit policy.
d. The ratios indicate that the firm is in worst liquidity position and is following liberal
credit policy.
e. The ratios indicate that the firm has a very good liquidity position.
174
327. The activity ratios of the Firm ABC are given below in comparison with the industry norms.
Stock turnover ratio 9.80 3.33
Assets turnover ratio 2.00 1.43
a. Ratios are indicating higher utilization of fixed assets.
b. Ratios are indicating under utilization of fixed assets.
c. Ratios are indicating average utilization of fixed assets.
d. Ratios are indicating no utilization of fixed assets.
328. The capital of XYZ Ltd., is as follows:
9% preference shares of Rs.10 each Rs.3,00,000
Equity shares of Rs.10 each Rs.8,00,000
The following further information is available:
Profit after tax Rs.2,70,000
Equity dividend paid 20%
Market price of equity shares Rs.40 each.
From the above information, the EPS and PE ratio are_________and__________.
a. Rs.4.77, 12.00
b. Rs.3.12, 10.80
c. Rs.3.33, 10.34
d. Rs.4.51, 12.56
e. Rs.3.04, 13.16.
329. J B Ltd., financial statements has furnished the information:
Cost of goods sold = 11 lakh
Administrative expenses = 0.35 lakh
Selling expenses = 0.25 lakh
Depreciation = 0.50 lakh
Sales = 15 lakh
Interest = 0.47 lakh
Income tax = 1.26
The operating ratio of the J B Ltd., is ________.
a. 71.26%
b. 80.67%
c. 77.33%
d. 67.54%
e. 51.90%.

Part II
175
330. J B Ltd., financial statements has following information:
Equity share capital 3,50,000
Preference share capital 2,00,000
Long-term loan (12%) 1,00,000
Debentures (14%) 2,50,000
PBDIT 3,15,000
Interest 47,000
Sales 12,00,000
Deprecation 16,000
The Interest coverage ratio and return on capital employed are ________and __________.
a. 6.36 times, 27.18%
b. 3.67 times, 18.34%
c. 5.98 times, 24.06%
d. 4.90 times, 20.06%
e. 5.09 times, 19.18%.
331. From the following information, the Inventory is __________.
Current ratio =2.6:1
Liquid ratio =1.5:1
Current liabilities =Rs.40,000
a. Rs.55,000
b. Rs.44,000
c. Rs.22,000
d. Rs.1,64,000
e. Rs.1,04,000.
332. From the following information, the Inventory is __________.
Current ratio =2.8
Liquid ratio =1.5
Working capital =Rs.90,000
a. Rs.55,000
b. Rs.60,000
c. Rs.65,000
d. Rs.70,000
e. Rs.75,000.
333. Rama Industries has furnished the following details:
Inventory Rs.80,000,
Prepaid expenses Rs.2,000,
Quick ratio 2.5 to 1
Current liabilities Rs.50,000.
The current ratio is _____________.
a. 4.14
b. 4.10
c. 3.16
d. 5.20
e. 3.88.
176
334. Current liabilities of a company is Rs.30,000. If current ratio is 3:1 and quick ratio is 1:1, the
value of stock in trade is ____________.
a. Rs.20,000
b. Rs.30,000
c. Rs.40,000
d. Rs.50,000
e. Rs.60,000.
Rajan & Co., supplies you the following information regarding the year ending 31st Dec, 2000.
Cash sales
Credit sales
Returns inward
Opening stock
Closing stock
Rs.80,000
Rs.2,00,000
Rs.10,000
Rs.25,000
Rs.30,000,
335. Gross profit ratio is 25%. The inventory turnover ratio is_________.
a. 6.54 times
b. 7.36 times
c. 6.98 times
d. 5.55 times
e. 7.56 times.
336. If current ratio is 2.6:1 and current liabilities are Rs.40,000, the current assets are _________.
a. Rs.1,09,000
b. Rs.2,32,000
c. Rs.1,54,000
d. Rs.1,04,000
e. Rs.2,12,000.
337. When current assets are Rs.50,000, current ratio is 3:1.5 and quick ratio is 1.5:1.0, the current
liabilities and inventory are _____and ____.
a. Rs.37,500, Rs.12,500
b. Rs.45,000, Rs.11,000
c. Rs.47,000, Rs.13,000
d. Rs.25,000, Rs.12,500
e. Rs.23,500, Rs.14,500.
338. A trader purchases goods both on cash as well as on credit terms. The following particulars
are obtained from the books:
Total purchases 8,00,000
Cash purchases 2,80,000
Purchase returns 1,61,000
Creditors at the end 1,85,000
Bills payable at the end 60,000
Reserve for discount on creditors 8,000
The average payment period is _________.
a. 249 days
b. 256 days
c. 195 days
d. 245 days
e. 268 days.
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177
339. Kalidas Electronics sells goods on cash as well as on credit. The following particulars are
extracted from their books of accounts:
Gross total sales 6,00,000
Cash sales 1,10,000
Sales returns 1,20,000
Debtors at the end 1,86,000
Bills receivable at the end 48,000
Provision for doubtful debts 3,000
Total creditors at the end 25,000
The average collection period is ________.
a. 210 days
b. 175 days
c. 115 days
d. 200 days
e. 231 days.
340. From the following information gross profit margin and net profit margin are _______.
Rs. Rs.
Sales 25,20,000 Fixed assets 14,40,000
Cost of sales 19,20,000 Net worth 15,00,000
Net profit 3,60,000 Debt 9,00,000
Inventory 8,00,000 Current liabilities 6,00,000
Other current assets 7,60,000
a. 23.81% and 14.29%
b. 25.56% and 18.90%
c. 20.34% and 12.45%
d. 22.75% and 20.01%
e. 19.06% and 15.33%.
341. Watson Ltd., provides the following information:
(Rs.)
Cash sales during the year 1,50,000
Credit sales during the year 2,70,000
Returns inward 20,000
Total debtors in the beginning 55,000
Total debtors at the end 45,000
Provision for bad and doubtful debts 5,000
The debtors turnover ratio and average collection period are _________and ________.
Assume 365 days in a year.
a. 3 times, 56 days
b. 4 times, 70 days
c. 5 times, 67 days
d. 5 times, 73days
e. 4 times, 90 days.
178
342. Sita Ltd., and Gita Ltd., are two firms operating in the same industry and maintain the
inventory at the same level in the beginning of the year. From the following details of these
firms relating to year 2002-03, comment on the average collection period comparing with the
industry norm of 80 days.
Sita Ltd. Gita Ltd.,
Sales 550 500
Debtors 182.60 88.88
Creditors 115 48
Gross profit 100 120
a. Gita Ltd., is not performing as good as Sita Ltd., since the collection period of Gita Ltd.,
is longer than the industry norm.
b. Sita Ltd., is not performing as good as Gita Ltd., since the collection period of Sita Ltd.,
c. Sita Ltd., is not performing as good as Gita Ltd., since the collection period of Sita Ltd.,
is shorter than the industry norm.
d. Gita Ltd., is not performing as good as Sita Ltd., since the collection period of Sita Ltd.,
e. Gita Ltd., is not performing as good as Sita Ltd., since the collection period of Sita Ltd.,
is shorter than the industry norm.
343. Sita Ltd., and Gita Ltd., are two firms operating in the same industry and maintain the
inventory at the same level in the beginning of the year. From the following details of these
firms relating to year 2002-03, comment on the average payment period comparing with the
industry norm of 75 days.
Sita Ltd. Gita Ltd.
Credit purchases 400 300
Debtors 182.60 88.88
Creditors 115 48
Gross profit 100 120
a. Gita Ltd. is able to pay its creditors in 53 days as against the industry norm of 75 days
whereas Sita Ltd. is taking 79 days to pay its creditors.
b. Gita Ltd. is able to pay its creditors in 79 days as against the industry norm of 75 days
c. Gita Ltd. is able to pay its creditors in 80 days as against the industry norm of 75 days
d. Gita Ltd. is able to pay its creditors in 73 days as against the industry norm of 75 days
e. Gita Ltd. is able to pay its creditors in 58 days as against the industry norm of 75 days
344. Sheetal Industries Ltd., has the following capital structure:
5% preference share of Rs.100 each Rs.10,00,000
Ordinary shares of Rs.10 each Rs.30,00,000
The following information are available for financial year just concluded:
Profit after taxation Rs.15,00,000
Market price of Ordinary share Rs.40
Dividend paid on equity shares Rs. 2
The dividend yield on the ordinary shares and the earnings yield are _______ and _______.
a. 11%, 12.8 times
b. 7.9%, 21 times
c. 12%, 18.9 times
d. 5%, 12.08 times
e. 12%, 25.1 times.
Part II
179
The following information relative to the Alpha Pneumatic Ltd.:
Current ratio 4.0
Acid-test ratio 2.80
Gross Profit Margin 30%
Tax 40%
Average collection period 75 days
EPS Rs.2.52
Net worth to long-term debt ratio 3.975
Inventory turnover ratio 6.452
Current liability Rs.15.5 lakh
Financial expenses Rs.3 lakh
Interest on long-term debt 15%
Selling and administrative expenses as a percentage of sales 10%
345. The profit after tax of Alpha Pneumatic Ltd., is .
a. Rs.21 lakh
b. Rs.18.77 lakh
c. Rs.24.0 lakh
d. Rs.12.0 lakh
e. Rs.20.0 lakh.
346. In the above question, consider the following new information
What are the fixed assets of Alpha Pneumatic Ltd.?
a. Rs.50 lakh.
b. Rs.51 lakh.
c. Rs.53 lakh.
d. Rs.54 lakh.
e. Rs.55 crore.
347. In 2003 W Inc., raised a fresh capital of Rs.200 million and invested on an average over a
period of six months. The total assets as at the beginning of 2003 was Rs.12,000. As at the
end of 2003 the fixed assets were Rs.10000, current assets were Rs.4,000 and other assets
were Rs.2,500. If the EBIT is Rs.1200, interest is Rs.400, depreciation is Rs.750 and the tax
payable is Rs.280 @35%. Compute the Return on Assets with the above data if the firm were
all equity financed. All figures in millions.
a. 6.35
b. 6.48
c. 6.41
d. 6.45
e. 6.54.
348. The Income Statement of A for the year ended 2004 is;
Sales Rs.5000
Costs Rs.4000
Net income Rs.1000
Balance sheet for the years 2003 and 2004;
2003 2004 2003 2004
Assets Rs.2500 Rs.3500 Debt Rs.1000 Rs.1400
Equity Rs.1500 Rs.2100
If the sales increases by 10 percent in and all other items including debt correspondingly
increase, what is the value of the balancing item?
a. 1,190.
b. 890.
c. 1,490.
d. 1,290.
e. 1,250.
180
349. M maintains a profit margin of 4 percent and a sales to assets ratio of 3. The debt equity ratio
is 1.0, the interest payments and taxes being Rs.10,000 each and the EBIT being Rs.40,000.
Compute the Return on equity and the Return on the assets.
a. 24% and 12%
b. 13% and 15%
c. 15% and 13%
d. 12% and 15%
e. 11% and 12%.
350. Z Inc., in its latest balance sheet reveals a cash balance of Rs.300, inventories Rs.2,000,
accounts receivables Rs.2,400, plant and property worth Rs.15,000, long term debt Rs.4,000,
short term debt Rs.2,000, accounts payables Rs.1,500, capital leases Rs.500 and common equity
Rs.6,500 among others. Determine the Net working capital, the Current ratio and the Debt ratio.
a. 1300, 1.38 and 0.41
b. 1200, 1.34 and 0.41
c. 1400, 1.36 and 0.43
d. 1250, 1.35 and 0.43
e. 1300, 1.36 and 0.43.
351. An US firm has sales of Rs.6 million, an asset turnover ratio of 5 for the year and net profits
of Rs.150,000.
i. Find the firm's return on assets/earning power.
ii. New equipment which the firm is planning to install will increase the investment in
assets by 18% and is expected to increase the net profit margin from 2.5% now to 3.5%
there will not be any change in sales. What I will be the return on assets after the
installation of the new equipment?
a. 12%; 13.5%.
b. 12.2%; 13.7%.
c. 12.5%; 14.2%.
d. 12.5%; 14.8%.
e. 12.8%; 14.5%.
352. The operating income of a firm is Rs.1500. The number of shares outstanding are 1000 at a
market price of Rs.10 per share. The firm plans to issue debt for Rs.2500 and buy back with
the proceeds 250 shares. The cost of debt is 10 percent. As the debt holders are of the opinion
that the fresh issue is not without risk they demand a return of 2.5% over and above the risk
free rate. Determine the return on assets and the return on equity.
a. 12.5% and 12.5%
b. 15.0% and 16.67%
c. 17.5% and 12.5%
d. 15.5% and 10.0%
e. 17.5% and 10.0%.
353. Troma Ltd., has achieved sales of Rs..40 million and a net profit of Rs..5 million in the
current year. The following figures are obtained from the current years Balance Sheet:
Paid-up equity share capital Rs.5 million
Reserves and surplus Rs.3 million
Long-term loans Rs.8 million
Current liabilities and provisions Rs.4 million
If the company wants to increase the return on equity by 7.5 percentage points next year then
by how much should the net profit margin change, other ratios remaining the same?
a. Increase by 1.5%.
b. Decrease by 2.0%.
c. Increase by 2.0%.
d. Decrease by 1.5%.
e. Increase by 3.2%.
Part II
181
354. The Profit After Tax for a toy manufacturing company is Rs.140 million. The company has a
paid-up equity capital of Rs.250 million and reserves and surplus worth Rs.150 million. The
tax paid by the firm is Rs.60 million. The total assets base of the firm is Rs.600 million. If the
firm is not having any interest expense, the return on equity and the return on investment for
the firm are
a. 20.10% and 33.33%
b. 25.00% and 32.00%
c. 35.00% and 33.33%
d. 33.33% and 40.00%
e. 30.09% and 40.33%.
355. Using the following information, complete the balance sheet. Assume 360 days in a year
Long-term debt to net worth 0.4
Total asset turnover 3.5
Inventory turnover 6
Gross profit margin 15%
Acid test ratio 1:1
Cash (vii) Notes and Payables 75,000
Accounts receivable (vi) Long term debt (i)
Inventory (v) Common Stock 150,000
Plant and Equipment (iv) Retained earnings 75,000
Total Assets (iii) Total liabilities and equity (ii)
a. Rs.90,000; Rs.370,000; Rs.370,000; Rs.122,625; Rs.192,750; 56,800; Rs.18,250
b. Rs.90,000; Rs.390,000; Rs.390,000; Rs.121,245; Rs.193,375; Rs.56,875; Rs.18,125
c. Rs.90,000;Rs.360,000;Rs.360,000; Rs.122,245; Rs.139,375; 55,750; Rs.18,125
d. Rs.75,000; Rs.350,000; Rs.350,000; Rs.121,750; Rs.193,425; 55,750; Rs.18,125
e. Rs.78,200; Rs.370,000; Rs.370,000; Rs.121,570; Rs.193,425; 55,750; Rs.18,520.
356. Given as at the end of 2003: Sales Rs.1000, Costs Rs.750, Interest Rs.25 and Tax Rs.90.
Total assets are Rs.2600, Debt being Rs.500 and equity at Rs.2100. The finance manager
forecasts a 10 percent increase in sales and costs in the next year. The ratio of sales to
average assets remains at 0.40 and interest is expected to be at 5 percent of debt at the start of
the year. If the company pays out 50 percent of net income as dividends, compute the debt
ratio if the company is unwilling to make an issue of common stock.
a. 0.38
b. 0.27
c. 0.25
d. 0.28
e. 0.29.
357. M Inc., in its latest balance sheet reveals a cash balance of Rs.1000, inventories Rs.400,
accounts receivables Rs.350, plant and property worth Rs.20000, long term debt Rs.7000, short
term debt Rs.200, accounts payables Rs.350, capital leases Rs.1500 and common equity
Rs.8000 among others. Determine the Net working capital, the Current ratio and the Debt ratio.
a. 1300, 3.38 and 0.58
b. 1200, 3.18 and 0.52
c. 2400, 3.36 and 0.43
d. 2250, 3.35 and 0.63
e. 2500, 3.36 and 0.49.
182
358. The market value of Zs shares is Rs.100000 at Rs.10 per share. The firm plans to issue debt
for Rs.3000 and buy back with the proceeds 300 shares. The cost of debt is 10 percent and
the number of shares outstanding are 1000. Calculate the EPS and the return on shares if the
operating income is Rs.1500 and Rs.2000.
a. 2.43, 2.43, and 19.1%, 24.3%
b. 1.67, 2.33, and 16.7%, 23.3%
c. 1.50, 1.50, and 20%, 20%
d. 2.33, 1.67, and 10%, 10.67%
e. 1.71, 2.43, and 17.1%, 24.3%.
359. If the dividend yield for a firm is 0.3, whose P/E multiple and EPS are 3 and Rs.6
respectively, the dividend per share of the firm is
a. 18.5
b. 6
c. 5.4
d. 0.6
e. 0.16.
360. If the return on equity is 25%, dividend pay-out ratio is 60% and dividend per share is Rs.3,
the EPS of the company is
a. Rs.15
b. Rs.10
c. Rs.5
d. Rs.3
e. Rs.1.5.
361. If the earning power of a firm is 0.3, the average of total assets are Rs.20,000 and interest
expense is Rs.1,500 then the interest coverage ratio will be
a. 1.2
b. 1.5
c. 3.0
d. 4.0
e. 4.5.
362. Which of the following is correct for a firm with EPS of Rs.1per share and a 30% pay-out ratio?
a. 30% of earnings will be ploughed back into the firm.
b. Dividends will equal Rs.0.7 per share.
c. Book value per share of equity will increase by Rs.0.7.
d. Retained earnings will be unchanged.
e. Book value per share of equity will decrease by Rs.0.3.
363. If the price earnings ratio is 12, asset turnover ratio is 0.9 and the dividend pay-out ratio is
0.6, then the dividend yield would be
a. 5.0%
b. 7.2%
c. 7.5%
d. 10.8%
e. Cannot be determined from the given data.
364. The capitalization rate of a company whose market price per share is Rs.28, net income is
Rs.2million and the number of outstanding shares is 0.56million is
a. 0.039
b. 0.078
c. 0.127
d. 0.156
e. 0.254.
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183
365. The total debt-equity ratio of Indian Online Corp Ltd., is 4:3. Its total asset is Rs.3500 lakh
and its short-term debt is Rs.500 lakh. If total debt consists of long-term debt as well as short-
term debt, the amount of long-term debt is
a. Rs.500 lakh
b. Rs. 700 lakh
c. Rs.1000 lakh
d. Rs.1500 lakh
e. Rs.1600 lakh.
366. For Sandal Ltd., net profit margin is 7.50 percent while total assets turnover ratio is 1.20. If
return on equity for the company is worked out as 12 percent, then the debt-asset ratio is
a. 0.25
b. 0.33
c. 0.75
d. 1.33
e. 1.75.
367. The following information is related to Padmaja Industries Ltd.
Current liabilities and provisions Rs.70 lakh
Net sales Rs.350 lakh
Inventory turnover ratio 7
Current ratio 1.40
Receivables/Quick Assets Ratio 0.75
What is the amount of cash and bank balance? (Assume 360 days in a year)
a. Rs.8 lakh
b. Rs.10 lakh
c. Rs.12 lakh
d. Rs.15 lakh
e. Rs.17 lakh.
368. Garodia Textiles Ltd., sells its goods on credit only. The average collection period of the
company is 30 days. Its balance sheet shows debtors balances of Rs.20 lakh as on 01.04.2002
and of Rs.30 lakh as on 31.03.2003. What was its annual sales turnover for the year 2002-03?
(Assume 360 days in a year.)
a. Rs.250 lakh
b. Rs.300 lakh
c. Rs.360 lakh
d. Rs.450 lakh
e. Rs.750 lakh.
369. Madhav Organics Ltd., raised money from the debt market at a rate of 8 percent per annum
to achieve a total debt-equity ratio of 0.5. In the last year, if its Return On Investment (ROI)
is 14 percent, what will be its return on equity? (Assume the applicable tax rate as 40 percent)
a. 9.20 percent
b. 10.20 percent
c. 11.20 percent
d. 12.20 percent
e. 14.00 percent.
184
370. For Signus J ute, the current ratio is 2.75 while the acid test ratio is 2.00. What is the
percentage of inventories with respect to the current liabilities?
a. 20.00%.
b. 27.50%.
c. 40.00%.
d. 55.00%.
e. 75.00 %.
371. The sales turnover of a company is Rs.120 lakh while the amount of credit sales is 80 percent
of total sales. If the amount of receivables increases from Rs.8.50 lakh and Rs.11.50 lakh
during the year, what is its average collection period from its debtors?
a. 22.5 days.
b. 27.5 days.
c. 32.5 days.
d. 37.5 days.
e. 42.5 days.
372. Following figures are taken from the annual report of M/s TDG Ltd.:
Term Loan at a rate of 12 percent per annum to be repaid in 5 equal
annual installments during the coming years
Rs.10 lakh
Debentures at a rate of 14 percent per annum to be repaid in 6 equal
annual installments during the coming years
Rs.24 lakh
Perpetual Preference Shares at a rate of 15 percent p.a. Rs.20 lakh
Net Worth Rs.40 lakh
Applicable tax rate 40 percent
Depreciation Rs.5.44 lakh
Dividend per shares Rs.1.50
Number of outstanding shares 600,000
Dividend pay out ratio 100 percent
What is the fixed charges coverage ratio for TDG Ltd.?
a. 1.534.
b. 2.534.
c. 3.534.
d. 4.534.
e. 5.534.
373. The following information is related to Fast Track Hotels Ltd.:
Gross profit Rs.45 lakh
Gross profit margin 20 percent
Total assets turnover ratio 3
Total debt to equity ratio 1.50
Current assets Rs.35 lakh
Current ratio 2.50
What is outstanding amount of term loan in its balance sheet? (Assume term loan is the only
interest bearing borrowings made by the company)
a. Rs.22 lakh
b. Rs.25 lakh
c. Rs.28 lakh
d. Rs.31 lakh
e. Rs.34 lakh.
Part II
185
374. The capitalization rate of a company whose market price per share is Rs.28, net income is
Rs.20 lakhs and the number of outstanding shares is 5.6 lakhs is
a. 0.0390
b. 0.0780
c. 0.1275
d. 0.1565
e. 0.2545.
375. Given the equity-multiplier as 4.55, the debt-asset ratio of a firm, according to Du Pont
analysis is
a. 0.22
b. 0.78
c. 1.28
d. 1.56
376. If the dividend yield for a firm is 0.3, whose P/E multiple and EPS are 3 and Rs.6
respectively, the dividend per share of the firm is
a. 18.5
b. 6
c. 5.4
d. 0.6
e. 0.16.
377. If the earning power of a firm is 0.3, the average of total assets are Rs.20,000 and interest
expense is Rs.1,500 then the interest coverage ratio will be
a. 1.2
b. 1.5
c. 3.0
d. 4.0
e. 4.5.
378. If the stock velocity is 6, cost of goods sold is Rs.54,000 and closing stock is Rs.10,000, the
opening stock is
a. Rs.8,000
b. Rs.9,000
c. Rs.10,000
d. Rs.12,000
e. Rs.18,000.
379. If net profit margin is 7.50%, asset turnover ratio is 0.90 and debt-asset ratio is 0.75, then the
return on net worth is
a. 18%
b. 24%
c. 27%
d. 30%
e. 36%.
186
380. If the total asset turnover ratio is 1.5, the net profit margin is 20% and the total assets to net
worth ratio is 2, then the Return On Equity (ROE) is
a. 60% p.a.
b. 45% p.a.
c. 25% p.a.
d. 15% p.a.
e. 8% p.a.
381. Given debt-equity ratio =3:2; total assets =1500; short-term debt =300. Assuming that total
debt consists only of long-term debt and short-term debt, the long-term debt is
a. 200
b. 300
c. 400
d. 500
e. 600.
382. If the interest coverage ratio is 3.5 the interest payment is Rs.12,000 then profit before tax is
a. Rs.10,000
b. Rs.20,000
c. Rs.30,000
d. Rs.42,000
e. Rs.50,000.
383. The current assets of ABC Ltd., are Rs.10 lakhs and its current liabilities are Rs.5 lakhs. The
composition of current assets is as follows:
Inventory Rs.5 lakh
Receivables Rs.3 lakh
Marketable securities Rs.1 lakh
Cash Rs.l lakh
The quick ratio for the company is
a. 2.00
b. 1.00
c. 0.50
d. 0.40
384. Suppose the net profit margin, total asset turnover ratio and debt/equity ratio are 5%, 2 and
1.5 respectively. The return on equity will be equal to
a. 6.66%
b. 7.50%
c. 10.0%
d. 15.0%
e. 25.0%.
Part II
187
385. Consider the following information relating to ABC Marketing (P) Ltd.
Inventory Rs.5.00 lakh
Debtors Rs.3.00 lakh
Cash Rs.0.20 lakh
Creditors Rs.2.00 lakh
What is the quick ratio of the company?
a. 1.60.
b. 2.50.
c. 2.20.
d. 4.10.
386. If net profit margin is 6%, asset turnover ratio is 3.0 and total asset to equity ratio is 1.5, then
return on equity is
a. 18%
b. 24%
c. 27%
d. 30%
e. 36%.
387. Consider the following information relating to NK Enterprises Ltd.:
Rs.
Dividend per share for year 2003-04 25.00
Face value per share 100.00
Price per share on April 04, 2003 80.00
Price per share on March 31, 2004 120.00
What is the dividend yield to an investor of NK Enterprises Ltd., who bought the companys
share on April 04, 2003?
a. 20.83%.
b. 22.73%.
c. 25.00%.
d. 31.25%.
388. If the earnings per share is Rs.3.50 and return on equity is 30%, the book value per share is
a. Rs.11.67
b. Rs.10.50
c. Rs.1.05
d. Rs.0.12
e. Cannot be determined with the given data.
389. If ABCs earnings before interest and taxes is 14.7% of net sales and total assets turnover
ratio is 2, then earnings power is
a. 9.80%
b. 22.05%
c. 29.40%
d. 39.20%
e. Insufficient data.
188
390. If the price earnings ratio is 12, and dividend pay-out ratio is 0.6, the dividend yield would be
a. 5.0%
b. 7.2%
c. 7.5%
d. 10.8%
391. In Du Pont analysis if equity multiplier is 4, then the debt to assets ratio is
a. 1.00
b. 0.80
c. 0.75
d. 0.60
e. 0.33.
392. Consider the following information on Magnets India Limited:
Number of shares outstanding 1,00,000
EBIT (Rs. lakhs) 20
PAT (Rs. lakhs) (before paying preference dividends) 10
P/E ratio 5
Current market price (Rs.) 20
The amount of preference dividend paid is
a. Rs.4.00 lakh
b. Rs.5.00 lakh
c. Rs.6.00 lakh
d. Rs.6.66 lakh
393. If a firms current ratio is 1.20, acid test ratio is 1.0, current liabilities are Rs.2,000 and
inventory turnover ratio is 6, then its cost of goods sold are _____
a. Rs.3,120
b. Rs.2,560
c. Rs.2,460
d. Rs.2,400
e. Rs.2,280.
394. The market value of Tata Steel share is Rs.150 (face value Rs.10), the company announces a
dividend of 40%, the dividend yield is
a. 40%
b. 4%
c. 8%
d. 2.67%
e. 26.67%.
395. Suppose the current assets and inventory are 140% and 20% of current liabilities, an increase
of 10% in current assets (without any increase in inventory) will increase the quick ratio by
a. 10%
b. 11.67%
c. 28.33%
d. 34.10%
Part II
189
396. Following is the balance sheet of Super Star Industries Ltd.
(Rs. in lakh)
Liabilities Assets
Equity capital 25 Land and Building 20
Long-term debt 15 Finished goods 30
Sundry creditors 10 Sundry debtors 10
Bills payable 10 Cash and Bank balance 10
Outstanding
payments
10
70 70
The quick ratio of the company is
a. 0.33
b. 0.67
c. 1.00
d. 1.33
e. 2.00.
397. If the current assets are 160% of current liabilities, an increase of 10% in current assets will
increase the current ratio by
a. 10%
b. 11.67%
c. 28.33%
d. 34.10%
398. If the net profit margin is reduced from 8% to 4% and the asset-equity ratio increases from
1.2 to 1.5, to leave the ROE unchanged from its original 14%, the asset turnover ratio must
a. Remain constant
b. Increase from 1.46 to 2.33
c. Decrease from 14.58 to 2.33
d. Increase from 4.76 to 9.60
399. Find ROI of a company given that the net operating profit margin is 5%, dividend pay-out
ratio is 40% and total assets turnover ratio is 2.
a. 5%
b. 40%
c. 20%
d. 10%
e. 15%.
400. The receivables of firm A constitute 60% of current assets. The current ratio of the firm
stands at 1.3, total assets turnover ratio is 1.2 and total assets are 2.5 times current assets. If
current liabilities of the firm are Rs.16 lakhs, the average collection period (in days) is
a. 72
b. 60
c. 54
d. 36
e. 80.
190
401. If the return on equity is 25%, dividend pay-out ratio is 60% and dividend per share is Rs.3,
the EPS of the company is
a. Rs.15
b. Rs.10
c. Rs.5
d. Rs.3
e. Rs.1.5.
402. If the average collection period of receivable varies between 20 days and 30 days for a
company whose sales are Rs.900 lakh, the level of receivable (Rs. in lakhs) varies between
a. 30 and 45
b. 30 and 50
c. 45 and 75
d. 50 and 75
403. If the ROE of a firm is 20%, cost of debt is 10%, debt-equity ratio is 1.5, what is the ROI, at
a tax rate of 35%?
a. 16.31%.
b. 18.31%.
c. 18.61%.
d. 16.81%.
e. 17.5%.
404. If net profit margin of a firm is 7%, asset turnover ratio is 2.5, and total assets to equity ratio
is 1.2, then the ROE for the firm is
a. 17.5%
b. 18%
c. 21%
d. 18.5%
e. 21.25%.
405. Exotica Ltd., requires Rs.10 crore for expansion. Internally generated funds that can be
utilized are Rs.1 crore. The balance amount is to be financed by issue of equity shares of
Rs.10 each at a premium of Rs.5. If issue costs are ignored, the number of shares to be
issued is
a. Rs.120.00 lakh
b. Rs.100.00 lakh
c. Rs.90.00 lakh
d. Rs.66.66 lakh
e. Rs.60.00 lakh.

Part II
191
Funds Flow Analysis
406. Balance sheet of Delta Ltd. is given below:
As on 31st March
Year 2
(Rs.)
Year 1
(Rs.)
Assets
Current Assets:
Cash 6,200 4,800
Inventory 8,400 6,200
Accounts Receivable 4,700 5,800
Fixed Assets (Gross):
Land 15,000 15,000
Building 11,000 11,000
Machinery 14,000 13,000
59,300 55,800
Liabilities:
Creditors 7,100 8,300
Accounts Payable 5,800 5,600
Provision for Doubtful Debts 1,700 2,500
Capital 12,000 10,000
Reserves and Surplus 18,000 18,200
Sinking Fund 6,600 5,400
Accumulated Depreciation:
Building 4,200 3,000
Machinery 3,900 2,800
59,300 55,800
Notes:
Net profit for the year 2: Rs.5,000
Dividends paid during the year 2: Rs.4,000
Which of the following represents the change in working capital and total working capital
generated through funds flow analysis?
a. Rs.4,500, 9,500.
b. Rs.4,300, 9,500.
c. Rs.4,300, 9,300.
d. Rs.4,500, 9,300.
e. Rs.700, 9,500.

192
407. Given the following information about Rhombus Ltd., what would be the profit from
operations of the company?
i. Net profit for the last year was 1,24,000 after charging depreciation on fixed assets to
the tune of 1,40,000 and provision of tax Rs.20,000.
ii. Fixed assets worth Rs.20,000 were sold for Rs.24,000 and the profit is included in P&L
Account.
a. Rs.2,80,000
b. Rs.2,68,000
c. Rs.20,000
d. Rs.12,000
e. Rs.2,40,000.
408. The following are the extracts from the balance sheets of Thermo Pack Ltd. for the two
consecutive years ending:
Rs. in 000s
200x Previous Year
Liabilities:
Share Capital 7,500 7,500
Reserves and Surplus 21,950 15,210
Unsecured Loans 1,425
Provision for depreciation 1,199 1,029
Creditors 88,642 33,720
Other Liabilities 47,527 13,298
Provisions 27,847 17,805
1,94,665 89,987
Assets:
Gross Fixed Assets 11,056 9,362
Investments 25 25
Inventories 29,535 12,711
Sundry Debtors 71,950 32,904
Cash and Bank 44,222 16,062
Other Current Assets 1,440 611
Loans and Advances 36,437 18,312
1,94,665 89,987
Additional Information:
i. Net profit for the year end 200x is Rs.1,49,90,000.
ii. Cash dividends paid during the year are Rs.75,00,000 and dividend tax paid is
Rs.7,50,000.
Which of the following represents the funds from operations and change in working capital,
when computed on working capital basis?
a. Rs.15,160, 3,791.
b. Rs.10,710, 4,097.
c. Rs.18,981, 2,590.
d. Rs.11,027, 3,654.
e. Rs.27,189, 2,070.
Part II
193
409. Consider the following financial statements of Brew Company Ltd. for the year ending
March 31, 200 x and the previous year:
(Amount in Rs.)
Previous Year March 31, 200x
Assets:
Net fixed Assets 11,13,000 13,98,000
Current Assets:
Cash 1,40,000 81,000
Accounts Receivable 3,46,000 5,28,000
Inventories 4,32,000 3,83,000
Total 20,31,000 23,90,000
Liabilities:
Equity Capital 1,00,000 2,00,000
Retained Earnings 4,92,000 5,64,000
Long-term Debt 7,00,000 8,00,000
Current Liabilities:
Accounts Payable 4,13,000 5,27,000
Accruals 2,26,000 1,14,000
Bank Borrowings 1,00,000 1,85,000
Total 20,31,000 23,90,000
During the current year, depreciation was Rs.1,89,000 and dividends paid were nil. The net
change in cash position on cash basis is .
a. Rs.61,000
b. Rs.27,500
c. Rs.1,05,000
d. Rs.59,000
e. Rs.44,300.
Given below are the Balance sheets of Dynamic Ltd.
As at 31st March 2003 As at 31st March 2004
Rs. Rs. Rs. Rs.
Fixed assets at cost 73,000 80,000
Addition during the year 7,000 17,000
80,000 97,000
Depreciation 35,000 45,000 46,000 51,000

Current Assets: Cash 12,000 16,000
Stock at cost 1,79,000 1,89,000
Trade debtors 1,31,500 1,38,700
3,22,500 3,43,700
Less current liabilities
Bank Overdraft 1,06,000 45,000
Trade creditors and provision 1,09,800 1,29,200
Proposed dividend 16,000 24,000
2,31,800 90,700 1,98,200 1,45,500
1,35,700 1,96,500
Represented by
Ordinary share capital 85,000 1,10,000
General reserve 15,500 27,500
Profit and loss A/c 35,200 48,500
8% Debenture 10,500
1,35,700 1,96,500
194
410. The funds from operations is __________.
a. Rs.77,000
b. Rs.60,300
c. Rs.65,600
d. Rs.76,300
e. Rs.57,700.
411. The statement of change in working capital is ____________.
a. Increase in working capital of Rs.3,700
b. Decrease in working capital of Rs.3,700
c. Increase in working capital of Rs.3,900
d. Decrease in working capital of Rs.2,200
e. No change in working capital.
412. The total Amount of Sources is ________.
a. Rs.1,00,000
b. Rs.1,10,000
c. Rs.1,19,000
d. Rs.98,000
e. Rs.75,000.
Based on the fol l owi ng i nformati on Answer Questi ons 413 to 415.
Two divisions of Amazon Ltd., start the year 2003 with identical Balance sheets but the
position changed by the end of the year as shown below:
Division A Division B
Beginning Ending Beginning Ending
Current assets 5,75,000 5,50,000 5,25,000 5,25,000
Current liabilities 2,75,000 2,75,000 2,75,000 4,00,000
Working capital 3,00,000 2,75,000 2,50,000 1,25,000
Fixed assets (net) 2,00,000 6,00,000 2,50,000 5,00,000
Capital employed 5,00,000 8,75,000 5,00,000 6,25,000
Financed by:
Long-term debt 2,50,000
Equity capital and reserve 5,00,000 6,25,000 5,00,000 6,25,000
You have the following additional information:
a. Both the divisions have identical earning power.
b. Each division earns a net profit of Rs.60,000 after taxation @ 50%.
c. Depreciation amounts to Rs.40,000.
413. From the above information funds from operations are and for Division A and Division B.
a. Rs.1,00,000 and 1,00,000
b. Rs.1,60,000 and 1,90,000
c. Rs.1,90,000 and 1,90,000
d. Rs.95,000 and 95,000
e. Rs.3,15,000 and 1,60,000.
414. From the above information what are the amount of funds procured from the long-term
sources of Division A and Division B respectively?
a. Rs.2,50,000 and 65,000
b. Rs.65,000 and 65,000
c. Rs.2,50,000 and 2,50,000
d. Rs.3,15,000 and 65,000
e. Rs.3,15,000 and 2,50,000.
Part II
195
415. From the above information what are the changes in working capital of Division A and
Division B are respectively?
(Amount in Rs.)
Division A Division B
Beginning Ending Beginning Ending
Current assets 5,75,000 5,50,000 5,25,000 5,25,000
Current liabilities 2,75,000 2,75,000 2,75,000 4,00,000
Working capital 3,00,000 2,75,000 2,50,000 1,25,000
Fixed assets (net) 2,00,000 6,00,000 2,50,000 5,00,000
Capital employed 5,00,000 8,75,000 5,00,000 6,25,000
Financed by:
Long-term debt 2,50,000
Equity capital and reserve 5,00,000 6,25,000 5,00,000 6,25,000
a. Decrease in working capital for division A Rs.25,000 and working capital of Division B
has decreased by Rs.1,25,000.
b. Decrease in working capital of Rs.1,25,000 for Division A and increase in working
capital of Rs.1,25,000 for Division A.
c. No change in working capital for Both Division A and Division B.
d. Increase in working capital of Rs.1,25,000 for both Division A and Division B.
e. Decrease in working capital of Rs.1,25,000 for both Division A and Division B.
416. The following changes were noted in the financial statement of Orient Ltd during the
financial year 2003-04.
Rs. In Lakh
Increase in inventories 15
Decrease in debtors 25
Increase in cash 5
Decrease in other assets 5
Decrease in short-term
borrowings
15
Increase in creditors 5
Decrease in provisions 10
What is the proportion of total resources that are used to increase the assets of the firm?
a. 77.4%.
b. 45.6%.
c. 44.44%.
d. 41.56%.
e. 40.74%.
417. The summarized balance sheet of Symphony. as on 31.12.2003 and 31.12.2004 are as follows:
31.12.2003 31.12.2004
Assets Rs. Rs.
Fixed assets at cost 7,50,000 8,50,000
Depreciation 2,00,000 2,00,000
Net fixed assets 5,50,000 6,50,000
Investments 80,000 60,000
Preliminary expenses 20,000 10,000
Current assets 2,50,000 3,00,000
9,00,000 10,20,000
196
31.12.2003 31.12.2004
Liabilities Rs. Rs.
Share capital 2,50,000 3,70,000
Capital reserve 10,000
General reserve 1,70,000 2,00,000
P&L account 85,000 1,00,000
Debentures 2,00,000 1,40,000
Sundry creditors 1,00,000 1,10,000
Tax provision 65,000 50,000
Unpaid dividend 4,000
9,00,000 10,20,000
During 2003, the company
1. Sold one machinery for Rs.25,000, the cost of the machine was Rs.64,000 and
depreciation provided for it amounted to Rs.35,000.
2. Provided Rs.95,000 as depreciation.
3. Redeemed 30% of debentures at Rs.103.
4. Sold investment at profit and credited it to capital reserve.
5. Decided to value the stock at cost, where as earlier the practice was to value stock at
cost less 10%. The stock according to books on 31.12.2003 was Rs.54,000 and stock on
31.12.2004 was Rs.75,000 which was correctly valued at cost.
From the above information given, the funds from operations of the company are ______
a. Rs.2,30,800
b. Rs.2,35,800
c. Rs.2,70,800
d. Rs.3,26,800
e. Rs.3,36,800.
Based on the fol l owi ng i nformati on Answer Questi ons 418 to 419.
The following are the balance sheets of ABC Ltd., for the year 2003 and 2004.
Balance Sheet
Liabilities 31.12.03 31.12.04 Assets 31.12.03 31.12.04
Share capital 300 400 Fixed assets 575 630
General reserve 125 190 Investments 105 175
P & L A/c 50 85 Debtors 125 200
Term loans 200 140 Stock 170 200
Sundry creditors 60 80 Bank balance 5 20
Bank Overdraft 230 280 Other Advances 25 30
Other Liabilities 40 80
Total 1,005 1,255 1,005 1,255
Additional Information
1. Dividend has been proposed @25% of the share capital additional capital of Rs.100
lakh was brought in during the year 2004 and is eligible for dividend for the full year.
For 2004 the proposed dividend is included in other liabilities.
2. Depreciation on fixed assets has been provided to the extent of Rs.90 lakh.
418. The net increase in working capital is ________
a. Rs.20 lakh
b. Rs.15 lakh
c. Rs.30 lakh
d. Rs.35 lakh
e. Rs.23 lakh.
Part II
197
419. The funds from operations is ___________
a. Rs.250 lakh
b. Rs.255 lakh
c. Rs.260 lakh
d. Rs.270 lakh
e. Rs.265 lakh.
420. The following changes were noted in the financial statements of X Ltd.
Rs. in 000
Increase in debtors 100
Decrease in bank 7
Decrease in stock 28
Increase in bills receivable 20
Decrease in creditors 28
Increase in bills payable 4
The proportion of total resources has been generated by an increase in liabilities is ______
a. 10.25%
b. 19.70%
c. 25.25%
d. 15.75%
e. 8.95%.
The following are the balance sheets of Cod Ltd. for the years 2003 and 2004.
Balance Sheets
(Amount in Thousands)
Liabilities 31.12.03 31.12.04Assets 31.12.03 31.12.04
Share capital 400 640Goodwill 200 160
8% preference capital 200 180Land and Building 400 340
General reserve 80 140Plant and Machinery 160 400
P & L A/c 60 96Debtors 300 500
Debentures 300 180Stock 174 118
Sundry creditors 110 166Bank balance 50 36
Bills payable 40 32Bills receivable 40 60
Proposed dividend 84 100Preliminary expenses 30 20
Provision for tax 80 100
Total 1,354 1,634 1,354 1,634
1. Rs.70,000 income tax was paid during the year.
2. Final dividend of Rs.50,000 was paid during the year.
3. During the year assets of another company were purchased for a consideration of
Rs.100,000 payable in shares. The assets purchased were stock Rs.40,000 and
Machinery Rs.50,000.
4. Rs.120,000, 8% preference share capital was redeemed at a premium of 5%.
5. A part of plant costing of Rs.50,000 was sold for Rs.40,000. Depreciation on plant
Rs.40,000 for the current year has been provided.
6. The company depreciates land and building by Rs.20,000. Land costing Rs.40,000 was
sold for Rs.1,00,000.
7. Equity shares of Rs.20,000 were issued as bonus shares.
8. Rs.20,000, 10% debentures were redeemed by purchase in the open market @ Rs.95.
9. The company also made a right issue of equity shares during the years.
198
421. The funds from operations of the company is ______.
a. Rs.2,78,500
b. Rs.3,00,000
c. Rs.3,15,000
d. Rs.3,50,000
e. Rs.3,48,000.
422. The Net change in Working Capital (WC) is _________
a. Net increase in WC of Rs.1,02,000
b. Net decrease in WC of Rs.1,02,000
c. Net increase in WC of Rs.1,50,000
d. Net decrease in WC of Rs.1,50,000
e. No change in WC.
423. The changes in the Working Capital from the Balance sheet data given below is _______.
March.31, 2003
Rs.
March. 31, 2004
Rs.
Capital and liabilities
Share capital 6,00,000 7,50,000
Trade creditors 2,12,000 1,40,000
P& L A/c 28,000 62,000
Total 8,40,000 9,52,000
Assets
Machinery 140,000 2,00,000
Stock in trade 2,42,000 2,72,000
Debtors 3,62,000 3,40,000
Cash 96,000 1,40,000
Total 8,40,000 9,52,000
a. Net decrease in Working Capital of Rs.1,24,000
b. Net increase in Working Capital of Rs.1,24,000
c. No change in Working Capital
d. Net decrease in Working Capital of Rs.1,46,000
e. Net increase in Working Capital of Rs.1,46,000.
424. Given below is the balance sheet for the years 2003 and 2004 for Rajivi Fabricators Ltd.,
31 Dec. 2004
(Rs.)
31 Dec. 2003
(Rs.)
Assets
Good will 10,000 20,000
Cash 1,40,000 50,000
Debtors 1,80,000 1,96,000
Closing stock 2,40,000 1,74,000
Long term investments 20,000 30,000
Land 54,000 30,000
Preliminary expenses 6,000 10,000
6,50,000 5,10,000
Part II
199
31 Dec. 2004
(Rs.)
31 Dec. 2003
(Rs.)
Liabilities
Trade creditors 90,000 1,00,000
Bills payable 70,000 40,000
Loans (Payable during 2003) 40,000
Share capital 3,00,000 2,50,000
P & L A/c 1,50,000 1,20,000
6,50,000 51,00,000
From the above Balance sheet, what is the net increase in Working Capital?
a. Rs.66,000.
b. Rs.80,000.
c. Rs.88,000.
d. Rs.1,66,000.
e. Rs.1,75,000.
425. Given below is the profit and loss a/c of M/s. Ram Kumar and Co., for the year ended
March 31, 2004 what is the funds from operations?
Profit and Loss A/c
(Rs.) (Rs.)
To Salaries 20,000 By Gross profit 4,00,000
To rent 6,000 By profit on sale of Machine 10,000
To commission 4,000 By Refund of tax 6,000
To Discount allowed 2,000 By dividend received 4,000
To provision for depreciation 28,000
To transfer to General reserves 40,000
To provision for tax 20,000
To loss on sale of investments 10,000
To discount on issue of debentures 4,000
To preliminary expenses 6,000
To selling expenses 40,000
To net profit 2,40,000
4,20,000 4,20,000
a. Rs.3,00,000
b. Rs.3,28,000
c. Rs.3,48,000
d. Rs.3,50,000
e. Rs.3,58,000.
426. The following is an extract taken from M/s. Agarwal Movers & Packers.
(Amount in Rs.)
31st Dec 2003 31st Dec 2004
Balance of profit and loss A/c 2,00,000 3,00,000
i. Depreciation charged on assets 20,000
ii. Preliminary expenses written off 10,000
iii. Amount transferred to dividend
equalization fund
30,000
iv. A plant having a book value of
Rs.1,20,000 was sold for
1,30,000
v. Interim dividend paid Rs.20,000
200
The funds from operations are Rs._______
a. 1,50,000
b. 1,70,000
c. 1,75,000
d. 2,00,000
e. 3,80,000.
Given below are the Balance sheet of M/s. Padmaja Diary Products Ltd.,
2003 2004
Rs. Rs.
Building 2,00,000 3,00,000
Provision for depreciation 50,000 60,000
P & L A/c 80,000 1,60,000
i. An additional building costing Rs.2,00,000 was purchased during the year.
ii. A part of building costing Rs.1,00,000 was sold for Rs.1,20,000; depreciation provided
on it was Rs.20,000.
427. The funds from operations of the company
a. Rs.30,000
b. Rs.2,00,000
c. Rs.70,000
d. Rs.1,20,000
e. Rs.80,000.
428. What are the sources of funds for the firm?
a. Purchase of building for Rs.2,00,000 and funds from operations of Rs.70,000.
b. Sale of building for Rs.1,20,000 and funds from operations of Rs.70,000.
c. Purchase of building for Rs.2,00,000 and sale of building for Rs.1,20,000.
d. Only funds from operations of Rs.70,000.
e. Purchase of building for Rs.2,00,000, sale of building for Rs.1,20,000 and funds from
operations of Rs.70,000.
Extracts from balance sheets:
As on 31.3.03 As on 31.3.04
Rs. Rs.
Equity share capital 4,00,000 6,00,000
Share premium A/c 40,000 60,000
9% debentures 2,00,000 3,00,000
9% debentures worth Rs.60,000 were redeemed during the year.
429. The total sources of funds of above balance sheet is Rs.________
a. 1,60,000
b. 1,90,000
c. 2,00,000
d. 2,50,000
e. 3,80,000.
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201
430. Which of the following is the application of funds?
a. Rs.1,10,000 of equity shares
b. Rs.1,80,000 of cash
c. Rs.60,000of redemption of debentures
d. Rs.1,00,000 of redemption of debentures
e. Rs.40,000 of equity shares.
Extracts of Balance sheet of M/s Vijaya Enterprises.
2003 2004
Rs. Rs.
Trade investments 1,00,000 1,40,000
i. Rs.10,000 by way of dividend has been received during the year including Rs.4,000
from pre-acquisition profits which have been credited to Investments A/c.
ii. Investments costing Rs.20,000 have been sold during the year for Rs.20,000.
431. The source of funds is an Rs._________ realized from sale of trade investments.
a. 1,000
b. 20,000
c. 1,00,000
d. 1,10,000
e. 11,000.
432. The investments purchased during the year is __________.
a. Rs.50,000
b. Rs.40,000
c. Rs.12,000
d. Rs.64,000
e. Rs.70,000.
Extract from the balance sheets:
31.3.03 31.3.04
Rs. Rs.
Provision for taxation (Non-current) 1,00,000 1,50,000
Profit and Loss A/c (cr.) 4,00,000 6,00,000
Tax paid during the year is Rs.60,000
433. Funds from operations of Rs._______ is a source of funds.
a. 2,00,000
b. 2,55,000
c. 3,00,000
d. 3,10,000
e. 4,60,000.
202
434. In which of the following is an application of funds?
a. Tax paid Rs.60,000.
b. Provision of taxation Rs.50,000.
c. Provision for taxation Rs.75,000.
d. Tax paid Rs.85,000.
e. Tax paid Rs.55,000.
435. Extracts from balance sheets of Mr. Raj and Co. Ltd.
2003 2004
Rs. Rs.
Proposed dividend 1,60,000 2,00,000
Retained earnings 6,00,000 8,00,000
Dividend proposed during the year and debited to Retained earnings A/c is Rs.2,00,000.
The funds from operations is Rs.__________.
a. 1,00,000
b. 1,80,000
c. 2,00,000
d. 2,80,000
e. 4,00,000.
436. From the following Balance sheet of Surana Industries, the total sources from funds flow
statement is ________.
Dec. 31,
2003
Dec. 31,
2004
Assets
Land and Building 1,00,000 1,00,000
Plant 48,000 68,000
Stock 18,000 14,000
Debtors 33,000 39,000
Cash at bank 8,000 18,000
Capital and liabilities
Capital 1,60,000 1,70,000
P&L appropriation A/c 29,000 49,000
Creditors 18,000 10,000
Mortgage 10,000
a. Rs.10,000
b. Rs.20,000
c. Rs.30,000
d. Rs.25,000
e. Rs.40,000.
Part II
203
Following is the balance sheet of Indian XL Ltd.
(Rs. in lakh)
Liabilities 2004 2003 Assets 2004 2003
Share capital 1090 1090 Fixed Assets 9,866 7984
Reserves 4918 3320 Less: depreciation 3854 3300
Loan Funds 5538 4590
11546 9000 6012 4684
Investments (long-term) 126 126
Current liabilities 2482 3066 Inventories 4150 3608
Provisions 924 654 Debtors 2314 1374
Cash and bank balance 1024 1688
Loan and advances 1326 1240
14952 12720 14952 12720
437. The Net change in working capital is ________.
a. Net increase in working capital of Rs.1218 lakh.
b. Net increase in working capital of Rs.1076 lakh.
c. Net decrease in working capital of Rs.2152 lakh.
d. Net decrease in working capital of Rs.1076 lakh.
e. No change in working capital.
438. The funds from operations are _________.
a. Rs.1,075 lakh
b. Rs.2,152 lakh
c. Rs.2,200 lakh
d. Rs.2,255 lakh
e. Rs.2,260 lakh.
The following are the balance sheets of Pasachim Corporation Ltd as on 31st March, 2003
and 2004.
Liabilities 2003 2004 Assets 2003 2004
Rs. Rs. Rs. Rs.
Share capital: (paid-up) Land and Buildings 30,000 25,000
11% cumulative
Preference shares
15,000 Plant and Machinery 15,000 25,000
Equity shares 55,000 60,000 Sundry debtors 20,000 24,000
General Reserves 2,000 2,000 Stock 30,000 35,000
P & L A/c 1,000 1,200 Bank 1,200 3,500
9% debentures 6,000 7,000 Cash 300 500
Provision for taxation 3,000 4,200
Current liabilities 24,500 17,800
96,500 1,13,000 96,500 1,13,000
204
439. Net increase in working capital is ______.
a. Rs.19,100
b. Rs.13,350
c. Rs.23,900
d. Rs.22,250
e. Rs.18,200.
440. What is the funds from operations generated?
a. Rs.10,200
b. Rs.18,000
c. Rs.27,100
d. Rs.16,950
e. Rs.25,850.
Given below are the following balance sheets of Kamakshi Combines Ltd.,
Liabilities 31.3.03 31.3.04 Assets 31.3.03 31.3.04
Rs. Rs. Rs. Rs.
Share capital 70,000 74,000 Cash 9,000 7,800
Debentures 12,000 6,000 Debtors 14,900 17,700
Reserve for doubtful debts 700 800 Stock 49,200 42,700
Land 20,000 30,000
Trade creditors 10,360 11,840 Good will 10,000 5,000
Profit and loss A/c 10040 10560
1,03,100 1,03,200 1,03,100 1,03,200
i. Dividend paid Rs.3,500
ii. During the year, land was purchased for Rs.10,000.
441. What is the change in working capital is ______.
a. Net increase in working capital of Rs.7,000
b. Net decrease in working capital of Rs.7,500
c. Net increase in working capital of Rs.6,900
d. Net decrease in working capital of Rs.6,480
e. Net increase in working capital of Rs.7,250.
442. What are the the funds from operations?
a. Rs.10,700.
b. Rs.11,920.
c. Rs.9,020.
d. Rs.8,780.
e. Rs.9,180.
Part II
205
443. What are the total sources of funds with funds for Kamakshi Combines for the year 2003-
2004?
a. Rs.20,000.
b. Rs.20,500.
c. Rs.21,000.
d. Rs.19,500.
e. Rs.19,000.
444. The data on the current assets and current liabilities of Best Flavur Ltd., for the financial year
2004-05 are given below (in terms of Rs. lakh):
Debtors Cash balance Inventory Current liabilities
Beginning 100 70 30 60
Ending 120 60 45 55
The change in net working capital of the company is
a. Rs.15 lakh
b. Rs.20 lakh
c. Rs.25 lakh
d. Rs.30 lakh
e. Rs.50 lakh.
445. Current assets and current liabilities of Metals and Steel Ltd., are Rs.36 lakh and Rs.23 lakh
respectively. If the company purchased raw materials worth of Rs.2.00 lakh on credit, took a
long-term loan of Rs.25 lakh from a financial institution and purchased capital equipment,
and converted preferential shares (having face value of Rs.7 lakh) into equity, what would be
the new Net Working Capital (NWC)?
a. Rs.13 lakh
b. Rs.15 lakh
c. Rs.11 lakh
d. Rs.9 lakh
e. Rs.7 lakh.
446. For M/s Tubes and Cap Ltd., the total current assets is Rs.6 lakh and the current ratio is 1.5.
The company repaid its outstanding debentures worth of Rs.30 lakh prematurely after making
a rights issue and sold its products on credit for an amount of Rs.2.50 lakh. What is the
impact on its net working capital?
a. Rs.2.00 lakh.
b. Rs.2.50 lakh.
c. Rs.5.00 lakh.
d. Rs.6.00 lakh.
e. No Change.
447. For the years 2004 and 2005, the following figures have been arrived at:
Increase in notes payable = Rs.28,000
Decrease in provision for taxes = Rs.2,500
Increase in creditors = Rs.76,500
Decrease in provision for dividends = Rs.40,000
The change in NWC (NWC =Net Working Capital) is
a. Decrease by Rs.86,000
b. Decrease by Rs.62,000
c. Decrease by Rs.11,000
d. Increase by Rs.11,000
e. Increase by Rs.62,000.
206
448. Current liabilities are Rs.10,000 and current assets are Rs.15,000. If debtors realized Rs.3,000
and Rs.6,000 worth preference shares got converted into equity, the impact on Working
Capital (WC) would be
a. Decrease of Rs.3,000 in WC
b. Increase of Rs.3,000 in WC
c. No change in WC
d. Increase of Rs.9,000 in WC
e. Decrease of Rs.9,000 in WC.
449. The provisions made by YSR Manufacturing Co. Ltd., have increased by Rs.30,000 during
the last year and the trade loans have decreased by Rs.50,000. Ignoring changes in all other
assets and liabilities, the net change in the funds flow of the company will be
a. Increase of Rs.20,000
b. Increase of Rs.30,000
c. Increase of Rs.50,000
d. Decrease of Rs.20,000
450. If the outstanding wages payable of PNB Financial Services Ltd. decreased by Rs.55,000 and
inventories increased by Rs.40,000, the amount of net working capital of PNB Financials will
a. Increase by Rs.15,000
c. Increase by Rs.95,000
d. Decrease by Rs.95,000
e. Increase by Rs.40,000.
451. In an analysis it has been found that receivables realized are Rs.10,000, debentures converted
into equity are Rs.10 lakhs and the current ratio before the above changes is 1.51. The net
working capital after the above changes
a. Increases by Rs.1,00,000
b. Reduces by Rs.1,00,000
c. Increases by Rs.11,00,000
d. Reduces by Rs.11,00,000
e. Does not change.
Leverage
Use the following data given and solve the following question:
Total sales 1,45,000 units
Selling price Rs.23
Fixed cost Rs.2,80,000
Variable cost Rs.17
Debt Rs.10,00,000 @11% interest rate
Equity Rs.20,00,000
Face value of each share Rs.10
Tax rate applicable 45%
Part II
207
452. The firms sales have to come down by what so that the earnings before taxes is equal to zero?
If EBIT doubles, what is the new level of EBT amount?
a. Rs.16,36,000, Rs.11,80,000.
b. Rs.18,40,000, Rs.10,70,000.
c. Rs.22,68,000, Rs.1,10,000.
d. Rs.20,35,300, Rs.5,90,000.
e. Rs.14,95,000, Rs.6,00,000.
453. The operating and combined leverages are and .
a. 1.475, 1.814
b. 0.412, 1.119
c. 1.675, 2.098
d. 1.086, 1.475
e. 1.230, 0.097.
454. If the asset turnover of the industry is 0.75, does the firmhave a high or low degree of asset leverage?
a. 0.99 and the firm is considered to have a low degree of asset leverage.
b. 1.00 and the firm is considered to have a high degree of asset leverage.
c. 1.11 and the firm is considered to have a high degree of asset leverage.
d. 1.10 and the firm is considered to have a high degree of asset leverage.
e. 0.65 and the firm is considered to have a low degree of asset leverage.
455. Use the following data given and solve the following question:
EBIT Rs.5,90,000
Interest @ 11% Rs.1,10,000
No. of shares outstanding 2,00,000
If another firm has the same ROI, same total assets as this firm and no debt, what is the
difference between EPS of the two firms and which one has the higher EPS?
a. Rs.0.09 and firm I has a higher EPS.
b. Rs.1.00 and firm II has a higher EPS.
c. Rs.0.01 and firm II has a higher EPS.
d. Rs.0.24 and firm I has a higher EPS.
e. Rs.0.06 and firm I has a higher EPS.
456. The share capital of a company is Rs.8,00,000 with shares of face value Rs.10. It has a debt
capital of Rs.5,00,000 at 12% interest rate. The sales of firm are 2,50,000 units per annum at
a selling price of Rs.5 per unit and the variable cost per unit is Rs.3. The fixed costs amount
to Rs.1,00,000 and the company pays tax @50%. If the sales increase by 20%, the degree of
operating leverage at the two levels is.
a. 1.20 in old level and 1.15 in new level
b. 1.25 in old level and 1.20 in new level
c. 1.30 in old level and 1.35 in new level
d. 1.25 in old level and 1.30 in new level
e. 1.00 in old level and 1.15 in new level.
208
457. What is the degree of financial leverage at the two levels for the firm mentioned in the above
question?
a. 1.076 in old level and 1.036 in new level.
b. 1.076 in old level and 1.136 in new level.
c. 1.176 in old level and 1.036 in new level.
d. 1.176 in old level and 1.116 in new level.
e. 1.176 in old level and 1.136 in new level.
458. Using the following information, the percentage change in earning per share of the two levels
of ABC Ltd. is .
Old level New level
Net profit (Rs.) 1,70,000 2,20,000
Number of shares 80,000 80,000
Sales 2, 00,000 2,50,000
units units
a. 29.4% increase
b. 29.4% decrease
c. 0.77% increase
d. 0.77% decrease
e. 27.7% increase.
459. Consider three different firms given below:
A B C
Operating leverage 1.14 1.23 1.33
Financial leverage 1.27 1.3 1.33
Which one of the combinations should be chosen for the combined leverage to be maximum
and what are your inferences?
a. The combined leverage is highest for the firm C and indicates that this firm is working
under high risky situation.
b. The combined leverage is highest for the firm B and indicates that this firm is working
under lesser risky situation.
c. The combined leverage is highest for the firm C and indicates that this firm is working
under lesser risky situation.
d. The combined leverage is maximum for A and indicates that this firm is working under
lower risky situation.
e. The combined leverage is highest for the firm C and indicates that this firm is working
under no risky situation.
460. The DOL for Mainstar Ltd., is for the following information:
Number of units produced 50,000
Selling price per unit Rs.50
Variable cost per unit Rs.20
Fixed cost per unit at current level of sales Rs.15

Part II
209
The new DOL is if the variable cost were Rs.30 per unit.
a. DOL =4, New DOL =2
b. DOL =3, New DOL =3
c. DOL =2, New DOL =4
d. DOL =1, New DOL =5
e. DOL =5, New DOL =1.
461. The degree of operating leverage is 1.2 and sales revenue is Rs.144 lakh of a company. The
annual interest burden is Rs.10 lakh and preference dividend payable is Rs.4.2 lakh. The total
variable costs to sales ratio is 60%. The fixed expenses of the company is .
a. Rs.9.6 lakh
b. Rs.0.96 lakh
c. Rs.96 lakh
d. Rs.0.09 lakh
e. Rs.1.96 lakh.
462. The High Gear Company and the Low Gear Company have provided you with the following
information:
HG Ltd. LG Ltd.
Sales (in units) 20,000 20,000
Price per unit 50 50
Variable cost per unit 20 25
Fixed financing cost 1,00,000 50,000
Fixed operating cost 4,00,000 3,00,000
Which firm do you consider to be more risky and why?
a. LG Ltd. is riskier as both DOL and DFL are higher.
b. HG Ltd. is riskier as both DOL and DFL are higher.
c. LG Ltd. is riskier as both DOL and DFL are lower.
d. HG Ltd. is riskier as both DOL and DFL are lower.
e. Both HG Ltd. and LG Ltd. are riskier.
463. The degree of operating leverage is 2.5 and degree of financial leverage is 1.6 of a firm then
the percentage change in EPS is if quantity increases by 5%.
a. 2%
b. 0.20%
c. 0.02%
d. 20%
e. 0.002%.

210
The following information is available regarding Nagarjuna Fertilizers Ltd.
PBDIT Rs.825.26 cr.
Depreciation Rs.5.96 cr.
Effective tax rate 30%
EPS Rs.3.647
Book value Rs.28.74 per share
Number of outstanding shares Rs.33.146 cr.
D/E ratio 1.4:1
464. The degree of financial leverage of the company is .
a. 47.4
b. 4.74
c. 7.44
d. 4.77
e. 74.4.
465. What is the financial break even point of Nagarjuna Fertilizers Ltd. and its significance?
a. Rs.646.61cr. and it is the level of EBIT, which recovers the total interest burden
b. Rs.64.66 cr. and it is the level of EBIT, which will not recover the interest burden
c. Rs.64.66 cr. and it is the level of PBDIT
d. Rs.646.6 cr. and it is the level of PBDIT
e. Rs.6,466 cr. and it is the level of PAT.
466. Alex Distilleries Ltd., have a financial leverage of 4 and operating leverage of 5. The interest
payment on borrowings during the year was Rs.300 lakh. The variable cost of production as a
percentage of sales is 75%. The tax rate applicable for the company is 45%. The variable
cost and fixed cost are .
a. Rs.6,000 lakh and Rs.1,600 lakh
b. Rs.600 lakh and Rs.160 lakh
c. Rs.60 lakh and Rs.16 lakh
d. Rs.6 lakh and Rs.1.6 lakh
e. Rs.0.6 lakh and Rs.0.16 lakh.
467. The following estimates are made of ELXI India Ltd. for the year 2000-01:
i. The degree of operating leverage is expected to be 1.30.
ii. Fixed costs are estimated to be Rs.2.50 lakh.
iii. Interest on Rs.30 lakh debt will be paid @15% p.a.
iv. The EPS of the company is expected to be Rs.2.
The degree of total leverage for the company is .
a. 5.62
b. 3.71
c. 2.54
d. 4.70
e. 2.83.
Part II
211
468. What would be the percentage decline in sales, which would wipe out profit before tax is, if
the degree of total leverage is 3 and the EPS of the company is expected to be Rs.2.
a. 33.33%
b. 41.33%
c. 55.35%
d. 12.09%
e. 47.87%.
469. The following figures relate to ABHI Ltd.,
(in Rs. lakh)
AB Ltd.
Sales 7,000
Variable cost 600
Contribution 2500
Fixed costs 1400
EBIT 800
- Interest 200
Profit before tax 300
The combined leverage of the company is _____.
a. 8.33
b. 7.52
c. 6.88
d. 5.43
e. 7.17.
470. The Zee Ltd. Provided following information:
Output (units) 1,20,000
Fixed costs 14,000
Variable cost per unit (Rs.) 0.40
Interest on borrowed funds (Rs.) 8,000
Selling price per unit (Rs.) 1.20
The Degree of Operating Leverage (DOL) of the firm is _____________.
a. 1.17
b. 1.31
c. 1.21
d. 1.11
e. 1.01.
471. The XYZ Ltd., provided following information:
Output (units) 30,000
Fixed costs 28,000
Interest on borrowed funds (Rs.) 16,000
The Degree of Financial Leverage (DFL) of the firm is __________.
a. 0.895
b. 1.055
c. 1.176
d. 1.145
e. 1.705.
212
472. The LMN Ltd., provided following information:
Fixed costs 3,500
Interest on borrowed funds (Rs.)
The Degree of Combined Leverage (DCL) of the firm is ____________.
a. 1.00
b. 1.72
c. 1.85
d. 1.33
e. 1.36.
473. A Zenith Corporation Ltd., has sales of Rs.5,00,000, variable cost of Rs.3,00,000 and fixed cost
Rs.1,50,000 and long term loan 1,50,000 at 10% rate of interest. The operating, financial and
combined leverages are ___________, _________ and ___________ respectively.
a. 3.00, 1.24. 3.72
b. 4.00, 1.24. 4.96
c. 4.00,1,42, 5.68
d. 4.00, 1.50, 6.00
e. 4.20, 1.42, 5.96.
474. Kumar Corporation has estimated that for a new product its break-even point is 3,000 units if
the item is sold for Rs.12 per unit; the cost accounting department has currently identified
variable cost of Rs.8 per unit. The degree of operating leverage for sales volume of 4,500
units and 5,000 units are ________ and _______.
a. 4, 4
b. 3, 2.5
c. 3, 5
d. 7, 1
e. 6, 2.
475. The following information is available in respect of two firms Tata Ltd. and Gemini Ltd.:
(Rs. in lakh)
Tata Ltd. Gemini Ltd.
Sales 1000 2000
Variable cost 300 800
Contribution 700 1200
Fixed cost 150 400
EBIT 550 800
Interest 50 100
Profit before tax 500 700
Comment on their relative risk position through operating leverage for both the firms.
a. Operating leverage is lower in case of Gemini Ltd. and hence it has higher degree of
operating or business risk.
b. Operating leverage is lower in case of Tata Ltd. and hence it has higher degree of
c. Operating leverage is same for both the companies and hence no business risk.
d. Operating leverage is higher in case of Tata Ltd. and hence it has higher degree of
e. Operating leverage is higher in case of Gemini Ltd. and hence it has higher degree of
Part II
213
476. The following information is available in respect of two firms Maruthi Ltd. and Ford Ltd.:
(Rs. in lakh)
Maruthi Ltd. Ford Ltd.
Sales 3500 7000
Variable cost 1200 2300
Contribution 2300 4700
Fixed cost 1150 2400
EBIT 1150 2300
Interest 150 300
Profit before tax 1000 2000
Comment on their relative risk position through financial leverage for both the firms.
a. Financial leverage is lower in case of Ford Ltd. and hence it has higher degree of
financial risk.
b. Financial leverage is lower in case of Maruthi Ltd. and hence it has higher degree of
financial risk.
c. Financial leverage is same for both the companies and hence both firms have same
financial risk.
d. Financial leverage is higher in case of Maruthi Ltd. and hence it has higher degree of
financial risk.
e. Financial leverage is higher in case of Ford Ltd. and hence it has higher degree of
financial risk.
477. The following information is available for Navkar and Co.
Rs.
EBIT 20,20,000
Profit before tax 13,20,000
Fixed costs 7,00,000
The percentage change in EPS is _______, if the sales are expected to increase by 5%.
a. 16.02%
b. 24.87%
c. 25.50%
d. 10.25%
e. 14.09%.
478. The combined leverage and operating leverage of a company are 3.5 and 2.25 respectively.
The financial leverage is ___________.
a. 1.56
b. 2.56
c. 3.00
d. 3.50
e. 4.00
479. The combined leverage and operating leverage of a company are 4.5 and 2.75 respectively.
The PV ratio is __________.
Equity dividend is Rs.2 per share
Interest payable is Rs.63,000
Sales is Rs.20,00,000
a. 10%
b. 15.87%
c. 21.6%
d. 22.41%
e. 30%.
214
A simplified income statement of Nile Ltd. is given below.
Income Statement of the Nile Ltd. for the year ending 31st March, 2003
Rs.
Sales 50,000
Variable cost 7,000
Fixed cost 5,000
EBIT 38,000
Interest 10,000
Taxes (30%) 9,400
Net income 8,600
480. The operating leverage is___________.
a. 1.13
b. 1.36
c. 0.87
d. 0.66
e. 0.51.
481. Use the data in the above problem and find the financial leverage of Nile Ltd?
a. 1.36.
b. 1.87.
c. 2.25.
d. 1.08.
e. 3.50.
482. The operating leverage from the following data is ___________.
Sales Rs.50,000
Variable cost 60%
Fixed costs Rs.12,000
a. 2.65
b. 2.21
c. 2.50
d. 1.45
e. 2.08.
483. The financial leverage from the following data is _______.
Rs.
Net worth 25,00,000
Debt/Equity 3:1
Interest rate 12%
a. 2.43
b. 2.16
c. 1.82
d. 1.56
e. 2.11.
484. Sheetal Ltd., has an average selling price of Rs.10 per unit. Its variable unit costs are Rs.4
and fixed costs amount to Rs.1,10,000. If finances all its assets by equity funds. It pays 40%
tax on its income. Arc Ltd., is identical to Sheetal Ltd., except in respect of the pattern of
financing. The latter finances its assets 40% by equity and 60% by debt, the interest on which
amounts to Rs.5,000. The combined leverage at Rs.2,00,000 sales for both the firms are
_______ and _______.
a. 9, 18
b. 12, 24
c. 10, 20
d. 8, 16
e. 4, 16.
Part II
215
Following data under situations I and II and financial plans P and Q are provided.
Installed Capacity 2,000 units
Actual production and sales 55% of the capacity
Selling price Rs.20 per unit
Variable cost Rs.10 per unit
Fixed cost: Under Situation I Rs.5,000; Under Situation II Rs.8,000.
Capital Structure:
Financial Plan P Q
Equity 5,000 7,000
Debt (Rate of interest at 20%) 6,000 3,000
Total 11,000 10,000
485. The operating leverages of situation I and situation II from the above information are ______
and _______.
a. 1.83 and 3.67
b. 1.2 and 1.3
c. 1.8 and 1.5
d. 1.8 and 1.3
e. 1.2 and 1.5.
486. The financial leverages of Plan P and Plan Q under situation II are:
a. 1.02 and 1.65
b. 1.21 and 1.43
c. 1.67 and 1.25
d. 1.04 and 1.09
e. l1.65 and 1.02.
487. You are a Finance Manager in ICICI Ltd., The degree of operating leverage of your
Company is 4.0 and the degree of financial leverage is 2.0. Your Managing Director has
found that the degree of operating leverage and the degree of financial leverage of your
nearest competitor HDFC Ltd., are 5.0 and 3.0 respectively. In his opinion, the HDFC Ltd., is
better than that of ICICI Ltd., because of higher value of degree of leverages. Do you agree
with the opinion of your Managing Director.
a. The Managing Directors opinion about HDFC Ltd., is wrong. Therefore, ICICI Ltd.,
carries more business risk and financial risk as compared to HDFC Ltd.
b. The Managing Directors opinion about HDFC Ltd., is correct. Therefore, ICICI Ltd.,
carries less business risk and financial risk as compared to HDFC Ltd.
c. The Managing Directors opinion about HDFC Ltd., is wrong. Therefore, ICICI Ltd.,
carries less business risk and financial risk as compared to HDFC Ltd.
d. The Managing Directors opinion about HDFC Ltd., is correct. Therefore, ICICI Ltd.,
carries no business risk and financial risk as compared to HDFC Ltd.
e. The Managing Directors opinion about HDFC Ltd., is wrong. Therefore, ICICI Ltd.,
carries no business risk and financial risk as compared to HDFC Ltd.
216
488. The following figures are available for Radhika & Co.,:
Net Sales: Rs.15 crores
EBIT as percentage of Net Sales: 12%
Capital employed:
Equity: Rs.5 crores
Preference shares of Rs.1 crore bearing 13% Rate of Dividends
Debt @ 15% : Rs.3 crores
The applicable Income Tax to be taken as 40%.
Operating Leverage of the company is______.
Given that its combined leverage is 3.
a. 2.07
b. 2.56
c. 1.54
d. 1.89
e. 2.89.
489. The net sales of B Ltd., is Rs.30 crores. An earnings before interest and tax of the company
as a percentage of net sales is 12%. The capital employed comprises Rs.10 crores of equity,
Rs.2 crores of 13% Cumulative Preference Share capital and 15% debentures of Rs.6 crores.
Income tax rate is 40%. The operating leverage of the company is_________, given that
combined leverage is 3.
a. 2.56
b. 2.03
c. 1.889
d. 1.12
e. 2.78.
490. The Balance sheet of Beta Numeric Company is given below:
Liabilities Rs. Assets Rs.
Equity capital (Rs.10 per share) 90,000 Net Fixed Assets 2,25,000
10% Long-term debt 1,20,000 Current assets 75,000
Retained earnings 30,000
Current liabilities 60,000
3,00,000 3,00,000
Companys total assets turnover ratio is 3, its fixed operating cost is Rs.1,50,000 and its
variable operating cost ratio is 50%. The Income tax rate is 50%. The combined leverage of
the company is __________.
a. 1.00
b. 2.00
c. 3.00
d. 2.56
e. 1.56.
Part II
217
491. _________is the degree of operating leverage for XYZ Company Ltd, given the following
information:
Quantity produced = 15,000
Variable cost per unit = Rs.350
Selling price per unit = Rs.500
Fixed cost = Rs.9,00,000.
a. 1.78
b. 1.67
c. 1.09
d. 1.88
e. 2.06.
The Supreme & Co. Ltd., given the following information:
Equity earnings 2,30,000
Quantity produced (Q) 7500 units
Variable cost per unit (V) Rs.300
Selling price per unit (S) Rs.600
Number of equity share holders (N) 7,00,000
Fixed expenses (F) Rs.10,00,000
Interest (I) Rs.95,000
Preference dividend (D
p
) Rs.35,000
Corporate tax (T) 40%
492. The Degree of total or combined leverage is_____
a. 1.45
b. 2.05
c. 1.09
d. 2.83
e. 1.22.
493. If degree of combined leverage for quantity of 5000 units is 9 and there is a 5% increase in
quantity. The affect on EPS is________.
a. 60%
b. 25%
c. 75%
d. 45%
e. 40%.
494. The following is the income statement of Dell Ltd. for the year 2000:
(Rs. in lakh)
Sales 30
Variable cost 10
Fixed cost 10
EBIT 10
Interest 5
Profit before tax 5
Tax at 40% 2
Profit after tax 3
Preference dividend 1
Profit for equity share holder 2
The company has one lakh equity shares issued to the shareholders. The DCL is________
and if the sales level increases by 10% then the EPS is _________.
a. DCL is 1.0 and the new EPS would be 1.40
b. DCL is 2.2 and the new EPS would be 2.82
c. DCL is 4.06 and the new EPS would be 3.60
d. DCL is 6.0 and the new EPS would be 3.20
e. DCL is 2.60 and the new EPS would be 4.85.
218
495. If the degree of operating leverage of a company is increased by 30 percent while the degree
of financial leverage is decreased by 20 percent. What will be the change in the degree of
total leverage?
a. 2 percent increase.
b. 3 percent increase.
c. 4 percent increase.
d. 2 percent decrease.
e. 4 percent decrease.
496. The following information have been collected from the Annual Report of Garden
Restaurant, selling biriyanis in parcel packets:
Total sales = Rs.1400,000
Contribution ratio = 25 percent
Fixed expenses = Rs.150,000
Outstanding bank loan = Rs.400,000 @ 12.50 percent
Preference Share Capital = Rs.200,000 @ 15.00 percent
Applicable Tax rate = 40 percent
The Degree of Financial Leverage (DFL) for Garden Restaurant?
a. 1.33
b. 1.50
c. 1.67
d. 2.00
e. 2.33.
497. The degree of operating leverage (DOL) for the specific level of operations of a firm is 2.25.
If the sales turnover increases by 6 percent, what is the percentage change in EBIT?
a. 4.50 % increase
b. 9.00 % decrease
c. 13.50 % increase
d. 18.00 % decrease
498. For ABC Corporation, the degree of operating leverage (DOL) is 3 and the degree of
financial leverage is 1.67. If the management targets to increase the EPS by 10 percent, by
how much percentage should the sales volume be increased? (Round off your answer to the
nearest value)
a. 1.67%
b. 2.00%
c. 3.00%
d. 5.00%
e. 10.00%.
499. Hyderabad Chemicals has never issued any preference share since its incorporation. Its
contribution margin is 20 percent against a selling price of Rs.500 per unit. The fixed
expenses for its operations is Rs.90,000 and the interest on term loan is Rs.75,000. What is its
overall break-even point?
a. 500 units.
b. 750 units.
c. 1,250 units.
d. 1,400 units.
e. 1,650 units.
Part II
219
500. For Phonetic Ltd., the selling price of the sandals is Rs.40 and contribution to sales ratio is 25
percent. Its income statement reveals its fixed costs as Rs.80 lakh, interest payment as Rs.30
lakh and preference dividend payment as Rs.12 lakh. If the applicable tax rate is 40 percent,
what is the output level at its overall break even point?
a. 9 lakh units.
b. 10 lakh units.
c. 11 lakh units.
d. 12 lakh units.
e. 13 lakh units.
501. If DFL of a firm is 1.61, EBIT is Rs.25,000 and the interest component is Rs.7,000, the
dividend on preference shares that the firm paid assuming a tax rate of 30% is
a. Rs.1,663
b. Rs.2,013
c. Rs.2,595
d. Rs.6,631
e. Rs.9,945.
502. The DTL of a firm whose total contribution is Rs.60,000 and fixed cost is Rs.30,000 and
pays an interest of Rs.10,000 assuming it does not pay any preferred dividend, is
a. 1
b. 1.5
c. 3
d. 3.25
e. 4.
503. A firm has a Degree of Total Leverage (DTL) of 3. If the sales increases by 10%, then the
EPS will increase by
a. 3.33%
b. 10%
c. 15%
d. 30%
e. Insufficient information.
504. If the percentage change in EBIT is 30% and percentage change in sales is 18%, then
a. DOL is 1.67
b. DFL is 1.67
c. DOL is 5.40
d. DFL is 0.60
e. DTL is 1.11.
505. What is the Degree of Operating Leverage (DOL) of Telco Ltd., given the following
information?
Quantity produced 5000 units
Variable cost per unit Rs.1,80,000
Selling Price per unit Rs.3,25,000
Fixed cost Rs.3cr.
a. 1.04
b. 2.50
c. 3.00
d. 1.85
e. 1.96.
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506. If the DOL is 2.5 and DFL is 3.5, then DTL is
a. 1.40
b. 8.75
c. 9.25
d. 8.25
e. 8.65.
507. If Degree of Operating Leverage (DOL) and Degree of Financial Leverage (DFL) for a firm
are 3.5 and 1.20 respectively it means that a one percent change in output will lead to ______
percent change in EPS.
a. 4.20
b. 3.50
c. 2.92
d. 1.20
e. 0.34.
508. X Ltd., achieves a sales of Rs.20 lakhs for the year ended 2003-04. The variable cost ratio is
70% and fixed cost is Rs.5 lakhs. The companys capital structure consists of 25,000 equity
shares, 2000 15% preference shares of face value Rs.100. If the corporate tax rate is 40%, the
financial break-even point for X Ltd., is
a. Rs.1.75 lakh
b. Rs.1.50 lakh
c. Rs.1.25 lakh
d. Rs.1.00 lakh
e. Rs.0.50 lakh.
509. If the current EPS is Rs.2.50, the DTL is 3.5 and the sales are expected to increase by 25%,
then the forecasted EPS for the next year is
a. Rs.2.50
b. Rs.3.13
c. Rs.3.86
d. Rs.4.69
e. Rs.7.00.
510. The total contribution earned by a company is Rs.100 lakhs and the EBIT is Rs.50 lakhs. The
Degree of Operating Leverage (DOL) of the company is
a. 0.50
b. 1.50
c. 2.00
d. 2.25
e. 3.30
511. Consider the following information relating to K R Marketing Ltd.:
Quantity produced : 5000 units
Total variable cost : Rs.10 lakh
Total sales revenue : Rs.25 lakh
What is the contribution per unit?
a. Rs.200.
b. Rs.300.
c. Rs.500.
d. Rs.700.
Part II
221
512. The financial analyst of MKJ Products Ltd., estimates that the EPS of the company increases
by 20% if the output is increased by 10%. The degree of total leverage of the company is
a. 1.0
b. 1.5
c. 2.0
d. 3.0
513. The contribution from a project is Rs.100 lakhs and EBIT is Rs.50 lakhs. What is Degree of
Operating Leverage?
a. 2.
b. 3.
c. 1.5.
d. 2.25.
514. If the contribution per unit is Rs.7 and fixed expenses are Rs.50,000, DOL at 50,000 units of
output is
a. 7.26
b. 2.26
c. 1.17
d. 1.26
e. 1.12.
515. The contribution from a project is Rs.100 lakhs and EBIT is Rs.50 lakhs. Degree of
Operating Leverage (DOL) is
a. 1.50
b. 2.00
c. 2.25
d. 3.00
516. Given the fixed cost =Rs.20,000, the operating BEP in units =2,500 and financial
BEP =Rs.4,000, the overall BEP in units is
a. 3,000
b. 4,000
c. 5,000
d. 6,000
e. 8,000.
517. Using the following information, find out the external funds requirement for the firm to
maintain expected growth rate in sales is.
Sales Rs.28,00,000
Assets Rs.18,75,000
Liabilities Rs.2,50,000
Expected increase in sales 25% of sales
Net profit margin 12.5%
Dividend pay-out ratio 50%
Next year sales Rs.35,00,000
a. Rs.3,50,000
b. Rs.8,00,000
c. Rs.1,87,500
d. Rs.4,06,250
e. Rs.2,18,750.
222
518. The balance sheet of Performance Ltd. is given below:
Share capital 1,000 Fixed assets 2,500
Retained earnings 2,000 Inventories 1,000
Term loans 1,000 Receivables 750
Accounts payable 500 Cash 500
Provisions 250
4,750 4,750
The sales for the year were Rs.6,000. The companys net profit margin was 7% and the company
pays-out 50% of its profits as dividends. If the next years sales are expected to be Rs.7,500. The
external funds requirement is .
a. Rs.800
b. Rs.775
c. Rs.745
d. Rs.738
e. Rs.770.
519. M.S.Shaw & Co., adopts a liberal pay-out ratio of 60%. Its sales during year 1 are Rs.60 lakh
and are expected to grow by 40% in year 2. During year 1, its asset turnover ratio is 3
and spontaneous liabilities are Rs.9 lakh. If the company expects to have excess funds
of Rs.1.50 lakh by the end of year 2, the net profit margin of the company during the
year 2 is .
a. 17%
b. 17.53%
c. 0.17%
d. 17%
e. 17.93%.
520. Sayodhya Ltd., has provided the following information of the company:
Sales for the year is Rs.45 lakh.
Growth rate in sales for the next year is 25%.
Dividend pay-out ratio is twice the growth rate in sales.
Profit margin is 40% of growth rate in sales.
Spontaneous liabilities are Rs.2.25 lakh Total assets are Rs.18 lakh.
The External Funds Required (EFR) for the company is .
a. Rs.1 lakh
b. Rs.1.125 lakh
c. Rs.0.11 lakh
d. Rs.0.012 lakh
e. Rs.2.5 lakh.
521. The balance sheet of a high growth company for the current year is as follows:
Equity capital 50.0 Fixed Assets 115.0
Reserves & Surplus 40.0 Inventories 50.0
Long-term loans 160.0 Debtors 150.0
Short-term bank borrowings 60.0 Cash 25.0
Provisions and other current liabilities 30.0
340.0 340.0
Part II
223
The sales and profit after tax for the current year are Rs.320 lakh and Rs.48 lakh
respectively. The company expects its sales to grow by 25% during the next year. 40% of
the incremental sales is expected to be financed by external funds. The maximum
dividends that can be declared assuming that the current net profit margin is maintained is
.
a. Rs.14.50 lakh
b. Rs.15.00 lakh
c. Rs.15.50 lakh
d. Rs.14.00 lakh
e. Rs.0.145 lakh.
Answer the following questions from the following balance sheet of Parameshwar Printing Works
Ltd., for the last year:
Rs. lakh
Liabilities Assets
Share Capital 165Net Fixed Assets 300
Reserves and Surplus 90Current Assets:
Secured Loans 120 Inventories 140
Current Liabilities and Provisions: Sundry Debtors 120
Sundry Creditors 75 Cash and Bank Balances 10
Bank Finance for WC 90
Provisions 30
570 570
522. The turnover of the company for the last year was Rs.60 crore. The company earns a net
profit of 5% and pays-out 80% of profits as dividends. The maximum growth rate in sales
that can be achieved by the company without raising external equity is .
a. 30.05%
b. 0.035%
c. 30.77%
d. 28.75%
e. 31.75%.
523. The amount of external funds to be raised by the company to achieve sales of Rs.75 crore in
the current year is .
a. 40
b. 37.2
c. 21.11
d. 26.25
e. 41.25.
Mylavaram Manufacturers Ltd., Company had sales during last year of Rs.10 crore. For the
current year projections of the company
Growth in sales by 25%.
Profit margin of 8%.
Dividend pay-out ratio of 50%.
Equity share capital of Rs.200 lakh.
Total assets and current liabilities worth Rs.650 lakh and Rs.150 lakh respectively.
224
524. The external funds required for the current year is .
a. Rs.75 lakh
b. Rs.1 crore
c. Rs.75 crore
d. Rs.0.75 lakh
e. Rs.1.75 lakh.
525. In the above question, what would be the sustainable growth rate without raising any external
finance, if the profit margin is 5%?
a. 8.67.
b. 14.29.
c. 11.09.
d. 34.39.
e. 21.63.
526. The following is the balance sheet of Laxmi Textiles Ltd.:
Rs. lakh
Liabilities: Assets:
Equity Capital 700 Fixed Assets 1,800
Retained Earnings 500 Inventories 800
Term Loan 1,000 Accounts Receivable 800
Short-term Bank Borrowing 400 Cash and Bank 400
Accounts Payable 600
Provisions 600
3,800 3,800
Net sales for the current year are Rs.25 crore and projected sales for the next year are Rs.28
crore. The net profit margin is 8% and the dividend pay-out ratio is 30%. The applicable tax
rate for the company is 40%. The company is planning to raise the additional external fund
requirement for the next year equally from term loan and short-term bank borrowings are .
a. Rs.77.6 lakh and Rs.77.6 lakh
b. Rs.77.6 lakh and 155.2 lakh
c. Rs.155.2 lakh and Rs.77.6 lakh
d. Rs.155.2 lakh and 155.2 lakh
e. Rs.0.155 lakh and 0.388 lakh.
527. The following is the balance sheet of Biswal & Co. Pvt. Ltd. for the year:
Liabilities: Rs. Thousand Assets: Rs. Thousand
Share Capital 750Fixed Assets 2,200
Reserve and Surplus 850Inventories 900
Long-term Loan 1,000Sundry Debtors 1,250
Short-term Borrowing 700Cash and Bank 200
Sundry Creditors 950
Provisions 300
4,550 4,550
Sales for the last year were Rs.64,00,000. The sales for the current year are expected to
go up by 25%. The net profit margin of 5% and dividend pay-out ratio of 60% for the
last year are expected to remain the same in this year. The external funds requirement for
the current year is .
a. 6.65 thousands
b. 6.65 lakh
c. 0.665 lakh
d. 665 lakh
e. 66.5 lakh.
Part II
225
528. From the following information, the sustainable growth rate of the BOC India Ltd., is .
(Amount in Rs.)
Profit & loss A/c 61,409
Income 2,401,484
Dividend Pay-out Nil
Total Assets 5,024,716
Net Worth 2,628,869
Current Sales 2,401,484
Sales 2,365,596
Depreciation 127,552
a. 3.09%
b. 2.39%
c. 2.24%
d. 1.19%
e. 3.22%.
529. The balance sheet of Excel Ltd., is given below:
(Amount in Rs.)
Share capital 2,000 Fixed assets 4,000
Retained earnings 3,000 Inventories 2,000
Term loans 2,000 Receivables 1,500
Accounts payable 1,000 Cash 1,000
Provisions 500
8,500 8,500
The sales for the year were Rs.12,000. The companys net profit margin was 14% and the
companys pays out 50% of its profits as dividends. If the next years sales are expected to be
Rs.15,000, the external funds requirement is ________.
a. Rs.525
b. Rs.550
c. Rs.575
d. Rs.675
e. Rs.625.
530. The Balance sheet of Dell Ltd., for the current year is as follows:
Rs. in lakh
Equity capital 75.00 Fixed Assets 250.00
Reserves and surplus 60.00 Inventories 50.00
Long term loans 200.00 Debtors 125.00
Short-term bank borrowings 80.00 Cash 50.00
Provisions and other current
liabilities
60.00
475.00 475.00
The sales and profit after tax for the current year are Rs.510 lakh and Rs.72 lakh respectively.
Dell expects its sales to grow by 30% during the next year. 50% of the incremental sales is
expected to be financed by external funds. The maximum dividends that can be declared is
______ assuming that the current net profit margin is maintained.
a. Rs.48.9 lakh
b. Rs.45.67 lakh
c. Rs.50.91 lakh
d. Rs.49.10 lakh
e. Rs.52.73 lakh.
226
531. Raj and Co., adopts a liberal payout ratio of 70%. Its sales during year 1 are Rs.75 lakh and is
expected to grow by 45% in year 2. During year 1 its asset turnover ratio is 4 and
spontaneous liabilities are Rs.12 lakh. If the company expects to have excess funds of
Rs.2.50 lakh by the end of year 2, the net profit margin of the company during year 2 is
______.
a. 15.10%
b. 18.75%
c. 16.54%
d. 13.29%
e. 16.95%.
532. Balance sheet of Raman Printing Works Ltd. for the last year:
(Rs. in lakhs)
Share capital 200 Net fixed assets 400
Reserves and surplus 100 Current assets
Secured loans 150 Inventories 150
Current liabilities and
provisions
Sundry debtors 110
Sundry creditors 90 Cash and bank
balances
40
Bank finance for
working capital
110
Provisions 50
700 700
The turnover of the company for the last year was Rs.85 crore. The company earns a net
profit of 7% and pay out 90% of profits as dividends. The maximum growth rate in sales that
can be achieved by the company without raising external equity is ________.
a. 13.68%
b. 24.24%
c. 18.71%
d. 30.79%
e. 28.11%.
533. For the data in above problem, the amount of external funds to be raised by the company is
_______ to achieve sales of Rs.100 crore in the current year.
a. 21.76
b. 0.67
c. 28.82
d. 20.55
e. 18.79.
534. Firm XYZ. has total assets worth Rs..800 million and spontaneous liabilities of Rs..250
million. Its sales, at present, are Rs..1,000 million. The net profit margin is 10% and the
dividend pay-out ratio is 40%. The sales are growing and, in the forthcoming period the
consequent growth in its assets will be financed entirely by an increase in its spontaneous
liabilities and an increase in its retained earnings without resorting to any external financing
in any form.
The growth rate that can be financed by the company without resorting to external finance is ____.
a. 13.45%
b. 12.25%
c. 11.34%
d. 10.89%
e. 9.56%
Part II
227
535. The following information is taken from the book of accounts of ABC Inc.
Equity capital at the beginning Rs. 100,000
Debt at the beginning Rs. 40,000
Sales in the previous year Rs. 500,000
Target earning retention rate 0.50
Target net profit margin 0.03
Target debt equity ratio 0.90
Target assets to sales 0.80
The sustainable growth rate is___________
a. 1.5%
b. 2.8%
c. 3.7%
d. 0.10%
e. 0.40%.
536. The assets to sales ratio of H Co., Inc. is 0.8 and the ratio of spontaneous liabilities to sales is
0.6 for the present year. Existing sales revenue is Rs.1,000. The company follows a retention
ratio of 0.4. If the company plans a 10% increase in sales without taking recourse to external
funds, what will be the profit margin?
a. 2.96.
b. 3.48.
c. 4.54.
d. 5.82.
e. 6.75.
537.The following information is available about Nirvan Inc.
Sales for the current year 20,000
Expected sales increase next year 15 %
Profit after tax this year 500
Dividend pay-out ratio 0.5
External funds requirement for the next year 500
Present level of spontaneous current liabilities 5000
What is the level of total assets of Nirvan now?
a. 14,000.
b. 12,250.
c. 11,250.
d. 10,450.
e. 10,250.

228
538. The balance sheet of Exotica Inc. as on December 31, 2002 is given below:
(Rs. in million)
Assets Liabilities Rs.
Fixed Assets 250 Share Capital 100
Inventories 150 Retained Earnings 70
Receivables 120 Long-term loans 180
Cash 30 Short-term Borrowings 100
Payables 60
Provisions 40
Total 550 Total 550
Sales for the year 1993 were Rs.600 million. For the year 2000 sales are expected to increase
by 20%. The profit margin and dividend payout ratio are expected to be 5% and 60%
respectively.
The external fund requirement for the year 2000 is __________.
a. 7.56 million
b. 16.54 million
c. 32.52 million
d. 75.6 million
e. 142.72 million.
539. Calculate the maximum sales growth that can be attained without additional external
financing when the following parameters are given for Alpha Enterprises:
Assets to sales ratio 0.75
Spontaneous liabilities to sales ratio 0.6
Profit margin 6%
Previous sales Rs.1,600
a. 12.9%
b. 15.6%
c. 18.2%
d. 20.2%
e. 21.9%.
540. The following information is taken from the book of accounts of Man Power Ltd.
Equity capital at the beginning Rs. 2,00,000
Debt at the beginning Rs. 20,000
Sales in the previous year Rs. 700,000
Earning retention rate 0.50
Net profit margin 0.07
Debt equity ratio 0.70
Assets to sales 0.65
The sustainable growth rate is__________
a. 10.08%
b. 12.67%
c. 8.71%
d. 0.109%
e. 1.090%.
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229
541. The following information is available from the book of accounts of Gayathri Electrical Ltd.
Sales for the current year 100,000
Expected sales increase next year 25 %
Profit after tax this year 1500
External funds requirement for the next year 800
Present level of spontaneous current liabilities 7500
The level of total assets of the company now is __________.
a. 14,000
b. 14,450
c. 21,250
d. 17,050
e. 18,200.
542. __________is the maximum sales growth that can be attained without additional external
financing when the following information is provided by the Seven Hills Ltd., are:
Profit margin 2%
Previous sales Rs. 900
a. 9.00%
b. 10.1%
c. 5.2%
d. 7.2%
e. 6.9%.
543. Tuff Cement finances its assets by taking debt as high as 66.67 percent of the value of the
assets. If the company plans to acquire a machine at a cost price of Rs.69 lakh, then the
minimum amount of retained earnings that can be used for this procurement is
a. Rs.69 lakh
b. Rs.46 lakh
c. Rs.23 lakh
d. Rs.13 lakh
544. Superlative Industries Ltd., has made the following projections:
Expected increase in Spontaneous Liabilities Rs.500 lakh
Expected increase in Assets Rs.1200 lakh
Expected net profit by the end of the year Rs.500 lakh
Expected pay-out ratio 40 percent
The amount of external funds required by the firm is
a. Rs.200 lakh
b. Rs.400 lakh
c. Rs.500 lakh
d. Rs.1200 lakh
545. The net profit margin for CompuSys is 10 percent at a sales level of Rs.120 lakh. It paid Rs.7.20
lakh as dividend. Both its total assets turnover ratio and debt-equity ratio are 1.5. The sustainable
growth rate by using internal equity will be (round off your answer to the nearest integer)
a. 4 percent
b. 18 percent
c. 29 percent
d. 33 percent
e. 61 percent.
230
546. For the year 2003-04, Bagaria Industrial Corporation Ltd., targeted to increase its sales
turnover to Rs.1560 lakh which is 30 percent more than the year 2002 03. The fixed assets
as well as the spontaneous liabilities of the company are expected to increase proportionately
with the increase in sales. The fixed assets are 66.67 percent of the total assets and 40 percent
of the current assets are financed by spontaneous liabilities. The annual report for the year
2002-03 indicates that the company maintained a total assets turnover ratio of 1.6 and
recorded a net profit margin of 8 percent while retained 40 percent of its total earnings. How
much amount of external funds should be required by the company in order to achieve the
targeted growth rate? (Round off your answer to the nearest integer.)
a. Rs.145 lakh
b. Rs.165 lakh
c. Rs.180 lakh
d. Rs.200 lakh
e. Rs.225 lakh.
547. For Mumbai Automobiles Ltd. (MAL), the total assets turnover ratio is 2 and the spontaneous
liabilities amount to 20 percent of total sales. MAL wants to maintain 100 percent dividend
pay-out ratio on its net profit. If it targets to increase the sales volumes by Rs.70 lakh, what
will be the amount of external funds requirements?
a. Rs.14 lakh.
b. Rs.21 lakh.
c. Rs.35 lakh.
d. Rs.49 lakh.
e. Rs.56 lakh.
548. For Chennai Automobiles Ltd. (CAL), the total assets turnover ratio is 2 and the debt-equity
ratio is 0.5. CAL uses to maintain 100 percent retention ratio. If its net profit margin is 8
percent, what is its sustainable growth rate without using any external funds?
a. 22.58%.
b. 25.58%.
c. 28.58%.
d. 31.58%.
e. 34.58%.
549. For Khazana Infocomm Ltd., (KIL), the net fixed assets at the end of the years 1 and 2 are
Rs. 4729 crore and Rs.4006 respectively. If the depreciation of KIL during the year 2 was
Rs.884 crore, what is its gross change in fixed assets?
a. Rs.161 crore.
b. Rs.161 crore.
c. No Change.
d. Rs. 1285 crore.
e. Rs.1285 crore.
550. The sales turnover of M/s Garodia Rubber is Rs.500 lakh. They are planning to increase it by
20 percent by the next year. Total assets of the company are Rs.320 lakh out of which
Rs. 120 lakh is financed by the spontaneous liabilities. Its net profit for the last year was
Rs.37.50 lakh while dividend paid was Rs.3. per share. If the number of outstanding shares is
500,000, what will be the amount of external funds requirements? (Assume net profit margin
and dividend pay-out ratio will be same)
a. Rs.5.00 lakh
b. Rs.7.00 lakh
c. Rs.9.00 lakh
d. Rs.11.00 lakh
e. Rs.13.00 lakh.
Part II
231
551. The following information is available for Super Growth Ltd.
Asset/Sales = 0.8
Spontaneous liabilities/sales = 0.3
Net profit margin = 8%
Dividend pay-out ratio = 20%
Last years sales = Rs.1500 lakh
The maximum sales growth that can be financed without raising external funds is
a. 12.2%
b. 13.5%
c. 14.7%
d. 15.3%
552. Carewell Products Ltd., provides the following information for the next year:
Expected increase in assets =Rs.8 lakh
Expected increase in spontaneous liabilities =Rs.3 lakh
Expected retained earnings =Rs.3 lakh
The external funds required for the firm is
a. Rs.2 lakh
b. Rs.3 lakh
c. Rs.5 lakh
d. Rs.8 lakh
e. Insufficient data.
553. If the expected increase in retained earnings is Rs.4.2 lakhs, D/E ratio is 1.5 and current level
of assets is Rs.5 crore, then the sustainable growth rate is
a. 2.1%
b. 5.4%
c. 7.5%
d. 9.0%
554. Ikon International Ltd., expects its sales to increase by Rs.1,00,000 to Rs.11,00,000. If the net
profit margin is to be maintained at 6% and dividend pay-out ratio at 60% and A/S and L/S
are 0.8 and 0.4 respectively, the external fund requirement is
a. Rs.13,600
b. Rs.15,600
c. Rs.20,800
d. Zero
555. If net profit margin is 5%, the dividend pay-out ratio is 30%, asset to equity ratio is 1.5 and
asset to sales is 1.3, the rate of sustainable growth with internal equity will be
a. 4.21%
b. 4.28%
c. 5.26%
d. 5.30%
e. 6.31%.

Part II: Solutions
1. (c) Yield on a treasury bills is given as
k =
(F P) 365
x
P d

Where
K = yield
F = face value
P = price
D = maturity period in days.
K =
100 96.52 365
x
96.52 182

Hence we get yield = 7.23%.
2. (c) Yield on a treasury bill is given as k =
(F P) 365
x
P d

Where
K = yield
F = face value
P = price
0.1150 =
100 P 365
x
P 364

Hence P = Rs.89.71
3. (e) Yield is given by k =
(F P) 365
x
P d
=
(100 88.24) 365
x
88.24 364

=
11.76 365
x
88.24 364
= 0.13327 x 1.0027 = 13.3636 or 13.364%.
4. (e) Yield, k =
(F P) 365
x
P d
=
100 98.12
98.12
x
365
61
11.46%.
Time Value of Money
5. (c) PV
O
= R(PVIFA
kn
)
1,00,000 = 16,274(PVIFA
k10
)
Approximate k = 10%.
6. (c) PV of cash inflows in case of scheme A
= (Rs.2.5 lakh 2.5 lakh x 10%) = Rs.2.25 lakh
PV of cash flows in case of Scheme B
= 18,000 + PVIFA
(K,60)
x 4,100
= [Where, K= (1.09)
1/12
1 = 0.0072 i.e., 0.72%]
= Rs.18,000 + (48.581 x Rs.4,100)
= Rs.18,000 + Rs.19,9182.10 = Rs.2,17,182.10
Hence (c) is the answer.
Part II
233
7. (b) Option 1:
At the end of 4th year, he would get
= Rs.7,000 + Rs.5,000 x
5, 000 4, 000
4, 000

= (Rs.7,000 + 1,250) = Rs.8,250
Option 2:
At the end of 4th year he would get = Rs.5,000 x FVIF
(15%,4)

= Rs.5,000
4
15
1
100

+

= Rs.5,000 x 1.749 = Rs.8,745.
8. (c) (a) Present Value = Rs.1,00,000
(b) Present Value = Rs.2,00,000 x PVIF
(14,6)
= Rs.2,00,000 (1.14)
6
= Rs.91,117
(c) Present Value = Rs.
15, 000
0.14
= Rs.1,07,143
(d) Present Value = Rs.(PVIFA
(K,12)
x 1,000) + (PVIF
(14%,1)
x 95,000)
[Where, K = (1.14)
1/12
1]
= Rs.[(11.186 x 1,000) + 83,333] = Rs. 94,51945edfc
(e) Present Value = Rs.(PVIFA
(14%,10)
x 18,000) = 5.216 x 18,000 = Rs.93,888
Therefore, choice (c) gives the highest return.
9. (d) Let X be the amount to be deposited today
Then,
X = Rs.
2
2 3
5, 000 5, 000(1.04) 5, 000(1.04)
.....
(1.14) (1.14) (1.14)
+ + +

=> Rs.
2
2 3
1 1.04 (1.04)
5, 000 .........
(1.14) (1.14) (1.14)

+ + +

The terms in the brackets represent a geometric progression of infinite terms with
initial term a =
1
1.14
and decreasing by r =
1.04
1.14

Hence, it is in the form of a, ar, ar
2
..
terms and the sum of this series is given by
a
1 r
.
Where, r < 1
Hence, Sum =
1
1.14
10
1.04
1
1.14
=

Therefore, X = Rs.5,000 x 10 = Rs.50,000.
Hence, Rs.50,000 is to be deposited today to receive a sum of Rs.5,000 next year which
grows at the rate of 4% per year forever.
10. (a) 23,905 = 1500(FVIFA
i,10
)
i = 10%
234
11. (b) The implied interest rate in the two schemes can be calculated as follows:
Scheme A:
[10,000 x FVIFA
(i,4)
] FVIF
(i,6)
= 1,00,000
If 13%, LHS = 100970.43
At 12%, LHS = 94335.46
i =
100, 000 94335.46
12 x1 12.85%
100, 970.43 94335.46
+ =

Scheme B:
[5,000 x FVIFA
(i,8)
] FVIF
(i,2)
= 1,00,000
At i= 17%. LHS = 1,01,115.54
At i = 16% LHS = 95807.35
i =
1,00,000 95807.35
1 = 16.79%
10,1115.54 95807.35

Hence, answer is (b).
12. (b) Let the amount which she can withdraw annually be X. Then,
5,00,000 = X x PVIFA
(15%, 15)
X =
(15%,15)
5,00,000
85, 514.
PVIFA
=
13. (a) Let X be the annual investment. Then,
X x FVIFA
(15%,10)
= [60,000 x PVIFA
(15%,5)
] +
(15%,5)
90, 000
x PVIF
0.15

20.304X = 4,99,320 = Rs.24,592.
14. (b)
a. X x 1.12 x FVIFA
(12,5)
= 10

10
X = = 1.41
1.12 x 6.353

b. Amount to be borrowed = 10 x PVIF
(24,5)
= 10 x 0.341 = Rs.3.41 lakh
Installment to be paid is X.
X x 1.18 x PVIFA
(18,5)
= Rs.3.41
X =
3.41
= 0.92
1.18 x 3.127

Hence (b) is the answer.
15. (c) Let the insured amount be Rs.1,000. Terminal value of cash outflows
= 62 x FVIFA
(K,20)

Terminal value of cash inflows
= 250 x FVIF
(K,15)
+ 250 x FVIF
(K,10)
+ 250 x FVIF
(K,5)
+ 250 + 400
Equating above two equations, we get
62 x FVIF
(K,20)
= 250 x FVIF
(K,15)
+ 250 x FVIF
(K,10)
+ 250 x FVIF
(K,5)
+ 650
250 [FVIF
(K,15)
+ FVIF
(K,10)
+ FVIF
(K,5)
]

+ 650 62 x FVIFA
(K,20)
= 0
Part II
235
For K = 10%,
LHS = 250 [4.177 + 2.594 + 1.611] + 650 62 (57.275)
= 2,095.5 + 650 3551.05 = 805.55
For K = 2%,
LHS = 250[1.104 +1.219 + 1.346] + 650 62 x 24.297 = 60.836
Therefore, K = 2% + (10 2) % x
60.836
60.836+805.55
= 2 + 8 x
60.834
= 2.56%
656.46

Therefore, the return from the policy is only 2.56%, whereas bank interest rate is 11%. So, it
is not advisable for Mr. Singh to go for the money back policy.
16. (d) If cash flows are expected for grow @ 4% p.a. forever, the present value of the cash flows
=
Cash flow at the end of one year
k g

Where,
K = Mr. Farooqs required rate of return = 12% p.a.
g = Annual growth rate in cash flows = 4% p.a.
Therefore, the amount to be paid by Mr. Farooq =
4,00,000 4,00,000
= = Rs.50,00,000.
0.12 0.04 0.08

17. (b) If the complex is sold at the end of four years at Rs.40 lakh, then the present value of the
future cash flows will be:
Year Cash flow Rs. PVIF @ 12% PV (Rs. )
1 4,00,000 0.893 3,57,200
2 4,16,000 0.797 3,31,552
3 4,32,640 0.712 3,08,040
4 4,49,946 0.636 2,86,166
4 40,00,000 0.636 25,44,000
38,26,958
Hence, Mr. Farooq would be willing to pay Rs.38,26,958.
18. (c) The company has to accumulate a sum S by the end of 7 years from now so that the
present value of the payment made at the end of 8th, 9th and 10th year is equal to S. Let X
be the amount saved per year
(Rs. in lakh)
30 30 40
0
Year 1 2 3 4 5 6 7 8 9 10
X. FVIFA
(8%, 7)
= S
and S =
2 3
30 30 40
+ + = 85.251
1.08 (1.08) (1.08)

X (8.923) = 85.251
or, X =
85.251
8.923
= 9.5541 lakh (approximately) per year, i.e., Rs.9,55,410(approx) per year.
19. (c) The present value of perpetual stream of cash flows may be found by dividing the annual
cash flow by the discount rate i.e., annual cash flow r
So, the present value of stream of Rs.950 per annum @8% is = Rs.950/0.08 = Rs.11,875
The present value of stream of Rs.950 per annum @10% is = Rs.950/0.10 = Rs.9,500
20. (c) Present Value of Rs.4,500 receivable in 7 years @15% is
PV = Rs.4,500 x PVIF
(15%, 7y)
= Rs.4,500 x 0.376 = Rs.1692.
236
21. (b) Present Value of annuity of Rs.8,000 starting in 7 years time for 7 years @10%
Present Value = 8,000 x PVIFA
(10%,7)
x PVIF
(10%, 6)

= 8,000 x 4.868 x 0.564 = Rs.21,964.
22. (c) Present Value of annuity of Rs.550 starting after 1 year for 6 year @12%
PV = 550 x PVIFA
(12%, 6)
= 550x 4.111 = Rs.2261.
23. (d) In this case Rs.1,300 would occur at present and annuity of Rs.1,300 would occur in the
beginning of each of next 8 years. So,
PV = Rs.1,300 + Rs.1,300 x PVIFA
(20%, 8)
= Rs.1,300 + Rs.1,300 x 3.837 = Rs.6,288.
24. (c) Present Value of perpetuity of Rs.800 starting in year 3 @18%.
PV =
Rs.800
0.18

x PVIF
(18%, 2)
= 4444.44 x 0.718 = Rs.3,191.
25. (b) The present value of a future annuity can be found with the help of PVAF. In the given
situation, amount of Rs.4,00,000 is incurred in each of 8 years @12%. The present worth is
PV = Rs.4,00,000 x PVIFA
(12%, 8)
= 4,00,000 x 4.968 = Rs.19,87,200.
26. (a) In this case, the firm pays Rs.1,50,000 out of total cost of Rs.8,00,000 immediately. So
the amount of Rs.6,50,000 remains outstanding which is paid by way of annuity of
Rs.1,50,000 for 6 years. This can be presented as follows:
Rs.6,50,000 = 1,50,000 x PVIFA
(r, 6y)

PVAF
(r,6y)
=
6, 50, 000
1, 50, 000
PVIFA
(r.6y)
= 4.333.
In this PVIFA table, value of 4.355 for 6 years is found in 10% column. So, the effective rate
of interest is 10%, approximately.
27. (a) In this case, Mr. X shall receive first payment after 10 years from now and thereafter he
will receive 15 more payments. This annuity of Rs.8,000 (total 16 payments) can be
discounted by PVIFA
(10%, 26y)
to find out the present value of the annuity. But this present
value will be located in the beginning of year 11 from now or at the end of year 10 from now
this value can be further discounted by PVIF
(10%, 10)
to find out the present value as follows:
PV = Rs.8000 x PVAF
(10%, 26)
Rs.8000 x PVAF
(10%, 10)

= Rs.8000 x 9.16 Rs.8000 x 6.14 = 73,280 49,120
= 24,160.
28. (d) Let the initial deposit be sum of the present values of the two later withdrawals by using
the present value table.
PV = FV x PVIF
(r,n)

PV = Rs.6,000 x PVIF
(8%,3)
+ Rs. 7,000 x PVIF
(8%,6)

PV = Rs.6,000(0.794) + Rs.7,000(0.630)
PV = Rs.4,764 + Rs.4,410
PV = Rs.9,174
The amount of Rs.9,174 grows to a value of Rs.11,557 in three years; Rs.5,000 is with drawn
then, leaving Rs.6,557. This amount is left for another three years to compound to enabling
withdrawing the desired amount of Rs.7,000. Therefore, an amount of Rs.9174 deposited
today will result in the desired withdrawals.
Part II
237
29. (e) The minimum amount in this case is the Present Value of the series of amount due
discounted @14% as follows:
Year Amount due PVIF
(14%, n)
PV (Rs.)
0 4,000 1,000 4,000
1 5,000 0.877 4,385
2 7,000 0.769 5,383
3 8,000 0.675 5,400
4 10,000 0.592 5,920
25,088
The minimum acceptable amount is Rs.25,088.
30. (c) Present Value =
n
FV
(1+k)
=
10
7,500
(1+0.10)
= Rs.2,891.57.
31. (b) FV
n
= PV(1 + k)
n

= 1,00,000(1 + 0.13)
3
= 1,00,000 (1.13)
3

= 1,00,000 (1.442) = Rs.1,44,200.
32. (e) Rate of interest = 18%
Doubling period = 0.35 +
69
Interest rate
= 0.35 +
69
18
= 0.35 + 3.83 = 4.18 years.
33. (c) According to Rule of 72:
Doubling period =
72
Rate of interest
=
72
12
= 6 years.
Hence, Rs.10,000 will double to Rs.20,000 in first 6 years; Rs.20,000 will double to
Rs.40,000 in the next 6 years i.e., 12 years, and Rs.40,000 will double to Rs.80,000 in next 6
years i.e., 18 years.
34. (a) FV = PV(1 + k)
n
= 20,000 (1 + 0.08)
5
= 20,000 (1.08)
5
= Rs.29,380.
35. (c) FVA
n
= A(1 + k)
n 1
+ A(1 + k)
n 2
+ A(1+ k)
n 3
+
= 2,000 (1.05)
4
+ 3,000(1.05)
3
+ 4,000(1.05)
2
+ 5,000(1.05) + 6,000 = Rs.21,559.
36. (a) PV = FV x PVIF
(6%, 5y)
= 20,000 x 0.747 = Rs.14,940.
37. (a) Calculation of Present Value
Year Flows Cash PV factor @ 8% Flows PV of cash
(1) (2) (3) (4 = 2 x 3)
1 Rs. 30,000 0.926 27780
2 20,000 0.857 17,140
3 10,000 0.794 7,940
4 10,000 0.735 7,350
Total Rs.60,210
38. (c) PV = FV x PVIFA
(k, n)

= 9,000 x PVIFA
(12%, 6y)
= 9,000 x 4.111 = Rs.36,999.
39. (d) PV = A x PVIFA
(k, n)

A =
(k, n)
PV
PVIFA
=
4,00,000
3.170
= Rs.1,26,183.
238
40. (d) PV = A x PVIFA
(k, n)

20,000 = 4025 (PVIFA
(i, n)
)
PVIFA
(i, n)
=
20,000
4,025
= 4.968
From the Annuity discount tables, we find that for annuity discount factor 4.968 for a period
of 8 years, the rate of interest is 12%. Hence, the rate of interest earned on deposit is 12% p.a.
41. (e) PV = A x FVIFA
(k, n)

25959 = 1,000(FVIFA
(k,n)
)
FVIFA
(k, n)
=
25,959
1,000
= 25.959
From the Annuity discount tables, we find that for annuity discount factor 25,959 for a
period of 10 years, the rate of interest is 20%. Hence, the rate of interest implied in the
offer is 20% p.a.
42. (b) According to Rule of 72
Doubling period =
72
Rate of interest
=
72
12
= 6 years
Therefore Rs.20,000 will double to 40,000 in first 6 years and further Rs.40,000 will
double to Rs.80,000 in another 6 years. We can say that Rs.20,000 will grow to Rs.80,000
in 12 years at 12% p.a.
43. (b) The first payment shall be received at the end of 7 years, and the last payment at the end
of 15 years to make 9 payments in all. This can be shown as:

0

7

15
Year
First payment Last payment
The present value discount factor for an annuity of 15 years @12% is 6.811. But as no
payment will be received for 6 years. We substract the present value discount factor for 6
years i.e., 4.111. Thus, the relevant present value factor of the annuity is:
PVIFA = 6.811 4.111 = 2.7.
Now we can calculate the present value of the annual payment of Rs.10,000 for 9 years
beginning 7 years hence @12% as below:
PV = 10,000 x 2.7 = Rs.27,000.
44. (a) R =
1,00,000
PVIFA
Since PV
0
= R (PVIFA
k, n
) =
1, 00, 000
6.145
= Rs.16,273.79.
45. (b)
i. Present Value of Rs.20,000 received annually for 15 years at 15% per annum rate of
interest.
PV = 20,000 x 5.847 = Rs.1,16,940
ii. Present Value of lumpsum payment of Rs.1,50,000 is 1,50,000.
As, the present value of Rs.20,000 received annually for 15 years at 15% rate of interest
(Rs.1,16,940) is less than the present value of lumpsum (Rs.1,50,000) Mr. X should
select the second alternative.
46. (a) A =
(12%, 10)
1
FVIFA
x 4,00,000 =
1
17.548
x 4,00,000 = Rs.22,795.
47. (b) PVA
n
=
A
(1 + k)
+
2
A
(1 + k)
+
3
A
(1 + k)
+
n
A
(1 + k)

=
1,000
1.10
+
( )
2
1,000
1.10
+
( )
3
1,000
1.10
= Rs.2486.85.
Part II
239
48. (d) The effective interest rate per annum has to be calculated
r =
m
k
1+ 1
m

=
4
0.12
1+ 1
4

= 12.55%
The effective rate of interest per month is calculated as below:
= (1 + 0.1255)
1/12
1 = (1.1255)
1/12
1 = 0.00990. 0.99%
The initial deposit can now be calculated as below:
PVA
n
= A
n
n
(1+k) 1
k(1+k)

= 1,000
12
12
(1+0.00990) 1
0.00990(1+0.00990)

= 1,000
0.1254
0.01114

= 1,000 x 11.256 = Rs.11,256.
49. (c) Amount receive at the end = 600 FVIFA
(11%, 8 )
= Rs.7,117.
50. (c) Let the amount be P then and discount rate = K
P (1+K)
6
= 25,000
P (1+K)
12
= 50,000
So (1+K)
6
= 2 i.e., K = 12.25%.
51. (d) FV = 4,00,000 0.1 (1.12)
30
= 40,000 x 29.96 = Rs.11,98,400.
52. (c) present value of perpetuity = 1/.10 =10
so amount at the beginning of the year = 10/2 =Rs.5.
53. (c) Interest rate = 5%
Annuity per year = Rs.10,000
Initial payment = 10,000 (PVIFA
5%, 15
) = 10,000 10.38 = Rs.1,03,800
at 10% it becomes 76,061
Similarly for other it will be Rs.2,890 and Rs.3,944.
54. (a) Financing by SFCL and relative of Mr. X
Let the interest rate be r.
Amount of finance from SFCL = 8,00,000 0.90 = Rs..7,20,000
Amount of finance from relative = Rs.80,000
Total amount of financing = Rs.7,20,000 + Rs..80,000 = Rs.8,00,000
Amount payable at the end of every month to SFCL = Rs.12,800
Number of months for which payments have to be made to SFCL = 8 12 = 96 months
Amount payable to relative:
At the end of one year (i.e., 12 months) = Rs.40,000
At the end of two years (i.e., 24 months) = Rs.50,000
8,00,000 = 12,800 PVIFA
(r, 96)
+
12 24
40,000 50,000
+
(1+r) (1+r)

Let r = 1.2%,
RHS = 12800
96
96 12 24
(1.012) 1 40000 50000
+ +
0.012(1.012) (1.012) (1.012)

= 12800 56.818 + 34665.2 + 37552.4 = Rs.7,99,488
Let r = 1.1%
240
RHS = 12800
96
96 12 24
(1.011) 1 40000 50000
+ +
0.011(1.011) (1.011) (1.011)

= 12,800 59.104 + 35,078.9 + 38,454.1 = Rs..8,30,064.2
r =
(1.2 1.1)
1.1+ x (830064.2 800000)
(830064.2 799488)
= 1.198%
Effective interest rate per annum
= (1 + r)
12
1 = (1.01198)
12
1 = 0.1536 i.e. 15.36%.
55. (a) Present value of perpetuity = 10/0.10 = Rs.100
Present value of cash flow = Rs.1 PVIFA
(7, 10%)
= 4.86 approx Rs.5.
56. (d) Monthly rate of interest is 12/12 = 1.0 percent = 0.01 = r (say)
Tenure of the scheme = 5 years = 60 months.
The maturity value of this recurring deposit plan will be
= Rs.100
( )
( )
( )
n 60
1 r 1 1.01 1
1 r Rs.100 1.01
r 0.01
+
+ =
= Rs.8248.67 Rs.8249 (approximately).
57. (e) Let the cost of funds be k.
So, from the terms of the question, we get, Rs.9,000
( )
( ) ( )
60
60 12
1 k 1
Rs.1, 20, 000
k 1 k 1 k
+
+
+ +

At, k = 1%, the RHS = Rs.9000 44.955 + Rs.1,20,000 0.887 = Rs.5,11,035
At, k = 2 percent, the RHS = Rs.9000 34.761 + Rs.1,20,000 0.788 = Rs.4,07,409
By interpolation, we get k = 1.106%
So, the annualized cost of funds will be = {(1.01106)
12
1} x 100 = 14.109 = 14.11 percent
(approximately).
58. (c) Eight years and six months = 8.5 years
According to the Rule of 69,
69
Interest Rate

Or, 8.5 = 0.35 +
69
Interest Rate

Or, 8.15 =
69
Interest Rate

Or, Interest rate =
69
8.4663%~8.47%
8.15
=
Therefore, Interest rate = 8.47 percent.
59. (b) The amount of equated half yearly installment will be
=
(12%,5years)
Rs.5, 00, 000 Rs.5, 00, 000
Rs.1, 38, 696 1, 38, 700
PVIFA 3.605
= = (approximately).
60. (c) The maturity value of the deposit should be Rs.250,000 (1.04)
3
= Rs.281,216
Here, the installments are being deposited at the end of every month and the concept of
FVIFA may be applied in this case.
Now, the number of installments to be paid = 3 12 = 36 and so.
Part II
241
FVIFA
(1 percent, 36)
=
( )
36
1.01 1
0.01
= 43.077
Hence, the amount of each installment will be =
Rs.281, 216
43.077
= Rs.6528.24 Rs.6528
(approximately).
61. (c) The doubling period as per the rule of 72 is
72
Rateof Interest
=
72
12 years
6
= .
62. (c) Nominal rate of interest is 6 percent p.a. compounded quarterly. So, the effective rate of
interest is:
r =
4
6
1 1 100
4 100

+

percent = 6.14 percent (approx.).
63. (b) Under the rule of 69, the doubling period is
D = 0.35 +
69
Rate of Interest
. Here the rate of interest is 6.19 percent.
Hence, the doubling period is D = 0.35 +
69
6.19
= 0.35 + 11.147 = 11.497 = 11.5 years
(approx.).
64. (d) Value of the car by the end of 5 years will be = Rs.2,50,000 1.20 = Rs.3,00,000
So, the amount to be deposited at the beginning of every year is =
( )
( ) 6%,5years
Rs.3, 00, 000
1 K x FVIFA +

=
Rs.3, 00, 000
5.637 1.06
= Rs.50,207.
65. (e) Let, the required rate of return be r per month
The present value of all the payments = Rs.100 PVIFA (r, 50)
So, by the condition,
100 PVIFA
(r, 50)
= 7,500 PVIF
(r, 60)

or, PVIFA
(r, 50)
75 PVIF
(r, 60)
= 0
If r = 1.00 percent, left hand side = 39.196 75 0.550 = 2.054 and at
r =2, left hand side = 31.424 75 0.305 = 8.549
By interpolation, we get,
r 1 0 2.054
2 1 8.549 2.054
+
=
+
or, r = 1.1937
So, the effective annual rate of interest =
12
1.1937
1 1 100
100

+

= 15.30 percent.
66. (a) Cost of the house = Rs.5,00,000 and the amount of loan = Rs.4,00,000
The effective rate of interest per annum =
4
9
1 1 100
4 100

+

= 9.31 percent.
And so the effective rate of interest per month is
= ( )
{ }
1/ 12
1.0931 1 100 = 0.74 percent
242
Now, PVIFA
(0.0074%, 120)
=
120
120
(1.0074) 1
(0.0074) (1.0074)
=
1.422
0.0074 2.422
= 79.348
Hence, the required amount of monthly installment is
=
Rs.400, 000
79.348
= Rs.5041.10 or Rs.5041 (approx.).
67. (b) The present value of annuity A receivable at the end of every year for a period of n years
at a rate of interest k is equal to PVA
n
= A x PVIFA
k, n

3,00,000 = A x PVIFA
(12%, 6)

A =
3, 00, 000
= 72, 975
4.111
.
68. (e) 10,000 = 1,000 x PVIFA
(12year, r)

10 = PVIFA
(12year, r)

By interpolation we get =
[10.575 10] 0.575
2 + 2 + = 2.925% p.m
(10.575 9.954) 0.621

Hence interest rate per annum = 2.925 x 12 = 35.1%.
69. (c) The general relationship between the effective and nominal rate of interest is as follows:
r = (1 + k/m)
m
1
Where
m = frequency of compounding per year.
r = (1 + 0.12/12)
12
1= 12.68%
For quarterly compounding,
4
0.12
1 1 =12.55%
4

+

The difference between the monthly and quarterly compounding = 0.13%.
70. (b) The present value of an annuity A receivable at the end of every year for a period of n
years at a rate of interest k is given as PV = A x PVIFA
(11%, 5 years)

PV = 200 x 3.696 = 739.2.
71. (b) The general relationship between the effective and nominal rate of interest is as follows:
= (1 + k/m)
m
1
Where,
r = (1 + 0.01/2)
2
1 = 0.1025 or 10.25%.
72. (e)
Year Amount PVIFA PV
1-3 2000 2.322 4644
4-6 3000 1.567 4701
(3.8892.32)
9345
Part II
243
73. (d) Effective Interest =
12
0.12
1
12

+

= 1.1268 ~ 12.68%
Applicable monthly interest =
0.1268
12
= 0.0106
FV = 1000 x
( )
12x5
1.0106 1
0.0106

= 83263.98 ~ Rs.83,264
74. (b) The present value of annuity A receivable at the end of every year for a period of n years
PVA
n
= A x PVIFA
k,n

A = 500/PVIFA
(16%,)10
= 500/4.833 = Rs.103.46 lakh.
75. (c) The present value of annuity A receivable at the end of every year for a period of n years
at a rate of interest k is equal to PVA
n
= A x PVIFA
k ,n

= 2,000 x PVIFA
12%,10
= 20,00 x 5.65 = Rs.11,300.
76. (c) r = (1 + k/m)
m
1
where,
r = 0.092 or 9.2%.
77. (c) The present value of annuity A receivable at the end of every year for a period of n years
PVA
n
= A x PVIFA
k,n

A = 5,00,000/PVIFA
12%,10
= 5,00,000/5.65 = 88,495.57.
78. (a) r = (1 + k/m)
m 1
where,
.1787 = (1 + k/4)
4
1
k = 0.1678 or 16.78%.
79. (a) (1 + r) = (1 + R) (1 + a)
where,
r = nominal rate of interest,
R = real rate of interest and a is the rate of inflation.
Using the above formula we get inflation rate to be 4.83%.
80. (c) The present value (PV) of a sum (FV
n
) receivable after n years at a rate of interest (k) is
given by the expression PV
n
= FVn / FVIF
(k,n)
12,550 = 20,000/FVIF
(8,r)

FVIF
(8, r)
= 20,000/12,550 = 1.594. This factor is equal to
r = 6%.
81. (b) The future value of a regular annuity for a period of n years at a rate of interest of k is
given as
PV
n
= A x PVIFA
(k,n)

A =
(8%, 4)
10, 000
PVIFA
= 3019.21 ~ 3019 interest for 1st year = 800
The amount of principal amortized at the end of first year is Rs.2,219. ( 3019 800).
244
82. (a) r = (1 + k/m)
m
1
where,
r = (1 + 0.10/4)

4
1 = 0.1038 or 10.38%.
given as FVA
n
= A x FVIFA
(k, n)
= 1 x FVIFA

12 %, 5

= Rs.6,353.
84. (c) The yield on treasury bills k =
(F P) 365
P d

where,
F = face value,
P = price
K = yield and
Hence yield on T-bill to be 10.67%.
85. (b) Coupon = Rs.120; Loss in value = 1000 980 = 20
Return =
170 20
10%
1000
=
Real rate of interest = 10% 6% = 4%.
given as
FVA
n
= A x FVIFA
(k, n)

A = 1000/ FVIFA
(15%, 6)

= Rs.114.24.
87. (b) The sinking fund factor is given as k/(1 + k)
n
1
By using the above formula we get 0.16/(1 + 0.16)

15

1
Hence sinking fund factor = 0.01935.
88. (d) r = (1 + k/m)
m
1
where,
r = (1 + 0.18/4)
4
1 = 0.169 or 16.9%.
89. (a) The Present Value (PV) of a sum (FV
n
) receivable after n years at a rate of interest k is
given by the expression
PV = FV
n
/(1 + k )
n

Hence present value is 10,00,000/(1 + 0.10)
60
= 3,284.
90. (e) The general relationship between effective and nominal rate of interest is given by
r = (1 + k/m)
m
1
where,
When the interest rate on loan is 1.5% p.m, then it will be 1.5 x 12 = 18% p.a. compounded
monthly.
Hence the effective rate of interest = (1 + 0.18 / 12)

12

1 = 19.56%.
Part II
245
91. (c) According to the Rule of 69 doubling period = 0.35 + 69/interest rate
Hence, the doubling period = 0.35 + 69/16 = 4.7 years.
92. (d) According to the Rule of 69 doubling period = 0.35 + 69/interest rate
Hence, the doubling period = 0.35 + 69/6 = 11.85 years.
93. (d) The present value of annuity is given
PVA

n
= A x PVIFA

(k, n)

Hence the amount to be invested today to earn annuity of Rs.1000 will be
1,000 x PVIFA

(12%, 5)
= Rs.3,605.
94. (c) An annuity of infinite duration is known as perpetuity. The PV of such perpetuity can be
expressed as P
a
= A x PVIFA
(k, a)
= A x 1/k
The amount to be deposited now to earn a constant annual income for an indefinite period
will be 10,000 x 1 / 0.10 = 1,00,000.
95. (b) The general relationship between effective and nominal rate of interest is given by
r = (1 + k/m)
m
1
r = (1 + 0.16/4)
4
1 = 0.1699 or 16.99%.
96. (d) The future value of a regular annuity for a period of n years at a rate of interest is given
by the formula
FVA
n
=
n
A[(1+k) 1]
K

where,
A = Amount deposited/invested at the end of every year for n years
k = Rate of interest (expressed in decimals)
n = Time horizon
FVA
n
= Accumulation at the end of n years
This can be rewritten as A = FVA
n
{k/(1+ k)
n
1}
Therefore, the amount to be invested every year will be A = 10,00,000{0.14/(1+ 0.14)
5
1}
= 1,51,283.55 Rs.1,51,284.
97. (e) The doubling period according to Rule of 69 is given by 0.35 + 69/interest rate
= 0.35 + 69/r = 4.75
The rate of interest will be r = 15.68%.
98. (a) The doubling period as per Rule 72 is given as 72/interest rate. Hence the doubling period
here will be 72/16 = 4.5 years.
99. (b) An annuity of infinite duration is known as perpetuity. The PV of such perpetuity can be
expressed as = A x 1/k = 1,000 x 12 x 1/0.12 = 1,00,000.
100. (a) Amount to be earned today to earn an annuity of Rs.1,000 for five years commencing
from the end of two years
1000 x PVIF

(12%, 2)

+ 1,000 x PVIF

(12%, 3)
+ 1000 x PVIF

(12%, 4)
+ 1,000 x PVIF

(12%, 5)

+ 1000 x PVIF

(12%, 6)

= 797 + 712 + 636 + 567 + 507 = 3,219.
101. (a) A rupee expected to be received one year from now with no risk of default would be
discounted at a lower rate and would be worth less than Re 1.
102. (c)The doubling period according to the rule of 69 is given as 0.35 + 69/interest rate
0.35 + 69/15.
Hence the doubling period will be r = 4.95 years.
246
103. (c) The future value of a single cash flow is given as FV = PV (1 + k)
n

(1 + k)
25
= 2,00,000/5500
k = 15.45% 15.5%.
104. (c) The present value of annuity is given
PVA
n
= A x PVIFA
(k, n)

5,00,000 = A x PVIFA

(15%, 5)

The equated annual payment A = 5,00,000/3.352 = 1,49,164.60 Rs.1,49,165.
105. (e) The generalized formula for shorter compounding periods is given as
FV
n
= PV (1 + k/m)

m x n

Where,
FV = future value for n years
PV = cash flow today
k = nominal interest rate per annum
m = number of times compounding is done during a year
n = number of years for which compounding is done
FV
n
= 5,000 (1 + 0.15/2)
2x3
= 7,716.
106. (a) The future value of a regular annuity for a period of n years at a rate of interest is given
by FVA
n
= A x FVIFA
(k, n)

A = 10,00,000 / FVIFA
(14%, 10)

By using the future value interest factor annuity tables we get A = 10,00,000/19.337
= 51,714
Risk and Return
107. (a) Stock x = Rise by 25% means, return is 25%. Decline by 5% means return is 5%.
Return Probability Expected return on X
25% 30% = 0.30
x
r = 25 % (0.3) + ( 5)(0.70)
5% 70% = 0.70 = 4%

2 2 2
X
= (25 4) (0.30) + ( 5 4) (0.70) = 189

X
= 189 13.75% = .
108. (c) Stock A
Return Probability Expected return on Y
20% 40% = 0.40 20(0.40) + (8)(0.60) = 3.2%
8% 60% = 0.60

2 2 2
y
= (20 3.2) (0.40) + ( 8 3.2) (0.60) = 188.16

y
= 188.16 = 13.72% .
109. (a) Co-variance between stocks x and y
=
xy
x y
.
Where,

xy
= Correlation coefficient between x and y.

x
= Standard deviation of x

y
= Standard deviation of y
Co-variance = 0.5 x 0.13 x 0.13 = 0.0084.
Part II
247
110. (e) The characteristic line for XYZ Ltd. will be in the form of
R
xyz
=
m
+ R
Where, R
xyz
= Average stock return =
x
K
and R
m
= Average market return =
m
K
Therefore,
= 6.83 (0.584 x 0.5)
= 6.83 + 0.292 = 7.122.
111. (b) Required return on a stock
(R
i
) = R
f
+ (R
m
R
f
)
Where, R
f
= Risk-free return
R
m
= Market return
Stock I:
R
I
= Required return
= 12 + 1.5 (18 12) = 21%
Since, the expected return is only 19%, this stock has been overvalued.
Stock II:
R
II
= Required return
= 12 + 0.75 (18 12) =16.5%
Since, the expected return is 18.5%, the stock has been undervalued.
Stock III:
R
III
= Required return = 12 + 1.4 (18 12) = 20.4%
Since, the expected return is 22%, this stock has been undervalued.
112. (a) We have from CAPM,
Return on a stock (R
j
) = R
f
+ (R
m
R
f
)
Where, R
f
= Risk-free return
R
m
= Market return
Also, we have =
j m
m
Covariance R , R
Variance R

=
jm j m
2
m
,

Where,
jm
= correlation coefficient of the scrip with market portfolio.

j
= Standard deviation of the stock.

m
= Standard deviation of the market portfolio

2
m
= Variance of the market portfolio
Given,

jm
= 0.5

j
= 0.24

m
= 0.20

2
m
= (0.20)
2
= 0.04
248
Hence, =
0.5 x 0.24 x 0.20
= 0.6
0.04

Given,
r
f
= 6%
r
m
= 16%
Hence,
r
j
= 6 + 0.6 (16 6) = 12%
Therefore, the return on Greaves Ltd. = 12%.
113. (a) The beta of Mr. Rameshs portfolio is the weighted average of the betas of individual
stocks in his portfolio.
Hence, portfolio = 0.95 x 0.15 + 1.1 x 0.2 + 1.25 x 0.3 + 0.8 x 0.05 + 1.05 x 0.2 + 0.7 x 0.1
= 1.0575
Using CAPM R
f
= 4% + 1.0575 (14 4)%
Return on portfolio = 14.575%.
114. (d) Using dividend capitalization model,
We have,
1
e
D
P =
K g

Where,
K
e
is the required rate of return on the stock A
K
e
can be found out using CAPM, as
K
e
= R
f
+ (R
m
R
f
)
Substituting the values of R
f
, and R
m

K
e
= 10 + 1.2 (15 10) = 16%
Therefore, plugging the values of K
e
, P
o
and D
1
30 =
4

0.16 g

g = 2.67%.
115. (c)
Scenario r
i
(%) P [r
i
E (r)]
2
[ri E(r)]
2
P
Recession 10 0.3 225 67.5
Low growth 5 0.4 0 0
High growth 20 0.3 225 67.5
Expected return = 10(0.3) + 5(0.4) + 20(0.3) = 5%
= 135 = 11.62%.
116. (a) E(r
p
) = (10 x 0.5) + (20 x 0.5) = 15%

2
p = (2)
2
(0.5)
2
+ (5)
2
(0.5)
2
+ (2 x 0.4 x 2 x 5 x 0.5 x 0.5) = 9.25

P
= 9.25 = 3.04%.
117. (c) K
e
= r
f
+ (r
m
r
f
) = 9 + 1(18 9) = 18%
P
o
=
2.5 (1.06)
= Rs. 22.08.
0.18 0.06

Part II
249
118. (b) k =
t t t -1
t-1
D +(P P )
P

k =
1.53+(28.75 37.25)
37.25
= 18.7%.
119. (e) k =
t t t -1
t-1
D +(P P )
P

k =
2.00+(280.00 200.00)
200.00
=
2.00 80
100
+
= 41%.
120. (e)
Eco. cond. K
i
P
i
k = k
i
x p
i
P
i
(K
i
k )
2+
Good 18% 0.1 0.018 0.1(0.18 0.124)
2
=

0.00031
Average 15% 0.4 0.060 0.4(0.15 0.124)
2
=

0.00036
Bad 12% 0.3 0.036 0.3(0.12 0.124)
2
= 0.0000
Poor 5% 0.2 0.010 0.2(0.05 0.124)
2
=

0.00098
0.124 0.0017
The average expected return = 0.124 or 12.4% (app)
= (0.00168)
1/2
= 0.041 or 4.1%
The expected return and risk associated are12.4% and 4.1% respectively.
121. (b) 10 shares of ABC Ltd can be purchased for Rs.2000. The expected return and the
standard deviation may be found as follows.
Return (k
i
) Prob (P
i
)
k = P
i
x k
i
(k
i
k ) P
i
(k
i
k )
2
10 x 200 0.3 600 120 4320
10 x 210 0.4 840 20 160
10 x 220 0.2 440 80 1280
10 x 240 0.1 240 280 7840

k =2,120
13,600
=
2
i i
P (k k) = 13, 600 = 116.62
Expected return is Rs.2120.
Standard deviation is 116.62.
122. (c) 10 shares of XYZ Ltd. can be purchased for Rs.1000. The expected return and the
standard deviation may be found as follows:
Return (k
i
) Prob (P
i
)
k = P
i
x k
i
(k
i
k ) P
i
(k
i
k )
2
10 x 250 0.3 750 290 25,230
10 x 230 0.4 920 90 3,240
10 x 190 0.2 380 310 19,220
10 x 160 0.1 160 610 37,210

k =2,210
84,900
=
2
i i
P (k k) = 84, 900 = 291.38%.
123. (d) K
j
= R
f
+
j
(k
m
R
f
) = 7% + 1.4(16% 7%) = 19.6%.
124. (e) K
j
= R
f
+
j
(k
m
R
f
) = 9% + 1.0 (15% 9%) = 15%.
125. (c) K
j
= R
f
+
j
(k
m
R
f
) = 11% + 2.3 (17% 11%) = 24.8%.
250
126. (c) K
j
= R
f
+
j
(k
m
R
f
) = 8 + 2.6 (18 8) = 34%.
127. (b)
y
= 15

m
= 10
Cor
ym
= 0.25
=
y m ym
2
m
Cor
=
15 x 10 x ( 0.25)
100
= 0.375.
128. (d) The beta factor may be computed as follows:
=
x m xm
2
m
Cor
=
15 x 12 x 0.72
144
= 0.90
129. (d) In order to calculate the required rate of return on the security i.e., R
s
; its beta factor
should also be calculated
=
s m sm
2
m
Cor
=
2
4 x 3.2 x 0.8
(3.2)
=
10.24
10.24
= 1.00.
Now, the required rate of return, R
s
can be calculated with the help of CAPM equation as
follows:
R
s
= R
f
+
j
(k
m
R
f
) = 6.2% + 1.00 (9.8% 6.2%) = 9.8%
130. (b) Equilibrium price of shares of XYZ Ltd:
The required rate of return of XYZ Ltd may be found with the help of CAPM as follows:
K
j
= R
f
+
j
(k
m
R
f
) = 0.11 + 1.2 (0.15 0.11) = 0.158 or 15.8%
Now K
e
= 15.8%
D
o
= Rs.3
g = 9%
Equilibrium price P
o
=
1
e
D
K g
=
3(1.09)
0.158 0.09
=
3.27
0.068
= Rs.48.08.
131. (c) Here the risk premium is (R
m
R
f
). If it further increases 2%,
New K
e
= 0.11 + 1.2 (0.06) = 18.2%
Equilibrium price, P
o
=
1
e
D
K g
=
3(1.09)
0.182 0.09
= Rs.35.54.
132. (b) If expected growth in dividends increases to 12%
New g = 12%
Equilibrium Price, P
o
=
1
e
D
K g
=
3(1.12)
0.158 0.12
= Rs.88.42.
133. (e) If market sensitivity index, , becomes 1.5, then
K
j
= R
f
+
j
(k
m
R
f
) = 0.11 + 1.5 (0.15 0.11) = 17%
Now equilibrium price,
1
e
D
K g

P
o
=
3(1.09)
0.17 0.09
= Rs.40.87.
Part II
251
134. (b) If the two securities A and B are correctly priced then the return required, based on their
levels of systematic risk and that calculated from the CAPM, will be the same as their
expected returns given above.
So, the required return can be ascertained with the help of CAPM equation as follows:
Security A:
K
A
= R
f
+
A
(k
m
R
f
) = 20% + 1.5 (28% 20%) = 32%
This is equal to the expected return of Security A.
Therefore, Security A is correctly priced.
Security B:
K
B
= R
f
+
B
(k
m
R
f
) = 20% + 0.7 (28% 20%) = 25.6%.
This return of 25.6% is less than the expected return of 27%. Therefore, Security B is not
correctly priced.
135. (d) The coefficient correlation between the returns on Zeenath Ltd can be ascertained as
follows:
Cor
(s, m)
=
(s, m)
s m
Cov
x

Where Cov
(s, m)
=
s s m m
P(K K ) (K K )
The expected return on the Zeenath Ltd. K
s
and K
m
are as follows:

s
K = (0.2 x 10%) + (0.4 x 15%) + (0.4 x 20%) = 16%

m
K = (0.2 x 5%) + (0.4 x 16%) + (0.4 x 18%) = 14.6%
Calculation of Standard Deviation and Correlation Coefficient
Probability
(K
m

m
k ) (K
5
k
s
) P(K
5
k
s
)
2
P((K
m

m
k )
2

P(1)(2)
(1) (2)
0.2 9.6 6 7.2 18.43 11.52
0.4 1.4 1 0.4 0.784 0.56
0.4 3.4 4 6.4 4.624 5.44
14.0 23.83 16.4
Therefore, the standard deviation of the market portfolio,

m
is (23.83)
1/2
= 4.88,
s
is (14.0)
1/2
= 3.74
Cor
(s, m)
=
(s, m)
s m
Cov
x
=
16.4
3.74 x 4.88
= 0.89.
136. (d) From the above solution we get
=
(s;m)
2
m
Cov

beta factor () = Cov
(s,m)
16.4
23.83
= 0.68.
137. (a) From the above, we get
R
m
= 14.6%, = 0.68 and given that R
f
= 9%
K
s
= R
f
+ (k
m
R
f
) = 9% + 0.68 (14.6% 9%) = 12.80%
The expected return on share of C Ltd. is 16% and is greater than the required rate of return
for its level of risk i.e., 12.8%. Therefore, the share price is lower as indicated by the CAPM
and is not efficiently priced.
252
138. (a) The expected returns R
M
and R
N
are just the possible returns multiplied by the associated
probabilities as follows:
R
M
= (0.20 x 0.25) + (0.50 x 0.30) + (0.30 x 0.70) = 31%
R
N
= (0.20 x 0.30) + (0.50 x 0.40) + (0.30 x 0.50) = 41%.
139. (c) The expected returns are first to be calculated:
R
M
= (0.20 x 0.25) + (0.50 x 0.30) + (0.30 x 0.70) = 31%
R
N
= (0.20 x 0.30) + (0.50 x 0.40) + (0.30 x 0.50) = 41%.
The standard deviation can now be calculated as follows:

M
=
2 2 2
0.20( 0.25 0.31) +0.50(0.30 0.31) +0.30(0.70 0.31) = 0.1084 = 32.92%

N
=
2 2 2
0.20(0.30 0.41) +0.50(0.40 0.41) +0.30(0.50 0.41) = 0.0049 = 7%.
140. (e) Since Risk free rate and expected return of market portfolio (R
M
) are not given, it is not
possible to find out whether both securities are correctly priced or not. Hence, data provided
was insufficient.
141. (e) K =
t 1 t 1
t 1
D +(P P )
P

K =
2.40+(69.00 60.00)
60.00
= 0.19 or 19%
The rate of return on stock is 19%.
142. (b) Required rate of return = R
f
+
x
(k
m
R
f
) = 8 + 1.4 (14 8) = 16.4%
Expected rate of return a year hence
=
0
0
D (1+g)
+g
P
=
2(1+0.09)
+0.09
14
= 24.57%
Since at equilibrium, the required rate is equal to the expected rate, this can be solved as
follows:
0.164 =
0
2.18
P
+ 0.09
P
0
=
2.18
0.074
= Rs.29.46
143. (a) Expected return =
Expected income
Market purchase price
=
Rs.18.5
Rs.64
= 0.289 or 28.9%.
144. (b) Covariance between stocks X and Y =
xy
y

where
xy
= 0.9

x
= 0.17

y
= 0.18
Cov
xy
= 0.9 x 0.17 x 0.18 = 0.027.
145. (c) portfolio = 0.75 x .20 + 0.9 x .25 + 1.2 x .30 + 1.1 x .25
= 0.15 + 0.225 + 0.36 + 0.275 = 1.01
Using CAPM = 6% + 1.01 (15 6)%
Return on portfolio = 15.09%.
146. (c) Using dividend capitalization model,
P
0
=
1
e
D
k g

Part II
253
k
e
= R
f
+ (R
m
R
f
) = 20 + 1.4 (25 20) = 27%.
Substituting the values k
e
, P
0
and D
1

40 =
10
0.27 g
10.8 40g = 10 10.8 10 = 40g 0.8 = 40g
g = 0.02 or 2%.
147. (a) E(r
p
) = (15 x 0.5) + (25 x 0.5) = 7.5 + 12.5 = 20%

2
p
= (3)
2
(0.5)
2
+ (6)
2
(0.5)
2
+ (2 x 0.6 x 3 x 6 x 0.5 x 0.5) = 2.25 + 9 + 5.4 = 16.65

p
= 16.65 = 4.08%.
148. (d) k
e
= 13 + 2(16 13) = 19%
P
0
=
4.5 (1.09)
0.19 0.09
= Rs.49.05.
149. (b)
Return Probability RXP R 20 (R 20)
2
x P
10 0.1 1 30 90
5 0.2 1 15 45
20 0.4 8 0 0
35 0.2 7 15 45
50 0.1 5 30 90
20 270
S.D 270 16.43
150. (a)

(i,m)
i m
2 2
m m
Cov

= =
Expected return from the market = p
i
k
m
= 0.30 (15) + 0.40 (12) + 0.30 (8) = 11.70%
Risk for the market,
m
=
2 1/2
i m m
[ p (k k ) ]
= [(15 11.70)
2
(0.30) + (12 11.70)
2
(0.40) + (8 11.70)
2
(0.30)]
1/2

= [3.267 + 0.036 + 4.107]
1/2
= (7.41)
1/2
= 2.72%.
Given
2
i
= 23.43(%)
2

i
23.43 =
= 4.84%
i.e. 1.77 =
41 . 7
) 72 . 2 )( 84 . 4 (

Therefore,
72 . 2 84 . 4
41 . 7 77 . 1
= = 0.996.
151. (b) Expected. Return = (2 x expected return on portfolio Z ) (1 x Interest rate on treasury bils)
= (2 x 15) 5 = 25%
Standard deviation = (2 x standard deviation of Z ) (1 x standard deviation of T. Bills)
= (2 x 16) 0 = 32
152. (c) In portfolio A and B - A as higher return for same risk
In portfolio C and D - cant say depend on investor attitude
In portfolio E and F - F as lower risk for same return
254
153. (c) Expected Return = 0.5 x 23 + 0.5 x 13 =18%
Standard deviation = (w
1
2
1
2
+ w
2
2
2

+ 2 w
1
w
2
12

1

2
)
1/2

= {(0.5)
2
(0.40)
2
+(0.5)
2
(0.24)
2
+ 2 x 0.5 x 0.5 x 0.80 x 0.40 x 0.24}
1/2
= 30.5%.
154. (c) K
e
= R
f
+ (R
m
R
f
) = 8 + 1.2(10 8) = 10.4%.
155. (d) Given R
f
=

Risk Free rate of return = 5%, Expected Yield = 14%, and = 1.25
Expected Yield = R
f
+ (R
m
R
f
)
0.14 = 0.05 + 1.25 (R
m
0.05)
R
m
= 12.20%.
156. (d) Let, the effective annual rate of interest be r.
So, Rs. 20,000 (1 + r)
9
= Rs.40,000
Or, (1 + r)
9
= 2
Or, r = 8.006 8 percent (approximately).
Therefore, the effective annual rate of interest will be = 8 percent.
157. (c) Total asset of a company is financed by equity capital and total debt. So, the total asset of
Subsonic Industries = Rs.150 lakh + Rs.250 lakh = Rs.400 lakh.
The return on investment (ROI) of a company is defined as:
ROI =
Earnings before Interest and Taxes
Total Assets
=
50
0.125
400
= = 12.50 percent.
Here, post-tax income = Rs.24 lakh and so the pre-tax earnings = Rs.30 lakh as the tax rate
= 20 percent.
Interest expenses = Rs.250 lakh 8 percent = Rs.20 lakh.
Hence, the amount of earnings before interest and taxes = Rs.30 lakh + Rs.20 lakh = Rs.50 lakh.
158. (e) The expected return from a stock may be calculated as:
=
Dividend Income + Increase in price
Purchase price

Expected stock price after 1 yr = 0.35 x 52 + 0.4 x 56 + 0.25 x 62
= 56.1
expected return =
56.1 50 2
50
+
= 16.2% ~ 16%

= 16 percent (approximately).
159. (d) Expected return from that equity share = 0.3 10 + 0.45 16 + 0.25 20
= 3 + 7.20 + 5.0 = 15.20 percent.
Expected risk may be calculated as: =
( )
i i
P R R

= ( ) ( ) ( )
{ }
2 2 2
0.3 10 15.20 0.45 16 15.20 0.25 20 15.20 + +
= ( ) 0.3 27.04 0.45 0.64 0.25 23.04 + +
= ( ) 8.112 0.288 5.76 + + = 14.160 3.76 = (approximately)
So, the required expected risk = 3.76.
Part II
255
160. (e) The expected rate of return from any security as per the Capital Asset Pricing Model can
be computed as:
k
x
= R
f
+
x
(k
m
R
f
)
Now, the beta of a security may be computed as:

x
=
j m
m
Cov(k k )
Var(k )
=
jm j m
m

Var(k )
=
0.9 7 6
36

= 1.05
Therefore, k
x
= R
f
+
x
(k
m
R
f
) = 0.055 + 1.05 x (0.12-0.055) = 12.325
Hence, the required rate of return as per CAPM = 12.33 percent.
161. (a) The expected return from the shares of ESL is k
j
= 12 0.20 + 16 0.50 + 22 0.30
= 2.40 + 8.00 + 6.60 = 17 percent
The expected return from the market portfolio is k
m
= 10 0.20 + 12 0.50 + 20 0.30
= 2.00 + 6.00 + 6.00 = 14 percent.
Now, the variance of returns from the market portfolio is :

2
m
= {0.20 (10 14)
2
+ 0.50 (12 14)
2
+ 0.30 (20 14)
2
}
= 0.20 16 + 0.50 4 + 0.30 36 = 3.2 + 2.0 + 10.8 = 16
The covariance of returns between the shares of ESL and the market portfolio is:
COV(k
j
,k
m
) = {0.20(10 14)(12 17) + 0.50(12 14)(16 17) +0.30(20 14)(22 17)}
= {0.20 (4) (5) + 0.5 (2) (1) + 0.30 (20 14)(22 17)}
= (0.20 20 + 0.50 2 + 0.30 30) = 4 + 1 + 9 = 14
Now, beta is defined as the ratio between
j m
2
m
Cov(k , k )
=
14
16
= 0.875
Hence, the required value of beta = 0.875.
162. (d) According to the CAPM approach, the required rate of return on a share is
k
e
=R
f
+ ( )
m f
R R 6 1.25 8 6 10 16 percent. = + = + =
163. (e) The Return on Equity (ROE) for a company may be stated as:
ROE =
Net profit Net profit Total Assets Sales
Networth sales Total assets Net worth
=
= Net profit margin total assets turn over ratio
Debt
1
Equity

+

= 12 1.67 3 = 60 percent.
164. (b) Retention ratio = 40% so, the dividend payout ratio is 60 percent.
Now, dividend yield =
o o o
D E 0.6 0.6 0.6
P P P / E 10
= = = = 0.06 = 6 percent.
165. (d) The expected return from the equity shares of Nectar systems is K
e
=
1 1 0
0
D (P P )
P
+

Here, D
1
= Rs.3.00
P
1
= Rs.28.00
P
0
= Rs.25.00
Therefore, the expected return on equity K
e
=
3 (28 25)
100%
25
+
= 24 percent.
256
166. (c) Beta of a stock =

Covariance between the return on the stodk and the return from the market
Variance of returns from the market.

Here, the standard deviation of the returns from the market is
= 12 percent and so, the variance
= 144 percent
2

But the beta coefficient is = 1.5
So, the required covariance is = 144 1.5 = 216 percent
2
.
167. (c) Return from each of the given scenarios may be obtained as
Price (Rs.) 21 23 25
Return
( ) 1 21 20
100
20
+

( ) 1 23 20
100
20
+

( ) 1 25 20
100
20
+

= 10 percent = 20 percent = 30 percent
So, the expected return is 10 0.30 + 20 0.40 + 30 0.30 = 3 + 8 + 9=20 percent.
168. (c) Returns from the market under various scenarios can be estimated as
Sensex 3978 4163 4348
Return
3978 3700
2 100
3700

= 15 percent
4163 3700
2 100
3700

= 25 percent
( ) 4348 3700 2 100
3700

= 35 percent
Hence, the required expected return = 15 0.3 + 25 0.4 + 35 0.3 = 25 percent.
169. (b) Return from each of the given scenarios may be obtained as
Price (Rs.) 32 35 38
Return
( ) 1 32 30
100
30
+

( ) 1 35 30
100
30
+

( ) 1 38 30
100
30
+

The expected return from the share of Saboo Ltd. is = 20 percent. So, the standard deviation
of returns from the shares of Saboo Ltd
= ( ) ( )
{ }
2 2
2
0.3 20 10 0.4 20 20 0.30 (30 20) + + = 2 0.3 100 = 7.75.
170. (b) Return from each of the given scenarios may be obtained as
Price (Rs.) 10 11 12
Return
( ) 1 10 10
100
10
+

( ) 1 11 10
100
10
+

( ) 1 12 10
100
10
+

Part II
257
Expected return from the shares of SMS Ltd is = 20 percent
Returns from the market under various scenarios can be estimated as
Sensex 4370 4750 5130
Return
4370 3800
100
3800

= 15 percent
4750 3800
100
3800

= 25 percent
( ) 5130 3800 100
3800

= 35 percent
Hence, the expected return = 15 0.3 + 25 0.4 + 35 0.3 = 25 percent.
And the expected return from sensex is = 25 percent
So, the variance on the market return can be calculated as
( ) ( ) ( )
{ }
2 2 2
2
m
0.3 15 25 0.3 25 25 0.3 35 25 60 = + + =
Now, the covariance between the return from the share and return form the market can be
calculated as
= 0.30 (10 20)(15 25) + 0.4 (20-20)(25 25) + 0.3(30 20)(35 25)
= 0.3 100 + 0.3 100 = 60
Hence, the beta value for the shares of SMS Ltd is
=
covariancr brtween the returns from the shares and market
var iance on the market returns
=
60
1.00.
60
=
171. (a) The general equation to calculate the rate of return k= [D
1
+ (P
1
P
t 1
)]/P
t 1
where,
k = rate of return
P
1
= price of the security at the time t
i.e., at the end of the holding period
P
t 1
= price of the security at time t 1,
i.e., at beginning of the holding period or purchase price
D
t
= income or each cash flows receivable from the security at the time
0.15 = [5 + (P
t
50)]/50
P
t
= 52.5.
172. (e) Expected rate of return K = P
i
K
i
.
The expected rate of return for any asset is the weighted average return using the probability
of each rate of return as the weight.
0.188 = 0.30 x 0.16 + 0.70 x r
r = 0.14/0.7 = 0.2 or 20%.
173. (e)
r
xy
= Covariance
xy
/
x

y

0.4 = 0.8 /
x

0.2

x

= 0.8/0.08 = 10

Variance =
2
= 10
2
= 100.

258
174. (d) Expected rate of return K =
n
i i
t =1
P K
Probability 0.20 0.50 0.20 0.10
Price 120 140 160 180
Rate of return 0.5 0.75 1.00 1.25
K = P
t
P
t 1
/ P
t-1
Rate of return
= 0.20 x 0.5 + 0.50 x 0.75 + 0.20 x 1 + 0.10 x 1.25
= 0.1 + 0.375 + 0.2 + 0.125 = 0.80 or 80%.
175. (e)
Beta =
j m
m
Convariance(K K )
Variance(K )

Variance = (Standard deviation)
2
= 514.92/264.06 = 1.95.
176. (a) The general equation to calculate the rate of return k = [D
t
+ (P
t
P
t1
)]/P
t1

Where k = Rate of return
P
t

= Price of the security at the time t i.e. at the end of the holding period
P
t-1
= Price of the security at time t 1 i.e. at beginning of the holding period or
purchase price
D
t
= Income or each cash flows receivable from the security at the time t
K = [15 + (1,000)]/ 5,000 = 20.30%.
177. (c) Beta =
J, m
m
Convariance(K K )
Variance(K )
=
177.85
= 1.469
121
.
178. (a) Expected rate of return K =
n
i i
t =1
P K
= 0.25 x 0.15 + 0.35 x 0.18 + 0.25 x 0.20 + 0.15 x 0.13 = 0.17 or 17%.
179. (d) The general equation to calculate the rate of return k = [D
t
+ (P
t
P
t-1
)]/P
t-1

Where,
k = Rate of return
P
t

= Price of the security at the time t i.e. at the end of the holding period
P
t

1

= Price of the security at time t1 i.e. at beginning of the holding period or purchase price
D
t
= Income or each cash flows receivable from the security at the time t
K = [2.5 + (35 21)]/21 = 78.57.
180. (b) The CAPM is represented by
k
j
= R
f
+
j
(k
m
R
f
)
Where,
k
j
= expected or required rate of return on security j
R
f
= risk-free rate of return

j
= beta coefficient of security j
k
m
= return on market portfolio
Required rate of return = 0.09 + 1.5 (0.15 0.09) = 0.18 or 18%.
Part II
259
181. (b) The general equation to calculate the rate of return k = D
t
+ (P
t
P
t-1
)/P
t1

k = [15 + (115 120)]/120 = 8.33%.
182. (e) Expected rate of return K =
n
t =1
P
i
K
i

k = 0.25 x 0.19 + 0.35 x 0.12 + 0.20 x 0.18 + 0.10 x 0.20 + 0.1 x 0.24
= 0.1695 or 16.95%.
183. (d) The CAPM is represented by
k
j
= R
f
+
j
(k
m
R
f
)
Where,
k
j
R
f

j
k
m
Require rate of return = 0.08 + 1.4 (0.15 0.08) = 0.178 or 17.8%.
184. (b)
Beta =
J, m
m
Convariance(K K )
Variance(K )

=
221
= 1.82
121
.
185. (d) The general equation to calculate the rate of return k = D
t
+ (P
t
P
t-1
)/P
t

The rate of return =
6.25 + (150 125)
125

= 0.25 or 25%.
n
i i
t =1
P K
k = 0.10 x 0.20 + 0.15 x 0.10 + 0.20 x 0.5 + 0.25 x 0.20 = 0.185 or 18.5%.
187. (c) The CAPM is represented by
k
j
= R
f
+
j
(k
m
R
f
)
0.18 = 0.08 +
j
(0.15 0.08)
Beta = 1.429.
n
i i
t =1
P K
= 0.2 x 0.10 + 0.25 x 0.12 + 0.25 x 0.15 + 0.3 x 0.18
= 0.1415 or 14.15%.
189. (e) The CAPM is represented by
k
j
= R
f
+
j
(k
m
R
f
)
0.18 = 0.06 +
j
(0.12 0.06)
= 2
190. (a) Beta =
J, m
m
Convariance(K K )
Variance(K )

= 7.4/4.8 = 1.54
260
191. (b) The CAPM is represented by
k
j
= R
f
+
j

(k

m
R

f
)
= 0.08 + 1.5 (0.12 0.08) = 0.14 or 14%.
192. (e)
j

= Non-diversifiable risk of asset or portfolio/Risk of market portfolio
=
0.08
0.12
= 0.67.
193. (e) The CAPM is represented by
k
j
= R
f
+
j
(k
m
R
f
)
0.16 = 0.10 +
j
(0.14 0.10)
j
= 1.5.
194. (c) Beta =
J, m
m
Convariance(K K )
Variance(K )

= 225/200 = 1.125.
195. (d)
j
= Non-diversifiable risk of asset or portfolio/Risk of market portfolio
=
0.20
0.10
= 2.
196. (b) Expected Price =
n
i i
t =1
P K = 0.67 x 85 + 0.33 x 90 = 86.65
Rate of return k = D
t
+ (P
t
P
t-1
)/P
t
= 15.54%.
197. (a) Assume K
1
and K
2
are the implied interest rates on Bonds I and II
Bond I:
Rs.10,000
1
(k ,1)
PVIF = Rs.8,929

1
Rs.10,000
= Rs.8,929
1 + k

(or )
Rs.8,929(1 + k
1
) = Rs.10,000
k
1
= 12%
Hence, implied interest rate is 12%.
Bond II:
Rs.997.18 = Rs.100
2
(K ,1)
PVIF + Rs.100
2
(K ,2)
PVIF + Rs.1100
2
(K ,3)
PVIF

Rs.997.18 =
2 3
2 2 2
Rs.100 Rs.100 Rs.1,100
+ +
(1 + K ) (1 + K ) (1 + K )

Solving, we get K
2
= 10.1%.
Hence, implied interest rate on Bond II = 10.1%.
Hence answer is (a).
Part II
261
198. (d) Present value or intrinsic value of the stock
= PV of future dividend stream + PV of stock price at the end of the above normal growth period.
PV of future dividend stream is calculated as follows:
End of
Year
Dividend PV at 16%
(Rs. )
1 3(1.14) = 3.42 2.95
2 3(1.14)
2
= 3.9 2.90
3 3(1.14)
3
= 4.44 2.85
4 4.44(1.11) = 4.93 2.72
5 4.44(1.11)
2
= 5.47 2.60
6 4.44(1.11)
3
= 6.07 2.49
16.51
PV of stock price at the end of above normal growth period, i.e., at the end the year 6.
=
7
6
D 1
K g (1 + K)

where, K is the return required, by equity investors and g is the growth rate.
Dividend for the year 7 = Rs.6.07 (1.04) = Rs.6.31.
Market price at the end of year 6 =
Rs.6.31
= Rs.52.58
0.16 0.04

Present value of Rs.52.58 @16% =
( )
6
Rs.52.58
= Rs.21.58
1.16

Hence, total value of the stock = Rs.(16.51 + 21.58) = Rs.38.09.
Therefore, Rs.38.09 can be paid now to acquire the stock.
199. (b) EPS =
Profit after tax
No. of outstanding shares

EPS =
Rs.20,000
= Rs.4
5,000

Hence, market price per share = P
0

= Rs.4 x 2.5 = Rs.10
Since, dividend pay-out ratio = 50%
DPS = 50% x Rs.4 = Rs.2 = D
0

Given, growth rate of earnings = g = 0.04
Required rate of return by equity share holders
K
e
=
1
0
D
+ g
P

Where, D
1
= Dividend at the end of the year = D
0
(1 + g)
= Rs.2 (1 + 0.04) = Rs.2.08
K
e
=
Rs.2.08
+ 0.04 = 0.248 or 24.8%.
Rs.10

200. (c) P
0
= 12 x PVIFA
(13%,10)
+ 105 x PVIF
(13%,10)
= Rs.96.087.
201. (a) K
e
= 8 + 0.7 (20 8) = 16.4
Using CAPM

0
2(1.08)
P = = Rs.25.71
0.164 0.08

As the share is currently valued at Rs.25, it is marginally underpriced.
262
202. (b) Let the yield to maturity be i. Then,
100 = 12 x 0.7 x PVIFA
(i,5)
+ 100 x PVIF
(i,5)
Solving, we get i = 8.40%.
203. (d)
4
0 4
3
e e
D (1 g) D
P = =
K g K g
+

=
4
3(1+0.08)
= Rs.102.04.
0.12 0.08

204. (e) The maximum price at which the share can be bought = The intrinsic value of the share.
PV of dividend share till 5th year + The PV of the price at the end of the 5th year

2 3 4 5 5
3 4 5 5
2
5x 1.30 5x 1.30 5x 1.30 5x 1.30 5x 1.30 5x 1.30 x1.2 1
= + + + + + x
1.25 1.25 1.25 1.25 0.25 - 0.20 (1.25)
1.25

= 28.17 + 146.00 = 174.17.
205. (b) The required YTM is given by r in the following equation:
1,062 = 70 x PVIFA
r,8
+ 500 x PVIF
r,8
+ 35 x PVIF
r,9
+ 535 x PVIF
r,10
For r = 6%,
RHS = 70 x (6.210) + 500 x (0.627) + 35 x (0.592) + 535 x 0.558 = Rs.1,067.45
For r = 7%
RHS = 70 x (5.971) + 500 x (0.582) + 35 x (0.544) + 535 x (0.508) = Rs.999.79
r = 6% + (7 6)% x
1,067.45 1,062
1,067.45 999.79
= 6 + 1 x
5.45
= 6.08%
67.66

Required rate = 6.08 x 2 = 12.16%
206. (a)
Year Dividend PV @ 14% PV (Div)
1 10.00 0.877 8.77
2 10.00 0.769 7.69
3 12.50 0.675 8.44
4 15.62 0.592 9.25
= 34.15

4
4
e
D (1+g)
15.62 (1.12)
P = =
K g 0.14 0.12
=
17.4944
874.72
0.02
=
PV(P
4
) = 874.72 x 0.592 = 517.83
PV of CF = 34.15 + 517.83 = Rs.551.98 per share.
Since the intrinsic value of the stock is greater than the market price of Rs.150 per share
investment at current price is recommended.
207. (b) The investor may buy the share only if the rate of return provided by the share investment
is at least equal to the required rate of return.
The required rate of return of the investor is given as 12% and the rate of return from the
share investment may be calculated as follows:
K
e
=
1
0
D
+g
P
=
2.50
0.05
50
+ = 0.10 or 10%
As the rate of return provided by the share investment is only 10% as against the required
rate of return of 12%, the investor need not buy the share.

Part II
263
208. (b) Situation I (Present Position):
The share price is P
0
=
0
e
D (1+g)
K g
=
Rs.16(1.08) 17.28
=
0.18 0.08 0.10
= Rs.172.8
Situation II (Proposed Position):
The share price after announcing the reorganization (assuming that the market believes the
Directors Forecast of growth in dividends) is:
Share price at the end of year 2:
The share price is P2 =
3
e
D
K g
=
Rs.12
= 300
0.18 0.14

The present value of this price is = Rs.300 x (1/1.18)
2
= Rs.215.45
Therefore, the price in the proposed situation is higher and so the directors may adopt the
reorganization process.
209. (b) In this case, the company has paid a dividend of Rs.4 during the last year. The growth
rate, g, is 5%. Then, the current year dividend (D
1
) with the expected growth rate of 5% will
be Rs.4.20 the share price is P
o
=
1
e
D
K g

=
Rs.4.20
= Rs.31.1.
0.185 0.05

In case the growth rate rises to 8% then the dividend for the current year (D
1
) would be
Rs.4.32 and the market price would be:
The share price P
0
=
1
e
D
K g
=
Rs.4.32
0.185 0.08
= Rs.41.1.
210. (c) If the growth rate falls to 3% then the dividend for the current year (D
1
) would be Rs.4.12
and the market price would be:
0
=
1
e
D
K g
=
Rs.4.12
0.185 0.03
= Rs.26.58
211. (d) In the given situation, the value of the share can be ascertained on the basis of earnings of
the firm and the price-earning multiple as follows:
Value = EPS x P/E ratio.
The P/E ratio is given and the EPS may be ascertained as follows:
Operating profit i.e., EBIT 35,00,000
Less: Interest on 15% secured loans 6,75,000
Interest on 12.5% unsecured loans 2,50,000
Profit before tax (PBT) 25,75,000
Tax @50% 12,87,500
Profit after tax (PAT) 12,87,500
No. of equity shares (Rs.80,00,000/20) 4,00,000
Therefore, EPS (Rs.12,87,500/4,00,000) = 3.22
P/E ratio (given)
Therefore, value = EPS x P/E ratio = 3.21 x 17.5 = Rs.56.35
264
212. (c) In this case, the earnings and dividends are declining at a rate of 6% p.a. So, the growth
rate, g, may be taken as g = 0.06
The dividend for the previous year was Rs.10 and taking growth rate, g as 0.06, the value of
D
1
comes to Rs.10 (1 0.06) = Rs.9.40
The value of the share as per constant growth model is P
0
=
1
e
D
K g

=
9.40 9.40
69.6.
0.075 ( 0.06) 0.135
= =

213. (c) Basic information:
Growth rate, g, for first 5 year 20%
Growth rate, g, for 6th year onwards 10%
K
e
i.e., required rate of return 12%
Now, the value of share at different point of time can be ascertained as follows:
Present value of dividends for first 5 years
Year Dividend (Rs.) (g=20%) PVF @ 12% Present value (Rs.)
1 6 0.893 5.358
2 7.2 0.797 5.738
3 8.64 0.712 6.15
4 10.37 0.636 6.59
5 12.44 0.567 7.05
Total 30.88
Now the price at the end of year 5 (T
5
) :
5
=
5
e
D (1+g)
K g
=
Rs.12.44 (1+0.10)
= Rs.684.2
0.12 0.10

Price at T
0
(now) = PV of Rs.684.2 for 5 year + PV of all dividends
= (684.2 x 0.567) + (Rs.30.88) = Rs.418.84.
214. (e) The current market price of the share is the present value of expected future dividends
discounted at the required rate of return i.e., 18%. Since the company is expected to pay a
dividend of Rs.15 for the next three years and thereafter, the dividend will grow @10%. The
present market price with these parameters can be ascertained as follows:
The present value of the dividend for the three years:
Dividend per year = Rs.25
PVAIF (@18% 3 years) = 2.174
Therefore, PV of dividends = Rs.54.35
Price of share at the end of year 3:
3
=
4
e
D
K g
=
Rs.25(1+0.15)
= Rs.958.3
0.18 0.15

Present value of this amount at 18% for 3 years:
= Rs.958.3.25 x PVF
(18%, 3y)
= Rs.958.3 x 0.609 = Rs.583.60
Present market price is (Rs.583.60 + Rs.54.35) = Rs.637.95.
Part II
265
215. (d) If the investment proposal is accepted then the present value of dividend will be as
follows:
Year Old div. Change in dividend. Net div. PVT @18% PV (Rs.)
1 25 20 5 0.847 4.24
2 25 20 5 0.718 3.59
3 25 2 27 0.609 16.44
4 28.75 23 51.75 0.516 26.70
5 33.06 41 74.06 0.437 32.36
Total 83.33
Price of share at the end of year 5:
5
=
6
e
D
K g
=
Rs.33.06(1+0.15)
Rs.1267.3
0.18 0.15
=

Present value of this amount @18% for 5 years:
= Rs.1267.3 x PVF
(18%, 5y)
= Rs.1267.3 x 0.437 = Rs.553.81
Therefore, market price under situation II when the investment proposal is accepted is Rs. Is
(553.81 + Rs.83.33) = Rs.637.14.
216. (a) The present value of the share may be found by using the varying growth in dividends
model. The current dividend, D
o
, is Rs.5.00. This is expected to grow @16% for 3 years,
@11% for next 3 years and then @ 6% forever. This may be presented as follows:

i i 3
3 6
o 3
o
i i 3
i=1
D (1+0.16) D (1+0.11)
P +
(1+0.09) (1+0.09)
6
D (1+0.06) 1
+
(1+0.09) (0.09 0.06)

The equation may be solved as follow:
Year Dividend PVF (9%) PV
1 5.00 (1.16) = 5.8 0.917 Rs.5.31
2 5.8 (1.16) = 6.72 0.842 5.65
3 6.72 (1.16) = 7.79 0.772 6.01
4 7.79 (1.11) = 8.65 0.708 6.12
5 8.65 (1.11) = 9.60 0.650 6.24
6 9.60 (1.11) = 10.66 0.596 6.35
35.68
The value of the share at the end of 6 years may be found by using the constant growth model
as follows:

6
6
D (1+0.06) 10.66(1.06)
P = = Rs.376.65
0.09 0.06 0.03

This value should be discounted @ 9% for six years to find out P
o
as follows:

0 (9%,6)
6
376.65
P = 376.65 x PVF
(1+0.09)
= = 376.65 x 0.596 = 224.5
The current price of the share would be Rs.35.68 + 224.5= Rs.260.2.
266
217. (c) Current Dividend, D
0
= Rs.2
Expected to grow @12% for 4 years and there after @15% infinitely.
Year Dividend PVF
(12%,n)
PV
1 2 (1.12) = 2.24 0.893 Rs.2.00
2 2.24 (1.12) = 2.50 0.797 1.99
3 2.50 (1.12) = 2.80 0.712 1.99
4 2.80 (1.12) = 3.13 0.636 1.99
7.97
The price at the end of year 4, P
4
, may be as follows:
P
4
=
4
D (1+0.06) 3.13 (1.06)
= = Rs.55.29
0.12 0.06 0.06

This may be discounted @12% for 4 years to find out P
o
as follows:
P
0
= P4 x PVF
(12%, 4y)
= 55.29 x 0.637 = Rs.35.21
The current market price of the share would be Rs.7.97 + 35.21 = Rs.43.18.
218. (a) Growth rate for 4 years 15%
Growth rate for 5 onwards 8%
K
e
i.e., required rate of return 12%
Now, the value of shares are different point of time can be ascertained as follows:
Present value of dividends for first years:
Year Dividend PVF
(14%, n)
PV (Rs.)
1 D
1
= 6 x (1.15) = 6.9 0.893 6.16
2 D
2
= 6.9 (1.15) = 7.93 0.797 6.32
3 D
3
= 7.93 (1.15) = 9.12 0.712 6.49
4 D
4
= 9.12 (1.15) = 10.5 0.636 6.67
25.64
Price at the end of year 4, T
4
is P
4
=
4
D (1+0.08) 10.5 (1.08)
= = Rs.283.5
0.12 0.08 0.04

Current market price of the share: = PV of P4 for 4 years + PV of D1 to D4
= (283.5 x 0.636 + 25.64) = Rs.205.95.
219. (b) Estimation of growth rate, g, based on dividends:
The dividend for the year 1998 was Rs.2.30 and has grown to Rs.3 for 2002. So, dividends
have increased by Rs.0.70 over 4 years on the base value of Rs. 2.30. The growth rate, g, can
be calculated as follows:
2.30 x CVF
(r, 4)
= 3
CVF
(r,4)
= 1.304
In the CVF table, the values close to 1.304 for 4 years may be found in 6% (1.262) and 7%
(1.311). By interpolation, the exact rate comes to 6.16%. So, the value of growth rate, g is
6.86%.
220. (c) Estimation of g, based on earnings:
In the earnings basis, the g is defined as b r. The value of r is given as 45% and b is the
retention ratio i.e., 1
3.00
5.50
= 0.545.
Now, g = 0.4545 x 0.45 = 20.45%
Share price: P
o
=
3.00x1.2045)
0.45 0.2045
= 14.72
Part II
267
221. (b) The value of the equity share at the end of 15th year depends upon the dividend for the
16th year (D
16
), K
e
and growth rate, g as follows:
D
16
= D
15
(1+g) = Rs.16.49
The share price P
15
=
16
e
D Rs.16.49
=
K g 0.09 0.07
= Rs.824.50
This amount of Rs.824.50 is realizable after 15 years. Therefore, the present value of this
amount @ 9% is Rs.226.74 (i.e., Rs.824.50 x 0.275).
Now, the value of the share is the sum of the (i) present value of future dividend and (ii)
present value of expected price at the end of year 15 i.e.,
Value = Rs.34.96 + Rs.226.74 = Rs.261.70
222. (a) P4 =
5
e
D
K g

Where D
5
is dividend in the fifth year, g is the growth rate and K
e
is required rate of return.
Now D
5
= D
4
(1+g)
D
5
= Rs.2.28 (1+0.08) = Rs.2.46
P
4
=
2.46
= Rs.123
0.10 0.08

Present market value of P
4
= 123 x PVIF
(10%,4)
= Rs.84.01
Hence the intrinsic value per share of Gemini Ltd. would be: (A+B+C) i.e.,
= Rs.3.08 + 3.11 + 84.01 = Rs.90.20
223. (a)
Year Coupon (Rs.) PVF@16% PV (Rs.)
1 5 0.862 4.31
2 5 0.743 3.71
3 13 0.641 8.33
4 13 0.552 7.17
5 16 0.476 7.61
6 16 0.410 6.56
7 16 0.354 5.66
43.35
The present value of the redemption amount of Rs.110 (i.e., Rs.100+Rs.10) @16% p.a. is
Rs.110 x 0.354 = Rs.38.94
Therefore, the present value of the debenture is Rs.43.35+Rs.38.94= Rs.82.29. The company
should issue the debentures at this value in order to yield a return of 16% to the investors.
224. (a) The annual interest payment is Rs.500. At the end of the year 20, the bondholder receives
Rs.500 interest payment and Rs.5000 per value.
The present value of the interest payments is obtained by using PVIFA @11% and 20
payments.
PV = Interest x PVIFA
(11%,20y)
= Rs.500 (7.963) = Rs.3981.5
The PV of the Rs.5,000 principal repayment is obtained by using the PV, single-payment
factor for 11% and 20 years.
PV = Amount x PVF
(11%, 20y)
= Rs.5000 (0.124) =620
Therefore, the bonds value is Rs.4601.5
i.e., (Rs.3981.5 + 620.00).
268
225. (b) PV of bond = Interest x PVIFA
(11%, 8y)
+ Face value x PVIF
(11%, 8y)

= Rs.3,000 (5.146) + Rs.15,000(0.434) = Rs.21,948
Current price = Rs.15,000 x 75% = 11,250
Since, the bond is available at a price lower than its present value of returns, the investment
in bond is desirable.
226. (b) Earnings and dividends are declining of a rate of 6% p.a. So, the growth rate, g, may be
taken as g = 0.06.
The dividend for the previous year was Rs.14 and taking growth rate g, as 0.06, the value of
D
1
comes to Rs.14(10.06) = Rs.13.16.
P
0
=
1
e
D 13.16 13.16
= = =Rs.54.833.
K g 0.18 ( 0.06) 0.24

227. (c) EPS =
Profit after tax
No.of outstanding shares

EPS =
Rs.10,000
= Rs.4
2,500

Hence market price per share = P
0
= Rs.4 x 1.5 = Rs.6
Since dividend pay out ratio = 25%
DPS = 25% x Rs.4 = Rs.1 = D
0

Given, growth rate of earnings = g = 0.02
Required rate of return by equity shareholders = K
e
=
1
0
D
+g
P

where, D
1
= Dividend at the end of the year.
= D
0
(1+g) = Rs.1 (1+0.02) = 1.02
K
e
= Rs.
1.02
+ 0.02
6
= 0.19 or 19%.
228. (b) P
0
= 4 x PVIFA
(12%, 10)
+ 75 x PVIF
(12%, 10)

= 4 x 5.650 + 75 x 0.322 = 22.60 + 24.15 = Rs.46.75.
229. (e) K
e
= 10 + 0.7 (15 10) = 13.5, using CAPM
P
0
=
2(1.10) 2.2
=
0.135 0.10 0.035
= Rs.62.85.
230. (a) P
0
= 15 x 0.55 x PVIFA
(11, 5)
+ 100 x PVIF
(11, 5)

= 8.25 x PVIFA
(11, 5)
+ 100 x PVIF
(11,5)

= 8.25 x 3.696 + 100 x 0.593 = Rs.89.79.
231. (a) P
3
=
4
e
D
K g
=
4
o
e
D (1+g)
K g
=
4
5(1+0.10)
0.15 0.10
=
7.32
= Rs.146.4.
0.05

232. (e) P
5
=
6
e
D
K g

Rs.157.45 =
6 6
0
e e
D (1+g) 2(1+0.16)
=
K g K 0.16

Rs.157.45 =
e
4.87
K 0.16

157.45 (K
e
0.16) = 4.87
157.45 K
e
25.192 = 4.87
157.45 K
e
= 4.87 + 25.192
K
e
=
30.062
= 0.1909.
157.45

Part II
269
233. (a)
Year Dividend PV@16% PV(Div)
1 20 0.862 17.24
2 20 0.743 14.86
3 25 0.641 16.025
4 31.25 0.552 17.25
=65.375

4
4
e
D (1+g) 31.25(1+0.14)
P = =
K g 0.16 0.14
=
35.625
= Rs.1781.25
0.02

PV(P
4
) = 1781.25 x 0.552 = 983.25
PV of CF = 65.375 + 983.25 = Rs.1048.625 per share.
Since the intrinsic value of the stock is greater than the market price of Rs.250 per share,
investment at current price is recommended.
234. (c) The market interest rate increases by 2%, then the interest rate for similar type of bonds
will be (12.16% + 2%) 14.16%
Price of bond = 70 x PVIFA
(7.08,8)
+ 500 x PVIF
(7.08,8)
+ 35 x PVIF
(7.08,9)
+ 535 x PVIF
(7.08,10)

= 70 x 5.953 + 500 x 0.579 + 35 x 0.540 + 535 x 0.505 =Rs.995.29.
235. (d) Dividend pay-out ratio (D/P) =
Dividend per share(DPS)
Earnings per share(EPS)

Hence, DPS = D/P x EPS = 0.25 x Rs.6.5 = Rs.1.625.
236. (c) V
o
=
n 5
t
t t
t=1 t=1
C 1,000
=
(1+k) (1+0.15)
=
5
15%,5y
t
t=1
1,000
= 1,000 (PVIFA )
(1+k)

= 1000 x 3.352 = Rs.3,352.
237. (a) Holding period return =
(900 950) 90
990
+
=
50 90
4.21%
950
+
= .
238. (d) YTM
I +(F P) / n
0.4F + 0.6P
=
60+(995 700) / 5 60+59
=
0.4(995) +0.6(700) 398+420
119
= = 0.145 (or) =14.5%
818
.
239. (c) P
0
=
1
e
D
K g
=
4.00 4.00
= = Rs.65.57.
0.15 0.089 0.061

240. (a) The expected price-earning ratio (E(P/E)) ratio is formed by dividing the present value of
the share by the expected earnings per share denoted by E (EPS)

PV per share
E(P/E) =
E(EPS)

E (EPS) =
Expected PAT Preferencedevidend
No.of outstandingshares
=
25, 500 7, 500
1.8
10, 000
=
E (P/E) =
27.85
15.47
1.8
= .
241. (d) P
0
=
1 2 2
2 2
e e e
D D P
+ +
(1+K ) (1+K ) (1+K )

=
2 2
8 9 180
1.10 (1.10) (1.10)
+ + =
8 9 180
1.10 1.21 1.21
+ + = 7.272 + 7.438 + 148.760 = Rs.163.470.
270
242. (b) P
0
=
e
D
K
=
9
= Rs.60.
0.15

243. (e)
YEAR Dividend
1 1.6X1.20=1.92
2 1.92X1.20 =2.304
3 2.304X1.20 = 2.76
4 2.76X1.20 =3.317
5 3.317 X1.13=3.749
6 3.749 X1.13 = 4.236
7 4.236X1.13=4.78
8 4.78 X1.13=5.409
9 5.409 X1.07 = 5.78
Price at the end of 8 years = D
9
/Kg
Present value of dividend stream:
30 =
2 3 4 5 6 7 8 9
1.92 2.304 2.76 3.317 3.749 4.236 4.78 5.409 5.78
(1 k) (1 k) (1 k) (1 k) (1 k) (1 k) (1 k) (1 k) (1 k) (k g)
+ + + + + + + +
+ + + + + + + + +

At K = 16% present value of cash flow = 33.42
At K = 17 % present value of cash flow = 29.82
So, K = 16 +
33.42 30
x1
33.42 29.82
= 16.95 %.
244. (d)
Year Dividend 18%
1 2.3000000 0.847 1.948100
2 2.6450000 0.718 1.899110
3 3.0417500 0.609 1.852426
4 3.3459250 0.516 1.726497
5 3.6805175 0.437 1.608386
6 4.0485693 0.370 1.497971
7 4.2509977
PV of dividends 10.53
Price of the share = PV of dividends @18% +
6
4.2509977
(1.18) x (0.18 0.05)
= 10.53 + 12.11 = Rs.22.64.
245. (d) EPS of the firm will increase by 50% as the market price will remains same
P/E ratio for unleveled firm x EPS = P/E ratio of levered firm x increased EPS
10 x EPS = = P/E ratio of levered firm x 1.5EPS
P/E ratio of levered firm =10/1.5 =6.67
246. (d) Debt of 160 million has been replaced with the equity so the market value of the firm
will be Rs.250 million and market price remains unchanged.
Part II
271
247. (d)
1 2 3 4 5
Dividend 10 10.5 11.025 11.57625
EPS 15 15.75 16.5375 17.36 18.23
Price at the year 4 = EPS
5
/ 0.8 187.5
PVIF 0.926 0.857 0.794 0.735
PV 9.26 8.9985 8.75385 176.02
Existing stock Price 203.02
248. (b) Current share price = 20/1.10+125/1.10 = Rs.131.82
249. (e) Market Price = 10/(0.08 0.05) = Rs.333.33
250. (b) Given dividend for year 0 D
0
= 1
D
1
= 1.20 D
2
= 1.20(1.20) = 1.44, D
3
= 1.44(1.20) = 1.728,
D
4
= 1.728(1.20) = 2.0736, D
5
= 2.0736(1.20) = 2.48 D
6
= 2.48 x 1.10 = 2.73
6
/ K g
Required rate of return is the value of K in the following equation
P
0
= 1.20 x PVIF
(K, 1)
+ 1.44 x PVIF
(K, 2)
+ 1.728 x PVIF
(K, 3)
+ 2.0736 x PVIF
(K, 4)
+ 2.48
PVIF
(K, 5)
+2.73/(K0.10) x PVIF
(K, 5)

By solving we can get
K = 18% L.H.S of the equation becomes 20.20 and K = 19% L.H.S = 17.83
So K= 18.10% (approx).
251. (d)
YEAR
Dividend PVIF(36%) PVIF(40%)
1 6 x1.20=7.20 5.29 5.14
2 7.20 x1.20 =8.64 4.67 4.41
3 8.64 x1.20 = 10.37 4.12 3.78
4 10.37 x1.20 =12.44 3.64 3.24
5 12.44 x1.13=14.05 3.02 2.61
6 14.05 x1.13 = 15.88 2.51 2.11
7 15.88 x1.13=17.94 2.08 1.70
8 17.94 x 1.13=20.28 1.73 1.37
9 20.68 x 1.07 = 21.70
9
/K g
At K = 36% P
8
= 74.82 and present value of cash flow = 33.41
At K = 40 % P
8
= 65.75 and present value of cash flow = 28.83
By Interpolation,
K = 36 +
33.41 30
4
33.41 28.83

= 38.97%.
252. (d) The required rate of return from that stock is k
e
= R
f
+ (R
m
R
f
)
= 6 + 1.50 (12 6) = 15 percent
The growth rate of dividend is 5%
So, the price of the share can be calculated as:

( )
0
e
D 1 g 2 1.05
P
k g 0.15 0.05
+
= =

= Rs.21.
272
253. (a) The face value of these bonds is = Rs.100 while the amount of coupon payment is
= Rs.100 12 percent = Rs.12.
Current yield of the bond will be =
12
100
114
= 0.10526 = 10.53 percent (approx).
254. (a) We know that dividend yield =
Dividend per share (DPS)
Market price per share (MPS)
=
DPS EPS
EPS MPS

= Dividend pay out ratio capitalization rate = 0.3 8 = 2.4 percent.
255. (a) Let the issue price of the bond be P
P (1.08)
20
= Rs.1,00,000
P =
Rs.1, 00, 000
4.66096
= Rs.21,455.
256. (d) Yield on the T-bills may be calculated as:
k =
F P 365
P d

where, F = Rs.100, P = Rs.98.48 and d = 91 days
Hence, k =
100 98.48 365 1.52 365
98.48 91 98.48 91
=
Or, k =
1.52 365
98.48 91

Or, k = 0.0619 (approximately)
Hence, the required yield on the T bills will be = 6.19 percent = 6.2 percent
(approximately).
257. (a) Discount rate before conversion = 5 + 3 = 8 percent and the same after conversion will be
= 8 + 4 = 12 percent.
The expected cash flows from that instrument will be as follows:
Year 1 2 3 4 5 6
Cash flows 9 9 9 10 10 10
Here, the cash flows for the first three years will occur half-yearly where each installment is
of Rs.4.50 and it has been assumed that the holder of the instrument will hold all the shares
and will get the dividends. The intrinsic value of the debentures is = Present value of all the
above cash flows = Rs.4.50 PVIFA
(4%,6)
+10 {PVIF
(12%,4)
+ PVIF
(12%,5)
+ PVIF
(12%,6)

+ .}
= Rs.4.50 5.242 +
( )
4
10 1
1
1.12
1
1.12

= Rs.4.5 5.24 +
( )
3
10 1
0.12
1.12

Hence, the required intrinsic value = Rs.82.90 = Rs.83 (approximately).
258. (c) Present market value of the bond is Rs.108 and the amount of coupon interest to be
received annually = Rs.108 8.33 percent = Rs.8.9964 = Rs.9
Hence, the amount of coupon payments to be received half-yearly = Rs.4.50 and the number
of coupons n = 2 3 = 6.
So, the approximate half-yearly realized yield to an investor will be
r =
( )
( )
( )
( )
I F P / n Rs.4.50 100 108 / 6
F p / 2 100 108 / 2
+ +
=
+ +
= 0.03045 = 3.045%
So, the approximate annualized yield to an investor will be = ( )
{ }
2
1.03045 1 100
= 6.18 percent.
Part II
273
259. (d) The present value of the dividend stream to an investor is given as:
=
2 3
Rs.2.00 1.15 1.15 1.15
Rs.2.00 Rs.2.00
1.10 1.10 1.10

+ +

3 3
4 5
(1.15) (1.15)
Rs.2.00 Rs.2.00 ...
(1.10) (1.10)
+ + +
= Rs.2.091 + Rs.2.186 + Rs.2.285
1
1
1
1.10

= Rs.29.41 = Rs.29 (approximately).
260. (c) Total assets of the company = Rs.25 lakh + Rs.40 lakh = Rs.65 lakh and so the amount of
EBIT registered by the company = Rs.65 lakh 12 percent = Rs.7.80 lakh.
Now, interest paid by the company against the debt capital = Rs.40 lakh 9 percent =
Rs.3.60 lakh. Hence, the earnings before taxes is = Rs.7.80 lakh Rs.3.60 lakh = Rs.4.20
lakh and the net profit for the company = Rs.4.20 lakh 0.60 = Rs.2.52 lakh.
Therefore, the earnings per share will be = Rs.2.52.
261. (c) Let, the effective yield from those bonds be r . So, by the condition,
Rs.5,000 ( )
1
5
3
1 r Rs.7, 000 + =
Or, ( )
16
3
1 r 1.4 + =
Or, r = 6.51 percent (approximately).
262. (c) The intrinsic value of the equity share of the company is = P
0
=
1
D
k g

Here, D
1
= Rs.2.50 1.08 = Rs.2.70
K = 16 percent and of = 8 percent.
So, the required intrinsic value is P
0
=
2.50 1.08
0.6 0.08
=
2.7
Rs.33.75
0.08
=
263. (b) Let the face value of the debentures be Rs.100
So, the annual interest from each of these debentures is = Rs.12
Present selling price of these debentures is = Rs.100 (1.08) = Rs.108.
Therefore, the current yield from each of these debentures =
12 100
100 11.11.
108 9
= =
264. (d) Let the issue price be x
By the terms of the issue of the T-bills,
6 percent =
100 x 365
100
x 91

or,
6 91 x
36, 500

= (100x)
or, 0.01496 x = 100 x
or, x =
100
1.01496
= Rs.98.53.
265. (c) Let the face value be Rs.100 and the amount of dividend per annum = 100 10% = Rs.10
So, the current yield =
Rs.10
100
Rs.125
= 8 percent
Now, if the required yield increases by one percent, the market value will be
=
Rs.10
Rs.111.11
0.09
=
So, the premium on the price of the preference shares will be = 11.11 percent.
274
266. (d) Dividends for the next three years are as follows:
Year 1 2 3
Dividend (Rs.) 4 1.15 = 4.60 4 1.15 1.15 = 5.29 4 (1.15)
3
= 6.084
So, the required intrinsic value of the share is
=
4.60
1.16
+
2
5.29
(1.16)
+
3
6.084
(1.16)
+
3
6.084 1.06 1
0.16 0.06 (1.16)

= 3.97 + 3.93 + 3.90 + 41.32 = 53.12 Rs.53 (approx.).
267. (c) Let the face value of the bond be Rs.100 and the interest on the bond is Rs.10 per annum.
The present market price of the bond = Rs.95.
Let k be the effective yield on the bond.
So, from the condition of the present values of the cash inflows and outflows
Rs.95 = Rs.10 PVIFA
(k, 5)
+ Rs.50 PVIF
(k, 5)
+ Rs.55 PVIF
(k, 6)

At k = 11%, the right hand side
= 10 3.696 + 50 0.593 + 55 0.535 = 36.96 + 29.65 + 29.425 = 96.035
and at k = 12%, the right hand side
= 10 3.60 5 + 50 0.567 + 55 0.507 = 36.05 + 28.35 + 27.885 = 92.285
By interpolation, we get
k 11
12 11
=
95 96.035
92.285 96.035

or, k = 11 +
1.035
3.75

or, k = 11.28.
So, the required effective yield to the investor = 11.28 percent.
268. (a) Let the approximate maturity period for the bonds be n years and the face value of the
bonds be Rs.100.
The yield to maturity of the bonds is defined as, through approximation method
YTM =
( )
( )
I F P / n
F P / 2
+
+

Here, we have, I = Rs.9.00, P = Rs.100 F = Rs.110 and YTM = 12 percent.

( )
( )
9 110 100 / n
0.12
110 100 / 2
+
=
+

9 10 / n
0.12
105
+
= or 12.6 9 =
10
n

or, n =
10
2.78
3.6
= years.
269. (c)
E(P/E) =
1
D 1
x
k g E(EPS)

D
1
= D
0
(1 + g)
33.3 =
20(1 g) 1
x
0.15 g 7.5
+

g = 6.47%.
Part II
275
270. (b) Current Yield =
Coupon interest
Current market price

Current market price =
Current yield
Coupon interest
=
70
0.09
= 777.77 or Rs.778.
271. (a) The intrinsic value or the present value of the bond is given by
V
0
=
d
k n
I (PVIF , )
+
d
k n
F (PVIF , )
Where,
V = Intrinsic vale of the bond
I = annual interest payable on the bond
F = Principal amount (par value) repayable at the maturity time.
N = maturity period of the bond
K
d
=
cost of capital
V
o
= 100 (PVIFA
12%, 5
) + 1000 (PVIF
12%, 5
) = 100 x 3.605 + 1000 x 0.567 = 927.5.
272. (d) The intrinsic value or the present value of the bond is given by
V
0
=
d
k n
I (PVIF , ) +
d
k n
F (PVIF , )
87.52 = I (PVIFA
15%, 7
) + 100 (PVIF
15%, 7
)
I = 12% .
273. (b) The value of a share when dividend increase at a constant, compound rate is given by
P
0
= D
1
/k g
Where,
P
0
= the current market price of the equity share
D
1
= the expected dividend a year hence
D
1
= D
0
(1 + g) where D
0
g = growth rate
By substituting the values in the above formula we get 20 = 2/0.14 g
g = 0.04 or 4%.
274. (c) The intrinsic value or the present value of the bond is given by
V
0
=
d
k n
I (PVIF , ) +
d
k n
F (PVIF , )
Value of the bond = 120 x PVIFA
10%,3
+ 1000 x PVIF
10%, 3
= 1049.44.
275. (d) The value of a share when dividend increase at a constant, compound rate is given by
P
0
= D
1
/k g
Where,
P
0
D
1
D
1
= D
0
(1 + g) where D
0

g = growth rate
By substituting the values in the above formula we get 70 = 3.5/0.20 g
g = 0.15 or 15%.
276
276. (c) The value of a share when dividend increase at a constant, compound rate is given by
P
0
= D
1
/k g
Where,
P
0
D
1
D
1
= D
0
(1 + g) where D
0
g = growth rate
P = 10 (1 + 0.10)/0.15 0.10 = 220.
277. (c) Current yield =
Coupon interest
=
150
900
= 16.67%.
P
0
= D
1
/k g
Where,
P
0
D
1
D
1
= D
0
(1 + g) where D
0
g = growth rate
41.25 = 3 (1 + g)/ 0.18 g
g = 0.1 or 10%.
279. (e) If a bond is purchased and then sold one year later, its rate of return over this single period
can be defined as
Rate Return =
Price gain or loss during the peiod + Coupon Interest (if paid)
Purchase Price at the beginning of the holding period

Price gain = 960 900 = 60
Rate of return = (60 + 80) / 900 = 0.1555 or 15.55%.
280. (d) Expected yield =
Expected income

Current market price =
Expected yield
Expected income
=
15
0.20
= 75.
P
0
= D
1
/k g
P = 2.6/0.18 0.10 = 32.5.
282. (b) The intrinsic value or the present value of the bond is given by
V
0
=
d
k n
I (PVIF , ) +
d
k n
F (PVIF , )
15%,

3
+ 1000 x PVIF

15%, 3
= 1000.45
When the required rate is equal to its coupon rate, the value of the bond is equal to its par
value.
Part II
277
283. (a) The value of a share when dividend increases at a constant, compound rate is given by
P
0
= D
1
/k g
Where,
P
0
D
1
D
1
= D
0
(1 + g) where D
0
g = growth rate
The intrinsic value or the current market price = 2.4 (1 + 0.10)/ 0.16 0.10 = 2.64/0.06 = 44.
284. (c) Issue price =
d
k n
F (PVIF , )
1,00,000 x PVIF
15%, 25
= 3,000.
285. (d) The value of a share when dividend increase at a constant, compound rate is given by
P
0
= D
1
/k g
D
1
= D
0
(1 + g)
Intrinsic value of the share = 2 (1 + 0.08)/0.15 0.08 = 30.857.
286. (a) Current yield = Coupon interest/Current market price
0.15 = 12/Current market price
Current market price = 80.
V
o
=
d
k n
I (PVIF , ) +
d
k n
F (PVIF , )
18%,4
+ 105 x PVIF
18%,4
= 94.53.
288. (c) P
0
= D
1
/kg when g = 0, P
0
= D
1
/k
P = 10/0.20 = 50.
V
o
=
d
k n
I (PVIF , ) +
d
k n
F (PVIF , )
10%,5
+ 1,000 x PVIF
10%, 5
= 360.5 + 567 = 927.50
290. (c) P
o
= D
1
/kg
32 = 2 / 0.13 g
g = 6.75%.
291. (c) The intrinsic value or the present value of the bond is given by
V
o
= I
d
k n
(PVIF , ) +
d
k n
F (PVIF , )
14%,5
+ 1,000 x PVIF
14%, 5
= 930.96 or 931.
292. (c) P
o
= D
1
/ k g = 3.2/ 0.12 0.04 = 40.
293. (a) Current yield =
Coupon interest
=
100
900
= 11.11%.
294. (c) P
o
= D
1
/ k g
D
1
= D
0
(1 + g)
154 = 15 (1 + 0.1)/k 0.1
k = 20.71%.
278
295. (b) Number of equity shares of the company
Rs.8,40,000
= Rs.84,000
Rs.10
=
Preference dividend paid =
15
x Rs.6,00,000 = Rs.90,000
100

i. Dividend yield =
Dividend per share (DPS)
Market Price per share (MPS)

Where, DPS =
Rs.3,36,000
= Rs.4
Rs.84,000

Hence, Dividend yield =
Rs.4
= 20%
Rs.20

ii. Return on equity =
Net profit after preference dividend
Net worth

=
Rs.(9,00,000 90,000)
Rs.(8,40,000 + 12,60,000)
=
Rs.8,10,000
Rs.21,00,000
= 0.386 = 38.6%.
296. (c) Yield on stock =
t t t 1
t 1
D + (P P )
P

Where,
D
t
= Dividend received during the year t
P
t1
= Share price during t1 year
P
t
= Share price during year t
Therefore, yield on stock =
Rs.4 + (Rs.20 18)
= 33.3%
Rs.18

.
297. (b) Given collection period = 180 days
Receivables turnover = 2
Therefore,
Accounts receivable =
Net credit sales
Receivable turnover
=
Rs.2,00,000
= Rs.1,00,000
2

Stock =
Net credit sales
Stock turnover
=
Rs.2,00,000
= Rs.1,60,000
1.25

Net profit = Rs.2,00,000 x 10% = Rs.20,000
Given net profit to investment = 4%
Total investment (or total assets) =
Rs.20,000
0.04
= Rs.5,00,000
Fixed assets =
Sales
Fixed assets turnover
=
Rs.2,00,000
= Rs.2,22,222
0.9

Hence, other current assets = Rs.5,00,000 Rs.2,22,222 = Rs.2,77,778
Total liabilities including capital = Rs.5,00,000
Given, Debt Assets ratio = 0.5
Total Debt = Rs.2,50,000
Given, shortterm debt = Rs.50,000
Longterm debt = Rs.2,00,000
Part II
279
Share capital (Liabilities total debt) = Rs.2,50,000
Number of shares = 25,000 [2,50,000/10]
Gross profit = Total sales Gross profit margin
= Rs.50,000
Cost of goods sold = Total sales Gross profit
= Rs.1,50,000
EPS =
PAT Rs.20, 000
No. of Share Rs.25, 000
= = Rs. 0.80 or 80 paise.
298. (c)
i. Sales =
Gross profit
Gross profit margin
Rs. 60,000
=
20%
= Rs. 3,00,000
ii. Cost of goods sold = Rs.(3,00,000 60,000) = Rs.2,40,000
iii. Average stock =
Cost of goods sold
Inventory turnover
Rs.2,40,000
=
6
= Rs.40,000
iv. Total stock = Rs.40,000 x 2 = Rs.80,000
Given, opening stock is Rs.5,000 less than closing stock.
Let opening stock = x
Closing stock = x + 5000
x + x + 5000= 80,000
2x = 75000
x = 37,500
Opening stock = Rs.37,500
Closing stock = 80,000 37,500 = 42,500
Closing stock = Rs.42,500
Opening stock = Rs.37,500
v. Accounts receivable =
Rs.3,00,000 x 2
= Rs.50,000
12

(Assuming all sales are credit sales)
vi. Fixed assets =
Sales
Fixed assets turnover
=
Rs.3,00,000
Rs.75,000
4
=
Since, it is a manufacturing company.
Purchases on credit = Cost of goods sold + Increase in inventory
(Assuming all purchases are credit sales) = Rs.2,40,000 + Rs.5,000 = Rs.2,45,000.
Creditors =
Purchases x Creditors payment period
365
= Rs.49,000
Equity =
Cost of goods sold
Capital turnover
=
Rs.2,40,000
Rs.1,20,000.
2
=
Balance Sheet
Equity 1,20,000 Fixed Assets 75,000
Reserves & Surplus 20,000 Inventory 42,500
Long-term Liabilities 60,000 Current Assets (balancing figure) 81,500
Creditors 49,000 Accounts Receivable 50,000
2,49,000 2,49,000
280
299. (b) The appropriate measure to be used is net profit margin as Rs.25 worth of groceries
represent the sales of the company.
Net profit margin =
33.75
15%
225
=
The profit that the company makes on a sales Rs.25 = 25 x 0.15 = Rs.3.75
As the child earns Rs.7.50, i.e., double of what the company earns, the claim is correct.
300. (c) To assess the liquidity position we need to calculate the current ratio and quick ratio.
Current ratio =
Current assets
Current liabilities

Current ratio (for year 1) =
1,77,000
= 2.64
67,000

Current ratio (for year 2) =
2,36,000
= 2.46
96,000

Quick ratio =
Current assets Inventories
Current liabilities

Quick ratio (for year 1) =
82,000
= 1.22
67,000

Quick ratio (for year 2) =
1,11,000
= 1.16
96,000

Comment: The CR and QR for the two years can be considered healthy as CR is more than 2
and QR is more than 1. But as the ratios are decreasing, we can say that the liquidity of the
company is being adversely affected.
To assess the profitability position we need to calculate the gross profit margin and net profit
margin.
Gross profit margin =
Gross profit
x 100
Sales

Gross profit margin (for year 1)=
1,06,000
x 100 = 23%
4,60,000

Gross profit margin (for year 2)=
1,44,000
x 100 = 24%
5,94,000

Net profit margin =
Net profit
x 100
Sales

Net profit margin (for year 1) =
25,500
x 100 = 5.5%
4,60,000

Net profit margin (for year 2) =
40,700
x 100 = 6.9%
5,94,000

Comment: Though GPM for the two years is high, NPM is too low for the two years which
indicates very high operating expenses. Both the ratios are following an increasing trend
which indicates improving performance.
Part II
281
301. (a)
1. Interest Coverage Ratio
(ICR) =
EBIT
Interest

EBIT = Earnings before interest and tax = EBDIT Depreciation
Year 3 = 3,318 855 = 2,463
Year 2 = 2,887 667 = 2,220
Year 1 = 2,233 410 = 1,823
ICR =
EBIT
Interest

ICR Year 3 =
2,463
= 3.38
728

ICR Year 2 =
2,220
= 4.41
503

ICR Year 1 =
1,823
= 6.07
300

2. Return on Net Worth =
PAT
NW
=
Profit after tax
Net worth

RON Year 3 =
1,704
= 0.1378 = 13.78%
12,369

RON Year 2 =
1,653
= 0.1379 = 13.79%
11,983

RON Year 1 =
1,323
= 0.1561 = 15.61%
8,471

Comment 1: Financial risk was covered significantly during year 1, whereas, during
year 2 and year 3 it has declined. The reducing interest coverage ratio indicates that
financial burden has been increased.
Comment 2: From data, net worth increased significantly (by Rs.3,512 crore) i.e., by
41.46% from year 1 to year 2 whereas PAT has increased by only 24.9% and hence
RONW has decreased from 15.62% to 13.79%. Similarly, from year 2 to year 3 net
worth increased by 3.2% and PAT also increased by 3.08% and hence RONW remain
almost unchanged.
302. (a) The investors would be interested in the D/E ratio and the interest coverage ratio of Max
Value Co. under pre and post debenture issue.
D/E ratio =
Long-term debt
Net worth

D/E ratio (for year 1) =
1,48,000
= 1.33
1,11,300

D/E ratio (for year 2) =
2,03,000
= 1.34
1,52,000

New D/E ratio =
4,03,000
= 2.65
1,52,000

(With issue of debentures)
Interest Coverage Ratio (ICR) =
EBIT
Interest
(Net profit + interest + taxes)
282
ICR (for year 1) =
53,950
= 3.08
17,500

ICR (for year 2) =
81,500
= 3.26
25,000

New ICR(with EBIT of year 2) =
81,500
= 1.43
57,000

The D/E ratio of the firm is low initially with the issue of debentures and without any change
in net worth D/E would increase to 2.65 which indicates high financial risk. The interest
coverage ratio is above 3 times in the two years but with the issue of debentures ICR will
decline to 1.43. Hence, it can be considered risky to invest in the debentures of the company.
303. (b) EPS =
Net profit
Number of outstanding shares
=
Rs.80.13
= Rs.7.705
10.4

i. Dividend Capitalization Approach:
Payout ratio =
18.72
= 23.36% = b
80.13

P
0
=
e
b x EPS(1+ g)
K g

Given, K
e
= 24% and g = 22% =
Rs.0.2336 x 7.705 x 1.22
= Rs.109.79
0.24 0.22

ii. PE Ratio Approach
P/E ratio =
28
7.705
= 3.63
Expected EPS = Rs.7.705 x 1.22 = Rs.9.40
P
0
= 9.4 x 3.63 = Rs.34.12.
304. (e)
i. Acid Test Ratio =
CA Inventories 3,800 2,100
= = 1.012
CL 1,680

ii. Earning Power =
EBIT
Total assets
=
PBT + I 1,060 460
=
Total assets 7,120
+
= 0.2135 i.e., 21.35%
iii. Debt Service Coverage ratio
PAT + Depreciation + Interest
=
Interest + Loan repayment during the year

=
742 + 480 + 460 1,682
= = 2.55(approx.)
460 + 200 660

305. (a)
i. Return on total assets (2004) =
Profit after tax
x100
Total assets
=
Rs.5, 20, 000
x100 = 8.12%
64, 00, 000

ii. Return on capital employed (2004) =
EBIT
x 100
Total Capital Employed

=
Rs.12,00,000
x 100 = 27.20%
Rs.44,12,000

iii. Return on equity funds (2004) =
PAT
x100
Equity funds
=
Rs.5, 20, 000
x100
Rs.28,12, 000
= 18.5%.
Part II
283
306. (d) i. Current ratio (2004) =
Current Assets Rs.30,52,000
=
Current liabilities Rs.8,00,000
= 3.81
ii. Acid test ratio (2004) =
Liquidassets
Current liabilities
=
Rs.30,52,000 21,72,000
Rs.8,00,000
= 1.1.
307. (a) i. Debt equity ratio =
Long termdebts
Equityfunds
=
Rs.16,00,000
Rs.28,12,000
= 0.57
ii. Interest coverage ratio =
EBIT
Interest charge
=
Rs.12,00,000
Rs.1,60,000
= 7.5 times.
308. (b) i. Debtors Turnover =
Sales
Average debtors
=
Rs.40,00,000
Rs.3,60,000
= 11.1 times
ii. Stock Turnover =
Cost of goodssold
Averagestock
=
Rs.28,00,000
Rs.20,00,000
= 1.4 times
iii. Total assets turnover =
Sales
Averageassets
=
Rs.40,00,000
Rs.60,00,000
= 0.67 times.
309. (b) i. Debt equity ratio =
Debt
Equity
=
Rs.300lakh
Rs.560lakh
= 0.54
ii. Interest coverage ratio =
EBIT
Interest
=
Rs.320lakh
Rs.120lakh
= 2.66
Working notes:
Debt:
Long-term loan = Rs.300 lakh + Short-term loan (360) = Rs.660 lakh
Equity:
Capital Rs.250 lakh
Reserve Rs.280 lakh
P&L A/c Rs.30 lakh
Rs.560 lakh
EBIT:
Rs.
Profit for the year (30 + 90) 120 lakh
Interest 120 lakh
Tax@ 40%
120 40
60

80 lakh
320 lakh
310. (c) Current ratio =
Current assets
Current liabilities
=
Rs.950lakh
Rs.540lakh
= 1.76.
Working notes:
(Rs. In lakh)
Current Assets Current Liabilities
Stock 460 Short term loan 360
Debtors 460 Trade Credit 150
Cash 10 Other Liabilities 30
930 540
284
311. (b)
(Rs.)
Operating profit 25,00,000
Less: Interest on
Secured loans @ 15% 3,75,000
Unsecured loans 1,25,000 5,00,000
Profit Before Tax (PBT) 20,00,000
Less: Income Tax @ 50% 10,00,000
Profit After Tax (PAT) 10,00,000
No. of equity shares 2,50,000
EPS =
Profit after tax
No.of equityshares
=
Rs.10,00,000
= Rs.4
Rs.2,50,000

P/E ratio = Market price per share/EPS = Rs.50/Rs.4 = 12.50.
312. (d) EPS = PAT/No. of shares = 1,50,000/50,000 = 3.00.
Price = (EPS) x (P/E) = (3.00 x 8) = Rs.24.
313. (a) i. Earning yield = EPS/Market price =
Rs.5,00,000 42,000/Rs.16,00,000
Rs.4
= 7.16%.
ii. Net cash flow
(Rs.)
Profit after tax 5,00,000
+ Depreciation 1,20,000
Dividend on pref. shares 42,000
Dividend on equity shares 3,20,000
Net cash flow Rs.2,58,000
314. (b) i. Dividend yield on ordinary shares:
Dividend per share = 20% of paid-up value = Rs.0.20/20ps
Therefore, Dividend yield = (DPS/Market Price) x 100 = (0.20/4) x 100 = 5%
ii. Price/Earnings ratio = Market price/EPS = 4/0.2863 = 13.97.
315. (e)
Balance Sheet of XYZ Ltd.
Owners equity 1,00,000 Fixed assets 60,000
Current debt. 24,000 Cash 60,000
Long-term debt. 36,000 Inventory 40,000
1,60,000 1,60,000
Working notes:
1. Total debt is 60% of owner equity and is therefore, Rs.60,000
2. Current debt is 40% of total debt and is therefore, Rs.24,000
3. Long-term debt is therefore, Rs.60,000 24,000 = Rs.36,000
4. Fixed assets are 60% of owners equity and are therefore, Rs.60,000.
Part II
285
5. Total Assets = Owners equity + Total debt
= Rs.(1,00,000 + 60,000) = Rs.1,60,000
6. Current Assets = Total assets Fixed assets = Rs.(1,60,000 60,000) = Rs.1,00,000
7. Inventory:
Asset turnover = (Sales/Assets) = 2
Therefore, Sales = Rs.3,20,000
Inventory turnover = Sales/Inventory
Therefore, Inventory = Rs.40,000.
316. (d) The EBIT of the firm is 12% of sales i.e., 12% of Rs.15 crore and is therefore Rs.1.8
crore.
Amount
EBIT 1,80,00,000
Less: Interest 45,00,000
Profit before tax 1,35,00,000
Less: Tax @ 40% 54,00,000
Profit after tax 81,00,000
Less: Pref. Dividend 13,00,000
Returns for equity 68,00,000
Return on equity =
PAT Pref.Dividend
x100
Equity
=
Rs.68,00,000
x100
Rs.5,00,00,000
= 13.6%.
317. (b) i. Net Profit Margin =
PAT
x 100
Sales
=
48,000
x 100
7,20,000
= 6.7%
ii. Assets Turnover =
Sales
Total assets
=
7, 20, 000
8, 00, 000
= 0.9 times.
318. (a) i. Return on assets =
PAT
x 100
Total assets
=
48,000
x 100
8,00,000
= 6%
ii. Return on owners equity =
PAT
x100
Equity
=
48,000
x 100
4,00,000
= 12%.
319. (b)
CA
=1.8 CA=1.8CL
CL

CA CL = 2,40,000
1.8 CL CL = 2,40,000
0.8CL = 2,40,000
CL = 3,00,000
CA =1.8 3,00,000
= 5,40,000

CA Stock 5, 40, 000 Stock
=0.6 =0.6
CL 3, 00, 000

Stock = 3,60,000
286
Total CA = 5,40,000
Stock = 3,60,000
Other current assets = 1,80,000
Total CL = 3,00,000
Bank OD (given) = 1,20,000
Other CL = 1,80,000.
320. (a)
(Rs. in lakh)
Existing Proposed
Earning Before Interest and Tax 15.00 18.00
Less: Interest
Term loan (15%) 7.50 7.50
Bank borrowing (20%) 6.60 11.60
Public deposit (14%) 2.10 2.10
Total interest 16.20 21.20
Loss after interest (1.20) (3.20)
Interest coverage ratio
Rs.15 lakh
Rs.16.20 lakh
= 0.925
Rs.18 lakh
Rs.21.20 lakh
= 0.849
So, it appears that the interest coverage ratio will fall and hence revised proposal is not
desirable.
321. (c) i. Earnings per share =
Net profit after preferencedividend
Number of equityshares

=
Rs.15,00,000 Rs.5,00,000
Rs.70,000
= Rs.14.29
ii. Price earnings ratio =
Market price per share
Earning per share
=
Rs.200
14.29
= 14 times.
322. (d) i. The cover for the preference and equity dividends:
=
Profit after tax
Preferencedividend +Equitydividend
=
Rs.15,00,000
Rs.5,00,000+Rs.7,00,000
= 1.25 times
ii. The net funds flow:
Profit after tax = Rs.15,00,000
Add. Depreciation = Rs. 6,00,000
Rs.21,00,000
323. (a) Inventory turnover ratio:
Cost of goods sold 60,00,000 75,00,000 80,00,000
Average inventory 10,00,000 15,00,000 20,00,000
= 6 times = 5 times = 4 times
The Inventory Turnover Ratio (ITR) indicates that firm A is having highest inventory
turnover of 6 times. So, this firm is able to make relatively higher sales with lower level of
inventories and thus is making an efficient use of its working capital.
Part II
287
324. (c) Average Collection Period:
Averagereceivables
360
Credit sales

=
13, 20, 000
360
66, 00, 000

=
24,97,500
360
83,25,000
=
35,84,000
360
89,60,000

= 72 days = 108 days = 144 days
The above calculations show that the number of days credit allowed by Firm A is 72 days, by
Firm B is 108 days and by Firm C is 144 days. It indicates that the Firm A is following a
relatively sound credit policy whereas B and C are following a liberal credit policy.
325. (a) The net profit ratio of the firm is lower than the industry standard and thus indicates
higher cost of production/higher operating expenses of the firm. The net profit to total assets
ratio is also less than the industry standard indicating that the total assets are
disproportionately higher and not properly managed. The ratio of net profit to Net worth is
also less than the industry standard indicating that the firm is not a leveraged firm.
326. (c) The current ratio of the firm is slightly higher than the industry standard indicating a
better position of the firm. However, the current assets may be proportionately higher due to
excessive stock maintained by the firm as reflected in the low stock turnover ratio. The firm
has Debtors turnover of 10 (i.e., the collection period is 36 days) as against the industry
average of 8 times (i.e., credit period of 45 days.) This indicates that the firm is following a
stringent credit policy. There may be a scope for making the credit policy more liberal so as
to attract more customers. So, there is a need for review of credit policy of the firm.
327. (b) The stock turnover ratio indicates that the firm is maintaining higher level of stock of 3.6
months (i.e.,12 3.33) as against the stock of 1.22 months (12 9.8) standard of the industry.
The assets turnover ratio of the firm also indicates that the assets of the firm are
comparatively higher indicating under utilization of fixed assets.
328. (e) i. Earning Per Share (EPS) =
Profit after tax preferencedividend
No.of equityshares

=
2,70,000 27,000
80,000
= Rs.3.04
ii. PE ratio (or) Price earnings ratio =
Market price
EPS
=
40
3.04
= 13.16.
329. (b) Operating ratio =
Operatingexpenses
x 100
Sales

= Rs.11,00,000 + Rs.35,000 +
Rs.25,000 + Rs.50,000
x 100
Rs.15,00,000

=
Rs.12,10,000
x 100
Rs.15,00,000
= 80.67%.
330. (a) Interest Coverage Ratio
=
Profit beforeinterest +Tax
Interest
=
Rs.2,99,000
Rs.47,000
= 6.36 times.
Return on capital employed (ROCE):
Capital employed: Rs.
Equity share capital 3,50,000
Preference share capital 2,00,000
Long-term loan (2%) 1,00,000
Debentures (14%) 2,50,000
11,00,000
ROCE =
Net profit beforeinterest and tax
x100
Capital employed
=
Rs.2,99,000
x100
Rs.11,00,000
= 27.18%.
288
331. (b) Current ratio =
Curretn assets
Current liabilities

2.6 =
Current Assets
40,000

Current assets = 40,000 x 2.6 = Rs.1,04,000
Liquid assets = 40,000 x 1.5 = Rs.60,000
Inventory = Current assets liquid assets = Rs.1,04,000 60,000 = Rs.44,000.
332. (c) Working capital = Current assets Current liabilities
Let current liabilities be X So, current assets will be 2.8X
90,000 = 2.8X X
90,000 = 1.8X
X =
90,000
1.8
= Rs.50,000
So, current liabilities = Rs.50,000
Current assets = Rs.50,000 x 2.8 = Rs.1,40,000
Liquid assets = Rs.50,000 x 1.5 = Rs.75,000
Inventory = Rs.1,40,000 75,000 = Rs.65,000.
333. (a) Quick Ratio =
Quick (liquid) assets
Current liabilities

2.5 =
Liquidassets
50,000

Liquid assets = Rs.50,000 x 2.5 = Rs.1,25,000
Current assets = Liquid assets + Inventory + Prepaid expenses
= Rs.1,25,000 + 80,000 + 2,000 = Rs.2,07,000
Current ratio =
Current assets
Current liabilities
=
2,07,000
50,000
= 4.14.
334. (e) Current ratio =
Current assets
Current liabilities

3 =
Current assets
30,000

Current assets = Rs.30,000 x 3 = Rs.90,000
Quick ratio =
Liquidassets
Current liabilities

1 =
Liquidassets
30,000

Liquid assets = Rs.30,000
Current assets Liquid assets = Stock-in-trade
(As there are no prepaid expenses)
or, Rs.90,000 30,000 = Stock-in-trade
Stock-in-trade = Rs.60,000
Part II
289
335. (b) Inventory turnover =
Cost of goods sold
Averageinventory at cost

Net sales = 80,000 + 2,00,000 10,000 = Rs.2,70,000
Cost of goods sold = Sales Gross profit
= 2,70,000 (25% of 2,70,000)
= 2,70,000 67,500 = Rs.2,02,500
Avg. Inventory =
25,000 + 30,000
2
= Rs.27,500
Inventory turnover =
Rs.2,02,500
Rs.27,500
= 7.36 times.
336. (d) Current ratio =
Current assets
Current liabilities

2.6 =
Current assets
40,000

Current assets = 2.6 x 40,000 = Rs.1,04,000.
337. (d) Current assets = Rs.50,000
Current ratio =
Current assets
Current liabilities

3
1.5
=
50,000
Current liabilities
=
50,000 x 1.5
3
= Rs.25,000
Quick assets = 25,000 x 1.5 = Rs.37,500
Inventory = Current assets Quick assets
= 50,000 37,500 = Rs.12,500.
338. (a) Average payment period =
Tradecreditors(Creditors +Bills payable)
Avg.dailypurchases

Average daily purchases
=
Annual credit purchases (total purchases cash purchases purchase returns)
No.of workingdaysin a year

=
359,000
365
= 983.56
Average payment period =
1,85,000 + 60,000
983.56
= 249.09 ~ 249
339. (e) Average collection period =
Tradedebtors(Debtors + Bills receivable)
Sales per day

Sales per day =
Net credit sales
No. of workingdays

or, Avg. collection period =
Tradedebtors x No.of working days
Net Credit sales

=
(1,86,000 + 48,000)
x 365
(6,00,000 1,10,000 1, 20,000)
= 231 days.
290
340. (a) Gross profit ratio:
Gross profit = Sales Cost of sales
= Rs.25,20,000 Rs.19,20,000 = Rs.6,00,000
Gross profit ratio =
Rs.6,00,000
x 100
Rs.25,20,000
= 23.81%
Net profit ratio:
Net profit ratio =
Net profit
x 100
Sales
=
Rs.3,60,000
x 100
Rs.25,20,000
= 14.29%.
341. (d) i. Debtors turnover ratio =
Net credit annual sales
Average tradedebtors

Net credit annual sales = Rs.2,70,000 Rs.20,000 = Rs.2,50,000
Average trade debtors =
Rs.55,000 + Rs.45,000
2
= Rs.50,000
Debtors turnover ratio =
Rs.2,50,000
Rs.50,000
= 5 times.
ii. Average collection period
=
Average tradedebtors x No.of daysina year
Net credit annual sales
=
Rs.50,000 x 365
Rs.2,50,000
= 73 days.
342. (b) Average collection period:

365
x Avg. debtors
Credit sales

Sita Gita Ind. norm.
=
365
x 182.60
550

365
x 88.88
500

= 121 days = 65 days 80 days
Hence, in debtors collections, Sita Ltd. is not performing as good as Gita Ltd. as the
collection period is longer than the industry norm.
343. (e) Average payment period :

365
x Avg. creditors
Credit purchases

Sita Ltd. Gita Ltd. Ind. norm.
=
365
x 115
400

365
x 48
300

= 105 days = 58 days 75 days
Gita Ltd. is able to pay its creditors in 58 days as against the industry average of 75 days,
344. (d) i. Dividend yield on ordinary shares =
Dividend
x 100
Market price
=
2
x 100
40
= 5%
ii. The earnings yield =
EPS
x 100
Market price

=
(15,00,000 50,000) 3,00,000
x 100
40
= 12.08 times.
Part II
291
CA
CL
= 4
or CA = 4CL = 4 x 15.5 = 62 lakh = Acid test ratio =
CA Inventory
CL
= 2.80
(or) CA Inventory = 2.80 x 15.5 = Rs.43.4 lakh
Inventory = 62 43.4 = Rs.18.6 lakh
Inventory turnover ratio =
COGS
Inventory
= 6.452
COGS = Rs.120.01 lakh
Sales =
120.01
0.7
= Rs.171.44 lakh
Sales = 6.452 x 18.6 = Rs.120 lakh
Gross profit margin =
Gross profit
Sales
= 0.30
Gross profit = 171.44 x 0.30 = Rs.51.43 lakh
Selling and administration expenses = 171.44 x 0.10 = Rs.17.14 lakh
Income Statement
(Rs. in lakh)
Sales 171.44
Cost of Goods Sold 120.01
Gross profit 57.43
Selling and Administration expenses 17.14
EBIT 34.29
Financial expenses 3.00
EBT 31.29
Tax @ 40% 12.52
PAT 18.77
CA
CL
= 4
or CA = 4CL = 4 x 15.5 = 62 lakh
Acid test ratio =
CA Inventory
CL
= 2.80
(or) CA Inventory = 2.80 x 15.5 = Rs.43.3 lakh
(or Inventory) = 62 43.4 = Rs.18.6 lakh
Inventory turnover ratio =
COGS
Inventory
= 6.452
or, COGS = 6.452 x 18.6 = Rs.120.01 lakh
Sales =
120.01
0.7
= 171.44
ACP =
Accounts receivable x 365
Sales
= 75
Or, Accounts receivable = ACP x
Sales
365
= 75 x
171.44
365
= Rs.35.23 lakh
292
Cash = C.A Inventory Accounts Receivable = 62 18.6 35.23 = 8.17
Long-term debt =
3
0.15
= Rs.20 lakh =
Interest paid
Rate of interest

Net worth
Long-term debt
= 3.975
Net worth = 3.975 x 20 = Rs.79.5 lakh
Balance Sheet
Net Worth 79.50 Fixed Assets 53.00
Inventory 18.60
Long term Debt 20.00 Accounts Receivable 35.23
Current Liability 15.50 Cash 8.17
115.00 115.00
347. (d) Return on Assets =
Assets Average
Tax EBIT
=
2 / ) 16500 12000 (
280 1200
+

=0.0645.
348. (b) Net income for year 2005 = 1000 x 1.10 =Rs.1,100
Assets = 3500 x 1.10 =Rs.3850
Debt = 1400 x 1.10 = Rs.1540
Equity = 2100 + 1100 =Rs.3200
Balance = 3200 + 1540 3850 =Rs.890.
349. (a) According to the Du Pont analysis
Return on equity = (Net profit/Sales) x (Sales/Average assets) x
(Average assets/Average equity).
Assets/equity = 1+D/E =1+1 =2
Return on equity = 4 x 3 x2 = 24% p.a.
PAT = 40000 10000 =Rs.30000
Sales = 30000/0.04 = Rs.7,50,000
Average Assets = sales /3 = 2,50,000
Return on Assets = EBIT Tax/ Average Assets = 40,000 14,000/2,50,000 = 12%.
350. (b) Net Working Capital = Total of Current Assets Total of Current Liabilities
= (300+2000+2400)-(2000+1500)=Rs.1200
Current Ratio = Current Assets / Current Liabilities = 4700 / 3500 = 1.34
Debt Ratio = Total Debt / Total Liabilities = (4000+2000)/(4000+2000+1500+500+6500) = 0.41.
351. (d) Sales = Rs.6 m
Asset turnover = 5
Asset = sales / asset turnover = 6 / 5 = Rs.1.2m
Net Profits = Rs.0.15m
Return on assets = Net Profit / Assets = .15/1.2 = 0.125 = 12.5%
New Assets = 1.2 x 1.18 = Rs.1.416m; New Net profit = Rs.0.21 mm
Return on assets after installation of new equipment =
0.21
14.8%.
1.416
=
Part II
293
352. (b) After issue of debt
Equity = Rs.7500 debt = Rs.2500, EBIT =1500
PAT = 1500 2500X0.10 =Rs.1250
ROA = EBIT /TA = 1500/10000 =15%
ROE = PAT / Equity = 1250/7500 =16.67%.
353. (a) At present Return on Equity (ROE) =
Equity
profit Net
=
3 5
5
+
= 0.625 i.e. 62.5%
Return on equity (ROE) can also be computed as:

Equity
assets Total
x
assets Total
Sales
x
Sales
profit Net

Given:
Net profit = Rs.5 million
Sales = Rs.40 million
Total liabilities = Total debt + Net worth
= Long-term loans + Current liabilities & provisions + Paid-up equity
share capital + Reserves & surplus
= (8 + 4) + (5 + 3) = Rs.20 million
Existing net profit margin =
Sales
profit Net
=
40
5
= 0.125 i.e. 12.5%
Total assets = Total liabilities = Rs.20 million.
Total asset turnover =
Sales
Total assets
=
20
40
= 2.00
Total asset to equity ratio =
Total assets
Net worth
=
) 3 5 (
20
+
= 2.50
Existing ROE = 62.5%
Required ROE = 62.5% + 7.5% = 70%
Required net profit margin =
ROE
Sales Total assets
x
Total assets Net worth
=
50 . 2 x 00 . 2
70
= 14%
Change in net profit margin = 14% 12.5% = 1.5% (increase).
354. (c) Return on investment =
assets Total
* EBIT
=
3
1
600
200
= = 0.3333 i.e. 33.33%
Return on equity =
Equity
PAT
=
150) (250
140
+
=
400
140
= 0.35 = 35%
* Since there is no interest expense, EBIT = Profit before tax = Profit after tax + tax
= 140 + 60 = Rs.200 lakh.
355. (b) Net worth = 1,50,000+75,000 =Rs.2,25,000
Long term debt/net worth = 0.4, long term debt = 2,25,000X0.4 =Rs.90,000
Total Liabilities = 3,90,000 so total assets = Rs.3,90,000
Sales/Total Assets =3.5, so Sales = 3.5 x 3,90,000 =Rs.13,65,000
GP/Sales =0.15 so Cost of goods sold = 13,65,000 X 0.85 = Rs.11,60,250
Cost of goods sold / Inventory = 6, Inventory = 11,60,250/6 = Rs.1,93,375
Account receivable = Sales /360/15 = 56,875
Quick ratio = 1, (Cash + Account receivable)/ (Notes and payable) =1
So cash = 18,125.
294
356. (c)
2003 2004

Sales 1,000.00 1100
Cost 750.00 825
PBIT 250.00 275
Interest 25.00 25
PBT 225.00 250
Tax 90.00 100
PAT 135.00 150
Dividend 75
Retained earning 75
Assets at the beginning = 2600 average assets = 1100/0.40=2750
So total assets = 2750 x 2 =5500
Assets at 2000 = 5500 2600 =2900
Equity = 2100+75 =2175
Debt = 2900 2175 = 725
Debt ratio = debt / assets = 725/2900 = 0.25
357. (b) CA = 1000 + 400+350 = Rs.1750
CL = 200+350 =Rs. 550
Net working capital = Rs.1,200 (1,750 550)
Current ratio = CA/CL = 1750/550 =3.18
Debt ratio = (Long term debt + lease payment) / (Long term debt + lease payment +Equity)
= (7,000+1,500)/(7,000+1,500+8,000)
= 8,500/16,500 =0.52.
358. (e)
1 2
Operating Income 1500 2000
Interest on debt @10% 300 300
Net income 1200 1700
No. of outstanding share after Buyback 700 700
EPS = net Income /no of share 1.71 2.43
Return on share = EPS / face value 17.1% 24.3%
359. (c) P/E ratio = 3, EPS =6 P = P/E X EPS = 18
Dividend Yield = dividend per share / Market price
So, Dividend per share = Dividend yield X market price = 0.3X18 = Rs.5.4.
360. (c) Dividend pay out ratio = DPS/EPS
DPS = Rs.3, Dividend pay out ratio = 0.60, EPS = DPS / Dividend payout =3/0.60 = Rs.5.
361. (d) EBIT = Total assets X Earning power = 20,000 X0.3 =6000 , Interest = Rs.1500
Interest coverage ratio = EBIT / Interest = 6000/1500 = 4.
362. (c) EPS = Rs.1 and dividend payout ratio = 30% retail earning ratio = 70% . So the Book
value per share will increase by Rs.0.7.
363. (a) Given P/E ratio = 12 , dividend payout ratio = 0.6 i.e. DPS/EPS = 0.6
Price per share = 12 X EPS = 12 X DPS/0.6
DPS/P i.e dividend Yield = 0.6/12 = 5%.
364. (c) Capitalization rate = Net Income /( price per share x No. of outstanding share)
= 2/(28 X 0.56) = 0.127.
Part II
295
365. (d) Here, the total debt-equity ratio is = 4:3 and the amount of total assets is Rs.3500 lakh.
So, the total amount of debt is = Rs.3500 lakh
4
7
= Rs.2000 lakh.
But the amount of short term debt is Rs.500 lakh.
Hence, the amount of long term debt = 2000 500 = Rs.1500 lakh.
366. (a) From Du Pont Analysis,
Return on Equity =
Total Assets Net Profit Sales
Sales Total Assets Total Equity

Or, 12 percent = 7.5 percent 1.20
Total Assets
Total Equity

Or, 12 percent = 9 percent
Total Assets
Total Equity

Or,
Total Equity
Total Assets
= 0.75
Hence, the debt-asset ratio for the company is 1 0.75 = 0.25.
367. (c) Inventory =
Sales Rs.350lakh
= = Rs.50 lakh
Current assets = Current liabilities current ratio = Rs.70 1.4 = Rs.98 lakh.
Quick assets = Current assets Inventories = Rs.98 lakh Rs.50 lakh = Rs.48 lakh
Receivables = Rs.48 lakh 0.75 = Rs.36 lakh
So, the amount of cash and bank balance will be = Rs.98 lakh Rs.50 lakh Rs.36 lakh
= Rs.12 lakh.
368. (b) Average collection period =
Average accounts receivable
Average dailysales

Let the annual sales of the company is = S and so the amount of average daily sales =
S
360

So, the average daily sales =
Average collection period

The average amount of account receivables for the company is : {20 + 30}/ 2 = Rs.25 lakh.
Hence,

Rs.25lakh S
360 30
= Or, S = Rs.300 lakh.
369. (b) Let total amount of asset be = Rs.300 lakh where the amount of debt is Rs.100 lakh.
The amount of PBIT = Rs.300 14 percent = Rs.42 lakh
Interest expenses = Rs.100 lakh 0.08 = Rs.8 lakh
Hence, PBT = Rs.34 lakh and PAT = Rs.34 0.6 = Rs.20.40 lakh
So, the return on equity =
20.40
200
= 10.20 percent.
370. (e) For any company, current ratio is the ratio between the current assets and current
liabilities while the acid test ratio is the ratio between the current assets less inventories and
current liabilities. So, if the current ratio is 2.75 and the acid test ratio is 2.00, then it can be
said that the inventories constitute for 75 percent of the current liabilities.
296
371. (d) Sales turnover = Rs.120 lakh and so credit sales = Rs.120 0.8
= Rs.96 lakh
So, the average daily credit sales =
96
Rs.0.267
360
= lakhs
And the average account receivables = ( ) 8.50 11.50 / 2 + = Rs.10 lakh
So, the required average collection period is =
Average daily credit sales

=
10
37.5days
0.267
= .
372. (a) Fixed charges coverage ratio =

Earnings before depreciation, interest and taxes
Pr eference dividends Loan repayment installemnt
Debt interest +
1-tax rate l tax rate
+

Here interest on term loan and debentures = 10 12% + 24 X 14% = Rs.4.56 lakhs.
Loan repayment installments =
10 24
5 6
+ = 2 + 4 = Rs.6 lakhs.
Preference dividends = 20 0.15 = Rs.3.00 lakhs.
The amount of dividend paid by the company = Rs.1.50 600,000 = Rs.9.00 lakh and so the net
profit of the company is = 9 + 3 = Rs.12 lakh. So, profit before tax = 12/(1 - 0.4 ) = Rs.20 lakh
Hence, the profit before interest, depreciation and taxes was = 20 + 5.44 + 4.56 = Rs.30 lakh
So, the required fixed charges coverage ratio is
=
30
6 3
4.56
1 0.4
+
+
=
30
4.56 15.00 +
=
30
19.56
= 1.534.
373. (d) Gross profit = Rs.45 lakhs and gross profit margin = 0.2
So, the sales turnover =
45
0.2
= Rs.225 lakhs
Total assets =
Sales
Total assets turnover ratio
=
225
3
= Rs.75 lakhs.
But, total assets = Total liabilities = Total Debt + Total equity
and the total debt equity ratio = 1.50
So, total debt = 75
3
2 3 +
= Rs.45 lakhs.
and total equity = 75
2
2 3 +
= Rs.30 lakhs
Now, the amount of current liabilities =
Current Assets
Current Ratio
=
35
2.5
= Rs.14 lakhs
So, the amount of term loan in its balance sheet = 45 14 = Rs.31 lakhs.
374. (c) Capitalization rate =
Earnings per share
Market price

EPS =
Net income
Number of outstanding shares
=
20
5.6
= 3.57
Capitalization rate =
3.57
28
= 0.1275.
Part II
297
375. (b) Equity multiplier = 1/(1 Debt to assets ratio)
4.55 = 1/(1 Debt to assets ratio)
Debt to assets ratio = 0.78.
376. (c) Dividend yield = Dividend per share/Market price
Dividend yield = 0.3, EPS = 6, P/E = 3
MPS = EPS x P/E = 6 x 3 = 18
0.3 = DPS / 18
DPS = 0.3 x 18 = 5.4.
377. (d) Interest coverage ratio =
EBIT
Interest expense

EBIT = 0.3 x 20,000 = 6,000
Interest coverage ratio = 6,000/1,500 = 4.
378. (a) Stock velocity or inventory turnover ratio = Cost of goods sold/Average inventory.
6 = 54,000/(Opening stock + 10,000)/2
Opening stock = 8,000.
379. (c) According to the Du Pont Analysis Return on assets
= (Net profit/Sales) x (Sales/Average assets) x (Average assets/Average equity)
Equity multiplier = (Average assets/Average equity) = 1/(1 Debt to assets ratio)
Return on net worth = 7.5 x 0.9 x (1/1 0.75) = 27%.
380. (a) According to the Du Pont analysis Return on assets
=
Net profit Sales Average assets
x x
Sales Average assets Average equity

Return on equity = 0.2 x 1.5 x 2 = 60% p.a.
381. (e) Total assets = 1,500. The total assets comprises of debt and equity
Debt 3 implies 900 i.e. 1,500 x 3/5
Equity 2 implies 600 i.e. 1,500 x 2/5
If the short-term debt is 300 then long-term debt would be 900 300 = 600.
382. (c) Interest coverage ratio = EBIT/interest expense
3.5 = EBIT/12,000
EBIT = 42,000
EBT = EBIT Interest
EBT = 42,000 12,000 = 30,000.
383. (b) Quick ratio = (Current assets Inventory)/ Current liabilities
Current assets = Inventories + Receivables + Marketable securities + Cash
Quick ratio = (10 5)/5 = 1.
384. (e) According to the Du Pont Analysis Return on equity = (Net profit/Sales) x (Sales/Average
assets) x (Average assets/Average
equity).
ROE = 5 x 2 x 2.5 = 25%
Debt/equity = 1.5 (3/2) implies total assets of 5. Debt/assets = 3/5 or 0.6
Equity multiplier = (Average assets/Average equity) = 1 / (1 debt to assets ratio) = 2.5.
385. (a) Quick ratio = (Current assets Inventory)/ Current liabilities = 3 + 0.2/2 = 1.6.
298
386. (c) According to the Du Pont Analysis Return on equity = (Net profit/Sales) x (Sales/Average
assets) x (Average assets/Average
equity)
ROE = 6 x 3 x 1.5 = 27%.
387. (d) Dividend yield = Dividend per share/Market price of the share = 25/80 = 31.25%.
388. (a) ROE = EPS/Book value of the share
Book value = 3.5/ 0.3 = Rs.11.67.
389. (c) Earning power = EBIT/Average total assets
Asset turnover = Sales/Average assets
(Assume sales to be 100)
2 = 100/Average assets
Average assets = 50
Earning power = 14.7/50 = 0.294 or 29.4%.
390. (a) PE ratio = Market price/Earnings per share
Dividend pay-out ratio = Dividend per share/ Earnings per share
Dividend yield = Dividend per share/ Market price per share
Dividend yield = Dividend pay-out ratio x 1/PE ratio = 0.6 x 1/12 = 0.05 or 5%.
391. (c) Equity multiplier = 1/(1 Debt to assets ratio)
4 = 1/(1 Debt to assets ratio)
Debt to assets ratio = 0.75.
392. (c) Intrinsic value of a share = Expected EPS x PE ratio
20 = EPS x 5
EPS = 4
Expected EPS = (Expected PAT Preference dividend)/Number of shares
4 = (10, 00,000 Preference dividend)/1,00,000
Preference dividend = 6,00,000.
393. (d) As current liabilities is 2,000,
Quick assets = 2,000
1.2 = 2,000 + stock / 2,000
Stock = 400
Inventory turnover = Cost of goods sold/Average inventory
6 = COGS/40
Cost of goods sold = 2,400.
394. (d) Dividend yield = Dividend per share / Market price of the share
Dividend per share = 4% of 10
Dividend yield = 4/150 = 2.666%.
395. (b) Let the current liabilities be 100
Then the current assets will be 140 and the stock will be 20
Quick ratio = 120/100 = 1.2
After an increase of 10% in current assets the figure changes to 154 i.e .(140 + 14)
Quick ratio = 134 / 100 = 1.34
Increase in Quick ratio = (1.34 1.2)/1.2 = 11.67%.
396. (b) Quick ratio = Current assets Stock/Current liabilities = (50 30)/30 = 20/30 = 0.67.
Part II
299
397. (a) Current ratio = Current assets/Current liabilities = 160/100 = 1.6.
After an increase of 10% in current assets the figure changes to 176, i.e. (160 + 16).
Current ratio = 176 / 100 = 1.76
Increase in current ratio = (1.76 1.6) / 1.6 = 10%.
398. (b) Return on equity = Net profit margin x Asset turnover ratio x Asset Equity ratio
0.14 = 0.08 x Asset turnover ratio x 1.2
Asset turnover ratio = 1.46
When the net profit margin and asset-equity ratio are changed and ROE remains unchanged
then 0.14 = 0.04 x Asset turnover ratio x 1.5
Asset turnover ratio = 2.33.
399. (d) Return on investments = EBIT/Total assets
Net profit margin = Net profit / Sales,
Total assets turnover = Sales/Average total assets
Return on investments = Net profit margin x Total assets turnover = 0.05 x 2 = 0.1 or 10%.
400. (a) Average collection period = Average accounts receivable/Average daily sales
Current ratio = CA/CL
CA = 1.3 x 16,00,000 = 20,80,000.
Average accounts receivable = 60% of 20,80,000 = 12,48,000.
Asset turnover ratio = Sales/Average assets
Sales = 1.2 x 52,00,000 = 62,40,000
Average daily sales = 62,40,000/360 = 17,333
Average collection period = 12,48,000/17,333 = 72 days.
401. (c) Dividend pay-out ratio = Dividend per share/Earnings per share
0.6 = 3/Earnings per share
Earnings per share = 3/0.6 = 5.
402. (d) Average collection period = Average accounts receivable/Average daily sales
Average daily sales = 9,00,000/360 = 2,50,000
When the average collection period is 20 days Average accounts receivable will be
2,50,000 x 20 = 50,00,000
When the average collection period is 30 days Average accounts receivable will be
2,50,000 x 30 = 75,00,000.
403. (b) ROE = [(ROI + (ROI r ) D/E)] (1 t)
0.2 = [(ROI + (ROI 0.1) 1.5)] (1 0.35)
ROI = 18.304 or 18.31%.
404. (c) Return on equity = Net profit margin x Asset turnover ratio x Asset to Equity ratio
ROE = 0.07 x 2.5 x 1.2 = 0.21 or 21%.
405. (e) Number of shares = Capital required/Issue price = 9 crore/15 = 60 lakh.
Capital required = Total requirement Funds generated internally.

300
Funds Flow Analysis
406. (c)
i. Schedule of Changes in the Working Capital:
Working Capital Charge
Year 2 Year 1 Increase Decrease
Current Assets :
Cash 6,200 4,800 1,400
Inventory 8,400 6,200 2,200
Accounts receivable 4,700 5,800 1,100
(A) 19,300 16,800

Current Liabilities:
Creditors 7,100 8,300 1,200
Accounts Payable 5,800 5,600 200
Provisions for Doubtful Debts 1,700 2,500 800
(B) 14,600 16,400

Working Capital (AB) 4,700 400
Change in Working Capital 4,300
5,600 5,600
ii. Sources and applications of working capital:
Rs.
Sources of funds:
Profit from operations (see Note 1: PAT + depreciation during year 2) 7,300
Issue of capital 2,000
Total working capital generated 9,300

Applications:
Purchase of machinery 1,000
Payment of dividend 4,000
Total working capital used 5,000
Net change in working capital 4,300
9,300
Note: 1
Profit from operations:
Net profit 5,000
Depreciation on buildings 1,200
Depreciation on machinery 1,100
7,300
Hence the change in working capital is Rs.4,300
and total working capital generated is Rs.9,300.

407. (a)
Net profit for the year
Rs.
1,24,000
Add: Depreciation 1,40,000
Add: Provision for Taxation 20,000
2,84,000
Less: profit on sale of fixed assets 4,000
Profit form operations 2,80,000
Part II
301
408. (a) Provision for depreciation for 200 x = 1,199 1,029 = 170
Rs.
Net profit = 14,990
Add: Provision for depreciation for 200 x = 170
Funds from operation = 15,160
Sources and uses of funds statement on working capital basis:
Sources: Rs.
Funds from operation = 15,160
15,160
Uses :
Increase in fixed asset = 1,694
Cash dividend = 7,500
Tax on dividend = 750
Repayment of loan fully = 1,425
11,369
Increase in working capital = 3,791
15,160
Hence, funds from operations is 15,160 and increase in working capital is 3,791.
409. (d) Cash Basis
Amount Rs. Amount Rs.
Sources of cash:
Increase in equity capital operations: 1,00,000
Net profit (Increase in retained earnings + dividend paid) 72,000
Depreciation 1,89,000 2,61,000
Increase in long-term debt 1,00,000
Increase in current liabilities
Accounts payable 1,14,000
Bank borrowings 85,000 1,99,000
Decrease in current assets other than cash
Inventories 49,000
Total cash generated 7,09,000
Uses of Cash:
Increase in gross fixed assets (Increase in net fixed assets +
depreciation for the year)

4,74,000
Increase in current assets other than cash
Accounts receivable 1,82,000
Decrease in current liabilities
Accruals 1,12,000
Total cash used 7,68,000
Net change in cash position = 7,68,000 7,09,000 = 59,000.
410. (b)
Amount (Rs.)
Increase in P&L A/c (48,500 35,200) 13,300
+ Transfer to general reserve 12,000
+ Proposed dividend 24,000
+ Depreciation for current year (46,000 35,000) 11,000
Funds from operations 60,300
302
411. (d)
Schedule of change in working capital
2003 2004 Inc in W.C Dec in W.C
I. Current Assets
Stock 1,79,000 1,89,000 10,000
Debtors 1,31,500 1,38,700 7,200
II. Current Liabilities
Creditors 1,09,800 1,29,200 19,400
17,200 19,400
Net decrease in working capital 2,200
412. (d) From solution 63 and 64. We get
Funds from operations = Rs.60,300
Decrease in working capital = Rs.2,200
Funds flow statement March 31st, 2004.
Sources Amount Application Amount
Funds from operation 60,300 Purchase of fixed assets 17,000
Issue of share capital 25,000 Repayment of bank overdraft 61,000
Issue of Debentures 10,500 Purchase of investment 4,000
Decrease in working capital 2,200 Payment of dividend 16,000
98,000 98,000
413. (a) Funds from operations:
Div. A (Rs.) Div. B (Rs.)
Profit after tax 60,000 60,000
+ Depreciation 40,000 40,000
1,00,000 1,00,000
414. (d)
Div. A (Rs.) Div. B (Rs.)
Increase in capital & Reserves 1,25,000 1,25,000
Less current year profit 60,000 60,000
Issue of share capital 65,000 65,000
+ long term debt 2,50,000
Funds procured 3,15,000 65,000
415. (a) Change in Working Capital:
Working capital Div. A (Rs.) Div. B (Rs.)
Increase
Decrease 25,000 1,25,000
Part II
303
416. (c) Total Uses:
Rs. In lakhs
Decrease in liabilities 25
Decrease in short term borrowings 15
Increase in Assets: 20
Increase in Inventories 15
Increase n cash 5
Total uses (Total sources) 45
Proportion of resources used in increasing the assets =
20
45
= 44.44%.
417. (b) Funds form operations:
Profit and loss adjustment account
To loss on sale of Fixed Assets 4,000 By balance b/d 85,000
Depreciation 95,000 Open stock adjustment 6,000
Premium on redemption of
debentures
1800
10
54, 000
90

Preliminary expenses 10,000 Funds from operation 2,35,800
Provision for tax 50,000 (Balancing figure)
Proposed dividend 36,000
Transfer to general reserve 30,000
Balance c/d 1,00,000
3,26,800 3,26,800
418. (b) Schedule of change in working capital
Amount in lakh
31.12.03 31.12.04 Inc. in WC Dec. in WC
I. Current Assets
Bank 5 20 15
Debtors 125 200 75
Stock 170 200 30
Others 25 30 5
II. Current Liabilities
Creditors 60 80 20
Bank Overdraft 230 280 50
Other liabilities 40 80 40
Total 125 110
Net increase in Working Capital 15
419. (e) Funds from operations:
Profit and loss adjustment account
Particulars Amount
(Rs.)
Particulars Amount
(Rs.)
To proposed dividend 75 By balance b/d 50
To depreciation 90 By funds from operations 265
To transfer to General reserve 65 (Balancing figure)
To balance c/d 85
315 315
304
420. (a) Sources of funds:
Rs. in lakh
Increase in liabilities:
Increase in bills payable 4
Decrease in assets:
Bank 7
Stock 28
Total sources 39
Proportion of sources arising due to increase in liabilities =
4
39
= 0.1025 or 10.25%.
421. (e) Funds from operations obtained from the profit and loss adjustment a/c.
Particulars Amount Particulars Amount
To preliminary expenses 10,000 By balance b/d 60,000
To depreciation on plant 40,000 By profit on sale of land
and building
60,000
To depreciation on land &
building
20,000
To loss on sale of plant 10,000 By funds from operations 3,48,000
To goodwill return off 40,000 (Balancing figure)
To premium paid on preference
shares
6,000
To transfer to general reserve 80,000
To provision for tax 90,000
To preference dividend 16,000
To dividend 50,000
To balance c/d 96,000
4,68,000 4,68,000
422. (a) Schedule of change in Working Capital
31.12.03 31.12.04 Inc. WC Dec. WC
I. Current Assets:
Bank 50 36 14
Debtors 300 500 200
Stock 174 118 56
Bills receivable 40 60 20
II Current Liabilities:
Creditors 110 166 56
Bills payable 40 32 8
Total 228 126
Net inc. in W.C 102
423. (b)
Schedule of changers in working capital
2003 2004 Increase in
working capital
Decrease in
working capital
Rs. Rs.
Current Assets:
Cash 96,000 1,40,000 44,000
Debtors 3,62,000 3,40,000 22,000
Stock in trade 2,42,000 2,72,000 30,000
7,00,000 7,52,000
Part II
305
working capital
Decrease in
working capital
Rs. Rs.
Current liabilities:
Trade creditors 2,12,000 1,40,000 72,000
2,12,000 1,40,000
Working capital (CA
CL)
4,88,000 6,12,000
Net increase in W.C 1,24,000 1,24,000
6,12,000 6,12,000 1,46,000 1,46,000
424. (b) Statement showing changes in working capital
working capital
Decrease in
working capital
Rs. Rs.
Current Assets:
Cash 50,000 1,40,000 90,000
Debtors 1,96,000 1,80,000 16,000
Closing stock 1,74,000 2,40,000 66,000
4,20,000 5,60,000
Trade creditors 1,00,000 90,000 10,000
Bills payable 40,000 70,000 30,000
Loans (payable during
2003)
40,000 40,000
1,40,000 2,00,000
W.C (CA CL) 2,80,000 3,60,000
Net increase in W.C 80,000 80,000
3,60,000 3,60,000 1,66,000 1,66,000
425. (b) Calculation of Funds from operations
Adjusted P & L A/c
To provision for depreciation 28,000 By opening balance
To transfers to general reserves 40,000 By profit on sale of machine 10,000
To provision for tax 20,000 By refund of tax 6,000
To loss on sale of investment 10,000 By dividends received 4,000
To discount on issue of debentures 4,000 By funds from operations 3,28,000
To preliminary expenses 6,000 (balancing figure)
To closing balance 2,40,000
3,48,000 3,48,000
426. (b) Adjusted profit and loss A/c
To depreciation 20,000 By opening balance 2,00,000
To preliminary expenses 10,000 By profit on sale of plant 10,000
To dividend equalization fund 30,000 By funds from operations 1,70,000
To interim dividend 20,000 (balancing figure)
To closing balance 3,00,000
3,80,000 3,80,000
306
427. (c) Provision for depreciation A/c
Rs. Rs.
To Building A/c 20,000 By balance b/d 50,000
To balance c/d 60,000 By adjusted p/L A/c 30,000
80,000 80,000
Building A/c
To balance b/d 2,00,000 By cash (sales) 1,20,000
To cash purchases 2,00,000 By provision for depreciation 20,000
To adjusted p/l A/c 40,000 By balance c/d 3,00,000
(profit on sale)
4,40,000 4,40,000
Adjusted profit and loss A/c
To provision for
depreciation A/c
30,000 By balance b/d 80,000
To balance c/d 1,60,000 By building A/c (profit on sale) 40,000
By funds form operations
(balancing figure) 70,000
1,90,000 1,90,000
428. (b) Sale of building for Rs.1,20,000 and funds from operations of Rs.70,000 are sources of funds.
429. (e) Equity Share Capital A/c
Rs. Rs.
To balance c/d 6,00,000 By balance b/d 4,00,000
By cash issue (balancing figure) 2,00,000
6,00,000 6,00,000
Share Premium A/c
Rs. Rs.
To balance c/d 60,000 By balance b/d 40,000
By cash issue of shares
(balancing figure)
20,000
60,000 60,000
9% debentures A/c
Rs. Rs.
To debenture redemption 60,000 By balance b/d 2,00,000
To balance c/d 3,00,000 By cash issue 1,60,000
3,60,000 3,60,000
Sources of funds:
Rs.
Issue of equity share 2,00,000
Share premium 20,000
Issue of debentures 1,60,000
3,80,000
430. (c) Redemption of debentures Rs.60,000 is an application of funds.
Part II
307
431. (b) Trade Investments A/c
Rs. Rs.
To balance b/d 1,00,000 By dividend (Pre-acquisition) 4,000
To cash purchases 64,000 By cash sale 20,000
(balancing figure) By balance c/d 1,40,000
1,64,000 1,64,000
Rs.20,000 realized from sale of trade investments is a source of funds.
432. (d) Investments purchased during the year for Rs.64,000 is an application of funds.
433. (d) Provision for taxation A/c
Rs. Rs.
To cash (tax paid) 60,000 By balance b/d 1,00,000
To balance c/d 1,50,000 By adjusted P/L A/c 1,10,000
(balancing figure)
2,10,000 2,10,000
Adjusted Profit and Loss A/c
Rs. Rs.
To cash provision for tax 1,10,000 By opening balance 4,00,000
To Closing Balance 6,00,000 By funds from operations 3,10,000
(balancing figure)
7,10,000 7,10,000
Funds from operations of Rs.3,10,000 is a source of funds.
434. (a) Tax paid Rs.60,000 is an application of funds.
435. (e) Proposed Dividend A/c
Rs. Rs.
To cash dividend paid
(balancing figure)
1,60,000 By balance b/d 1,60,000
To balance c/d 2,00,000 By adjusted P/L A/c 2,00,000
3,60,000 3,60,000
Adjusted P/L A/c
Rs. Rs.
To proposed dividend A/c 2,00,000 By opening balance 6,00,000
To closing balance 8,00,000 By funds from operations
(balancing figure)
4,00,000
9,60,000 9,60,000
308
436. (e)
Schedule of changes in working capital
W.C
Decrease in
W.C
Rs. Rs. Rs. Rs.
Current Assets:
Cash at bank 8,000 18,000 10,000
Debtors 33,000 39,000 6,000
Stock 18,000 14,000 4,000
59,000 71,000
Creditors 18,000 10,000 8,000
18,000 10,000
Working capital (CA CL) 41,000 61,000
67,000 61,000 24,000 24,000
Funds flow statement
Sources Rs. Applications Rs.
Issue of capital Purchase of plant
(1,70,000 1,60,000) 10,000 (68,000 48,000) 20,000
Mortgage 10,000 Net increase in W.C 20,000
40,000 40,000
The total sources of funds from funds flow statement is Rs.40,000.
437. (a) Schedule of changes in working capital (W.C)
(Rs. in lakh)
W.C
Decrease in
W.C
Current assets:
Inventories 3608 4150 542
Debtors 1374 2314 940
Cash and bank balances 1688 1024 664
Loans and advances
(Assumed to be short- term) 1240 1326 86
7910 8814
Current liabilities 3066 2482 584
Provisions (Assumed to be
current liabilities)
654 924 270
3720 3406
Working capital (CA CL) 4190 5408 1218
Net increase in W.C 1218
5408 5408 2152 2152

Part II
309
438. (b) Calculation of funds from operations
Rs.
Reserves in the beginning of 2003 3320
Reserves at the end of 2004 4918
Profit for the year (4918 3320) 1598
Add: Depreciation (3854 3300) 554
(or)
Funds From Operates 2,152
439. (e) Schedule of changes in working capital:
2003 2004 Increase
in W.C
Decrease
in W.C
Currents Assets: Rs. Rs. Rs. Rs.
Sundry debtors 20,000 24,000 4,000
Stock 30,000 35,000 5,000
Bank 1,200 3,500 2,300
Cash 300 500 200
51,500 63,000
Current liabilities
Current liabilities 24,500 17,800 6,700
45,200 45,200 18,200 18,200
440. (a) Calculation of funds from operations:
Closing balance of P/L Account in 2004 1,200
Add: Non-fund and Non-operating items debited to P/L A/c:
Provision for taxation 4,200
5,400
Proposed dividend 5,800
Less: Opening balance of P/L A/c 1,000
Alternatively:
Adjusted P & L A/c
Rs. Rs.
To provision for taxation 4,200 By balance b/d 1,000
To proposed dividend 5,800 By funds from operations
To balance c/d 1,200 (balancing figure) 10,200
11,200 11,200
Funds from operations are Rs.10,200 from above calculations.
441. (d) Schedule of changes in working capital
2003 2004 Increase in WC Decrease in WC
Current Assets: Rs. Rs. Rs. Rs.
Cash 9,000 7,800 1,200
Debtors 14,900 17,700 2,800
Stock 49,200 42,700 6,500
73,100 68,200
Current liabilities
Trade creditors 10,360 11,840 1,480
Reserve for doubtful debts 700 800 100
11,060 12,640
Net decrease in WC 6,480 6,480
62,040 62,040 9,280 9,280
310
442. (c) Calculation of funds from operations:
Closing balance of P/L A/c (2004) 10,560
Add: Non fund and non-operating items which have
already been debited to p/l A/c:
Good will written off 5,000
Dividend paid 3,500
19,060
Less: Opening balance of P/L A/c (2003) 10,040
(or)
Alternatively:
Adjusted P&L A/c
To dividend paid 3,500 By balance b/d 10,040
To good will written off
(10,000 5,000)
5,000 By funds from
operations
9,020
To balance c/d 10,560
19,060 19,060
443. (d) Net change in W.C and funds from operations.
Sources Rs. Applications Rs.
Issue of share capital
(74,000 70,000)
4,000 Redemption of Debentures
(12,000 6,000)
6,000
Funds from operations 9,020 Purchase of land
(30,000 20,000)
10,000
Net decrease in W.C 6,480 Payment of dividend 3,500
19,500 19,500
So total sources of funds with funds from operations are Rs.19,500.
444. (d) Change is net working capital can be calculated as:
(120 + 60 + 45 55) (100 + 70 +30 60) = 170 140 = Rs.30 lakh.
445. (a) In this case, purchase of capital equipment (a long-term asset) by taking loan (a long-term
liability) does not have any impact on the net working capital. Purchases of raw materials
will increase raw material but simultaneously there is an equal increase in current liability as
that was purchased on credit. Hence there is no impact on net working capital. Conversion of
preferential shares into equity only changes the capital structure of the company. Therefore,
the net working capital of the company will be Rs.36 lakh Rs.23 lakh = Rs.13 lakh. Hence,
the answer is (a).
446. (e) Here, the repayment of the debentures prematurely by using the proceeds of the rights
issue does not make any impact on the net working capital as neither of the facts is related to
the working capital. Selling products on credit reduces the amount of inventory in the
company but also simultaneously increases the volume of debtors in the balance sheet of the
company. Therefore, it makes a resultant impact of zero.
447. (b) Change in net working capital = Increase in current assets Increase in current liabilities
Increase in current assets = 2,500 + 40,000 = 42,500
Increase in current liabilities = 28,000 + 76,500 = 1,04,500
Hence change in working capital = (62,000) or decrease by 62,000.
448. (c) When the debtors receivable decreases, the cash balance increase the net effect being
zero. When preference shares get converted into equity there is no effect on the net working
capital.
Part II
311
449. (a) Rs.
Decrease in current liabilities = 50,000
Increase in Provisions = 30,000
Net decrease in current liabilities = 20,000
Net change in funds flow statement decrease of 20,000
450. (c) Rs.
Decrease in current liabilities = 55,000
Increase in current assets = 40,000
Change in working capital = Current assets Current liabilities
Hence the increase in working capital = 95,000
451. (e) Receivables realized has no effect on the current asset position as receivables balance
decrease and the cash balance increase. Debentures converted into equity will not result in any
inflow or outflow of funds. Hence there will be no change in the working capital position.
Leverage
452. (b) Turnover of the firm = Rs.23 x 1,45,000 = Rs.33,35,000
Total cost = Rs.17 x 1,45,000 + Rs.2,80,000 = Rs.27,45,000
EBIT = Rs.(33,35,000 27,45,000) = Rs.5,90,000
Interest charges = Rs.10,00,000 x 0.11= 1,10,000
If the earning before taxes is equal to zero.
EBIT should be equal to the interest charges.
Let this happen at a sales level of X units.
Profit function = (SP VC)Q FC;
Where, stands for EBIT.
Then, (Rs.23 Rs.17) X Rs.2,80,000 = Rs.1,10,000
X =
Rs.3,90,000
Rs.6
= 65,000 units
or
Sales required =
Required EBIT Fixed cos t
Contribution per unit
+
=
1,10, 000 2, 80, 000
6
+
= 65,000 units
Therefore, the sales should come down by 80,000 units, i.e., (1,45,000 65,000) or 80,000 x
Rs.23 = Rs.18,40,000, so that EBIT is equal to zero.
If EBIT doubles, the new level of EBIT would be equal to Rs.2 x 5,90,000 = Rs.11,80,000.
New level of EBT = EBIT I = Rs.11,80,000 Rs.1,10,000 = Rs.10,70,000.
453. (a) Turnover of the firm = Rs.(23 x 1,45,000) = Rs.33,35,000
Total cost = Rs.(17 x 1,45,000) + Rs.2,80,000 = Rs.27,45,000
EBIT = Rs.(33,35,000 27,45,000) = Rs.5,90,000
Interest charges = Rs.10,00,000 x 0.11 = Rs.1,10,000
Degree of operating leverage =
Q(P V)
Q(P V) F

=
1, 45, 000(23 17)
1, 45, 000(23 17) 2, 80, 000

= 1.475
The degree of financial leverage is
EBIT
EBIT I
since preferred dividend is zero.
Hence, DFL =
5,90,000
5,90,000 1,10,000
= 1.23
Combined leverage = DOL x DFL = 1.475 x 1.23 = 1.814
Hence, degree of operating leverage and combined leverage are 1.475 and 1.814.
312
454. (c) Turnover of the firm = Rs.23 x 1,45,000 = Rs.3,35,000
The asset turnover of the firm is
*
Total sales
Total assets
=
Rs.33,35,000
Rs.(10,00,000+20,00,000)
= 1.11
Since, the asset turnover of the industry is 0.75, the firm is considered to have a high degree
of asset leverage.
*(Assuming that the firm has no other liabilities Debt + Equity = Total Assets)
455. (d)
Firm I:
EBIT = Rs.5,90,000
Less: Interest = Rs.1,10,000
EBT = Rs.4,80,000
Tax rate = 45%
Net earnings = Rs.4,80,000(1 0.45) = Rs.2,64,000
No. of shares outstanding = 2,00,000
EPS =
2,64,000
2, 00, 000
= Rs.1.32
Firm II:
EBIT = Rs.5,90,000
Less: Interest charges = 0
EBT = Rs.5,90,000
Tax rate = 45%
Net earnings = Rs.5,90,000(1 0.45) = Rs.3,24,500
Since both firms have the same total assets and firm II has no debt, equity of firm I would be
Rs.30,00,000. Therefore, the number of shares outstanding would be 3,00,000.
EPS =
3, 24, 500
3, 00, 000
= Rs.1.08
Difference in EPS = Rs.1.32 1.08 = Rs.0.24.
Firm I which has a levered capital structure has a higher EPS because of the tax shield benefit
associated with interest on debt.
456. (b)
Old level New level
A Sales (at Rs.5/unit) 2,50,000 units 2,50,000 + 0.2 x 2,50,000
= Rs.12,50,000 = 3,00,000 units
= Rs.15,00,000
B. Variable cost (Rs.3/unit) Rs.7,50,000 Rs.9,00,000
C. Contribution (A B) Rs.5,00,000 Rs.6,00,000
D. Fixed Cost Rs.1,00,000 Rs.1,00,000
E. Operating Profit (EBIT) = (C D) Rs.4,00,000 Rs.5,00,000
F. Less: Interest(at 12%) Rs.60,000 Rs.60,000
G. Less: Tax @ 50% Rs.1,70,000 Rs.2,20,000
H. Net profit Rs.1,70,000 Rs.2,20,000
I. EPS

=
Net Profit
No.of Shares

Rs.1,70,000
80,000

= Rs.2.125
Rs.2,20,000
80,000

= Rs.2.75
J. Operating Leverage

=
Contribution
Operating profit

Rs.5, 00, 000
Rs.4, 00, 000

Rs.6, 00, 000
Rs.5, 00, 000

= 1.25 = 1.2
Operating leverages at the two levels are 1.25 in old level and 1.2 in new level.
Part II
313
457. (e)
Old level New level
A. Sales (at Rs.5/unit) 2,50,000 units 2,50,000 + 0.2 x 2,50,000
= Rs.12,50,000 = 3,00,000 units =Rs.15,00,000
B. Variable cost (Rs.3/unit) Rs.7,50,000 Rs.9,00,000
C. Contribution (A B) Rs.5,00,000 Rs.6,00,000
D. Fixed Cost Rs.1,00,000 Rs.1,00,000
E. Operating profit (EBIT) = (C D) Rs.4,00,000 Rs.5,00,000
F. Less: interest (at 12%) Rs.60,000 Rs.60,000
G. EBT Rs.3,40,000 Rs.4,00,000
H. Less: Tax @ 50% Rs.1,70,000 Rs.2,20,000
I. Net profit Rs.1,70,000 Rs.2,20,000
J. EPS

=
Net profit
No.of Shares

Rs.1, 70, 000
80, 000
Rs.2, 20, 000
80, 000
K. Financial leverage

=
Operating profit
Profit before tax

Rs.4, 00, 000
Rs.3, 40, 000
= 1.176
Rs.5, 00, 000
Rs.4, 40, 000
= 1.136
The financial leverage at old level in 1.176 and new level is 1.136.
458. (a) Earning per share =
Net Profit
No.of Shares

At old level =
Rs.1,70,000
80,000
= Rs.2.125
At new level =
Rs.2,20,000
80,000
= Rs.2.75
Percentage increase in EPS =
2.75
2.125
x 100 = 129.4 = 129.4 100 = 29.4% increase.
459. (a)
A B C
Combined leverage 1.14 x 1.27 1.23 x 1.3 1.33 x 1.33
= Operating leverage x Financial leverage = 1.4478 = 1.599 = 1.7689
The combined leverage is highest for firm C and a high degree of leverage indicates that the
firm is working under high risky situation.
460. (c) DOL =
Q(S V)
Q(S V) F

=
*
50,000(50 20)
50,000(50 20) 7,50,000

=
15,00,000
7,50,000
= 2
Note: *15 x 50,000 = 7,50,000
New DOL =
50,000(50 30)
50,000(50 30) 7,50,000

=
10, 00, 000
2, 50, 000
= 4.
314
461. (a) Degree of Operating Leverage (DOL) = 1.2

Q(P V)
Q(P V) F

= 1.2
Where,
Q(P V) = Sales (1 Variable costs to sales ratio) =
144(0.4)
144(0.4) F
= 1.2
57.6 = 69.12 1.2F
1.2F = 69.12 57.6
1.2F = 11.52
F =
11.52
1.2
= 9.6.
Fixed expenses of the company = Rs.9.6 lakh.
462. (b) Riskiness of the firms, given the information can be assessed by calculating financial,
operating and total leverage.
DOL =
Q(P V)
Q(P V) F

LG Ltd. =
20, 000(50 25)
20, 000(50 25) 3, 00, 000

= 2.5
HG Ltd. =
20, 000(50 20)
20, 000(50 20) 4, 00, 000

= 3
DFL =
P
EBIT
D
EBIT I
1 t

LG Ltd. =
(20, 000x 25) 3, 00, 000
2, 00, 000 50, 000
= 1.33
HG Ltd. =
(20, 000x30) 4, 00, 000
2, 00, 000 1, 00, 000
= 2
DTL = DOL x DFL
LG Ltd. = 3.325
HG Ltd. = 6
Hence, for the same level of expectations, HG Ltd. is riskier as both DOL and DFL are higher.
463. (d) DOL = 2.5
DFL = 1.6
DTL = 2.5 x 1.6 = 4
Increase in EPS = DTL x Change in Q = 4 x 5% = 20%.
464. (b)
Rs in crore
PBDIT 825.26
() Depreciation 5.96
Profit Before Interest and Tax (PBIT) 819.30
Profit After Tax (PAT) = EPS x Number of shares
= Rs.3.647 x 33.146 cr. = Rs.120.88 cr.
Part II
315
PBT =
PAT
1 T
=
Rs.120.88 cr.
1 0.30
= Rs.172.69 cr.
Interest charges = PBIT PBT = Rs.646.61cr.
DFL =
EBIT
EBIT I
=
Rs.819.3 cr.
Rs.819.3 cr. Rs.646.61 cr.
=
Rs.819.3 cr.
Rs.172.69cr.
= 4.74.
465. (a)
PBDIT Rs.825.26 cr.
() Depreciation Rs.5.96 cr.
Profit Before Interest and Tax (PBIT) Rs.819.30 cr.
Profit After Tax (PAT) = EPS x Number of shares = Rs.3.647 x 33.146 cr. = Rs.120.88 cr.
PBT =
PAT
1 T
=
Rs.120.88 cr.
1 0.30
= Rs.172.69 cr.
Interest charges = PBIT PBT = Rs.646.61 cr.
Financial break even point is that level of EBIT at which EPS = 0.
Therefore,
EBIT I = 0
EBIT 646.61 = 0
EBIT = Rs.646.61 cr.
Significance: It is the level of EBIT which recovers the total interest burden.
466. (a) DFL =
EBIT
EBIT I
= 4
or EBIT = 4(EBIT 300)
or EBIT =
1,200
3
= Rs.400 lakh
DOL =
Contribution
EBIT
= 5
Contribution = 5 x 400 = Rs.2,000 lakh
Contribution = 25% sales
or Sales =
2,000
0.25
= Rs.8,000 lakh
Variable cost = 8,000 2,000 = Rs.6,000 lakh
Fixed Cost = Contribution EBIT
= 2000 400 = Rs.1,600 lakh.
467. (e) DOL = 1.30 =
Contribution
Contribution Fixedcost

(or) 1.30 (Contribution 2.50) = Contribution
(or) 1.30 Contribution 1.30 x 2.50 = Contribution
(or) (1.30 1.00) Contribution = 1.30 x 2.50
(or) Contribution =
1.30 x 2.50
0.30
= Rs.10.83 lakh
EBIT = Contribution Fixed Cost = 10.83 2.50 = Rs.8.33 lakh
DFL =
EBIT
EBIT I
=
8.33
8.33 30x 0.15
= 2.175
DTL = DOL x DFL = 1.30 x 2.175 = 2.83.
316
468. (a) If a decline in sales causes the profit before tax to be zero then profit after tax and EPS
will also be zero.
DTL =
EPS/EPS
S/S
or
S
S
=
EPS/EPS
DTL

If such a situation arises then,
EPS = 0 2.0 = 2.0

EPS
EPS
=
2.00
2.00
= 1.00

S
S
=
1.00
3.00
= 0.3333
i.e., a decline in sales by 33.33%.
469. (a) Operating Leverage (OL) =
Contribution
EBIT
Rs.2,500lakh
=
Rs.800lakh
= 3.125
Financial Leverage (FL) =
EBIT
PBT
=
Rs.800lakh
Rs.300lakh
= 2.66
Combined Leverage of AB Ltd. = OL x FL = 3.125 x 2.66 = 8.33.
470. (a) Degree of Operating Leverage (DOL) =
Q(S V)
Q(S V) F

=
1,20,000(1.20 0.40)
1,20,000(1.20 0.40) 14,000

=
96,000
82,000
= 1.17
(or)
Degree of Operating Leverage (DOL) =
Contribution
EBIT

Zee Ltd.
Variable cost per unit 0.40
0.80
Total contribution Rs.96,000
Fixed costs 14,000
EBIT 82,000
Interest 8,000
74,000
DOL =
96, 000
1.17.
82, 000
=
471. (c)
XYZ Ltd.
Output (units) 30,000
Contribution per unit (Rs.) 4.50
Total contribution (Rs.) 1,35,000
Fixed costs 28,000
EBIT 1,07,000
Interest 16,000
Profit Before Tax (PBT) 91,000
Degree of Financial Leverage (DFL) =
EBIT 1,07,000
=
PBT 91,000
= 1.176.
Part II
317
472. (d)
LMN Ltd.
Contribution per unit (Rs.) 0.07
Total contribution (Rs.) 14,000
Fixed costs 3,500
EBIT 10,500
Interest
Profit Before Tax (PBT) 10,500
DOL =
Contribution 14,000
=
EBIT 10,500
= 1.33
DFL =
EBIT 10,500
=
PBT 10,500
= 1.00
DCL = DOL x DFL = 1.33 x 1.00 = 1.33
473. (c)
Rs.
Sales 5,00,000
Variable cost 3,00,000
Contribution 2,00,000
Fixed cost 1,50,000
EBIT 50,000
Interest @ 10% on 1,50,000 15,000
PBT 35,000
Operating leverage =
Contribution
EBIT
=
2,00,000
=4
50,000

Financial leverage =
EBIT 50,000
= =1.42
PBT 35,000

Combined leverage = 4 x 1.42 = 5.68.
474. (b) Statement of Operating Leverage
Particulars 4500 units 5000 units
Sales @ Rs.12 per unit 54,000 60,000
Variable cost @ 8 per unit 36,000 40,000
Contribution 18,000 20,000
Fixed cost: 3000 x (Rs.12 8) 12,000 12,000
EBIT 6,000 8,000
Contribution
EBIT
=
18,000
6000
;
20, 000
8, 000
= 3; 2.5
318
475. (e) Operating leverage of Tata Ltd. =
Contribution Rs.700lakh
=
EBIT Rs.550lakh
= 1.27
Operating leverage of Gemini Ltd. =
Contribution Rs.1200lakh
=
EBIT Rs.800lakh
= 1.5
The operating leverage is higher in case of Gemini Ltd. and hence it has higher degree of
476. (c) Financial leverage of Maruthi Ltd. =
EBIT Rs.1150lakh
=
PBT Rs.1000lakh
= 1.15
Financial leverage of Ford Ltd. =
EBIT Rs.2,300lakh
=
PBT Rs.2,000lakh
= 1.15
Both the companies have same degree of financial leverage. Hence, both the firms have same
financial risk.
477. (d) In order to find out the % change in EPS as a result of % change in sales, the combined
leverage should be calculated as follows:
Operating leverage = Contribution/EBIT =
Rs.20,20,000+Rs.7,00,000
20,20,000
= 1.34
Financial leverage = EBIT/Profit before tax =
Rs.20,20,000
Rs.13,20,000
= 1.53
Combined leverage =
Contribution
Profit before tax
= OL x FL = 1.34 x 1.53 = 2.05
The combined leverage of 2.05 implies that for 1% change in sales level, the % change in
EPS would be 2.05%. So, if the sales are expected to increase by 5%, then the % increase in
EPS = 5 x 2.05 = 10.25%.
478. (a) Combined leverage = 3.50
Operating leverage = 2.25
Combined leverage = Financial leverage x Operating leverage
Hence, Financial Leverage =
Combined leverage
Operating leverage

3.50
2.25
= 1.56.
479. (d) Financial leverage =
Combinedleverage
Operatingleverage
=
4.50
2.75
= 1.63
EBT+Interest
EBT

1.63 =
EBT+63,000
EBT

1.63 EBT = EBT + 63,000
1.63EBT EBT = 63,000
EBT = 1,00,000
EBIT = EBT + Interest
= 1,00,000 + 63,000 = 1,63,000
Part II
319
Contribution
EBIT

Contribution = Operating leverage x EBIT = 2.75 x 1,63,000 = 4,48,250
P/V ratio =
Contribution
x 100
Sales
=
4,48,250
x 100 = 22.41%
20,00,000
.
480. (a) Operating leverage =
Contribution
Earnings Before Interest and Tax(EBIT)

Contribution = Sales Variable Cost = Rs.50,000 Rs.7,000 = Rs.43,000
EBIT = Sales Variable Cost Fixed Cost = 38,000
Rs.43,000
= 1.13
Rs.38,000

481. (a) Financial leverage =
EBIT
EBT

EBT = EBIT Interest = Rs.38,000 + 10,000 = Rs.28,000
Rs.38,000
= 1.36.
Rs.28,000

482. (c) Rs.
Sales 50,000
Variable cost @ 60% 30,000
Contribution 20,000
Fixed cost 12,000
Operating profit 8,000
Contribution
Operating profit
=
20,000
= 2.50
8,000
.
483. (c)
Net worth Rs.25,00,000
Debt/Equity 3:1
Hence, Debt Rs.75,00,000
EBIT 20,00,000
Interest @12% on 75,00,000 9,00,000
PBT 11,00,000
EBIT 20,00,000
= = 1.82.
PBT 11,00,000

484. (b) Operating statements of 2 firms
Sheetal Ltd. Arc Ltd.
Sales 2,00,000 2,00,000
Variable cost @ 4/- 80,000 80,000
Contribution 1,20,000 1,20,000
Fixed cost 1,10,000 1,10,000
EBIT 10,000 10,000
Interest 5,000
Profit before tax 10,000 5,000
Tax @40% 4,000 2,000
Profit after tax 6,000 3,000
320
Calculation of leverages:
Sheetal Ltd. Arc Ltd.
1, 20, 000
10, 000
= 12
1, 20, 000
10, 000
= 12
10, 000
10, 000
= 1
10, 000
5, 000
= 2
Combined leverage = 12 x 1= 12 12 x 2 = 24.
485. (a) Calculation of operating leverage =
Contribution
EBIT

Rs. Rs.
Situation I Situation II
Sales (2000 units @Rs.20 per unit) x 0.55 22,000 22,000
Less: Variable Cost (2000 units @Rs.10 per unit) x 0.55 11,000 11,000
Contribution 11,000 11,000
Less: Fixed costs 5,000 8,000
EBIT 6,000 3,000
Operating leverage
11,000 11,000
1.83;
6,000 3,000
= = 3.67.
486. (c) Calculation of financial leverage =
EBIT
PBT

Rs. Rs.
Financial Plan A B
EBIT in situation II 3,000 3,000
Less: Interest on debt 1,200 600
PBT 1,800 2,400
Financial leverage
3, 000
1.67
1, 800
=
3, 000
1.25.
2, 400
=
487. (c)
Particulars ICICI Ltd. HDFC Ltd.
1. Operating leverage =
Contribution
EBIT

4 5
2. Financial leverage =
EBIT
EBT

2 3
3. Combined leverage =
Contribution
EBT

8 15
1. The operating leverage of ICICI Ltd. is 4 and of HDFC Ltd. is 5. It means change in the
level of sales will have more impact on EBIT of HDFC Ltd. than that of ICICI Ltd. The
volume of fixed cost may be higher in case of HDFC Ltd. than that of ICICI Ltd. The
business risk of HDFC Ltd. is also more as compared to ICICI Ltd.
2. The financial leverage of ICICI Ltd. is 2, and of HDFC Ltd. is 3. It means the interest
burden of HDFC Ltd. is higher than ICICI Ltd. Financial risk of HDFC Ltd. is higher as
compared to ICICI Ltd.
3. The degree of combined leverage of ICICI Ltd. is 8 and that of HDFC Ltd. is 15. It
means any change in sales will show more impact on EPS in case of HDFC Ltd.
In view of the above, the Managing Directors opinion about HDFC Ltd. is wrong.
Therefore, ICICI Ltd. carries less business risk and financial risk as compared to HDFC Ltd.
Part II
321
488. (d)
Rs. in lakh
Net Sales 1500
EBIT (12% of net sales) 180
Less: Interest (Rs.300 lakh x 15/100) 45
EBT 135
Less: Tax @40% 54
EAT 81
Less: Preference dividend (Rs.100 lakh x 13/100) 13
Earnings available to equity share holder 68
Calculation of operating leverage:
EBIT
Dp
EBT
1 T

=
180
1.588
13
135
1 0.4
=

Combined leverage = 3 (given)
Combined leverage = Operating leverage x Financial leverage
3 = Operating leverage x 1.588
Operating leverage = 3/1.588 = 1.89.
489. (c)
Rs. in crore
Net sales 30.00
EBIT (12% of Net Sales) 3.60
Less: Interest on 15% debentures (Rs.6 crores x
15
100
) 0.90
EBT 2.70
Less: Tax @ 40% 1.08
EAT 1.62
Less: Preference dividend (Rs.2 crore x 13/100) 0.26
Earnings available to equity share holders 1.36
Calculation of operating leverage:
P
EBIT
D
EBIT I
(1- T)

=
3.6
0.26
3.6 0.9
(1 0.4)

=
3.60
1.588
2.267
=
Combined leverage = 3 (given).
Combined leverage = Operating leverage x Financial leverage
3 = Operating leverage x 1.588
Operating leverage = 3/1.588 = 1.889.
490. (e) Calculation of Sales:
=
Sales
= Sales turnover ratio
Total assets
=
Sales
3
3,00,000
=
Sales = 3 x 3,00,000 = Rs.9,00,000
322
Calculation of leverages:
Rs.
Sales 9,00,000
Less: Variable Cost (50% of sales) 4,50,000
Contribution 4,50,000
Less: Fixed operating cost 1,50,000
EBIT 3,00,000
Less: Interest (1,20,000x10/100) 12,000
EBT 2,88,000
Less: Tax @ 50% 1,44,000
EAT 1,44,000
1. Operating leverage =
Contribution
EBIT
=
4,50,000
=1.50
3,00,000

2. Financial leverage =
EBIT
EBT
=
3,00,000
=1.04
2,88,000

3. Combined leverage = operating leverage x financial leverage = 1.50 x 1.04 = 1.56
491. (b) DOL =
Q(S V)
Q(S V) F

=
15,000(500 350)
15,000(500 350) 9,00,000

=
22, 50, 000
22, 50, 000 9, 00, 000
=
22, 50, 000
1.67.
13, 50, 000
=
492. (b) DTL =
p
Q(S V)
D
Q(S V) F I
(1 T)
=
7500(600 300)
35, 000
7500(600 300) 10, 00, 000 95, 000
(1 0.4)

=
22, 50, 000
22, 50, 000 10, 95, 000 58, 333.3
= 2.05
493. (d) Percentage change in EPS = DTL x Percentage change in Q. = 9 x 5% = 45%.
494. (d) DOL =
Contribution
EBIT
=
20, 00, 000
2
10, 00, 000
=
DFL =
p
EBIT
D
EBIT Interest
(1 t)

=
10, 00, 000
1, 00, 000
10, 00, 000 5, 00, 000
0.6

= 3.
DCL = DOL x DFL = 2 x 3 = 6
If the sales level increases by 10%, then the EPS would increase by 10% x DCL i.e., 10% x 6
= 60% and the new EPS would be 60% higher than the existing EPS. The existing EPS is
Rs.2 (i.e., Rs.2,00,000 1,00,000). The new EPS would be Rs.2 + 60% i.e., Rs.3.20.
495. (c) The Degree of Total Leverage (DTL) is defined as the product between the Degree of
Operating Leverage (DOL) and the Degree of Financial Leverage (DFL).
The resultant DTL
will be = 1.3 DOL 0.8 DFL = 1.04 DTL

Hence DTL

= 1.04 DTL Hence the DTL will increase by 4 percent.

Part II
323
496. (d) For Garden Restaurant, the amount of contribution = Rs.14,00,000 25 percent
= Rs.350,000.
EBIT = Rs.350,000 Rs.150,000 = Rs.200,000
Interest on bank loan = Rs.400,000 12.50 percent = Rs.50,000
Preference Dividends = Rs.200,000 15 percent = Rs.30,000.
So, the degree of financial leverage (DFL) will be:
DFL =
p
EBIT
D
EBIT I
1 T

=
200, 000 200, 000
30, 000
200, 000 100, 000
200, 000 50, 000
1 0.4
=
= 2.00
The required degree of financial leverage (DFL) = 2.00.
497. (c) According to the concept of the operating leverage, the percentage change in EBIT is
equal to the degree of operating leverage multiplied by the percentage increase in sales
turnover = 6 2.25 = 13.50 percent.
498. (b) The Degree of Total Leverage (DTL) is the product between the Degree of Operating
Leverage (DOL) and the degree of financial leverage. So, the DTL = 3 1.67 = 5.00.
Therefore, as per the concept of DTL, in order to increase the EPS by 10 percent, the sales
volume should be increased by 10/5 = 2.00 percent.
499. (e) The overall break-even point for any company is Q =
P
D
F I
1 t
(S V)
+ +

For Hyderabad chemicals, SV = Rs.500 20% = Rs.100,
F = Rs.90,000 and I = Rs.75,000 while D
P
= 0.
Hence, Q =
90, 000 75, 000
100
+
= 1,650.
500. (e) The overall break even point of any company is defined as:
Q
*
=
P
F I D /(1 T)
(S V)
+ +

Here, F = Rs.80 lakh, I = Rs.30 lakh, D
P
= Rs.12 lakh, T = 40 percent and
(SV) = Rs.40 25% = Rs.10.
So, Q
*
=
12
80 30
1 0.4
10
+ +
=
80 30 20
10
+ +
= 13 lakh units.
501. (a) EBIT
DFL =
EBIT
EBIT I D (I t)

1.6 =
p
25, 000
25, 000 7, 000 D /(1 03)

D
p
= 1663.
502. (c) Q (S V)
DTL =
p
Q(S- V)
Q(S V) F I D /(1 0.3)

DTL = (60,000)/(60,000) 30,000 10,000 = 3
324
503. (d) DTL = % change in EPS/% change in output
3 = % change in EPS / 0.10
Change in EPS = 30%.
504. (a) DOL = % Change in EBIT/% Change in Quantity = 0.3/0.18 = 1.67.
505. (a) Q (S V)/Q(S V) F
DOL = [5,000(3,25,000 1,80,000)]/ [5,000(3,25,000 1,80,000)] 3 crore = 1.043.
506. (b) DTL = DOL x DFL = 2.5 x 3.5 = 8.75.
507. (a) DTL = DOL x DFL or % Change in EPS/% Change in output = 3.5 x 1.2 = 4.2
i.e. one percent change in output will lead to 4.2 % change in EPS.
508. (e) Financial BEP = Dp/1 t = 2000 x 100 x 0.15/(1 0.4) = 50,000.
509. (d) DTL = % Change in EPS / % Change in output
3.5 = Change in EPS/0.25
Change in EPS = 87.5%.
EPS next year = 2.5 + 87.5% of 2.5 = 2.5 + 2.187 = 4.687 4.69
510. (c) DOL = Contribution/EBIT = 100/50 = 2.
511. (b) Contribution = S V
Sales per unit = 500
Variable cost per unit = 200
Contribution per unit = S V = 500 200 = 300.
512. (c) DTL = % Change in EPS/% Change in output = 0.20/0.10 = 2.
513. (a) DOL = Contribution/EBIT = 100/50 = 2.
514. (c) Q (S V)
DOL =
Q(S V) A
Q(S V) F

= 50,000 x 7/50,000 x 7 50,000 = 1.166 or 1.67% 1.17%.
515. (b) DOL = Total contribution/EBIT
Contribution = Q (S V)
DOL =
100
50
= 2
516. (a) Overall BEP (Q) =
p
F+ I +D /(1 t)
S V

Financial BEP = D
p
/ 1 t + I
Operating BEP= F/SV
SV= 20,000/2,500 = 8
Overall BEP = (20,000 + 4,000)/8 = 3,000.
Part II
325
517. (c) External Fund Requirement (EFR) =
A L
S S

S MS
1
(1 d)
Where,
A
S
and
L
S
are assets and current liabilities as a percentage of sales respectively.
S = Expected increase in sales
M = Net profit margin
S
1
= Next year sales
d = Dividend pay-out ratio
Substituting the value
EFR =
Rs.18,75,000 Rs.2,50,000
Rs.28,00,000 Rs.28,00,000

0.25 x 28,00,000 0.125 x Rs.35,00,000 x 0.5
= Rs.(4,06,250 2,18,750) = Rs.1,87,500.
518. (d) M = 0.07
d = 0.5
Total assets = 4,750
A/S =
4,750
6,000
= 0.792
L = 750(Spontaneous liabilities)
L/S =
750
6,000
= 0.125
S
1
= 7,500
S = 1,500
EFR =
A L
S S

(S) mS
1
(1 d) = (0.79 x 1,500 0.125 x 1,500) (0.07 x 7500 x 0.5)
= Rs.738.
519. (b) Projected Sales = 60 x 1.4 = Rs.84 lakh
Given
NS
TA
= 3

TA
NS
= 0.333
d = 0.6 and

SL
NS
=
9
60
= 0.15
EFR = Rs.1.5 lakh, as the company can generate its own excess funds.
i.e.,
TA SL
NS NS

S mS
1
(1 d) = EFR
4.392 33.6m = 1.5
33.6
M = 5.892
m = 0.1753 or 17.53%.
326
520. (b) EFR =
A L
S S

S mS
1
(1 d)
Where,
A = Total Assets = Rs.18 lakh
L = Spontaneous liabilities = Rs.2.25 lakh
S = Sales in the current year = Rs.45 lakh
S
1
= Projected sales = Rs.45 x 1.25 = Rs.56.25
M = Profit margin = 0.4 x 0.25 = 0.1
D = Dividend pay out = 2 x 0.25 = 0.5
EFR =
18 2.25
45 45

45 x 0.25 0.10 x 56.25 x (1 0.5) = 3.9375 2.8125 = Rs.1.125 lakh.
521. (a) Increment in Sales = 0.25 x 320 = Rs.80 lakh
External funds required = 80 x 0.4 = Rs.32 lakh
S
1
= 320 + 80 = 400
EFR =
A
S
S
L
S
S mS
1
(1 d)
32 =
340
320
x 80
30
320
x 80
48
320
x 400(1 d)
32 = 85 7.5 60(1 d)
60(1 d) = 45.5
1 d =
45.5
60
= 0.758
d = 1 0.758 = 0.2416
Maximum dividend payable = d x Net profit
Total dividends = 0.2416 x
48
320
x 400 = Rs.14.50 lakh.
522. (c) g =
0
m(1 d)A/E
A/S m(1 d)A/E

=
570
0.05(1 0.80) x
255
570 570
0.05(1 0.80)
6,000 255

=
0.0224
0.0726
= 0.3077 or 30.77%.
523. (e) S
0
= 6,000, S
1
= 7,500 and L = 75 + 30 = 105
EFR =
A
S
(S)
L
S
(S) mS
1
(1 d)
=
570
6,000
x 1,500
105
6,000
(1500) 0.05 x 7,500 x 0.20
= 142.50 26.25 75.0 = 41.25.
524. (a) EFR =
A L
S S

S mS
1
(1 d)

A
S
= 650/1,000 = 0.65

L
S
= 150/1,000 = 0.15
L = Sundry Creditors + Provisions
S = 250
m = 8%, S
1
= 1,250 lakh and d = 50%
EFR = (0.65 0.15)250 1,250 x 0.08 x 0.5) = Rs.75 lakh.
Part II
327
525. (b) g =
0
m(1 d)A/E
A/S m(1 d)A/E

=
650
0.05(1 0.5)
200
650 650
0.05(1 0.50)
1000 200

=
0.08125
0.65 0.08125
=
0.08125
0.56875
= 1429 i.e. 14.29%.
526. (a) Given
A = Rs.3,800 lakh
S = Rs.2,500 lakh
L = 600 + 600 = 1,200 lakh
S
1
= Rs.12,800 lakh
m = 0.08
d = 0.3
EFR =
A L
S S

S mS
1
(1 d)
=
3,800 1,200
2,500 2,500

x 300 0.08 x 2,800 x (1 0.30)
= (1.52 0.48) x 300 0.08 x 2,800 x 0.70
= 312 156.8 = Rs.155.2 lakh
EFR is to be raised equally from term loan and short-term bank borrowings.
Amount to be raised through term loan =
155.2
2
= Rs.77.6
Amount to be raised through short-term bank borrowings = Rs.77.6 lakh.
527. (b) Given,
m = 0.05
d = 0.6
S
0
= 6,400
S
1
= 6,400(1.25) = 8,000
L = 950 + 300 = 1,250
A = 4,550
EFR =
A L
S S

S mS
1
(1 d) =
4,550 1,250
6,400 6,400

1,600 0.05 x 8,000(1 0.60)
= 825 160 = 665
i.e., Rs.6,65,000 or Rs.6.65 lakh.
528. (b) The sustainable growth rate can be calculated as follows:
Net profit margin (m) =

61, 409
24, 01, 484
= 0.02557
Dividend pay-out (d) = 0
Total Assets (A) = 50,24,716
Net Worth = 26,28,869
Current Sales (S
0
)* = 24,01,484
Sustainable Growth Rate (g)
=
0
m(1 d) A/E
A/S m(1 d)A/E

=
0.02557 (1- 0) 50, 24, 716/26, 28, 869
(50, 24, 716/24, 01, 484) - 0.02557.1.(50, 24, 716/26, 28, 869)

=
0.04887
2.09234 0.04887
=
0.04887
2.04347
= 0.0239 or 2.39%.
328
529. (d) m = 0.14
d = 0.5
Total Assets = 8,500
A/S =
8, 500
12, 000
= 0.70
L = 1500 (spontaneous liabilities)
L/S =
1, 500
12, 000
= 0.125
S
1
= 15,000
S = 15,000 12,000 = 3,000
EFR =
A
S

L
S
(S) m.S
1
(1 d)
= (0.70 0.125)3000 (0.14 x 15,000 x 0.5) = 1725 1050 = Rs.675.
530. (b) Increment in sales = 0.30 x 510 lakhs = 153 lakhs
External fund required = 153 x 0.50 = 76.5 lakhs
S
1
= 510 + 153 = 663
EFR =
A
S
S
L
S
(S) m.S
1
(1 d)
76.5 =
475
510
x 153
60
510
x 153
72
510
x 663(1 d)
76.5 = 142.5 18 93.6(1 D)
93.6(1 d) = 48.
1 d =
48
93.6
= 0.512
Maximum dividend payable = d x net profit
Total dividends = 0.488 x
72
510
x 663 = Rs.45.67 lakh.
531. (e) S
1
= Projected sales = 75 x 1.45 = Rs.108.75 lakhs.
Given
NS
TA
= 4

TA
NS
= 0.25
d = 0.7

SL
NS
=
12
75
= 0.16, S = 108.75 75 = 33.75.
EFR = Rs.2.5 lakh, as the company can generate is own excess funds
i.e.,
TA SL
NS NS

S mS
1
(1 d) = EFR
= (0.25 0.16)33.75 m x 108.75(1 0.7) = 2.5
= 3.03 m32.62 = 2.5
3.03 + 2.5 = m32.62
5.53 = m32.62 = 0.1695 or 16.95%.
532. (b) g =
0
m(1 d)A/E
A/S m(1 d)A/E

=
700
0.07(1 0.90)
300
700/8,500 0.07(1 0.90)700/300

=
0.016
0.082 0.016
=
0.016
0.066
= 0.2424 or 24.24%.
Part II
329
533. (c) S
0
= 8,500
S
1
= 10,000
L = 90 + 50 = 140
EFR =
A
S
S
L
S
(S) m.S
1
(1 d)
=
700
8, 500
x 1,500
140
8, 500
x 1500 0.07 x 10,000 (1 0.90) =123.52 24.70 70
EFR = 28.82.
534. (b) We know,
EFR = ) S (
S
L
) S (
S
A
mS
1
(1 d)
S
1
= S + S
EFR = ) S (
S
L
) S (
S
A
m (S + S) (1 d)
Given:
Sales (S) = Rs.1000 million
Total Assets (A) = Rs.800 million
Spontaneous liabilities (L) = Rs.250 million
Net profit margin (m) = 0.10
Dividend pay-out ratio (d) = 0.40
EFR = 0 (by the problem)
0 =
800 250
( S) ( S)
1, 000 1, 000

(0.10) (1000 + S) (1 0.40)
or 0 = 0.80 S 0.25 S (0.10)(0.60) (1000 + S)
or 0 = (0.80 0.25) S 0.06 (1000 + S)
or 0 = 0.55 S 0.06 S 60
or 0.49 S = 60
or S =
49 . 0
60
= 122.45 i.e. Rs.122.45 million
Growth rate in sales that can be achieved without raising external funds
=
S 122.45
S 1, 000
= = 0.1225 i.e. 12.25%.

535. (c)
m(1 d) A/ E
g
A/ S m(1 d) A/ E
=

Here m =0.03, d = 10.5 = 0.5, D/E = 0.9 so A/E = 1+D/E = 1+0. 90 = 1.90, A/S
0
= 0.80

0.03(1 0.5)(1.90)
g
0.80 0.03(1 0.5)(1.90
=

; So, g =3.7%
536. (c) The external financing requirement can be found out with the help of the equation

EFR A L m(1 g)(1 d)
S S S g
+
=
If EFR = 0
Then, m =
(A/ S L/ S)g
1 g)(1 d)
+

So m =
(0.8 0.6) x 0.10
4.54%
(1.10) (0.4)
=
330
537. (e) EFR =
1
(A L)
x S mS (1 d)
S

Where A = total assets, L = spontaneous liabilities, m = profit margin ratio,
d = dividend payout ratio, S = sales, S
1
is increased sales and S= change in sales
Here L = 5000, m = 500/20000 = 0.025 and EFR = 500
S = 20000, S
1
= 23000 and S= 3000
By putting the values in the equation,
we get A i.e. total assets = 10,250.
538. (d) EFR =
1
(A L)
x S mS (1 d)
S

Here L = 100, m = 0.05, d = 0.60 so= Rs.600million, A = Rs.550 million S =Rs. 120
million
So EFR =
(550 100)
x120 0.05(1 0.6)
600
= Rs. 75.6 million.

539. (e) EFR =
1
(A L)
x S mS (1 d)
S

So, 0 = (0.750.60) S
0
g 0.06X S
0
(1+g)(1.55)
0.15S
o
g = 0.027S
o
(1 + g)
0.15g = 0.027 + 0.027g
So, g = 21.9.
540. (a)
m(1 d) A/ E
g
A/ So m(1 d) A/ E
=

Here m = 0.07, d = 10.5 = 0.5, D/E = 0.7 so A/E = 1+D/E = 1+0.70 = 1.70, A/S
0
= 0.65
0.07(1 0.5) (1.70) 0.0595
g
0.65 0.07(1 0.5) (1.70) 0.5835

= =

= 0.1008 or 10.08%
So g =10.08%.
541. (b)
1
(A L)
EFR x S mS (1 D)
S
=
Where A = total assets, L = spontaneous liabilities, m = profit margin ratio,
d = dividend payout ratio, S = sales, S
1
is increased sales and S= change in sales
Here L = 7500, m = 1500/100,000 = 0.015 and EFR = 800
S = 100,000, S
1
= 1,25,000 and S= 25000
By putting the values in the equation,
We get A i.e. total assets = 14,450.
542. (c)
1
(A L)
EFR x S mS (1 D)
S
=
So 0 = (0.600.40) S
0
g 0.02 x S
0
(1+g)(10.50)
So, g = 5.2%
543. (c) The amount of debt used to finance the cost of any asset is equal to 66.67 percent of the
value of the asset. So, the debt asset ratio is =
66.67 2
100 3
= .
Part II
331
544. (b) The amount of external funds required by a company is given by : Expected increase in
assets Expected increase in spontaneous liabilities Expected retained earnings.
Here, the expected retained earnings of the company is Rs.500 lakh 60 percent = Rs.300
lakh. Hence, the required figure is Rs.1200 lakh Rs.500 lakh Rs.300 lakh = Rs.400 lakh.
545. (b) Sustainable growth rate g =
( )
( )
o
A
m 1 d
E
A A
m 1 d .
S E

Here, net profit =
12
100
120
= 10 percent
Dividend pay-out ratio d =
7.2
12
= 0.6
Debt-equity ratio = 60:40 = 1.50 and so the asset-equity ratio =
A
E
=
D E D
1 2.50
E E
+
= + =
Total asset turnover ratio =
S
1.5
A
= so
A 1
0.67
S 1.50
= =
So, g =
0.1 0.4 2.5 0.10 0.10
0.1754(approximately)
0.67 0.1 0.4 2.5 0.67 0.10 0.57

= = =

= 17.54 percent.
Therefore, the required sustainable growth rate = 17.54 percent = 18 percent (approximately).
546. (a) The amount of sales in the year 2002-03 was
1, 560
= Rs.1, 200
1.30
lakh
Total assets in the last year was =
1, 200
= Rs.750
1.60
lakh and the amount of current assets
= Rs.750 lakh 33.33 percent = Rs.249.975 lakh Rs.250 lakh.
The amount of spontaneous liabilities = Rs.250 lakh 40 percent = Rs.100.
The amount of External Funds Requirements (EFR) is given by:
EFR = ( ) ( ) ( )
1
A L
S S mS 1 d
S S

EFR=
1 100
360 360 0.08 1560 0.4
1.6 1, 200

Here,
A 1
S 1.6
= = A/S = 1/1.6, L/S = 100/1200 S = Rs.1560 lakh Rs.1200 lakh = Rs.360
lakh, S
1
= Rs.1560 lakh, m = 8 percent and (1 d) = 0.4
So, EFR = 225 30 49.92 = Rs.145.08 lakh = Rs.145 lakh (approximately)
Therefore, the required amount of external funds requirements = Rs.145 lakh.
547. (b) The external funds requirements is given by
EFR =
1
A L
S S m (1 d)
S S

For MAL,
A 1
0.5,
S 2
= =
L
0.20
S
= d = 100% and s = Rs.70 lakh
So, EFR = (0.50 0.20 ) Rs.70 lakh = Rs.21 lakh.
332
548. (d) Substainable growth rate of =
( )
( )
o
A
m 1 d
E
A A
m 1 d
S E

For CAL, m = 8 percent, d = 0, A/E =
d
1 1 0.5 1.5
E
+ = + =
A/S
o
= 0.5
So, the required sustainable grow the rate of =
0.08 1 1.5
0.50 0.08 1 1.5

=
0.12
0.5 0.12
= 0.3158 = 31.58 percent
549. (a) Gross change in fixed assets = Rs.4006 crore + Rs.884 crore Rs.4729 crore = Rs.161 crore
550. (e) External funds requirements (EFR) of any firm is given by
EFR =
o o
A L
S MS, (1 d)
S S

Here, A= Rs.320 lakhs, L= Rs.120 lakhs, So = Rs.500 lakhs, S = 500 20% = Rs.100
lakhs, S, (500+100) = Rs.600 lakhs.
The net profit margin of Garodia Rubber is m = 37.50/500 = 7.5 percent = 0.075
The amount of dividend paid was = Rs.3.00 500,000 = Rs.15 lakh. Hence, the dividend pay
out ratio was d =
15
37.50
= 0.40 or 40 percent.
So, the required EFR =
320 120
100 0.075 600 (1 0.4)
500 500

=
200
100 45 (1 0.4) 40 27
500
= = Rs.13 lakhs.
551. (c) The external financing requirement can be found out with the help of the equation

EFR A L m(1+g) (1 d)
=
S S S g

= 0.8 0.3
0.08 (1+ g) (0.8)
g
= 0.8 0.3
0.08 (1+ g) (0.8)
g

g = 14.67%.
552. (a) The external financing requirement can be found out with the help of the equation
=
EFT A L m(1+g) (1 d)
=
S S S g

= 8 3 3 = 2 lakh.
553. (e) As the net profit margin m is not given the growth rate cannot be determined.
554. (a) EFR = A/S (S) L/S S) m S
1
(1d)
= 0.8 x 1,00,000 0.4 x 1,00,000 0.06 x 11,00,000 x 0.4 = 13,600.
555. (a)
g =
m(1 d) A/E
A/SO m(1 d) A/E

= 1.3 0.05 (1 0.3) (15) = 4.21%.


The model question paper consists of two parts A and B. Part A is intended to test the
conceptual understanding of the students. It contains 40 multiple-choice questions carrying one
point each. Part B contains problems with an aggregate weightage of 60 points. Students are
requested to note that this is an indicative format of the question paper in general and that the
ICFAI University reserves the right to change, at any time, the format and the pattern without any
notice. Hence, the students are advised to use the model question papers for practice purposes
only and not to develop any exam-related patterns out of these model question papers.
The suggested answers given herein do not constitute the basis of evaluation of the students
answers in the examination. These answers have been prepared by the faculty members of the
ICFAI University with a view to assist the students in their studies. And, they may not be taken as
the only answers for the questions given.

Model Question Paper I
Time: 3 Hours Total Points: 100
Part A: Basic Concepts (40 Points)
Answer all the questions. Each question carries one point.
1. Which of the following is not a systematic risk?
a. Fluctuation in interest rates.
b. Decline in the purchasing power of money.
c. Risk of the government increasing the tax rates.
d. Risk of non-availability of major raw materials of a company.
2. Which of the following is not a marketable instrument?
a. Commercial paper.
b. Certificate of deposit.
c. Term deposit.
d. Corporate debentures.
e. Treasury bills.
3. Security market line shows the relationship between required rates of return on the securities and
a. Variance of the security returns
b. Beta of the securities
c. Risk-free rate of return
d. Standard deviation of security returns
e. Returns on the market index.
4. If a securitys return plots above the security market line, then
a. The securitys beta is less than one
b. The securitys rate of return is more than the return on the market portfolio
c. The risk-free rate is equal to the return on the market portfolio
d. The security is underpriced
e. The security is overpriced.
334
5. Which of the following is a function of the primary capital market?
a. Providing a market for trading outstanding long-term securities.
b. Providing a market for trading outstanding short-term securities.
c. Helping companies to raise funds for long-term uses by creating new securities.
d. Imparting liquidity to existing long-term securities held by investors.
a. Increase in fixed assets.
b. Increase in accrued expenses.
c. Decrease in provisions.
d. Payment of taxes.
7. Which of the following is a source of cash?
a. Increase in fixed assets.
b. Increase in depreciation.
c. Increase in inventory.
d. Decrease in term loans.
e. Decrease in bank borrowings.
8. Other things being equal, which of the following will cause an increase in bond value?
a. Decrease in coupon rate.
b. Increase in yield to maturity.
c. Decrease in the amount repayable at maturity.
d. Increase in the amount repayable at maturity.
9. The amount that a company can realize if it sells its business as an operating one is called
b. Replacement value
c. Market value
d. Book value
e. Liquidation value.
10. Which of the following is true when the required rate of return on a bond is less than the coupon
rate?
a. The discount on the bond decreases as the maturity approaches.
b. The premium on the bond decreases as the maturity approaches.
c. The value of the bond is equal to its par value.
d. The value of the bond is less than its par value.
e. The discount on the bond increases as the maturity approaches.
11. If the degree of financial leverage of a firm is zero, then which of the following statements is
true?
a. The firm has no interest expense.
b. No preference dividend is payable by the firm.
c. The EBIT of the firm is zero.
d. No tax is payable by the firm.
Part III
335
12. Which of the following is false with regard to the Degree of Operating Leverage (DOL)?
a. Each level of output has a distinct DOL.
b. DOL is negative above the operating break even point.
c. DOL is negative below the operating break even point.
d. DOL is positive above the operating break even point.
e. DOL is undefined at the operating break even point.
13. Which of the following is/are the objective method(s) of sales forecasting?
c. Trend analysis.
a. Debt-equity ratio.
b. Debt-asset ratio.
c. Acid-test ratio.
d. Return on equity.
e. Return on investment.
15. Current ratio indicates the
a. Capacity to meet the long-term obligations
b. Percentage of current assets in total assets
c. Percentage of cash in the current assets
d. Capacity to meet the current obligations
e. Percentage of current liabilities in total liabilities.
16. According to the dividend discount model, the current value of a stock is equal to the
a. Present value of all expected future dividends
b. Sum of all future expected dividends
c. Next expected dividend, discounted to the present
d. Discounted value of all dividends growing at a constant rate
e. Future value of all past declared dividends.
17. Which of the following equity concepts would you expect to be least important to a financial
analyst?
a. Par value per share.
b. Additional paid-up capital.
c. Retained earnings.
d. Net common equity.
e. Cost of equity.
18. Financial risk refers to the
a. Risk of owning equity securities
b. Risk faced by equity holders when debt is used
c. General business risk of the firm
d. Possibility that interest rates will increase
e. Possibility that interest rates will decrease.
336
19. A DOL of +2 would mean
a. If there is an increase of 10% in quantity EBIT will increase by 20%
b. If there is an increase of 10% in fixed costs the EBIT will increase by 20%
c. The business risk of the firm is 2%
d. The effect on EBIT will be very great for a given % change in quantity
20. Which is false w.r.t External Fund Requirement?
a. If the NP margin increases EFR decreases.
b. If the Dividend Pay-out Ratio increases EFR increases.
c. If the A/S increases EFR increases.
d. If the growth rate increases EFR increases.
e. The growth rate is the growth rate of the earnings.
a. Risk-return trade-off means minimizing the risks of a firm and increasing returns.
b. The profit maximization goal takes into account the variability associated with risk.
c. Every decision involving finance should balance between risk and return necessarily.
d. The goal of both Financial Management and that of the firm is wealth minimization only.
e. The profit maximization principle serves as a good measure to compare two firms.
22. The k
j
in k
j
=R
f
+
j
(k
m
R
f
) is
a. The expected rate of return
b. The required rate of return
c. The rate which induces the investor to purchase the security
23. Funds from operation is
a. EBIT
b. PAT +DEP
c. EBDIT
d.
P

AT Non-cashcharges
1 Taxrate
+
e. PAT +INT(1 Tax Rate).

24. Which of the following risks can be diversified away?
b. Market risk.
c. Business risk.
d. Inflation risk.
25. What is the maximum maturity period for which companies can accept deposits?
a. 1 year.
b. 2 years.
c. 3 years.
d. 4 years.
e. 5 years.
Part III
337
26. The yield curve depicts the current relationship between
a. Bond yields and default risk
b. Bond maturity and bond ratings
c. Bond yields and maturity
d. Promised yields and default premiums
e. Bond yields and bond duration.
27. The value of common stock is likely to decrease if
a. The investment horizon decreases
b. The growth rate of dividends increases
c. The discount rate increases
d. Dividends are discounted back to the present
e. Discount rate decreases.
28. Increases in the risk-free rate will
a. Reduce the market risk premium
b. Increase the stocks risk premium
c. Reduce the stocks beta
d. Increase the stocks expected return when beta <1
e. Increase the stocks beta.
29. When the firm is operating at overall BEP
a. It cannot meet its fixed costs
b. The DTL is
c. The EPS will be 1
d. The DFL will be ve
e. The DTL is 0.
30. The techniques of financial forecasting are
a. Pro forma statements
b. Delphi technique
c. Operating budgets
31. Technical insolvency is a position when
a. The current assets are not equal to current liabilities
b. The firm cannot honor current liabilities including short-term bank borrowings in spite
of earning profits
c. The firm cannot make interest payments to the debt holders
d. The firm defaults for two accounting periods consecutively in paying its current liabilities
e. The firm cannot declare dividends in spite of good profits.
32. The leverage is measured as a
a. % change of an independent variable for a unit change in the dependent variable
b. % change of a dependent variable as a ratio to the percentage change in the independent
variable
c. Ratio between the changes in two variables
d. Ratio between the percentage change of the independent variable over that of dependent
variable
338
33. Your CEO feels that the companys short-termbank borrowings are increasing disproportionately,
whereas you think otherwise. Which of the following ratios would you like to use along with debt
equity ratio to present your view?
a. Current ratio.
c. Interest coverage ratio.
34. The numerator of receivables turnover ratio can be
a. Gross sales
b. Net credit sales
c. Net sales
d. All of the above
e. None of (a), (b) and (c) above.
35. Which of the following is true regarding valuation of securities?
The basic concept involved in the valuation of any security is
a. The FV of future cash flow streams
b. The yearly returns in the form of dividend/interest alone are taken for
calculating the PV.
c. The PV of future cash flow streams discounted at the required rate of return.
d. The PV of future cash flow streams discounted at the firms cost of capital.
36. Commercial Paper is
a. A demand promissory note
b. Issued for fixed maturities
c. Issued at discount to face value
37. Forecasting inconsistencies can be minimized by
a. Allowing managers to establish their own forecasts
b. Establishing a standardized economic forecast to be used by the firm, year in, year out
c. Generating current economic forecasts that are used throughout the firm
d. Following economic forecasts given by the finance ministry
38. The stability of a firms operating income is the focus of
a. Financial leverage
b. Weighted average cost of capital
c. Capital structure
d. Business risk
e. Individual components of cost of capital.
Part III
339
39. Sinking Fund Factor is equal to
a.
1
FVIFA

b.
1
FVIF

c.
PVIF
PVIFA

40. Which of the following is a disadvantage of bought-out deals?
a. It is more expensive than public issue.
b. It involves a time consuming procedure.
c. It is difficult to convince a wholesale investor.
d. Promoters are not assured of immediate funds.
e. Sponsors may misuse their power.
Part B: Problems (60 Points)
Solve all the problems. Points are indicated against each problem.
41. Mr. Anand Suman is considering investment in the shares of ATCO Ltd. He has the
following expectations of return on the stock. The variance of the market returns is 42.2 (%)
2

approximately.
Return (%)
Probability
ATCO Market
0.35 30 25
0.30 25 20
0.15 40 30
0.20 20 10
The yield on 182-day T-bills is 10% p.a.
a. The risk associated with shares of ATCO Ltd. is more than the market risk.
b. The standard deviation of the returns on the shares of ATCO Ltd., is greater than the
standard deviation for the market returns by 0.30% (approximately).
c. The probability distribution of the market returns is wider than the probability
distribution of ATCO Ltd.
(3 points)
42. The beta of a security of SK Ltd., is 1.77. The variance of the securitys returns is 23.43(%)
2
.
The market return has the following probability distribution:
Projected Market Return Probability
15%
12%
8%
30%
40%
30%
The value of the correlation coefficient between market return and the securitys return is
a. 0.996
b. 0.812
c. 0.723
d. 0.123
e. 0.191.
(3 points)
340
43. The current risk-free rate is 10% and the expected return on the market portfolio is 15%. The
expected returns for four scrips are listed together with their expected betas.
Scrip Expected
return (%)
Expected
beta
1. AB Ltd.
2. CD Ltd.
3. EF Ltd.
4. GH Ltd.
17.0
14.5
15.5
18.0
1.3
0.8
1.1
1.7
Based on the above data, in which of the securities will a rational investor not invest in?
a. AB Ltd.
b. CD Ltd.
c. EF Ltd.
d. GH Ltd.
e. Both AB Ltd. and GH Ltd.
(2 points)
44. Using the following information determinethe increase in the EPS of the firm if the EBIT of
the firm increases by 2%?
Sales Rs.120 lakh
Variable cost 70%
Fixed cost Rs.12 lakh
Net worth Rs.10 lakh
Debt-Equity ratio 2:1
Interest rate 16%
Tax rate 35%
a. 0.897%
b. 1.154%
c. 2.001%
d. 2.308%
e. 3.897%.
(2 points)
45. The following data is available about Brooke Ltd.
Sales Rs.30 lakh
Fixed operating costs Rs.10,00,000
The company has the following capital structure:
Equity capital (Shares of Rs.10 each) Rs.2,00,000
Debt Rs.5,00,000
The interest on debt is paid at the rate of 15%. The degree of total leverage for the firm is
a. 4.31
b. 3.81
c. 3.53
d. 2.92
e. 1.23.
(2 points)
Part III
341
46. The DFL of Mountaintop Ltd. is 3. The company pays an annual interest of Rs.1,50,000 to its
debenture holders and does not have any preference shares on its books. The tax rate
applicable to the firm is 45%. If the companys EBIT falls by Rs.22,500, the percentage fall
in its EPS will be
a. 20%
b. 25%
c. 30%
d. 39%
e. 40%.
(2 points)
47. The following information is related to Tip Top Traders Pvt. Ltd.
(Rs. in lakh)
Sales for the year (2000-2001) 80
Purchases for the year (2000-2001) 50
Inventory as on 31-03-2001 15
Inventory as on 31-03-2000 10
The gross profit margin for the company is
a. 34.56%
b. 43.75%
c. 55.67%
d. 57.34%
e. 59.78%.
(2 points)
48. The following information is available about Vectra Ltd.
Current liabilities Rs.49,000
Stock Rs.42,500
Average Collection Period 2 months
The gross profit for the company is Rs.60,000 and the gross profit margin is 20%. Cash in hand is
63% of debtors. The entire sales are on credit basis. The current ratio of the company is
a. 1.50
b. 1.98
c. 2.03
d. 2.53
e. 3.33.
(3 points)
49. Mr. Srinivas is considering investment in Bond X which has a coupon rate of 12%, maturity
period of 5 years and a par value of Rs.100. The bond is presently traded in the market at a
price of Rs.95 and it is redeemable at par on maturity. The approximate YTM of the bond is
a. 12.4%
b. 13.3%
c. 14.6%
d. 15.1%
e. 16.3%.
(2 points)

342
50. Imperial Industries Ltd., has total assets worth Rs.800 lakh and spontaneous liabilities of
Rs.250 lakh. Its sales, at present, are Rs.1,000 lakh. The net profit margin is 10% and the
dividend pay-out ratio is 40%. The sales are growing and, in the forthcoming period the
consequent growth in its assets will be financed entirely by an increase in its spontaneous
liabilities and an increase in its retained earnings without resorting to any external financing in
any form.
The growth rate that can be financed by the company without resorting to external finance is
a. 13.45%
b. 12.25%
c. 11.34%
d. 10.89%
e. 9.56%.
(3 points)
51. The balance sheet and profit and loss account of India Infotech Ltd. for the financial year
April 01, 2003 to March 31, 2004 are given below.
Balance Sheet for India Infotech Ltd. as on
March 31, 2004
(Rs. in lakh)
Liabilities March 2004 March 2003 Assets March 2004 March 2003
Shareholders Fund 3307 3307 Fixed Assets
Reserves & Surplus 80185 54136 Gross block 28403 16892
Current liabilities 8414 4283 Depreciation 13632 8309
Provisions 8183 4213 Net block 14771 8583
Capital work-in-progress 5696 1488
Investments
Investment in subsidiary 1383 75
Current assets
Sundry debtors 13618 8452
Cash & Bank balances 43608 40505
Loan & advances 21013 6836
Total 100089 65939 Total 100089 65939
Profit & Loss Account for the year ended
March 31, 2004
(Rs. in lakh)
Income
Software development products 88232
Other Income 3914
92146
Expenditure
Software development & others 54258
Profit before interest, depreciation and tax 37888
Interest
Depreciation 5323
Provision for tax 3970
Profit after tax 28595
Extraordinary income 757
Profit after tax & extraordinary income 29352
Dividend 2976
Dividend tax 327
Amount transferred to reserves 26049
Part III
343
The total cash used during the period April 2003-March 2004 is
a. Rs.12,116
b. Rs.32,776
c. Rs.34,560
d. Rs.39,673
e. Rs.42,776.
(3 points)
52. Knit Fabric India Ltd. (KFIL) is a leading producer of cotton textiles. KFIL has over 200
employees on its rolls. The management of the company is planning to launch a pension
scheme for its employees with 15 years of service left. It has been proposed that KFIL would
create a fund for the purpose and each employee will be required to contribute to this fund a
fixed sum of Rs.10,000 per annum at the end of each year for 15 years. The contributions to
the fund will earn a 9% rate of interest per annum compounded annually. After retirement
each employee will get Rs.60,000 at the end of every year for 20 years which is paid from
this fund. As the employees annual contribution is not adequate for the planned payment,
KFIL will contribute a lump sum amount per employee to the fund at the time of retirement
of the employee.
The contribution to be made by each employee is
a. Rs.2,93,609
b. Rs.2,54,101
c. Rs.5,47,710
d. Rs.60,000
e. Rs.4,87,710.
(2 points)
53. In the above problem, the lump sum amount per employee to be contributed by KFIL at the
time of retirement of the employee is
a. Rs.60,000
b. Rs.1,50,000
c. Rs.2,54,101
d. Rs.2,93,609
e. Rs.3,12,000.
(2 points)
54. National Electricals Ltd. has achieved sales of Rs.40 crore and a net profit of Rs.5 crore in
the current year. The following figures are obtained from the current years balance sheet:
Paid-up equity share capital Rs.5 crore
Reserves and surplus Rs.3 crore
Long-term loans Rs.8 crore
provisions
Rs.4 crore
If the company wants to increase the return on equity by 7.5 percentage points next year then
by how much should the net profit margin change, other ratios remaining the same?
a. Increase by 1.5%.
b. Decrease by 2.0%.
c. Increase by 2.0%.
d. Decrease by 1.5%.
e. Increase by 3.2%.
(3 points)
344
55. Suraj lent Rs.30,000 to his friend Akash. Akash will repay the loan in five equal annual
installments of Rs.10,000 each, with the first installment to be received at the end of one year
from now. The approximate rate of return that Suraj will receive on the loan is
a. 10%
b. 12%
c. 14%
d. 20%
e. 22%.
(2 points)
56. The degree of operating leverage at a specific level of operations of a firm is 2.50. If the sales
increase by 4% then the percentage change in EBIT will be
a. 10.0%
b. 2.5%
c. 4.0%
d. 5.0%
e. 10.0%.
(1 point)
57. If the effective rate of interest is 10.25% per annum and the nominal rate of interest is
compounded twice a year, then the nominal rate of interest per annum is
a. 9.00%
b. 10.00%
c. 10.50%
d. 11.00%
e. 12.00%.
(2 points)
58. If the approximate doubling period according to the rule of 69 is 6.1 years, then the interest
rate is
a. 7%
b. 9%
c. 11%
d. 12%
e. 14%.
(1 point)
59. Given Total debt-equity ratio =5:4; total assets =Rs.4,500; short-term debt =Rs.600 and
total debt consists only of long-term debt and short-term debt, the long-term debt is equal to
a. Rs.1,567
b. Rs.1,900
c. Rs.2,167
d. Rs.2,500
e. Rs.2,833.
(2 points)
Part III
345
60. Mr.Rajsinha is 70 years old and he is expecting that he will live for another ten years. His
total savings are Rs.1,00,000, which he has deposited in a bank. He wants to spend his
savings equally over these ten years. If the interest earned on these deposits is 10% per
annum, the annual withdrawal made over the defined period such that the account balance
becomes zero at the end of 10 years is
a. Rs.38,550
b. Rs.20,000
c. Rs.18,550
d. Rs.16,273
e. Rs.6,275.
(1 point)
61. Consider the following data regarding the bonds issued by Zeta Ltd. on J uly 15, 2001 to be
redeemed on J uly 15, 2008:
Face value of the bond Rs.100
Issued at a discount of 10%
Redeemable at a premium of 10%
Interest payable semi-annually 8% p.a.
Current market price as on July 15, 2003 Rs.95
The yield to maturity of the bond to a prospective investor is
a. 9.27%
b. 10.80%
c. 12.24%
d. 12.66%
e. 13.55%.
(2 points)
62. A Ltd., and B Ltd., are two companies that manufacture computer hardware. The most recent
dividend paid by these two companies is Rs.1.80 per share and the required rate of return for
both the companies is 11%. The intrinsic value of the share of A Ltd., is Rs.34.12. The
dividends of B Ltd., are expected to grow at a rate of 8% annually for 3 years, followed by
x% annual growth rate from year 4 to infinity. The price of the security of A Ltd., is greater
than the price of the share of company B by Rs. 7.60. The value of x is
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%.
(3 points)
63. The networth of M/s. Ashok Ltd. is Rs.10,00,000. The company has the policy of retaining
50% of its earnings. If the company earns 10% on its net worth the growth rate in dividends is
a. 8%
b. 7%
c. 6%
d. 5%
e. 4%.
(2 points)
346
64. The following data pertain to Mehta & Co.:
Cost of goods sold = Rs.80 lakh
Inventory turnover = 4
Closing stock = Rs.25 lakh
The opening stock is
a. Rs.5 lakh
b. Rs.10 lakh
c. Rs.15 lakh
d. Rs.20 lakh
e. Rs.25 lakh.
(1 point)
65. Mr.Shyam plans to send his son abroad for higher education 15 years hence. Presently the
expenditure on the same is Rs.5,00,000 and this is growing at a rate of 3 percent per annum.
If the rate of interest is 8 percent per anum then, how much should Mr. Shyam invest at the
end of each year for the next 15 years in order to finance the expenditure on his sons higher
education after 15 years?
a. Rs.28,690.
b. Rs.76,187.
c. Rs.7,34,426.
d. Rs.8,50,755.
e. Rs.9,50,825.
(2 points)
66. Asita borrowed an amount of Rs.41,000 from a bank to be repaid in five equal annual
installments. If the rate of interest is 7% p.a. on the reducing balances, the amount of
principal amortized in the first payment is
a. Rs.2,870
b. Rs.7,130
c. Rs.10,000
d. Rs.12,345
e. Rs.13,130.
(2 points)
67. Consider the following data regarding M/s. X Ltd.:
Profit after tax Rs.50,000
10% Preference shares Rs.1,00,000
Degree of total leverage 4
Tax rate 20%
If EBIT has to increase by 10%, sales have to be increased by
a. 10%
b. 8%
c. 5%
d. 4%
e. 2.5%.
(2 points)
Part III
347
68. The stock of Titan Housing Ltd., a housing finance company, sells for Rs.50 per share. The
dividend it is likely to pay after one year is Rs.2.50 per share and the price of the share after
one year is likely to be Rs.55. The return at the end of one year on the basis of the likely
dividend and price per share, will be
a. 5%
b. 10%
c. 15%
d. 20%
e. 25%.
(1 point)
69. The net worth and total debt of Modern Threads Ltd. are Rs.300 lakh and Rs.500 lakh
respectively. The EBIT of the company is Rs.160 lakh. The earning power of the company is
a. 12%
b. 15%
c. 18%
d. 20%
e. 24%.
(1 point)
70. The doubling period of the Kisan Vikas Patra is 7 years and 8 months. What is the rate of
interest according to the Rule of 69?
a. 9.28 %.
b. 9.43 %.
c. 9.58%.
d. 9.73%.
e. 9.88%.
(1 point)


Suggested Answers
Part A: Basic Concepts
1. (d) Systematic risks affect the overall economy. Hence all companies are affected by it. Any
risk which is company specific is not a systematic risk. All alternatives other than (d) are
systematic risks.
2. (c) A term deposit is held for a specific term or maturity with a bank; it is not marketable. All
other alternatives except (c) represent marketable instruments.
3. (b) The security market line shows the relationship between required rates of return on the
securities and beta of the securities.
4. (d) If a securitys return plots above the Security Market Line (SML) then the return on the
security is more than the required rate of return on the security according to the SML. A
greater return means a lesser price of the security than its intrinsic value. Hence the security
is underpriced.
5. (c) Primary capital markets help in the creation of new long-term securities. These long-term
securities are issued by the companies to raises funds for fulfilling their long-term
requirements.
6. (b) A decrease in a liability or an increase in asset is a use of fund. Alternative (b) represents an
increase in a liability, which is a source of fund.
7. (b) Depreciation is a non cash expense. All other alternatives involve the use of cash. Hence
for understanding the funds flow as flow of cash, depreciation represents a source of cash.
8. (d) Intrinsic value of bond = C PVIFA
(k,n)
+ F PVIF
(k,n)

Where, C = coupon payment on the bond
F = amount payable at maturity
k = discount rate
n = number of years to maturity.
From the expression of intrinsic value of bond we can see that other things being equal if the
amount payable at maturity increases then the value of bond increases.
9. (a) The amount that a company can realize if it sells its business as an operating one is called
going concern value.
10. (b) When the required rate of return on a bond is less than the coupon rate, the intrinsic value
of the bond is more than its par value, hence there exists a premium above its par value. This
premium on the bond decreases as the maturity approaches. All other alternatives except (b)
are false.
11. (c) Degree of Financial Leverage (DFL) =
p
EBIT
D
EBIT I
1 t

When, DFL = 0,
t 1
D
I EBIT
EBIT
p

= 0
or EBIT = 0
All other alternatives except (c) are false.
Part III
349
12. (b) The following are true with regard to the Degree of Operating Leverage (DOL)
Each level of output has a distinct DOL.
DOL is negative below the operating break even point.
DOL is positive above the operating break even point.
DOL is undefined at the operating break even point.
13. (c) Trend analysis is an objective method of sales forecasting.
14. (c) Debt-equity ratio and debt-asset ratio are leverage ratios. Return on equity and return on
investment are profitability ratios. Acid-test ratio is a liquidity ratio.
15. (d) Current ratio indicates the capacity to meet current obligations.
16. (a) According to the dividend discount model, the value of an equity share is the discounted
present value of dividends received plus the present value of resale price expected when the
equity share is sold.
17. (a) The value stated on the face of the share is called the face value or the par value. The par
value of the share is least important to a financial analyst because no corporate benefits are
calculated on the par value.
18. (b) Financial risk arises when companies resort to financial leverage or use of debt financing.
The more the company resorts to debt financing, the greater is the financial risk.
19. (a) DOL=Percentage change in EBIT/Percentage change in quantity.
Hence a DOL of +2 indicates that a 10% increase in quantity will lead to a 20% increase
in EBIT.
20. (e) External financing requirement can be found out with the help of the following equation:
EFR = (A/S) (S) (L/S) (S) m S
1
(1 d)
The equation highlights that the amount of external financing depends on the firms
projected growth in sales and not on growth rate in earnings.
21. (c) Decision-making in all areas of management including financial management involves
the balancing of the trade off between risk and return. A finance manager has to decide
whether any opportunity is worth more than its cost and whether additional burden of debt
can be safely borne.
22. (d) The CAPM is represented by k
j
= R
f
+
j
(k
m
R
f
)
Where,
k
j
R
f

j
k
m
23. (b) Funds from operations are not expressed directly in the income statement. In order to get
funds from operations, depreciation has to be added back to the profit after taxes.
24. (c) Business risk refers to the risk of doing business in a particular industry or environment
and it gets transferred to the investors who invest in the business or company. Since this risk
is specific to a company it can be diversified.
25. (e) At present the maximum maturity period for which companies can accept deposits is 60
months or 5 years. Earlier it used to be 36 months.
26. (c) The yield curve depicts the current relationship between yield of the bond and the term to
maturity of the bond.
27. (c) The value of common stock decreases with the increase of discount rate, other things
remaining the same.
350
28. (d) The CAPM is represented by k
j
= R
f
+
j
(k
m
R
f
)
Where,
k
j
R
f

j
k
m
The expected rate of return has a direct relationship to the risk-free rate of return. Hence if there
is an increase in the risk-free rate and < 1 then the stocks expected return also increases.
29. (b) When DTL is calculated for various levels of output then we find that at the overall break
even point of output the degree of total leverage is undefined.
30. (e) All the given techniques are used for financial forecasting.
31. (b) A situation in which a firm can no longer honor its financial obligations. Although its
assets may exceed its total liabilities, thereby indicating a positive net worth, the company
simply does not have sufficient liquidity to pay its debts.
32. (b) Leverage is the influence which an independent financial variable has over a
dependent/related financial variable. When leverage is measured between two financial
variables it explains how the dependent variable responds to a particular change in the
independent variable.
33. (a) Liquidity implies a firms ability to pay its debts in the short run. Here the firms short-
term liquidity has to be found out. Hence current ratio can be used which is commonly used
to measure the liquidity.
34. (b) Receivables turnover ratio measures the speed with which inventory is converted into sales
and accounts receivable converted into cash. It is given as Net credit sales/Average accounts
receivable.
35. (c) The basic concept involved in the valuation of any security is that the value of a security
is the present value of future cash streams discounted at the required rate of return i.e. the
intrinsic value of an asset is equal to the present value of the benefits associated with it.
36. (d) Commercial papers are short-term, unsecured promissory notes issued at a discount to
37. (c) Inconsistencies in forecasting can be minimized by generating current economic forecasts
that are used throughout the firm.
38. (d) Business risk refers to the uncertainty or variability of the firms EBIT or the operating
income. So, everything else being equal, a higher degree of operating leverage DOL means
higher business risk and vice versa.
39. (e) Sinking Fund Factor =
n
k
(1 k) 1 +

FVIFA =
n
(1 k) 1
k
+

Hence Sinking Fund Factor =
1
FVIFA

n
n n
PVIF 1 k (1 k)
x
PVIFA (1 k) (1 k) 1
+
=
+ +
n
k
(1 k) 1
=
+
= Sinking Fund Factor.
Hence, both (a) and (c) are correct. Therefore, option (e) is the answer.
40. (e) Since in a bought-out deal, the shares are initially offered to the sponsor and the sponsor
has the discretion to offload the shares to the public at an appropriate time, it may misuse its
discretion to disinvest the shares in favor of the public; this may affect the interests of the
promoters of the company.
Part III
351
Part B: Problems
41. (c)
Expected return for ATCO
= 30(0.35) + 25(0.30) + 40(0.15) + 20(0.20) = 28%
Variance of returns for ATCO Ltd.
= (30 28)
2
(0.35) + (25 28)
2
(0.30) + (40 28)
2
(0.15) + (20 28)
2
(0.20)
= 38.50 (%)
2
.
The variance of market returns is given to be 42.2 (%)
2
.
Hence, the variance of market returns is more than the variance of returns on a security of
ATCO Ltd.
In other words, risk associated with market returns is more than the risk associated with
ATCO Ltd. Hence option (a) is wrong.
Standard deviation (ATCO) Ltd.= 38.50 = 6.20%
Standard deviation for market returns = 42.20 = 6.50% (approximately)
Hence the standard deviation of the returns on the shares of ATCO Ltd. is lesser than the
standard deviation for the market returns by 0.30% (approximately).
The market returns have a wider probability distribution than the returns on the shares of
ATCO Ltd. (as clearly indicated by the higher standard deviation of the market returns).
42. (a)

i m
2 2
m m
Cov(i,m)

= =
Expected return from the market = p
i
k
m

= 0.30 (15) + 0.40 (12) + 0.30 (8) = 11.70%
m
=
2 1/2
i m m
[ p (k k ) ]
= [(15 11.70)
2
(0.30) + (12 11.70)
2
(0.40) + (8 11.70)
2
(0.30)]
1/2

= [3.267 + 0.036 + 4.107]
1/2
= (7.41)
1/2
= 2.72%.
Given
2
i
= 23.43(%)
2

i
23.43 =
= 4.84%
i.e. 1.77 =
41 . 7
) 72 . 2 )( 84 . 4 (

Therefore,
72 . 2 84 . 4
41 . 7 77 . 1
= = 0.996.
43. (d) Risk-free rate (r
f
) = 10%,
Market return (r
m
) = 15%
Scrip Expected Return (%) Required return (%) = ) r r ( r
f m j f
+
AB Ltd. 17.0 10 + 1.3(15 10) = 16.5
CD Ltd. 14.5 10 + 0.8(15 10) = 14.0
EF Ltd. 15.5 10 + 1.1(15 10) = 15.5
GH Ltd. 18.0 10 + 1.7(15 10) = 18.5
On the basis of the above information, we find that the expected return in case of GH Ltd. is
less than the required rate of return. Hence it is not advisable to buy the security of GH Ltd.
352
44. (d) Total debt = Debt-equity ratio x Net worth = 2 x 10 = Rs.20 lakh.
Interest = 20 x 0.16 = Rs.3.20 lakh.
Preference dividend = 0.
EBIT = Sales variable costs fixed costs
= 120 120 (0.70) 12 = Rs.24 lakh.
DFL =
0 3.20 24
24
t) (1
D
Interest EBIT
EBIT
P

=

= 1.154.
Hence, if EBIT increases by 2%, EPS will increase by 2.308%.
45. (a) Q =
unit per price Selling
Sales
=
30 lakh
150
= 20,000 units.
DTL =
t) (1
D
I F V) Q(S
V) Q(S
p

=
20, 000(150 80)
20, 000(150 80) 10, 00, 000 75, 000 0

= 4.31.
46. (c) It is given that DFL = 3.
Also, DFL =
000 , 50 , 1 EBIT
EBIT
I EBIT
EBIT

3 EBIT 4,50,000 = EBIT
EBIT = Rs.2,25,000.
Fall in EBIT (percentage) =
000 , 25 , 2
500 , 22
= 10%.
Hence, the EPS will fall by (10 x 3) = 30%.
47. (b) Gross Profit margin
=
Sales Cost of goods sold
Sales

Cost of goods sold
= Opening stock + Purchases Closing stock
= 10 + 50 15 = Rs.45 lakh.
Gross Profit Margin =
80
45 80
= 0.4375 = 43.75%.
48. (d) Gross Profit margin =
Gross Profit
Sales

Therefore, Sales =
Gross Profit
Gross Profit Margin
=
20 . 0
60000
= Rs.3,00,000.
Average Collection Period =
Debtors
Dailycredit sales

Part III
353
Debtors = Daily credit sales x Average collection period
=
3, 00, 000 3, 00, 000
x 2
12 6
= = Rs.50,000.
Cash in hand = 0.63 x 50,000 = Rs.31,500.
Current assets = Debtors + Stock + Cash in hand
= 50,000 + 42,500 + 31,500 = Rs.1,24,000.
Current Ratio =
000 , 49
000 , 24 , 1
s liabilitie Current
assets Current
= = 2.53.
49. (b) Interest payment on the bond, C = Rs.12.00
Maturity period, n = 5 years
Market price, P = Rs.95
Redemption value, F = Rs.100
Approximate YTM, r
=
2
95 100
5
95 100
12
2
P F
n
P F
C
+
+
=
+
+
= 0.1333 i.e. 13.33%.
Alternative Method:
95 = 12 PVIFA
(r,5)
+ 100 PVIF
(r,5)

r = 13% RHS = 12 PVIFA
(13%,5)
+ 100 PVIF
(13%,5)

= 12 (3.517) + 100 (0.543)
= 96.504
r = 14% RHS = 12 PVIFA
(14%,5)
+ 100 PVIF
(14%,5)

= 12 (3.433) + 100 (0.519)
= 93.096
r = 13 +
) 096 . 93 504 . 96 (
) 13 14 (
(96.504 95.000) = 13.44%.

50. (b) We know,
EFR = ) S (
S
L
) S (
S
A
mS
1
(1 d)
S
1
= S + S
EFR = ) S (
S
L
) S (
S
A
m (S + S) (1 d)
Given:
Sales (S) = Rs.1000 lakh
Total Assets (A) = Rs.800 lakh
Spontaneous liabilities (L) = Rs.250 lakh
Net profit margin (m) = 0.10
Dividend pay-out ratio (d) = 0.40
EFR = 0 (by the problem)
354
0 =
800 250
( S) ( S)
1, 000 1, 000
(0.10) (1000 + S) (1 0.40)
or 0 = 0.80 S 0.25 S (0.10)(0.60) (1000 + S)
or 0 = (0.80 0.25) S 0.06 (1000 + S)
or 0 = 0.55 S 0.06 S 60
or 0.49 S = 60
or S =
49 . 0
60
= 122.45 i.e. Rs.122.45 lakh
Growth rate in sales that can be achieved without raising external funds
=
S 122.45
S 1, 000
= = 0.1225 i.e. 12.25%.

51. (d) Funds Flow Analysis Cash Basis
Uses of Cash
Payment of dividend tax 327
Payment of dividend 2,976
Increases in non-current assets:
Fixed assets (gross block) 11,511
Capital work-in-progress 4,208
Investment in subsidiary 1,308 17,027
Increases in current assets other than cash:
Sundry debtors 5,166
Loans & Advances 14,177 19,343
Total cash used 39,673
52. (c) Future value of contributions at the end of 15 years (per employee)
1. Amount contributed per annum = Rs.10,000
2. FVIFA
(9%, 15 years)
= 29.3609
3. Accumulated sum at the end of 15 years (FV of Annuity) = 1 2 = Rs.2,93,609.
Sum required at the end of 15 years to pay pension in the years 16 through 35
4. Pension per annum for 20 years (from year 16 to 35) = Rs.60,000
5. PVIFA
(9%, 20 years)
= 9.1285
6. Sum required at the end of the 15th year is the required contribution to be made by
each employee = 4 5 = Rs.5,47,710.
53. (c)
7. Sum accumulated at the end of 15 years from employees contribution
= Rs.2,93,609
8. Amount to be contributed by the company (6 7) = Rs.2,54,101.
Part III
355
54. (a) At present Return on Equity (ROE) =
Equity
profit Net
=
3 5
5
+
= 0.625 i.e. 62.5%
Return on Equity (ROE) can also be computed as:
Equity
assets Total
x
assets Total
Sales
x
Sales
profit Net

Given:
Net profit = Rs.5 crore
Sales = Rs.40 crore
Total liabilities = Total debt + Net worth
= Long-term loans + Current liabilities & provisions + Paid-up equity share capital +
Reserves & surplus
= (8 + 4) + (5 + 3) = Rs.20 crore
Existing net profit margin =
Sales
profit Net
=
40
5
= 0.125 i.e. 12.5%
Total assets = Total liabilities = Rs.20 crore.
Total asset turnover =
Sales
Total assets
=
20
40
= 2.00
Total asset to equity ratio =
Total assets
Net worth
=
) 3 5 (
20
+
= 2.50
Existing ROE = 62.5%
Required ROE = 62.5% + 7.5% = 70%
Required net profit margin =
ROE
Sales Total assets
x
Total assets Net worth
=
50 . 2 x 00 . 2
70
= 14%
Change in net profit margin = 14% 12.5% = 1.5% (increase).
55. (d)
10000 x PVIFA
(k,5)
= 30,000
PVIFA
(k,5)
= 3.
Looking at PVIFA tables
PVIFA
(18,5)
= 3.127
PVIFA
(20,5)
= 2.991
By interpolation,
k = 18 + 2 x
991 . 2 127 . 3
3 127 . 3

= 19.87% or approximately 20%.
56. (e) DOL =
Percentage change in EBIT
Percentage change in sales

or Percentage change in EBIT = DOL Percentage change in sales
= 2.50 4 = 10%.
57. (b) e = 1
m
r
1
m

+
Where, e = effective rate of interest
r = nominal rate of interest
m = number of times compounding is done in a year.
356
Given: e = 10.25% and m = 2
0.1025 =
2
r
1 1
2

+

or 1.1025 =
2
r
1
2

+

1 +
r
2
=
1025 . 1

or r = ( 1.1025 1)
2
= 0.10 i.e. 10%.
58. (d) Rule of 69:
69
Interest rate(i)

Given: Doubling period = 6.1 years.
Therefore, 0.35 +
i
69
= 6.1
or
i
69
= 5.75
or i =
75 . 5
69
= 12%.
59. (b)
Total debt 5
Equity 4
=
Adding 1 to both sides of the equation we get:

Total debt 5
1 1
Equity 4
+ = +
or
Total debt Equity 5 4
Equity 4
+ +
=
or
Total assets 9
Equity 4
=
Equity =
4 4
x total assets x 4, 500
9 9
= = Rs.2,000.
Now, total assets = Total debt + Equity = Rs.4,500
Total debt + 2,000 = 4,500
Total debt = 2,500
Long-term debt = Total debt Short-term debt = 2,500 600 = Rs.1,900.
60. (d) Let Equated annual withdrawal be X
X. PVIFA(10,10%) = Rs.1,00,000
X 6.145 = 1,00,000
CIF = 1,00,000/6.145 = Rs.16,273.393.

Part III
357
61. (b) The YTM is the value of i in the following:
95 = 4PVIFA
i,10
+ 110PVIF
i,10

At i = 5%, RHS = 98.428
At i = 6%, RHS = 90.82
i =
98.428 95
5
98.428 90.82
= 5.4 = 10.8% (approximately).

62. (c) IV of A Ltd. = Rs.34.12
Price of B Ltd. = 34.12 7.60 = Rs.26.52
Price = PV of dividends + PV of IV
=
2 3 3
2 3 3
1.8(1.08) 1.8(1.08) 1.8(1.08) 1.8(1.08) (1+x)
+ + +
1.11 (1.11) (1.11) (k g)(1.11)
= 26.52
= 1.751 + 1.704 + 1.658 +
1.658(1 x)
26.52
0.11 x
+
=

1.658(1 x)
0.11 x
+
= 21.407
1.658 + 1.658x = 2.355 21.407x
23.065x = 0.6968x = 0.03 = 3%.
63. (d) Let net worth = Rs.10,00,000
Year 1
Rs.
Total earnings
(10% of Rs.10, 00, 000)
= 1,00,000
Less: Retained earnings (50%) = 50,000
Dividends distributed = 50,000
Year 2
Rs.
Earnings on net worth = 1,05,000
(Rs.1,00, 000 + 10 % of Rs.50, 000)
Less: Retained earnings (50%) = 52,500
Dividends distributed = 52,500
Growth in dividends
(Dividends in 2nd year Dividends in 1st year/ Dividends in 1st year) x 100
= (Rs.52, 500 Rs.50, 000) / Rs.50, 000
= Rs.2, 500/Rs.50, 000
= 5%.
358
64. (c) Inventory turnover =
Cost of Goodssold
Average Inventory
= 4
Now,
COGS = Rs.80 lakh, hence average inventory will be = Rs.20 lakh
But the amount of closing stock = Rs.25 lakh
Therefore the amount of opening stock will be = (20 x 2) 25 = Rs.15 lakh.
65. (a) At the end of 15 years, the amount of expenditure will be = Rs, 5,00,000 x (1.03)
15

= Rs.7,78,983.71
So the required amount of annual installment will be =
7, 78, 983.71
FVIFA(8%,15 years)

7, 78, 983.71
27.152
= = 28,689.74 = Rs.28,690.
66. (b) Let the equal annual installment be A.
41,000 = A x PVIFA
(7%,5)

Therefore A =
41, 000
Rs.10, 000
4.1
= .
Every installment comprises an interest component and a principal component.
The interest component in the first installment of Rs. 10,000 = 0.07 x 41,000 = Rs. 2,870.
Hence the amount of principal amortized by the first installment = 10,000 2,870 = Rs. 7,130.
67. (c) Change in EBIT with respect to change in sales is known by Degree of operating
leverage.
Degree of operating leverage =
Degree of Total leverage
Degree of Financial leverage

DFL =
p
EBIT
D
EBIT I
1 T

PAT = Rs.50,000
Given tax rate = 20%,
PBT =
50, 000
Rs.62, 500
0.8
=
Given EBIT = Rs.1,00,000,
Interest = 1,00,000 62,500 = Rs.37,500
DFL =
1, 00, 000 1, 00, 000
2
0.1x1, 00, 000
50, 000
1, 00, 000 37, 500
1 .2
= =

DOL =
4
2
2
=
Hence, if EBIT has to increase by 10%, sales have to be increased by 5%.
68. (c) Holding period return is given as
r =
t t 1 t
t 1
P P D
P
+

Here P
t
= Rs.55, P
t1
= Rs.50, D
t
= Rs. 2.50
So,
55 50 2.50
r 100 15percent
50
+
= = .
Part III
359
69. (d) Earning power =
EBIT 160
Total Assets 300 500
=
+

160
0.2
800
= =
Hence, earning power of the company = 20%.
70. (b) 7 years and 8 months =
8
7 7.67 years
12
=
According to the Rule of 69, Doubling period =
69
0.35
Rateof Interest
+
Or, 0.35 +
69
7.67
k
= or,
69
k
=7.32
Or, k = 9.426 9.43
Hence, the required rate of interest = 9.43 percent.

Model Question Paper II
1. Which of the following is not the reason for money having time value?
a. Money can be productively deployed to generate real returns over time.
b. In an inflationary period the purchasing power of money declines over time.
c. Future is uncertain and individuals prefer to have the money today than sometime in
future.
d. Money in the form of currency is a legal tender guaranteed by the government.
2. The minimum number of persons required to form a public limited company is
a. 2
b. 4
c. 6
d. 7
e. 8.
3. The objective of financial management to increase the wealth of the shareholders means an
a. Increase in the physical assets owned by the shareholders due to any reason whatsoever
b. Increase in the cash in hand of the shareholders due to any reason whatsoever
c. Increase in the bank account balance of the shareholders due to any reason whatsoever
d. Increase in the market value of the shares of the firm held by the shareholders
e. Increase in the total number of shares of various companies held by the shareholders.
4. Which of the following is not a function of the finance manager?
a. Deployment of funds.
b. Risk-return trade off.
c. Giving proposals for investment in various technical projects.
d. Mobilization of funds.
e. Control over the use of funds.
5. Which of the following is not true with regard to the sole proprietorship firm?
a. It is easy and inexpensive to establish the firm.
b. There is no tax on the income of the firm.
c. Life of the firm is perpetual.
d. Raising funds from the public is not possible.
e. The personal liabilities of the proprietor are unlimited.
6. Which of the following functions of the financial system facilitates conversion of investments
in stocks, bonds, debentures, etc. into money?
d. Risk function.
e. Policy function.
Part III
361
7. In which of the following markets short-term financial instruments are traded?
a. Primary market.
b. Secondary market.
c. Capital market.
d. Money market.
8. In which of the following types of issue, new securities are offered to the existing
shareholders of the company on a pro rata basis?
a. Public issue.
b. Rights issue.
c. Bonus issue.
d. Private placement.
9. Which of the following is not a diversifiable risk in the context of investment in stocks?
a. Company strike.
b. Bankruptcy of major supplier.
c. Bankruptcy of major customer.
d. Unexpected entry of new competitors into the market.
10. Which of the following is not an assumption in the CAPM?
a. Investors use the expected return and standard deviation of returns as the appropriate
measures of return and risk of the portfolios.
b. Investors are risk averse.
c. Investors do not agree with each other on the nature of return and the risk associated
with each investment.
d. The assets can be bought and sold in any unit desired.
e. Transaction costs are low.
11. Which of the following represents the amount that can be realized by a company if it
terminates its business and sells all its assets?
a. Book value.
b. Liquidation value.
c. Replacement value.
d. Going concern value.
e. Market value.
12. When the required rate of return on a bond is greater than its coupon rate the
a. Premium on the bond increases as the maturity approaches
b. Premium on the bond declines as the maturity approaches
c. Discount on the bond increases as the maturity approaches
d. Discount on the bond declines as the maturity approaches
e. Discount on the bond remains constant till the maturity.
362
13. Which of the following ratios indicates the capital structure?
a. Debt-assets ratio.
b. Price-earnings ratio.
c. Total asset turnover ratio.
d. Return on equity.
14. At the time of the bond being sold, the bond price has fallen by an amount exceeding the
coupon payment. Then
a. It earns a holding period return
b. Current yield can be measured
c. The holding period return will be negative
15. Which of the following ratios does not affect the ROE in Du Pont analysis?
a. Debt assets ratio.
b. Assets turnover ratio.
c. Return on assets ratio.
d. Net profit margin.
e. Assets to equity ratio.
16. As per Funds Flow Statement prepared on cash flow basis
a. The increase in prepaid expenses is a source
b. The increase or decrease in cash balance will be equal to the difference between the
opening and closing cash balance
c. The figures w.r.t. increase or decrease in assets include cash
d. Funds from operations is equal to the PAT +DEP
e. The total of sources and uses of funds is the same as that of total resources basis.
17. DOL will be equal to
a. Contribution/Profit or Loss before tax
b. EBIT/PAT
c. EBIT/QTY
d. Sales/EBIT
18. Which of the following is true with reference to funds flow statement?
a. It is the same as balance sheet.
b. It only represents how the firm is meeting its revenue expenditure.
c. It is also called statement of financial expansion and replacement.
d. It is more concerned with depicting cash flow position.
e. It is prepared on the basis of B/S and P&L a/c.
19. The numerator of Inventory turnover ratio can be
a. Total assets
b. Current assets
c. Cost of goods sold
d. Either (a) or (c) above
Part III
363
a. The face value of a bond is the amount realized by the firm on its issue.
b. The coupon rate of the bond varies with the interest rate fluctuations in the economy.
c. The amount the bondholder gets on maturity is the redemption value.
d. The bond is generally redeemed at market value at that time.
e. The redemption value of a bond represents the amount borrowed by the firm.
21. Which of the following is true if the effective rate of interest =r, nominal rate =k and
frequency of compounding =m?
a. ((1 +r) 1)
m
=k .
b. r =(1 +k/m) 1.
c. (1 +k/m)
m
1 =r.
d. r =(1 +k)
m
.
22. The variance of a stocks returns can be calculated as the
a. Average value of deviations from the mean
b. Average value of squared deviations from the mean
c. Square root of average value of deviations from the mean
d. Sum of the deviations from the mean
e. Square root of the sum of the deviations from the mean.
23. Which of the following would not be considered a money market instrument?
a. Treasury bill with 91 days until maturity.
b. Commercial paper with 180 days until maturity.
c. Certificate of deposit with 365 days until maturity.
d. A repurchase agreement, backed by government securities, with less than one week
until maturity.
24. Which of the following risks can be classified as a non-diversifiable risk?
a. Industrial disputes in a company.
b. Bankruptcy of the customers of a company.
c. Unexpected entry of a new competitor to a company.
d. Major changes in tax rates.
e. Resignation of a key officer of a company.
25. Which of the following will not permit a higher internal growth rate, other things being
equal?
a. A higher plowback ratio.
b. A higher spontaneous liabilities-to-assets ratio.
c. A higher return on equity.
d. A higher return on assets.
26. Some part of the total risk is non-diversifiable because
a. Certain macro level factors like economy, politics affect all the securities
b. Securities will all be more or less similar in business and finance risks
c. Securities are perfectly positively correlated
d. Certain amount of risk is inherent in every investment because return is uncertain
e. Securities are selected from certain industries which are highly risky.
364
27. Interest coverage ratio takes EBIT as the numerator because
a. After tax the funds may not be sufficient to pay interest
b. Interest payment is not affected by tax
c. The firm has to earn the interest to be paid also, before tax
d. To facilitate inter-firm comparison
28. Which of the following analysis can be helpful in inter-firm comparison?
a. Index analysis.
b. Common size analysis.
c. Cross-sectional analysis.
d. Time series analysis.
e. Comparative analysis.
29. Which of the following statements is/are false?
i. The coupon rate remaining the same, the current yield will increase with increase in the
market price of the bond.
ii. Current yield is equal to the coupon rate if the market price is equal to the face value of
the bond.
iii. Current yield is equal to the coupon rate if the bond is trading at its face value.
a. Only (i) above.
b. Both (i) and (ii) above.
c. Both (i) and (iii) above.
a. Spontaneous sources of finance can finance unlimited current assets.
b. Spontaneous sources are created in the normal course of business.
c. Provision for taxes is a spontaneous source of finance.
d. Spontaneous sources of finance are literally cost-free.
e. Spontaneous sources do not mean immediate drain of cash resources, that is why
they are treated as a source of finance.
31. If the fixed costs of the firm are increased, then
a. DOL will increase while DTL will decrease
b. DOL will decrease while DTL will increase
c. DOL and DTL will decrease
d. DOL and DTL will increase
32. Funds Flow Statement shows
a. Changes in working capital
b. Changes in cash position
c. Changes in capital structure
Part III
365
33. Which of the following is the most significant ratios to the owners of the company?
a. Earnings per share.
b. Dividend pay-out ratio.
c. Debt-equity ratio.
d. Interest coverage ratio.
34. Which of the following assumptions is/are true while calculating the external funds
requirement?
a. The assets of the firm will increase proportionately to cost of goods sold.
b. Net profit margin will increase at a constant rate.
c. Dividend pay-out ratio will remain constant.
d. Fixed assets will increase proportionately to sales while current assets remain constant.
e. The current liabilities will increase proportionately to sales.
35. The FVIFA tables are constructed to give the values of
a. Deferred annuities
b. Annuity dues
c. Capital recovery factors
36. Which of the following will increase the present value of an annuity, other things being
equal?
a. Increasing the interest rate.
b. Decreasing the interest rate.
c. Decreasing the number of payments.
d. Decreasing the amount of the payment.
37. A times interest earned ratio of 3.5 indicates that the firm
a. Pays 3
1
2
times its earnings in interest expense
b. Earns notably more than its interest obligations
c. Has defaulted on its debt obligations
d. Has low tax liability
e. Does not earn more than its interest obligations.
38. Which of the following is most likely to result in a higher P/E ratio for a firm, other things
being equal?
a. Lower growth rate in dividends.
b. Reduction in the stocks required rate of return.
c. Lower dividend yield.
d. Lower stock price.
e. Higher EPS.
39. If the slope of the line measuring a stocks historic returns against the markets historic
returns is positive, then the stock
a. Has a beta greater than 1.0
b. Has no unique risk
c. Is a good investment
d. Has a positive beta
e. Has a negative beta.
366
40. Standard Deviation is a superior measure of risk because
a. It takes into account the negative deviations from mean only
b. It is often used by statisticians to measure variability
c. It measures the dispersion around the expected value
d. It is a square root of the squared deviations from the mean which ensures that the effect
of major deviations is more
41. A money lender has borrowed Rs.3,00,000 at an interest rate of 10% per annum compounded
annually to be repaid in 5 equated annual installments (each annual installment will be paid at
the end of the year). He has also borrowed Rs.5,00,000 at an interest rate of 12% per annum
compounded annually to be repaid in 5 equated annual installments (each annual installment
will be paid at the end of the year). He lends the total funds borrowed at an interest rate of 15%
per annum compounded annually which will be repaid by the borrower in 5 equated annual
installments (each annual installment will be paid by the borrower at the end of the year). The
surplus cash flow that will be left with the money lender at the end of every year for a period of
5 years is
a. Rs.10,000
b. Rs.13,456
c. Rs.16,456
d. Rs.20,832
e. Rs.23,456.
(3 points)
42. The dividends on the equity shares of Sun Industries Ltd. (SIL) have been experiencing a
growth rate of 12% per annum in the recent years, which is considered to be above normal. The
above normal growth rate in dividends is expected to continue for four years after which the
growth rate will reduce to 5% per annum which will continue indefinitely. The company has
recently announced a dividend of Rs.2.00 per share. The required rate of return on the equity
shares is 15%.
The present value of the dividend stream payable during the period of above-normal growth
rate is
a. Rs.7.49
b. Rs.8.90
c. Rs.9.08
d. Rs.10.56
e. Rs.11.00.
(2 points)
43. ACE Ltd., paid a dividend of Rs.2 per share last year. The estimated growth rate of the
dividends is 5% p.a. The required rate of return of the equity investors is 15.5%. The
percentage change in the intrinsic value of the share if the estimated growth rate in dividends
rises to 8% is
a. 32%
b. 33%
c. 35%
d. 44%
e. 46%.
(2 points)
Part III
367
44. Western Industries Ltd., has total assets worth Rs.900 lakh and spontaneous liabilities
amounting to Rs.300 lakh. Presently, it has a sales level of Rs.1,200 lakh. The company has a
net profit margin of 4% and has dividend pay-out ratio of 50%. It is anticipating a growth in
sales. The growth in its assets will be financed by an increase in its spontaneous liabilities
and retained earnings. The increase in sales that the company can achieve without resorting
to any external finance is
a. Rs.169 lakh
b. Rs.156 lakh
c. Rs.150 lakh
d. Rs.94 lakh
e. Rs.50 lakh.
(2 points)
45. Modi Enterprises Ltd., is in the trading business. The projected sales of the company for the
next financial year is Rs.195 lakh which is 20% more than the sales in the current financial
year. The assets of the company entirely consist of fixed assets and current assets, and these
will change in direct proportion with sales. The ratio of fixed assets to current liabilities is
2.5. The current liabilities entirely consist of spontaneous liabilities and these will change in
direct proportion with sales. The current ratio of the company is 1.50, the total asset turnover
is 1.30, the net profit margin is 4% and the dividend pay-out ratio is 65%. The external funds
required by the company are equal to
a. Rs.16.02 lakh
b. Rs.12.10 lakh
c. Rs.10.19 lakh
d. Rs.9.87 lakh
e. Rs.8.76 lakh.
(3 points)
46. The gross profit of the MICA Ltd., is Rs.36 lakh. The gross profit margin ratio of the firm is
20%. If the inventory turnover ratio for the firm is 5, the amount of inventories maintained
by the firm is
a. Rs.36 lakh
b. Rs.23 lakh
c. Rs.20 lakh
d. Rs.19 lakh
e. Rs.15 lakh.
(2 points)
47. The sales for a company are Rs.180 lakh and the asset turnover ratio is 2. The current ratio
for the firm is 2.20 and the amount of current liabilities and provisions is Rs.30 lakh. The net
fixed assets for the company are
a. Rs.14 lakh
b. Rs.18 lakh
c. Rs.24 lakh
d. Rs.26 lakh
e. Rs.28 lakh.
(2 points)
368
48. The total debt of Rama Ltd., consists of term loan from SBI and current liabilities. The total
debt equity ratio for Rama Ltd., is 2:1. The company has a net worth of Rs.30 lakh. The
current ratio for the firm is 2.20 and the current assets of the firm are Rs.66 lakh. The amount
of term-loan borrowed by the company is
a. Rs.60 lakh
b. Rs.40 lakh
c. Rs.35 lakh
d. Rs.30 lakh
e. Rs.15 lakh.
(2 points)
49. The long-term capital structure of United Enterprises Ltd. (UEL) consists of net worth, term
loan and preference shares. The net worth amounts to Rs.150 lakh, term loan amounts to
Rs.100 lakh and preference shares amount to Rs.100 lakh. The term loan carries an interest
rate of 13% and the preference shares carry a dividend rate of 12%. The tax rate applicable to
the company is 40%.
The level of EBIT at which EPS is zero is
a. Rs.23 lakh
b. Rs.30 lakh
c. Rs.33 lakh
d. Rs.45 lakh
e. Rs.47 lakh.
(1 point)
50. The operating break even point and financial break even point of a company are 50,000 units
and Rs.1,50,000 respectively. The contribution per unit is Rs.10. The sales quantity at which
the EPS of the firm will be zero is
a. 65,000 units
b. 69,000 units
c. 70,000 units
d. 72,000 units
e. 75,000 units.
(2 points)
51. The variable cost per unit and selling price per unit for J ET Ltd., is Rs.30 and Rs.50
respectively. The present sales of the company are Rs.900 lakh and the company has fixed
costs of Rs.300 lakh. The percentage change in sales quantity required to increase EBIT by
30% is
a. 5%
b. 6%
c. 7%
d. 5%
e. 12%.
(2 points)
Part III
369
52. Toss Ltd., is presently selling 1,00,000 units of its product. The selling price per unit is Rs.25
and the variable cost per unit is Rs.15. The fixed costs for the company are Rs.5,00,000. The
financial break even point for the company is Rs.1,50,000. The percentage change in EBIT
required to increase EPS by 20% is
a. 10%
b. 12%
c. 14%
d. 20%
e. 21%.
(3 points)
53. The contribution per unit for Can Ltd., is Rs.20. The fixed costs for the company amount to
Rs.300 lakh. The long-term capital structure of UEL consists of net worth, term loan and
preference shares. The company has an interest obligation of Rs.13,00,000 on the term loan.
It has preference shares worth Rs.100 lakh which carry a dividend rate of 12%. Currently the
firm is selling 18 lakh units. The tax rate applicable to the company is 40%. The percentage
change in sales quantity required to increase EPS by 40% is
a. 3%
b. 4%
c. 3%
d. 2%
e. 1.5%.
(2 points)
54. An investor is seeking a price to pay for a security, whose standard deviation is 3.00%. The
correlation coefficient for the security with the market is 0.8 and the market standard
deviation is 2.2%. The return from government securities is 5.2% and from the market
portfolio is 9.8%. The required rate of return on the security as per CAPM is
a. 9.87%
b. 10.21%
c. 11.23%
d. 12.10%
e. 15.09%.
(2 points)
55. The risk-free rate of return is 8%. The shares of Eastern Pharmaceuticals Ltd. (EPL) have a
beta of 1.5 and the return on the market portfolio is 16%. The company has recently paid a
dividend of Rs.3.00 per share and the dividends are expected to grow at the rate of 5%. The
current market price of the equity share of EPL is Rs.15.75 per share. Assume that the
CAPM is applicable. Currently the share price is not at equilibrium. If the market adjusts
in such a way that the share is valued at its equilibrium price then what will be the change
in the market value of an investment in 1000 shares of the company?
a. Rs.4,321.
b. Rs.5,250.
c. Rs.6,567.
d. Rs.6,600.
e. Rs.6,989.
(2 points)
370
56. The gross profit margin for the company is 23%. The current sales of the company are
Rs.40,00,000. The operating expenses for the company are Rs.6,80,000 and the tax rate
applicable to the firm is 46%. If the EPS for the company is Rs.12.96, the number of
outstanding equity shares for the company are
a. 5,000
b. 10,000
c. 13,000
d. 14,000
e. 15,000.
(2 points)
57. Vijay Finance, is offering a pension scheme for people who are at the age of 40 years.
According to the scheme the individuals who subscribe will have to deposit Rs.15,000 per
year for 20 years. At the end of 20 years, every subscriber will receive a specific sum plus an
annuity of Rs.75,000 for a period of 25 years. If the depositors wish to earn 11% rate of
return, the minimum amount to be paid by Vijay finance at the end of 20 years is
a. Rs.1,18,007
b. Rs.3,31,395
c. Rs.6,31,650
d. Rs.9,63,045
d. Rs.15,94,695.
(2 points)
58. Chandra Textiles presently pays a dividend of Rs.3 per share. The dividend is expected to
grow at the rate of 4% for the next four years then at 3% for next three years, after that if it
expected to grow at a rate of 1% forever. If the required rate is 10% the value one can pay
now if the holding period is (a) infinite and (b) 3 years respectively is
a. Rs.55.58, Rs.55.58
b. Rs.38.54, Rs.38.54
c. Rs.46.75, Rs.46.75
d. Rs.38.75, Rs.30.75
e. Rs.38.75, Rs.46.75.
(2 points)
59. Pacific Ltd., is a toy manufacturing company. The Degree of Operating Leverage and the
Degree of Financial Leverage for the company are 1.1 and 1.5 respectively. The company has
a debt of Rs. 6 crore on which interest is paid at 10% p.a. It has a preference capital of Rs. 4
crore on which preference dividend is payable at 10 % p.a. The variable cost to sales ratio is
40%. The tax rate applicable to the firm is 50%.
The sales revenue and the fixed costs of the firm are
a. Rs.7.7 crore and Rs.40 lakh
b. Rs.7.0 crore and Rs.42 lakh
c. Rs.7.7 crore and Rs.42 lakh
d. Rs.8.0 crore and Rs.50 lakh
e. Rs.9.6 crore and Rs.40 lakh.
(3 points)
Part III
371
60. Consider the following data regarding the companies M/s. X Ltd. and M/s. Y Ltd.
Particulars X Ltd.(Rs.) Y Ltd.(Rs.)
Sales 32,00,000 30,00,000
Net profit after tax 1,23,000 1,58,000
Equity capital (Rs.10
share)
10,00,000 8,00,000
General reserves 2,32,000 6,42,000
Long-term debt 8,00,000 6,60,000
Creditors 3,82,000 5,49,000
Bank credit (short term) 60,000 2,00,000
Fixed assets 15,99,000 15,90,000
Inventories 3,31,000 8,09,000
Other current assets 5,44,000 4,52,000
The management of company X declared a dividend of 6% and company Y declared a
dividend of 8% for the current year.
Which of the following statements is/are false?
i. Asset utilization of company X is more than company Y.
ii. Company Y retains larger proportion of its income in the business than Company X.
iii. Company X is using the shareholders money more profitable than Company Y.
a. Only (i) above
b. Only (ii) above
c. Only (iii) above
e. All (i), (ii) and (iii) above.
(3 points)
61. The probability distributions of returns of Micorsun Ltd. and the market returns are given below:
Probability 0.40 0.25 0.15 0.20
Microsun Ltd. (in %) 3 4 5 7
Market return (in %) 6 9 8 7
The covariance of market returns and returns from Microsun Ltd., is 0.4625(%)2. If the
market return is zero, the return earned by Microsun Ltd., will be
a. 1.595%
b. 1.900%
c. 2.103%
d. 5.695%
e. 6.598%.
(2 points)
62. Mr. J aswant has planned to purchase a flat, whose present cost is Rs.15 lakhs. He has
approached City Home Finance, which has agreed to finance 80% of the cost of the flat. As
he, presently, has Rs.1 lakh only which is not sufficient to purchase the flat, he deferred his
plan of purchase for three years and deposited the amount he had in a bank. Mr. J aswant
planned to save annually at the start of the year for the next three years and purchase the flat
withthe bank finance of 80%, at the end of three years. The rate of interest that can be earned
on the bank deposits is 8% p.a. and the cost of the flat is expected to escalate by 5% p.a. The
amount that Mr. J aswant has to save annually, the first deposit being made today, is
a. Rs.0.630 lakh
b. Rs.0.795 lakh
c. Rs.0.859 lakh
d. Rs.1.248 lakh
e. Rs.1.348 lakh.
(3 points)
372
63. If the return on assets is 10% and the debt to assets ratio is 1:3, the return on equity is
a. 16.19 %
b. 15.89 %
c. 15.00 %
d. 14.02 %
e. 13.26 %.
(2 points)
64. If the interest rate is 9% per annum, how much should Mr. Ashish invest today in a bank
scheme that would fetch him an annuity of Rs.2,000 for a period of 6 years commencing
from the beginning of fourth year?
a. Rs.6,352.18.
b. Rs.6,926.38.
c. Rs.7,554.42.
d. Rs.8,232.32.
e. Rs.10,655.50.
(2 points)
65. Presently the current assets and current liabilities of BSN Ltd. are Rs.10 lakh and Rs.5 lakh
respectively. In the current year fixed assets worth Rs.2 lakh were purchased, new shares are
issued for Rs.5 lakh, bills receivable worth Rs.10,000 were dishonored and Rs.10,000 cash is
collected fromcustomers. The current ratio will
a. Increase by 0.60
b. Decrease by 0.60
c. Increase by 0.25
d. Increase by 0.75
e. Have no change.
(1 point)
66. Consider the following:
Provision for contingencies =Rs.30,000
Loans and advances (given) =Rs.20,00,000
Stipulated amount for
provident fund =Rs.10,00,000
Short-term investments =Rs.30,00,000
The following changes have occurred during the year:
Increase in provision for contingencies =Rs.20,000
Increase in the stipulated amount for provident fund =Rs.10,00,000
Loan and advances (taken) =Rs.10,00,000
Decrease in short-term investments =Rs.20,00,000
After considering the above changes, the new net working capital will be
a. Rs.50,000
b. Rs.9,50,000
c. Rs.19,70,000
d. Rs.39,70,000
e. Rs.49,50,000.
(2 points)
Part III
373
67. ABBA Ltd., has issued fully convertible debentures of face value Rs.100 each with a coupon
rate of 10% p.a. The debentures will be converted into 2 equity shares at a price of Rs.50
each at the end of four years from the date of issue. After two years the share price decreased
to Rs.40. The value of the convertible after two years from the date of issue at the required
rate of return of 12% is
a. Rs.80.68
b. Rs.81.25
c. Rs.93.97
d. Rs.96.60
e. Rs.111.62.
(1 point)
68. Consider the following data regarding M/s. Amar Labs Ltd., for the year 2002-2003:
Rs. lakh
Retained earnings 20
Interest earned on investments 6
Amortization of copy rights written off 5
Depreciation 4
Dividends 10
Preliminary expenses written off 5
Funds from operations of M/s. Amar Labs Ltd., during the year was
a. Rs.50 lakh
b. Rs.41 lakh
c. Rs.38 lakh
d. Rs.21 lakh
e. Rs.20 lakh.
(1 point)
Rs. lakh
Closing balance of accounts receivables 25
Operating balance of accounts receivables 15
Average collection period (days) 25
Credit sales are 80% of sales
Assuming 365 days in year, the total sales amount to
a. Rs.234 lakh
b. Rs.243 lakh
c. Rs.292 lakh
d. Rs.365 lakh
e. Rs.456 lakh.
(1 point)
70. Bank A pays interest at 10 percent p.a. compounded semi-annually. Bank B compounds
interest on monthly basis. If Bank B wishes to pay the same effective rate of interest as that
of A, the annual rate of interest it should quote is
a. 9.80%
b. 10.00%
c. 10.25%
d. 10.75%
e. 11.00%.
(1 point)


Suggested Answers
1. (d) The fact that money in the form of currency is a legal tender guaranteed by the
government does not justify its time value. All other alternatives than (d) justify its time
value.
2. (d) The minimum number of persons required to form a public company is 7.
3. (d) According to the objective of financial management to increase the wealth of the
shareholders means increase in the market value of the shares of the firm held by the
shareholders.
4. (c) Giving investment proposals on technical projects is not the function of a finance
manager. All other alternatives relate with functions of a finance manager.
5. (c) Life of a sole proprietorship firm is not perpetual; it is limited to the life of the proprietor.
6. (b) The liquidity function of the financial system facilitates conversion of investment in
stocks, bonds, etc. into money.
7. (d) Short-term financial instruments are traded in money market.
8. (b) In rights issue, new securities are offered to the existing shareholders of the company on a
pro rata basis.
9. (e) Industrial recession is not a diversifiable risk in the context of investment in stocks
because it affects all companies in general. All other alternatives state those risks which are
company specific and which can be diversified away.
10. (c) CAPM assumes that the investors agree on the nature of return and risk associated with
each investment.
11. (b) The amount that can be realized by a company if it terminates its business and sells all its
assets (i.e. liquidation) is called liquidation value.
12. (d) When the required rate of return on the bond is greater than the coupon rate, the discount
on the bond declines as the maturity approaches.
13. (a) Debt-assets ratio indicates capital structure.
14. (c) Current yield = Coupon interest/Market price of the bond. Since we do not know the
market price of the share and coupon payment, we cannot determine the current yield of the
bond. Holding period return = (Profit or loss + Current interest)/Purchase price. Since the
numerator is less than zero, the holding period return will be negative.
15. (c) According to the Du Pont Analysis,
ROE = Net profit margin x Assets turnover ratio x Equity multiplier
Where Equity multiplier = Average assets/ Average equity (or) 1/(1 Debt to Assets ratio).
Hence return on assets ratio will not affect the ROE in Du Pont analysis.
16. (b) The simplest funds flow statement for a period, may merely be the difference between the
corresponding cash balance at the beginning and at the end of the period. Here, all increases
and decreases are classified as sources and uses of funds and if sources exceed uses there is
an increase in cash to that extent, if uses exceed sources there is a decrease in cash to that
extent.
17. (c) Operating leverage examines the effect of change in the quantity produced on the EBIT of
the company and is measured as Percentage change in EBIT/Percentage change in output.
18. (e) A funds flow statement can be prepared with the help of the two balance sheets (opening
and closing) and the profit and loss statement of the intervening period. Such a funds flow
statement defines funds as total resources and the sources of funds will always be equal to the
uses of funds.
19. (c) The inventory turnover ratio measures how fast the inventory is moving through the firm
and generating sales. It is given as Cost of goods sold/Average inventory.
Part III
375
20. (c) The value which the bondholder gets on redemption is called the redemption value.
The value that is stated on the face of the bond is known as the face value or the par value.
The coupon rate on the bond is fixed. Market value is the price at which the bond is usually
bought or sold. The face value represents the amount of borrowing of the firm.
r = (1 + k/m)
m
1
where,
22. (b) The variance of an assets rate of return can be found as the sum of the squared deviation
of each possible rate of return from the expected rate of return multiplied by the probability
that the rate of return occurs.
23. (e) Money market deals with all transactions in short-term instruments with a period of
maturity of one year or less. All the above are money market instruments.
24. (d) Major changes in the tax rates cannot be diversified as it is related to the general economy
as a whole.
25. (b) Higher spontaneous liabilities to assets ratio mean that the liabilities are more than the assets
and the assets cannot meet the liability requirements. This does not permit higher internal growth
rate.
26. (a) Non-diversifiable risk is that part of total risk (from various sources like interest rate risk,
inflation risk, financial risk, etc.) that is related to the general economy or the stock market as a
whole and hence cannot be eliminated by diversification.
27. (c) Interest coverage ratio is a measure of a firms ability to handle financial burdens. This
ratio tells how many times the firm can cover or meet the interest payments associated with
debt.
Interest coverage ratio = EBIT/Interest expense
EBIT is the source of interest payments.
28. (b) Common size statements are very helpful for inter-firm comparison because the financial
statements of a variety of companies can be recast into the uniform common size format
regardless of the size of individual accounts.
29. (a) Current yield =
price Market
amount Coupon

Coupon rate =
value Face
amount Coupon

Current yield = Coupon rate implies that market price = face value. Further this means that
the bond is trading at its face value.
Hence both (ii) and (iii) are true.
The coupon rate remaining the same, current yield will decrease if the market price
increases. So statement (i) is incorrect. Hence (a) is the answer.
30. (a) The sources of finance which arise from the normal course of business operations are
referred to as spontaneous sources of finance. These sources can be used to finance current
assets to some extent.
31. (d) DOL =
( ) F V S Q
) V S ( Q

DTL =
p
Q (S V)
Q(S V) F I D / (1 T)

Increase in fixed assets reduces the value of the denominators in both the equations and
hence it increases both DOL and DTL.
376
32. (e) A funds flow statement is a statement which explains the various sources from which
funds were raised and the uses to which these funds were put. Hence it shows changes in all
the above.
33. (e) All the given alternatives are ownership ratios which will help the shareholders (owners)
in analyzing his present and future investment in a firm.
34. (c) External funds requirement is equal to
) d 1 ( mS ) S (
S
L
) S (
S
A
1

Where,
EFR = External financing requirement.
A/S = Current assets and fixed assets as
a proportion of sales.
S = Expected increase in sales.
L/S = Spontaneous liabilities as a
proportion of sales.
m = Net profit margin.
S
1
= Projected sales for the next year.
d = Dividend pay-out ratio.
The above equation assumes that the dividend pay-out ratio remains constant. Hence, the answer
is (c).
In the above equation the assets of the firm are assumed to increase proportionately to sales
and not cost of goods sold. Hence, (a) is not true. Similarly, net profit margin is assumed to
be constant. Hence, (b) is also not true. Fixed assets, current assets and spontaneous liabilities
are assumed to increase proportionately to sales. Hence, (d) and (e) are also not true.
35. (a) If the equal amounts of cash flow occur at the end of each period over the specified time
horizon, then this stream of cash flows is defined as regular annuity or deferred annuity. The
FVIFA tables are constructed to give the values of deferred annuities.
36. (b) PVIFA =
n
n
(1+k) 1
k(1+k)

Hence a drop in interest rate increases the PVIFA.
37. (b) Interest coverage ratio or the times interest earned ratio is a measure of a firms ability to
handle financial burdens. This ratio tells how many times the firm can cover or meet the
interest payments associated with debt.
Interest coverage ratio = EBIT/Interest expense
A ratio of 3.5 indicates that the firm earns more than its interest obligations.
38. (b) The price earnings ratio is calculated by taking the market price of the stock and dividing
it by earnings per share. When there is a reduction in the stocks required rate of return then
the market price of the share increases and as a result the P/E ratio also increases.
39. (d) When the slope of the line measuring the stocks historic returns against the markets
historic return is positive, then the stock must have a positive beta. A positive slope of the
line shows positive relationship between stock and market returns.
40. (d) Standard deviation is obtained as a square root of the sum of squared differences
multiplied by their probabilities. This facilitates comparison of risk as measured by standard
deviation and expected returns as both are measured in the same costs. This is why standard
deviation is preferred to variance as a measure of risk.

Part III
377
Part B: Problems
41. (d) Equated annual installment to be paid by the money lender on the borrowing of
Rs.3,00,000
=
(10%,5)
3,00,000
PVIFA
=
791 . 3
000 , 00 , 3
= Rs.79,135 (approx.)
Equated annual installment to be paid by the money lender on the borrowing of Rs.5,00,000
=
(12%,5)
5,00,000
PVIFA
=
605 . 3
000 , 00 , 5
= Rs.1,38,696 (approx.)
Equated annual installment to be received by the money lender on the amount lent by him
=
(15%,5)
(3,00,000 + 5,00,000)
PVIFA
=
352 . 3
000 , 00 , 8
= Rs.2,38,663 (approx.)
Excess cashflow receivable by the money lender every year
= Annual cash inflow Annual cash outflow
= 2,38,663 (79,135 + 1,38,696) = Rs.20,832.
The surplus cash flow receivable by the money lender at the end of every year for 5 years
= Rs.20,832.
42. (a) Dividend stream during the period of abnormal growth:
D
1
= 2.00 (1.12)
D
2
= 2.00 (1.12)
2

D
3
= 2.00 (1.12)
3

D
4
= 2.00 (1.12)
4

Present value of the dividends payable during the period of above-normal growth
=
4
4
3
3
2
2
) 15 . 1 (
) 12 . 1 ( 2
) 15 . 1 (
) 12 . 1 ( 2
) 15 . 1 (
) 12 . 1 ( 2
15 . 1
) 12 . 1 (
+ + +
2
= Rs.7.49.
43. (d) Share Price =
0
e
D (1 g)
2 (1 0.05)
k g 0.155 0.05
+
+
=

= Rs.20.
When the growth rate rises to 8%, share price will be
=
0
e
D (1 g)
2 (1 0.08)
k g 0.155 0.08
+
+
=

= Rs.28.80.
Percentage change in the share price when the growth rate increases to 8%
=
28.80
= 0.44 i.e. 44%.
20
20
44. (e) EFR = S

S
L
S
S
A
mS
1
(1 d)
S
1
= Projected sales = S + S
EFR = 0
0 =
S
1200
900

S
1200
300

(0.04) (S + S)(1 0.50)
or, 0 =
S
4
3
S
4
1
(0.04)(0.50)(1200 + S)
378
or, 0 =
S
2
1
0.02 (1200 + S)
or, 0.02 (1200 + S) = 0.5S
or, 24 + 0.02 S = 0.5S
or, 24 = 0.48S
or, S =
48 . 0
24
= 50
The company can increase sales by Rs.50 lakh without using any external financing.
45. (a) External funds requirement is given by
EFR =
A
( S)
S

S
L
(S) m (S + S) (1 d)
Net profit margin (m) = 4% = 0.04
Dividend pay-out ratio (d) = 65% = 0.65

) A ( assets Total
) S ( Sales
= 1.30

A 1 1
= =
S S/A 1.30

Given:
assets Current
= 1.50; Also,
Fixed assets
Current liabilities
= 2.5

FA CA
+ = 2.50+1.50
CL CL

or
CL
CA FA +
= 4.00 or
CL
A
= 4.00

S
A
= 1.30 (given)

S
A
x
A
CL
= 1.30 4.00 or
CL
S
= 5.20

S
CL
=
20 . 5
1

The current liabilities entirely consist of spontaneous liabilities (L).

L 1
=
S 5.20

Present Sales (S) =
Projected Sales
1 g +
=
20 . 1
195
= Rs.162.50 lakh
Growth in sales (S) = Projected sales Present sales
= 195 162.50 = Rs.32.50 lakh.
Putting the values computed above in the formula for EFR, we get
EFR =
1
1.30
(32.50)
1
5.20
(32.50) (0.04) (195) (1 0.65)
= Rs.16.02 lakh.
Part III
379
46. (a) Gross Profit Margin =
Gross Profit
Sales

Therefore, Sales =
Gross Profit
Gross Profit Margin
=
36,00,000
0.20
= Rs.180 lakh.
Inventory Turnover Ratio =
Sales
Inventory

Inventory =
Sales
Inventory Turnover Ratio
=
180 lakh
5
= Rs.36 lakh.
47. (c) Total assets =
Sales
Assets Turnover Ratio
=
2
180
= Rs.90 lakh
Current assets = Current ratio x Current liabilities
= 2.20 30 = Rs.66 lakh
Net fixed assets = Total assets Current assets
= 90 66 = Rs.24 lakh.
48. (d) Total debt-equity ratio = 2 x Net worth
= 2 x 30 lakh = 60 lakh.
Current ratio =
Current Assets
Current Liabilities

Therefore, current liabilities =
Current assets
Current ratio

Current liabilities =
66
2.20
= Rs.30 lakh.
Term Loan = Total Debt Current Liabilities
= 60 30 = Rs.30 lakh.
49. (c) At the financial break even point, EPS = 0.
The amount of EBIT at the financial break even point
= I +
t 1
D
p

= 100 (0.13) +
40 . 0 1
) 12 . 0 (
100
= Rs.33 lakh.
50. (a) At the overall break even point, EPS = 0,
Sales quantity at the overall break even point =
p
D
F+I +
(1 T)
Q=
(S V)

Given, Financial break even point =
p
D
I
(1 T)
+

= Rs.1,50,000.
Operating break even point =
V) (S
F
= 50,000.
Also given that contribution per unit (i.e. S V) = 10.
Therefore, fixed costs (F) = 10 x 50,000 = Rs.5,00,000.
Hence, Sales quantity at the overall break even point =
5,00,000 1,50,000
10
+

= 65,000 units.
380
51. (d) Degree of operating leverage =
F ) V P ( Q
) V P ( Q

Present sales quantity =
50
900
= 18 lakh units
DOL =
300 ) 30 50 ( 18
) 30 50 ( 18

= 6
DOL =
Percentage change required in EBIT
Percentage change in sales

Percentage change in quantity sold required to increase EBIT by 30%
=
Percentage change required in EBIT
DOL
=
6
30
= 5% increase.
52. (c) DFL =
+
T) (1
D
I EBIT
EBIT
P

Financial breakeven point =
p
D
I
(1 T)
+
= 1,50,000 (given).
EBIT = Q (S V) F = 1,00,000 (25 15) 5,00,000 = Rs.5,00,000.
DFL =
5,00,000
5,00,000 1,50,000
= 1.43.
DFL =
Required change in EPS
Change in EBIT

i.e., 1.43 =
20%
Change in EBIT

Therefore, the percentage change in EBIT required to increase EPS by 20% is

43 . 1
% 20
= 13.99% i.e., 14% approximately.
53. (c) Degree of Total Leverage (DTL) =
t 1
D
I F ) V P ( Q
) V P ( Q
p

=
20 13 300 360
360

=
3
40
=
1820
100 (0.12)
1820 300 13
1 0.40

DTL =
Percentage changein EPS
Percentage change in quantity

or, Percentage change in quantity required

Percentage change required in EPS
=
DTL

Percentage change in sales quantity required to increase EPS by 40%
=
3
40
40
= 40 x
3
40
= 3% increase.
Part III
381
54. (b)
i
2
m
m m
Cov(i,m)
= =

2
where is the correlation coefficient between the security and the
market returns.
4.84
5.28
(2.2)
3 2.2 0.80
2
=

= = 1.09.
As per CAPM, required rate of return
= = 5.2% + (9.8% 5.2%)1.09 = 10.21%.
f j m f
r (r r ) +
55. (b) According to CAPM
k
j
= R
f
+
i
(k
m
R
f
)
Given: R
f
= 8%,
i
= 1.5, k
m
= 16%
Required rate of return of the share of EPL is = 8 + 1.5(16 8) = 20%
Current market price per share = Rs.15.75
It is given that presently the market price of the share is not at equilibrium.
The market will adjust itself in such a way that the share is valued at its equilibrium price.
Let the equilibrium price be P
0
.
0.20 =
0
3(1.05)
P
+ 0.05
or, 0.15 =
0
3.15
P

or, P
0
=
3.15
0.15
= Rs.21
The market price will increase from Rs.15.75 per share to Rs.21 per share. For an investment
in 1000 shares of the company the change in market value = 1000 (21 15.75) = Rs.5,250
(increase).
56. (b) Gross Profit Margin =
Sales
Profit Gross
.
Therefore, Gross profit = Gross profit margin x Sales = 0.23 x 40,00,000 = Rs.9,20,000.
Profit before tax = Gross profit Operating Expenses
= 9,20,000 6,80,000 = Rs.2,40,000.
Profit after tax = Profit before tax taxes
= 2,40,000 0.46 x 2,40,000 = Rs.1,29,600.
EPS =
Profit after tax
ber of outstanding shares Num

i.e., 12.96 =
shares g outstandin of Number
1,29,600

Therefore, Number of outstanding shares = 10,000.
57. (b) According to the given information subscribers will deposit Rs.15,000 for 20 years and
after 20 years scheme will pay Rs.75,000 at the end of every year for 25 years plus Rs. X at
the end of 20 years from now.
The discount rate is 11%.
Therefore the data can be fit into a equation as
15,000 FVIFA
(11%, 20)
= X + 75,000 PVIFA
(11%, 25)
15,000 64.203 = X + 75,000(8.422)
9,63,045 = X + 6,31,650
X = The amount which will be returned = Rs.3,31,395.
382
58. (b)
(Amount in Rs.)
End of year Dividend Present value of dividends at 10 %
1 3(1.04) 3.12 0.909 = 2.84
2 3(1.04)
2
3.24 0.826 = 2.68
3 3(1.04)
3
3.37 0.751 = 2.53
4 3(1.04)
4
3.50 0.683 = 2.39
5 3.50(1.03) 3.605 0.621 = 2.24
6 3.50(1.03)
2
3.713 0.564 = 2.09
7 3.50(1.03)
3
3.824 0.513 = 1.96
16.73
Year 8 dividend = Rs.3.824 (1.01) = Rs.3.862
Therefore Market price at the end of year seven =
3.862
0.1 0.01
= Rs.42.51
Present value of Rs.42.91 at 10% discount rate = Rs.42.51 0.513 = Rs.21.81
Intrinsic value if the holding period is infinite = Rs.21.81 + Rs.16.73 = Rs.38.54
Market value at the end of year 3
=
2 3 4
3.605 3.713 3.824 42.51
1.1 (1.1) (1.1) (1.1)
+
+
3.5
+ +
= 3.182 + 2.978 + 2.788 + 31.646 = Rs.40.594
PV of MP = 40.594 x 0.751 = Rs.30.49
PV of dividends to be received at the end of year
1, 2 and 3 is Rs.(2.84 + 2.68 + 2.53) = Rs.8.05
Total value = 30.49 + 8.05 = Rs.38.54.
59. (c) Let S represent Sales,
V represent Variable costs,
and F represent Fixed costs.
Degree of Operating Leverage =
Sales Variable Costs
(Sales Variable Costs) Fixed Costs

= 1.1
i.e.
S 0
= 1.1
.4S
(S 0.4S) F
i.e. 0.6 S = 0.66S 1.1F

i.e. 0.06 S 1.1F = 0. ---- (Equation 1)
Degree of Financial Leverage =
(Sales VariableCosts) FixedCosts
Preferencedividend
(Sales VariableCosts) FixedCosts Interest payment
1- tax rate

= 1.5.
i.e.
(S 0.4S) F
40,00,000
(S 0.4S) F 60,00,000
1 0.50

= 1.5
Part III
383
0.6S F
0.6S F 60,00,000 80, 00, 000

= 1.5
i.e. 0.6S F = 0.9S 1.5 F 210,00,000
i.e. 0.3S 0.5F = 210,00,000. -------(Equation 2)
Multiplying equation 1 by 0.3 and multiplying equation 2 by 0.06, and solving the resultant
equations, we get
0.018 S 0.33 F = 0
0.018 S 0.03 F = 12,60,000.
0.30 F = 12,60,000
i.e. F = Rs. 42,00,000.
Putting the value of F in equation 1, we get S =
1.1 42, 00, 000
0.06
= Rs. 770,00,000.
60. (c) Efficiency in the utilization of assets is measured by asset turnover ratio.
Asset turnover ratio = sales/total assets
Asset turnover ratio (company X) = Rs.32,00,000/Rs.24,74,000 = 1.29 times
Asset turnover ratio (company Y) = Rs.30,00,000/Rs.28,51,000 = 1.05 times
So asset utilization of company X is greater than company Y.
Hence statement (i) is correct.
Payout ratio determines the amount that is paid-out by the company and (1 paid-out) gives
the amount retained.
(Amount in Rs.)
X Y
Dividends declared 0.06 10 1,00,000 0.08 10 80,000
= Rs.60,000 = Rs.64,000
Net profit Rs.1,23,000 Rs.1,58,000
Retained earnings Rs.63,000 Rs.94,000
R E as % of N P 51.2% 59.5%
Hence company Y retains larger proportion of its income & statement ii is also true.
Utilization of shareholders money is determined by return on net worth.
(Amount in Rs.)
X Y
Net worth 12,32,000 14,42,000
Net profit 1,23,000 1,58,000
R O N W 9.98% 10.96%
Hence, company Y utilizes shareholders funds more profitably than company X.
61. (c)

a
k
= 0.40 x 3 + 0.25 x 4 + 0.15 x 5 + 0.20 x 7 = 4.35%.

m
k
= 0.40 x 6 + 0.25 x 9 + 0.15 x 8 + 0.20 x 7 = 7.25%.

sm
2
m
COV
=

= (6 7.25)
2
m
2
0.4 + (9 7.25)
2
0.25 + (8 7.25)
2
0.15 + (7 7.25)
2
0.2
= 0.625 + 0.766 + 0.084 + 0.0125 = 1.4875
384

0.4625
0.31
1.4875
= =
The alpha factor helps us in computing the rate of return that the security will earn when
market return is zero.
A A
k k =
m
=4.35% (0.31) 7.25% = 2.1025 %.
Hence, the security will earn a return of 2.1025% when the market return is zero.
62. (a) 1(1.08)
3
+ X FVIFA
8%,3
(1.08) = 15(1.05)
3
0.2
X =
3.473 1.260
Rs.0.630lakh
3.506
=
Hence, statement (iii) is not true and the answer is (c). Hence the sales revenue for the firm is
Rs.7,70,00,000 and the fixed costs are Rs.42,00,000.
63. (c) According to Du Pont Analysis
Return on Equity (ROE) = Return on assetsEquity multiplier
Where, Equity Multiplier =
1
1 Debt to assets ratio
=
1/3 1
1
= 3/2.
Hence, Return On Equity = 0.10 x 3/2 = 0.15
or 15%.
64. (c) Amount that Ashish should invest = Rs 2,000 x PVIFA
(9%,6 years)
x PVIF
(9%,2 years)
= 2,000 x 4.486 x 0.842 = Rs. 7,554.42.
65. (a) Present current ratio = Rs.10lakh/Rs.5lakh = 2.
Fixed assets purchases of Rs.2 lakh will decrease the current assets to Rs.8 lakh. Issue of
new shares for Rs.5 lakh will increase cash at bank, and the current assets to Rs.13 lakh.
Bills receivables dishonored will increase debtors (one form of current assets) and decrease
bills receivables. As a result there will be no change in the amount of current assets. Cash
worth Rs.10,000 collection from customers will increase one constituent of current assets,
and i.e., debtors (decrease another constituent of current assets) and, hence, will have no
change.
So the new current ratio = Rs.13lakh/Rs.5lakh = 2.60.
66. (a) Change in WC = (current assets + increase in current assets)
(current liabilities + increase in current liabilities)
Increased provision for contingencies (CL) = 30,000 + 20,000 = Rs.50,000
Loans and advances (given) (CA) = 20,00,000
Stipulation for provident fund (CL) = 10,00,000 + 10,00,000 = Rs.20,00,000
Short-term investments (CA) = 30,00,000 20,00,000 = Rs,10,00,000
New loans and advances taken (CL) = Rs.10,00,000
New net WC = 20,00,000 + 10,00,000 50,000 20,00,000 10,00,000
= Rs.50,000.
67. (a) Value of the convertible = PV of cash inflow
=
2
10 10 40 2
1.12 (1.12)
+
+ = 8.929 + 71.747 = Rs.80.68.
68. (c) Funds from operations = Retained earnings interest earned + amortization
+ depreciation + dividends + P/E W. off
= 20 6 + 5 + 4 + 10 +5 = Rs.38 lakh.
Part III
385
69. (d) Average collection period =
Receivables balance
Averagedailycredit sales

Average daily credit sales =
Sales
365

Receivables balance
x365
Credit sales

Average collection period=25 days (given)
Average Receivables balance =
25 15
2
+
= Rs.20 lakh.
25 =
20
x 365
Credit sales

or Credit sales =
20 x 365
25
= Rs.292 lakh.
Total sales =
292
0.8
= Rs.365 lakh.
70. (a) Effective rate of interest of Bank A =
2
(1.10)
1
2
+ = 10.25%
Nominal rate of interest of Bank B = [(
1/12
1.1025)] 1] 12 = 9.80.


Model Question Paper III
1. The quick ratio is a type of
a. Leverage ratio
b. Coverage ratio
c. Profitability ratio
d. Liquidity ratio
e. Turnover ratio.
2. In common size analysis the items in the income statement are expressed as percentage of
a. Total assets
b. Net sales
c. Total expenses
d. Current assets
e. Current liabilities.
3. A funds flow statement is also known as
a. Profit and loss account
b. Income statement
c. Balance sheet
d. Cash budget
e. Statement of changes in financial position.
4. Which of the following is not shown by a funds flow statement on cash basis?
a. The sources of cash.
b. The uses of cash.
c. The net change in cash.
d. The net change in working capital.
5. In a funds flow statement on working capital basis, a short-term loan taken by the
organization
a. Is shown as a source of working capital
b. Is shown as a use of working capital
c. Is shown as an increase in cash
d. Is shown as a decrease in cash
e. Does not have any effect on working capital as it causes an equal increase in a current
asset (cash) and a current liability (short-term loan).
6. Which of the following is true with regard to a funds flow statement?
a. It shows the level of sources and uses of funds on a specific date.
b. It shows how the change in owners equity takes place.
c. It shows a snapshot picture of the affairs of a business.
d. It shows the movement of funds through the business over a period of time.
Part III
387
7. The operating break even point represents the quantity produced and sold for which the
a. Sales revenue is equal to the variable cost
b. Sales revenue is equal to the fixed cost
c. Fixed cost is equal to the variable cost
d. EBIT is zero
e. EBIT is negative.
8. Which of the following is not true with regard to the Degree of Financial Leverage (DFL)?
b. DFL is zero at the financial break even point.
c. DFL is negative below the financial break even point.
d. DFL is positive above the financial break even point.
9. Which of the following is/are statistical method(s) of sales forecasting?
a. Jury of executive opinion.
b. Sales force estimates.
10. Which of the following is not true with regard to a private company?
a. The minimum number of persons required to form a private company is 2.
b. The minimum number of directors required in a private company is 2.
c. A private company cannot issue shares for subscription to public.
d. There is no limit on the number of members in a private company.
11. Which of the following is not traded in the money market?
a. Treasury bills.
b. Certificates of deposit.
c. Commercial paper.
d. Debentures.
12. Which of the following players can act as a borrower as well as a lender in the call money
market?
a. LIC.
b. SBI Mutual Fund.
c. State Bank of India.
d. PFC (Power Finance Corporation)
e. NABARD.
13. The objective of financial management is to
a. Maximize the revenues
b. Minimize the expenses
c. Maximize the return on investment
d. Minimize the risk
e. Maximize the wealth of the owners by increasing the value of the firm.
388
14. Which of the following is a part of the control function of the finance manager?
a. Negotiating with the banks and financial institutions for loans.
b. Negotiating with the merchant banks for issue of shares and debentures.
c. Reporting on the performance of individual departments within the organization.
d. Appraisal of investment proposals given by various departments.
e. Deciding on the manner of deployment of funds in various assets.
15. Which of the following is not true with regard to valuation of bonds?
a. An increase in the required rate of return, other things remaining the same, will decrease
the bond value.
b. An increase in the number of years to maturity, other things remaining the same, will
increase the present value of the face value of the bond payable at maturity.
c. An increase in the coupon rate, other things remaining the same, will increase the bond value.
d. An increase in the face value of the bond payable at maturity, other things remaining the
same, will increase the bond value.
e. An increase in yield to maturity will occur if the amount payable at maturity increases,
other things remaining the same.
16. If the beta of a stock is equal to zero, which of the following is/are true according to CAPM?
i. Slope of SML is zero.
ii. Risk-free rate of return is equal to the required rate of return of the given stock.
iii. Stock will lie on the SML.
a. Only (i) above.
b. Only (ii) above.
17. The intrinsic value of a share of a firm
a. Is its economic value
b. Is arrived at, treating the firm as a going concern
c. Is based on the nature of business
d. Is based on the investment environment
18. The capital structure ratios measure the
a. Financial risk
b. Business risk
c. Market risk
d. Operating risk
e. Firms total risk.
19. Supraja Chemicals is a company in which a major percentage of shareholders consist of
people who have invested their retirement benefits in the shares. Then which of the ratios
would make the investors happy?
a High interest coverage ratio.
b. High dividend pay-out ratio.
c. High dividend yield.
d. Both (b) or (c) above.
Part III
389
20. DTL is not affected by
a. Tax Rate
b. EBIT
c. Number of Equity Shares
d. Debt Proportion
21. The difference between hypothecation and pledge is
a. Pledge of assets is made for long-term borrowings while hypothecation is for short-term
borrowings
b. Goods are in the possession of the borrower in hypothecation and of the lender in pledge
c. Hypothecation is for short-term borrowings and pledge is for long-term borrowings
e. None of (a), (b) and (c) above.
22. The percent of sales method of financial forecasting assumes that
a. The future relationship between the manufacturing costs only and sales will be similar
to their historical relationship
b. The future relationship between the selling and administrative costs only and sales will
be similar to their historical relationships
c. All the cost elements change by the same percentage as the change in sales
d. All the cost elements will bear the same relationship with sales as in the past
e. Only the variable cost elements will bear the same relationship with sales as in the past.
23. Which of the following is true with regard to the basis used for preparing a funds flow
statement?
a. It can be prepared on total resources basis.
b. It can be prepared on cash basis.
c. It can be prepared on working capital basis.
24. The dividend capitalization approach assumes
a. That the first dividend is to be paid a year hence
b. 100% dividend pay-out ratio
c. Dividends are paid every year
25. Which of the following is/are not true?
a. The probability of death, sometime in future, of a human being is 1.
b. Boom, Depression and Normal periods of economy have a probability of 0.2, 0.4, 0.7
respectively.
c. Bindre tells her chances of getting back the money invested in a mutual fund is 0.7
390
26. A financial market is one
a. Where all transactions involving finance take place
b. A well-defined place like Bank, Stock Market where borrowing and lending of funds
take place
c. Where all assets are marketed for money
d. Where financial assets are created and transferred
27. In common size analysis
a. All balance sheet items are expressed as a % of total assets
b. All items of income statements are expressed as a % of net sales
c. All items of balance sheet are expressed as a % of total liabilities
28. Beta is a ________ measure of risk.
a. Relative
b. Absolute
c. Variable
d. Subjective
e. Average.
29. Which of the following ratios can measure the ability of a firm to meet its obligation in the
short-term most conservatively?
a. Debt-equity Ratio.
b. Current Ratio.
c. Quick Ratio.
d. Earning Power.
e. Asset Turnover Ratio.
30. Return is
a. Income or cash receipts on an investment every year
b. Difference of the selling price and the purchase price of an investment divided by the
purchase price
c. The income from the investment and the appreciation for the total holding period as a
percentage of purchase price
d. The income + the capital appreciation from an investment during the holding period
expressed as an annual percentage of the purchase price or the investment at the
beginning
31. Which of the following can be a source/sources of financial information?
a. Balance sheet.
b. Income statement.
c. Footnotes to the statements.
d. Market information from various media.
32. On-Tap treasury bills, Ad hoc Treasury bills and Auction Treasury bills are Treasury bills
classified basing on the
a. Nature of issue
b. Mode of interest payment
c. The issuer
d. The maturity period
e. Mode of redemption.
Part III
391
j m
k = + k +e
33. Which of the following is/are not money market instruments?
a. Commercial Paper.
b. Equity Shares.
c. Certificates of Deposit.
a. In both note lending and bill discounting credit is given for the full amount.
b. Hypothecation and Pledge are similar for a banker.
c. Lending is a form of credit in which the bank does not bear any risk.
d. The letter of credit is opened in favor of the buyer.
e. Under hypothecation only movable goods are kept as security.
35. The graphic representation of the equation
j
is the
j j
a. Security Market Line
b. Characteristic Line
c. Capital Market Line
d. Portfolio Market Line
e. Risk-return Line.
36. Which of the following is true if the degree of operating leverage and total leverage are
equal?
a. DFL is undefined.
b. Change in EPS is the same as change in EBIT.
c. Percentage change in EPS is the same as change in EBIT.
d. Percentage change in EPS is the same as percentage change in EBIT.
37. Money market deals with
a. Mortgage loans
b. Certificates of deposit
c. Deposits with the RBI under CRR
d. Fixed deposit receipts
a. Bond prices decline when the interest rates decline.
b. As the term to maturity increases the bonds sensitivity or the interest rate changes
decreases.
c. A change in YTM affects the bonds with higher YTM more than bonds with lower
YTM.
d. When the YTM is more than the coupon rate, the premium on the bond declines as the
e. When the YTM is less than the coupon rate, the discount on the bond declines as the
392
39. Common size analysis is
a. Used for comparing the performance of a share with that of the market
b. A statistical tool for arranging the balance sheet in a columnar form
c. A method of identifying the value of assets and liabilities assuming the base year
figures are correspondingly equal to 100
d. A method of considering the total assets/liabilities as 100 and identifying the values of
the assets and liabilities correspondingly
e. A part of cross-sectional analysis.
a. Increase in profits.
b. Increase in liabilities.
c. Increase in share capital.
d. Increase in assets.
41. The equity shares of Specialty Foods Ltd., a food processing company, are presently trading
at Rs.96 per share. The company has recently paid a dividend of Rs.3.00 per share. A security
analyst has projected the following information for the next year:
Scenario Optimistic Normal Pessimistic
Probability 30% 40% 30%
Projected
Share Price
Rs.110.00 Rs.105.00 Rs.99.00
Projected
Dividend
Rs.4.00 Rs.3.00 Rs.3.00
If Vishal wants to buy a share of Specialty Foods Ltd., the expected rate of return on the
equity shares earned by him will be
a. 12.5%
b. 10.3%
c. 9.8%
d. 8.9%
e. 7.5%.
(2 points)
42. The following distribution is given with respect to the market returns.
Probability Projected market return
30%
40%
30%
15%
12%
8%
The risk associated with the market returns is
a. 1.89%
b. 2.27%
c. 2.72%
d. 3.54%
e. 7.40%.
(2 points)
Part III
393
43. The expected return on a security of Tide Ltd., is 9.6%, expected market return is 11.2%. If
the return on the security of Tide Ltd. changes by 17%, when the market returns change by
20%, the alpha intercept for the security is
a. 0.89%
b. 0.23%
c. 0.08%
d. 1.77%
e. 1.89%.
(2 points)
44. The following information is given about Reliance Industries Ltd.
(Rs. in crore)
As on 31.03.2004 As on 31.03.2003
Current Assets:
Inventories
Sundry Debtors
Cash and bank balances
Current Liabilities and Provisions:
Current liabilities
Provisions

780
110
10

400
50

920
80
100

460
70
What is the approximate percentage increase/decrease in the current ratio for the company in
the year 2003-2004 as compared to the year 2002-2003?
a. An increase of 0.04%.
b. A decrease of 0.04% .
c. An increase of 4%.
d. A decrease of 4%.
e. The current ratio is constant for the year 2003-2004 and 2002-2003.
(2 points)
45. The following information is related to KIL Ltd.
As on 31.03.2004 As on 31.03.2003
Sources of funds:
Shareholders funds:
Equity share capital 300 300
Reserves and surplus 1150 1050
Loan funds:
Secured loans 400 600
Unsecured loans 600 700
provisions:

Current liabilities 400 460
Provisions 50 70

394
a. The financial risk of the company has increased as the debt-equity ratio in the year 2004
has increased to 1.36.
b. The financial risk of the company has increased with the debt-equity ratio in the year
2004 reaching 1.00.
c. The financial risk of the company has decreased in the year 2004 with the total debt
being equal to total equity.
d. The percentage change in the debt-equity ratio of the company in the year 2004 relative
to the year 2003 is + 0.27%.
e. The financial risk of the company has decreased as the total debt to equity ratio has
come down to 0.87.
(2 points)
46. The net sales for STOC Ltd., in the year 2002-2003 were Rs.2,000 crore. The sales figure
increased by 20% in the year 2003-2004. If the inventories for the years 2002-2003 and
2003-04 were Rs.550 crore and Rs.650 crore respectively, the inventory turnover ratios for
the years 2002-2003 and 2003-2004 are
a. 3.646 and 2.201
b. 3.692 and 3.636
c. 2.121 and 3.636
d. 3.636 and 3.692
e. 1.921 and 3.041.
(2 points)
47. The following information is given about FM Ltd.
2003-04 2002-03
Depreciation
Interest
Profit before tax
180
100
500
200
120
630
The decrease in the interest coverage ratio (using cash flows) in the year 2003-2004 as
compared to the year 2002-03 is
a. 0.12
b. 0.17
c. 0.22
d. 0.33
e. 0.38.
(2 points)
48. The following data is given about National Tyre Company Ltd.
(Rs. in crore)
Net sales 2070
Cost of goods sold 1100
Selling expenses 550
Administrative expenses 65
25% of the cost of goods sold and 20% of the selling expenses are fixed costs. Administrative
expenses are entirely fixed in nature.
Part III
395
By how much will the EBIT increase if the sales increase by 1%?
a. 4.889%.
b. 3.765%.
c. 2.268%.
d. 1.984%.
e. 0.892%.
(2 points)
49. The following information is given about a textile manufacturing firm:
(Rs. in crore)
Interest 75
Taxes 84
Net profit 196
The paid-up equity share capital of the company consists of 100 lakh equity shares of Rs.10
each. Further, the company has employed preference share capital which has a book value of
Rs.150 crore and the dividend rate on the same is 12%. It is expected that there will be no
change in its capital structure in the near future.
The Degree of Financial Leverage (DFL) for the firm is
a. 1.196
b. 1.253
c. 1.396
d. 2.786
e. 2.345.
(3 points)
50. If the DOL for a firm is 2.00 and the DFL is 1.43, the percentage change in the EPS of the
firm if the sales figure doubles is
a. 5.720%
b. 5.678%
c. 3.166%
d. (5.720)%
e. (6.332)%.
(2 points)
51. The contribution for GK Ltd., is Rs.805 lakh. The fixed costs amount to Rs.450 lakh. The
financial break even point for the company occurs at an EBIT of Rs.100.71 lakh. Assuming
that the unit selling price, the unit variable cost, the fixed costs, the interest and the
preference dividend remain constant in the forthcoming year, by how much should the net
sales increase if the company plans to increase its EPS by 25%?
a. 3.5%.
b. 4.3%.
c. 6.8%.
d. 7.9%.
e. 8.9%.
(2 points)
396
52. The DFL for a firm is 1.396. The existing sales figure and EBIT for the firm are Rs.2,070
crore and Rs.355 crore respectively. The existing cost of sales for the company is Rs.1,715
crore. If the company cannot increase its sales revenue due to competition, by how much
percentage should it reduce its cost of sales in order to increase EPS by 25%?
a. 3.71%.
b. 4.20%.
c. 3.12%.
d. 6.15%.
e. 7.00%.
(3 points)
53. The Income Statement for PG Ltd., is given below:
Income Statement for the year ended March 31, 200
(Rs. in crore)
Net sales 340
Other income 30
Total 370
Cost of goods sold 260
Selling and administrative expenses 37
Depreciation 10
Interest 8
Total 315
Provision for tax 22
Profit after tax 33
Additional information for next year:
Sales are expected to decline by 5%.
The other income is expected to decrease by 8%.
Cost of goods sold is expected to go up by 5% due to a general rise in costs.
Selling and administrative expenses will reduce by 4%.
The interest expense will remain constant.
Depreciation is expected to decrease by 20%.
The sundry creditors will decrease by 5% and provisions will be maintained only to the
extent of provision for taxes.
The tax rate to be applied for arriving at the provision for taxes will be 30%.
The company expects to pay dividends to the extent of Rs.5.50 crore.
The expected profit after tax for the company in the year 2003-2004 is
a. Rs.12.76 crore
b. Rs.27.81 crore
c. Rs.26.08 crore
d. Rs.34.56 crore
e. Rs.35.00 crore.
(3 points)
Part III
397
54. The balance sheet of Modern Industries Ltd. for the financial year 2003-04 is given below.
Balance Sheet as on 31.3.2004
(Rs. in crore)
Owners equity and liabilities Assets
Paid-up equity share capital 25 Fixed assets:
Reserves and Surplus 40 Gross block 105
65 Accumulated depreciation 25
Secured loans 30 Net block 80
Unsecured loans 20 Current assets, loans and
advances:

Current liabilities
and provisions
Inventories 40
Sundry creditors 40 Sundry debtors 20
Provisions 25 Loans and advances 35
Cash and bank balances 5
180 180
For the forthcoming year, loans and advances will remain constant and cash and bank
balances will be maintained at a level of Rs.2 crore. Both inventories and sundry debtors are
expected to reduce by 5%. One sixth of the outstanding balance of secured loans will be
repaid at the end of the financial year 2004-05. The unsecured loans will remain constant and
provisions will be maintained only to the extent of provision for taxes. Gross fixed assets will
remain unchanged for the year 2004-05. Depreciation charged in the year 2003-04 was
Rs.10 crore and it is expected to decrease by 20%. The Proforma Income Statement for the
year ended 31-03-2005 reflects the retained earnings to be Rs.12.76 crore and taxes to be
Rs.7.82 crore. If the total liabilities of the firm in the year 2005-06 are projected to be
Rs.168.58 crore, the surplus funds available in the year 2005-06 are
a. Rs.1.00 crore
b. Rs.2.58 crore
c. Rs.3.02 crore
d. Rs.4.00 crore
e. Rs.5.40 crore.
(3 points)
55. The Needles and Thread Finance Ltd. (NTFL) is offering a deposit scheme in which the
investor is required to deposit Rs.100 at the end of every month for a period of three years
and four months and after five years NTFL will pay a sum of Rs.6,000.
The approximate effective rate of interest (per annum) under the deposit scheme is
a. 10.01%
b. 11.22%
c. 12.92%
d. 13.69%
e. 14.05%.
(3 points)
56. Two years ago Indian Photofilms Ltd., had issued bonds which have a book value of
Rs.5 crore. These bonds carry an interest rate of 12% per annum payable semi-annually
and are redeemable in two equal annual installments, each amounting to 50 percent of
the par value of the bonds, payable at the end of the last two years of the life of the bonds.
These bonds have a maturity period of 7 years. The yield to maturity on these bonds
prevailing in the market is 10%.
398
The aggregate market value of the bonds at present is
a Rs.5,35,52,500
b. Rs.5,90,87,900
c. Rs.6,12,45,676
d. Rs.6,23,67,800
e. Rs.6,50,00,560.
(3 points)
57. M/s. Paras Ltd., issued bonds having a par value of Rs.1000, maturity value of Rs.1,200 and
a coupon rate of 17%. If the current market price of the bond is Rs.1,114 and the YTM of the
bond by approximation method is 16.4%, the maturity period of the bond is approximately
a. 6.0 years
b. 5.5 years
c. 5.0 years
d. 4.4 years
e. 3.0 years.
(2 points)
58. The required rate of return on security Z as per CAPM is 10%. If the current purchase price
of the security is Rs.40, the last paid dividend is Rs.3 and the growth rate is 5%, then what
should be the increase/decrease in the price of security Z such that it is at equilibrium?
a. Increase by Rs.23.
b. Increase by Rs.20.
c. Decrease by Rs.15.
d. Decrease by Rs.23.
e. Security is already at equilibrium.
(2 points)
59. M/s. Excel Ltd., has declared a dividend of Rs.4 per share last year. If the net profit is
Rs.300 lakhs, growth rate in dividends is 6% p.a. and the current market price of the share is
Rs.50, the required rate of return is
a. 10.24%
b. 14.00%
c. 14.48%
d. 18.00%
e. 18.72%.
(1 point)
60. Consider the following information of M/s. ABC Ltd:
Preference dividend Rs.30,000
Corporate tax rate 40%
Interest Rs.65,000
Fixed expenses Rs.6,00,000
The level of output at which DTL will be undefined is
a. 1,480 units
b. 1,430 units
c. 1,390 units
d. 1,366 units
e. 1,354 units.
(2 points)
Part III
399
61. Consider the following information regarding the bond issued by M/s. Zeta Ltd.:
Face value of the bond : Rs.1000
Coupon (payable annually) : 9% p.a.
Maturity period : 5 years
The above bonds are issued at a discount of 5% and are redeemed at a premium of 10%.
The intrinsic value of the bond at the required rate of return of 8% p.a. is
a. Rs.1,007.20
b. Rs.1,074.80
c. Rs.1,090.35
d. Rs.1,108.47
e. Rs.1,473.60.
(2 points)
62. The Profit After Tax (PAT) for M/s. KVP Ltd., is Rs.2,40,000, preference dividends is
Rs.30,000 and the number of outstanding shares is 30,000. If the market price of the share is
Rs.100 and the book value of the share is Rs.80, the capitalization rate for M/s. KVP Ltd., is
a. 7.00%
b. 8.00%
c. 8.75%
d. 9.00%
e. 10.00%.
(1 point)
63. The correlation coefficient between return of M/s. X Ltd. and the market return is 0.45. The
variance of M/s. X Ltd., is 3.33 and that for the market is 10. The risk-free rate of return is 5%
and the market return is 10%. The last paid dividend is Rs.2 and the current purchase price is
Rs.25. The growth rate for the company is 3%.
The required rate of return on the security as per the Capital Asset Pricing Model is
a. 5.12%
b. 6.30%
c. 7.25%
d. 8.14%
e. 11.24%.
(2 points)
64. The EBIT for a company at 6,000 level of production is Rs.7,50,000. At the financial break
even point, the EBIT of the company is Rs.2,10,000. The Degree of Financial Leverage
(DFL) for the company at 6000 level of production is
a. 1.56
b. 1.51
c. 1.49
d. 1.46
e. 1.39.
(2 points)
65. The effective rate of interest under a particular scheme is 8.48%. If the frequency of
compounding is three times in a year, the nominal rate of interest under the scheme is
a. 6.78%
b. 7.35%
c. 8.74%
d. 8.25%
e. 9.35%.
(1 point)
400
66. The current sales and income of M/s. Excel Industries Ltd., is Rs.25 lakhs and Rs.4 lakhs
respectively. It is expected to increase its sales by 30%. If the company maintains the net
profit margin ratio, pay out 30% as dividends and does not resort to external equity but
maintains the debt-equity ratio of 1.75, the increase in borrowings will be
a. Rs.2.10 lakh
b. Rs.3.64 lakh
c. Rs.5.20 lakh
d. Rs.6.37 lakh
e. Rs.9.10 lakh.
(2 points)
67. The following information is related to M/s. Indigo Ltd., for the year 2002-03:
Current ratio
Quick ratio
Net working capital
31:13
18:13
Rs.9,00,000
The average inventory is
a. Rs.9,00,000
b. Rs.7,25,000
c. Rs.6,50,000
d. Rs.5,00,000
e. Rs.4,50,000.
(2 points)
68. If the current assets and current liabilities are Rs.1,200 lakhs and Rs.1,500 lakhs respectively, then
the amount of short-term borrowings that have to be repaid to increase the current ratio to 1.2 is
a. Rs. 50 lakhs
b. Rs. 60 lakhs
c. Rs.250 lakhs
d. Rs.300 lakhs
e. Rs.500 lakhs.
(1 point)
69. As per the Rule of 69, if the amount deposited today doubles in four years and seven months,
the effective interest rate per annum is
a. 15.1 percent
b. 15.5 percent
c. 15.8 percent
d. 16.0 percent
e. 16.3 percent.
(1 point)
70. Consider the following for the year 2002-03:
Rs.
Sales 10,00,000
Gross profit margin 40%
Current Ratio 2.5
Total assets turnover ratio 2
Fixed assets: Current assets 3:1
The quick ratio is
a. 0.6
b. 0.8
c. 1.0
d. 1.2
e. 1.5.
(1 point)

Suggested Answers
1. (d) The quick ratio is a type of liquidity ratio.
2. (b) In common size analysis the items in the income statement are expressed as percentage of
net sales.
3. (e) A funds flow statement is also known as a statement of changes in financial position.
4. (d) A funds flow statement on cash basis does not show the net change in working capital.
5. (e) In a funds flow statement on working capital basis, a short-term loan taken by the
organization does not have any effect on working capital as it causes an equal increase in a
current asset (cash) and a current liability (short-term loan).
6. (d) A funds flow statement shows the movement of funds through the business over a period
of time.
Alternatives (a) & (c) are shown by a balance sheet.
Alternative (b) is shown by income statement.
7. (d) At the operating break even point, the EBIT is zero. The operating break even point can
be expressed in quantity of sales or value of sales.
8. (b) DFL is undefined at the financial break even point.
9. (c) Regression analysis is a statistical method used for sales forecasting. All other alternatives
are subjective methods of sales forecasting.
10. (d) The maximum number of members in a private company is 50.
11. (d) Debentures are long-term financial instruments which are traded in capital market.
12. (c) Commercial banks can act both as lenders and borrowers in the call money market but the
financial institutions like LIC, mutual funds, NABARD can act only as lenders in the market.
13. (e) When the market value of the firm increases the wealth of its owners increases. The
ultimate objective of financial management is to maximize the wealth of the owners. All the
other alternatives may not necessarily maximize the wealth of the owners.
14. (c) The management of an organization exercises its control on the overall performance of
the organization on the basis of the reports sent by the finance manager on the performance
of the individual departments. Since this function of the finance manager helps the
management to exercise control over the overall performance of the organization it is
considered to be a part of the control function of the finance manager.
15. (b) In the intrinsic value formula the face value of the bond is multiplied with the factor
PVIF
(r,n).
The factor PVIF
(r,n)
decreases as the number of years to maturity increases, other
things remaining the same. Hence, other things remaining the same, the present value of the
face value of the bond decreases as the number of years to maturity increases. Therefore,
alternative (b) is not true. All other alternatives are true.
16. (b) According to CAPM, required rate of return = R
f
+ (R
m
R
f
)
Where R
f
is the risk-free rate of return, is the Beta of the stock and R
m
is the market return.
If Beta is equal to zero, required rate of return is equal to risk-free rate of return. Hence, (ii) is
true.
In the SML equation, slope is measured by R
m
R
f
and the Beta of the stock is not relevant to find
the slope of SML. Hence, (i) is not true. A stock whether it will lie below or above the SML
depends on whether the stocks required rate is more than or less than the expected rate of return.
It is immaterial whether the Beta is equal to zero or not. Hence, (iii) is not true and the answer is
(b).
17. (e) The intrinsic value is the value of a stock which is justified by assets, earnings, dividends,
definite prospects and the factor of the management of the issuing company. It is its
economic value as a going concern, taking account of its characteristics, the nature of its
business and the investment environment.
402
18. (a) The capital structure ratios measure the financial risk i.e. the risk which arises from the
use of debt capital.
19. (d) A shareholder who has invested his retirement benefits will be very much concerned
about the firms policy regarding the payment of cash dividends. Hence a high dividend pay-
out ratio and a high dividend yield would make such shareholders very happy.
20. (e) DTL =
p
Q(S V)
EBIT I D /(1 t)

=
Q %
` EPS %
= % change in EPS/% change in output.

Hence (e) is the answer
21. (b) Under hypothecation agreement, the goods hypothecated will be in possession of the
borrower. In pledge the goods/documents in the form of share certificates, book debts,
insurance policies, etc. which are provided as security will be in the possession of the bank
lending funds but not with the borrowing company.
22. (d) The percent of sales method of financial forecasting assumes that the future relationship
between various elements of costs to sales will be similar to their historical relationship.
23. (e) A funds flow statement may be so prepared as to explain only the change in the working
capital from the beginning of a period to the end of the period. Alternatively it may explain
the change in the cash position during the period or it may be prepared so as to indicate the
changes in total resources.
24. (d) The dividend capitalization assumes that dividends are paid annually which is a common
practice for business firms in India and that the first payment of dividend is made one year
after the equity share is bought.
25. (d) Probability cannot be greater than 1, in case of option (b),
the sum of probabilities = 0.2 + 0.4 + 0.7 = 1.3.
Hence (b) is false. Also probability can never assume a negative value. Therefore, option (c) is
also false.
26. (d) Financial market is defined as the market in which financial assets are created or
transferred.
27. (e) In common size analysis, in the balance sheet the assets as well as liabilities and capital
are each expressed as 100 percent, and each item in these categories is expressed as a
percentage of the respective totals. Similarly, in the income statement, net sales are set at 100
percent and every other item in the statement is expressed as a percentage of net sales.
28. (a) Beta measures the relative risk associated with any individual portfolio as measured in
relation to the risk of the market portfolio. Hence Beta is a relative measure of risk.
29. (c) The quick ratio gives the abilities of a firm to pay its liabilities without relying on the sale
and recovery of its inventories.
30. (d) Return is the motivating force, inspiring the investor in the form of rewards, for
undertaking investment. It is equal to the income plus the capital appreciation from an
investment during the holding period expressed as an annual percentage of the purchase price
or the investment at the beginning.
31. (e) All the given alternatives are the sources of financial information.
32. (a) The T-bills are classified into 3 categories based on the nature of issue. On tap T-bills are
issued by the RBI on tap to investors on any working day. Auctioned T-bills are issued
through auctions conducted by the RBI. Ad-hoc T-bills were specially created in favor of the
RBI to replenish the cash balances of central government whenever it falls below the
minimum prescribed level.
Part III
403
33. (b) Equity shares are capital market instruments.
34. (e) Security in the form of hypothecation is limited to movable properties like inventories.
35. (b) The characteristic regression line is a graphic representation of the market model

j j j
j m
k = + k + e .
36. (d) Degree of operating leverage = Percentage change in EBIT/Percentage change in output.
Degree of total leverage = Percentage change in EPS/Percentage change in output.
Hence when degree of operating leverage and total leverage are equal it means that percent
change in EPS is equal to the percent change in EBIT.
37. (b) Money market deals with all transactions in short-term instruments (with a period of maturity
of one year or less like treasury bills, bills of exchange, etc.). Certificates of deposit are defined as
short-term deposits by way of usance promissory notes having a short maturity of not less than 15
days and not more than one year.
38. (c) This is a bond theorem explaining how YTM determines the bonds market price. Bonds price
will fluctuate in response to the change in the market interest rates. A change in YTM affects the
bonds with higher YTM more than it does bonds with lower YTM.
39. (d) In common size analysis, in the balance sheet the assets as well as liabilities and capital are
each expressed as 100 percent, and each item in these categories is expressed as a percentage of
the respective totals. Similarly, in the income statement, net sales are set at 100 percent and every
other item in the statement is expressed as a percentage of net sales.
40. (d) Increase in assets is an application of funds, as funds are used in the purchase of additional
assets.
Part B: Problems
41. (a)
Scenario Optimistic Normal Pessimistic
Projected rate of return
=
D + P
1 1
1
P
0

110 + 4
1
96
= 0.1875
105 + 3
1
96

= 0.125
99 + 3
1
96

= 0.0625
i.e. 18.75% i.e. 12.5% 6.25%
Expected rate of return from the share = p
i
k
i
= 18.75 (0.30) + 12.5 (0.40) + 6.25 (0.30) = 12.5%
42. (c) Expected return from the market = p
i
k
m
= 15 (0.30) + 12 (0.40) + 8 (0.30) = 11.70%
m
= [p
i
(k
m

m
k
)
2
]
1/2
= [(15 11.70)
2
(0.30) + (12 11.70)
2
(0.40) + (8 11.70)
2
(0.30)]
1/2
=[3.267 + 0.036 + 4.107]
1/2
= (7.41)
1/2
= 2.72%.
43. (c) Expected return on Tide Ltd. (r
t
) = 9.6%.
Expected market return (r
m
) = 11.2%.
Beta of the security
Change in the return on security for a given change in the market return
=
Change in the market return

404
Beta ( ) =
20
17
= 0.85.
Alpha Intercept ( ) = r
t
r
m
= 9.6% 0.85 x 11.2% = 0.08%.
44. (d) Current ratio =
assets Current

2000 - 2001 : Current ratio =
450
900
= 2.00
1999 - 2000 : Current ratio =
530
110
= 2.08
Percentage change in current ratio =
2.00 2.08
2.08
= (3.9)%
i.e. the current ratio has decreased by approximately 4.0%.
It indicates that the liquidity of the company has deteriorated slightly.
45. (c) Debt-equity ratio =

Equity
debt Total

Long - term loans + Current liabilities & provisions
=
Equity share capital + Reserves & surplus

2003-2004 : Debt-equity ratio =

1450
1450
1450
) 50 400 ( ) 600 400 (
=
+ + +
= 1.00
2002-2003 : Debt-equity =
(600 700) (460 70) 1830
1.36
1350 1350
+ + +
= =

This indicates that the financial risk of the company has reduced significantly. This is due to
the reduction in the total of secured and unsecured loans and the total current liabilities, and
simultaneous increase in reserves and surplus, compared to 19992000.
46. (d) Inventory turnover ratio =
Inventory
Sales

2002-2003: Inventory turnover =
2000
550
= 3.636 approx.
Sales for 2003-2004 = 2000 + 0.20 x 2000 = Rs.2,400 crore
2000-2001: Inventory turnover
2400
3.692
650
= = approximately.
47. (a) Interest coverage ratio (using cash flow)

EBIT Depreciation
Interest
+
=
2000-2001 : Interest coverage ratio
500 100 180
7.80
100
+ +
= =

1999-2000 : Interest coverage ratio
630 120 200
7.92
120
+ +
= =

Hence, the interest coverage ratio has decreased by 0.12 (i.e., 7.92 7.80). This indicates that
the margin of safety provided by the cash flow to the interest payments has decreased to
some extent. This has happened mainly because EBIT and depreciation have both reduced
proportionately more than the decrease in interest payment.
Part III
405
48. (c) Degree of Operating Leverage (DOL) indicates the change in EBIT for a given change in
sales. It is computed as

F QV QP
QV QP
F V) Q(P
V) Q(P

=

=

=

Sales Variable Cost
Sales Variable Cost Fixed Cost

(Rs. in crore)
Variable costs:
Cost of goods sold (75%) 825
Selling expenses (80%) 440
Total variable cost 1265
Fixed costs:
Cost of goods sold (25%) 275
Selling expenses (20%) 110
Administrative expenses 65
Total fixed cost 450
Sales = Rs.2,070 crore (given)
DOL =
450 1265 2070
1265 2070

= 2.268.
Hence increase in EBIT when sales increases by 1% = DOL x 1%
= 2.268 x 1% = 2.268%.
49. (c) Degree of financial leverage (DFL) =
t 1
D
I EBIT
EBIT
p

EBIT = Net profit + Taxes + Interest
= 196 + 84 + 75 = Rs.355 crore
Interest = Rs.75 crore (given)
Dividend on preference shares adjusted for tax =

p
D
1 t
Tax rate, t =
tax before ofit Pr
Taxes

=
Taxes
Net profit Taxes +
=
84 196
84
+
= 0.30 i.e., 30%
Preference dividend (D
p
) = 150 0.12= Rs.18 crore.

p
D
1 t
=
30 . 0 1
18
= Rs.25.71 crore.
DFL =
71 . 25 75 355
355

= 1.396.
50. (a) Degree of Total Leverage (DTL) = DOL x DFL = 2.00 x 1.43 = 2.86.
Percentage in EPS if the sales figure doubles = DTL x Percentage change in sales
= 2.86 x 2% = 5.72%.
406
51. (d) EBIT at financial break even point =
P
D
I +
(1 t)

p
Q(S V)
DTL
D
Q(S V) F I +
(1 t)

805 805
=
805 450 100.71 245.29
=

= 3.166.

Percentage change in EPS
DTL
Percentage change in sales revenue
=
Percentage change in sales revenue
Percentage change in EPS
DTL
=
Given: Desired increase in EPS = 25%
Required increase in net sales =
166 . 3
25
= 7.9% (approximately)
Net sales should increase by 7.9% in order to increase EPS by 25%.
52. (a) The EPS can be increased if the EBIT can be increased, given the fact that there is no
change in the financial expenses and the capital structure. This can be done either by
increasing sales or by decreasing costs (both variable and fixed) or by doing both.
DFL
R
= = 1.396 (given)
equired percentage change in EPS
Percentage change in EBIT
Percentage change in EBIT (required)
25%
=
1.396
= 17.91% increase.
So, EBIT should increase by 17.91% in order to increase EPS by 25%.
Since sales cannot be increased due to competition, the company must try to reduce the cost
of sales (total of variable and fixed costs).
EBIT = Q(P V) F = QP QV F
= Sales (Variable cost + Fixed cost)
= Sales Cost of sales
Since EBIT has to be increased by 17.91%, targeted EBIT
= 1.1791 x (Existing EBIT) = 1.1791 355 = Rs.418.58 crore
Sales Cost of sales = 418.58
or, 2070 Cost of sales = 418.58
or, Cost of sales = 2070 418.58 = Rs.1,651.42 crore
Required Cost of sales = Rs.1,651.42 crore
Existing Cost of sales = Rs.1,715 crore
Cost of sales must be reduced by
1,715 1,651.42
1,715
100
= 3.71% in order to increase EPS by 25%.
Part III
407
53. (b) Proforma Income Statement for the year ended 31-3-2004
(Rs. in crore)
Net sales (340 0.95) 323.00
Other income (30 0.92) 27.60
Total 350.60
Cost of goods sold (260/323 1.05) 259.35
Selling and administrative expenses
(37 0.96) 35.52
Depreciation (10 0.80) 8.00
Interest 8.00
Total 310.87
Profit before tax 39.79
Provision for taxes (26.08 0.30) 11.92
Profit after tax 27.81
54. (b) Proforma Balance Sheet as on 31-3-2005
Owners Equity and Liabilities Assets
Paid-up equity share capital 25 Fixed assets:
Reserves and surplus (40 + 12.76) 52.76 Gross block 105
77.76
Accumulated depreciation (25
+ 8)
33
Secured loans (30 5/6) 25 Net block 72
Unsecured loans 20
Current assets loans and
advances:

Current liabilities & provisions Inventories (40 0.95) 38
Sundry creditors (40 0.95) 38 Sundry debtors (20 0.95) 19
Provisions 7.82 Loans and advances 35
Cash and bank balances 2
Surplus funds available 2.58
168.58 168.58
55. (c) Amount to be deposited at the end of every month = Rs.100
Number of months for which money has to be deposited = 3 12 + 4 = 40
Number of months after which maturity value will be received = 5 12 = 60
Present value of the outflows = Rs.100 PVIFA
(k, 40)
Where k = rate of interest per month.
Present value of maturity value = Rs.6000 PVIF
(k, 60)
(5 years = 60 months)
Therefore, 100 PVIFA
(k, 40)
= 6000 PVIF
(k, 60)
Or, 100 PVIFA
(k, 40)
6000 PVIF
(k, 60)
= 0
Or, PVIFA
(k, 40)
60 PVIF
(k, 60)
= 0
At k = 1%, L.H.S. = 32.835 60 0.550 = 0.165
While at k = 2%, L.H.S. = 27.355 60 0.305 = 9.055
408
By interpolation,

1 2
1 k

=
) 165 . 0 ( 055 . 9
) 165 . 0 ( 0

=
220 . 9
165 . 0
or, k = 1.018
Nominal rate of return = 1.018 12 = 12.216 12.22% (approximately)
Hence the effective rate of return will be % 100 x 1
100
018 . 1
1
12
+

Effective rate of return = 12.92%.
56. (a) The value of the bond can be calculated as:

2n
t 2
t 1
d d
I /2 F
V= +
(1+k / 2) (1+k / 2) =
n

Since the redemption value of the bond is payable in two equal installments, the first term as
well as the second term on the RHS have to be modified.
Given,
F = book value = Rs.5,00,00,000
I = 5,00,00,000 (0.12) = Rs.60,00,000
I/2 = Rs.30,00,000
k
d
= 10% = 0.10
k
d
/2 = 5% = 0.05
n = 7 2 = 5 (Since the bonds were issued two years ago, two years have to be
deducted from the maturity period of seven years).
2n = 2 5 = 10
V =
8

t 9 10
t =1
30,00,000 2,50,00,000 (0.12)(0.5) 2,50,00,000 (0.12)(0.5)
+ +
(1.05) (1.05) (1.05)

8 10
2, 50, 00, 000 2, 50, 00, 000
(1.05) (1.05)
(5%, 8)
, 00, 000 PVIFA
+ +
= 30
9 10
15, 00, 000 15, 00, 000
+ +
(1.05) (1.05)
8 1
2,50,00,000 2,50,00,000
+ +
(1.05) (1.05)
0

= 30,00,000 (6.463) + 15,00,000 (0.645 + 0.614) + 2,50,00,000 (0.677 + 0.614)
= Rs.5,35,52,500.
57. (d)
YTM =
(F P)
I
n
P)
2
(F
+
+
0.164 =
(1200 1114)
170
n
(1200 1114)
2
+
+

Solving we get n = 4.35 years = 4.4 years.
58. (a) Expected rate of return =
0
0
D (1 g)
g
P
+
+
At equilibrium, the required rate of return is equal to the expected rate of return.
Hence, 0.10 =
0
3(1 0.05)
0.05
P
+
+
P
0
= Rs. 63.
Hence, the price of the security should increase by Rs. 23 to be at equilibrium.
Part III
409
59. (c)
1
e
0
D
k g
P
= +
Where D
1
is the next year dividends
P
0
is current market price
g is growth rate in dividends
e
4(1.06)
k 0.06 14.48%
50
= + = .
60. (b) The point at which DTL is undefined is called the overall break-even point. At this
point the quantity produced can be computed as:
Q =
V) (S
T) (1
p
D
I F

+ +
,
Where, F is the fixed expenses
I is the interest expense
D
p
is the preference dividend
T is the corporate tax rate
S is the selling price per unit and V is the variable cost per unit
Hence Q =
400) (900
0.40) (1
30,000
65,000 6,00,000

+ +
= 1,430 units.
61. (d) The value of the bond is computed as:
V
0
= I (PVIFA
k%,n
) + F (PVIF
k%,n
)
Where I is the annual interest payment and F is the redemption value.
V
0
= 90 x PVIFA
(8%, 5 years)
+ 1,100 PVIF
(8%,5 years)
= 90 x 3.993 + 1,100 x 0.681 = Rs.1,108.47.
Hence, option (d) is correct.
62. (a) Capitalization rate =
share the of Price Market
Share Per Earning

Earning Per Share = (2,40,000 30,000) / 30,000 = Rs. 7.
Hence, capitalization rate = 7/100 = 7%.
63. (b) The expected rate of return as per the Capital Asset Pricing Model can be computed as:
k
x
= R
f
+ (k
x
m
R
f
)
where k
x
is the required rate of return on the security,
k
m
is the return on market portfolio,
R
f
is the risk free rate of return
x
=
j m
m
Cov(k k )
Var(k )
=
xm x m
m

Var(k )
=
0.45 10 3.33
10

= 0.26.
Therefore, k
x
= R
f
+ (k
x
m
R
f
) = 0.05 + 0.26 x (0.10 0.05) = 6.3%
Hence, the required rate of return as per CAPM = 6.3%.
410
64. (e) At the financial break even point,
EBIT = I +
t) (1
D
P

i.e. I +
t) (1
D
P
= Rs 2,10,000.
DFL=
T) (1
D
I EBIT
EBIT
p

=
p
EBIT
D
EBIT I +
(1 T)

=
7, 50, 000
1.39.
7, 50, 000 2,10, 000
=

Hence, option (e) is the correct choice.
65. (d) If k is the nominal interest rate then the effective interest rate (say r) can be computed
as:
r = (1+
m
k
1+
m

1
where, m is the frequency of compounding per year.
Hence, 0.0848 =
3
3
k
1

+ 1
Hence, k = 8.25%.
Option (d) is the correct choice.
66. (d) New sales = 25 (1.3) = Rs.32.5 lakh
NPM =
4
16%,
25
=
New PAT = 32.5 x 0.16 = Rs.5.2 lakh
Dividends = 30% of 5.2 = Rs.1.56 lakh
Retained earnings = Rs.3.64 lakh
Increase in borrowings = 3.64 x 1.75 = Rs.6.37 lakh.
Current assets
Current liabilities
=
31
13
i.e., Current assets =
31
13
Current liabilities
We know that working capital = Current assets Current liabilities = Rs. 9,00,000
i.e.,
31
13
Current liabilities Current liabilities = 9,00,000
Current liabilities = 9,00,000 x
13
18
= Rs. 6,50,000.
Current assets =
31
13
Current liabilities =
31
13
x 6,50,000 = Rs. 15,50,000.
It is given that liquid ratio =
18
13

i.e.,
Current liabilities
=
18
13

15,50,000 Inventories
6,50,000
=
18
13

Therefore, Inventory = Rs. 6,50,000.
Part III
411
68. (e) If the current ratio (CR) should be equal to 1.2 i.e.,
CL
CA
should be equal to 1.2,
i.e., CA should be 1.2 CL. i.e., current liabilities should be
2 . 1
CA
i.e.,
2 . 1
1200
= Rs.1000 lakhs.
As the existing current liabilities amount to Rs.1500 lakhs, Rs.500 lakhs of short-term
borrowings have to be repaid to increase the CR to 1.2.
69. (e) According to the Rule of 69,
Doubling period (in years) = 0.35 +
i
69

4 +
12
7
= 0.35 +
i
69

Solving the above equation we get i = 16.3%.
70. (c) Quick ratio =
Quick assets
Current liabilities

Inventory turnover ratio = 8
Given sales = Rs.10,00,000 and GPM = 40%, COGS = Rs.6,00,000
Inventory =
COGS
Inventory turnover ratio

=
6, 00, 000
Rs.75, 000
8
=
Total assets =
Sales
Total assets turnover ratio

=
10

, 00, 000
5, 00, 000
2
=
Given FA : CA = 3 : 1
CA =
1
5, 00, 000 Rs.1, 25, 000
4
=
CR = 2.5
CL =
CA
Rs.50, 000
2.5
=
QA =
1, 25, 000 75, 000
1
50, 000
=
Hence, answer is (c).

Model Question Paper IV
1. Which of the following companies generally provide risk capital to the technology oriented
and highly risky businesses?
a. Venture Capital Funding Companies.
b. Lease Finance Companies.
c. Hire Purchase Finance Companies.
d. Commercial Banks.
e. Insurance Companies.
2. Which of the following is not implied by the single period equity valuation model?
a. k
e
=
0
1 1
P
P D +
.
b. k
e
=
0
1 1
P
P D +
1.
c. P
0
(1 +k
e
) P
1
=D
1
.
d. P
0
(1 +k
e
) D
1
=P
1
.
3. Which of the following risks is diversifiable?
a. Changes in tax rates.
b. Increase in inflation rate.
c. Labor unrest in a company.
d. Recession.
e. Increase in energy prices.
4. If the rates of return from a security are not at all related to the market returns, then the beta
for that security will be
a. 1
b. 0
c. Between 0 and 1
d. Greater than 1
e. Less than 1.
5. Present Value Interest Factor of Annuity (PVIFA) is equal to
a. FVIFA interest rate
b. FVIFA / interest rate
c. FVIFA PVIF
d. FVIFA PVIF
e. FVIF interest rate.
Part III
413
6. Which of the following is not truewith regard to the multi period valuation model of equity
shares?
b. The value of an equity share is equal to the present value of the dividends over an
infinite duration.
dividends.
7. The quick ratio is a type of
a. Liquidity ratio
b. Profitability ratio
c. Leverage ratio
d. Turnover ratio
e. Valuation ratio.
8. Which of the following indicates the business risk of a company?
a. Return on investment.
b. Debt equity ratio.
c. Operating leverage.
d. Financial leverage.
e. Interest coverage ratio.
9. A type of analysis in which the items of the balance sheet are expressed as percentages of
total assets and the items of the income statement are expressed as percentages of the net
sales is known as
a. Time series analysis
b. Common size analysis
c. Du Pont analysis
d. Cross-sectional analysis
e. Financial ratio analysis.
10. If the debt-equity ratio increases, then the degree of operating leverage
a. Reduces
b. Increases
c. Remains unchanged
d. Becomes zero
e. Changes unpredictably.
11. Which of the following is a source of funds in a funds flow statement on total resources
basis?
a. Depreciation.
b. Dividend payment.
c. Tax payment.
d. Increase in fixed assets.
e. Decrease in debt capital.
414
12. Which of the following is an objective method of sales forecasting?
13. Which of the following is equal to the expected rate of return for a security according to the
CAPM?
a. Risk-free rate of return plus risk premium.
b. Risk-free rate of return minus risk premium.
c. Risk-free rate of return multiplied by risk premium.
d. Risk-free rate of return divided by risk premium.
14. The beta coefficient of a stock is an indicator of the
a. Systematic risk
b. Unsystematic risk
c. Total risk
d. Financial risk
e. Business risk.
15. If the risk-free rate of return is expected to increase in future and the investors become more
risk averse, then the Security Market Line (SML) will
a. Shift up and the slope will increase
b. Shift up and the slope will decrease
c. Shift down and the slope will increase
d. Shift down and the slope will decrease
e. Remain unchanged.
16. Low asset turnover indicates
a. Low investment in fixed assets
b. Low debt
c. Inefficient utilization of assets
d. Efficient utilization of assets
e. Low equity.
17. Which of the following results from an increase in the fixed operating costs of a firm?
a. The degree of operating leverage increases.
b. The degree of operating leverage decreases.
c. The operating break even point decreases.
d. The financial break even point increases.
e. The financial break even point decreases.
18. Which of the following is related to the control function of the finance manager?
a. Interaction with the bankers for arranging a short-term loan.
b. Comparing the costs and benefits of different sources of finance.
c. Analysis of variance between the targeted costs and actual costs incurred and reporting
on the same.
d. Assessing the costs and benefits of a project under consideration.
e. Deciding the optimum quantity of raw materials to be ordered for procurement.
Part III
415
19. In which of the following types of issues is the amount of share capital increased without any
increase in the net worth of the company?
a. Public issue.
b. Rights issue.
c. Bought out deal.
d. Bonus issue.
e. Private placement.
a. DFL is undefined at the financial break even point.
b. DFL will be negative when the EBIT level goes below the financial break even price.
c. DFL will reach a limit of 1 as EBIT increases.
21. Interest coverage ratio of 6 indicates
a. Sales are 6 times of interest
b. Profit after tax is 6 times of interest
c. Profit before tax is 6 times of interest
d. Earning before interest and taxes is 6 times of interest
e. Profit after tax is equal to 1/6th of interest.
22. In the context of financial statement analysis, cross-sectional analysis involves comparison
between
a. Two divisions of a company
b. Historical and current data
c. A company and its competitor
d. A company and the industry
23. The advantages of a partnership firm over a company are
a. Easy to set-up, as the cumbersome procedures of the Companies Act need not be
followed
b. Financial liability of the partners is limited, unlike the directors of a company
c. Funds can be raised more easily because the guidelines of the SEBI need not be
followed
24. When a client does not fix any time or price limit for the execution of an order, it is called
a. Best rate order
b. Limited discretionary order
c. Stop loss order
d. Open order
25. Which of the following risks affect the value of an investment instantaneously?
b. Market risk.
c. Liquidity risk.
416
26. The equity multiplier is
a.
Assets Total
Worth Net

b.
Equity Average
Assets Average

c.
Equity Average
Sales

d.
1
1 (Debt toAssets Ratio)

27. In the Du Pont chart the left apex term is
a. Earnings Per Share (EPS)
b. Return on equity
c. Net profit to total assets
d. Operating profit before interest and taxes to total assets
e. Net profit margin.
28. The Sinking Fund Factor
a. Helps in finding the interest rate implicit in financial schemes
b. Is the inverse of FVIFA
(k, n)
c. Is equal to PVIFA
(k, n)
d. Is the inverse of PVIFA
(k, n)
e. Helps in finding the terminal value of a constant cash flow.
29. When compounding of interests is done at intervals which are lesser than a year
a. The effective rate of interest will be the same as the nominal rate of interest
b. The effective rate of interest will be lesser than the nominal rate
c. The nominal rate of interest will be lesser than the effective rate
d. There is no difference between the effective and nominal rates in the first year
e. It cannot be ascertained as to which rate is more unless the frequency of compounding
is known.
30. Which of the following transactions would affect the cash balance in the Funds Flow
Statement as per cash basis?
a. Purchase of Machinery issuing Debentures.
b. Sale of old machinery and repaying the creditors to the same extent.
c. Accepting corporate deposits and investing in inventories.
d. Payment of tax provided in the previous year balance sheet.
e. Issuing commercial paper and paying off bills payable.
31. The firm is now operating at the BEP. Then
a. The DOL will increase if the quantity produced increases
b. The DOL will be negative if the quantity increases
c. The DOL will start decreasing as the quantity increases
d. The DOL will not be affected by quantity unless the fixed costs also change
e. The DOL at the BEP is 0.
Part III
417
32. The financial forecasting exercise starts with the
a. Sales budget
b. Cash budget
c. Pro forma income statement
d. Pro forma balance sheet
e. Current balance sheet.
33. What is true with respect to commercial paper?
a. It is a secured pro note issued by firms.
b. It has a well-developed secondary market.
c. It is issued at a discount and redeemed at face value.
d. Its issue is not based on the working capital limit of the company.
34. The money lent in money market for a period of 2 to 15 days is referred to as
a. Call money
b. Demand loan
c. Term loan
d. Notice money
35. The different maturities for which T-bills are now being issued are
a. 91 days, 182 days, and 364 days
b. 91 days and 364 days
c. 14 days, 28 days, 91 days, 182 days and 364 days
d. 14 days, 28 days, 91 days and 364 days
36. Which of the following statements regarding the risk of a portfolio is/are true?
a. The risk of a portfolio can be reduced by adding to it stocks whose returns have a
perfect positive correlation to the return from the portfolio.
b. The risk of a portfolio can be reduced by adding to it stocks whose returns have a
perfect negative correlation to the return from the portfolio.
c. The reduction in the risk of a portfolio is directly proportionate to the number of stocks
in the portfolio.
d. Both (a) and (c) are true.
e. Both (b) and (c) are true.
37. From the total resources point of view of preparing a funds flow statement, which of the
following are considered uses of funds?
a. Reduction in liabilities.
b. Reduction in assets.
c. Increase in net working capital.
d. Increase in equity capital.
38. Which of the following is not true with regard to the multi period valuation model of equity
shares?
b. The value of an equity share is equal to the present value of the dividends over an
infinite duration.
dividends.

418
39. If the interest coverage ratio has to be adjusted for the effect of cash flow then
a. Tax payment should be subtracted fromEBIT
b. Depreciation and other non-cash charges should be added back to EBIT
c. Whatever interest is actually paid in terms of cash should be taken as the denominator
d. Any of the above can be done
40. Which of the following are not diversifiable risks?
a. Rigid managements.
b. A dying industry.
c. Raw material bottlenecks.
d. Declining market share.
41. Quality Products Limited is planning a plant expansion program costing Rs.50 lakh. The
company will meet 20% of the outlay with retained earnings and will borrow the remaining
amount at an interest rate of 10% p.a. Repayment will be made in 8 equal annual installments
beginning 3 years from now.
The approximate value of the equated annual installment to be paid by the company is
a. Rs.9,07,707
b. Rs.9,89,087
c. Rs.10,89,764
d. Rs.11,56,678
e. Rs.12,56,789.
(3 points)
42. Mr. Chandramouli Singh is considering taking a life insurance policy of Rs.1,000 from
SAFELIFE Ltd., for 20 years. The insurance agent is advising him to take a money-back policy.
The scheme offers money-back at the end of the 5th, 10th, 15th and 20th year to the extent of
25%, 25%, 25% and 50% of the insured amount. The premium he will have to pay is Rs.62 for
every Rs.1,000 insured. The insurance agent also informs him that he will get a minimum
bonus to the extent of 40% at the end of the insurance term. The approximate rate of return on
the policy is
a. 2.31%
b. 4.01%
c. 5.74%
d. 7.89%
e. 12.00%.
(3 points)
43. An investment manager is evaluating the option of investing in a bond of Leather
Products (India) Ltd. The bond has a maturity period of 5 years and a coupon rate of
12%. The market price of this bond is Rs.480 and the current yield on it is 12.5%. The
bond will be redeemed at par on maturity.
The intrinsic value of the bond at the required rate of return of 14% is
a. Rs.500.78
b. Rs.498.70
c. Rs.465.50
d. Rs.413.00
e. Rs.398.70.
(3 points)
Part III
419
44. Rakesh is trying to make a choice between two investment alternatives. Under the first
alternative, he can invest in a bond of CIL Ltd. He found that the intrinsic value of the bond
is Rs.470 and the market price is Rs.480.
Under the second alternative he can invest in an equity share of Western Drugs &
Pharmaceuticals Ltd. The company has recently paid a dividend of Rs.3.20 per share. It has
been studied that dividends have been growing at an approximate rate of 8% p.a. over a
sufficiently long period of time. The market price of the share is Rs.48. Rakesh requires a
rate of return of 14%.
a. If Rakesh invests in the equity shares of Western Drugs & Pharmaceuticals Ltd., the
rate of return earned will be more than the required rate of return.
b. If Rakesh invests in the bonds of CIL Ltd., the rate of return earned will be more than
the required rate of return.
c. Rakesh will not be able to earn a rate of more than 14% fromeither of the alternatives.
d. The rate of return earned if Rakesh invests in an equity share of Western Drugs &
Pharmaceuticals Ltd. will be greater than the required rate of return by 6%.
(3 points)
45. The following data is given about Quik Ltd.
(Rs. in lakh)
Sundry creditors 100
Accrued expenses 60
Provisions 40
Inventories 100
Sundry debtors 100
Cash and bank 50
The acid-test ratio for the firm is
a. 1.23
b. 0.75
c. 0.68
d. 0.56
e. 0.45.
(1 point)
46. The current net sales and receivables balance for KR Ltd., are Rs.1,500 lakh and Rs.100 lakh
respectively. The level of sundry debtors remaining the same, if the net sales decrease by
10% then the approximate increase in the average time taken by the firm for collecting its
receivables will be (assume 1 year =360 days)
a. 1 day
b. 3 days
c. 7 days
d. 8 days
e. 10 days.
(2 points)
47. The Profit After Tax for a toy manufacturing company is Rs.140 lakh. The company has a
paid-up equity capital of Rs.250 lakh and reserves and surplus worth Rs.150 lakh. The tax paid by
the firmis Rs.60 lakh. The total assets base of the firmis Rs.600 lakh. If the firmis not having any
interest expense, the return on equity and the return on investment for the firmare
a. 20.10% and 33.33%
b. 25.00% and 32.00%
c. 35.00% and 33.33%
d. 33.33% and 40.00%
e. 30.09% and 40.33%.
(2 points)
420
48. Pioneer Stationeries Ltd., has the following balance sheet and income statement for the
financial year 2003-04.
Balance sheet as on March 31, 2004
Owners equity and liabilities (Rs. in lakh) Assets (Rs. in lakh)
Paid up equity share capital 250 Net fixed assets 300
Reserves and surplus 150 Investments (long-term) 50
Sundry creditors 100 Inventories 100
Accrued expenses 60 Sundry debtors 100
Provisions 40 Cash and bank 50
600 600
If the inventories grow by 50%, and long-term debt is raised to the extent of 60% of the
increase in inventories, reserves and surplus increase by 20% of the increase in inventories
and trade credit increases by 20% of the increase in inventories, the percentage increase in
the debt-equity ratio is
a. 14.00%
b. 15.07%
c. 16.25%
d. 16.54%
e. 17.08%.
(3 points)
49. The following figures have been extracted from the balance sheet as on March 31, 2004
of Dr. Martins Healthcare Ltd.
(Rs. in lakh)
Inventories
Sundry debtors
Prepaid expenses
Cash and bank
150
150
50
50
The projected funds flow statement for the financial year April 1, 2003 to March 31, 2004 is
given below:
Sources of funds (Rs. in lakh) Uses of funds (Rs. in lakh)
Profit before tax 300 Payment of taxes 130
Depreciation 50 Payment of dividends 120
Issue of debentures 50 Decrease in loans and
advances
50
Increase in sundry creditors 50 Decrease in provisions 25
Decrease in inventories 25 Increase in prepaid expenses 25
Decrease in sundry debtors 75 Increase in cash and bank 50
Repayment of term loan 100 Miscellaneous expenditures &
losses written off

50
Investment in gross fixed
assets
100
600 600
The amount of current assets in the projected balance sheet for March 2005 will be
a. Rs.425 lakh
b. Rs.375 lakh
c. Rs.325 lakh
d. Rs.275 lakh
e. Rs.250 lakh.
(2 points)
Part III
421
50. The net fixed assets and the accumulated depreciation for PR Ltd., as on 31st March, 2004
were Rs.500 lakh and Rs.150 lakh respectively. If the projected funds flow statement shows a
depreciation of Rs.50 lakh and investment in gross fixed assets as Rs.100 lakh the projected
figure for the net fixed assets of the firm is
a. Rs.750 lakh
b. Rs.650 lakh
c. Rs.550 lakh
d. Rs.500 lakh
e. Rs.475 lakh.
(2 points)
51. The sundry creditors of DM Ltd. as on 31st March, 2004 were Rs.150 lakh and the provisions
were Rs.50 lakh. If sundry creditors are expected to increase by
1
33
3
% and provisions are
expected to come down by 50%, the amount of current liabilities in the projected balance
sheet of the company is
a. Rs.225 lakh
b. Rs.230 lakh
c. Rs.250 lakh
d. Rs.375 lakh
e. Rs.390 lakh.
(2 points)
52. A portfolio manager is studying the equity shares of two companies. He has arrived at the
following probability distribution of returns on the shares of the two companies under the
market conditions expected to prevail in the near future:
Rates of return (%)
Economic conditions Probability
Oriental Foods Ltd. Capital Industries Ltd.
Optimistic 0.25 30 35
Normal 0.40 25 15
Pessimistic 0.35 20 2
a. The risk associated with Oriental Foods Ltd., as measured in terms of standard deviation is
greater than the risk associated with Capital Industries by approximately 8.769%.
b. The probability distribution of the returns on the shares of Capital Industries Ltd. is
wider as compared to that for Oriental Foods Ltd.
c. A risk-averse investor will prefer the shares of Oriental Foods Ltd.
(3 points)
53. Ashir wants to construct a portfolio by investing in the shares of the two companies AB Ltd.,
and XY Ltd., in the ratio of 3:1. The returns of the two companies have the following
probability distribution:
Economic
Conditions
Probability AB Ltd. XY Ltd.
Boom
Recession
65%
35%
20%
18%
22%
16%
The approximate value of the risk associated with the portfolio (as measured in terms of
standard deviation) is
422
a. 0.72%
b. 0.98%
c. 1.43%
d. 2.70%
e. 12.4%.
(2 points)
54. The capital structure of Magna Coolers Ltd. (MCL) consists of equity shares, debentures,
preference shares and retained earnings. The equity share capital consists of 1,00,000 equity
shares. The amount of debenture capital is Rs.50 lakh and the coupon rate on it is 10%. The
preference share capital amounts to Rs.50 lakh and the rate of dividend payable on it is 12%.
As per the forecast of operations for the current financial year, the earnings per share is
expected to be Rs.7.00. The degree of operating leverage on the basis of the forecast for the
current financial year is 1.50.
The tax rate applicable to the company is 35%.
If the EBIT increases by 1%, the percentage increase in the value of EPS will be
a. 1.45%
b. 2.00%
c. 2.32%
d. 3.02%
e. 4.50%.
(3 points)
55. The current years contribution for Startrek Ltd., is Rs.37,50,000. The next financial years
sales and variable expenses are expected to decrease by Rs.20 lakh and Rs.14 lakh
respectively. Presently the fixed costs of the firm are Rs.12,50,000 but they are expected to
decrease by 20%. It is assumed that selling price per unit and variable costs per unit will
remain constant. The company has to make a preference dividend payment of Rs.6,00,000
next year. The tax rate applicable to the firm is 35%.
The degree of Operating leverage for the next financial year will be
a. 1.465
b. 2.57
c. 1.752
d. 3.78
e. 3.67.
(2 points)
56. Pertaining to the information given in the above problem, The degree of total leverage for the
firm in the next financial year will be
a. 2.57
b. 3.67
c. 3.78
d. 4.00
e. 5.00.
(2 points)
57. If the beta of a share is 1.5 and the return on the market portfolio increases by 8%, then the
return on the share
a. Decreases by 10%
Part III
423
b. Increases by 11%
c. Increases by 12%
d. Decreases by 14%
e. Increases by 16%.
(1 point)
58. If a deep discount bond is issued at Rs.5,000, the redemption value of the bond is Rs.1,00,000
and the maturity period is 20 years, then the effective yield on the bond is
a. 15.25%
b. 16.16%
c. 17.50%
d. 18.30%
e. 20.00%.
(1 point)
59. M/s. Varun Textiles Ltd., issued fully convertible debentures of face value Rs.100 each with
a coupon rate of 10% p.a. The debentures will be converted into 2 equity shares of Rs.50
each at the end of one year. If the expected share price at the end of one year is Rs.60 and the
required rate of return is 12%, the value of convertible is
a. Rs.98
b. Rs.107
c. Rs.116
d. Rs.125
e. Rs.142.
(2 points)
60. Consider the following data of M/s. Super Colors Ltd. for the year 2003-04:
Profit after tax Rs.14.98 lakh
Interest expenses Rs.9.2 lakh
Non cash charges Rs.6.5 lakh
Repayment of term loan Rs.7.5 lakh
Effective tax rate 26%
Debt-service coverage ratio of the company is
a. 1.59
b. 1.76
c. 1.84
d. 2.24
e. 2.70.
(2 points)
61. M/s. Fincap Ltd., has 10,000 outstanding equity shares of face value Rs.20 per share. The net
income of the company is Rs.50,000. If the company pays out 40% of its earnings as
dividend and the market price of the share is Rs.50, the dividend yield is
a. 4%
b. 8%
c. 10%
d. 12%
e. 16%.
(1 point)
62. The debt-equity ratio of ABC Ltd., is 2 and its annual report indicates that the earnings per
share and book value per share are Rs.5 and Rs.20 respectively. What is its return on equity?
a. 5%.
424
b. 15%.
c. 20%.
d. 25%.
e. Data is insufficient.
(2 points)
63. Mr. Sharma wishes to purchase a 91 day T-bill of face value Rs.100, maturing after 60 days.
If, on maturity, he wishes to earn a yield of 11.5%, the purchase price for Mr. Sharma should
be
a. Rs.88.50
b. Rs.92.21
c. Rs.97.22
d. Rs.98.14
e. Rs.99.03.
(2 points)
64. Mr. Vivek purchased a coupon-bearing debenture of the face value Rs.1,500 for Rs.1,800. At
the end of the year the price of the security increased to Rs.2,000. If the rate of return earned
on this debenture is 20%, the amount of coupon received on the debenture is
a. Rs.50
b. Rs.60
c. Rs.100
d. Rs.110
e. Rs.160.
(1 point)
65. The probability distribution of the rates of return on the shares Alpha and Beta are as follows:
Probability (%) Returns (%)
Share Alpha Share Beta
10 10 3
20 15 18
40 28 32
20 12 16
10 5 8
A portfolio consisting of 40 percent of Alpha and 60 percent of Beta is formed.
The expected rate of return and the standard deviation of returns on the portfolio is respectively
a. 18.5%; 11.6%
b. 18.5%; 29.8%
c. 14.8%; 11.6%
d. 19.7%; 11.6%
e. 14.8%; 29.8%.
(2 points)
66. If the dividend payout ratio is 0.40 and capitalization rate is 12.5 percent, then the dividend
yield is
a. 4%
b. 5%
c. 6%
d. 7%
e. 8%.
(2 points)
67. The following information is given about M/s. SP Ltd.:
Inventories Rs.4.0 lakh
Part III
425
Sundry debtors Rs.3.0 lakh
Cash and Bank balances Rs.5.0 lakh
Short-term bank borrowings Rs.1.0 lakh
Spontaneous liabilities Rs.2.2 lakh
The quick ratio for the firm is
a. 5.45
b. 3.75
c. 3.64
d. 2.50
e. 1.56.
(1 point)
68. Penguin India Limited has issued 10 year bonds of face value of Rs.1,000 on May 1, 2000.
The bonds carry a coupon of 10% p.a. payable semi-annually on October 31 and April 30 of
every year. Mr. Anand wants to purchase the bond on J uly 1, 2003. If the market rate of
return is 12 percent p.a. Mr. Anand has to purchase the bond (without considering the
accrued interest) at
a. Rs.870
b. Rs.930
c. Rs.980
d. Rs.1,000
e. Rs.1,010.
(2 points)
69. A bond, which is currently selling for Rs.1,200 is yielding a rate of return of 15% p.a. The
face value of the bond is Rs.1,000 and maturity period is 5 years. If the coupons are paid
annually, the current yield on the bond is
a. 12.5%
b. 15.0%
c. 17.5%
d. 18.0%
e. 21.0%.
(2 points)
70. The average collection period for M/s. Beta Ltd., is 45 days and the average accounts
receivables of the company is Rs.37,000. The annual sales for the company, assuming 360
days in a year, is
a. Rs.3,15,000
b. Rs.2,96,000
c. Rs.2,50,000
d. Rs.2,45,000
e. Rs.2,34,567.
(1 point)


Suggested Answers
1. (a) The term venture capital fund is usually used to denote mutual funds or institutional
investors that provide equity finance or risk capital to little known, unregistered, highly risky,
young, small private businesses, especially in technology-oriented and knowledge-intensive
businesses or industries which have long development cycles and which usually do not have
access to conventional sources of capital because of the absence of suitable collateral and the
presence of high risk.
2. (a) The single period equity valuation model is : P
0
= (D
1
+ P
1
) / (1 + k
e
). All the alternatives
except (a) are implied by the single period valuation model.
3. (c) All the alternatives except (c) represent risks which arise out of economy-wide factors; so
these risks affect all the firms operating in the economy. Hence the impact of these risk
factors on the investment portfolio cannot be reduced by diversification. Alternative (c) is a
firm-specific risk factor that affects only the concerned firm and its effect on the investment
portfolio can be reduced by diversification.
4. (b) Beta = .When the returns from the security are not at all related to the
market returns, cov(r
2
m m i
)/ r , (r cov
i
, r
m
) is equal to zero. Hence in such a case the beta of the security will
be zero.
5. (c) PVIFA
=
n n
n n
(1 k) 1 (1 k) 1 1
x
k k(1 k) (1 k)
+ +
=
+ +

= FVIFA x PVIF.
6. (a) There is no pre-specified maturity period in the multi-period valuation model of equity
shares; cash flows over an infinite duration are considered.
7. (a) Quick ratio or acid-test ratio is a type of liquidity ratio that is computed as
Current assets other than inventories
Current liabilities
. The quick ratio is a more stringent measure of
liquidity and it gives the ability of the firm to pay its liabilities without relying on the sale and
recovery of its inventories.
8. (c) Operating leverage examines the effect of the change in the quantity produced on the
EBIT of the company. It is a measure of the firms business risk (i.e., the uncertainty or
variability of the firms EBIT).
9. (b) Common-size analysis of financial statements helps in finding out the proportion that a
single item represents of a total group or subgroup. Under common-size analysis, the items of
the balance sheet are expressed as percentages of total assets and the items of the income
statement are expressed as percentages of the net sales. Hence (b) is the correct answer.
Time series analysis involves a comparison of financial statements over two to three years
that can be undertaken by computing the year-to-year change in absolute amounts and in
terms of percentage changes.
Cross-sectional analysis helps to assess whether the financial ratios are within the limits as
compared with the industry averages or with a good player in normal business conditions if
an organized industry is not there.
Du Pont analysis involves analyzing return ratios in terms of profit margin and turnover
ratios.

Part III
427
10. (c) Degree of Operating Leverage (DOL)
= (Sales Variable costs) (Sales Variable costs Fixed costs)
The variable and fixed costs do not include any financial costs. Hence the DOL remains
unchanged if the debt-equity ratio increases.
11. (a) Depreciation is a non-cash expense which is provided for from the profit. Since it is a
provision created out of profit it is considered as a source of funds.
12. (c) Regression analysis is a statistical method which is free from subjectivity.
13. (a) According to the CAPM the expected rate of return on a security is equal to the risk-free
rate of return plus a premium to compensate for the risk taken on investing in the security.
14. (a) Total risk of the security is composed of diversifiable or unsystematic risk and undiversifiable or
systematic risk. Beta of a stock indicates the systematic part of the total risk of the stock.
Hence, (a) is the answer.
Variance of the returns on the stock indicates the total risk and the difference between the
total risk and systematic risk is the unsystematic risk. Financial risk arises when the
companies resort to debt financing. This is measured by degree of financial leverage.
Business risk refers to the risk of doing a particular business and it can be measured by
means of DOL.
15. (a) In the security market line (SML) the y-intercept is the risk-free rate of return (r
f
) and the
slope is the difference between the rate of return on the market index and the risk-free rate of
return (i.e. slope = r
m
r
f
). If the risk-free rate of return increases then the y-intercept
increases; so the SML shifts up. If the investors become more risk averse then (r
m
r
f
)
increases i.e. the slope of SML increases. Hence alternative (a) is the answer.
16. (c) Low asset turnover indicates that low sales are generated from the utilization of assets. Hence
it indicates inefficient utilization of the assets.
17. (a) Degree of Operating Leverage (DOL)
= (Sales Variable costs) (Sales Variable costs Fixed costs)
An increase in the fixed operating costs causes a reduction in the denominator. So the DOL
increases.
18. (c) Alternative (a) is a part of the mobilization of funds/financing function of the finance
manager. Alternative (b) involves partly the funds mobilization function and partly the
risk-return tradeoff function. Alternative (c) is the control function. Alternative (d) is a part
of the deployment of funds function. Alternative (e) is also related with the deployment of
funds function.
19. (d) Some companies distribute profits to the existing shareholders by way of fully paid
bonus shares in the ratio of existing shares held. In this method of issue, though the amount
of share capital is increased, there will not be any increase in the net worth because it is just
conversion of eligible reserves into share capital. Hence, answer is (d).
Public issue is the method of raising capital from the public. In this method there will be an
equal increase in the share capital and net worth of the company. Rights issue is the method
of raising capital from the existing members by offering shares to them on a pro rata basis.
This method also results in an increase in share capital and net worth of the company.
Similarly in case of bought out deals and private placement, there is an increase in share
capital as well as net worth of the company.
20. (e) The DFL varies with different levels of output. All the given observations can be made
from studying the behavior of DFL.
21. (d) Interest coverage ratio or the times interest earned ratio is a measure of a firms ability to
Interest coverage ratio = EBIT / Interest expense
A ratio of 6 indicates that the EBIT is 6 times its interest obligations.
428
22. (d) In cross-sectional analysis assessment is made whether financial ratios are within the
limits and are compared with the industry averages or with a good player in normal business
conditions if an organized industry is not there.
23. (a) Partnership firm is a business owned by two or more persons. They are partners in
business and they bear the risks and reap the rewards of the business. A partnership firm is
governed by the Indian Partnership Act, 1932. These firms can be easily set up, as the
cumbersome procedures of the Companies Act, 1956 need not be followed.
24. (d) When the client does not fix any time or price limit for execution of order it is called open
order. Best rate order is to execute the buy/sell order at the best possible price. In limited
discretionary order discretion is given to a broker to execute order at any price which almost is
approximate price fixed by client. In stop loss order a particular limit is given for sustenance of
loss.
25. (a) Interest rate risk is the variability in a securitys return resulting from changes in the level
of interest rates.
26. (e) Equity multiplier = Average assets/Average equity
= Average assets/[Average assets Average debt]
= 1/[1 (Average debt/Average assets)]
= 1/[1 (Debt to assets ratio)]
27. (e) Analyzing return ratios in terms of profit margin and turnover ratios, referred to the
Du Pont System. According to the Du Pont analysis ROE = Net profit margin x Assets
turnover ratio x Equity multiplier. In the Du Pont chart the left apex term is the net profit
margin.
28. (b) The Sinking fund factor is given by
k/[(1 + k)
n
1]
It represents the amount that has to be invested at the end of every year for a period of n years
at the rate of interest k, in order to accumulate Re.1 at the end of the project. It is the inverse
of FVIFA
(k, n)
.
r = (1 + k/m)
m
1
where,
Hence the nominal interest rate will always be lesser than the effective rate.
30. (d) There is a use of fund when tax in the previous years balance sheet is paid. Hence there
is a decrease in cash to that extent. Since this transaction affects the cash balance it is shown
in the funds flow statement prepared as per cash balance. All the other transactions do not
affect the cash balance.
31. (c) When the degree of operating leverage is calculated for various levels of output then it is
observed that the DOL will start declining as the level of output increases and will reach a
limit of 1.
32. (a) Financial forecasting is a planning process with which the companys management
positions the firms future activities relative to the expected economic, technical, competitive
and social environment. Sales forecast provides the basis around which the firms planning
process is centered. Hence this exercise starts with the sales budget.
Part III
429
33. (c) Commercial papers are short-term, unsecured promissory notes issued at a discount to
34. (d) The money that is lent for one day in the money market is called the call money and if it
exceeds one day but less than 15 days is referred as notice money.
35. (b) Treasury bills are short-term instruments (promissory notes or finance bills) issued by the
government to tide over short-term liquidity short falls. At present there are 2 types of
treasury bills that exist based on maturity 91 days, and 364 days.
36. (e) The risk of a portfolio can be diversified by adding to it stocks whose returns have a
negative correlation to that of the portfolio because the loss arising from one stock is
compensated by a gain in another as the stocks are negatively correlated. The more the
number of securities, the greater the diversification. Hence reduction of risk of the portfolio is
directly proportionate to the number of stocks in the portfolio.
37. (a) Reduction in liabilities will be a result of payment for obligation which is an outflow of
funds and hence a use of funds. All the other options lead to inflow of funds and hence are
sources of funds.
38. (a) According to the multi period valuation model, the value of an equity share is the discounted
value of stream of dividends of infinite duration. Hence, the model does not assume any maturity
period. Hence (a) is not true and (b) is true.
This model can be used for raising, declining, constant or randomly fluctuating dividend
stream. Hence the model can be applied to the situations given in (c) and (d). Hence (a) is the
answer.
39. (b) Interest coverage ratio or the times interest earned ratio is a measure of a firms ability to
Interest coverage ratio = EBIT / Interest expense
If we take the source of interest payments as cash flow before interest and taxation, the ratio
could be modified as EBDIT / Interest expense.
40. (e) All the given alternatives are diversifiable risks as they are specific to a company or to an
industry and can be diversified.
Part B: Problems
41. (a)
Total outlay Rs.50,00,000
Less: Initial payment Rs.10,00,000
Borrowed amount Rs.40,00,000
Let the amount of each annual installment be A.
Repayments (Rs.)
A A A A A A A A

0 1 2 3 4 5 6 7 8 9 10
Years

430
Method 1:
Present value of the annuity at year 0 = Rs.40,00,000
Present value of the annuity at the end of year 2 x PVIF
(10%, 2)
= 40,00,000
or A x PVIFA
(10%, 8)
x PVIF
(10%, 2)
= 40,00,000
or A(5.335)(0.826) = 40,00,000
or A =
0.826) x (5.335
40,00,000

= 9,07,706.66 (approx.)
= Rs.9,07,707 (approx.)
Method 2:
Present value of the annuity at the end of year 2
= Future value of Rs.40,00,000 at the end of year 2
or
A x PVIFA
(10%, 8)
= 40,00,000 FVIF
(10%, 2)
or
A
=
(10%, 2)
(10%, 8)
40, 00, 000 FVIF
PVIFA

=
5.335
(1.210) 40,00,000

= 9,07,216.5 (approx.)
= Rs.9,07,217 (approx.)
(Please note that the deviation of Rs.490 occurs because of approximation error which can be
removed by increasing the number of decimal places in the interest factors.)
42. (c) Let the insured amount be Rs.1,000.
Terminal value of cash outflows = 62 x FVIFA
(k, 20)
Terminal value of cash inflows = 250 x FVIF
(k,15)
+ 250 x FVIF
(k,10)
+ 250 x FVIF
(k,5)

+ 500 + 400.
To find k, we equate the terminal value of cash outflows to terminal value of cash inflows.
62 x FVIFA
(k,20)
= 250 x FVIF
(k,15)
+ 250 x FVIF
(k,10)
+ 250 x FVIF
(k,5)
+ 900
250 x FVIF
(k,15)
+ 250 x FVIF
(k,10)
+ 250 x FVIF
(k,5)
+ 900 62 x FVIFA
(k, 20)
.
For k = 10%
LHS = 250 (4.1777 + 2.594 + 1.611) + 900 (62 x 52.275) = (Rs.555.55).
For k = 5%
LHS = 250 (2.079 + 1.629 + 1.276) + 900 (62 x 33.066) = Rs.95.91.
Therefore,
k = 5% + (10% 5%) x
555.55 95.91
95.91
+
= 5.74%.
43. (c) Given, n = 5 years
Coupon rate = 12%
Price (P) = Rs.480
Current yield =
(P) Price
(C) payment Coupon
= 12.5%

C
P
= 0.125
or C = 0.125P = 0.125 x 480 = Rs.60
Part III
431
Par value or redemption value, F
=
rate Coupon
C
=
0.12
60
= Rs.500
Required rate of return (k) = 14%
Intrinsic value of the bond at a required return of 14%
= C x PVIFA
(k, n)
+ F x PVIF
(k, n)
= 60 PVIFA
(14%, 5)
+ 500 PVIF
(14%, 5)
= 60 (3.433) + 500 (0.519)
= Rs.465.48 Rs.465.50 (approx.)
44. (e) Given, Current dividend, (D
0
) = 3.20
Growth rate, (g) = 8% p.a.
Market price (P) = Rs.48
Required rate of return, (k
e
) = 14%
Intrinsic value =
g k
D
e
1
=
0
e
D (1 g)
k g
+
=
08 . 0 14 . 0
) 08 . 1 ( 20 . 3
= Rs.57.60
Bond of CIL Ltd.:
Intrinsic value at 14% required return = Rs. 470
Market Price = Rs. 480
Equity share of Western Drugs & Pharmaceuticals Ltd.:
Intrinsic value at 14% required return = Rs.57.60
Market price = Rs.48.00
It can be seen that if investment is made in the bond at the current market price then the
return earned will be less than the required return of 14%; and if the investment is made in
the share at the current market price, the return will be more than the required return of 14%.
Hence, alternative II, i.e. the equity shares must be selected for investment so that the
minimum return of 14% is earned.
45. (b) The acid-test ratio for the firm
=
Current liabilities

40 60 100
50 100
+ +
+
= = 0.75.
46. (b) Average collection period
day per sales Average
balance s Receivable
=

=
100
1, 500/ 360
= 24 days
New sales level = 1,500 0.10 x 1,500 = Rs.1,350
New average collection period =
360 / 1350
100
= 26.67 = 27 days
Increase in average collection period = 27 24 = 3 days.
47. (c) Return on Investment =
assets Total
* EBIT
=
3
1
600
200
= = 0.3333 i.e. 33.33%
Return on Equity =
Equity
PAT
=
150) (250
140
+
=
400
140
= 0.35 = 35%
* Since there is no interest expense, EBIT = Profit before tax
= Profit after tax + tax = 140 + 60
= Rs.200 lakh.
432
48. (e) Debt-equity ratio =
Equity
debt Total
=
) 150 250 (
40) 60 (100
+
+ +
=
400
200
= 0.50
Increase in inventories = Rs.50 lakh
Add: Inventories as on 31.03.2001 = Rs.100 lakh
New balance of inventories = Rs.150 lakh
Financing of the inventories
Long-term debt = 50 x 0.60 = Rs.30 lakh
Reserves and surplus = 50 x 0.20 = Rs.10 lakh
Trade credit = 50 x 0.20 = Rs.10 lakh
Rs.50 lakh
=
410
240
= 0.5854 Debt-equity ratio =
10 150 250
] 40 60 ) 10 100 ( 30 [
+ +
+ + + +
Percentage increase in the debt equity ratio =
5 . 0
5 . 0 5854 . 0
= 17.08%.
49. (b) Inventories = 150 25 = 125
Sundry debtors = 150 75 = 75
Prepaid expenses = 50 + 25 = 75
Cash and bank = 50 + 50 = 100
Hence, the amount of current assets in the projected balance sheet for March 2004
= 125 + 75 + 75 +100 = Rs.375 lakh.
50. (c) Gross fixed assets = Net fixed assets + Depreciation = 500 + 150 = Rs.650 lakh
New level of gross fixed assets = Gross fixed assets + Increase in gross fixed assets
= 650 + 100 = Rs.750 lakh
Accumulated Depreciation = Accumulated depreciation as on 31st March, 2004 + Depreciation
provided for 2004-2005
= 150 + 50 = Rs.200 lakh
Hence net fixed assets as on 31st March, 2005 = 750 200 = Rs.550 lakh.
51. (a) Existing level of sundry creditors = Rs.150 lakh
New level of sundry creditors = 150 + (33 1/3% x 150) = Rs.200 lakh
Current amount of provisions = Rs.50 lakh
New level of provisions = 50 50% x 50= Rs.25 lakh
New level of current liabilities = 200 + 25= Rs.225 lakh.
52. (e) Oriental Foods Ltd.
Expected returns ) r (
0
= 30 (0.25) + 25 (0.40) + 20 (0.35) = 24.5%
Risk: Standard deviation ) (
0
= [(30 24.5)
2
(0.25) + (25 24.5)
2
(0.40) + (20 24.5)
2
(0.35)]
1/2

= [(30.25)(0.25) + (0.25)(0.40) + (20.25)(0.35)]
1/2
= 3.841% (approx.)
Capital Industries Ltd.
Expected returns ) r (
e
= 35(0.25) + 15(0.40) + 2(0.35) = 15.45%
Risk: Standard deviation ) (
e
= [(35 15.45)
2
(0.25) + (15 15.45)
2
(0.40) + (2 15.45)
2
(0.35)]
1/2

= [(382.20)(0.25) + (0.20)(0.40) + (180.90) (0.35)]
1/2
= 12.607 12.61% (approx).

Part III
433
53. (c) The portfolio will consist of 3/4 (i.e. 75%) of AB Ltd. and 1/4 (i.e. 25%) of XY Ltd.
Probability Rate of return on portfolio
65% 20 (0.75) + 22 (0.25) = 20.5%
35% 18 (0.75) + 16 (0.25) = 17.5%
Expected rate of return on portfolio = 0.65 (20.5) + 0.35 (17.5) = 19.45%
Portfolio risk = [0.65 (20.5 19.45)
2
+ 0.35 (17.5 19.45)
2
]
1/2

= (2.0475)
1/2
= 1.43%.
54. (c) Current financial year
EPS = Rs.7.00
No. of equity shares = 1,00,000
Earnings available for equity shareholders = 7.00 x 1,00,000 = Rs.7,00,000
PAT = Earnings available for equity shareholders + Preference dividend
= 7,00,000 + (50,00,000 x 0.12) = Rs.13,00,000
PBT = PAT/(1 t)
= 13,00,000/(1 0.35) = Rs.20,00,000
EBIT= PAT + Interest
= Rs.20,00,000 + (Rs.50,00,000 x 0.10) = Rs.25,00,000
Computation of DFL for the current year:
DFL = EBIT/[(EBIT I Preference Dividend/(1 t)]
=
0.35) (1
6,00,000
5,00,000 25,00,000
25,00,000

= 2.32
If EBIT increases by 1%, percentage increase in EPS = DFL x 1%
= 2.32 x 1% = 2.32%.
55. (a) Computing the DOL for the next financial year:
Contribution for the next year
= Contribution for the current year Decrease in contribution in the next year
= 37,50,000 (Decrease in sales Decrease in variable cost)
= 37,50,000 (20,00,000 14,00,000) = Rs.31,50,000
EBIT for the next year
= Contribution for the next year Fixed costs for the next year
= 31,50,000 (Fixed cost for the current year Decrease in fixed cost for the next year)
= 31,50,000 (12,50,000 2,50,000) = Rs.21,50,000.
DOL for the next year
=
year next the for EBIT
year next the for on Contributi

=
000 , 50 , 21
31,50,000
= 1.465 (approximately).

434
56. (a) Computation of DFL for the next year
DFL = EBIT/[EBIT I Preference Dividend/(1 t)]
=
) 35 . 0 1 (
000 , 00 , 6
0 000 , 50 , 21
000 , 50 , 21

= 1.752 (approximately)
DTL for the next year = DOL x DFL
= 1.465 x 1.752 = 2.57 (approximately).
57. (c) The change in the return on the share = Beta x Change in the return on the market index
= 1.5 x (+8) = +12%.
The return on the share increases by 12%.
58. (b) 1,00,000 = 5,000 (1 + r)
20
or r =
20 / 1
000 , 5
000 , 00 , 1
1 = 16.16% p.a.
59. (c) Value of convertible = PV of interest + PV of MP of received shares
=
10 2x60
1.12 1.12
+ = 8.929 + 1.7.143 = Rs.116.072.
60. (c) Debt service coverage ratio
=
P

AT + Non-cash charges + Interest
I + Repayment of TL
=
14
.
.98 6.5 9.2 30.68
1.84
9.2 7.5 16.7
+ +
= =
+
61. (a) Dividend yield =
Dividend per share
Market price per Share

=
Net Income x Payout ratio 1
x
No. of shares MP

=
50,000 x 0.4 1
x 0.04 4
10,000 50
= = %
62. (d) Return on equity =
Profit after tax
Net worth

EPS =
Profit after tax
No. of shares

Book value =
NW
No. of shares

Hence, ROE =
EPS 5
25%
BV 20
= =
Hence, the answer is (d).
Part III
435
63. (d) Yield is calculated as
d
365
P
P F

Where, F is face value
P is purchase price
d is the duration/maturity period
In the given case, yield =
60
365
P
P 100

If yield = 11.5%, P is calculated as,

60
365
P
P 100
= 0.115

P
P 100
=
365
60 115 . 0

P
P 100
= 0.0189
1.0189 P = 100 P =
0189 . 1
100

P = Rs.98.14.
64. (e) Return on debenture =
year the of beginning at the Price Purchase
price in the on Appreciati payment Coupon +

i.e. 0.20 =
Coupon payment (2000 1800)
1800
+

Hence coupon payment = 1800 x 0.2 200 = Rs.160.
Hence, (e) is the answer.
65. (a)
Returns (%) Prob % RiPi (%) Ri Ri (Ri Ri)
2
Pi
40% of Alpha + 60% of Beta
4 + 1.8 5.8 0.10 0.58 24.3 59.049
6 + 10.8 16.8 0.20 3.36 1.7 0.578
11.2 + 19.2 30.4 0.40 12.16 11.9 56.644
4.8 + 9.6 14.4 0.20 2.88 4.1 3.362
2 + 4.8 6.8 0.10 0.68 11.7 13.689
Expected Return Ri 18.50 133.322
TRi = 133.322 = 11.55%.
66. (b) Given dividend payout ratio is 0.4 i.e.,
EPS
DPS
= 0.4
And the capitalization rate is 12.5 i.e.,
EPS
Price per share
= 0.125.
e Price/shar
EPS
EPS
DPS
=
e Price/shar
DPS
= Dividend yield
= 0.4 0.125 = 0.05 i.e., 5%.
436
67. (d) Quick ratio =
Current liabilities
=
3 5
2.5.
3.2
+
=
Hence, option (d) is the correct choice.
68. (b) Discounted interest payments and Face value as on October 31, 2003
6%,13 6%,13
= 1000 x 0.05PVIFA +1000 0.05 +1000 PVIF
= 442.65 + 50 + 469 = Rs.961.65
The discounted value as on July 31, 2003 = 961.65 PVIF
3%,1

= 934 = Rs.930 (approx).
69. (c)
15%,5 15%,5
C PVIFA 1000 PVIF 1200 + =
C = Rs.210
CY =
210
17.5%
1200
= .
sales daily Average
receivable accounts Average

Hence, Average daily sales = Average accounts receivable/ Average collection period
= 37,000/45.
Hence, Annual sales = 360 x 37,000/45 = Rs.2,96,000.

Model Question Paper V
1. If the Yield To Maturity (YTM) of bond X is greater than the yield to maturity of bond Y,
with the same coupon rate and maturity, then which of the following is/are true?
i. The price of bond X will change more than the price of bond Y for a given change in YTM.
ii. The market price of bond Y is more than that of X.
iii. The current yield of both the bonds would be the same.
a. Only (i) above.
2. If the slope of the Security Market Line is zero then, which of the following is true?
a. Beta is equal to zero.
b. Risk-free return =Market return =Expected return of the given security.
c. The returns on the given security are not correlated with the returns on the market.
d. Risk-free rate of return Market return.
e. Market return Expected return of the given security.
3. Which of the following is not a feature of a Commercial Paper (CP)?
a. It is an unsecured instrument.
b. It is issued in multiples of Rs.5 lakh.
c. Buy-back facilities are not available for CPs.
d. It is negotiable by endorsement and delivery.
4. Which of the following indicates the Debt Service Coverage Ratio (DSCR) of 1.5 of a firm?
a. The total obligations (i.e. interest plus repayment on the long-term loan) of the firm are
1.5 times its PBDIT.
b. The total obligations are 1.5 times its PAT.
c. The post-tax cash earnings are 1.5 times its total obligations.
d. The post-tax earnings plus depreciation and other non-cash expenses plus interest on
term loan is 1.5 times the interest on term loan and the amount of loan repayment.
e. The total obligations are 1.5 times the equity earnings.
5. Which of the following is/are the objective method(s) of sales forecasting?
c. Market survey.
d. Regression analysis.
6. Which of the following is a source of cash in a funds flow statement drawn on cash basis?
a. Increase in inventory.
b. Decrease in accrued taxes.
c. Increase in receivables.
d. Repayment of short-term bank loan.
e. Increase in accounts payable.
438
7. Which of the following is not a diversifiable risk?
a. Lock-out in a company due to workers demanding a wage hike.
b. Recession in the economy.
c. Lack of strategy for the management of a company.
d. A change in the product portfolio of a company.
e. Entry of new competitors into the market.
i. Current yield is equal to the coupon rate if the market price is equal to the face value of
the bond.
ii. Current yield is equal to the coupon rate if the bond is trading at its face value.
iii. Current yield is equal to the interest paid divided by the face value of the bond.
a. Only (i) above.
9. Which of the following is not a part of the money market?
a. Call money market.
b. Treasury bills market.
c. Commercial paper market.
d. Stock market.
10. The risk arising out of the use of debt financing is called
a. Price risk
b. Market risk
c. Trading risk
d. Liquidity risk
e. Financial risk.
11. Which of the following is considered while preparing funds flow statement on working
capital basis?
a. Increase in prepaid expenses.
b. Payment of dividend.
c. Decrease in sundry creditors.
d. Decrease in provision for tax.
e. Purchase of raw materials.
12. The present value interest factor of annuity is equal to
a.
n
n
) k 1 ( k
1 ) k 1 (
+
+

b.
n) (k, FVIF
n) (k, FVIFA

c.
n
k) (1
n) (k, FVIFA
+

d. Reciprocal of sinking fund factor for k% and n years PVIF (k, n)
Part III
439
13. Which of the following statements is/are true regarding the Degree of Financial Leverage
(DFL)?
i. It measures the financial risk of the firm.
ii. It is undefined at financial break even point.
iii. It decreases as the EBIT increases above the financial break even point.
a. Only (i) above.
b. Only (ii) above.
d. All of (i), (ii) and (iii) above.
14. Growth with internal equity will decrease with the
a. Increase in debt-equity ratio
b. Increase in dividend pay-out ratio
c. Increase in net profit margin
d. Decrease in assets to sales ratio
15. Du Pont Analysis
a. Examines the interrelationships between items of financial statements of two different
companies
b. Examines the interrelationships of items in financial statements of the same company
c. Studies the trends over the years by dividing the ratio into its components
d. Examines the effect of various factors in an industry on the firm
16. If inflation rises, the prices of the securities
a. Move upwards
b. Move downwards
c. Remain unaffected
17. The phenomenon of imbalance in distribution of funds does not exist in
a. Socialistic economies.
b. Capitalistic economies.
c. Mixed economies.
d. Developed economies with high savings.
18. Which of the following is not an assumption of CAPM?
a. Investors are risk-averse.
b. No tax effects.
c. No transaction costs.
d. Securities can be sold in marketable lots only.
19. Which of the following is false?
a. The simple interest and compound interest on an amount of money are same for a
period of 1 year at the same rate.
b. The future values of different cash flows, occurring at different periods of time, at the
end of a particular time can be added together for comparison.
c. The value of a cash flow occurring at the end of the year is the same as at the beginning
of the year.
d. Financial analysis always assumes compounding.
e. Discounting is the reverse process of compounding.
440
is
20. When we talk about diversification, what risks are we trying to reduce?
a. Business Risk.
b. Financial Risk.
c. Liquidity Risk.
21. What is true with respect to liquidity risk?
a. It is associated with secondary market.
b. Securities with ready markets have high liquidity risks.
c. The greater the price concession, the lower the liquidity.
d. It is associated with money markets alone where liquid cash is in abundance.
e. It is directly related to market risk.
22. The success and accuracy of Ratio Analysis depends on
a. Accounting practices
b. Availability of benchmarks
c. Interpretational skills
d. All of the above
23. Which of the following factors will lead to volatility of call rates?
a. Overextension of loans by banks in excess of their own resources.
b. Lack of liquidity in the money market.
c. Withdrawal of funds by institutional lenders to meet business requirements.
24. Which of the following statements regarding Certificates of Deposit is/are true?
a. They are issued only by banks and All India Financial Institutions.
b. They are transferable, but only after thirty days after issue.
c. The maturity period ranges from three months to one year if issued by a bank and one
year to three years if issued by All India Financial Institutions.
d. Both (a) and (b) are true.
e. All of (a), (b) and (c) are true.
25. Companies that offer saving schemes that carry an assurance to provide credit when required
by the saver are called
a. Investment trusts
b. Loan and finance companies
c. Nidhis or mutual benefit companies
d. Venture capital funds
26. In the characteristic line equation
j j j m j j
k k e, = + +
a. The risk-free rate of return in the market
b. The return from the security when the return on the market portfolio is zero
c. The intercept of the characteristic line
d. The unexpected return resulting from influences not explicitly considered in the
regression equation
Part III
441
27. Which of the following is/are considered sources of funds while preparing funds flow
statement on cash basis?
a. Payment of dividends.
b. Decrease in fixed assets.
c. Issue of equity capital.
a. The inverse of FVIFA factor is equal to PVIFA factor.
b. The inverse of FVIF factor is equal to PVIF factor.
c. The inverse of FVIFA factor is called the capital recovery factor.
a. If security returns move in opposite directions they are positively correlated.
b. It is not always possible to find perfectly negatively correlated securities.
c. Diversification is resorted only to achieve higher returns.
d. It is only the perfectly negatively correlated securities that reduce the risk of a portfolio.
e. Investing all your funds in a single security may reduce the risk sometimes.
30. The P/E ratio applicable to a share under consideration is influenced by
a. Stability of earnings
b. Size of the company
c. Quality of management
d. Dividend pay-out ratio
31. Which ratio measures efficiency in companys activity directly?
a. Current Ratio.
b. Quick Ratio.
c. Debtors Turnover Ratio.
d. Dividend Pay-out Ratio.
e. Net Profit Margin Ratio.
32. The debt-equity ratio is affected by
a. Nature of industry
b. Patterns of cash flow
c. Operating cycle
33. Comparative Analysis
a. Can locate trends in the ratios
b. Can reflect secular changes
c. Is influenced by transitory forces
34. At financial break even point
442
a. EBIT =0
b. EPS =0
c. The firm is operating at break even quantity
d. The contribution =Fixed costs
35. In the percentage of sales method of projecting income statement
a. The distribution of earnings is also projected based on sales
b. The sales and all other elements of costs have to be estimated
c. The elements of cost bear a % to sales figure and the % keeps changing
d. The sales will be estimated and the costs will be increased by the same % as that of
increase in sales
e. The elements of cost are projected as a % of cost of goods sold.
36. Which of the following statements is/are true regarding Money Market Mutual funds?
a. Open-ended schemes cannot be offered by MMMFs as open-ended funds become very
difficult to manage if the money market becomes volatile
b. MMMFs are subject to the regulations of the RBI
c. Amounts collected by banks under MMMF schemes are always subject to reserve
requirements
d. Only (a) and (b) above are true
e. All of (a), (b) and (c) are true.
37. A positive DOL indicates that
a. Increase in the quantity produced will increase the EBIT
b. The quantity produced at the given level of DOL is more than the operating break even
point
c. The quantity produced at the given level of DOL is less than the operating break even
point
b. Repayment of debt.
c. Decrease in outstanding expenses.
d. Increase in accumulated depreciation.
e. Decrease in bank borrowing.
39. DSCR is defined as
a.
P

AT+Depreciation+Othernon charges+Int.ontermloan
Interestontermloan+Repaymentof termloan
b.
PAT+Depreciation+Othernon charges+Int.ontermloan
Repaymentof termloan

c.
PAT+Depreciation+Int.ontermloan
Interestontermloan+Repaymentof termloan

d.
PAT+Depreciation
Repaymentof termloan

40. Which of the following is not true with respect to valuation of bonds?
Part III
443
a. An increase in the redemption value of the bond, other things remaining the same, will
increase the bond value.
b. For a given difference between YTM and coupon rate, the longer the term to maturity of
the bonds, the greater will be the change in price with a change in YTM.
c. For a given maturity, the change in the bonds price will be lesser with a decrease in the
bonds YTM than the change in bond price with an equal increase in the bonds YTM.
d. For a given change in YTM, the percentage price change in case of bonds with high
coupon rate will be smaller than in case of bonds with low coupon rate, other things
remaining the same.
e. An increase in the required rate of return, other things remaining the same, will decrease
the bond value.
41. Reliable Textiles Ltd., currently paid a dividend of Rs.5.60 per share. The dividends have
been constantly growing at the rate of 3.20% per annum. The dividend declared by the
company six years ago was
a. Rs.1.6000
b. Rs.2.9897
c. Rs.3.1999
d. Rs.3.5687
e. Rs.4.6356.
(1 point)
42. Western Alloys Ltd., has recently paid a dividend of Rs.2.70 per share. The dividend paid by
the company six years before was Rs.1.80 per share. Dividends paid by the company have
been growing consistently over the last six years. The required rate of return of the equity
shareholders of the company is 24%.
The intrinsic value of the shares of Western Alloys Ltd., is
a. Rs.45
b. Rs.37
c. Rs.26
d. Rs.17
e. Rs.15.
(2 points)
43. The return on the security of Y2 Ltd., has the following probability distribution:
Returns (in %) Probability
20
21
22
23
24
0.15
0.20
0.50
0.10
0.05
If Harish invests in the shares of Y2 Ltd., the total risk involved in the investment will be
a. 0.067 (%)
2
b. 1.020 (%)
2
c. 2.108 (%)
2
d. 3.160 (%)
2
e. 4.148 (%)
2
.
(2 points)
444
44. The variance of the returns on the security of Alpha Ltd. is 7.92(%)
2
and the beta of the
security is 1.3. The market returns have the following probability distribution:
Returns (in %) Probability
11
20
19
0.30
0.40
0.30
The correlation coefficient between the returns of Alpha Ltd., and the market returns is
a. 0.58
b. 0.98
c. 0.58
d. 1.824
e. 0.13.

(3 points)
45. Mr. Satish Sharma is planning to invest in the shares of Southwestern Airways Ltd. (SAL).
He has the following expectations of returns from the shares of SAL and the market index:
Probability Return from SAL (%) Return from market (%)
0.10
0.20
0.25
0.30
0.05
0.10
15
20
18
12
25
22
18
30
25
22
35
32
The variance of the market returns is 22.15(%)
2
. If the market return increases by 13%, the
effect on the returns of SAL Ltd., will be
a. The returns on shares of SAL Ltd. will decrease by 9.62%
b. The returns on the shares of SAL Ltd. will decrease by 13%
c. The returns on the shares of SAL Ltd. will increase by 6%
d. The returns on the shares of SAL Ltd. will increase by 9.62%
e. The returns on the shares of SAL Ltd. will increase by 13%.
(3 points)
46. VR Ltd., has sales of worth Rs.800 lakh and the variable costs amount to 62.5% of sales. The
company has fixed costs of Rs.100 lakh. If the sales of the company increase by 5% from the
existing level, the percentage change in the EBIT of the firm will be
a. 7.5%
b. 7.9%
c. 8.7%
d. 9.7%
e. 10.9%.
(1 point)
47. The EBIT of Nebula Ltd., is Rs.200 lakh. The interest obligation of the firm is Rs.50 lakh.
The company has sales of Rs.800 lakh and the contribution to sales ratio is 37.5%. If the sales
increase by 7% from the existing level then the percentage change in EPS will be
a. 8%
b. 9%
c. 10%
d. 12%
e. 14%.
(1 point)
Part III
445
48. The current EBIT of PK Ltd., is Rs.200 lakh and the interest expense is Rs.50 lakh. The
company expects that there will be an increase in interest expense by Rs.30 lakh due to an
expected increase in its borrowings. The selling price per unit is expected to remain constant.
If the company wants to maintain its Profit Before Tax at its present level by what percentage
must it increase its sales from the existing level?
a. 15%.
b. 10%.
c. 8%.
d. 7%.
e. 5%.
(2 points)
49. The current ratio of a company is 2.4 and the acid-test ratio is 1.6. If the difference between
current assets and liabilities is Rs.56 lakhs, what proportion of current assets is made up of
inventories?
a. 1/2.
b. 1/3.
c. 1/4.
d. 3/4.
e. 2/5.
(2 points)
50. The cost of goods sold for Sunrise Ltd., is Rs.256 lakh. The gross profit margin for the firm is
20%. If the average collection period for the firm is 45 days, the amount of accounts
receivables for the firm is (Assume 1 year =360 days)
a. Rs.40 lakh
b. Rs.35 lakh
c. Rs.32 lakh
d. Rs.30 lakh
e. Rs.29 lakh.
(2 points)
51. The total debt-equity ratio for BA Ltd., is 2:5. The total assets of the firm are Rs.140 lakh and
the total debt capital of the firm is Rs.40 lakh. The reserves and surplus of the firm amount to
two-thirds of equity share capital and fixed assets amount to 44% of the net worth. The
amount of reserves and surplus and fixed assets of the firm are
a. Rs.140 lakh and Rs.60 lakh
b. Rs.100 lakh and Rs.40 lakh
c. Rs.44 lakh and Rs.40 lakh
d. Rs.42 lakh and Rs.43 lakh
e. Rs.40 lakh and Rs.44 lakh.
(2 points)

446
52. The following changes were noted in the financial statements of Orient Spares Ltd., during
the financial year ended March 31, 2004:
(Rs. in lakh)
Increase in equity share capital 120
Increase in reserves and surplus 95
Increase in cash and bank 40
Decrease in inventories 40
Increase in intangible assets 50
Increase in debtors 60
Increase in net fixed assets 140
Decrease in marketable securities 25
Increase in working capital advance 60
Increase in long-term investments 50
Decrease in sundry creditors 80
Increase in prepaid expenses 40
What proportion of total resources has been used to increase the assets of the firm?
a. 67.17%.
b. 68.23%.
c. 70.45%.
d. 79.17%.
e. 89.45%.
(2 points)
53. The following information is available about J ubilee Ltd.
(Rs. in lakh)
Increase in owners equity
Increase in term loan
Increase in debentures
Increase in working capital advance
Increase in assets
Decrease in inventories
Decrease in marketable securities
215
60
80
60
380
40
25
The percentage of total sources that is generated by an increase in liabilities is
a. 16.67%
b. 29.16%
c. 35.67%
d. 41.67%
e. 45.00%.
(2 points)
54. Mr. Anil Sharma is planning to purchase a house which costs Rs.8,00,000. He has contacted
City Housing Finance Ltd. (CHFL). CHFL has offered for 100% financing for a period of 7
years. Mr. Sharma has to repay the loan along with interest in equated monthly installments of
Rs.18,500 each, payable at the end of every month over a period of 7 years.
The approximate effective rate of interest (per annum) involved if Mr. Anil Sharma makes
use of the scheme offered by CHFL for purchasing a house is
a. 29.85%
b. 23.77%
c. 30.65%
d. 38.76%
e. 40.75%.
(3 points)
Part III
447
55. Mr. Kartik wants to buy a farmhouse which would cost him Rs.8,00,000. SFCL has offered
to provide 90% finance for a period of 8 years. Mr. Kartik has to bring in 10% of the cost of
the house at the time of purchase. He will borrow the amount of his contribution from one of
his relatives and will pay back his relative Rs.40,000 and Rs.50,000 (which include the
amount borrowed and the interest) at the end of the first year and the second year
respectively. The amount borrowed from SFCL has to be repaid alongwith interest in equated
monthly installments of Rs.12,800 each, payable at the end of every month over a period of 8
years. If Mr. Kartik borrows 90% of the purchase price from SFCL Ltd., and the rest from his
relative, the effective rate of interest per annum involved is
a. 15.36%
b. 16.75%
c. 17.89%
d. 18.00%
e. 18.75%.
(3 points)
56. Orient Ltd., has financed its assets by taking debt as high as 60% of the value of assets. If the
equity capital of the company is Rs.60 lakh, then the debt is
a. Rs.60 lakh
b. Rs.90 lakh
c. Rs.120 lakh
d. Rs.125 lakh
e. Rs.150 lakh.
(2 points)
57. Mr. Ashish borrowed an amount of Rs.4,80,000 from M/s. Paywell Finance Ltd., As per the
loan agreement, he has to repay Rs.3 lakh at the end of 7th year, Rs.4 lakh at the end of 8th
year, Rs.2 lakh at the end of 9th year and Rs.1 lakh at the end of 10th year from now. In order
to meet these payments, he wants to deposit money in a bank scheme that offers an interest
rate of 9% p.a. The approximate amount that Mr. Ashish should invest at the end of every
year for a period of 6 years, so that he can repay the loan as per the agreement is
a. Rs.1,02,090
b. Rs.1,11,270
c. Rs.1,21,293
d. Rs.1,28,905
e. Rs.1,89,389.
(3 points)
58. The probability distribution of returns of stock of M/s. ACRO Ltd., and the returns on market
are given below:
Probability (P) Returns of stock of
M/s. ACRO Ltd. (in %)
Market returns
(in %)
0.30
0.35
0.15
0.20
7
8
14
16
9
5
10
14

448
The variance associated with the market returns is 10.6875(%)
2
. The risk-free rate of return is
6%. According to CAPM, the risk premium for the stock of M/s. ACRO Ltd., is
a. 1.77%
b. 2.43%
c. 2.56%
d. 2.72%
e. 3.39%.
(3 points)
59. The face value of a T-Bill is Rs.100. The bid made by Mr. A for Rs.96 was accepted by RBI.
If the yield earned on the bill is 16.71% p.a., the maturity period of the bill is (Assume 365
days a year)
a. 14 days
b. 28 days
c. 91 days
d. 182 days
e. 364 days.
(1 point)
60. Consider the following information of M/s.SS Ltd for the year 2003-04:
Current liabilities to sales ratio 0.20
Net profit margin 0.06
Dividend payout ratio 0.40
The maximum sales growth that can be achieved without resorting to external financing is
a. 5.63%
b. 8.70%
c. 9.89%
d. 13.64%
e. 16.80%.
(2 points)
61. During the year 2003-04, M/s. X Ltd., realized receivables worth Rs.10,000 and there is an
increase of Rs.30,000 in the inventories. The additional inventory was bought on credit. The
impact of the above on the net working capital will be
a. Increase by Rs.10,000
c. No change in the net working capital
d. Increase by Rs.40,000
e. Decrease by Rs.10,000.
(1 point)

Part III
449
62. Consider the following information regarding M/s. Z Ltd., for the year 2003-04:
Earnings after tax Rs.9,00,000
Interest payment Rs.8,00,000
Assets turnover 1.50
Net profit margin 5%
Corporate tax rate 40%
Earning power of the company is
a. 7.5%
b. 8.5%
c. 14.2%
d. 19.2%
e. 25.4%.
(3 points)
63. Ms.Smitha is considering investing in the equity shares of Good Smile Tooth Paste Limited.
She gathers the following information on the equity shares of the company:
Return on the stock when the market return is zero =4%
Rate of return on the market 12%
Beta of the shares 0.9
Expected Earnings per share next year Rs.3
Pay-out ratio 60%
Current market price of the share Rs.40
Ms.Smitha expects the earnings of the company to grow at a constant rate and the pay-out
ratio to remain constant.
If the equity share is in market equilibrium according to the Single-index model, the expected
price of the share at the end of five years will be
a. Rs.72
b. Rs.65
c. Rs.58
d. Rs.45
e. Rs.35.
(2 points)
64. The total capital employed by M/s. Venus Ltd., is Rs.36,00,000. The firm has debt-equity
ratio of 5:4. The ratio of owners equity to fixed assets is 8:15. The amount of fixed assets in
the company is
a. Rs.30,00,000
b. Rs.36,00,000
c. Rs.40,00,000
d. Rs.42,00,000
e. Rs.50,00,000.
(2 points)
450
65. The balance sheet for M/s. CySpace Ltd., which is a semi-conductor manufacturing firm is
given below:
Balance Sheet as on Mar 31st 2004
(Rs. in lakh)
Liabilities Assets
Share Capital
Retained Earnings
Long-term Loan
Short-term Borrowings
Accounts Payable
Provisions
220
90
210
105
160
15
Fixed Assets
Inventories
Accounts Receivable
Cash and Bank
450
120
160
70

800 800
The sales for the year 2003-2004 were Rs. 12 crore and they are expected to go up by 26% in
the year 2004-2005. Last years net profit margin of 5% and the dividend payout ratio of 40%
are expected to remain same in the year 2004-2005. The external funds requirement of the
company for the year 2004-2005 is Rs.117.14 lakh. The company wants to raise external
funds through short-term borrowings and equity (in the same order). If the current ratio
should not be less than 1.2, the minimum amount of equity to be raised by the company is
a. Rs.94.50 lakh
b. Rs.89.90 lakh
c. Rs.75.14 lakh
d. Rs.45.01 lakh
e. Rs.22.64 lakh.
(2 points)
66. Consider the following data regarding M/s. Zee Ltd. for the year 2004:
Cost of goods sold : Rs.39,00,000
Gross profit margin : 25%
Average receivables turnover
ratio : 52 : 15
Quick assets : Rs.18,00,000
The cash balance is
a. Rs.2,75,000
b. Rs.3,00,000
c. Rs.6,00,000
d. Rs.9,00,000
e. Rs.9,56,250.
(2 points)
67. Consider the following data regarding
M/s. M&C Ltd.
Assets turnover ratio 1.111
Return on total assets 16%
Equity multiplier 3.75
Dividend 37.5%
Equity capital Rs.12 lakh
Face value per share Rs.6
The internal growth rate that the company can achieve without resorting to external equity is
a. 15%
b. 18%
c. 25%
d. 29%
e. 33%.
(3 points)
Part III
451
Risk-free rate of return 6% p.a.
Market risk premium 8% p.a.
Beta of stock X 1.15
If the risk free rate of return increases to 8% p.a. and the slope of the SML remains constant, the
existing and the new required rate of return will be
a. 8.3%; 10.3%
b. 8.3%; 8.0%
c. 15.2%; 19.5%
d. 15.2%; 17.2%
e. 10.2%; 12.2%.
(1 point)
69. Consider the following information regarding the bond issued by XL Pharma Ltd:
Face value of the bond Rs.1,000
Coupon per annum 10%
Issued at a discount of 10%
If the current yield of the bond is 8.33%, the bond is trading at a
a. Discount of 12%
b. Discount of 16.67%
c. Premium of 20%
d. Premium of 16.67%
e. Premium of 30%.
(1 point)
70. The data on the current assets and current liabilities of Fitmark Ltd. for the financial year
2003-04 are given below:
(Rs. in lakh)
Debtors Cash balance Inventory Spontaneous liabilities
Beginning 80 50 10 40
Closing 100 60 25 35
Apart from the above, the company for the first time borrowed short-term bank borrowings
of Rs.10 lakh and long-term secured loan of Rs.30 lakh. The change in net working capital is
a. Rs.10 lakh
b. Rs.15 lakh
c. Rs.20 lakh
d. Rs.40 lakh
e. Rs.50 lakh.
(1 point)

Suggested Answers
1. (b) If the YTM of bond X is greater than the YTM of bond Y, other things remaining the same,
then the market price of bond X is less than the market price of bond Y. So (ii) is true. (i) is true
according to the bond value theorem, A change in YTM affects the bonds with a higher YTM
more than it does bonds with a lower YTM.
Hence alternative (b) is correct.
2. (b) According to the SML equation:
k
j
= R
f
+
j
(k
m
R
f
)
The slope is (k
m
R
f
). When the slope is zero,
k
j
= R
f
+ 0 = R
f
Further, k
m
R
f
= 0 implies that k
m
= R
f
R
f
= k
m
= k
j
i.e. Risk-free rate of return = Market return = Expected return of the given security.
3. (c) Commercial papers are short-term, unsecured promissory notes issued by corporates which are
financially strong and have high credit rating. The minimum amount to be invested by a single
investor is Rs.5 lakh. These instruments are issued in multiples of Rs.5 lakh. The maturity period
varies from 15 days to a year. It is negotiable by endorsement and delivery. Unlike certificates of
deposit, CPs can be bought back by the issuers. Hence, (c) is not a feature about commercial
paper.
4. (d) Debt service coverage ratio is defined as
PAT + Depreciation + Other non - cash charges + Interest on term loan
Interest on term loan Re payment of term loan +

Thus, DSCR of 1.5 indicates that post-tax cash earnings + interest on term loan is 1.5 times
the interest on term loan and repayment of term loan. Hence the answer is (d).
5. (d) Regression analysis is a statistical method while the others involve individual judgments.
Hence, (d) represents an objective method.
6. (e) All the alternatives except (e) represent uses of cash.
7. (b) Alternatives (a), (c), (d) and (e) represent risk factors which are specific to the firm and
can be diversified away.
8. (b) Current yield =
price Market
amount Coupon

Coupon rate =
value Face
amount Coupon

Current yield = Coupon rate implies that market price = face value.
Further this means that the bond is trading at its face value.
Hence both (i) and (ii) are true.
9. (d) Stock market is a part of the capital market. Alternatives (a), (b) and (c) are parts of the
money market.

Part III
453
10. (e) Price or inflation risk refers to the rise in prices due to which there will be reduction in the
purchasing power of money.
Market risk refers to the variability of returns due to fluctuations in the securities market.
Trading or business risk is the risk of doing business in a particular industry or environment.
Liquidity risk is the risk associated with the secondary market in which the security is traded.
Financial risk is the risk that arises when companies resort to financial leverage or the use of
debt financing.
Hence (e) is the correct answer.
11. (b) All other alternatives except for payment of dividend will cause either an equal increase in
current assets and current liabilities or an increase in one current asset and decrease in another
current asset by the same amount or an equal decrease in current liabilities and current assets or a
decrease in one current liability and increase in another current liability by the same amount.
These will not cause any change in the working capital position. Hence, these are not considered
while preparing funds flow statement on working capital basis.
12. (e) Present value interest factor of annuity
=
n
n
) k 1 ( k
1 ) k 1 (
+
+
=
+
k
1 ) k 1 (
n

n
) k 1 (
1
+

=
n
) k 1 (
) n , k ( FVIFA
+
=
) n , k ( FVIF
) n , k ( FVIFA

= Reciprocal of sinking fund factor for k% and n years
) n , k ( FVIF
1

= Reciprocal of sinking fund factor for k% and n years PVIF(k,n)

1
Sinking fund factor .
FVIFA(k, n)

=

13. (d) DFL measures the financial risk of the firm. At the financial break even point, EBIT = 0 and
hence DFL is undefined. Beyond the financial break even point, DFL increases with increase in
EBIT.
14. (b) Growth with internal equity (g) =
E / A ) d 1 ( m S / A
E / A ) d 1 ( m
0

It can be observed from the formula that
As debt-equity ratio increases the assets to equity ratio (A/E) increases and g increases.
As dividend payout ratio (d) increases, g decreases.
As profit margin (m) increases g increases.
As assets to sales ratio (A/S) decreases g increases.
15. (b) Analyzing return ratios in terms of profit margin and turnover ratios, referred to as the Du
Pont System. According to the Du Pont analysis ROE = Net profit margin x Assets turnover
ratio x Equity multiplier. In the Du Pont chart the left apex term is the net profit margin. The
Du Pont analysis examines the interrelationships of items in financial statements of the same
company.
16. (b) If inflation rises (falls), the prices of the securities move downwards (upwards).
17. (e) The phenomenon of imbalance in distribution of fund does exist in all types of
economies.
454
k = + k +e
18. (d) CAPM assumes that transaction costs in financial markets are low enough to ignore and
assets can be bought and sold in any unit desired. The investor is limited only by his wealth
and price of the asset.
19. (c) The value of a cash flow occurring at the end of the year will be more than the value of
cash flow at the beginning of the year because interest is accumulated on the amount at the
beginning for that particular year.
20. (e) Business risk refers to the risk of doing business in a particular industry or environment and
it gets transferred to the investors who invest in the business or company. Financial risk
arises when companies resort to financial leverage or use of debt financing. Liquidity risk is
associated with the secondary market in which a particular security is traded in. All the above
risks can be diversified.
21. (a) Liquidity risk is associated with the secondary market in which a particular security is
traded in. The greater the uncertainty about the time element and the price concession, the
greater the liquidity risk.
22. (d) Ratios are well known and most widely used tools of financial analysis. The usefulness of
ratios is ultimately dependent on the accounting practices, availability of benchmarks and
their intelligent and skillful interpretation.
23. (e) All the given factors lead to volatility of call rates.
24. (a) Certificates of Deposit are short-term deposits by way of usance promissory notes having
a short-term maturity of not less than 15 days and not more than one year. They are issued by
Banks and All India Financial Institutions.
25. (b) Loan and finance companies are those which offer savings schemes that carry an
assurance to provide credit when required by the saver.
26. (c) The characteristic regression line is a graphic representation of the market model.

j

j j j m
Where, k
j
= the expected rate of return on security = beta coefficient of security j
j
k
m
= intercept of the characteristic line.
j
27. (d) Decrease in fixed assets and issue of equity capital lead to inflow of funds. Hence both
are sources of funds.
28. (b) The generalized procedure for calculating the future value of a single cash flow
compounded annually is given as FV
n
= PV (1 + k)
n
.
In general, the present value PV of a sum FV
n
receivable after n years at a rate of interest k is
given as PV = FV
n
/ (1 + k)
n
Hence the inverse of FVIF is equal to the PVIF.
29. (b) All the securities are effected by the changes in the economy. Hence it is difficult to find
perfectly negatively correlated securities.
30. (e) The P/E ratio is given as market price of the share/earnings per share. This ratio gives the
relationship between the market price of the stock and its earnings by revealing how earnings
affect the market price of the firm's stock. All the given factors influence the P/E ratio.
31. (e) Net profit margin ratio is given as Net profit/Net sales. This ratio shows the earnings left
to the shareholders (both equity and preference) as a percentage of net sales. It measures the
overall efficiency of production, administration, selling, financing, pricing, and tax
management.

Part III
455
32. (e) The debt-equity ratio which indicates the relative contributions of creditors and owners is
given as Debt/Equity. Depending on the type of business and the patterns of cash flows the
components in debt to equity ratio will vary.
33. (d) The comparison of financial statements is accomplished by taking the individual items of
different financial statements and reviewing the changes that have occurred from year to year
and over the years. The important factors revealed by comparative financial statements are
trend and the secular changes.
34. (b) DFL = % change in EPS/% change in EBIT
When financial leverage is measured at various levels of EBIT we can observe that DFL is
undefined at the break even point where there is no profit no gain i.e. the EPS is zero.
35. (c) In the percent of sales method, the future relationship between various elements of costs
to sales will be similar to their historical relationship. This percentage of cost to sales
keeps changing because of seasonal variations.
36. (b) Money market mutual funds are mutual funds that invest primarily in money market
instruments of very high quality and of very short maturities. MMMFs can be set up by
commercial banks, the RBI and public financial institutions either directly or through their
mutual fund subsidiaries. Guidelines also state that MMMFs would be supervised and
regulated by the RBI.
37. (e) When DOL is measured for a particular company at the varying levels of output we
observe that DOL is undefined at the operating break even point. When the quantity is greater
than the break even point, DOL will be positive.
38. (d) In the funds flow analysis, depreciation or increase in accumulated depreciation is a
source of funds. Hence the answer is (d). Increase in assets and decrease in liabilities
results in uses of funds. Hence, increase in cash, repayment of debt, decrease in
outstanding expenses and decrease in bank borrowing are uses of funds.
39. (a) Debt service coverage ratio indicates how much the firm has as post-tax earnings over the
total obligations in the particular year.
It is given as
PAT + Depreciation + Other non cash charges + Interest on term loan
Interest on loan payment Repayment of the term loan
+

40. (c) For equal size increases and decreases in the YTM, price movements are not symmetrical.
For a given maturity, the change in bonds price will be greater with a decrease in the bonds
YTM than the change in bond price with an equal increase in the bonds YTM. Hence (c) is not
true.
The intrinsic value of the bond is the present value of coupon payments and the redemption
value. Hence, if there is an increase in the redemption value, the value of the bond will
increase. Hence, (a) is true.
In case of long maturity bonds, a change in YTM is applied to a series of coupon payments
which is longer than the shorter maturity bonds and the principal payment is discounted at the
new rate for a longer number of years compared to shorter maturity bonds. Hence, the longer
the term to maturity, the greater will be the change in price with a change in YTM. Hence (b)
is also true. The percentage price change in case of high coupon bonds will be smaller than
the price change in case of smaller coupon bonds with a change in YTM. Hence, (d) is true.
In the equation of the intrinsic value of the bonds, if the required rate of return, which is the
discounting rate, is increased the value of the bond decreases. Hence, (e) is true.
456
Part B: Problems
41. (e) Let the dividend paid 6 years ago be x.
Therefore, 5.60 = (1 + 0.032)
6
x
x =
6
) 032 . 0 1 (
60 . 5
+
= Rs.4.6356.
42. (d) Growth rate in dividend can be obtained from the following equation:
1.80 (1 + g)
6
= 2.70
where, g is constant compound growth rate.
(1 + g)
6
= 2.70/1.80 = 1.50
Hence, g = (1.50)
1/6
1 = 0.0699 0.07 i.e. 7%
Dividend expected one year hence (D
1
) = (2.70)(1.07) = Rs.2.889 Rs.2.89
Intrinsic value of equity share =
1
e
D
k g

where, k
e
is required rate of return by the shareholder.
Intrinsic value of the equity shares of Western Alloys Ltd. =
) . . (
.
07 0 24 0
89 2
= Rs.17.00.
43. (b) Expected return ( x ) =20(0.15) + 21(0.20) + 22(0.50) + 23(0.10) + 24(0.05) = 21.80%.
Total risk associated with the security (Variance)
=
=
n
. ) x x ( p
1 i
2
i i

0.15(20 21.80)
2
+ 0.20(21 21.80)
2
+ 0.50 (22 21.80)
2
+ 0.10(23 21.80)
2
+ 0.05
(24 21.80)
2
= 1.020 (%)
2
.
44. (c) Expected market return (
m
k ) = 0.30(11) + 0.40(20) + 0.30(19) = 17%.
Market risk (measured in terms of variance)
=

=

n
1 i
2
m i i
) k (k p
= 0.30 (11 17)
2
+ 0.40 (20 17)
2
+ 0.30 (19 17)
2
= 15.6(%)
2
.
Market standard deviation = 6 . 15 = 3.95%
We know that
x m
2
m
Cov(k , k )
=

where k
x
denotes the return on the security and k
m
denotes the market returns.
Alternatively,
km x m
2
m

=

where is the correlation coefficient between the security and the market returns.
km
It is given that beta of the security is 1.3 and variance for Alpha Ltd. = 7.92(%)
2
or in other
words, standard deviation = 7092 = 2.814.
i.e. 1.3 =
km
2.814 3.95
15.6

= 1.824
Part III
457
45. (d) Expected return on the security of SAL Ltd. )
x
k (
= 0.10(15) + 0.20(20) + 0.25(18) + 0.30(12) + 0.05(25) + 0.10(22) = 17.05%.
Expected market return ) k (
m

= 0.10(18) + 0.20(30) + 0.25(25) + 0.30(22) + 0.05(35) + 0.10(32) = 25.60%.
for SAL shares =
2
m
Cov(k ,k )
i m

=
m m i i
2
m m
(k k )(k k )p
(k k ) p

=
16.38
22.15
= 0.74
Where k
x
denotes the return on the security and k
m
denotes the market returns.
Therefore, if the market returns increase by 13%, the returns on security will increase by
(0.74) (13%) = 9.62%.
46. (a) DOL =
Contribution
EBIT

=
Sales Variable costs
Sales Variable costs Fixed costs

=
800 0.625(800)
800 0.625(800) 100

= 1.5.
If the sales of the company increase by 5%, then increase in EBIT = 1.5 x 5% = 7.5%.
47. (e)
DTL =
Contribution
Preference dividend
EBIT Interest
1 tax rate

= . 00 . 2
0 50 200
800 x 375 .
=

0
= 2.00.
Change in EPS when sales increase by 7%
= DTL x Percentage increase in sales
= 2 x 7% = 14%.
48. (b)
Currently Profit Before Tax = EBIT Interest
= 200 50 = Rs.150 lakh.
The company wants to maintain PBT at the existing level,
i.e. desired Profit Before Tax (PBT) = 150
Add: Interest expense expected (50 + 30) = 80
Desired EBIT = 230
Desired percentage increase in EBIT =
Desired
EBIT EBIT 230 200
EBIT 200

= = 0.15 or 15%.
DOL =
sales in change Percentage
EBIT in change Percentage

Percentage increase in sales required =
Percentage change in EBIT 15
DOL 1.5
= = 10%.
458
Current assets
Current liabilities
= 2.4
i.e. Current assets = 2.4 current liabilities
Also, current assets current liabilities = Rs.56 lakh
i.e. 2.4 current liabilities current liabilities = Rs.56 lakh
1.4 Current liabilities = 56 lakh
Current liabilities = Rs.40 lakh.
Therefore, current assets = 40 + 56 = Rs.96 lakh.
Quick ratio or acid-test ratio =
Current liabilities

i.e. 1.6 =
96 Inventories
40
-

Inventories = Rs.32 lakh.
Proportion of inventories in current assets = 32/96 = 1/3.
50. (a) Gross Profit Margin =
Sales Cost of goods sold
Sales
-

0.20 =
Sales 256 lakh
Sales

0.20 x Sales = Sales 256 lakh
0.80 Sales = Rs.256 lakh.
Sales = Rs.320 lakh.
Average Collection Period =
Accounts Receivables
Sales/360

45 =
Accounts Receivables
320 lakh/360

Accounts Receivables = (320/360) x 45 = Rs.40 lakh.
51. (e)
Equity
debt Total
i.e.
40 lakh
Equity
=
5
2
=
5
2
Equity = Rs.100 lakh.
Equity = Equity share capital + Reserves and surplus
i.e., 100 lakh = Equity share capital +
2
x Equity share capital
3

100 lakh =
5
3
x Equity share capital
Equity share capital =
3
100 x
5
= Rs.60 lakh.
Therefore, reserves and surplus = (2/3) x 60 lakh = Rs.40 lakh.
Fixed assets = 0.44 x 100 lakh = Rs.44 lakh.

Part III
459
52. (d) Total Uses:
(Rs. in lakh)
Decrease in Liabilities 100
Sundry creditors 80
Provisions 20
Increase in Assets 380
Cash & bank 40
Debtors 60
Net fixed assets 140
Long-term investments 50
Prepaid expenses 40
Intangible assets 50
Total uses (= total sources) 480
Proportion of sources used in increasing the assets =
24
19
480
380
= = 79.17%.
53. (d)
Sources of Funds
Increase in owners equity 215
Increase in liabilities: 200
Term loan 60
Debentures 80
Working capital advance 60
Decrease in assets: 65
Inventories 40
Marketable securities 25
Total sources 480
Proportion of sources arising due to increase in liabilities =
480
200
= 41.67%.
54. (b) Cost of house = Rs.8,00,000
Financing by CHFL:
Let the interest rate per month be r.
Number of months for which payments have to be made to CHFL = 7 12 = 84
Amount payable at the end of every month to CHFL = Rs.18,500
8,00,000 = 18,500 PVIFA
(r, 84)
or PVIFA =
8, 00, 000
18, 500
= 43.243

84
84
(1.017) 1
For, r =1.7%, PVIFA= =44.548
0.017(1.017)

460
For, r = 1.8%,
PVIFA =
84
84
(1.018) 1
0.018(1.018)
-
= 43.141
r =
(1.8 1.7)
1.7 x (43.243 44.548)
(43.141 44.548)
= 1.793%
Effective interest rate
= (1 + r)
12
1 = (1.01793)
12
1 = 23.77% p.a. (approx.)
55. (a) Financing by SFCL and relative of Mr. Kartik:
Let the interest rate be r.
Amount of finance from SFCL = 8,00,000 0.90 = Rs.7,20,000
Amount of finance from relative = Rs.80,000
Total amount of financing = Rs.7,20,000 + Rs.80,000 = Rs.8,00,000
Amount payable at the end of every month to SFCL = Rs.12,800
Number of months for which payments have to be made to SFCL = 8 12 = 96 months
Amount payable to relative:
At the end of one year (i.e. 12 months) = Rs.40,000
At the end of two years (i.e. 24 months) = Rs.50,000
8,00,000 = 12,800 PVIFA (r, 96) +
12 24
40,000 50,000
+
(1+r) (1+r)

Let r = 1.2%,
RHS = 12800
96
96 12 24
(1.012) 1 40000 50000
0.012(1.012) (1.012) (1.012)
+ +
= 12800 56.818 + 34665.2 + 37552.4 = Rs.7,99,488
r = 1.1%
RHS = 12800
96
96 12 24
(1.011) 1 40000 50000
0.011(1.011) (1.011) (1.011)
+ +
= 12,800 59.104 + 35,078.9 + 38,454.1 = Rs.8,30,064.2
r =
(1.2 1.1)
x (800000 830064.2)
(799488 830064.2)
1.1 = 1.198%
Effective interest rate per annum = (1 + r)
12
1
= (1.01198)
12
1 = 0.1536 i.e. 15.36%.
56. (b) Total assets = 100 (say)
Debt = 60% of total assets = 60
Equity = 100 60 = 40

60 3
Debt equityratio= =
40 2

Given equity = Rs.60 lakh

Debt 3 3
or Debt 60
60 2 2
= = = Rs.90 lakh.

Part III
461
57. (b) At the end of 6 years, the future value of the amount that Ashish deposits each year for a
period of 6 years, should be equal to the present value of the payments that he has to make
under the loan agreement in the 7th, 8th, 9th and 10th years.
The discounted value of the payments to be made at the end of 7th, 8th, 9th and 10th years, as
at the end of the 6th year
=
2 3 4
3 4 2 1
+ + + = Rs.8.371 lakh
1.09
(1.09) (1.09) (1.09)

Future value of the deposits made at the end of every year, for a period of 6 years
= X. FVIFA
(9%, 6 years)
(where X is the amount to be invested at the end of every period till 6
years).
X. FVIFA
(9%, 6 years)
= Rs. 8.371 lakh
X=
8.371 lakh 8.371 lakh
Rs.1.1127 lakh
FVIFA 7.523
(9%,6 years)
= = i.e. Rs.1,11,270.
Hence, Ashish has to deposit Rs.1,11,270 at the end of every period for 6 years so as to be
able to make the payments under the loan agreement.
58. (b) Risk premium = (R
m
R
f
)
Prob. k
A
k
m (k
A
A
k ) (k
m
) (k
m
m
k
m
k )
(k
A
A
k )
(k
m
m
k )
(k
A
A
k ). P
0.30
0.35
0.15
0.20
7
8
14
16
9
5
10
14
3.2
2.2
3.8
5.8
0.25
-3.75
1.25
5.25
0.8
8.25
4.75
30.45
0.24
2.8875
0.7125
6.09

k = k P
A A
=
10.20
k = k P
m m
=8.75
9.45
=
A
A m
m
v(k k )
Var(k )
Co
=
A A m m
2
m
m
P.(k k )(k k )
P(k k )

=
9.45
0.884
10.6875
=
Risk premium = 0.884 (8.75 6) = 2.43%.
Hence, option (b) is the correct choice.
59. (c) The yield on a T-bill, (k) =
d
365
P
P F

Where d is the maturity period
F is the face value and P is the price
0.1671=
d
365
96
96
100

Hence d = 91.01 days. i.e. approximately 91 days.
60. (b) The maximum sales growth rate that can be financed without resorting to external
financing can be computed by equating
A L m(1 g)(1 d)
to zero.
S S g
+

i.e.
A L m(1 g)(1 d)
S S g
+
= 0
0.6 0.15
0.06(1 g)(1 0.40)
g
+
= 0
0.45 = 0.036
g
g) (1+

12.5g = 1 + g
462
Hence, g = 1/11.5 = 8.7%.
Alternative solution:
EFR = 0
1
A L
S S mS (1 d)
S S
= 0
A L
S S m(S S)(1 d)
S S
+ = 0
0.6 S 0.15 S 0.06 x 0.6 (S + S) = 0
0.6 S 0.15 S 0.036S 0.036S = 0
0.414S = 0.036S
S
g 8.7%.
S
= =
61. (c) When receivable worth Rs.10,000 are realized then cash will increase by 10,000 and
receivables worth Rs.10,000 would decrease so there will not be any affect. Similarly when
inventory worth Rs.30,000 is bought on credit, both current assets and current liabilities will
increase by Rs.30,000 such that there will not be any impact on the net working capital.
62. (d) Earning Power =
Assets Total Average
EBIT

Earnings After Tax = Rs. 9.0 lakh.
Therefore, Earnings Before Tax =
9
Rs.15 lakh
(1 0.40)
=

EBIT = Earnings Before Tax + Interest = 15 + 8 = Rs.23 lakh.
Net profit margin =
Net profit
Net sales

i.e. Net sales =
NP 9, 00, 000
NPM 0.05
= = Rs.180,00,000
ATO ratio =
Net sales
Total assets

180lakh
i.e TA Rs.120lakh
1.5
= =
Therefore, Earning power =
Assets Total Average
EBIT
=
23
120
= 0.192 i.e. 19.2%.
63. (b) According to the single-index model,
R
i
=
m
R +
= 0.04 + 0.9 x 0.12 = 14.8%
As the shares are said to be in equilibrium,

1
0
D
g
P
+ = R

3 0.6
g
40
+ = 0.148
0.045 + g = 0.148 = 0.103
MP at the end of 5 years =
6
D
k g

=
5
3 0.6 (1.103)
0.148 0.103

= Rs.65.30.
Part III
463
64. (a) Debt equity ratio = 5:4
Therefore Equity =
4
36, 00, 000
9
= Rs.16,00,000.
Computation of fixed assets:
It is given that ratio of owners equity to fixed assets is 8:15.
i.e.
16, 00, 000 8
Fixed Assets 15
=
Therefore, fixed assets = 16,00,000 x
15
8
= Rs.30,00,000.
Hence Choice (a) is the correct option.
65. (c) Let new short-term borrowing be denoted by x.
Current ratio should not be less than 1.2 i.e.
Current Assets
1.2
Short-term bank borrowing + Current Liabilities

i.e.
441
1.2
x 105 220.50

+ +
(Note: Current assets here are computed as 350 (1+26%) = Rs.441 lakh
and Spontaneous liabilities are computed as: 175 x (1+ 26%) = Rs.220.50 lakh)
i.e. 441 1.2 (x +105+220.5)
x Rs.42 lakh
i.e. x Rs.42 lakh
Hence, maximum short-term bank borrowing that can be made is Rs.42 lakh.
Therefore minimum equity to be raised
= External funds requirement New short-term bank borrowing
= 117.14 lakh 42 lakh = Rs. 75.14 lakh.
66. (b) Cost of goods sold = Rs.39,00,000.
Gross profit margin is given to be 25%. In other words gross profit is 25% of sales.
Let Sales be x.
Therefore, Cost of goods sold + 0.25 x = x
39,00,000 + 0.25x = x
Hence x (i.e. Sales) = Rs. 52,00,000.
Average receivables turnover ratio is given to be 52:15
i.e.
Net credit sales
Average accounts receivables
=
52
15

(assume that the entire sales are on a credit basis)
52,00,000
Average accounts receivables
=
52
15

Therefore, Debtors (or average account receivables) = Rs.15,00,000.
Cash and Bank = Quick assets debtors
= 18,00,000 15,00,000 = Rs.3,00,000.
464
67. (d) Sustainable growth rate =
A
m(1 d)
E
A A
m(1 d)
S E

Equity capital = Rs.12 lakh
Dividend = 37.5% = 0.375 x 12 = Rs.4.5 lakh
ROA = NPM x ATO Ratio
NPM =
ROA 0.16
14.4%
ATO 1.111
= =
Equity multiplier =
Average assets
Equity

3.75 =
Average assets
12

Average assets = Rs.45 lakh
ROA =
PAT
Assets

0.16 =
PAT
45

PAT = Rs.7.2 lakh
d =
Dividends 4.5
0.625
PAT 7.2
= =
SGR =
0.
=
144(1 0.625)3.75
1
0.144(1 0.625)3.75
1.111

0.2025
29%.
0.90 0.2025
=

68. (d) Required rate of return = R
f
+ (R
m
R
f
)
= 6 + 1.15 8 = 15.2%
New required rate of return = 8 + 1.15 8 = 17.2%.
69. (c) Current Yield =
Coupon Interest
Market Price
= 8.33%.
Market Price =
0833 . 0
Interest Coupon

=
0.10 1000
0.0833
= Rs.1,200 (approx.)
Hence, the bond is trading at a premium of Rs.200 i.e., 20%. Hence, answer is (c).
70. (e) Change in net working capital can be calculated as :
(100 +60 +25 35) (80 + 50 +10 40) = 150 100 = Rs.50 lakh.

Sources of Long-Term Finance
The long-term decisions of a firm involve setting up of the firm, expansion, diversification,
modernization and other similar capital expenditure decisions.
All these decisions involve huge investment, the benefits of which will be seen only in the
long-term. In addition to this they are also irreversible in nature.
One of the most important consideration for an investment and financing decision will be
proper asset-liability management. Companies will have to face a severe asset-liability
mismatch if the long-term requirements are funded by the short-term sources of funds. Such a
mismatch will lead to an interest rate risk thereby enhancing the interest burden of the firm
and a liquidity risk with the short-term funds being held up in long-term projects.
Firms can issue three types of capital equity, preference and debenture capital. These three
types of capital distinguish amongst themselves in the risk, return and ownership pattern.
Equity Shareholders are the owners of the business. They enjoy the residual profits of the
company after having paid the preference shareholders and other creditors of the company
and their liability is restricted to the amount of share capital they contributed to the company.
The advantage of equity capital to the issuing firm is that without any fixed obligation for the
payment of dividends, it offers permanent capital with limited liability for repayment.
The cost of equity capital is higher than other capital. Firstly, since the equity dividends are
not tax-deductible expenses and secondly, the high costs of issue. In addition to this since the
equity shareholders enjoy voting rights, excess of equity capital in the firms capital structure
will lead to dilution of effective control.
Preference shares have some attributes similar to equity shares and some to debentures. Like in
the case of equity shareholders, there is no obligatory payment to the preference shareholders
and the preference dividend is not tax- deductible (unlike in the case of the debentureholders,
wherein interest payment is obligatory). However, similar to the debentureholders the
preference holders earn a fixed rate of return for their dividend payment. In addition to this, the
preference shareholders have preference over equity shareholders to the post-tax earnings in the
form of dividends and assets in the event of liquidation.
Preference shares can be of two types (i) Cumulative or Non-cumulative preference shares
(ii) Redeemable or Perpetual preference shares.
For cumulative preference shares the dividends will be paid on a cumulative basis, in case
they remain unpaid in any financial year due to insufficient profits. The company will have to
pay up all the arrears of preference dividends before declaring any equity dividends.
Non-cumulative shares do not enjoy such right to dividend payment on cumulative basis.
Redeemable preference shares will be redeemed after a given maturity period while the
perpetual preference share capital will remain with the company forever.
A debenture is a marketable legal contract whereby the company promises to pay its owner, a
specified rate of interest for a defined period of time and to repay the principal at the specific
date of maturity.
Debentures are usually secured by a charge on the immovable properties of the company.
The interest of the debentureholders is usually represented by a trustee and this trustee (which
is typically a bank or an insurance company or a firm of attorneys) is responsible for ensuring
that the borrowing company fulfills the contractual obligations embodied in the contract.
If the company issues debentures with a maturity period of more than 18 months, then it has
to create a Debenture Redemption Reserve (DRR), which should be at least half of the issue
amount before the redemption commences.
Debentures can be classified based on the conversion and security.

468
Non-Convertible Debentures (NCDs): These debentures cannot be converted into equity
shares and will be redeemed at the end of the maturity period.
Fully Convertible Debentures (FCDs): These debentures will be converted into equity shares
after a specified period of time at one stroke or in installments. These debentures may or may
not carry interest till the date of conversion. In the case of a fully established company with
an established reputation and good, stable market price, FCDs are very attractive to the
investors as their bonds are getting automatically converted to shares which may at the time
of conversion be quoted much higher in the market compared to what the debentureholders
paid at the time of FCD issue.
Partly Convertible Debentures (PCDs): These are debentures, a portion of which will be
converted into equity share capital after a specified period, whereas the Non-Convertible
Debenture (NCD) portion of the PCD will be redeemed as per the terms of the issue after the
maturity period. The non-convertible portion of the PCD portion will carry interest right up
to redemption whereas the interest on the convertible portion will be only up to the date
immediately preceding the date of conversion.
Secured Premium Notes (SPNs): This is a kind of NCD with an attached warrant that has
recently started appearing in the Indian Capital Market.
The warrant attached to the SPN gives the holder the right to apply for and get allotment of one
equity share for cash by payment of Rs.100 per share. This right has to be exercised between
one and one-and-half year after allotment, by which time the SPN will be fully paid-up.
A firm can raise capital from the primary market (both domestic and foreign) by the issue of
securities in the following ways: Public Issue Rights Issue Private Placement BODs Euro-Issues
Companies issue securities to the public in the primary market and get them listed on the
stock exchanges. These securities are then traded in the secondary market. The major
activities involved in making a public issue of securities are appointment of the lead
manager, preparation of prospectus and appointment of intermediaries.
Under Section 81 of the Companies Act, 1956, when a firm issues additional equity capital,
it has to first offer such securities to the existing shareholders on a pro rata basis.
The private placement method of financing involves direct selling of securities to a limited
number of institutional or high networth investors.
Buy-out is a process whereby an investor or a group of investors buy-out a significant portion
of the equity of an unlisted company with a view to take it public within an agreed time
frame.
The instruments like Global Depository Receipts (GDRs), Euro-Convertible Bonds (ECBs),
Foreign Currency Convertible Bonds (FCCBs) are issued abroad and listed and traded on a
foreign stock exchange. Once they are converted into equity, the underlying shares are listed
and traded on the domestic exchange.
Term Loans constitute one of the major sources of debt finance for a long-term project. Term
loans are generally repayable in more than one year but less than 10 years.
The interest rate on the term loans will be fixed after the financial institution appraises the
project and assesses the credit risk. Generally there will be a floor rate fixed for different
types of industries.
The major advantage of this source of finance is its post-tax cost, which is lower than the
equity/preference capital and there will be no dilution of control. However, the interest and
principal payments are obligatory and threaten the solvency of the firm. The restrictive
covenants may to a certain extent hinder the companys future plans.
Financing through internal accruals can be done through the depreciation charges and the
retained earnings. While depreciation amount will be used for replacing an old machinery
etc., retained earnings on the other hand can be utilized for funding other long-term
objectives of the firms.
The major advantages the company gets from using this as a source of long-term finance are
its easy availability, elimination of issue expenses and the problem of dilution of control.

469
However, the disadvantage is that there will be limited funds from internal accruals. In
addition to this, ploughing back of retained earnings implies foregoing of dividend receipts
by the investors which may actually lead to higher opportunity costs for the firm.
The deferred credit facility is offered by the supplier of machinery, whereby the buyer can
pay the purchase price in installments spread over a period of time. The interest and the
repayment period are negotiated between the supplier and the buyer and there are no uniform
norms. Bill Rediscounting Scheme, Suppliers Line of Credit, Seed Capital Assistance and Risk
Capital Foundation Schemes offered by financial institutions are examples of deferred credit
schemes.
Leasing and hire purchase of assets are supplementary to the actual long-term sources. They are
offered by financial institutions, Non-Banking Finance Companies, Banks and manufacturers of
equipment/assets.
Leasing is a contractual agreement between the lessor and the lessee, wherein companies
(lessee) can enter into a lease deal with the manufacturer of the equipment (lessor) or through
some other intermediary. This deal will give the company the right to use the asset till the
maturity of the lease deal and can later return the asset or buy it from the manufacturer.
During the lease period the company will have to pay lease rentals, which will generally be at
negotiated rate and payable every month.
Very similar to leasing is hire purchase, except that in hire purchase the ownership will be
transferred to the buyer after all the hire purchase installments are paid-up. With the
mushrooming of non-banking finance companies offering the leasing and hire purchase of
equipments, many companies are opting for this route to finance their assets. The cost of such
financing generally lies between 20 25%.
Cost of Capital and Capital Structure Theories
The cost of capital to a company is the minimum rate of return that it must earn on its
investments in order to satisfy the various categories of investors who have made investments
in the form of shares, debentures or term loans.
A companys cost of capital is nothing but the weighted arithmetic average of the cost of the
various sources of finance that have been used by it.
The use of this measure for appraising new investments will depend upon two important
assumptions: (a) risk characterizing the new project under consideration is not significantly
different from the risk characterizing the existing investments of the firm, and (b) the firm
will continue to pursue the same financing policies.
For calculating the cost of capital of the firm, you have to first define the cost of various
sources of finance used by it.
The sources of finance that are typically tapped by a firm are (a) debentures (b) term loans
(c) preference capital (d) equity capital and (e) retained earnings.
The cost of a debenture is defined as that discount rate which equates the net proceeds from
issue of debentures to the expected cash outflows in the form of interest and principal
repayments.
The cost of the term loans will be simply equal to the interest rate multiplied by (1 tax rate).
The interest rate to be used here will be the interest rate applicable to the new term loan. The
interest is multiplied by (1 tax rate) as interest on term loans is also tax deductible.
The cost of a redeemable preference share (k
p
) is defined as that discount rate which equates
the proceeds from preference capital issue to the payments associated with the same i.e.,
dividend payment and principal payment.
According to the dividend forecast approach, the intrinsic value of an equity stock is equal to
the sum of the present values of the dividends associated with it.
Realized Yield Approach: According to this approach, the past returns on a security are
taken as a proxy for the return required in the future by the investors. The assumptions
behind this approach are that (a) the actual returns have been in line with the expected
returns and (b) the investors will continue to have the same expections from the security.

470
Bond Yield Plus Risk Premium Approach: The logic behind this approach is that the return
required by the investors is directly based on the risk profile of a company. This risk profile
is adequately reflected in the return earned by the bondholders. Yet, since the risk borne by
the equity investors is higher than that of bondholders, the return earned by them should also
be higher.
Earnings Price Ratio Approach: According to this approach, the cost of equity can be
calculated as E1/P Where E1 =expected EPS for the next year, P =current market price per
share, E1 can be arrived at by multiplying the current EPS by (1 +growth rate).
Cost of external equity comes into picture when there are certain floatation costs involved in
the process of raising equity from the market. It is the rate of return that the company must
earn on the net funds raised, in order to satisfy the equityholders demand for return.
The Weighted Average Cost of Capital increases with the level of financing required. The
supplies of capital generally require a higher return as they supply more capital.
A schedule showing the relationship between additional financing and the weighted average
cost of capital is referred to as the weighted marginal cost of capital schedule.
The capital structure of a company refers to the mix of the long- term finances used by the
firm. It is the financing plan of the company.
The objective of any company is to mix the permanent sources of funds used by it in a
manner that will maximize the companys market price. In other words companies seek to
minimize their cost of capital. This proper mix of funds is referred to as the Optimal Capital
Structure.
The capital structure decision is a significant managerial decision which influences the risk
and return of the investors. The company will have to plan its capital structure at the time of
promotion itself and also subsequently whenever it has to raise additional funds for various
new projects. Wherever the company needs to raise finance, it involves a capital structure
decision because it has to decide the amount of finance to be raised as well as the source from
which it is to be raised.
The use of fixed charges sources of funds such as preference shares, debentures and term
loans along with equity capital in the capital structure is described as financial leverage or
trading on equity.
The term trading on equity is used because it is the equity that is used as a basis for raising debt.
Increased use of leverage increases the fixed commitments of the company in the form of
interest and repayments and thus increases the risk of the equity shareholders as their returns
are affected.
The other factors that should be considered whenever a capital structure decision is taken are:
a. Cost of capital
b. Cash flow projections of the company c. Size of the company
d. Dilution of control
e. Floatation costs.
Profitability, Flexibility, Control and Solvency are the features of an optimal capital
structure.
Net Income Approach: According to this approach, the cost of equity capital (k
e
) and the cost
of debt capital (k
d
) remain unchanged when B/S, the degree of leverage varies.
Net Operating Income Approach: According to the net operating income approach, the
overall capitalization rate and the cost of debt remain constant for all degrees of leverage.
The traditional approach has the following propositions:
i. The cost of debt capital, k
d
, remains more or less constant up to a certain degree of
leverage but rises thereafter at an increasing rate.
ii. The cost of equity capital, k
e
, remains more or less constant or rises only gradually up to
a certain degree of leverage and rises sharply thereafter.

471
iii. The average cost of capital, k
o
, as a consequence of the above behavior of k
e
and k
d

(a) decreases up to a certain point; (b) remains more or less unchanged for moderate
increases in leverage thereafter and (c) rises beyond a certain point.
Modigliani and Miller have stated that the relationship between leverage and the cost of
capital is explained by the net operating income approach in terms of three basic
propositions. They argue against the traditional approach by offering behavioral justification
for having the cost of capital, k
o
, remain constant throughout all degrees of leverage.
Dividend Policy
Firms can either plough back the earnings by retaining them or distribute the same to the
shareholders as dividends.
The second option of declaring cash dividends out of the after tax profits will lead to
maximization of the shareholders wealth.
The returns to the shareholders either by way of the dividend receipts or capital gains are
affected by the dividend policies of the firms.
The dividend policy of the firm gains importance especially due to unambiguous relationship
that exists between the dividend policy and the equity returns.
The traditional approach to the dividend policy, which was given by B Graham and
D L Dodd lays a clear emphasis on the relationship between the dividends and the
stock market. According to this approach, the stock value responds positively to higher
dividends and negatively when there are low dividends.
The traditional approach, states that the P/E ratios are directly related to the dividend pay-out
ratios.
The dividend policy given by J ames E Walter also considers that dividends are relevant and
they do affect the share price. In this model he studied the relationship between the internal
rate of return (r) and the cost of capital of the firm (k), to give a dividend policy that
maximizes the shareholders wealth.
According to the Walter Model, when the return on investment is more than the cost of
equity capital, the earnings can be retained by the firm since it has better and more profitable
investment opportunities than the investors.
Firms which have their r >k
e
are the growth firms and the dividend policy that suits such
firms is the one which has a zero pay-out ratio. This policy will enhance the value of the firm.
When the firm has a rate of return that is equal to the cost of equity capital, the firms
dividend policy will not affect the value of the firm. The optimum dividend policy for such
normal firms will range between zero to a 100% pay-out ratio, since the value of the firm will
remain constant in all cases.
Gordons Model assumes that the investors are rational and risk- averse. They prefer certain
returns to uncertain returns and thus put a premium to the certain returns and discount the
uncertain returns. Thus, investors would prefer current dividends and avoid risk. Retained
earnings involve risk and so the investor discounts the future dividends. This risk will also
affect the stock value of the firm.
Gordon explains this preference for current income by the bird- in-hand argument.
Miller and Modigliani have propounded the MM hypothesis to explain the irrelevance of the
firms dividend policy.
According to the model, it is only the firms investment policy that will have an impact on
the share value of the firm and hence should be given more importance.
According to the rational expectations model, there would be no impact of the dividend
declaration on the market price of the share as long as it is at the expected rate.
The rational expectations model suggests that alterations in the market price will not be necessary
where the dividends meet the expectations and only in case of unexpected dividends will there be
a change in the market price.

472
Estimation of Working Capital Needs
Current assets are those liquid assets of the company which are either held in the form of
cash or can be easily converted into cash within one accounting period, usually a year.
Examples of current assets are cash, short-term investments, sundry debtors or accounts
receivable, stock, loans and advances etc.
Current liabilities have to be paid within the accounting period like sundry creditors or
accounts payable, bills payable, outstanding expenses, short-term loans, etc.
Working capital management involves not only managing the different components of
current assets, but also managing the current liabilities, or to be more precise, the financing
aspect of current assets.
The basic objective of working capital is to provide adequate support for the smooth
functioning of the normal business operations of a company.
Management of current assets leads to a trade-off between profitability and liquidity.
An aggressive approach to working capital management results in greater profitability but
lower liquidity while a conservative approach results in lower profitability but higher liquidity.
Under moderate approach some liquidity and profitability have to be sacrificed so that the
resultant figures of liquidity and profitability are reasonably satisfactory to the company.
Working capital management encompasses the management of current assets and the means
of financing them.
The objective of working capital management is one of balancing the liquidity and
profitability criteria while taking into consideration the attitude of management toward risk
and the constraints imposed by the banking sector while providing short- term credit in the
form of cash credit/bank overdraft.
Gross working capital is equal to the total of all current assets (including loans and
advances) of a company.
Net working capital is defined as the difference between gross working capital and current
liabilities (including provisions).
The dynamic approach to working capital is far more useful from the point of view of
managerial decision-making than the static approach.
Nature of Business, Nature of Raw material used, process technology used, Nature of
finished goods, degree of competition in the market, Paying Habit of customers and degree of
synchronization among cash inflows and outflows are some of the factors affecting the
composition of working capital management.
Operating cycle approach proves quite useful as a technique for exercising control over
working capital.
Liquidity, Availability of cash, inventory turnover, credit extended to customers, credit
obtained from suppliers, undertrading and overtrading are some of criteria on which working
capital management is evaluated.
A situation of under-trading arises in a company when the volume of sales is much less than
the amount of assets employed.
Under-trading also indicates that funds of the company are locked up in current assets
resulting in a lower turnover of working capital.
Over-trading is a situation which is the opposite of under-trading. The symptoms of over-trading
can be noticed fromthe disproportionately high turnover of assets compared to the volume of
sales.
Precautionary measures for over-trading can be taken by initially reducing the sales to a level
commensurate with the amount of assets and a final solution lies in increasing the asset base
through additional finances raised through the issuance of shares and/or obtaining loan funds.

473
Financing Current Assets
The current assets of a company vary depending upon the level of activity or operations.
The level of Accounts Receivables will also tend to increase as a result of the increased level
of sales. Thus, the level of current assets associated with the tempo of business activity can
be regarded as the fluctuating or temporary component of current assets.
The level of current assets of a company can be looked upon as the permanent component of
current assets superimposed by the fluctuating component.
The temporary or fluctuating component can be financed from short-term sources such as
accounts payables or trade credit, short-term bank borrowings and public deposits.
The behavior of current assets influences in a broad sense the pattern of financing to be
adopted by a company.
Accrued Expenses, Provisions, Trade credit are important sources of financial current assets.
Bank finance may be either direct or indirect.
Under direct financing the bank not only provides the finance but also bears the risk. Cash
credit, overdraft, note lending, purchase/discounting of bills belong to the category of direct
financing.
When the bank opens a Letter of Credit in favor of a customer, the bank assumes only the
risk of default by the customer and the finance is provided by a third party.
Examples of indirect financing are letter of credit, security, hypothecation and pledge.
The deposits mobilized from public by non-financial manufacturing companies are known as
Public Deposits or Fixed deposits. These are governed by the regulations of public
deposits under the Companies (Acceptance of Deposits) Amendment Rules, 1978.
Commercial Papers (CPs) are short-term usance promissory notes with a fixed maturity
period, issued mostly by the leading, reputed, well-established, large corporations who have a
very high credit rating. They can be issued by body corporates whether financial companies
or non-financial companies. Hence, They are is also referred to as Corporate Papers.
CPs are mostly used to finance current transactions of a company and to meet its seasonal
needs for funds.
The Reserve Bank of India had appointed some special study groups for streamlining the
practices followed by banks so that the weaknesses of the existing practices are removed and
a better sense of direction provided to the banking sector.
The Reserve Bank of India (RBI) constituted in J uly, 1974 a study group to frame guidelines
for follow up of bank credit under the chairmanship of P L Tandon. The report submitted by
the committee in August, 1975 is popularly referred to as the Tandon Committee Report.
The Tandon Committee Report had made some recommendations regarding the style of
credit.
The Working Group appointed under the Chairmanship of K B Chore in April, 1979 had
analyzed the existing data in respect of cash credit/overdraft by the banking sector, practices
followed by other countries and submitted its report on August 31, 1979.
The Reserve Bank provided an additional measure of credit regulation for ensuring greater
alignment of bank credit to the requirements of the plan. This regulation of RBI is the genesis
for what has come to be known more popularly as the Credit Authorization Scheme (CAS).
The Reserve Bank of India, set up a committee under the chairmanship of Shri S S Marathe
in November, 1982.
Kannan Committee headed by Bank of Baroda chairman, Mr. K Kannan was formed on the
suggestion of the Reserve Bank of India in J anuary, 1997 to examine the validity of the
MPBF concept and to suggest what could replace it.

474
Inventory Management
Inventory Management involves the control of assets being produced for the purposes of sale
in the normal course of the companys operations.
Inventories include raw material inventory, work-in-process inventory and finished goods
inventory.
The goal of effective inventory management is to minimize the total costs i.e., the direct and
indirect cost that are associated with holding inventories.
Liquidity Lag: Inventories are tied to the firms pool of working capital in a process that
involves three specific lags, namely, Creation Lag, Storage Lag and Sale Lag.
Creation Lag: In most cases, inventories are purchased on credit, creating an account payable.
This liquidity lag offers a benefit to the firm.
Storage Lag: Once goods are available for resale, they will not be immediately converted into
cash. First, the item must be sold. Even when sales are very active, a firm will hold inventory
as a back-up. Thus, the firm will usually pay suppliers, workers, and overhead expenses
before the goods are actually sold. This lag represents a cost to the firm.
Sale Lag: Once goods have been sold, they normally do not create cash immediately. Most
sales occur on credit and become accounts receivable. The firm must wait to collect its
receivables. This lag also represents a cost to the firm.
Shelf stock refers to items that are stored by the firm and sold with little or no modification to
customers. An automobile is an item of shelf stock.
Raw Materials Inventory: This consists of basic materials that have not yet been committed
to production in a manufacturing firm. The purpose of maintaining raw material inventory is
to uncouple the production function from the purchasing function so that delays in shipment
of raw materials do not cause production delays.
Stores and Spares: This category includes those products which are accessories to the main
products produced for the purpose of sale.
Work-in-Process Inventory: This category includes those materials that have been committed
to the production process but have not been completed. The more complex and lengthy the
production process, the larger will be the investment in work-in-process inventory.
Finished Goods Inventory: These are completed products awaiting sale. The purpose of a
finished goods inventory is to uncouple the productions and sales functions so that it no
longer is necessary to produce the goods before a sale can occur.
Material Costs: These are the costs of purchasing the goods including transportation and
handling costs.
The ordering costs refer to the costs associated with the preparation of purchase requisition
by the user department, preparation of purchase order and follow-up measures taken by the
purchase department, transportation of materials ordered for, inspection and handling at the
warehouse for storing.
Carrying Costs: These are the expenses incurred in storing goods. Once the goods have been
accepted, they become part of the firms inventories. These costs include insurance,
rent/depreciation of warehouse, salaries of storekeeper, his assistants and security personnel,
financing cost of money locked-up in inventories, obsolescence, spoilage and taxes.
Cost of Funds Tied up with Inventory: Whenever a firm commits its resources to inventory, it
is using funds that otherwise might be available for other purposes. The firm has lost the use
of funds for other profit making purposes. This is its opportunity cost. Whatever be the
source of funds inventory has a cost in terms of financial resources. Excess inventory
represents unnecessary cost.
Cost of Running out of Goods: These are costs associated with the inability to provide
materials to the production department and/or inability to provide finished goods to the
marketing department as the requisite inventories are not available.

475
The Economic Order Quantity (EOQ) refers to the optimal order size that will result in
reduction of total ordering and carrying costs for an item of inventory given its expected
usage, carrying costs and ordering cost. By calculating an economic order quantity, the firm
attempts to determine the order size that will minimize the total inventory costs.
As order Quantity (Q) increases the total ordering costs will decrease while the total carrying
costs increase.
Inflation affects the EOQ model through increased carrying costs. As inflation pushes interest
rates up, the cost of carrying inventory increases.
The EOQ Model can be extended to production runs to determine the optimum production
quantity. The two costs involved in this process are: (i) set up cost and (ii) inventory carrying
cost.
The set-up cost is of the nature of fixed cost and is to be incurred at the time of
commencement of each production run. The larger the size of the production run, the lower
will be the set-up cost per unit.
The carrying cost will increase with increase in the size of the production run.
There is an inverse relationship between the set-up cost and inventory carrying cost.
The reorder point for replenishment of stock occurs when the level of inventory drops down to
zero.
The two factors that determine the appropriate order point are the procurement or delivery
time stock which is the inventory needed during the lead time (i.e., the difference between the
order date and the receipt of the inventory ordered) and the safety stock which is the
minimum level of inventory that is held as a protection against shortages.
The stock level subsystem keeps track of the goods held by the firm, the issuance of goods,
and the arrival of orders. It maintains records of the current level of inventory. For any period
of time, the current level is calculated by taking the beginning inventory, adding the
inventory received, and subtracting the cost of goods sold. Whenever this subsystem reports
that an item is at or below the reorder-point level, the firm will begin to place an order for the
item.
A firm using the ABC system segregates its inventory into three groups: A, B and C. The
A items are those in which it have the largest rupee investment. These are the most costly or
the slowest turning items of inventory. The B group consists of the items accounting for the
next largest investment. The C group consists of least rupee investment.
There are different ways of valuing the inventories and a knowledge of these methods of
valuing stocks is essential for an efficient inventory management process.
First-In-First-Out (FIFO): When a firm adopts the FIFO method to price its raw material, the
issue of material from the stores will be in the order in which it was received. Thus the
pricing will be based on the cost of material that was obtained first.
Last-In-First-Out (LIFO): In the LIFO method, the material issued will be priced based on
the cost of the material that has been purchased recently.
Weighted Average Cost Method: The pricing of materials will be on weighted average basis
(weights will be given based on the quantity).
Standard Price Method: Material is priced based on a standard cost which is predetermined.
When the material is purchased the stock account will be debited with the standard price. The
difference between the purchase price and the standard price will be carried into a variance
account.
Replacement/Current Price Method: In this method material is priced at the value that is
realizable at the time of the issue.

476
Receivables Management
The average balance in the receivables account is average daily credit sales multiplied by
average collection period.
The objective of receivables management is to promote sales and profits until that point is
reached where the returns that the company gets from funding of receivables is less than the
cost that the company has to incur in order to fund these receivables.
The credit policy of a company can be regarded as a kind of trade-off between increased
credit sales leading to increase in profit and the cost of having larger amount of cash locked
up in the form of receivables and the loss due to the incidence of bad debts.
The objective of collection policy is to achieve timely collection of receivables, thereby
releasing funds locked up in receivables for a longer period than they should have been under
the credit terms and to minimize bad debt losses.
In judging the creditworthiness of an applicant, three basic factors the three Cs have to be
considered. And they are character, capacity, and collateral.
Character refers to the willingness of the customer to honor his obligations. It reflects
integrity, a moral attribute considered very important by credit managers.
Capacity refers to the ability of the customer to pay on time. It depends on the financial
situation (particularly the working capital position and profitability) and the general business
conditions affecting the performance of the customer.
Collateral represents the security offered by the firm in the form of mortgages.
Credit evaluation of the prospective customer involves obtaining information from which the
financial capacity as also the paying habits can be evaluated.
An important aspect of receivables management is to monitor the payment of receivables.
Several measures are employed by the credit manager for this purpose. (i) Days Sales
Outstanding, (ii) Ageing Schedule and (iii) Collection Matrix are some of the measures
employed.
The average number of days sales outstanding at any time, say end of the month or end of
the quarter, is same as for an average collecation period.
In case, the days sales outstanding is within a pre-specified norm linked to the credit period
followed by the company then the status of receivables is regarded to be under control. In
case it is found to be higher, then the collection policy has to be strengthened as the
collections are slow.
The age-wise distribution of accounts receivable at a given time is depicted in the ageing
schedule.
The ageing schedule can be compared with the credit period extended by the company. When
the percentage of receivables belonging to higher age groups is above a stipulated norm,
action has to be initiated before they turn into bad debts.
If sales are decreasing, average collection period and the ageing schedule will differ from
what they would be if sales are constant.
From the collection matrix, one can judge whether the collection is improving, stable, or
deteriorating. A secondary benefit of such an analysis is that it provides a historical record of
collection percentages that can be useful in projecting monthly receipts for each budgeting
period.
Cash Management
Cash, the most liquid asset and also referred to as the life blood of a business enterprise is of
vital importance to the daily operations of business firms.
There are two ways of viewing the term cash. In a narrow sense it includes actual cash in
the form of notes and coins and bank drafts held by a firm and the deposits withdrawable on
demand. And in a broader sense, it includes even marketable securities which can be
immediately sold or converted into cash.

477
There is a general tendency to confuse profits with cash. But there is a difference between
profits and cash.
Profits can be said to be the excess of income over the expenditure of the business entity, for
a particular accounting period. It includes both cash incomes (cash sales, interest on
investments, etc.) and non-cash incomes.
Cash refers to the cash as well as the bank balances of the company at the end of the
accounting period, as reflected in the Balance sheet of the company.
Transaction Motive: A company is always entering into transactions with other entities.
While some of these transactions may not result in an immediate inflow/outflow of cash (for
example, credit purchases and sales), other transactions cause immediate cash inflows and
outflows. So firms always keep a certain amount as cash to deal with routine transactions
where immediate cash payment is required.
Precautionary Motive: Contingencies have a habit of cropping up when least expected.
A sudden fire may break out, accidents may happen, employees may go on strike, creditors
may present bills earlier than expected or debtors may make payments later than warranted.
The company has to be prepared to meet these contingencies to minimize its losses. For this
purpose companies generally maintain some amount in the form of cash.
Speculative Motive: Firms also maintain cash balances in order to take advantage of
opportunities that do not take place in the course of routine business activities. For example,
there may be a sudden decrease in the price of raw materials which is not expected to last
long or the firm may want to invest in securities of other companies when the price is just
right. These transactions are of a purely speculative nature for which the firms need cash.
The objective of cash management can be regarded as one of making short-term forecasts of
cash position, finding avenues for financing during periods when cash deficits are anticipated
and arranging for repayment/investment during periods when cash surpluses are anticipated
with a view to minimizing idle cash as far as possible.
Cash forecasting refers to estimation of cash inflows and outflows for a future or forecasted
period. Cash forecasting helps in reaching figures that are likely to be there during and at the
end of the forecasted period.
Cash forecasting is merely a statement showing figures that are likely to be there during and
at the end of a future period. Whereas a cash budget shows the results of the remedial actions
that are planned to be taken by the management to nullify the future undesired deviations.
Short-term cash forecasting is prepared under the receipts and payments method, showing the
time and magnitude of expected cash receipts and payments.
Under this method, estimation of future cash requirements is done by extracting relevant
information from the already prepared forecasted accounting statements such as forecasted
P&L account and balance sheet, and then adjusting the figures in such statements to translate
accrual based figures to cash based figures. The resultant statement so derived is called
forecasted cash flow statement.
Cash Forecasting is of immense use in the measurement of cash deficits and surpluses,
technical insolvency and bankruptcy, long-term cash requirements. It also determines
profitability and cash flows of different projects.
Cash budgets are short-term cash forecasts and their advantage lies in their amenability for
monitoring actuals for exercising control.
Cash reports provide a comparative picture of actual with forecasted figures and help in
controlling and revising cash forecasts continuously. Cash reports can be prepared in
several types and the important ones are (i) the daily cash report, (ii) the daily treasury
report and (iii) the monthly cash report.
Prompt Billing and mailing, collection of cheques and remittance of cash, centralized
purchases and payment to suppliers and playing the float are some of the factors that affect
the cash management.

478
The amount of cheques deposited by a company in the bank awaiting clearance is called
collection float.
The amount of cheques issued by the company awaiting payment by the bank is called
payment float.
The difference between payment float and collection float is called net float. When the
net float is positive, the balance in the books of the company is less than that in the banks
books; when net float is negative the book balance of the company is more than that in the
banks books.
The cash in excess of the firms normal cash requirements is termed as surplus cash. Before
determining the amount of surplus cash, the minimum cash balance required by the firm has
to be accounted. This minimum level may be termed as safety level for cash.
Desired days of cash is the number of days for which cash balance should be sufficient to
cover payments.
Average daily cash outflows is the average amount of disbursements to be made daily.
If future cash flows were known with certainty, the EOQ model (used in inventory
management) is one of the simple models for determining the optimal average amount of
transaction cash. Here, in this model, the opportunity (carrying) cost of holding cash, is
balanced against the fixed costs associated with securities transactions to arrive at an optimal
balance.
Capital Expenditure Decisions
Capital expenditure decisions occupy a very important place in corporate finance for the
following reasons: Once the decision is taken, it has far-reaching consequences which extend
over a considerably long period, which influences the risk complexion of the firm.These
decisions involve huge amounts of money.These decisions are irreversible once taken.These
are among the most difficult to make when the company is faced with various potentially
viable investment opportunities.
While capital expenditure decisions are extremely important, managers find it extremely
difficult to analyze the pros and cons and arrive at a decision because: Measuring costs and
benefits of an investment proposal whether it be a mini-steel plant or a library is difficult
because all costs and benefits cannot be expressed in tangible terms. The benefits of capital
expenditure are expected to occur for a number of years in the future which is highly
uncertain.Because the costs and benefits occur at different points of time, for a proper
analysis of the viability of the investment proposal, all these have to be brought to a common
time-frame. Hence time value of money becomes very relevant here.
The investment decision consists of (i) identification of potential investment opportunities
(ii) preliminary screening (iii) Feasinility study (iv) Implementation and (iv) Performance
Review.
The appraisal of a project includes the following types of appraisal:
Market Appraisal
Technical Appraisal
Financial Appraisal
Economic Appraisal.
Evaluation Criteria

Non-Discounting
Criteria

Discounting
Criteria

Payback
Period
Accounting
Rate of
Return
(ARR)
Net
Present
Value
(NPV
Benefit
Cost
Ratio
(BCR)
Internal
Rate of
Return
(IRR)
Annual
Capital
Charge

479
The financial appraisal of a project can be viewed as a two-step procedure:
Step 1: Define the stream of cash flows (both inflows and outflows) associated with the
project.
Step 2: Appraise the cash flow stream to determine whether the project is financially viable
or not. The two important assumptions that underlie the discussions are: (a) The cash flows
occur only once a year, (b) The risk characterising the project is similar to the risk
complexion of the on-going projects of the firm.
The payback period measures the length of time required to recover the initial outlay in the
project.
In order to use the payback period as a decision rule for accepting or rejecting the projects,
the firm has to decide upon an appropriate cut-off period. Projects with pay back periods less
than or equal to the cut-off period will be accepted and others will be rejected.
The accounting rate of return or the book rate of return is typically defined as follows:
Accounting Rate of Return (ARR) =Average Profit After Tax/Average book value of the
investment.
To use it as an appraisal criterion, the ARR of a project is compared with the ARR of the firm
as a whole or against some external yard-stick like the average rate of return for the industry
as a whole.
The net present value is equal to the present value of future cash flows and any immediate
cash outflow. In the case of a project, the immediate cash flow will be investment (cash
outflow) and the net present value will be therefore equal to the present value of future cash
inflows minus the initial investment.
A project will be accepted if its NPV is positive and rejected if its NPV is negative.
The NPV is a conceptually sound criterion of investment appraisal because it takes into
account the time value of money and considers the cash flow stream in its entirety. Since net
present value represents the contribution to the wealth of the shareholders, maximizing NPV
is congruent with the objective of investment decision making viz., maximization of
shareholders wealth.
The decision-rules based on the BCR (or alternatively the NBCR) criterion will be as
follows:
If -
BCR >1 (NBCR >0) Accept the project
BCR <1 (NBCR <0) Reject the project.
The internal rate of return is that rate of interest at which the net present value of a project is
equal to zero, or in other words, it is the rate which equates the present value of the cash
inflows to the present value of the cash outflows. While under NPV method the rate of
discounting is known (the firms cost of capital) under IRR this rate which makes NPV zero
has to be found out.
Annual Capital Charge: This appraisal criterion is used for evaluating mutually exclusive
projects or alternatives which provide similar service but have differing patterns of costs and
often unequal life spans.
480
Part I: Questions on Basic Concepts
Sources of Long-term Finance
1. Which of the following feature(s) of preference shares are similar to those of equity shares?
a. Redeemability.
b. No obligation to pay dividend.
c. Voting rights.
d. Charge over assets.
2. The costliest of long-term sources of finance is
a. Preference share capital
b. Retained earnings
c. Equity share capital
d. Debentures
e. Capital raised through private placement.
3. Euro-Convertible Bonds (ECBs) issued by Indian Companies refer to bonds issued in foreign
currency in
a. India or any country outside India
b. European countries only
c. Any country other than India
d. India and any country in Europe
e. Europe and North America.
4. At present, which of the following financial instruments are non-existent in India?
a. Convertible Preference Shares.
b. Partly Convertible Debentures.
c. Non-voting Shares.
d. Perpetual Preference Shares.
5. Which of the following is/are features of equity capital?
a. The payment of dividend is compulsory, irrespective of the companys financial
performance.
b. The dividend, if not paid during a year, becomes payable in the next year.
c. Dividend becomes payable only if recommended by the BoD and passed by the
company in the AGM.
6. Which of the following statement(s) is/are true? With the commencement of the Companies
Act, 1956 the issue of preference shares with voting rights has been restricted only to the
following cases:
i. There are arrears in dividends for two or more years in case of cumulative/preference shares.
ii. Preference dividend is due for a period of two or more consecutive preceding years.
iii. In the preceding six years including the immediately preceding financial year if the
company has not paid the preference dividend for a period of three or more years.
a. Both (i) and (ii) above.
b. Both (i) and (iii) above.
c. Both (ii) and (iii) above.
d. All of (i), (ii) and (iii) above.
Part I
481
7. A firm can raise capital from the primary market by the issue of securities in which of the
following ways?
a. Private placement.
b. Bought out deals.
c. Euro issues.
d. Rights issues.
8. If N are the number of shares required for a rights share; P
0
is the cum-rights price per share
and `S the subscription price at which rights shares are issued. Ex-rights share price will be:
a. V
0
=

0 1
E / P g +
b. V
0
=
0
P NS
N 1
+
+

c. V
0
=
0
N 1
NP S
+
+

d. V
0
=
0
0
NP 1
.
NP S
+
+

e. V
0
=
0
NP S
.
N 1
+
+

9. The major advantage of privately placing the securities are:
i. Easy access for any company.
ii. Fewer procedural formalities.
iii. Lower issue cost.
iv. Access to funds is faster.
a. Both (i) and (ii) above
b. Both (ii) and (iii) above
c. Both (iii) and (iv) above
d. All of (i), (ii) and (iv) above
e. All of (i), (ii), (iii) and (iv) above.
10. The major advantages of entering into a Bought-Out-Deal (BOD) is/are
i. Companies, both existing and new, which do not satisfy conditions laid down by SEBI
for premium issues, may issue at a premium through the BOD method.
ii. The procedural complexities are reduced considerably and the funds reach the firm
upfront.
iii. There is less issue cost.
iv. An advantage accruing to the investor is that the issue price usually reflects the
companys intrinsic value.
a. Both (i) and (iii) above
b. Both (i) and (ii) above
c. All (i), (ii) and (iv) above
d. All (ii), (iii) and (iv) above
e. All (i), (ii), (iii) and (iv) above.
482
11. Which one of the following is not a source of long-term finance?
a. Equity capital.
b. Preference capital.
c. Debenture capital.
e. Term loan.
12. A cumulative preference share is one
a. In which all the unpaid dividends are carried forward and payable
b. Which allows the issuing company the right to call the preference shares wholly or
partly at a certain price
c. Which can be converted in to equity shares
d. Which can be redeemed
e. Which entitle the preference shareholders to participate in surplus profits and assets.
13. Which of the following is true about equity capital as a source of finance?
a. Using equity capital to finance working capital may lead to a situation of technical
insolvency.
b. Assessing the cost of equity capital is a difficult and complex task.
c. Equity capital provides tax benefits to the issuing company.
d. Cost of retained earnings is lesser than the cost of debt capital.
14. When a company makes a rights issue, which of the following is true regarding the wealth of
the existing shareholders?
a. It will increase if he sells his rights.
b. It will not be affected, if he allows his rights to expire.
c. It will increase if he exercise the rights.
d. It will decrease if he allows the right to expire.
15. The theoretical value of a right is given by the formula
( )
( )
0
P S
N 1
+
where P
0
stands for
a. Ex-rights market price per share
b. Cum-rights market price per share
c. Par value per share
d. The number of right shares allotted
16. Rights issue is the method of raising funds
a. By issuing securities simultaneously to the existing shareholders and the public issue
b. Generally issued to the existing shareholders at a price lower than the current market price
c. Generally entails lower costs of issue
d. Generally made to high net worth individuals
17. Which of the following statement/s is/are true?

a. Equity shareholders enjoy the rewards of ownership and bear the risks of the ownership.
b. Post-tax cost of debentures is always less than the post-tax cost of the term loans.
c. The par value and issue price of an equity share are always equal.
d. All outstanding issues of shares are traded in the primary markets.
e. The interest payment on irredeemable debentures is a statutory obligation where as the
interest payment on redeemable debentures is not.
Part I
483
18. Which of the following, from the firms point of view, can be considered as the advantage of
using equity capital as a source of long-term funds?
a. If does not involve any fixed obligation for payment of dividends.
b. Equity dividends are payable frompost-tax earnings. They are not tax-deductible expenses.
c. It enhances the creditworthiness of the company.
19. Which of the following characteristics are true, with reference to preference capital?
a. Preference dividend is payable only out of distributable profits.
b. Preference dividend is tax deductible.
c. The claim of preference shareholders is prior to the claim of equity shareholders.
20. What are the factors which make debentures attractive to investors?
a. They enjoy a high order of priority in the event of liquidation.
b. Stable rate of return.
c. Protected by the provisions of Debenture Trust Deed.
21. The salient features of cumulative convertible preference shares are
a. Only public limited companies are entitled to issue them
b. The dividends paid are tax-deductible
c. They must be listed on one or more recognized sock exchanges
22. The method of raising equity capital from existing members by offering securities on pro rata
basis is referred to as
a. Public issue
b. Rights issue
c. Bonus issue
e. Bought-Out-Deal.
23. Which of the following is not a source of long-term finance?
a. Equity shares
b. Debentures
c. Preference shares
d. Commercial papers
e. Reserves and surplus
24. A company is in dire need for funds but lost the confidence of its shareholders due to the
inadequate return on investments. Which of the following methods is/are suitable to that
company to raise funds?
a. Public issue.
b. Rights issue.
c. Private placement.
d. Bought out deals.
484
25. For which of the following factors are the debentures more attractive to the investors?
a. The rate of return is specified at the time of investment.
b. The principal is redeemable at maturity.
c. A debenture-holder enjoys prior claim on the assets of the company over its
shareholders in the event of liquidation.
d. A trustee is appointed to preserve the interest of the debenture holders.
e. All of the above
26. If debentures are issued by a company,
a. The interest of the debenture holders is assured by SEBI
b. Debenture redemption reserve should be at least 75 percent of the issue amount prior to
the commencement of the redemption process
c. Debenture redemption reserve must be created if the maturity period is less than 18 months
d. Call option on debentures allows the issuer to redeem the debentures at a certain price
before maturity
e. Put option on debentures allows the issuer to redeem the debentures at a certain price
before maturity.
27. A company may raise capital from the primary market through
a. Public issue
b. Rights issue
c. Bought Out Deals
d. Private placements
28. According to traditional approach, the average cost of capital
a. Remains constant up to a degree of leverage and rises sharply thereafter with every
increase in leverage
b. Rises constantly with increase in leverage
c. Decreases up to a certain point, remains unchanged for moderate increase in leverage
and rises beyond a certain point
d. Decreases at an increasing rate with increase in leverage
e. Increases up to a certain point, remains constant for moderate decrease in leverage and
decreases beyond a certain point.
29. Which of the following approaches advocates that the costs of equity capital and debt capital
remain unaltered when the degree of leverage varies?
a. Net Income Approach.
b. Net Operating Income Approach.
c. Traditional Approach.
d. Modigliani-Miller Approach.
30. The cost of capital of a firm is
a. The dividend paid on the equity capital
b. The weighted average of the dividends paid on the equity capital and the preference capital
c. The weighted average of the cost of various long-term and short-term sources of finance
d. The average rate of return it must earn on its investments to satisfy the various investors
e. The minimum rate of return it must earn on its investments to keep its investors
satisfied.
Part I
485
31. The constant growth model of equity valuation assumes that
a The dividends paid by the company remain constant
b. The dividends paid by the company grow at a constant rate of growth
c. The cost of equity may be less than or equal to the growth rate
d. The growth rate is less than the cost of equity

a. The cost of retained earnings is always less than the cost of external equity.
b. The cost of external equity is always less than the cost of retained earnings.
c. The cost of retained earnings is lower than the cost of external equity in the presence of
flotation costs.
d. In the presence of flotation costs, the cost of external equity is less than the retained
earnings.
33. Cost of equity capital is
a. Lesser than the cost of debt capital
b. Equal to the last dividend paid to the equity shareholders
c. Equal to the dividend expectations of equity shareholders for the coming year
d. Equal to the discounting factor which equates the net amount realized from the issue to
the future dividend payments
34. Which of the following is not a feature of an optimal capital structure?
a. Profitability.
b. Safety.
c. Flexibility.
d. Control.
e. Solvency.
35. The overall capitalization rate and the cost of debt remains constant for all degrees of
leverage. This is pronounced by
a. Traditional approach
b. Miller and Modigliani approach
c. Net operating income approach
d. Net income approach
36. Agency cost arises due to
a. Cost overrun in implementing new projects
b. Failure of budgeted cost
c. Restrictions imposed by the supplier of debt capital
d. Rise in the cost of production
37. While calculating weighted average cost of capital
a. Retained earnings are excluded
b. Bank borrowings for working capital are included
c. Cost of issues are included
d. Weights are based on market value or on book value
e. Equity shares are given more weights.
486
a. The company should make maximum use of leverage at a minimum cost.
b. The capital structure should be flexible to be able to meet the changing conditions.
c. The capital structure should involve minimum dilution of control of the company.
d. The company should aim at not using excessive debt in its capital structure.
e. The company should make minimum use of leverage at a minimum cost.
39. Which of the following is not an assumption of Miller and Modigliani approach?
a. There are no corporate or personal income tax.
b. Firms can be grouped into equivalent return classes on the basis of their business risks.
c. Investors are assumed to be rational and behave accordingly.
d. There is no corporate tax though there are personal income tax.
e. Capital markets are perfect.
40. An appropriation formula for calculating the cost of debenture is
a. K
d

I (F P)/ n
(F P)/ 2
+
=
+

b. K
d

I(1 t) (F P)/ n
(F P)/ n
+
=
+

c. K
d

F/ N I(1 T)
(F P)/ n
+
=
+

d. K
d

I(1 t) (F P)/ n
(F P)/ 2
+
=
+

e. K
d

I / 2 F P
F P
+
=
+
.
41. The important assumption(s) underlying the definition of cost of capital is/are:
i. The risk characterizing the new project under consideration is not significantly different
from the risk characterizing the existing investments of the firm.
ii. The firm will continue to pursue the same financing policies.
iii. The management of the firm will remain the same.
iv. The firm will be part of a growing market.
a. Both (i) and (ii) above
b. Both (ii) and (iii) above
c. Both (ii) and (iv) above
d. Both (i) and (iv) above
42. Which of the following is/are assumption(s) underlying the Miller and Modigliani analysis?
b. Investors are assumed to be rational and behave accordingly.
c. The average expected future operating earnings of a firm are subjected to random
variables.
d. There is no corporate or personal income tax.
Part I
487
43. The Bond Yield Plus Risk Premium Approach is a method of finding out the cost of
a. Preference capital
b. Equity capital
c. Debenture capital
d. Term loans
44. Which of the following is/are an assumption behind the realized yield approach?
a. The yield earned by investors has been, on average, in confirmity with their expectations.
b. The future expectations of the investors are similar to their past expectations.
c. The dividends will continue growing at a constant rate forever.
d. The market price will continue growing at a constant rate forever.
45. Which of the following is not an advantage of using book value weights for computing the
cost of capital?
a. The calculation of the weights is very simple.
b. Book value weights are likely to fluctuate less over a period as these are not affected by
the fluctuations in market prices.
c. Book value weights are the only usable basis when market values are not obtainable or reliable.
d. Book value weights are consistent with the concept of cost of capital.
46. According to the net operating income approach
a. The equity capitalization rate remains constant with any increase or decrease in the
degree of leverage
b. The overall capitalization rate of the firmdecreases as the degree of leverage increases
c. The market is assumed to capitalize the firm at a discount rate that is independent of the
firms degree of leverage
d. The cost of debt increases with increase in the degree of leverage
e. The overall capitalization rate increases as the degree of leverage increases.
47. Which of the following is not an assumption in the Miller & Modigliani approach?
a. There are no transaction costs.
b. Securities are infinitely divisible.
c. Investors are rational.
d. Investors have homogeneous expectations.
e. All the firms pay tax on their income at the same rate.
48. _________Which of the following regarding cost of capital of a new project is not true?
a. Risk characteristics of new investment need not be the same as that of existing
investments of a firm.
b. Capital structure will be affected by new investment when it is funded frominternal sources.
c. We can take overall cost of equity as cost of capital.
488
49. Which of the following is/aretrue regarding cost of capital?
a. It is a measure of the returns required by all the suppliers of long-term finance.
b. It is equal to the Internal Rate of Return of a project if the projects Net Present Value is zero.
c. It is the weighted arithmetic average of the cost of the various sources of long-term
finance used.
50. The cost of debt capital, k
d
, is defined as the value which satisfies the equation
n
t n
t 1 d d
C(1 T) F
P
(1 k ) (1 k )
=
= +
+ +

where P & F stand respectively for
a. Net amount realized on debt issue and redemption price
b. Redemption price and net amount realized on debt issue
c. Net proceeds received and face value of debt
d. Par value of debt and redemption price
e. Current market price and face value.
51. While calculating the weighted average cost of capital, market value weights are preferred
because
a. Book value weights are historical in nature
b. It is very difficult to estimate book value weights at the time of calculating the weighted
average cost
c. This is in conformity with the definition of cost of capital as the investors minimum
required rate of return
d. Book value weights fluctuate violently
e. Market value weights are fairly consistent over a period of time.
52. Which, among the following, are common misconceptions about cost of capital?
a. Depreciation-generated funds have no cost.
b. Cost of capital is low if a project is heavily debt-financed.
c. Cost of equity is equal to the dividend rate.
53. Identify the correct expression among the following, to express the tax advantage of debt
where t
c
is the corporate tax rate, t
ps
is the personal tax on equity income, t
pd
is the personal
tax rate on debt income and B is the face value of debt.
a. t
c
B(1 t
c
)
b. t
p
.B(1 t
c
)
c.
c ps
pd
(1 t )(1 t )
1
(1 t )

B
d.
pd
c
(1 t )
(1 t )

e.
c td
ps
1 (1 t )(1 t )
(1 t )

.
Part I
489
54. Which of the following is not an assumption made by Modigliani-Miler in their propositions
on market value of firms?
b. Investors are rational.
c. Investors have different expectations about future operating earnings.
d. Firms can be grouped into equivalent risk classes on the basis of their business risk.
55. Cost of equity capital
a. Is lesser than the cost of debt capital
b. Is equal to the dividend rate expectations of equity shareholders for the coming year
c. Is equal to the discounting factor which equates the net amount realized from the equity
issue to the present value of future dividend payments
d. Is equal to the dividend rate declared on equity shares
e. Is equal to the return earned on equity capital.
56. Which of the following is/are true with respect to the capital structure of a 100% Export
Oriented Unit?
a. Equity capital should be preferred to term loans.
b. Term loans should be preferred to equity capital.
c. Internal accruals should be preferred to term loans.
57. While calculating weighted average cost of capital
a. Preference shares are given more weightage
b. Cost of issue is considered
c. Retained earnings are always excluded
d. Tax factor is ignored.
58. Cost of retained earnings is equal to
a. Cost of equity to be issued
b. Cost of internal equity
c. Rate of dividend expected to be declared
d. Dividend pay-out ratio
e. Present rate of dividend declared.
59. Under which of the following approach(es) cost of equity capital is assumed to be constant
with the change in leverage?
a. Net income approach.
b. Net operating income approach.
c. Modigliani and Miller approach.
490
60. Which of the following statement/s is/are true according to traditional approach of capital
structure?
a. Cost of capital increases with the use of debt after a certain amount of debt and later
falls.
b. Cost of equity and debt more or less remain constant with the use of debt up to a certain
amount of debt.
c. Cost of equity declines and cost of debt remains constant with increase in debt.
d. Cost of equity declines and cost of debt increases with increase in debt.
e. Cost of equity and cost of debt increase with the use of debt up to a certain amount of
debt.
61. Which of the following ratios is not affected by the financial structure and the tax rate of a
company?
a. Return on equity.
b. Net profit margin.
c. Earning power.
d. Earnings per share.
e. Capitalization rate.
62. Where E
0
is current earning, P
0
is the current market price and g is the growth rate, according
to Earnings Price Ratio approach, the cost of equity is equal to
a. [E
0
(1 +g)/P
0
] +g
b. E
0
/P
1
+g
c. E
1
/P
0
(1 +g) +g
d. E
0
/P
0

+g
e. E
1

P
0
.
63. Which of the following features distinguishes a cumulative preference share from
non-cumulative preference shares?
a. It is always irredeemable.
b. Cumulative preference share holders are eligible to receive dividends at a variable rate
not exceeding a specified limit.
c. Cumulative preference share holders are eligible to get all the arrears of preference
dividends before the declaration of any equity dividend.
d. A cumulative preference share holder enjoys right to participate in surplus profits after
equity dividends have been paid.
e. It may be redeemed after a specified maturity period at the discretion of the company.
64. Which of the following is not a merit of using book values as weights for calculating the
weighted average cost of capital?
a. The book value weights are independent of the fluctuations of the market prices.
b. The calculation of weights is simple.
c. The book values of the different sources of finance are approximately related to their
present economic values.
d. The book value weights are suitable for a firm whose securities are not traded regularly.
e. The book value weights are the most suitable for the unlisted firms.
65. Which of the following is/are false regarding capital structure theory as stated by Miller and
Modigliani?
i. If agency costs are considered, the expected agency costs increases as the debt-equity
ratio decreases.
ii. With the given assumptions, there is no optimal capital structure.
Part I
491
iii. In the presence of taxes, the market value of the firm decreases by the tax shield of debt.
a. Only (i) above
b. Only (ii) above
c. Both (i) and (ii) above
d. Both (i) and (iii) above
66. Which of the following assumption(s) is/are correct with respect to the definition of cost of
capital under capital expenditure decisions?
i. The risk profile of the new project to be implemented is significantly higher than the
risk profile of the earlier capital investments made by the firm
ii. The management of the firm will not change for the new project
iii. The firm will continue to adopt the same debt to equity ratio
a. Only (i) above.
b. Only (ii) above.
67. Which of the following factors influence(s) the capital structure of a business entity?
a. Bargaining power with the suppliers.
b. Demand for the product of the company.
c. Expected income.
d. Technology adopted.
e. Adequacy of the assets to meet any sudden spurt in demand.
68. Which of the following is false about equity capital as a source of finance?
a. Using equity capital to finance working capital will never lead to technical insolvency.
b. Assessing the cost of equity capital is an easy task.
c. Dividend to the equity shareholders do not provide any tax benefit to a company.
d. Cost of equity capital is generally more than the cost of debt.
e. The more a company depends on equity capital the less will be the financial risk.
69. In the calculation of the weighted average cost of capital, why are the weights based on the
market values preferred?
a. The weights based on the book values are difficult to estimate while calculating the
weighted average cost of capital.
b. Weights based on the market values are fairly constant in nature.
c. Weights based on the book values have a high degree of volatility.
d. The weights based on the book values are historical in nature and may not reflect the
true economic value.
70. Which of the following statements related to the capital structure theories is true?
a. According to net income approach, the costs of equity and debt remain constant
irrespective of the degree of leverage.
b. As per the traditional approach, the overall cost of capital for a firm remains same for
all degrees of leverage.
c. A firm should choose the debt-equity ratio in such a way that it will minimize the tax
liability.
d. The higher the degree of leverage, the lower the risk to the equity shareholders.
e. According to the net operating income approach, the overall cost of capital increases as
the degree of leverage increases.
492
71. Which of the following statements is an assumption under Miller and Modigliani approach to
capital structure?
a. Investors are assumed to be greedy.
b. The average expected future operating earnings of any firm are certain and same as that
of the others belonging to the same class of business risk.
c. Firms can be grouped into the equivalent return classes based on their business risk.
d. Individuals and business firms are liable to pay taxes.
e. The securities are traded in marketable lots only.
72. Calculate the realized yield from the price per share at the beginning of the year =Rs.10
Year 1 2 3
DPs 2.00 2.80 3.20
Price/share at the end of the year 11.75 12.50 13.40
a. 21.52%
b. 33.47%
c. 38.72%
d. 27.56%
e. 18.41%
73. Which of the following approaches to dividend policy assumes a constant amount of EPS for
all the subsequent years for all the firms within an industry?
a. Net income approach.
b. Net operating approach.
c. Walter Model.
d. Capital asset pricing model.
74. If N be the number of existing shares, which are presently traded at a price P, required to be held
by an investor to get one rights share at a subscription price S, then the value of a right will be
a. (NP +S) / (N +1)
b. (NP S) / (N 1)
c. (P S) / (N +1)
d. (P +S) / N
e. (P S) / (N 1).
75. Which of the following factors does not affect the capital structure of a company?
a. Cost of capital.
b. Composition of the current assets.
c. Size of the company.
d. Dilution of control.
e. Expected nature of cash flows.
Dividend Policy
76. In order to maximize the value of a firmaccording to Walter Model, when the return on investment
is more than the cost of equity capital, the firmshould
a. Adopt 100% dividend pay-out policy
b. Not pay dividends at all
c. Be indifferent as to the dividend policy
d. Plough back 50% of profits and pay the rest as dividends
e. Leave the decision of dividend payment to the discretion of Board of Directors.
77. Which of the following is true with respect to Miller-Modigliani model on dividend policies?
a. If the firm declares dividends, the share price goes up.
b. If the firmdeclares dividends, the share price comes down since retained earnings decrease.
c. The market value of the share is not affected by dividend policy.
d. The share price goes up only when the dividends grow at a fixed rate.
e. Share price is influenced not only by dividend policy, but by a host of other factors too.
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493
78. Which of the following methods does a firm resort to avoid dividend payments?
a. Share splitting.
b. Declaring bonus shares.
c. Rights issue.
79. Which of the following is the assumption of the MM model on dividend policy?
a. The firm is an all-equity firm.
b. The investments of the firm are financed solely by retained earnings.
c. There is no change in the risk complexion of the firm.
d. The firm has an infinite life.
80. The rational expectations model of dividend policy says that
a. Since the expectations of the investors are always rational, there will be no effect of
dividend policy on the valuation of the firm
b. If the investors have rational expectations, they will value a dividend paying firm higher
than a non-dividend paying firm
c. If the investors have rational expectations, they will value a non-dividend paying
firm higher than a dividend paying firm
d. If the declared dividend is in line with the expectations of the investors, there will
be no effect on the valuation of the firm
e. If the declared dividend is in accordance with the expectations of the investors, the
change in the firms value will be minimal.
81. Which of the following real life factors go against the initial dividend theory propounded by
Modigliani-Miller?
a. Different tax rates applicable to income and capital gains.
b. The presence of flotation costs.
c. The presence of transaction costs.
d. Underpricing of shares.
e. All of (a), (b), (c) and (d) above.
82. According to the Walter Model, a firm should have 100% dividend pay-out ratio when
a. r =k
e
b. r <k
e
c. r >k
e
d. g >k
e
e. g =k
e
.
83. Which approach of dividend policy states that the stock value responds positively to higher
dividends and negatively when there are low dividends?
a. Traditional position.
b. Walter model.
c. Gordon model.
d. Miller and Modigliani position.
e. Rational expectations model.
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84. Which of the following is not an assumption of Gordons Dividend Capitalization model?
a. Firm has an infinite life.
b. Return on investment varies with leverage.
c. Retention ratio remains constant.
d. Cost of equity capital is greater than growth rate.
e. Cost of equity capital remains constant.
85. Which of the following is not an assumption underlying the Walters Model on dividend policy?
a. Retained earnings is the only source of finance available to the firm, with no outside
debt or additional equity used.
b. Firm has an infinite life.
c. For a given value of the firm, the dividend per share and earnings per share remain constant.
d. The internal rate of return and firms cost of capital are assumed to vary in fixed
proportions and thus additional investments made by the firm will change its risk and
return profile.
e. The internal rate of return and firms cost of capital are assumed to be constant and thus
additional investments made by the firm will not change its risk and return profiles.
86. Which of the following statement(s) is/are true? Gordons dividend policy for firms is based
on the following assumptions.
i. The firm will be an all equity firm with the new investment proposals being financed
solely by the retained earnings.
ii. Return on investment (r) and the cost of equity capital (K
e
) remain constant.

iii. The retention ratio remains constant and hence the growth rate also is constant.
a. (i) only.
b. (ii) only.
c. (ii) and (iii) only.
d. (i) and (iii) only.
87. According to the traditional position on dividend policy, the weight attached to the dividends
in the valuation of shares is
a. One-fourth of the weights attached to the retained earnings
b. Half of the weights attached to the retained earnings
c. Same as the weights attached to the retained earnings
d. Twice the weights attached to the retained earnings
e. Four times the weights attached to the retained earnings.
88. Which of the following is not an assumption in the Walters Model of dividend policy?

a. Retained earnings represents the only source of financing for the firm.
b. Return on the firms investment remains constant.
c. Cost of capital of the firm remains constant.
d. The firm has infinite life.
e. The risk and return profiles of the firm are subject to change resulting from additional
investments made by the firm.
89. Which of the following is not a common assumption in the Walters model and Gordons
model on dividend policy?
a. Retained earnings represent the only source of financing for the firm.
b. The rate of return on the firms investment is constant.
c. The cost of capital of the firm remains constant.
d. The firm has an infinite life.
e. The cost of capital is greater than the growth rate.
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90. The Debt-Equity Ratio of a Company
a. Affects its financial leverage
b. Does not affect the Earnings Per Share
c. Affects the dividend decision of the company
91. Dividend changes are perceived important than the absolute level of dividends because
a. Management change dividends to protect their seats
b. Dividend changes have signal value for future
c. MM state that absolute level of dividends is irrelevant
d. Changes determine the level of borrowing
e. Dividend changes are better than constant dividends.
92. If the expected dividend is less than the actual dividend paid, the rational expectation
approach suggests that the
a. Share price increases
b. Value of the firm will go up
c. Dividend and the share price are not related
d. Share price will go down
93. Which of the following statement(s) is/are true, as per the basic Gordon Model?
a. The price per share increases as the dividend pay-out increases, when the rate of return
is greater than the discount rate.
b. When the rate of return is less than the discount rate, the price per share increases as the
dividend pay-out ratio increases.
c. When the rate of return is greater than the discount rate, the price per share increases as
the dividend pay-out decreases.
94. According to Modigliani and Miller theory on dividends, which of the following is true?
a. As dividend pay-out ratio increases, value of the share decreases if it is a growth firm.
b. As dividend pay-out ratio decreases, value of the share decreases if it is a declining
firm.
c. Dividend pay-out ratio is irrelevant if it is a normal firm.
d. Dividend pay-out ratio is irrelevant for all firms.
e. Irrespective of nature of firm, as dividend increases the value of the share increases.
95. If expected earnings per share is EPS, equity capitalization rate is k
e
, dividend pay-out ratio
is 100% and growth rate is nil, then the value of share is equal to
a. EPS/k
e
b. EPS k
e
c. k
e
/EPS
d. EPS/(1 +k
e
)
e. EPS(1 +k
e
).
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96. According to Gordons model, the optimal dividend pay-out ratio for a firm whose cost of
capital and return on investment are 15% and 12% respectively is
a. 100%
b. 80%
c. 60%
d. 0%
e. No relationship between dividend pay-out ratio, cost of capital and return on investment.
97. Which of the following is true according to the rational expectations model of dividend policy?
a. The market price of the stock responds positively to higher dividends.
b. When the return on investment is greater than the cost of capital, there is an inverse
relationship between value of the share and pay-out ratio.
c. The dividend pay-out ratio is irrelevant for the valuation of a stock.
d. There is a positive relationship between dividends declared and the stock price, if the
dividends declared are more than the expected dividends.
e. There is always a negative relationship between the pay-out ratio and the value of a
share.
98. Agency costs are the costs arising out of
a. Restrictive covenants imposed by the creditors of a firm at the time of lending
b. Large dividend payments made to the equity and preference shareholders
c. The servicing of the debt capital
d. The cost of recovering dues from the debtors through a chain of collection agents
e. The fees to be paid to a financial analyst for designing the capital structure.
99. Walters model on dividend policy assumes that
a. The firm offers an increasing amount of dividend per share at a given level of price per
share
b. The firm has a finite life
c. The cost of capital of the firm is variable
d. The internal rate of return on the firms investments is gradually decreasing
e. The retained earnings are the only source of finance available to the firm.
100. Which of the following approaches assumes that the future expectations of the investors are
same as that of their past expectations for the estimation of cost of equity capital?
a. Realized yield approach.
b. Dividend forecast approach.
c. Bond yield plus risk premium approach.
d. Earnings price ratio approach.
e. Capital asset pricing model approach.
101. If the dividend declared is lower than the expectation of the shareholders, what will be
probable consequence according to the rational expectations model?
a. The share price will remain same.
b. The shareholders will expect a lower dividend per share in future.
c. The share price will start rising after some time.
d. The share price will fall immediately.
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102. Which of the following is an assumption of the Gordons Dividend Capitalization Model?
a. The financial risk of the company is same as that of its peers in the same industry.
b. It is applicable to companies that finance their investments by using retained earnings.
c. It is applicable for the levered firms only.
d. If the return on investment is greater than the cost of capital, the retention ratio should
be less.
e. The life of the firm is for a limited period only.
103. Which of the following concepts of dividend policies considers the changes in dividend
payment vis--vis the expectations of shareholders as more important than the absolute value
of the dividend actually paid by a company?
a. Traditional position.
b. Walter model.
c. Gordon model.
d. Miller and Modigliani model.
e. Rational expectation model.
104. Net working capital can be said to be financed by
a. Cash credit
b. Overdraft
c. Equity capital only
d. Term loan only
e. Long-term sources of capital.
105. The relationship between market price (P) and dividend per share (D) as per Traditional
Approach is: (where E is the earnings per share and m is a multiplier chosen arbitrarily)
a. D =m(P +E/3)
b. P =m(D +E)/3
c. P =m(D/3 +E)
d. P =m(D +E/3)
e. P =m(D/3) +E.
106. Which of the following statements is an assumption of the Walters Model on dividend policy?
a. The firm may resort to external financing debt or equity for additional investments,
if any such opportunity arises.
b. The return on investment for the firm will vary depending upon the economy.
c. The firm has a limited life.
d. For a given value of the firm, the dividend per share and the earnings per share will
remain constant.
e. The cost of equity for the firm will vary as the return expectations of the shareholders
change.
107. Which of the following models on dividend policy stresses on the investors preference for
the current dividends?
a. Traditional Model.
b. Walter Model.
c. Gordon Model.
d. Miller and Modigliani Model.
e. Rational expectation model.
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108. The phenomenon of overtrading in working capital is characterized by
a. Less amount of cash invested in current assets
b. Overcapitalization of the company as compared to volume of sales
c. High amount of cash invested in current assets
109. If the average collection period of a company is higher than the credit period extended by it,
the firm is supposed to have a
a. Satisfactory liquidity position
b. Liquidity crunch
c. High liquidity
d. Collection period has no effect on liquidity
e. Either (a) or (c) above.
110. Which of the following is/are not measure(s) to curb the situation of undertrading?
a. Changing the capital structure to bring down debt/equity ratio.
b. Selling of some fixed assets.
c. Hastening the collection process.
d. Reducing inventory levels.
e. All of (a), (c) and (d) above.
111. Which of the following items does not figure while calculating finished goods storage period?
a. Excise duty.
b. Selling and distribution costs.
c. Financial costs.
d. Cost of production.
e. Average daily credit purchases.
112. Which of the following is a determinant of working capital of a firm?
a. Depreciation policy.
b. Taxes payable by the firm.
c. Production policy.
113. Operating cycle can be delayed by
a. Increase in WIP period
b. Decrease in raw materials storage period
c. Decrease in credit payment period
114. In which of the following enterprises the ratio of current assets to total assets is highest?
a. Electricity generation and distribution firms.
b. Restaurants and Bakeries.
c. Software development firms.
d. Construction and real estate firms.
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115. Technical insolvency refers to
a. Bankruptcy on the part of the firm
b. Inability to pay debts by a firm for the purchase of machinery
c. Inability to pay debts by a firm for the transfer of technology
d. Inability to honor its current liabilities
116. The management of current assets is a trade-off between
a. Risk and Return
b. Liquidity and Profitability
c. Current ratio and Current assets turnover ratio
117. If the conversion period is arrived at as 10, it means
a. It takes 10 days to convert the raw materials to finished goods
b. 10 days cost of production is held on an average as WIP
c. Raw materials which can be consumed in 10 days are held in WIP
118. The results of overtrading may be
a. Overcapitalization
b. Illiquidity
c. Technical insolvency
119. Which of the following is not a current asset?
a. Cash in hand.
b. Cash in transit.
c. Goods on consignment.
d. Debtors.
a. A company following an aggressive working capital policy will finance its current
assets more from long-term sources.
b. A company following a conservative working capital policy will finance its current
assets more from long-term sources.
c. A company having a conservative working capital policy will have a higher current
ratio than one following an aggressive working capital policy.
121. According to the dynamic view of working capital
a. Gross working capital is defined as the total of all current assets
b. Net working capital is the difference between total current assets and total current
liabilities
c. Working capital is the amount of capital required for the smooth flow of the normal
business operations of the company
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122. Which of the following statements is/are true in respect of working capital?
a. Gross Working Capital is the sum of the total current assets.
b. Net working capital represents the margin on working capital supported by long-termfunds.
c. Net working capital can be negative.
123. Undertrading means
a. Having low amount of working capital
b. High turnover of working capital
c. Sales are less compared to assets employed
d. Assets are less compared to sales generated
e. Low turnover of working capital.
124. Working capital gap is
a. Equal to current assets plus current liabilities including bank borrowings
b. Equal to current assets less current liabilities including bank borrowings
c. Equal to current assets less current liabilities excluding bank borrowings
d. Equal to current assets plus current liabilities other than bank borrowings
125. Working capital margin is
a. The difference between current assets and current liabilities
b. The increase in working capital requirement as a result of increased production
c. The portion of working capital requirement that will be financed through bank loans
d. The portion of working capital which will be financed through long-term sources
126. Overtrading implies
a. A disproportionately high investment in current assets compared to the value of sales
b. Greater sales generated by smaller investment in current assets
c. A high turnover of current assets in proportion to sales
d. High turnover of working capital
127. The average collection period is determined by
a. Daily credit sales divided by average balance in receivable account
b. Balance in receivable account divided by average daily credit sales
c. Total credit sales divided by average balance in receivable account
d. Balance in the receivables account divided by average total credit sales
128. Which of the following is not

a factor that affects the composition of the working capital?
a. Nature of business.
b. Nature of raw materials used.
c. Tax structure of the company.
d. Process technology used.
e. Nature of finished goods.

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129. Which of the following statement(s) is/are true of undertrading?
a. The symptoms of undertrading can be noticed from the disproportionately high turnover
of assets compared to the volume of sales.
b. Precautionary measures for undertrading can be taken by initially reducing the sales to a
level commensurate with the amount of assets.
c. Undertrading arises when the volume of sales is much less than the amount of assets
employed.
d. Undertrading also indicates that funds of the company are locked up in current assets
resulting on lower turnover of working capital.
130. Which of the following is/are criterion/criteria for evaluation of working capital
management?
a. Liquidity.
b. Inventory turnover.
c. Availability of cash.
d. Credit obtained from suppliers.
131. Current assets are characterized by
a. Short life span
b. Long life span
c. Quick transformation into other forms of asset
d. A greater significance of time value of money
132. Which of the following factors does not influence the composition of working capital?
b. Nature of raw materials used.
c. Nature of finished goods.
d. Financial leverage of the firm.
e. Degree of competition.
133. If the net working capital is negative then it indicates that
a. Long-term funds have been used for financing short-term assets
b. Long-term funds have been used for financing long-term assets
c. Short-term funds have been used for financing long-term assets
d. Short-term funds have been used for financing short-term assets
e. The financing structure of the firm is normal.
134. Which of the following will not be considered as a current asset?

a. Sundry debtors.
b. Cash.
c. Marketable securities.
d. Inventories.
e. Goodwill.
502
135. Which of the following measures should be taken to overcome undertrading?
a. Increasing the debt-equity ratio.
b. Decreasing the debt-equity ratio.
c. Hastening the collection process.
d. Slowing down the collection process.
136. Which of the following factors have bearing on working capital management?
a. Import duties on capital goods.
b. Manufacturing cycle.
c. Continuity in the supply of raw material.
137. Which of the following is/are true whena company follows a conservative working capital policy?
a. The ratio of current assets to sales is at the minimum.
b. Profitability is sacrificed for liquidity.
c. The cost of financing current assets is greater as compared to an aggressive policy.
138. Fill in the blanks with most appropriate combination.
Compared to the management of fixed assets, in the management of current assets the
consideration of time value of money is _____ important, liquidity is _____important and
profitability is _____ important.
a. Less, less, equally
b. Less, more, equally
c. More, less, equally
d. More, more, equally
e. More, more, less.
139. Two most important issues in formulating working capital policy are
a. Nature of business and operating cycle
b. Trade credit and permissible bank finance
c. The ratios of current assets to sales and short-term financing to long-term financing
d. The level of current ratio and quick ratio
e. Working capital margin and working capital gap.
140. The profit criterion for working capital
a. Is relevant in analyzing working capital decisions
b. Is compulsory for analyzing working capital decisions
c. May be substituted with the Net Present Value criterion in analyzing working capital
decisions
d. May be substituted with PVIFA concept for analyzing working capital decisions
141. If the net working capital is negative, it signifies that
a. Current ratio is negative
b. The current ratio is less than 1
c. Long-term uses are met out of short-term sources
d. The liquidity position is not comfortable
e. All of (b), (c) and (d) above.
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142. A current ratio less than one implies
a. Negative net working capital
b. Financing of working capital using long-term sources
c. Adoption of a conservative working capital policy
d. A low debt service coverage ratio
143. The criterion of profit per period is equivalent to the criterion of net present value in the case
of current assets because
a. Current assets form a small fraction of total assets
b. Investment in current assets is reversible
c. The value of current assets is higher than the value of current liabilities
d. Part of the current assets are financed from long-term sources
144. When the current ratio is less than one, to improve the ratio the firm should adopt which of
the following strategy(ies)?
a. Sell marketable securities for cash at their investment cost.
b. Pay-off accounts payable.
c. Sell inventory at cost on credit.
d. Buy inventory on credit.
145. Net operating cycle period is
a. Equal to the accounting period of the company
b. The period from raw material procurement to sale of finished goods.
c. The length of time taken for a rupee invested in current assets to come back with profit
to the company
d. The time taken to convert raw materials into finished goods
e. The time between payment of raw material purchases and the collection of cash for sales.
146. The fact that current assets can be easily liquidated leads us to the conclusion that
a. Investment in current assets is reversible
b. Net profit per period is equivalent the net present value of the investment
c. The profit for the year will be equal to Initial Investment (Rate of Returns less cost of
capital)
d. All of (a), (b) and (c) above
147. Operating cycle can be shortened by increasing
a. Manufacturing time
b. Duration of credit availed
c. Credit period to the customer
d. Stock held in stores
148. Which of the following is true with respect to net working capital?
a. It is the total of current assets.
b. It is necessarily financed by short-term funds.
c. It is the difference between current assets and spontaneous current liabilities.
d. Negative net working capital implies long-term funds utilized for short-term purposes.
e. It is equal to the sum of long-term liabilities and owners equity less net fixed assets.
504
149. Which of the following is true regarding net operating cycle?

a. It is the sum of inventory conversion period, book debts conversion period and the
payables deferral period.
b. It is the sum of inventory conversion period and book debts conversion period.
c. It is the sum of inventory conversion period and book debts conversion period less
payments deferral period.
d. It is the difference of the payments deferral period and the book debts conversion
period.
e. It is the difference of the payments deferral period and the inventory conversion period.
150. The duration of the operating cycle can be reduced by
a. Increasing the time available for payments to creditors
b. Increasing the raw material storage period
c. Decreasing the work-in-progress period
151. Which of the following is correct with respect to undertrading?
a. Low amount of assets employed in the business of an entity.
b. Low amount of working capital required by a company.
c. Less amount of sales turnover achieved by a company in comparison to the level of
working capital.
d. It is very risky situation in relation to the working capital management of a company.
e. Low cost of funds employed in the management of working capital..
152. Which of the following factors influences the choice of liquidity mix to be maintained by a
company?
a. Nature of control with the managers.
b. Extent of leverage.
c. Marginal cost of capital.
d. Quality of the product of the company.
e. Uncertainty in cash flows.
153. Which of the following factors influence(s) the composition of working capital?
b. Seasonality of operations.
c. Marketability of the finished goods.
d. Degree of competition in the market.
154. Which of the following is true in relation to aggressive working capital policy?
a. Cost of financing the current assets tends to be high.
b. Maintaining a high current ratio.
c. High level of investment in current assets.
d. Higher risk of technical insolvency for the firm.
e. Greater reliance on long term sources to finance current assets.
155. Which of the following istrue with regard to the working capital financing policy of a company?
a. Working capital margin is generally provided by the short-term borrowing by a
company.
b. Negative net working capital implies that short-termfunds are used to finance long-termassets.
c. A company that follows conservative working capital management policy generally
maintains a very low current ratio in comparison to its peers.
d. Time value of money must be considered for the estimation of the working capital needs.
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156. Which of the following will result in an increase in the net operating cycle of a firm?
a. An increase in the consumption of the raw materials.
b. Synchronizing the various processes in the production system for a better volume.
c. Incremental demand for the product owing to a favorable government policy.
d. Negotiating with the suppliers for a special discount in lieu of a shorter credit period.
e. Searching for the new customers to sell the product against cash.
157. Which of the following factors does not influence the working capital management policies
of a firm?
a. Excise duties on the capital equipments.
b. Sudden increase in the demand for the product of the company.
c. Adoption of better technology leading to the reduction in production time.
d. Sudden stoppage of the supply of a major raw material.
e. Increase in the short term interest rate.
158. If a company adopts a conservative working capital policy,
a. It takes more risk in relation to its working capital management
b. The ratio between current assets to sales turnover is at the minimum level
c. It spends more to finance its current assets
d. It maintains a minimum current ratio
e. It prefers profitability in comparison to a higher level of liquidity.
159. Which of the following statements is true with respect to overtrading?
a. It is indicated by the low current assets turnover ratio
b. It is practiced by the companies following conservative working capital management
policy
c. It is practiced by the companies following aggressive working capital management
policy
d. It is also referred to as over capitalization
e. It also indicates a substantially high current ratio
160. Net working capital is defined as
a. Current assets minus current liabilities
b. Current assets minus current liabilities excluding short term bank borrowings
c. Current assets plus current liabilities including short term bank borrowings
d. Current assets minus current liabilities excluding creditors
e. Current assets plus current liabilities excluding short term bank borrowings.
161. Which of the following factors does not affect the working capital management of a company?
c. Amount invested in the fixed assets.
d. Process used.
e. Degree of competition in the market.
162. Letter of credit means
a. Credit agreement between a bank and a company
b. Credit agreement between a company and its supplier
c. Bank undertaking responsibility on behalf of its customer, in case the customer fails to
pay to his supplier
d. Agreement that facilitates a company to stretch the credit period extended by its supplier
e. Agreement that facilitates a supplier to contract the credit period that is extended to a
company.
506
163. The major difference(s) between pledge and hypothecation is/are
a. Pledge is for immovable property and hypothecation is for movable property
b. Possession of the asset goes into the hands of lender in case of pledge unlike in
hypothecation
c. In a pledge, the lender can sell the assets to realize the amount due, in case of default,
whereas in a hypothecation the lender cannot do so
164. A manufacturing and non-financial private limited company has Rs.12,000 paid-up equity,
Rs.20,000 Reserves and surplus and Rs.6,000 as debt. Reserves and surplus include
Debenture Redemption Reserve (DRR) of Rs.4,000, Capital Redemption Reserve (CRR)
Rs.2,000, and Free Reserves of Rs.8,000. The maximum amount of public deposits it is
permitted to raise is
a. Rs.2,200
b. Rs.2,600
c. Rs.3,200
d. Rs.7,700
e. Rs.11,200.
165. Which one of the following statement(s) is/are not true regarding public deposits raised by
non-financial manufacturing firms?

a. The maximum maturity period is 3 years.
b. They are underwritten by merchant bankers.
c. Government companies cannot raise funds by this way.
d. Post-tax cost of public deposits is less than that of bank loans.
166. Which of the following is/are false statements?
i. In recourse factoring the client gets total credit protection.
ii. In maturity factoring the client pays some amount as advance and the rest upon maturity.
iii. In full factoring the loss due to bad debts is borne by the factor.
iv. In invoice discounting, interest is charged for the period between dates of prepayment
and collection.
v. Sales ledger administration is carried out by the factor in invoice discounting.
a. Only (i) and (ii) of above.
b. Only (ii) and (iii) of above.
c. Only (i), (ii) and (v) of above.
d. Only (ii), (iii) and (iv)of above.
e. Only (ii), (iii) and (v) of above.
167. Which of the following statement(s) is/are true regardingTandon Committee recommendations?
i. The borrowers credit limit is bifurcated into demand cash credit and loan components.
ii. The loan component is used for the borrowing that is expected throughout the year
while cash credit component is used for fluctuating part.
iii. Cash credit component is used for the borrowing that is expected throughout the year
while loan component takes care of fluctuating part.
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507
iv. Interest on loan component is higher than that of cash credit component.
v. Excess borrowing than the stipulated credit limit will attract higher interest rate.
a. Only (i) and (ii) above.
b. Only (i), (ii) and (v) above.
c. Only (i), (iii), (iv) above.
d. Only (i), (ii) and (iv) above.
e. Only (iii), (iv) and (v) above.
168. Which of the following was set up based on the recommendations of Vaghul Committee?
a. National Stock Exchange.
b. Stock Holding Corporation of India Ltd.
c. Discount and Finance House of India Ltd.
d. National Securities Depository Ltd.
e. Infrastructure Leasing and Financial Services Ltd.
169. Which of the following committees recommended the issuance of short-termworking capital
debentures of 12-18 months maturity by corporates to banks?
a. Dahejia Committee.
b. Marathe Committee.
c. Ghosh Committee.
d. Kannan Committee.
e. Krishna Swamy Committee.
170. Which of the following is/are one of the major recommendations of Kannan Committee?
a. Need-based working capital finance should be made by the bank.
b. A borrower should not be financed by more than one bank.
c. Particular attention should be paid by banks to monitor key branches and critical accounts.
d. Removal of bifurcation of cash credit limit into a demand loan portion and a
fluctuating cash credit component. Quarterly Profit and Loss Statements with details of
previous years, current years and previous quarters figures.
e. Abolishing of stamp duty on usance bills.
171. Given two suppliers A & B with the terms of sale 2/10 net 60; 2/15 net 30 respectively,
which of the following is/are true?

a. The company would be better off if it chooses supplier A, because it has a longer credit
period.
b. The cost of trade credit is higher for Supplier B than that of Supplier A.
c. If the opportunity cost of cash is equal to cost of trade credit of supplier B, it is better to
choose supplier A and avail cash discount.
d. If the credit period of supplier A is reduced to 30 then the company is indifferent in choosing
the supplier with respect to cost of trade credit.
172. Which of the following is/are spontaneous liabilities?
b. Salary accrued but not due.
c. Provision for payment of bonus.
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173. The difference between cash credit and overdraft facilities is that
a. The limit to which the customer can draw under an overdraft is fixed while there is no
limit on the amount that can be borrowed under cash credit
b. While under overdraft interest is charged only on the amount overdrawn, under cash credit
interest is charged on the credit sanctioned
c. While cash credit is extended against a security, no security is required for overdraft
d. Cash credit is given against the security of inventory and debtors, overdraft is generally
given against shares and fixed assets
e. While the overdraft is paid back, cash credit is generally only rolled over.
174. Which of the following services does a factor provide?
a. Purchasing of the accounts receivables.
b. Managing the sales ledger.
c. Collecting the accounts receivables.
d. Assuming the losses arising from bad debts.
175. Quick assets are defined as
a. Current assets less current liabilities
b. Current assets excluding inventories
c. Current assets excluding prepaid expenses
d. Current assets excluding cash
e. Current assets excluding loan and advance.
176. Which of the following is not an item of current liabilities?

b. Advances from customers.
c. Hire purchase dues.
d. Unclaimed dividends.
e. Fixed deposit for 18 months.
177. Which of the following is/are salient features of public deposits?
a. A company cannot raise more than 10% of its paid-up share capital and free reserves.
b. The maximum maturity period allowed for public deposits is three years while the
minimum permitted maturity period is six months.
c. The maximum maturity period of public deposits is three years while the minimum
maturity period theoretically can be 1 day.
d. A company cannot raise more than 25% of its paid-up share capital and free
reserves as public deposits.
178. Which of the following statements is true ?
a. Under recourse factoring, the factor purchases the receivables on the condition that any
loss arising out of irrecoverable receivables will be borne by the client.
b. Under full factoring, the factor purchases the receivables on the condition that any loss
arising out of irrecoverable receivables will be borne by the client.
c. Under maturity factoring, the full payment is made on the date the factor agreement is
signed.
d. Under invoice discounting the factor provides no prepayment, and all the payment is
made on the maturity date of factor agreement.
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179. Which of the following is/are criterion/criteria on which the supplier of raw materials
evaluates a firm?
a. Good track record of profitability and liquidity.
b. A record of prompt payment by the company to other suppliers.
c. Synchronization with cash inflows and outflows.
d. The state of company management.
180. Which statement is true about terms of trade credit of 4/10, net 30?

a. A 10% cash discount is offered for payment before 30 days.
b. A 4% cash discount can be taken for payment before the 10th of the following month.
c. A 10% cash discount can be taken if paid by the fourth day after invoicing.
d. No cash discount is offered after eleventh day.
e. 4% cash discount is awarded for payment on the 30th day after purchase.
181. Which of the following is not a spontaneous source of financing current assets?
a. Accrued wages and salaries.
b. Provision for dividends.
c. Cash credits/overdrafts.
d. Trade credit.
182. Which of the following is not an advantage to a company using public deposits to finance is
current assets
a. The procedure of raising public deposits is very simple.
b. No security is required in case of public deposits.
c. Post-tax cost of public deposits is much lesser than the post-tax cost of bank loans.
d. Financing with public deposits will not increase the financial leverage.
e. Public deposits do not have any restrictive covenants.
183. Full Factoring
a. Is one where the factor has no recourse to the client in the case of bad debts
b. Is one where the factor gets total protection and not the client
c. Is the only type of factoring available in India at present
184. In the books of the customer, credit sale extended by the company will be shown as
a. Current Asset
b. Current Liability
c. Outstanding Expenses
d. Closing Stock
e. Accounts Receivable.
185. Permanent investment means, investments in
a. Current Assets
b. Fixed Assets
c. Fixed Assets and Core Current Assets
d. Land and Buildings only
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186. Permanent Current assets mean
a. The minimum level of current assets maintained by a company which is more in the
nature of fixed assets
b. Mainly tools and spares
c. Permanent component of current assets
d. Those items of inventory which are permanently required
187. Which of the following would not normally rise spontaneously with a rise in sales and
approximately in proportion to the sales increase?
a. Inventories.
b. Retained earnings.
c. Accrued wages.
d. Accounts payable.
188. The credit term 2/45 net 90 indicates
a. There is no cost of funds up to 90 days
b. There is no cost of funds up to 45 days
c. The cost of funds up to 45 days is 2%
d. The cost of funds up to 90 days is 2%
e. That credit will be extended only twice; either for 45 days or for 90 days.
189. Which of the following is true about method 2 of lending as per Tandon Committee Norms?
a. Method 2 is more stringent than method 1.
b. The margin required is more than in method 1.
c. The margin required is equal to 1/4th of current assets.
e. Both (a) and (b) of the above.
a. The higher the discount rate offered, the lower will be the cost of trade credit.
b. The higher the discount rate offered, the higher will be the cost of trade credit.
c. The smaller the spread between credit and cash discount periods, the lower will be the
cost of trade credit.
d. One should avail cash discount only when the opportunity cost of trade credit is less
than the opportunity cost of cash.
e. The cost of trade credit during the discount period is equal to discount rate
191. Core current assets
a. Refer to that portion of the current assets normally financed through long-term sources
b. Refer to the raw material component of current assets without which production cannot go on
c. Refer to the current asset requirement of core sector industries like steel or cement
industry
d. Are reduced from total current assets to calculate maximum permissible bank finance
under Method I of Tandon Committee Norms
e. Refer to the excess of current assets over current liabilities for a particular period.
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a. The second tier of foreign exchange market consists of transactions in the inter-bank
market.
b. The 1996 budget introduced full convertibility of the rupee.
c. An exchange rate quoted as 2.1309/Rs.100 is a direct quote.
d. A foreign exchange transaction in which the value date is the same as the date on which
the transaction is entered into is known as a spot transaction.
e. Economic risk occurs because there is an appreciation/depreciation in the currency in
which purchases/sales are made.
193. Which of the following is a spontaneous source of financing working capital?
a. Trade credit.
b. Letter of credit.
c. Cash credit.
d. Overdraft.
194. Which of the following means of financing the current assets does not call for security?

a. Debentures.
b. Cash credit limits from a private bank.
c. Public deposits.
d. SPNs.
e. Term loan from LIC.
195. Which of the following statement is false?
a. The factoring firm bears default risk in case of full factoring.
b. When the quality of receivables is good, the discount rate is likely to be high.
c. The selling firm allows discount as a reduction to the total bill amount.
d. Factoring may become the cheapest financing source.
e. Factor may select the receivables.
196. 1/10 net 30 indicates
a. Pay immediately 10% and get 30 days credit
b. Pay in 30 days and get 10% discount
c. Pay in 10 days and get 1% discount
d. For getting 1% discount pay in 10 days otherwise the credit period is allowed up to 30 days
e. By making a down payment of 1/10 of the bill amount you can get a credit for 30 days.
197. Hypothecation is the form of working capital finance provided by the bank
a. Against the security of the movable property without ownership nor possession being
transferred
b. Against the security of the property, the property being transferred physically
c. Against the security of the property where the legal title of the property is transferred to
the bank
d. Wherein the bank has the right to retain the property until the claim associated with the
security is fully paid
e. Wherein the bank has the right to retain the property until all the claims are settled.
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198. Which of the following is not true if the credit terms are liberalized by increasing the discount?
a. It may increase sales.
b. It may increase the bad debts losses.
c. It may reduce the average collection period.
d. It may increase the cost of discount.
199. Which of the following is an indirect method of financing current assets with the support of a bank?
a. Purchase/discount of bills.
b. Letter of credit.
c. Cash credit.
d. Overdraft.
e. Factoring.
200. Which of the following is a spontaneous source of financing current assets?
a. Accrued wages and salaries
b. Commercial paper
c. Public Deposits
d. Cash credit
e. Overdraft.
201. Which of the following means of financing does not need any collateral security?
a. Cash credit from a private sector bank.
b. Overdraft from a public sector bank.
c. Cash credit from a co-operative bank.
d. Public deposit.
e. Term loan from a financial institution.
a. Cash credit.
b. Provision for taxes.
c. Owners equity.
d. Letter of credit.
e. Overdraft.
203. In which of the following types of factoring, the seller does not get any advance payment?
a. Recourse factoring.
b. Non-recourse factoring.
c. Maturity factoring.
d. Invoice discounting.
204. Which of the following assets is least liquid?
a. Work-in-process.
b. Cash and bank balance.
c. Debtors.
d. Bills receivable.
e. Certificates of deposits.
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205. Which of the following statements is true with respect to public deposits?
a. The minimum maturity period allowed is one year.
b. The maximum maturity period is five years.
c. A private company can raise at most 25 percent of its share capital and free reserves.
d. A government company can raise deposits up to 35 percent of its share capital and free
reserves.
e. The advertisement relating to the invitation of public deposits is required to be filed
with SEBI.
206. Which of the following is a source of short-term finance?
a. Term loan.
b. Debentures.
c. Note lending.
d. Equity capital.
e. Preference capital.
207. Shelf stock refers to
a. Perishable goods
b. Items that are to be packaged and sold
c. Items that are stored by the firm and sold with little or no modifications
d. Accessories which are not part of the standard equipment
e. Stock which is to be stored in the shelf.
208. A group items in the ABC system are
a. Large number of items with large rupee investment
b. Very high quality items
c. Large number of items with small rupee investment
d. Small number of items with large rupee investment
e. Sub-standard items in terms of quality.
209. If the material is priced at the value that is realizable at the time of issue, such pricing method
is referred to as
a. Standard price method
b. Replacement method
c. LIFO method
d. Weighted average cost method
e. FIFO method.
210. Lead time refers to
a. Work-in-process time
b. The time gap between placing of the order and procuring the material
c. The period in which a whole lot of inventory is consumed
d. The time finished goods lie as inventories
e. The time gap between two orders.
211. Which of the following is/are not an assumption to EQQ model?
a. Cost of carrying is a fixed proportion of the average value of inventory.
b. The demand is even throughout the year.
c. The usage for one year can be anticipated.
d. Cost per order is proportional to the size of the order.
e. There is no delay in placing and receiving the orders.
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212. Which of the following is/are true regarding EQQ analysis/formula?
i. EOQ analysis does not take inflation into account.
ii. If inflation rate is predictable, EOQ formula cannot be modified.
iii. If inflation rate is known, it should be added to the annual carrying cost expressed as a
percentage.
iv. Inflation ratio should be added to the percentage of fixed cost.
v. Average inventory and EOQ definitely increase during inflationary period.
a. Only (i) and (iii) above.
b. Only (ii), (iv) and (v) above.
c. Only (iii) and (v) above.
d. Only (i), (iii) and (v) above.
e. Only (i) and (v) above.
213. When a firm thinks of availing discount on bulk purchases, then
a. The number of orders will increase if the minimumquantity of purchase is less than the EOQ
b. The carrying costs will increase if the EOQ is less than the minimumquantity for purchase
c. The discount will not affect the carrying costs
d. Incremental benefits come due to discount and carrying costs
e. The incremental costs are equal to incremental benefits and so discount can be ignored
to calculate EOQ.
214. ABC analysis of inventory
a. Is useful for companies having different items in an inventory with different quantities
and values
b. Segregates items with smaller value in the category A
c. Segregates items which are large in number with small rupee investments into category C
215. Which of the following is/are false?
a. In the FIFO method the issue is in the order of receipt.
b. In the replacement method the current realizable value is taken for pricing the issues.
c. In the weighted average method issue price is the weighted average of price and the
weights being the percentage of value of each lot in the total stock.
d. Under inflationary conditions LIFO method will show low value of inventory.
216. Which of the following is not a benefit of storing inventories?
a. Avoidance of lost sales.
b. Availing of quantity discounts.
c. Reduction of order costs.
d. Reduction of carrying costs.
e. Reducing risk of production shortages.
217. The reorder point is given by where
i. S is daily usage
ii. L is lead time
iii. F is stock-out acceptance factor
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515
iv. R is average quantity ordered
a. S L F (S R L )
1/2
b. S +L +F (S R L )
1/2
c. S +L F (S R L )
1/2
d. S L +F (S R L )
1/2
218. Which of the following are subsystems of the inventory management system?
a. EOQ subsystem.
b. Stock-level subsystem.
c. Reorder-point subsystem.
219. Which of the following is not a method of pricing inventories?
a. First-in-first-out method.
b. Last-in-first-out method.
c. Standard price method.
d. Shadow price method.
e. Replacement price method.
220. Which of the following is/are assumption(s) underlying the Economic Order Quantity (EOQ)?
a. Constant/uniform demand.
b. Constant unit price.
c. Independent orders.
d. Instantaneous delivery.
221. Which of the following statement(s) is/are true of ABC analysis of inventory management?
a. All the items of inventory are to be ranked in ascending order of their annual usage
value.
b. An approximate categorization of items into A, B and C groups can be made by
comparing the cumulative percentage of items with the cumulative percentage of the
corresponding usage value.
c. It ensures closer control on costly items in which a large amount of capital investment
has been made.
222. Which of the following statements is not true of pricing of inventories?
a. In FIFO method, the issue of material from the stores will be in the order which it was
received.
b. In LIFO method, the material issued will be priced based on the material that has been
purchased recently.
c. Under current price method, material is priced at the value that is realizable at the time
of issue.
d. The pricing of materials under weighted average cost method will be done on weighted
average basis.
e. Under standard price method, material is priced based on the current market price.
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223. Which of the following is not an advantage if a company that follows a policy of centralized
purchases and payments to suppliers?
a. By the sheer size of purchases there is scope to obtain bulk purchase discounts on
certain items which will effectively reduce the cost.
b. As cash receipts get consolidated at the head office, the disbursement schedule can be
more effectively implemented.
c. As far as possible cash discounts on purchases can be utilized, preferably by remitting
cheques on the last day for utilizing such facility.
d. Under the centralized purchase system, arrangements can be made with the suppliers for
direct shipment of materials to the companys units located at different parts.
e. The carrying cost decreases.
224. Which of the following costs are not associated with inventories?
a. Material cost.
b. Ordering cost.
c. Carrying costs.
d. Costs of running out stocks.
e. Cost of long-term debt locked in inventories
225. Which of the following is not an assumption in the EOQ inventory model?
a. The usage/demand over a given period is known.
b. The ordering costs are constant.
c. The carrying costs are constant.
d. The lead time is constant for all volumes of order.
e. The unit price of the product is constant regardless of the order size.
a. In an inflationary period the FIFO method of inventory pricing tends to inflate reported
profits.
b. LIFO method of inventory pricing causes reported profits to be low in an inflationary period.
c. The weighted average cost method of inventory pricing tends to smooth out price
fluctuations.
d. Under the standard price method issues are priced based on a predetermined standard cost.
227. The basic EOQ Model does not consider stock-out costs because
a. The magnitude of stock-out cost is insignificant
b. The estimation of stock-out cost is very difficult
c. Of the assumption of instantaneous delivery
d. A provision for stock-out cost is built into the ordering and carrying costs
228. Which of the following would cause a firms EOQ to increase, other things held constant?
a. Costs of stock-outs increase.
b. Fixed ordering costs per order drop by half.
c. Purchase price of inventory items doubles.
d. Delivery time for ordering doubles.
e. None above.
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229. The cost of issue of materials during a period of deflation is high in the method of
a. First-In-First-Out
b. Last-In-First-Out
c. Weighted average cost
d. All of the above
230. Optimal safety stock are determined to reduce
a. Ordering costs
b. Carrying costs
c. Stock-out costs
d. Total costs
231. A decrease in inventory order costs will
a. Decrease the economic order quantity
b. Increase the reorder point
c. Have no effect on the economic order quantity
d. Increase the economic order quantity
e. Decrease the holding cost percentage.
232. ABC analysis is useful for
a. Beginners to have a basic idea about management of inventories
b. Analyzing inventories based on their movement
c. Analyzing inventories based on their essentiality
d. Better control of inventories
e. Understanding the procurement of inventories.
233. Which of the following is included in carrying cost
a. Obsolescence
b. Cost of capital
c. Leakages and normal wastage
d. Insurance Cost
234. Which of the following statement is true?
a. Under FIFO profit will go up, if the inflationary conditions prevail.
b. Under FIFO profit will go down, if the inflationary conditions prevail.
c. Under LIFO the profits will go up, if the inflationary conditions prevail.
d. Under LIFO the profits will go down, if the deflationary conditions prevail.
e. Under weighed average method the profits will go up irrespective of whether
inflationary or deflationary conditions prevail.
a. Storage lag refers to the waiting period for unloading the inventory for want of storage space.
b. Storage lag refers to the time taken for the raw material to be transferred into work in
process.
c. Storage lag refers to time taken for the goods to be converted to cash by sale.
d. Storage lag refers to the average stocking period of raw material.
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236. Safety stock
a. Is equal to the economic order quantity
b. Is equal to the difference between the reorder level and the level of normal consumption
c. Is equal to one months production quantity
d. Is that point at which carrying and ordering costs are optimal
237. The Just-In-Time inventory system is difficult to implement because
a. It is a J apanese system
b. It requires reliable suppliers who are easily accessible
c. It requires the use of highly sophisticated manufacturing systems
d. The traditional formula for EOQ cannot be applied
e. It contracts the operating cycle.
238. C group items under ABC Analysis are
a. High value items
b. High quantity items
c. Low value items
d. Low quantity items
239. Which of the following is true when the level of inventory is increased?
a. Ordering costs decreases but carrying costs increases.
b. Carrying costs increases but ordering costs remain same.
c. Both ordering and carrying cost increases.
d. Both ordering and carrying cost decreases.
e. Carrying costs decreases but ordering costs increases.
240. Which of the following is true regarding reorder point?

a. It is the time normally taken in replenishing inventory after the order is made.
b. It is the product of lead time and average usage per day.
c. Under uncertainty conditions safety stock should be deducted from the product of lead
time and average usage per day to obtain reorder point.
d. If the lead time is nil, reorder point is equal to the economic order quantity.
e. It is equal to the difference between economic order quantity and the product of lead
time and average usage per day.
241. Which of the following is/are true under ABC analysis of inventory management
?

a. A represents the maximumproportion of total units and minimumproportion of total value.
b. A represents the maximum proportion of total units and total value.
c. A requires the minimum control measures.
d. A represents the maximumproportion of total value and minimumproportion of total units.
242. Opportunity cost of funds tied up with inventory results from
a. Carrying cost
b. Materials cost
c. Cost of losses due to damage and pilferage
d. Cost of stock out
e. Ordering cost.
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519
243. Which of the following types of factoring offers short-term finance, sales ledger
administration as well as credit protection simultaneously?
c. Maturity factoring.
d. Invoice factoring.
e. Bulk factoring.
244. Which of the following is an assumption in the economic order quantity model?
a. Carrying cost per unit increases as the number of units ordered increases.
b. Delivery of the material within a certain time as the order is placed.
c. Purchase price per unit of the raw material increases as the number of units ordered
decreases.
d. Ordering cost is constant.
e. Inventory level during the year varies as per the boom phase and recessionary phase in
business.
245. Which of the following is not an advantage of the ABC system of inventory management?
a. It is a very selective approach to inventory management.
b. It facilitates a better control on the costlier items.
c. It helps the beginners to learn the various techniques of inventory management.
d. It helps the usage of the scientific system for the inventory management.
e. It helps to maintain the optimum level of stocks.
246. Which of the following is not correct with respect to maintaining inventories?
a. To reduce the costs of ordering.
b. To improve the product quality.
c. To avoid lost sales.
d. To reduce the possibility of the stoppage of production.
e. To obtain discounts through buying more quantity.
247. Which of the following may cause a reduction of the economic order quantity for a firm
when other things are held constant?
a. An increase in carrying cost as a percentage of unit price.
b. An increase in the fixed ordering cost per order.
c. An increase in the purchase price of the inventory items.
d. Increasing the delivery time of the materials.
e. Availing the discount for purchasing the materials.
248. Which of the following is/are the assumption(s) made under the EOQ model?
a. The cost of carrying inventories is a fixed percentage of the average value of the inventories.
b. The usage of the product is uniform throughout the period.
c. The cost per order is constant irrespective of the size of the order.
d. The unit price of the raw material will remain constant.
249. An increase in the ordering costs will
b. Increase the economic order quantity
c. Not affect the economic order quantity
d. Increase the reorder point
e. Increase the carrying cost.
520
250. Which of the following statements is true with respect to ABC Analysis?
a. It is a technique for the analysis of the inventories on the basis of their quality.
b. This idea can be used by the beginners for the study of Inventory Management.
c. This technique analyses the inventory requirements on the basis of essentiality.
d. It helps to achieve a better control for the inventories.
e. It considers the issues relating to the procurement of the inventories.
251. Which of the following costs is not associated with the extension of credit and accounts
receivables?
a. Cost of investment tied up in accounts receivables.
b. Collection cost.
c. Default cost.
d. Cost of measures initiated to collect blocked funds beyond expiry date.
e. All are associated.
252. Which of the following is not a cost linked with maintaining receivables?
a. Cost of funds.
b. Discount costs.
c. Collection costs.
d. Default costs.
253. The variables associated with credit policy are
a. Credit standards
b. Credit period
c. Cash discount
d. Collection program
254. Which of the following is not used for credit evaluation?
a. Ratio analysis.
b. Bank references.
c. Past experience with the customer.
d. Numerical credit scoring.
255. Which of the following statements is correct?
a. Liberalizing credit standards will increase investment in receivable while pushing up sales.
b. Shortening the credit period will increase bad debts loss as customers will not be able to
pay within the shorter period.
c. A rigorous collection programwill bring down sales and increase the percentage of bad debts.
d. A cash discount will increase average collection period and increase bad debt losses.
256. Which of the following is not a cost of maintaining receivables?
a. Administrative costs.
b. Collection costs.
c. Defaulting costs.
d. Costs of additional fund required.
e. Marketing costs.
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521
257. Which of the following is not the Cs for judging creditworthiness of a customer?
a. Collateral.
b. Capacity.
c. Credibility.
d. Character.
258. Which of the following is not a measure for monitoring receivables?
a. Collection matrix.
b. ABC system.
c. Days sales outstanding.
d. Ageing schedule.
259. Which of the following is not a credit policy variable or a non-financial company?
a. Overdraft limit.
b. Credit standard.
c. Collection program.
d. Cash discount.
e. Credit period.
260. Which of the following is/are objective(s) of companies making credit sales?
a. Increasing total sales.
b. Increasing profits as a result of increase in sales.
c. To ward off competition.
d. To increase market share.
261. Ignoring the time value of money, how much does a firm lose on a Rs.1000 sale that has a
25% profit margin if the 20% probability of default occurs?
a. Rs.150.
b. Rs.600.
c. Rs.650.
d. Rs.750.
e. Rs.1,000.
a. If credit standards are liberalized then sales will increase.
b. Strict credit standards will tend to reduce incidence of bad debt loss.
c. Increase in credit period will tend to increase the investment in receivables.
d. Liberalizing cash discount policy will tend to increase the average collection period.
e. A rigorous collection effort tends to increase the collection expense.
263. When a company liberalizes its cash discount policy
a. It increases the cost of discount
b. It leads to an increase in the average collection period
c. The discount period may be lengthened
d. It may involve an increase in the percentage of discount
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264. The collection matrix approach is extremely useful in monitoring receivables because
a. It portrays payments alongwith their respective probabilities
b. It segregates cash sales and credit sales to focus on receivables
c. It facilitates review of the payment pattern
d. It represents the time taken at different stages for raw material to get converted into cash
265. Days Sales outstanding
a. Shows the age-wise classification of receivables
b. Is superior to the collection matrix
c. Is an indication of the sales orders of the company yet to be executed
d. Is an indication of the average collection period
e. Indicates the percentage of receivables outstanding on a daily basis.
266. An ageing schedule gives particulars about
a. Profit and present value
b. Accounts receivable and proportion of sales
c. Employees and age of their service
d. Accounts receivable and their average time outstanding
e. Current ratio and the corresponding year.
267. Incidence of bad debt loss increases with the change in which of the following variable(s) of
the credit policy?
a. Credit standards liberalized.
b. Credit period reduced.
c. Collection efforts relaxed.
268. Liberalizing a companys cash discount policy by lengthening its discount period leads to
an/a
a. Increase in its average collection period accompanied by an decrease in sales
b. Decrease in its average collection period accompanied by an increase in the cost of discount
c. Increase in its average collection period accompanied by an increase in the cost of
discount
d. Decrease in the discount percentage
e. Increased receivables.
269. Average collection period is equal to
a. 360/Receivables Turnover ratio
b. Average Debtors/sales per day
c. Sales/debtors
270. Which of the following is/are the limitation(s) of Days Sales Outstanding (DSO) and Ageing
Schedule (AS)?
a. Both are influenced by the payment behavior of customers.
b. Both are influenced by the sales pattern.
c. Both are based on an aggregation of sales and receivables.
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523
271. Which of the following is/are true with regard to cash credit offered by a bank?
i. The customer is charged interest on the amount actually utilized subject to some
minimum service charge
ii. The customer is allowed to borrow the entire funds under the cash credit limit
iii. No security is required from the customer against the borrowed amount.
a. Only (i) above
b. Only (ii) above
c. Only (iii) above
272. Which of the following Cs is not used for the assessment of the creditworthiness of a
debtor?
a. Character.
b. Capacity.
c. Contingencies.
d. Collateral.
273. Which of the following is a credit policy variable for a firm?
a. Credit standard.
b. Cash discounts.
c. Credit period.
d. Collection effort.
274. Which of the following is a technique for monitoring the status of the receivables?
a. Ageing schedule.
b. Outstanding creditors.
c. Selection matrix.
d. Funds flow analysis.
e. Credit evaluation.
275. Despite a rigorous collection effort, a company is facing difficulties in getting prompt
payments. What should be the possible course(s) of action?
a. Attractive cash discounts should be offered at the time of selling.
b. Quality of accounts receivables is to be improved.
c. Volume of credit disbursed is to be increased.
d. Collection efforts are to be reduced.
276. Other things remaining the same, which of the following will generally result as a
consequence of making the credit standards more stringent one?
a. More bad debt losses.
b. Increase in the number of customers.
c. Higher sales turnover.
d. Reduction of the outstanding debtors in the balance sheet.
e. Incremental cost of collection of the receivables.
524
277. Which of the following is a factor influencing the credit policy of a firm?
a. Cash credit limit.
b. Average payment period.
c. Collection effort.
d. Outstanding creditors.
278. Which of the following statements is true with respect to Days Sales Outstanding (DSO)?
a. DSO shows the pattern of sales made by the suppliers of the firm.
b. It indicates the outstanding sales order of a company.
c. It shows the agewise classification of the receivables.
d. It indicates the average collection period for a company for various time periods.
e. It represents the percentage of receivables outstanding on a daily basis.
279. The pattern of collections associated with the credit sales is represented by
a. Days sales outstanding.
b. Ratio analysis.
c. Average collection period analysis.
d. Collection matrix.
e. Ageing schedule.
Cash Management
280. Which of the following investments has/have no default risk?
a. Inter-Corporate Deposits.
b. Treasury Bills.
c. Commercial Papers.
d. Money Market Mutual Funds.
281. The basis of estimation for receipts of interest and dividend in the cash budget is usually the
a. Receipts pattern of the past
b. Financial forecast
c. Companys investment portfolio
d. Past proportion of interest and dividend to total sales
e. Past proportion of interest and dividend to total sales +annual growth rate.
282. Which of the following assumes paramount importance for investing surplus cash by a firm?
a. Yield.
b. Liquidity.
c. Tax shelter.
d. Security.
e. Maturity.
283. Which of the following is not associated with the cash management of a firm?
a. Stretching accounts payable without affecting the credit of the firm.
b. Speedy collection of receivables.
c. Investing surplus funds in long-term securities.
d. Avoiding idle funds lying in firms current accounts.
e. Maintaining liquidity.
Part I
525
284. In a broader sense, cash includes
a. Notes and coins
b. Bank balance
c. Bank drafts
d. Marketable securities
285. Which of the following is not a motive for holding cash?
a. Transaction purposes.
b. Precaution against unexpected expenses.
c. Extending loans to group companies.
d. Speculation purposes.
e. Mismatch between cash inflows and outflows.
286. When the net float is positive
a. The balance of funds in the books of the firm is lower than the balance in the books of
the bank
b. The firm cannot issue checks as it has an overdrawn bank account in its own books
c. The payment float is less than collection float
d. The balance of funds in the books of the bank is lower than the balance in the books of
the firm
287. When the net float is negative
a. Balance in the books of company is more than that in the banks book
b. Balance in the books of company is less than that in the banks book
c. Company can issue cheque to play the float
d. The collection float is greater than payment float
288. Which of the following is not a motive for the companies to hold cash?
a. Transaction motive.
b. Precautionary motive.
c. Speculative motive.
d. Lack of proper synchronization between cash inflows and outflows.
e. Capital investments.
289. Cheques that have been deposited may not be immediately available for use due to
a. Collection float
b. Payment float
c. Net float
d. Deposit float
290. Float denotes the
a. Difference between bank balance and the balance shown in the firms books
b. An instrument to expedite cash inflows
c. Difference between cash inflows and outflows
526
291. Playing the float indicates
a. Issuing cheques without balance in the account
b. Purchasing machinery and dishonoring the instrument after the delivery of machinery
c. Converting a credit customer into a cash customer
d. Expediting the implementation of the project to the firms convenience before sanction
of loan
e. Manipulating the books of accounts.
a. The amount of cheques issued by a company not yet paid out is referred to as net float.
b. A negative net float can be used by the company to play the float.
c. A positive net float can be used by the company to play the float.
293. Cash management does not call for

a. Lengthening creditors period
b. Lengthening receivables period
c. Investing surplus funds
d. Nullifying idle funds
e. Ignoring the existence of float.
294. Which of the following is/are true regarding the concept of float?
a. The amount of cheques deposited but awaiting clearance by the bank is called as
payment float.
b. If the payment float is more than the collection float then there would be positive net float.
c. Playing the float is possible only when the collection float is more than the payment float.
d. If the net float is positive the balance in the books of the company is more than the
balance in the banks books.
295. Holding cash balance to pay for the purchases made is
a. An indication of the precautionary motive
b. An implication for the transaction motive
c. A motivation due to the speculative motive
d. Caused by lack of synchronization between cash inflows and outflows
296. When the net float is negative, it is said that
a. The company has used the short term sources of funds for financing long term assets
b. The current ratio is less than unity
c. The payment float is larger than the collection float
d. The balance in the books of the bank is less than the balance in the books of the firm
e. The outstanding debtors are more than the outstanding creditors.
297. Which of the following is not a relevant factor in an efficient cash management system for a
business entity?
a. Billing promptly and thereafter mailing the same to the customers.
b. Payment of interest on term loans whenever it is due.
c. Collection of receivables from the branch level.
d. To deposit the cheques immediately to the bank on receiving the same from the
customers.
e. Making a centralized payment system for the suppliers.
Part I
527
298. Which of the following statements is true with respect to float in the context of cash
management?
a. It is an instrument that may increase the cash inflows.
b. It represents the difference between the total cash inflows and total outflows during any
given period.
c. It is the difference between the actual bank balance and the bank balance in the cash
book of the company.
d. It means the time required for the encashment of a cheque submitted to a bank.
e. It implies the time lag between the public issue and the actual receipt of funds.
299. Which of the following is/are true if the internal rate of return on a project is same as the cost
of capital?
a. Net benefit cost ratio of the project is equal to zero.
b. Net benefit cost ratio of the project is negative.
c. Net present value of the project is positive.
d. Net present value of the project is negative.
e. The project provides excess returns to the equity shareholders.
300. In a broader sense, cash may include
a. Notes and coins only
b. Notes, coins and deposits in a bank
c. Notes, coins, deposits in a bank and drafts only
d. Notes, coins, deposits in a bank, drafts and cheques only
e. Notes, coins, deposits in a bank, drafts, cheques and highly liquid marketable securities
only.
301. Cross-elasticity of demand for a product refers to the responsiveness of the
a. Quantity demanded to a given change in its price
b. Quantity demanded to a given change in the price of a related product
c. Price change to a given change in the supply of a product
d. Price change to a given change in the supply of a related product
e. Either (b) or (d) above.
302. Which of the following is/are true regarding the measurement of cash inflows and outflows
of a project?
a. Depreciation amount should be added to PBT.
b. Depreciation amount should be added to PAT.
c. Depreciation should neither be added to nor be subtracted from PAT.
d. Working Capital requirement in the first year should be treated as capital expenditure.
303. Net salvage value of fixed assets is equal to
a. Excess of salvage value over book value
b. Excess of book value over salvage value
c. Working capital requirement in the first year
d. Salvage value of fixed assets less any income tax payable on the excess of salvage value
over book value
e. Scrap value.
528
304. Accounting rate of return is the ratio of average values of
a. Profit before tax to book value of the investment
b. Profit after tax to salvage value of the investment
c. Profit before tax to present value of the investment
d. Profit after tax to present value of the investment
e. Profit after tax to book value of the investment.
305. Which of the following statement(s) regarding IRR is/are true?
a. A project can have only one IRR.
b. If IRR is less than the firms cost of capital, the project should be rejected.
c. A project can have multiple IRRs depending on the cash flow streams.
306. Which of the following appraisal methods is preferred for comparing projects differing in life
spans?
a. Annual capital charge.
b. IRR.
c. NPV.
d. Accounting rate of return.
e. Pay-back period.
307. Which of the following statement(s) is/are true regarding Net Benefit-Cost Ratio (NBCR)?
a. It does not take time value of money into consideration.
b. This criterion cannot be used when the investment outlay is spread over more than one period.
c. If NBCR =0.75 the project cannot be accepted.
308. Which of the following is/are false regarding Accounting Rate of Return?
i. Depreciation is not considered for its calculation.
ii. Depreciation is added back to the annual income.
iii. For decision making, ARR of a project is compared with that of the firm or industry as a
whole.
iv. If ARR is greater than one for a project, it should be accepted.
v. For calculating average annual income, non-cash expenses are also deducted from sales
revenue.
a. Only (ii) and (iv) above.
b. Only (ii) and (v) above.
c. Only (i), (ii) and (iv) above.
d. Only (ii), (iii) and (v) above.
e. Only (iii), (iv) and (v) above.
309. Incremental cash flows in relation to capital budgeting decisions refer to the
a. Cash flows which are increasing over a period of time
b. Incremental change in cash flows if the project is extended one year beyond its life period
c. Cash flows which are directly attributable to the investment
b. Difference between cash inflow streams and the initial outflow
e. Difference between any two cash outflows in a projects life period.
Part I
529
310. Which of the following is/are considered for defining cash flows for a project involving a
capital budget decision?
a. Interest on short-term bank borrowings must be included.
b. Interest on long-term debt must be excluded.
c. Interest on long-term borrowings should be treated only when principal is repaid in
lump sum.
311. Which of the following appraisal criterion does not take into account the remaining cash
flows once the initial investment is recovered?
a. Internal Rate of Return.
b. Accounting Rate of Return.
c. Pay-back Period.
d. Net Benefit Cost Ratio.
e. Net Present Value.
312. Which of the following statement(s) is/are false?
a. Sometimes IRR fails to indicate correct choice between mutually exclusive projects.
b. Pay-back Period is widely used since it is a measure of profitability.
c. One of the demerits of NPV is that it is sensitive to discount rates.
313. Which of the following is not a principle underlying measurement of cash flows from the
long-term funds point of view?
a. All non-cash charges should be added back to PAT.
b. Cash flows should be defined in pre-tax terms.
c. Only incremental cash flows should be considered.
d. Interest on long-term loans should not be deducted from profit.
314. Which of the following evaluation criteria does not consider time value of money?
a. Benefit-cost ratio.
b. Annual capital charge.
c. Pay-back period.
d. IRR.
e. Net benefit cost ratio.
315. Which of the following relationships is true?
a. NBCR =BCR +1.
b. NBCR =BCR I.
c. NBCR =BCR 1.
d. NBCR =BCR +I.
e. NBCR =NPV 1.
316. Which of the following is/are not drawback(s) of the Accounting Rate of return criteria?
a. It gives equal weightage to near-flows and distant flows.
b. It is calculated using the accounting income and not cash flows.
c. The cut-off ARR is arbitrarily fixed.
d. All of (a), (b) and (c) above.
530
317. Which of the following is/are true about NPV?
a. It considers all the cash flows.
b. It gives more weightage to distant flows than to near-term flows.
c. It considers time value of money.
318. Cash flows occurring from a project in different periods are not comparable unless
a. Interest rates are expected to be stable
b. The flows occur periodically every year
c. Interest can be earned on the cash flows
d. The flows have been discounted to a single date
e. Inflation is constant.
319. A project can have as many as different internal rates of return as it has
a. Cash inflows
b. Cash outflows
c. Periods of cash flows
d. Changes in the sign of cash flows
e. No connection with cash flows.
320. In IRR, the cash inflows are assumed to be reinvested in the project at
a. Internal rate of return
b. Cost of capital
c. Marginal cost of capital
d. Risk-free rate
e. Risk adjusted rate.
321. For a project, benefit cost ratio is equal to one, then the
a. IRR will be greater than one
b. IRR will be greater than discount rate
c. IRR will be lesser than discount rate
d. IRR will be equal to discount rate
e. Insufficient information to conclude anything about IRR.
322. HGS Ltd is evaluating 2 projects for internal logistics. System A has a life of 4 years and
system B has a life of 3 years. The initial outlay reparation costs are as
Year A B
0 10,00,000 7,00,000
1 1,00,000 80,000
2 2,00,000 1,20,000
3 2,50,000 1,70,000
4 3,00,000
Calculate the annual Capital Change for both assuming cost of capital to be 10%
a. A 5,00,111.5, B 271,098
b. A 5,70,376.5, B 351,491
c. A 5,20,132.5, B 401,918
d. A 619,432.5, B 307,926
Part I
531
323. Which of the following is/are not considered for cost-benefit analysis of capital investment
decisions?
a. Opportunity costs.
b. Incremental costs.
c. Sunk costs.
d. Common fixed costs.
324. Which of the following is not related to the basic principles of costs and benefits analysis?
a. Interest exclusion principle.
b. Accrual principle.
c. Incremental principle.
d. cash flow principle.
e. Post-tax principle.
325. If net present value for a project is negative, then
a. IRR =Cost of capital
b. IRR >Cost of capital
c. BCR >1
d. BCR =1
e. IRR <Cost of capital.
326. Which of the following criteria is not used for the preliminary evaluation of a project?
a. Compatibility of the promoter.
b. Availability of raw materials.
c. Cost-benefit analysis.
d. Size of potential market.
e. Threat of the competitors.
a. Capital expenditure benefits accrued only in the current period.
b. Pay-back period method selects a project based on the profitability before the pay-off
period.
c. Internal rate of return fails to take into account time value of money.
d. Net present value method uses cost of debt as a discounting rate.
e. Annual capital charge method is used for projects having different life-spans.
328. Capital expenditure decisions occupy a very important place in corporate finance for which
of the following reasons?
i. Once the decision is taken, it has far reaching consequences which extend over a
considerably long period, which influence the risk complexion of the firm.
ii. These decisions involve huge amounts of money.
iii. These decisions once taken are irreversible.
iv. These are among the most difficult to make when the company is faced with various
potentially viable investment opportunities.
a. Only (i) and (ii).
b. Only (i) and (iv).
c. Only (ii) and (iii).
d. Only (ii) and (iv).
e. All of (i), (ii), (iii) and (iv).
329. Which of the following are important principles underlying measurement of costs and
benefits of a project?
a. All costs and benefits must be measured in terms of cash flows.
b. Interest on long-term loans must be included for determining the net cash flows.
c. Interest on long-term loans must not be included for determining the net cash flows.
d. The cash flows must be measured in incremental terms.
e. Only (a), (c) and (d) of the above.
532
a. If BCR >1 and NBCR <0, accept the project.
b. If BCR >1 and NBCR >0, accept the project.
c. If BCR <1 and NBCR >0, reject the project.
d. If BCR <1 and NBCR <0, reject the project.
331. Which of the following is not an important issue in the technical appraisal of a project?
a. Size of the total market for the proposed product or services.
b. Availability of the required quality and quantity of the raw materials and other inputs.
c. Optimality of the scale of operations.
d. Availability of utilities like power, water, etc.
e. Appropriateness of the plant design and layout.
332. If the NPV is greater than zero, then
a. BCR <1.00
b. BCR =1.00
c. IRR >Cost of capital
d. IRR =Cost of capital
e. NBCR <0.
333. Which of the following is not an advantage of the IRR?
a. It considers the time value of money.
b. It considers the cash flow stream over the entire investment horizon.
c. It appeals to businessmen who think in terms of rate of return.
d. It is uniquely defined for every project.
334. The setting up of a tree plantation by a matches manufacturing company is an example of
a. Expansion
b. Forward Integration
c. Backward Integration
d. Diversification
335. Which of the following is not included in the economic appraisal of a project?
a. Contribution of the project towards generation of employment.
b. Impact of the project on the level of savings in the society.
c. Optimality of the scale of operations.
336. The incremental principle of measuring costs and benefits of a project implies that
a. The impact of the project on existing operations of the firm should also be considered
b. Sunk costs must be ignored
c. Opportunity costs must be included
d. All of the above
Part I
533
337. DCF methods are superior because
a. Time value of money is taken into account
b. Entire cash flows are considered
c. Takes into account the objective of share holders
338. Three projects R, S and T have cash outflows and inflows as under
Year Project R Project S Project T
0 100 80 80
1 15 30 20
2 20 20 20
3 20 30 50
4 30 40 60
5 35 50 70
Which one of the following is true?
a. R and S will have unique IRR.
b. R and T will have unique IRR.
c. IRR cannot be a meaningful criterion of appraisal for T.
339. Conflicts in ranking of projects on the basis of Net Present Value and Internal Rate of Return
arise due to
a. Disparity in the timing of cash inflows
b. Disparity in the size of cash inflows
c. Disparity in the life of cash inflows
(R =IRR, K =cost of capital)
a. If K =R, NPV =0.
b. If K >R, NPV <0.
c. If R >K, NPV <0.
d. K is directly proportional to NPV.
a. A high internal rate of return is always a desirable feature for the firm.
b. If the NPV of the cash flows at 12% discount rate is positive, the IRR is also 12%.
c. If the NPV of the cash flows is positive, we can conclude that IRR is unequally defined.
d. If the NPV of the cash flows is zero, the IRR of the project is equal to the opportunity
cost of capital.
342. Which of the following statements is correct for a project with a positive is NPV?
a. IRR exceeds the cost of capital.
b. Accepting the project has an indeterminate effect on shareholders.
c. The discount rate exceeds the IRR.
d. The profitability index equals one.
e. IRR is equal to the cost of capital.
534
343. The rationale for not including sunk costs in capital budgeting decisions is that they
a. Are usually small in magnitude
b. Revert at the end of the investment
c. Are irreversible
d. Represent nominal, not real, outflows
e. Are historical costs.
344. Which of the following will not have any impact on the cost of project?
a. Increase in the expected cost of land.
b. Decrease in margin money requirements.
c. Increase in pre-operative salaries.
d. Increase in excise duty on the items to be produced.
e. Decrease in import duty of machinery.
345. While formulating net cash flows for capital investment appraisal the `interest exclusion
principle is followed because
a. The `means of financing are not clearly known at the time of appraisal
b. The basic objective is to obtain a measure of financial attractiveness irrespective of the
`means of financing
c. The fallacy of double counting under the discounted cash flow techniques is to be
avoided
d. The average cost of capital does not consider the interest on long-term debt
e. The interest is not a cash flow expenditure.
346. What are the implications of poor infrastructure in India?
a. Poor infrastructure distorts the level playing yield for Indian corporates and results in
competitive disadvantage.
b. Lack of infrastructural facilities leads to delays in project implementation and
consequently to time and cost overruns in a project.
c. Poor infrastructure paves the consumer to pay more for product than what they should
be actually paying.
d. Poor infrastructure hinders the flow of Foreign Direct Investments in to the country.
347. New capital budgeting decisions are evaluated using the existing cost of capital of the firmbecause
a. The firm does not pay taxes
b. The firm is assumed to be financed by all equity
c. Cost of debt is always less than cost of equity
d. New assets are assumed to have the same risk as existing assets
e. The firm does not pay dividends till the new project earn profits.
348. Which of the following can be considered as the limitations of using average rate of return,
for investment appraisal?
a. It is simple to calculate.
b. It considers benefits over the entire life of the project.
c. It is some what akin to the break-even point.
d. It is based upon accounting profit, and not cash flows.
e. It can be considered as a measure of a projects capital recovery.
349. In a capital budgeting decision incremental cash flows mean
a. Cash flows which are increasing
b. Cash flows occurring over a period of time
c. Cash flows directly related to the project
d. Difference between cash inflows and cash outflows for each and every expenditure
Part I
535
350. If the life span of 2 projects is different, the appraisal method useful for evaluating the
projects is
a. Pay-back period
b. Accounting rate of return
c. Net present value
d. Internal rate of return
e. Annual capital charge.
351. Which of the following statements is/are true regarding capital expenditure decisions?

a. Opportunity cost must be ignored.
b. Sunk costs must be included.
c. Cash flows must be defined from the point of view of suppliers of long-term funds.
d. Interest on long-term debt must be excluded.
352. Net benefit-cost ratio of a project is equal to
a. Present value of cash inflows/Initial investment
b. Net present value of cash flows/Initial investment
c. Benefit-cost ratio +1
d. Initial investment/Net present value of cash inflows
e. Initial investment/Present value of cash flows.
353. Which of the following is not a principle to determine the costs and benefits of a project?
a. The cash flows must be determined in incremental terms.
b. All costs and benefits must be measured in terms of cash flows.
c. Interest on long term funds must be excluded from the determination of net cash flows.
d. All revenues and costs accrued must be considered as benefits and costs respectively.
e. Cash flows are to be defined by duly considering the impact of taxes.
354. Which of the following techniques of project appraisal does not consider the time value of money?
a. Benefit cost ratio.
b. Net present value.
c. Internal rate of return.
d. Annual capital charge.
e. Accounting rate of return.
355. Which of the following statements is true if the Net Present Value (NPV) of a project is positive?
a. Internal Rate of Return(IRR) is more than the cost of capital.
b. The pay-back period of the project is less than one year.
c. The discount rate is equal to the risk free rate of return.
d. Benefit cost ratio is less than unity.
e. Accepting the project has an indeterminate effect on shareholders.
a. Capital expenditure benefits accrue over a long term.
b. Net present value uses cost of capital as the discounting rate.
c. Internal rate of return considers the time value of money.
d. If the benefit-cost ratio is equal to one, the equity shareholders can be said to have
earned more than expected return.
e. Pay-back period considers the cash flows up to a certain number of years.
536
357. The incremental principle of measuring costs and benefits of a project does not consider
a. The impact of the project on existing operations of the firm
b. Existing overhead costs
c. Opportunity costs
d. Depreciation costs
e. Interest on long-term debts.
358. If the benefit cost ratio of a project is unity, then its NPV
a. Will be zero
b. Will be plus 1
c. Will be minus 1
d. Will be any value
359. Which of the following is a part of the economic appraisal of any project?
a. Determination of present and past consumption trends in the society.
b. Determination of the total value of imports and exports by the country.
c. Determination of consumer requirements.
d. Impact of the project on the savings and investments.
e. Determination of optimal scale of operations.
360. If two projects are mutually exclusive and differ substantially in terms of the initial outlays
and subsequent expenses, which of the following criteria of evaluation is best suited?
a. Pay-back period.
b. Annual capital charge.
c. NPV.
d. IRR
e. Accounting rate of return.
361. Which of the following is false with respect to the IRR?
a. It considers the cash flow stream throughout the life of the project.
b. It is appealing to the businessmen who prefer to think in terms of the rate of return from
the project.
c. It considers the time value of money.
d. It is uniquely defined for every type of project.
e. Several mutually exclusive projects may be ranked on the basis of IRR despite the
changes in the cost of capital.

537
Part I: Answers on Basic Concepts (with Explanatory Notes)
Sources of Long-term Finance
1. (b) There is no obligation to pay dividends on equity capital as well as preference capital.
Preference capital includes the call feature wherein the issuing company has the option to
redeem the shares, prior to maturity date. Only equity shareholders enjoy voting rights.
2. (c) Cost of equity capital is higher than other capital because the equity dividends are not tax
deductible expenses and the cost of issue is very high.
3. (c) Euro-convertible Bonds (ECBs) issued by Indian Companies refer to bonds issued in
foreign currency in any country other than India.
4. (d) With the introduction of Companies Amendment Act, 2000 issue of non-voting shares is
permitted. Perpetual preference shares are not common in India.
5. (c) There is no fixed obligation for payment of dividend on equity shares. Dividend is
payable only if recommended by the BoD and passed by the company in the AGM.
6. (d) With the commencement of the Companies Act, 1956 the issue of preference shares with
voting rights has been restricted only to all the above cases.
7. (e) A firm can raise capital from the primary market by issue of securities in all the above
ways.
8. (e) Ex-rights share price is given by Ex-rights share price determines the value of the share
price after the rights issue.
V
0
=(N P
0
+S)/ N +1
9. (e) The private placement method of financing involves direct selling of securities to a
limited number of institutional or high net worth investors. All the above are advantages of
placing the shares privately.
10. (e) Bought out deal is a process whereby an investor or a group of investors buy-out a
significant portion of the equity of an unlisted company with a view to take it public within
an agreed time frame. All the above are advantages of entering into bought out deal.
11. (d) Commercial paper is a short-term money market instrument.
12. (a) A cumulative preference share is one on which the dividends are paid on accumulative
basis, in case they remain unpaid in any financial year due to insufficient profits.
13. (b) Measuring the cost of equity capital is a difficult and complex task because the dividend
stream receivable by the equity shareholder is not specified by any legal contract.
14. (d) When a shareholder allows the right to expire, then the shares are issued to new investors
thereby increasing the number of shareholders. Hence, it will decrease the wealth of the
existing shareholders.
15. (b) Theoretical value of the right = / N +1 where stands for cum rights price of the
share.
0
(P S)
0
P
Rights offer is the offer made to the existing shareholders, when a firm issues additional
equity capital.
16. (e) Under Section 81 of the Companies Act, 1956 when a firm issues additional equity
capital, it has to offer such securities to the existing shareholders on a pro rata basis. The cost
of issue of rights issue will be comparatively less than the public issue, since these securities
are issued to the existing shareholders, thereby eliminating the marketing costs and other
relevant public issue expenses.
17. (a) Equity shareholders are owners of the business. They enjoy the rewards of ownership and
bear the risks of the ownership.
18. (e) The advantage of equity capital to the issuing firm is that without any fixed obligation to
pay dividends, it offers permanent capital with limited liability for repayment. The
creditworthiness of the company is also increased. Equity capital not being a tax deductible
expense is a disadvantage as it increases the cost of issue.
19. (e) Preference shareholders have preference over equity shareholders to the post tax earnings.
Preference dividend is payable only out of distributable profits. Preference dividend is not tax
deductible.
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20. (d) A debenture is a marketable legal contract whereby the company promises to pay its
owner, a specified rate of interest for a defined period of time and to repay the principal at the
specific date of maturity. All the above are advantages of debenture capital.
21. (a) Only public limited companies are entitled to issue cumulative convertible preference
shares.
22. (b) Under Section 81 of the Companies Act, 1956 when a firm issues additional equity
capital, it has to offer such securities to the existing shareholders on a pro rata basis. This
method is referred to as Rights issue.
23. (d) Commercial papers are issued for a period of 15 days to one year by the reputed
companies to finance their working capital requirements. Equity capital and reserves and
surplus are perpetual capital with an infinite maturity period while preference shares and
debentures are generally issued for a long term. Hence, (d) is the answer.
24. (e) As the company is in the dire need for funds, it must have to raise the same. In this case, it
cannot go to for public issue or rights issue, as it failed to provide satisfactory returns to the
shareholders. The company should go for private placement or brought out deals where the
managers of the company may convince the sponsors regarding the past problems as well as
the prospects of future business opportunities. It is very difficult to do so with the retail
investors. Hence, the option (e) is the correct choice.
25. (e) All the options collectively represent the advantages of making investment in the
debentures and so all factors as mentioned in the question make the debentures attractive to
investors.
26. (d) The interest of the debenture holders is looked after by a trustee set up by the company,
not assured by SEBI. Debenture redemption reserve should be at least 50 percent of the issue
amount prior to the commencement of the redemption process. Debenture redemption reserve
is to be created, only if the maturity of the debentures is more than 18 months. Call option on
debentures allow the issuer to redeem the debentures at a certain price before maturity while
put option on debentures allow the debenture holders to redeem the debentures at a certain
price before maturity.
27. (e) A company may adopt any of the techniques given in the question to raise money from
the primary markets.
28. (c) According to the traditional approach the average cost of capital, K
0
as a consequence to
the behavior of K
e
and K
d
decreases up to a certain point, remains unchanged for moderate
increases in leverage thereafter and rises beyond a certain point.
29. (a) According to the net income approach, the cost of equity capital and the cost of debt
capital remains unchanged when B/S, i.e. the degree of leverage varies.
30. (c) The weighted average of the cost of various long-term and short-term sources of finance.
31. (e) The constant growth model of equity valuation assumes that the dividends paid by the
company grow at a constant rate of growth and the growth rate is less than the cost of equity.
32. (c) The cost of retained earnings is equal to the rate of return expected by the equity
investors. Cost of external equity
1 e
e
k
K =
1-f

1
e e
K k >
Where, =cost of external equity
1
e
K
K
e
=required rate of return
f =cost of issue
K
e
=K
r

1
e r
K k >
33. (e) Cost of equity is the rate at which the intrinsic value market price of the share is equal to
the discounted value of dividends.
34. (b) An optimal capital structure should have profitability, flexibility, control and solvency.

539
35. (c) According to the net income approach, the cost of equity capital and the cost of debt
capital remains unchanged when B/S i.e. the degree of leverage varies. According to the net
operating income approach, the overall capitalization rate and the cost of debt remains
constant for all degrees of leverage.
36. (c) When creditors are approached by a firm to obtain debt capital; they impose certain
restrictions on the firm in the form of some protective covenants incorporated in the loan
contract. Such restrictions generally entail legal and enforcement costs which also impairs the
efficiency of the firm. Such costs are called the agency costs.
37. (d) For calculating the weighed average cost of capital present market value weights or book
value weights of the sources of finance included in the capital structure is taken.
38. (e) The company should make maximum use of leverage at the minimum cost to have a
optimal capital structure.
39. (d) Miller and Modigliani approach assumes that there is no corporate or personal income
tax. However, in their later studies they have ignored this assumption.
40. (d) Post-tax cost of debt is given by
K
d
=
I(1 t) (F P)/ n
(F P)/ 2
+
+

P is the net amount realized per debenture
F is the redemption price per debenture
t is the corporate tax rate
n is the maturity period
I is the annual interest payment per debenture capital.
41. (a) The use of the measure of cost of capital for appraising new investments will depend on
the above two assumptions.
42. (e) All the give alternatives are assumptions underlying the MM analysis.
43. (b) The bond yield plus risk premium approach is a method of finding out cost of equity
capital. The logic behind this approach is that the return required by the investors is directly
based on the risk profile of a company.
44. (e) According to the realized yield approach, the past returns on a security are taken as a
proxy for the return required in the future by the investors. Both (a) and (b) are the
assumptions behind this approach.
45. (d) All the statements are advantages of book value except for statement (d) which is a
disadvantage of using book value weights for computing the cost of capital.
46. (c) According to the net operating income approach, the overall capitalization rate and the
cost of debt remains constant for all degrees of leverage.
47. (e) MM approach assumes that there is no corporate or personal income tax.
48. (e) Statements (b) and (c) are not true regarding cost of capital of a new project.
49. (d) All the given alternatives are true regarding cost of capital.
50. (a) Post-tax cost of debt is given by
P =
( )
( ) ( )
n
t n
t=1
d d
C 1 t
F
+
1+k 1+k

P is the amount realized per debenture
F is the redemption price per debenture.
51. (c) While calculating the weighted average cost of capital, market value weighs are preferred
because this it is in conformity with the definition of cost of capital as the investors minimum
required rate of return.
52. (e) All the given alternatives are common misconceptions of cost of capital.
540
53. (c) When the tax rate on stock income (t
ps
) differs from the tax rate on debt income (t
pd
) the
tax advantage of debt capital may be expressed as
c ps
pd
(1 t )(1 t )
1 x
(1 t )

B
54. (c) MM approach assumes that the expected probability distribution values of expected
operating earnings for all future periods are the same as present operating earnings.
55. (c) The cost of equity capital to a company is the discounting factor that equates the PV of
future dividends to the set amount realized from shares.
56. (e) In respect of a 100% export oriented unit equity capital should be preferred to term loans
and internal accruals should be preferred to term loans.
57. (b) While calculating weighted average cost of capital, cost of various sources of finance is
determined, weightage is given as per their share in the total capital. Cost of issue (f) is
associated with the cost of external equity capital.
58. (b) The cost of retained earnings is equal to the rate of return expected by the equity
investors. K
e
=K
r
.
59. (a) According to the net income approach, the cost of equity capital (K) remains unchanged
when B/S i.e. the degree of leverage varies.
60. (b) Traditional theory proposed that the cost of debt capital K remains more or less constant
up to a certain degree of leverage but rises thereafter at an increasing rate.
61. (c) Earning power is a measure of operating profitability EP =EBIT/Average total assets
62. (a) Cost of equity
K
e
=
e 1 0
K =D / P +g

1 0
D =E (1+g)

e 0 0
K =E (1+g) / P +g
63. (c) In cumulative preference shares, the dividends are to be paid on cumulative basis,
including the situations where the dividends are unpaid in any financial year due to lack of
profits. The things stated in the other options are not correct in relation to the cumulative
preference shares.
64. (c) The book values of the different sources of finances may not be related to their current
economic values e.g. the land price may appreciate, the machine may become obsolete, etc.
The reasons stated in the other options are the advantages of using book values as the basis of
the weights for the calculation of the cost of capital.
65. (d) As per Miller and Modiglianis model, there is no optimal capital structure. Other two
options are not the assumptions of the Miller and Modiglianis model. Hence the statements I
and III are false.
66. (e) It is assumed that the risk characterizing the new project under consideration is same as
the risk characterizing the existing investments of the firm. Therefore, (I) is not correct. The
management of firm is also expected to stay. Hence, (II) is correct. It is assumed that the firm
will adopt the same financing policy for the new project and so the debt-equity mix will
remain same in the capital structure. Hence, (III) is correct.
67. (c) The optimal capital structure is decided on the basis of the expected income of the firm
and the nature of the cash flows to meet the expectations of the stake holders. It is not at all
related to the suppliers, demand for the product of the company, technology adopted and the
availability of the capital to meet a sudden spurt in demands.
68. (b) Assessing the cost of equity capital is one of the most difficult and complex task because
the income to the equity shareholders in the form of dividends as well as capital gains is fully
uncertain and that depends on many factors, unlike the borrowed funds. The characteristics
mentioned in the other options with respect to the equity capital are correct.

541
69. (d) The weights based on the book values are historical in nature and hence these do not
reflect the cost of capital owing to the changes in the business and financial risk of the
company. The reasons mentioned in the other options do not correctly reflect the advantages
of choosing the weights based on the book values in comparison to the market values.
70. (a) According to net income approach, the cost of equity and debt remains constant
irrespective of the degree of leverage. As per the traditional approach, the overall cost of
capital for a firm increases as the degree of leverage increases. A firm should choose the
debt-equity ratio in such a way that it will minimize the cost of capital, not tax liability. The
higher the degree of leverage, the more the risk of insolvency and hence correspondingly the
higher will be risk to the equity shareholders. According to the net operating income
approach, the overall cost of capital increases as the degree of leverage increases.
71. (c) The assumptions under Miller and Modigliani approach are as:
Investors are assumed to be rational, not greedy
The average expected future operating earnings of any firm are subjected to random
variables, and the expected probability distribution for all the investors is same.
Firms can be grouped into the equivalent classes of expected return based on their
perception towards business risk
Individuals and business firms are not liable to pay any tax
The securities are infinitely divisible
Therefore, the option (c) is correct.
72. (b) Wealth ratio W
t
=
t
t
P D
P 1
+
t
; W
1
=
11.75 2
10
+
=1.375; W
2
=
12.50 2.80
11.75
+
=1.302
W
3
=
13.40 3.20
12.50
+
=1.328
Realized yield =(1.375 x 1.302 x 1.328)
1/3
1 =0.3347 33.47%
73. (e) Net income approach and net operating income approach are concerned with the capital
structures of a company. Walter model states the relationship between the share price and the
dividend payment made by a company, not with the constant earning per share. Capital asset
pricing model is useful to assess the cost of capital. Hence, the option (e) is correct.
74. (c) If N be the number of existing shares, which are presently traded at a price P, required to
be held by an investor to get one rights share at a subscription price S, then the value of a
right will be (P S)/ (N +1)
75. (b) Except the composition of current assets, all the factors as mentioned in the question may
affect the capital structure of a company.
Dividend Policy
76. (b) According to Walter model
e
e
D r/ k (E D)
P
K
+
=
Hence When no dividends are paid the price is maximized. Hence the firm need not pay
dividends.
77. (c) If the firm distributes its earnings as cash dividends, then it will have to raise capital for
financing its investment decisions by selling new shares. Here, the arbitrage process will
neutralize the increase in the share value due to the cash dividends by the issue of additional
shares.
78. (b) Bonus shares, are the additional shares issued to the existing shareholders to increase the
ownership in the company.
79. (c) One of the assumption of MM approach is a constant investment policy of a firm, which
will not change the risk complexion nor the rate of return even in cases where the
investments are funded by the retained earnings.
80. (d) According to the rational expectations model there would be no impact of the dividend
declaration on the market price of the share as long as it is at the expected rate.
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81. (e) MM theory assumes that there are no differential tax rates for the dividend income and the
existence of perfect market in which the floatation and the transaction costs do not exist.
82. (b) The Walter model implies that the optimal pay-out ratio of a declining firm ( r <k) is 100
percent.
83. (a) The traditional approach lays a clear emphasis on the relationship between the dividends
and the stock market. According to it, the value of the stock responds positively to higher
dividends and negatively when there are no dividends.
84. (b) Gordons Dividend capitalization model assumes that return on investment (r) and cost of
equity capital (K
e
) remains constant.
85. (d) The Walters model assumes that the internal rate of return and firms cost of capital are
constant and thus additional investments made by the firm will not change its risk and return
profiles.
86. (e) Gordons dividend policy for firms is based on all the above assumptions.
87. (e) According to the traditional position approach, in the valuation of shares the weight
attached to dividends is equal to 4 times the weight attached to retained earnings. E is
replaced by (D +R) in equation
P =m (D +E/3).
Hence P =m (D +(D +R)/3)
=m 4 D/3 +m R/3.
88. (e) In Walter model, r and k are assumed to be constant and thus additional investments made
by the firm will not change its risk and return profiles.
89. (e) Only Gordon model assumes that the cost of capital is greater than the growth rate.
90. (d) Debt/Equity ratio determines, the amount of leverage adopted by the firm to finance its
long-term requirements.
91. (b) Changes in dividend gives a signal that the market value is going to increase in future and
hence given more importance.
92. (e) According, to the rational expectation model, there would be no impact of dividend
declaration on the market price of the share as long as it is at the expected rate. If it is lower
than the expected rate the share prices decreases.
93. (d) According to the Gordon model, investors prefer certain returns to uncertain returns and
thus put a premium to the certain returns and discount the uncertain returns. Thus, investors
would prefer current dividends and avoid risk.
94. (d) MM theory explains that dividend policy will not effect the share price of the firm. It is
only the firms investment policy that will have an impact on the share value of the firm.
95. (a) According to the Gordon model value of the share P =E (1 b)/k
e
br When earnings
per share is EPS, capitalization rate k
e
and dividend pay-out ratio is 100% then the value of
the share will be P =EPS x 1/k
e
0 =EPS/k
e

96. (a) The basic Gordon model leads to dividend policy implications that the optimal pay-out
ratio for a declining firm ( r <k) is 100 percent. Here r =0.12, k =0.15. Hence optimal pay-
out ratio is 100 percent. When r <k, the price per share increases as the dividend pay-out
ratio increases.
97. (d) According to the rational expectation model, there would be no impact of the dividend
declaration on the market price of the share as long as it is at the expected level. It shows
adjustments in case the dividends declared are higher or lower than the expected rate.
98. (a) Whenever the lenders offer any loan to the customers, they consider the safety and
security of the amount lend and stress on the repayment of the loan. Due to these factors, the
lenders impose some restrictive covenants to the borrowing entity that lead to agency
problem. The other reasons are not matching with the concept of agency costs.

543
99. (e) The assumptions under Walters model are as follows:
Retained earnings is the only source of finance available to a firm, with no outside debt
or additional equity used
Cost of capital and return on investment are constant for a firm
Firm has an infinite life
For a given value of the firm, the dividend per share and earnings per share remain
constant
Hence, the option (e) is the answer.
100. (a) The realized yield approach assumes that future expectations of investors are same as that
of their past expectations. Dividend forecast approach assumes that the intrinsic value a share
is equal to the sum of the present values of the dividends associated with that share. Bond
yield plus risk premium approach assumes that the return required by the investors is directly
related to the risk borne by them. Hence, the equity return is given by the yield on the long
term bonds of the company plus risk premium. While earnings price ratio approach considers
the expected EPS of the company for the next year. Lastly, capital asset pricing model helps
to find out the cost of equity capital at a premium on the risk free rate of return.
101. (d) According to the rational expectations model if dividend declared is lower than what was
expected by the equity share holders then the shareholders will have a bearish feelings
regarding the earnings of the company. As a result of that the share price will fall.
102. (b) Option (a) is not true because Gordons model on dividend policy does not assume the
absence business risk of any business entity. Gordons model assumes that the firm finances
its investments by only using its retained earnings hence the option (b) is correct. Gordon
dividend capitalization model is applicable only against the all equity firms or unlevered
firms having an infinite life. According to Gordons model, firms with a higher rate of return
than the cost of capital, should have a higher retention ratio in order to earn a better return for
its their equity shares, hence the option (d) is not true.
103. (e) The rational expectations model states that the market price may show some adjustments
if the actual dividend declared is higher or lower than the expected one. Otherwise, there
would be no impact of the dividend declaration on the market price of the share as long as it
is at the expected rate. Hence the option (e) is correct.
104. (e) Working capital margin is generally financed by the long term sources of funds that
mostly comprises of the equity capital and part of the term loan. Cash credit and overdraft are
the short term bank borrowing to finance the current assets, not to finance the working capital
margin.
105. (d) According to the Traditional Approach, market price and dividend are related as P =m(D
+E/3).
106. (d) The assumptions of the Walters Model on dividend policy are as follows:
The retained earnings are the only source of finance for the firm. The firm does not
resort to external financing debt or equity for additional investments
The return on investment and the cost of equity for the firm will be constant
The firm has an infinite life
For a given value of the firm, the dividend per share and the earnings per share will be
constant
So, the option (d) is correct
107. (c) Gordon argued that the investors would prefer the income that they earn currently to that
income in future that may or may not be available. Hence, they prefer to pay a higher price
for the stocks which earn them current dividend income and would discount those stocks,
which either reduce or postpone the current income. For that reason, this model emphasizes
the entire weight on the dividends, while other models consider the dividend payment and the
retained earnings. Hence, the option (c) is correct.
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108. (a) The symptoms of overtrading can be noticed from the disproportionately high turnover of
assets compared to the volume of sales. Disproportionately high turnover is indicative of less
amount of cash invested in current assets which can create problems of liquidity at the time
of making payments for current obligations.
109. (b) The degree of liquidity depends upon the paying habits of customers and the collection
efforts made by the company.
110. (b) The situation where volume of sales is less than the amount of assets employed is under
trading.
111. (e) Finished goods storing period =Average stock of finished goods/Average daily cost of
sales.
Average Cost of sales = Opening stock of finished goods +cost of production +Excise
duty +Selling and distribution costs +General administrative
costs +Financial costs Closing stock of finished goods.
112. (d) All the given alternatives are determinants of working capital of a firm.
113. (d) Net Operating cycle of the firm =Raw material storage period +Conversion period +
finished goods storage period +Average collection period Average payment period.
Hence operating cycle can be delayed by increasing the WIP period and decreasing the credit
payment period.
114. (d) Construction and real estate business involves daily purchase of raw materials. Hence the
ratio of current assets to total assets is highest.
115. (d) Technical insolvency of a firm refers to the inability to honor its current liabilities.
116. (b) In view of the uncertainty/ risk, the quantum of investment in current assets has to be
made in a manner that is not only meets the needs of the forecasted sales but also provides a
built-in cushion in the form of safety stocks to meet unforeseen contingencies. The larger the
amount of investment in current assets, the smaller will be the amount available for
investment in other profitable avenues available to the company. Hence the objective would
be a trade off between profitability and liquidity.
117. (d) Average conversion period =Average stock of WIP / Average daily production. Thus if
the conversion period is arrived at as 10 it means it takes 10 days to convert the raw materials
to finished goods. It also implies that 10 days cost of production is held as an average WIP.
118. (d) Working capital overtrading refers to the high turnover of assets compared to the volume
of sales. Overtrading may lead to the technical insolvency of the firm and cause illiquidity in
the business.
119. (e) Current assets are liquid assets of the company which are either held in cash or can be
easily converted into cash within one accounting period, usually a year. All the above are
current assets.
120. (e) The investment in current assets for a given level of forecasted sales will be higher if the
management follows a conservative attitude. Hence statements (b) and (c) are true.
121. (c) According to the Dynamic view working capital can be viewed as the amount of capital
required for smooth and uninterrupted functioning of the normal business operations of a
company ranging from the procurement of raw materials, converting the same into finished
products for sale and realizing cash along with profit from the accounts receivables that arise
from the sale of finished goods on credit.
122. (e) All the given alternatives are true in respect of working capital.
123. (c) A situation of under trading arises in a company when the volume of sales is much less
when compared to the amount of assets employed.
124. (c) Working capital gap is equal to the difference between current assets and current
liabilities less bank borrowings.
125. (d) The portion of working capital which will be financed by long-term sources is the
working capital margin.

545
126. (c) The symptoms of overtrading can be noticed from the disproportionately high turnover of
assets compared to the volume of sales. Disproportionately high turnover is indicative of
fewer amounts of cash invested in current assets which can create problems of illiquidity at
the time of making payments for current obligations.
127. (b) Average collection period =Average balance of sundry debtors/Average daily credit
sales.
It refers to the number of days required by accompany to collect its receivables.
128. (c) Nature of business, nature of raw material used, process technology used, nature of
finished goods, degree of competition in the market, paying habit of customers, degree of
synchronization among cash inflows and outflows are some of the factors affecting
composition of working capital.
129. (e) A situation of undertrading arises in acompany, when the volume of sales is much less
than the amount of assets employed. Statements (c) and (d) are true about undertrading.
130. (e) All the above are criterion for evaluation of working capital management.
easily converted into cash within one accounting period, usually a year.
132. (d) Nature of business, nature of raw material used, process technology used, nature of
finished goods, degree of competition in the market, paying habit of customers, degree of
synchronization among cash inflows and outflows are some of the factors affecting
composition of working capital.
133. (c) Net working capital is the difference between the current assets and current liabilities. A
negative working capital indicates that the current liabilities are more than the current assets
and hence the current assets may have been used to finance long-term assets.
easily converted into cash within one accounting period, usually a year. Goodwill is a
fictitious asset and not a liquid asset.
135. (c) As under trading would result in lower turnover, the company has to take precautionary
measures such as altering capital structure so that the debt equity ratio comes down,
hastening the collection process, reducing the levels of inventory to reasonable levels
compared to the sales forecast and production plans.
136. (e) The basic objective of working capital management is providing adequate cover to meet
the current obligations of a company as and when they become due. Hence manufacturing
cycle and continuity in supply of raw material have bearing on working capital management.
137. (e) Since current assets will be more for a given level of sales forecast under the conservative
approach, the turnover of current assets will be less. The company following a conservative
policy will have a low percentage of operating profitability.
138. (b) Compared to the management of fixed assets, in the management of current assets the
consideration of time value of money is less important, liquidity is more important and
profitability is equally important.
139. (c) The ratios of current assets to sales and short-term financing to long-term financing are
the two most important issues in formulating working capital policy.
140. (c) Since the NPV criteria is a multiple of the profit period, they can be taken as equivalent.
141. (e) Net working capital is the difference between the current assets and current liabilities. A
negative working capital indicates that the current liabilities are more than the current assets
and hence the current assets may have been used to finance long-term assets. Current ratio =
Current assets/current Liabilities. When current assets <Current liabilities the ratio will be
less than 1.
142. (a) Current ratio =Current assets/Current liabilities. When Current assets <Current liabilities
the ratio will be less than 1. Net working capital is the difference between the current assets
and current liabilities. Hence current ratio of less than 1 implies negative working capital.
143. (b) Investment in current assets is generally completely realizable at the time of liquidation.
For these type of investments, profit per period criteria is equivalent to the NPV criteria.
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144. (e) Current ratio =Current assets/Current liabilities
When current ratio is less than one, to improve the ratio the firm should increase current
assets or decrease current liabilities or both.
145. (e) Net Operating cycle of the firm =Raw material storage period +Conversion period +
Finished goods storage period +Average collection period Average payment period.
Hence it is the time between payment of raw material purchases and the collection of cash for
sales.
146. (a) Investment in current assets is generally completely realizable at the time of liquidation.
147. (b) Net operating cycle of the firm =Raw material storage period +Conversion period +
Finished goods storage period +Average collection period Average payment period.
When the duration of credit availed is increased the average payment period is increased and
hence the operating cycle decreased.
148. (b) Net Working capital is the excess of current assets over current liabilities. Hence it is
necessarily financed by short-term funds.
149. (c) Net operating cycle of the firm =Raw material storage period +Conversion period +
150. (d) Net operating cycle of the firm =Raw material storage period +Conversion period +
Hence the duration of the operating cycle can be reduced by increasing the average payment
period and decreasing the conversion period.
151. (c) The problem of under-trading is observed in a company, if a less amount of sales turnover
is achieved by the company in comparison to the level of current assets employed by the
company. It is a very risky situation, not in relation to the working capital management, but
in terms of the operational efficiency of the company.
152. (e) A company generally choose the liquidity mix on the basis of the level of uncertainty in
the cash flows. Nature of control with the managers, extent of leverage, marginal cost of
capital and the quality of the products of the company does not play any role in this respect.
153. (e) All the factors given in the above options influence the composition of working capital to
a business entity.
154. (d) The salient features of aggressive working capital policy are as follows:
Cost of financing the current assets tends to be low
Current ratio is maintained at a very low level
Low amount of investments in the receivables
Higher risk of technical insolvency for the firm
Greater reliance on short term sources to finance the current assets.
Hence, the option (d) is correct.
155. (b) A firm generally employs long term sources of funds to finance its working capital
margin that is the difference between the current assets and current liabilities. A negative net
working capital implies that current assets are less than current liabilities and hence the
option (b) is true. A current ratio of less than unity means current liabilities are more than
current assets that signifies the usage of the short term funds for financing the long-term
assets. A company that follows a conservative working management policy generally
maintains a very high current ratio in comparison to its peers while the opposite thing occurs
in case of aggressive working capital management policy.
156. (d) The gross operating cycle of a business entity is defined as the sum of raw material
storage period, work-in-process period, finished goods storage period and average collection
period. An increase in the consumption of the raw materials will reduce the raw materials
storage period while synchronization of the various processes of productions for a better
volume will reduce the work in process period. Incremental demand for the product of the
company will reduce the finished goods storage period and the proposition for selling the

547
products against cash payment will shorten the debtors payment period. The average
payment period is to be deducted from the gross operating cycle to get the net operating
cycle. Hence a decrease in the average payment period will increase the net operating cycle.
157. (a) Excise duties on the capital equipments influence the initial cost of the machineries, not
the operating cycle for the operation of a company. Sudden increase in the demand for the
product of a company, adoption of better technology and the sudden stoppage of the supply
of a major raw material affect the finished goods storage period, work in process period and
the raw material storage period respectively. While an increase in the short-term interest rate
will increase the interest expenses of the firm against the borrowings for the current assets.
So, the option (a) is correct.
158. (c) A risk averse company in relation to the working capital management generally prefers a
conservative working capital policy. Hence, its current ratio and current assets to sales
turnover ratio is at the maximum level in comparison to its peers not following a conservative
working capital policy. The company is therefore required to spend more to finance its
current assets in order to maintain a higher level of liquidity.
159. (c) A situation called overtrading arises when the current assets experience a very high
turnover in comparison to the sales. It is generally practiced by the companies following an
aggressive working capital management policy. In this case, the current assets turnover ratio
is high while the current ratio will be very low, thereby leading a situation of under
capitalization.
160. (a) Net working capital is defined as the current assets minus current liabilities.
161. (c) The working capital management policy of a company depends the factors like, nature of
business, seasonality of operations, seasonality of operations, process technology used,
degree of competition in the market, conditions of supply, and the synchronization between
the cash inflows and cash outflows. Theamount invested in the fixed assets does not play in
the formulation of the working capital management policy of any company.
162. (c) Letter of credit is opened by a bank in favor of its customer undertaking the responsibility
to pay to the supplier (or the suppliers bank) in case its customer fails to make payment for
the goods purchased from the supplier within the stipulated time.
163. (b) Under hypothecation agreement, the goods hypothecated will be in possession of the
borrower and under pledge the goods / documents in the form of share certificates, book
debts, insurance policies etc., which are provided as security will be in possession of the bank
lending funds and not with the borrowing company.
164. (a) Rs.12,000 is the paid-up share capital and Rs.10,000 is free reserves +Capital redemption
reserve. A company cannot raise more than 10 % of its paid-up share capital and free
reserves. Capital redemption reserve is treated as part of free reserves and share premium
account is treated as part of paid-up capital.
165. (e) Government companies can accept deposits up to 35% of their paid-up capital and free
reserves. They need not be underwritten by merchant bankers.
166. (c) In maturity factoring, the factor does not make any advance or prepayment. Sales ledger
administration and collection are carried out by client. The factor has revenue to the client if
the receivables purchased turn out to be irrecoverable.
167. (d) Tandon committee framed guidelines for follow up of bank credit under the chairmanship
of P.L Tondon. Statements (i) (ii) and (iv) are true regarding Tandon Committee
recommendations.
168. (c) Discount and Finance House of India Ltd. was set up based on the recommendations of
Vaghul Committee.
169. (d) The Kannan Committee recommended the issuance of short-term working capital
debentures of 12-18 months maturity by corporate to banks.
170. (a) One of the major recommendations made by Kannan Committee is that need based
working capital finance should be made by banks.
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171. (b) 2/10 net 30 implies 2 percent discount offered for payment made on or before the 10th day
of sales.
Cost of trade credit =
Rateof discount
x
1-Rateof discount p
360
T t

Supplier A =0.02/(1 0.02) x 360/60 10
=14.69%
Supplier B =0.02/(1 0.02) x 360/30 10
=48.98%
Cost of trade credit for supplier A is 14.69% and cost of trade credit for supplier B is 48.98%.
Hence cost of trade credit is higher for supplier B than supplier A.
172. (e) The liabilities which emerge in the normal course of business are referred to as
spontaneous liabilities.
173. (e) Under the cash credit arrangement, the customer is permitted to borrow up to a pre-fixed
limit called the cash credit limit. Under the overdraft arrangement, the customer is permitted
to overdraw up to a pre-fixed limit. Overdraft is paid back while cash credit is rolled over.
174. (e) Factoring is a continuing arrangement between a financial intermediary called a factor and
a seller of goods and services. A factor provides all the above services.
175. (b) Assets which are easily convertible into cash are quick assets.
176. (e) Current liabilities are economic obligations of a company to be paid within the accounting
period. Fixed deposit for 18 months is not a current asset.
177. (e) Public deposits are unsecured deposits made by small and large firms to meet their
working capital requirements. Statements (a) and (b) are true regarding public deposits.
178. (a) Under full factoring there is no recourse to the client, under maturity factoring the factor
does not make any advance or pre-payment, under invoice discounting the factor provides a
pre payment to the client against accounts receivable and collects interest for the period
extending from the date of pre-payment to the date of collection.
179. (e) All the given alternatives are criterion on which the supplier of raw materials evaluates a firm.
180. (b) 4/10, net 30 implies a 4% cash discount can be taken for payment within 10 days fro m
the date of sales. If the sale has taken place on 1st the statement (b) is true.
181. (b) As the use of provisions as a source of financing current assets is very much limited
provision for dividends is not a spontaneous sources of financing current assets.
182. (d) Public deposits are unsecured deposits made by small and large firms to meet their
working capital requirements. Financing with public deposits will increase the financial leverage.
183. (a) Full factoring is one where the factor has no recourse to the client if the receivables are
not recovered, i.e. the client gets total credit protection.
184. (b) Current liabilities are economic obligations of a company to be paid within the accounting
period. Hence credit sales extended by a company will be shown as current liability in the
books of the customer.
185. (c) Permanent investments are investment which cannot be reversed quickly. Investments in
fixed assets and core current assets are permanent investments.
186. (e) All the given alternatives are true about permanent current assets.
187. (e) Retained earnings is the amount of profit left after the distribution of dividends and
accrued wages is the outstanding wages to be paid to the to labor. They do not raise with a
raise in sales.
188. (b) 2/45 net 90 days means a firm can avail a cash discount of 2% if payment is made within
45 days from the date of sale. Hence there is no cost of funds up to 45 days.
189. (e) Under method II, the borrower will finance 25% of total current assets through long-term
sources. That is the maximum permissible bank finance.
=(0.75 x Current assets) Current liabilities

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190. (b) Cost of trade credit
=
Rateof discount
1 Rateof discount
x
Number of daysinayear
(Creditperiod Discountperiod)

Hence higher the discount rate, higher the cost of trade credit.
191. (a) The portion of assets normally financed through long-term sources are called core current
assets.
192. (d) Spot transaction is where the transaction and its settlement takes place on the same day.
193. (a) Trade credit or accounts payables or sundry creditors is a very important spontaneous
source for financing current assets. It occurs in the normal course of business.
194. (c) Public deposits are unsecured deposits made by small and large firms to meet their
working capital requirements.
195. (b) When the quality of receivables is good, the discount rate is likely to be low.
196. (d) 1/10 net 30 indicates that a 1% discount can be availed if the payment is paid within 10
days or else full payment has to be made within 30 days.
197. (a) Security in the form of hypothecation is limited to movable property like inventories.
198. (b) When the credit terms are liberalized by increasing the discount, debtors would try to
avail the discount which result in decrease in bad debt losses.
199. (b) In letter of credit, a bank assures the payment to be made to the supplier, in case of
default committed by the buyer, the client of the bank. Hence, it may be termed as an indirect
method of financing current assets with the support of a bank. In cash credit, overdraft and
purchase or discount of bills, the banks generally offer direct cash to the client. Factoring
services are offered by the factors, not the banks.
200. (a) Spontaneous liabilities generally occur during the normal course of business operations
where a company will usually have a ready access to certain sources for financing its current
assets. But a company is required to take proper initiative for the sources of finance as
mentioned in the other options to finance its current assets.
201. (d) Public deposit may be raised by a company by duly following certain norms as per the
Companies Act. 1956 without the requirement of any collateral security. While in the other
cases, security is to be provided compulsorily.
202. (b) With the normal operations of the business, some amount of money is set aside to pay for
the taxes. However, taxes are generally paid at the last date as decided by the competent
authority. In the mean time, this money may be used by the company for the regular course
of its business. Hence, it may be termed as the spontaneous sources of financing current
assets. Cash credit and overdraft are the two arrangements of borrowing money while letter
of credit is nature of guarantee from the bank to pay to the supplier in case of any default
committed by the buyer, the customer of the bank.
203. (c) In maturity factoring, the seller does not get any advance payment from the factor where
the same is paid after realizations of the receivables. While in the other cases, the factor
purchases the receivables from the seller on the basis of the terms of the services offered.
204. (a) Work in process cannot be converted into cash instantaneously. It is to be converted into
finished goods and sold against cash or credit, as may be the case. But the other items are
cash or may be liquidated within a short time. So, the option (a) is answer.
205. (d) The salient features of public deposits scheme offered by any company are as follows:
The minimum maturity period allowed is six months
The maximum maturity period is three years
A private company can raise at most 10 percent of its share capital and free reserves
A government company can raise deposits up to 35 percent of its share capital and free
reserves
The advertisement relating to the invitation of public deposits is required to be filed
with the Registrar of Companies, not SEBI
Therefore, the option (d) is correct.
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206. (c) Note lending is a source of short term finance for any business entities. The sources as
mentioned in the other options are generally meant for financing in the long term. Hence, the
option (c) is correct.
207. (c) Items that are stored by the firm and sold with little or no modifications are called the
shelf stock.
208. (d) ABC is an inventory management technique in which inventory is segregated into three
groups A, B and C on the basis of value of annual usage. The A items are those in which it
has the largest rupee investment.
209. (b) If the material is priced at the value that is realizable at the time of issue, such pricing
method is called replacement method. This method is also called constant market price
method.
210. (b) The time gap between placing an order and procuring the material is called the lead time.
211. (d) EOQ assumes that the ordering costs are constant. Ordering cost is constant irrespective
of the size of the order.
212. (a) EOQ = 2UP/S
EOQ does not take inflation into consideration. However, when the inflation is predictable
accurately then EOQ formula can be modified. If inflation rate is known, it should be added
to the annual carrying cost expressed as a percentage.
213. (b) When the minimum quantity for purchases is more than the economic order quantity, then
there will be an increase in the average value of inventory which will result in higher
incidence of carrying cost.
has the largest rupee investment, the B group consists of items accounting for the next largest
investment and the C group consists of a large number of items accounting for a small rupee
investment.
215. (c) The pricing of materials will be alone on weighted average basis, weights will be given
based on the quantity.
216. (d) Carrying costs increase on storing inventories. Hence reduction of carrying costs is is not
a benefit of storing inventories.
217. (d) The reorder point is given by S x L +F SxRxL
218. (e) All the given alternatives are subsystems of inventory management system.
219. (d) Shadow price represents the opportunity cost of a unit of constrained resource. Hence it
quantifies the benefit that the firm can expect from increase in capacity.
220. (e) All the given alternatives are assumptions underlying Economic Order Quantity (EOQ).
221. (e) ABC is an inventory management technique in which inventory is segregated into three
groups A, B and C on the basis of value of annual usage. The ABC analysis enables the
management to concentrate attention and keep a close watch on a relatively less number of
items which account for a high percentage of value of annual usage of all items of inventory.
222. (e) Under standard price method material is priced based on a standard cost which is
predetermined.
223. (e) The carrying cost increases.
224. (e) Cost of long-term debt locked in inventories is a capital cost. (Investment)
225. (d) EOQ model assumes that there is no lead time. Delivery is instantaneous.
226. (e) All the given statements are true.
227. (c) EOQ model assumes that there is no lead time. Delivery is instantaneous. Hence it does
not consider stock out costs.

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228. (e) EOQ = 2CP/S
229. (a) During the period of deflation, prices decrease and in FIFO, pricing is based on the cost
of material that was obtained first.
230. (e) Higher the quantity of safety, lower will be the stock out costs and the higher will be the
incidence of carrying costs. The optimal safety stock will be at a level where the expected
stock-out costs and the carrying costs will be minimal.
231. (a) EOQ = 2CP/S
Where E =Economic order quantity or the optimum production quantity
U =Annual output
P =Ordering cost
S =Cost of carrying
Hence a decrease in the inventory order costs will decrease the economic order quantity.
groups A, B and C on the basis of value of annual usage. The ABC analysis enables the
management to concentrate attention and keep a close watch on a relatively less number of
items which account for a high percentage of value of annual usage of all items of inventory.
Hence it is useful for better control on inventories.
233. (e) All are included in carrying cost.
234. (a) Under FIFO pricing is based on the cost of material that was obtained first. Hence profit
will go up, if the inflationary conditions prevail, as the cost will be less.
235. (c) The goods which are available for sale will not be immediately converted into cash.
This time taken for the goods to be converted into cash by sale is called the storage lag.
236. (b) Safety stock is the minimum level of inventory that is held as a protection against
shortages.
Safety stack =Reorder point Normal consumption
237. (b) J ust in time is a inventory management technique where the inventory is ordered just at
the time of manufacture. There is no safety stock maintained. Hence this system is reliable
only when there are reliable suppliers who are easily accessible.
238. (e) ABC is an inventory management technique in which inventory is segregated into three
investment.
239. (a) When the level of inventory is increased the ordering costs decrease as the number of
orders come down but the carrying cost increase as a larger quantity of inventory has to be
maintained.
240. (b) The level at which the replenishment of stock takes place is called the reorder level.
Reorder level =Average daily usage rate x lead time in days.
investment.
242. (d) Opportunity cost means the expenses or loss of profit for not availing an opportunity. In
this case, when a firm is in situation of stock out, it suffers in two ways loss of profit due to
foregone sales as well as the loss of reputation to its valuable customers. Hence, the option
(d) is the right choice as the other options do not represent such a situation.
243. (b) In case of non-recourse factoring, the factor offers short-term finance, sales ledger
administration as well as credit protection simultaneously. It is not available in any other
mode of factoring.
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244. (d) The assumptions of the economic order quantities are as follows:
Constant or uniform demand of the product throughout the year
Constant unit price of the raw material
Constant carrying cost of the material
Constant ordering cost
Instantaneous delivery of the materials.
Hence, the option (d) is the correct choice.
245 (c) ABC system of inventory management has the following advantages:
It leads a closer control on the costly items where a large amount of funds is blocked.
A scientific method of controlling inventories can be developed based on the ABC
system that will lead to the reduction of clerical costs are reduced.
ABC system also helps to maintain the optimum level of stocks.
The stock turnover rate can be maintained at a comparatively higher level through
scientific control of inventories.
But it cannot help the beginners to learn the different techniques of inventory management.
Hence option (c) is the answer.
246. (b) Storing the products in the form of inventories can neither improve the quality of the
inventory nor can improve the quality of the finished products. While the other purposes as
mentioned in the other options are served through the maintenance of the inventories. Hence,
the option (b) is the answer.
247. (a) The economic order quantity (EOQ) is directly related to the annual usage and the fixed
cost per order while inversely related to the carrying cost of the inventories. An increase in
the carrying cost for the inventories will decrease the EOQ for a company while the
conditions as mentioned in the other options will increase the economic order quantity.
Hence, the option (a) is the correct one.
248. (e) The following assumptions are made in framing the EOQ model:
a. The demand for the product will be uniform.
b. The unit price for the product will remain constant
c. The cost of carrying inventories is a fixed percentage of the average value of the
inventories
d. The ordering cost will remain the same irrespective of the size of the order.
Therefore, the option (e) is correct.
249. (b) The economic order quantity, according to the EOQ model, is directly proportional to the
ordering costs. The ordering cost is neither related to the reorder point nor related to the
carrying costs. Hence, the option (b) is correct.
250. (d) The word ABC Analysis means for Always Better Control. This system categorizes
the several items in the inventories on the basis of their costs and thereby implies the control
measures to be adopted against each of such category.
251. (e) All the costs are associated with the extension of credit and accounts receivables as some
of the firms resources are blocked and there is a time lag between the credit sale to customer
and receipt of cash from them as payment.
252. (e) All the given alternatives are costs linked with maintaining receivables. All the costs are
associated with the extension of credit and accounts receivables as some of the firms
resources are blocked and there is a time lag between the credit sale to customer and receipt
of cash from them as payment.
253. (e) Credit policy encompasses the policy of a company in respect of the credit standards
adopted, the period over which credit is extended to customers, any incentive in the form of
cash discount offered, and also the period over which the discount can be utilized by the
customers and the collection effort made by the company.

553
254. (e) Credit evaluation of the prospective customer involves obtaining information from which
the financial capacity and also the paying habits can be evaluated.
255. (a) Shortening the credit period will tend to lower sales, as customers decrease investment in
receivables, and reduce the incidence of bad debts loss.
Rigorous collection program will bring down sales and the amount of receivables and bad
debt losses will reduce to a certain extent.
A cash discount will decrease the average collection period and will also decrease bad debt
losses.
Hence only statement (a) is correct.
256. (e) The costs incurred when some of the firms resources are blocked and there is a time lag
between the credit sale to customer and receipt of cash from them as payment are called the
costs of maintaining receivables. Marketing costs are not maintaining costs.
257. (c) Collateral represents the security offered by the firm in the form of mortgages, capacity is
the ability of the customer to pay on time, character is willingness of a customer to honor his
obligations. Hence credibility is the answer.
258. (b) ABC is a system of inventory management and not a measure for monitoring receivables.
259. (a) Overdraft limit is the amount of cash which can be drawn in excess of the firms holdings.
The variables associated with the credit policy of a company are credit standards, credit
period, cash discount and collection program.
260. (e) All the given alternatives are objectives of companies making credit sales.
261. (d) If the 20% probability of default occurs than the firm losses Rs.750, i.e. the cost of order.
262. (d) Liberalizing cash discount policy will decrease the average collection period as firms tend
to avail the cash discount in order to reduce costs.
263. (e) When a company liberalizes its cash discount policy than all the above statements are
true.
264. (c) Collection matrix is helpful to look at the pattern of collections associated with credit
sales. Hence it is extremely useful in monitoring receivables.
265. (d) The average number of days sales outstanding at any time is called the days sales
outstanding given by the formula =Accounts receivable at the time chosen / Average daily
sales. It is an indication of average collection period.
266. (d) The age-wise distribution of accounts receivable at a given time is depicted in the ageing
schedule.
267. (d) When the credit standards are liberalized and the collection efforts relaxed then the bad
debt losses may increase.
268. (c) Liberalizing cash discount will increase the average collection period and will also
increase the cost of discount.
269. (d) Average collection period =
Averagebalanceof sundrydebtors
Averagedailycreditsales

Annual credit sales
360
.
270. (e) The average number of days sales outstanding at any time is called the days sales
outstanding given by the formula =Accounts receivable at the time chosen / Average daily
sales. The age-wise distribution of accounts receivable at a given time is depicted in the
ageing schedule. All the above are limitations of days sales outstanding and ageing schedule.
271. (a) In cash credit, the customer is charged interest on the outstanding amount borrowed but
the customer is allowed to borrow only up to a pre-specified limit, against suitable securities
as per the terms of the bank. Borrowings may be made as often as required by the customer.
Moreover, irrespective of the number of borrowings and the pre-specified borrowing limit,
the customer is required to pay a fee to the bank.
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272. (c) In judging the creditworthiness of a customer, three Cs are considered. These are
character (willingness to meet the obligations), capacity (ability to pay at the required time)
and collateral (the quality of security offered). The contingencies faced by the customer are
not at all considered.
273. (e) All the given factors as given in the several alternatives in this question are the credit
policy variable to a company.
274. (a) Ageing schedule is used to monitor the status of the receivables. Outstanding creditors in
the balance sheet indicate the position of accounts receivables but do not help to monitor the
status of the same. Selection matrix, funs flow analysis and credit evaluation do not play any
role in this respect.
275. (e) If a company faces difficulties in getting prompt payments despite a rigorous collection
effort, it may considers for an attractive cash discount as well as to improve the quality of the
receivables. If the volume of credit disbursed is increased or the collection effort is reduced,
the amount of bad debt will be piled up to a significant amount. Hence, the option (e) is the
answer.
276. (d) Making the credit standards more stringent one will result in lower volume of sales
turnover thereby decreasing the collection costs due to the reduced number of customers
which in turn reduces the bad debt losses. As a consequence of the above event, the
outstanding debtors in the balance sheet will also come down. Hence, the option (d) is
correct.
277. (c) The credit policy variables are: cash discounts, credit standards, collection efforts and
credit period. Therefore, the option (c) is the correct one.
278. (d) Days Sales Outstanding (DSO) is the ratio between the accounts receivables at the time
chosen and the average daily sales. In this way, it gives some indication regarding the span of
the average collection period. DSO is neither better than collection matrix, nor does it
indicate the outstanding sales order of a company. DSO shows the pattern of sales made by
the company, not any of its supplier. Agewise classification of the receivables is shown in the
ageing schedule. Hence, the option (d) is correct.
279. (d) In collection matrix, the payment behavior of the customers is studied through the pattern
of collections associated with the credit sales. In days sales outstanding (DSO), the idea
regarding the average collection period is obtained while in the ageing schedule, the agewise
distribution of the receivables at a given point of time is depicted. Ratio analysis is not
relevant in this context. So, the option (d) is correct.
Cash Management
280. (b) Treasury bills are issued by the government of a country. Hence they do not bear any
default risk.
281. (c) The basis of estimation for receipts of interest and dividend in the cash budget is usually
the companys investment portfolio and the returns expected therefrom. (Interest and
dividends made by a company are obtained from the investment made and the returns
expected therefrom.
282. (d) Security is the assurance of getting back the original amount, and it takes paramount
importance for investing surplus cash by a firm.
283. (c) Cash management involves managing short-term liquid funds.
284. (e) Cash in the broader sense includes actual cash in the form of coins and bank drafts held by
the firm, deposits withdrawable on demand and marketable securities which can be
immediately sold or converted in to cash.
285. (c) Cash is held for all the purposes mentioned in statements a, b, d and e but not for the
purpose mentioned in statement (c).
286. (a) Net float is the difference between the payment float and collection float. The balance in
the books of the company is less than that in the banks books when the float is positive and
vice versa when the float is negative.
287. (a) Net float is the difference between the payment float and collection float. The balance in
the books of the bank is less than that in the books of the company when the float is negative
and vice versa when the float is positive.

555
288. (e) Capital investment is a long-term objective and not a motive for companies to hold cash.
289. (a) The amount of cheques deposited by a company in a bank awaiting clearance is called
collection float.
290. (a) Net float is the difference between the payment float and collection float. Hence it is the
difference between the bank balance and the balance shown in the firms books.
291. (a) When the company has a positive float it may issue cheques to the extent that the amount
shown in the bank books is higher than the amount shown in the companys books, even if
the companys books indicate an overdrawn position. The company is then said to have been
playing the float.
292. (c) When the company has a positive float it may issue cheques to the extent that the amount
shown in the bank books is higher than the amount shown in the companys books, even if
the companys books indicate an overdrawn position. The company is then said to have been
playing the float.
293. (b) The objective of cash management can be regarded as one of making short-term forecasts
of cash position, finding avenues for financing during periods when cash deficits are
anticipated and arranging for repayment/ investment during periods when cash surpluses are
anticipated with a view to minimizing idle cash as far as possible. Hence it does not involve
lengthening of receivables period.
294. (b) Net float is the difference between the payment float and collection float. The balance in
the books of the bank is less than that in the books of the company when the float is negative
and vice versa when the float is positive.
295. (b) With precautionary motive, a company holds cash to meet the contingent cases while
transaction motive implies the reason for holding cash to meet the day to day transactions. A
motivation due to the speculative motive encourages a company to hold cash in order to
make speculative profit by exploiting the opportunities due to price changes in the market.
Lack of synchronization between cash inflows and outflows is also an example of
precautionary situation. It is also required for the large business entities.
296. (d) When the net float is negative the balance in the books of bank is less than the balance in
the books of the firm. Any relationship between the current asset and current liability does
not play any role in the determination of the net float as it is related to the cash balance.
297. (b) Whether or not to pay for the outstanding interest on term loans depends on the financial
position of the company and its willingness to pay for the same. A cash management policy
may influence this but this payment is not a part of the cash management policy.
298. (c) A float, in the context of cash management, arises when a bank does not credit its
customers account in its book despite a cheque was being deposited or does not debit its
customers account against the issue of a cheque. This fact is mentioned in the option (c).
299. (a) The net benefit cost ratio of any project is defined as the ratio between the net present
value of the project and the initial investments. As the IRR is zero at the cost of capital, the
NPV of the project will also be zero, which in turn implies a zero net benefit cost ratio for the
project. If the project provides excess returns to the equity investors, the internal rate of
return on a project will be more than the cost of capital.
300. (e) In broader sense, cash in comprising of notes, coins, deposits in a bank, drafts, cheques
and marketable securities that can be easily converted into cash.
301. (b) Cross elasticity of demand for a product is the responsiveness of the Quantity demanded
to a given change in the price of related product.
302. (b) Depreciation is a non-cash charge and hence has to be added back to the profit after tax.
303. (d) Net salvage value of fixed assets is equal to the salvage value of fixed assets less any
income tax payable on the excess of salvage value over book value.
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304. (e) Accounting rate of return (ARR) =Average profit after tax / Average book value of investment.
305. (e) The internal rate of return is that rate of interest at which the net present value of a project
is equal to zero.
306. (a) Annual capital charge appraisal criterion is used for evaluating mutually exclusive
projects or alternative which provide similar service but have differing patterns of costs and
307. (b) Net benefit cost ratio =NPV / Investment
When NBCR <0, the project is rejected.
When investment outlay is spread over more than one period, this criterion cannot be used.
308. (c) Accounting Rate of Return (ARR) =Average profit after tax / Average book value of
investment.
Depreciation is not added back to the average profit after tax, ARR of a project is compared
with the ARR of the firm as a whole or against some external yard stick like the average rate
of return for the industry as a whole.
309. (c) Increments in the present level of costs and benefits that occur on account of the adoption
of the project are alone relevant for the purpose of determining the net cash flows.
310. (b) Interest on long-term loan must not be included for determining the net cash flows. Since
the net cash flows are defined from the point of view of suppliers of long-term funds, the
post-tax cost of long-term funds will be used as the interest rate for discounting.
311. (c) Payback period measures the length of time required to recover the initial outlay in the
project.
312. (b) Since the application of payback criterion leads to discrimination against projects which
generate substantial cash inflows in later years, the criterion cannot be considered as a
measure of profitability.
313. (b) The post-tax cost of long-term funds will be used as the interest rate for discounting.
314. (c) Payback period measures the length of time required to recover the initial outlay in the
project. It does not consider time value of money.
315. (c) NBCR =NPV/I
=(PV I)/I
=(PV/I) 1
=BCR 1
316. (e) Accounting rate of return (ARR) =Average profit after tax / Average book value of
investment. All the above are drawbacks of ARR.
317. (d) Near term flows are given more weightage than distant flows.
318. (d) Only when the cash flows are discounted to a single period various cash flows occurring
in different periods can be compared.
319. (d) If the cash flow stream has one or more cash outflows interspread with cash inflows, there
can be multiple internal rate of return.
320. (a) The internal rate of return is that rate of interest at which the net present value of a project
is equal to zero or in other words, it is that rate which equates the present value of cash
inflows to the present value of cash outflows. The cash flows are assumed to be reinvested in
the project at internal rate of return.
321. (d) BCR =PV/I implies that present value is equal to the investment, hence IRR will be equal
to the discount rate.
322. (c) PV(A) =10,00,000 +1,00,000 x 0.909 +2,00,000 x 0.826 +2,50,000 x 0.751 +3,00,000
x 0.683 =16,48,750
Annual capital charge (A) =
16,48,750
PVIFA(10%,4)
=5,20,132.50

557
PV(B) =7,00,000 +80,000 x 0.909 +1,20,000 x 0.826 +1,70,000 x 0.751 =9,99,510
Annual capital charge (B) =
9,99,510
PVIFA(10%,3)
= 4,01,917
323. (e) Sunk costs, common fixed costs are ignored as money has already been sent in it and no
additional or incremental money is spent on it for the purposes of the project.
324. (b) Since the net cash flows relevant from the firms point of view are what accrue to the firm
after paying tax, cash flows for the purpose of appraisal must be defined in post-tax terms.
325. (e) When the rate of interest at which the net present value of a project is equal to zero, i.e.
IRR (r) is less than the funds employed in the project (k), r k then the NPV is negative.
326. (e) The criteria that are typically applied for preliminary evaluation are compatibility with the
promoter, compatibility with government priorities, availability of raw materials and utilities,
size of the potential market, reasonableness of cost and risk inherent in the project.
327. (e) Annual capital charge appraisal criterion is used for evaluating mutually exclusive
328. (e) All the given alternatives are reasons responsible for capital expenditure decisions to
occupy a very important place in corporate finance.
329. (e) Interest on long-term loans must not be included for determining the net cash flows since
the net cash flows are defined from the point of view of suppliers of long-term funds, the
post-tax cost of long-term funds will be used as the interest rate for discounting.
330. (e) BCR measures the present value per rupee outlay.
BCR =PV / I
NBCR =BCR 1
Hence BC >1, NBCR > 0, accept the project.
BCR < 1, NBCR < 0, reject the project.
331. (a) Technical appraisal is done to ensure that all technical aspects related to the successful
commissioning of the project have been taken care of. Size of the total market for the
proposed product or services is not considered.
332. (c) When the rate of interest at which the net present value of a project is equal to zero, i.e.
IRR (r) is less than the funds employed in the project (k), r <k then the NPV is negative.
When NPV >0, the discount rate is less than IRR.
333. (d) IRR is uniquely defined only for a project whose cash flows pattern is characterized by
cash outflows followed by cash inflows. (Simple investments)
334. (c) Using the firms own output to produce other products is backward integration.
335. (c) Economic appraisal is done to adjudge whether the project is desirable from the social
point of view.
336. (d) The incremental principle of measuring costs and benefits implies all the above.
337. (d) DCF method makes sense to businessmen who want to think in terms of rate of return,
and find an absolute quantity like NPV difficult to workwith.
338. (d) IRR is uniquely defined for a project whose cash flow pattern is characterized by cash
outflow followed by cash inflows. If the cash flow stream has one or more cash outflows
interspersed with cash inflows, there can be multiple internal rates of return.
339. (d) Conflicts in ranking of projects on the basis of net present value and internal rate of return
arise due to disparity in the timing and size of the cash inflows.
340. (e) When the rate of interest at which the net present value of a project is equal to zero, i.e.
IRR (r) is less than the funds employed in the project (k), r <k then the NPV is negative and
vice versa.
341. (e) The internal rate of return is that rate of interest at which the net present value of a project
is equal to zero, or in other words, it is the rate which equates the present value of the cash
inflows to the present value of cash outflows.
558
342. (a) Internal rate of return (r) is the rate at which NPV =0. NPV is positive when IRR is
greater than the cost of funds.
343. (e) Sunk costs, common fixed costs are ignored as money has already been sent in it and no
additional or incremental money is spent on it for the purposes of the project. They are
historical costs.
344. (d) The increments in the present levels of costs and benefits that occur on the adoption of the
project are alone relevant for the purpose of determining the net cash flows. Hence increase
in excise duty on the items to be produced is ignored.
345. (c) If interest on long-term debt is deducted in the process of cash flow analysis; the cost of
long-term debt will be counted twice.
346. (e) All are implications of poor infrastructure in India.
347. (d) New assets are assumed to have the same risk as that of the existing assets. Hence the new
capital budgeting decisions are evaluated using the existing cost of capital of the firm.
348. (d) Since cash flows and accounting income are often different and investment appraisal
emphasizes cash flows, a profitability measure based on accounting income cannot be used as
a reliable investment appraisal criterion.
349. (d) Difference between cash inflows and cash outflows for each and every expenditure is
called the incremental cash flow.
350. (e) Annual capital charge appraisal criterion is used for evaluating mutually exclusive
351. (c) Statements (c) is an important principles underlying measurement of costs (outflows).
352. (b) Benefit cost ratio or the profitability ratio is defined as present value of future cash flows
divided by initial investment. The variant of the benefit cost ratio is net benefit cost ratio. It is
given as NPV/I.
353. (d) According to the principles followed for the determination of the costs and benefits of a
project, only the cash inflows and outflows are taken as benefits and costs. All revenues
generated from the implementation of the project may not lead to the actual cash inflows
while all expenses to be incurred may not result in actual cash outflows due to the project.
The other statements as mentioned in the other options are correct for determining the costs
and benefits of a project.
354. (e) Accounting rate of return does not consider the time value of money while the other
criteria as mentioned in the other options consider the time value of money.
355. (a) If cost of capital is less than IRR of a project, the NPV of the project will be positive.
Similarly, the benefit cost ratio is less than unity indicates the present value of the benefits is
less than the present value of costs at a given cost of capital, thereby making the NPV a
negative one. Similarly, a discount rate is greater than the IRR will make the NPV a negative
one and hence for a project of benefit cost ratio is less than unity. Such a project will have a
positive effect on the wealth of the shareholders, not an indeterminate effect.
356. (d) If the benefit cost ratio is equal to one, the present value of the cash flows at the cost of
capital is equal to the initial investment. This implies all the stakeholders of the project have
enjoyed the return expected. Hence the option (d) is false. However, the other statements are
correct with respect to the capital expenditure.
357. (b) As per the incremental principle of measuring costs and benefits of a project, the impact
of the project on existing operations of the firm is carefully analyzed. The opportunity costs
in the form of foregone sales or savings in expenses are considered. The depreciation costs
or the interest on long term debts are also taken into account. However, the existing overhead
costs are neglected.

559
358. (a) Benefit Cost Ratio (BCR) of a project is the ratio between the present value of benefits
and the initial investments. If the BCR is unity, the NPV of the project (the present value of
the benefits minus initial investments) will be zero.
359. (d) The facts mentioned in the first three options are the part of the marketing appraisal of the
project while the option (e) is a part of the technical appraisal of the project. But in the
economic appraisal of any project, the impact of the project on the savings and investments
of the society is studied. Hence, the option (d) is the answer.
360. (b) In annual capital charge method, sum of the present value of all the expenses are
evaluated, which is divided by the a PVIFA factor depending on the cost of capital and the
life of the project. But the other criterions, as mentioned in the other options, only consider
the initial investments and the benefits in the form of cash flows accrue annually. So, the
option (b) is the answer.
361. (d) IRR is uniquely defined for a project whose cash flow pattern is characterized by the
initial cash outflow followed by cash inflows, not for the projects that experience cash
outflows more than once. It is false with respect to the application of IRR as an appraisal
criterion. The points mentioned in the other options are correct for using IRR as an appraisal
criterion.

560
Frequently Used Formulae
1. Ex-rights Value of a Share
The value of a share, after the rights issue, is
0
NP +S
N+1

Where,
N = number of existing shares required for a rights share
P
0
= cum-rights price per share
S = subscription price at which rights shares are issued.
2. Value of a right
The theoretical value of a right is
0
P S
N+1

1.
n
n
t =1
d d
I(1 t) F
P
(1+k ) (1+k )
= +
.(1)
Where,
k
d
= Post-tax cost of debenture capital
I = Annual interest payment per debenture capital
t = Corporate tax rate
F = Redemption price per debenture
P = Net amount realized per debenture and
n = Maturity period.
2. An approximation formula as given below can also be used.
F P
I(1 t) +
n
F+P
2
k
d
=
3. When the difference between the redemption price and the net amount realized can be written
off evenly over the life of the debentures and the amount so written-off is allowed as a tax-
deductable expense, the above two equations can be changed as follows:
n
t n
t =1
d d
(F P)T
I(1 t)
F
n
P
(1+k ) (1+k )

= +

or
d
F P
I(1 t) + (1 t)
n
k =
F+P
2

4.
n
t n
t =1
p p
D F
P
(1+k ) (1+k )
= +

Where,
k
p
= Cost of preference capital
D = Preference dividend per share payable annually

561
F = Redemption price
P = Net amount realized per share and
n = Maturity period.
5. An approximation formula as given below can also be used.

p
F P
D+
n
k =
F+P
2

6.
n
t
e t
t =1
e
D
P =
(1+k )

Where,
P
e

=

Price per equity share

D
t
= Expected dividend per share at the end of year t and

k
e
= Rate of return required by the equity

shareholders.

7. Assuming a constant growth rate in dividends, the equation can be simplified as follows:

1
e
e
D
P =
k g

If the current market price of the share is given (P
e
), and the values of D
1
and g are known,
then
1
e
e
D
k =
P g +

8. The realized return over a n-year period is calculated as W (W
1
x W
2
x .. W
n
)
1/n
1

where W
t
, referred to as the wealth ratio, is calculated as
t t
t
D +P
P 1
and t = 1, 2.... n.
D
t
= Dividend per share for year t payable at the end of year
P
t
= Price per share at the end of year t.
9. Capital Assets Pricing Model Approach
According to this approach, the cost of equity is reflected by the following equation:

i f i m f
k =R + (R R )
i
Where,
k
i
= Rate of return required on security i
R
f
= Risk-free rate of return
= Beta of security i
R
m
= Rate of return on market portfolio.
10. Return = Yield on the long-term bonds of the company + Risk premium.
11. Under the dividend capitalization model, the following formula can be used for calculating
the cost of external equity:

1
e
0
D
K g
P (1 f )
= +

Where,
= Cost of external equity
e
K
D
1
= Dividend expected at the end of year 1
P
0
= Current market price per share
g = Constant growth rate applicable to dividends
f = Floatation costs as a percentage of the current market price.

562
12.
e
e
k
K
1 f
=

Where,
k
e
= Rate of return required by the equity investors
e
K
f = Floatation costs as a percentage of the current market price.
13. Breaking Point on Account of a Source
=
Total newfinancingfromthat sourceat thebreaking point
Proportion of that financingsourcein thecapital structure

14. Assuming that the debt capital is perpetual, k
d
represent the cost of debt which is the discount
rate at which discounted future constant interest payments are equal to the market value of
debt, i.e.,
B =
t
t =1
d
F
(1+k )
or
d
F Annual interest charges
k =
B Market valueof debt
=
15. Based on the assumption of 100% dividend pay-out and constant earnings, cost of equity is
the discount rate at which the discounted future dividend (or earnings) are equal to the MV of
equity, i.e.
S =
t
t =1
E
(1+k)
or
e
E Equityearnings
k =
S Market valueof equity
=
16. Given the net operating income to be constant, the cost of capital of the firm, k
0
is the
discount rate at which the present value of net operating incomes is equal to the market value
of the firm (i.e., sum of the market values of debt and equity). Hence,
k
0
is =
O Net Operating Income
V Market valueof theFirm
=
17. V = B + S and k
0
is the overall capitalization rate for the firm. Since it is the weighted
average cost of capital, it may be expressed as k
0
= k
d
(B/(B + S) + k
e
(S/(B + S).
18. k
0
, the average cost of capital measured as
k
0
= k
d
(B/(B + S) + k
e
(S/(B + S) declines as B/S increases. This happens because when B/S
increases, k
d
, which is lower than k
e
, receives a higher weight in the calculation of k
0
.
19. The cost of equity can be expressed as: k
e
= k
0
+ (k
0
k
d
)(B/S).
20. The total market value of the firm which is equal to the total of MV of debt and market value
of equity is independent of the degree of leverage and is equal to its expected operating
incomes discounted at the rate appropriate to its risk class.
Symbolically, it is represented as: V
j
= S
j
+ B
j
= O
j
/
k
Where,
V
j
= Total market value of the firm j

S
j
= Market value of the equity of firm j
BB
( r)B /S
j
= Market value of the debt of firm j

O
j
= Expected operating income of firm j

= Discount rate applicable to the risk class k to which the firm j belongs.

k
21. The expected yield on equity, i

j
, is equal to
k
plus a premium which is equal to the
debt-equity ratio times the difference between
k
and the yield on debt, r.

Symbolically it is represented as
j
i =
j k k j
+

563
22. Consider the case wherein the unlevered firm X has a market value which is less than that of
the levered firm Y (V
x
, V
y
).
23. If an investor holds S
y
rupees worth of equity shares of firm Y, representing a fraction of the
total outstanding market value of equity shares of firm
y y
Y (s S ), = the return he gets is
.
y y
P (O rB = )
24. If the same investor sells his shares, i.e.,
y
S worth of shares of firm Y and borrows at
an interest rate of r percent on his personal account, then he can purchase of
the equity shares of firm X. (For firm X, V
y
B
y y
(S B )/S +
x
x
= S
x
since it is an all-equity firm).
After the above transactions, the return obtained by the investor would be:

y y
x y
x
(S B )
P O
S
+
= r B
25. Next is the case wherein V
x
> V
y
. Here, let us put V
x
/V
y
= > 1. For instance, if an investor
holds equity shares of firm X worth S

x
, representing a fraction x of the total market value
of the outstanding shares, S
x
, the return he gets is:

x
x
x
s
P O=
S
= O.
26. If he sells his shareholding worth V
x
(V
x
= S
x
) he can buy a fraction of the equity shares
and bonds of firm Y because the market value of the firm X is times the market value of
the firm Y which will therefore make his return equal to:

y y y
P (O rB ) (rB ) O. = + =
27. The present value of tax shield associated with interest payments, assuming debt to be
perpetual in nature would be equal to
Present value of tax shield =
c
c
t Br
=t B
r

Where,
t
c
= Corporate tax rate

B = Market value of debt
r = Interest rate on debt.
28. In general when corporate taxes are considered the value of the firm that is levered would be
equal to value of the unlevered firm increased by the tax shield associated with debt, i.e.,
V =
c
c
1 t )
+t B
k
O(

29. When the tax rate on stock income (t
ps
) differs from the tax rate on debt income (t
pd
) the tax
advantage of debt capital may be expressed as:

c ps
pd
(1 t ) (1 t )
1 x B.
(1 t )

Dividend Policy
1. The following expression, given by traditional approach, establishes the relationship between
market price and dividends using a multiplier: (which is chosen appropriately)
P = m (D + E/3)
Where,
P = Market Price
m = Multiplier
D = Dividend per share
E = Earnings per share.

564
2. Price of the firm is given as
P = D/(k
e
g)
Thus, we have
k
e
= D/P + g

since, g =
P/P
we have, k
e
= D/P + P/P

but since,
P =
e
r (E D)
k

(since retained earnings is the only sources of finance)
By substituting the same, we have

e
e e
r (E D)/k D
P= +
k k

Where,
P = Market price per share
D = Dividend per share
E = Earnings per share
r = Internal rate of return
k
e
= Cost of equity capital

P = Change in the price
g = Growth rate of earnings.
3. Gordons dividend capitalization model gave the value of the stock as follows:
P =
e
E(1 b)
k br

Where,
P = Share price
E = Earnings per share
b = Retention ratio
(1 b) = Dividend pay-out ratio
k
e
= Cost of equity capital (or cost capital of firm)

br = Growth rate (g) in the rate of return on investment.
4. MM Model of Dividend Policy
i. Value of firm when dividends are paid:
Step-1
Price per share at the end of year 1:
P
0
=
( )
e
1
1 k +
(D
1
+ P
1
).
Where,
P
0
= Current Market price of the share (t = 0)
P
1
= Market price of the share at the end of the period (t = 1).
D
1
= Dividends to be paid at the end of the period (t = 1).
k
e
= Cost of equity capital.

565
Step-2

Amount to be raised by the issue of new shares:
n
1
p
1
= I (E nD
1
)
Step-3
No. of additional shares to be issued,
n
1
=
1
1
I (E ND )
p

Step-4
Value of the firm,
nP
0
=
1 1
e
(n +n )P I +E
(1+K )

ii. The value of the firm when dividends are not paid, is also calculated as above.
we observe value of firm in (i) and (ii) is same.
Raw Material Storage Period
1. Annual consumption of raw materials, components etc.
2. Average daily consumption of raw materials, components etc. assuming an year of 360 days
for convenience = (1) 360
3. Average stock of raw materials, components etc. =
Opening Stock +Closing Stock
2

4. Raw material storage period = (3) (2) = n
1
days.
Conversion Period
1. Annual cost of production = Opening Stock of work-in-process + Consumption of raw
materials etc + Other manufacturing costs such as wages and
salaries, power and fuel etc. + Depreciation Closing work-in-
process.
2. Average daily cost of production = (1) 360.
3. Average Stock of work-in-process =
Opening W.I.P+Closing W.I. P
2

4. Average conversion period = (3) (2) = n
2
days.
Finished Goods Storage Period
1. Annual cost of sales = Opening stock of finished goods + Cost of production + Excise
duty + Selling and distribution costs + General administrative
costs + Financial costs Closing stock of finished goods.
2. Average daily cost of sales = (1) 360.
3. Average stock of finished goods =
Opening Stock +Closing Stock
2

4. Finished goods storage period = (3) (2) = n
3
days.
Average Collection Period
1. Annual credit sales of the company.
2. Average daily credit sales = (1) 360.
3. Average balance of sundry debtors =
Opening Balance +Closing Balance
2

4. Average collection period = (3) (2) = n
4
days

566
Average Payment Period
1. Annual credit purchases made by the company
2. Average daily credit purchases = (1) 360
3. Average balance of sundry creditors =
Opening Balance +Closing Balance
2

4. Average payment period = (3) (2) = n
5
days.
From the above calculations the gross operating cycle period is obtained as (n
1
+ n
2
+ n
3
+ n
4
)
days where n
1
denotes the raw material storage period, n
2
denotes the period for conversion
of raw materials into finished goods, n
3
denotes the finished goods storage period and n
4

denotes the average collection period each of which is expressed in days. When the average
payment period of n
5
days is subtracted from the gross operating cycle period, as calculated
above, the resultant figure provides the operating cycle period.
1. Cost of Trade Credit =
Rateof Discount Number of daysin a year
1 Rateof Discount (Credit period Discount period)

1. Total inventory cost = Ordering cost + Carrying Cost
Total ordering costs = Number of orders Cost per order
=
U
Rs. F
Q

Where,
U = Annual usage
Q = Quantity ordered
F = Fixed cost per order
The total carrying costs = Average level of inventory x Price per unit x Carrying cost
(percentage)
Total carrying costs =
Q
Rs. P C
2
=
QPC
Rs.
2

Where,
Q = Quantity ordered
P = Purchase price per unit
C = Carrying cost as % cost
2. EOQ = Q* =
2UF
PC

3. The formula for EOQ can also be used for determining the optimum production quantity as
given below:
E =
2U P
S

Where,
E = Optimum production quantity
U = Annual monthly output
P = Set-up cost for each production run
S = Cost of carrying inventory per unit per annum per month.

567
4. The reduction in ordering cost
= (The difference between the number of orders with sizes of Q* and Q) x
(The cost per order of Rs. F)
=
*
U U
Rs. F
Q Q

Thus, the total incremental benefits will be the sum of the above two expressions and is given by
Total incremental benefits = Rs.UD + Rs.{U/Q
*
U/Q} x F.
5. Incremental carrying cost =
*
Q (P D)C Q PC
2 2

6. Net incremental benefits = Rs.UD +
*
*
U U Q (P D)C Q PC
Rs. F Rs.
Q 2 Q

If the net incremental benefits are positive, then the optimal order quantity becomes Q.
Otherwise Q* will continue to remain valid even in a situation of bulk purchase discount.
7. Reorder Point = Normal consumption during lead time + Safety Stock.
8. Reorder level = Average daily usage rate Lead time in days.
9. Reorder point = S L + F (S R L)
where,
S = Usage in units
L = Lead time in days
R = Average number of units per order
F = Stockout acceptance factor
1. The effect of relaxing the credit standards on profit may also be estimated by using the following
formula.

n
P S(1 V) k I b S =
Where,
P = Change in profit
S = Increase in slaes
V = Variable costs to sales ratio
k = Cost of captal
I = Increase in receivables management
=
S
360
Average Collection Period (ACP) x V

b
n
= Bad debts loss ratio on new sales
1 V = Contribution to sales ratio.
2. The effects of increasing the credit period are similar to that of relaxing credit standards and
hence we can also estimate the effect on profit of change in credit period using the same
formula.

n
P S(1 V) k I b = S
The components of the formula are same excepting

0
N O N
S S
I (ACP ACP ) V(ACP )
360 360

= +

568
S
Where,
I = Increase in investment
ACP
N
= New ACP (after increasing credit period)
ACP
O
= Old ACP
V = Ratio of variable cost to sales
S = Increase in sales
3. The effect of cash discount on gross profit may be estimated by the following formula.
P S(1 V) k I DI =
Where,
V = Ratio of variable cost to sales
k = Cost of capital
I = Savings in receivables management
=
0
O N
S S
(ACP ACP ) V (ACP )
360 360

N

DIS = Increase in discount cost
=
n 0 n 0 0 0
p (S S)d p s d +
Where,
p
n
= Proportion of discount sales after liberalizing
S
0
= Sales before liberalizing
d
n
= New discount percentage
p
0
= Proportion of discount sales before liberalizing
d
0
= Old discount percentage
4. The effect of decreasing the rigor of collection program on profit may be estimated as
follows:
P = S(1 V) k I BD
Where,
P = Change in profits
V = Variable costs to sales ratio
k = Cost of capital
I = Increase in investment in receivables
=
0
N O N
S S
(ACP ACP ) ACP V
360 360

+

BD = Increase in bad debts cost
= b
n
(S
0
+ S) b
0
S
0
5. Days Sales Outstanding (DSO) =
Accounts receivable at the timechosen
Average dailysales

569
Cash Management
1. Safety level of cash = Desired days of cash Average daily cash outflows.
2. Safety level of cash
= Desired days of cash at the business period Average of highest daily cash outflows.
3. According to EOQ model,
Total cost = Transaction cost + Carrying (opportunity) cost
This cost can be expressed as: F (T/C) + I(C/2).
Where,
F = Fixed transaction cost associated with a transaction
T = Total demand for cash over the specified period
I = Interest rate on marketable securities for the period
C = Cash balance for the period.
4. The optimal level of cash can be determined using the underlying equation.
C =
2FT
I

1. The benefit cost ratio (or the Profitability Index) is defined as follows:
BCR =
PV
I

Where,
BCR = Benefit-Cost Ratio
PV = Present Value of future cash flows and
I = Initial Investment
A variant of the benefit-cost ratio is the Net Benefit-Cost Ratio (NBCR) which is defined as:
NBCR =
NPV
I

=
PV

I
I
=
PV
1
I
= BCR 1.

570
Part II: Problems
1. A company declared to issue one rights share for every four shares held by an investor at a
price of Rs.100 when the actual market price for the shares of the company was Rs.140. The
ex-rights price of the share would be
a. Rs.100
b. Rs.110
c. Rs.122
d. Rs.132
e. Rs.140.
2. If X company issues two shares for every 5 shares held at a price of Rs.50 per share, and
existing price of the stock is Rs.70 per share, the ex-rights price of the stock would be
a. Rs.60.20
b. Rs.66.67
c. Rs.66.00
d. Rs.66.80
e. Rs.70.00.
3. The current price of a share is Rs.50. The company issues 1 rights share for every 4 shares held
@Rs.45 per share. The ex-rights price of the share is
a. Rs.47
b. Rs.48
c. Rs.49
d. Rs.50
e. Rs.51.
4. A company issues one right share for every 4 shares held at a subscription price of Rs.60 per
share. The current market price of the share is Rs.80. Value of the right is
a. Rs.4
b. Rs.5
c. Rs.15
d. Rs.20
e. Rs.28.
5. The current market price of the share is Rs.50. The firm needs Rs.75,000 for expansion and
the new shares can be sold only at Rs.45. The expected dividend at the end of current year is
Rs.2.5 with a growth rate of 8%. The cost of existing equity capital and new equity are ___
and _________ respectively.
a. 13%, 14%
b. 12%, 13%
c. 14%, 13.33%
d. 13.55%, 14.44%
e. 14.44%, 13%.
Part II
571
6. Titan Ltd., issues 10% debentures of face value Rs.100 each and realizes Rs.90 per
debenture. The dentures are redeemable after 12 years at a premium of 8%. Company is
paying income tax @45%. The cost of debt is _______.
a. 7.07%
b. 4.55%
c. 6.14%
d. 5.67%
e. 4.92%.
7. Tata Consultancy Services Ltd., has 12% redeemable preference share, which are redeemable
at par at the end of 10th year from the date of issue. The underwriting expenses are expected
to 4%. Face value is Rs.100. The effective cost of preference share capital is ______.
a. 12%
b. 12.65%
c. 11%
d. 11.44%
e. 11.79%.
8. Mr. Prasad is a shareholder in Eureka Company Ltd. Although earnings for the Eureka
Company Ltd., have varied considerably, Prasad has determined that long run average
dividends for the firm have been Rs.5 per share. He expects a similar pattern to prevail in the
future. Given the volatility of the Eurekas dividends, Mr. Prasad has decided that a
minimum rate of 25% should be earned on his share. The price that Mr. Prasad would be
willing to pay for the Eurekas shares is Rs. __________.
a. 10
b. 20
c. 30
d. 40
e. 100.
Based on the following information Answer Questions 9 to 12
Evan Soft Ltd. has assets of Rs.2,80,000 which have been financed with Rs.64,000 of debt
and Rs.1,10,000 of equity and a general reserve of Rs.18,000. The firms total profits after
interest and taxes for the year ended 31
st
March 2004 were Rs.25,700. It pays 13% interest on
borrowed funds and is in the 60% tax bracket. It has 1,000 equity shares of Rs.100 each
selling at a market price of Rs.125 per share. The firm pays 60% of its earnings as dividends.
9. The earning per share is Rs._________.
a. 31.2
b. 22.44
c. 12.78
d. 25.7
e. 27.54.
10. The cost of debt is __________.
a. 6.7%
b. 5.2%
c. 4.8%
d. 5.5%
e. 6.12%.
572
11. The cost of equity is __________.
a. 10.11%
b. 12.34%
c. 15.55%
d. 19.78%
e. 20.51%.
12. The weighted Average Cost of capital is __________.
a. 12%
b. 9.96%
c. 15.6%
d. 16.71%
e. 12.54%.
13. Zoom technologies Ltd., issues 1,00,000 14% debentures redeemable after 5 years at Rs.110
each. The commission payable to underwriters and brokers is 10%. The after tax cost of debt
assuming a tax rate of 45% is __________. (Face value of the debentures is Rs.100)
a. 15.1%
b. 12.54%
c. 10%
d. 11.7%
e. 8.76%.
14. Companies A and B are identical in all respects including risk factors except for debt equity,
A has issued 15% debentures of Rs.25,00,000 while B has issued only equity. Both the
companies earn 18% before interest and taxes on their total assets of Rs.45,00,000. Assuming
a tax rate of 45% and capitalization rate of 20% for an all equity company, the value of
company A using net income approach is Rs. __________.
a. 36,96,250
b. 44,58,450
c. 31,56,750
d. 51,67,500
e. 18,92,500.
15. The value of Company B using net income approach is __________.
a. 11,00,000
b. 29,67,800
c. 31,56,550
d. 22,27,500
e. 45,55,500.
Part II
573
The following is an extract from the financial statements of Beta Ltd.
(Rs. in lakh)
Operating profit 230
Interest on debentures 74
156
Income tax (50%) 78
Net Profit 78
Equity Share capital (of Rs.10 each) 150
Reserves and Surplus 200
15% Non-Convertible Debentures 150
Total 500
16. The market price of equity share and debenture is Rs.13 and Rs.108.75 respectively. The
earning per share is Rs. __________.
a. 7.21
b. 3.18
c. 6.7
d. 5.88
e. 5.20.
17. The cost of equity is __________.
a. 40%
b. 35%
c. 46%
d. 53%
e. 36%.
18. The cost of debenture funds at book value is __________.
a. 3.89%
b. 4.71%
c. 7.5%
d. 6.23%
e. 5.42%.
19. Surya Industries Ltd., has recently made an issue of non-convertible debentures for Rs.500
lakh. The terms of issues are as follows: each debenture has a face value of Rs.100 and
carries a rate of interest of 14%. The interest is payable annually and the debentures are
redeemable at 98.10 after 10 years. If Surya Industries Ltd., realizes Rs.95 per debenture and
the corporate tax rate is 50%, the cost of the debenture to the company is __________.
a. 3.89%
b. 4.71%
c. 7.57%
d. 6.23%
e. 5.42%.
574
Consider two firms Ram Ltd., and Raj Ltd., which are identical in all respects except in the
degree of leverage employed by them. The following is the financial data for these firms.
Ram Ltd., Raj Ltd.,
Net operating income Rs.45,000 Rs.45,000
Interest on debt Rs.0 Rs.10,000
Equity earnings Rs.45,000 35,000
Cost of equity capital 14% 14%
Cost of debt capital 10% 10%
Market value of equity (E/K
e
) Rs.3,00,000 Rs.2,33,333
Market value of debt Rs. 0 Rs.50,000
Total value of the firm Rs.3,00,000 Rs.2,83,333
20. The average cost of capital for Ram Ltd., is __________.
a. 11.05%
b. 16.75%
c. 13.75%
d. 15.00%
e. 12.77%.
21. The Average Cost of capital for Raj Ltd., is __________.
a. 11.05%
b. 16.75%
c. 13.29%
d. 14.11%
e. 12.77%.
Consider two firms Peers Ltd., and Serena Ltd., which are similar in all respects except in the
degree of leverage employed by them. The following is the financial data for these firms.
Peers Ltd. Serena Ltd.
Net operating income Rs.55,000 Rs.55,000
Overall capitalization rate 0.33 0.33
Total market value Rs.1,66,667 Rs.1,66,667
Interest on debt Rs.2,000 Rs.4,500
Debt capitalization rate 0.25 0.25
Market value of equity (V-B) Rs.1,58,667 Rs.1,48,667
Market value of debt (F/K
d
) Rs.8000 Rs.18,000
Degree of leverage 0.050 0. 121
22. The equity capitalization rates of firms Peers Ltd., is __________.
a. 30%
b. 11.11%
c. 22.23%
d. 33.4%
e. 44.34%.

Part II
575
23. The equity capitalization rates of firms Serena Ltd., is __________.
a. 33.9%
b. 22.77%
c. 44.65%
d. 11.11%
e. 22.85%.
24. The total market value of a firm Gamma Ltd., is Rs.70 lakh and its overall capitalization rate
is 28%. The firm has a debt component of Rs.25 lakh on which it pays interest @14%. If the
corporate and personal taxes are 35% and 25% respectively, the combined income of
stockholders and debt holders after personal taxes is Rs. __________.
a. 7,45,366
b. 5,54,879
c. 10,47,375
d. 8,54,671
e. 4,44,655.
PAM Ltd. has three divisions viz. paper, airlines and mineral water. Each division has a
capital structure with debt, preferred stock and equity in the proportion of 0.3:0.3:0.4
respectively. The company plans to raise debt, preferred stock, and equity combinedly for all
the three divisions. It plans to take loan at 14% interest rate. It has issued preference shares at
a face value of Rs.50 at 12% rate, the net proceedings of which are Rs.47 per share. Since the
risk pattern for these three divisions are different, the company has taken betas of the
respective industries. They are paper =0.8, airlines =0.98 and mineral water =1.1.
25. The corporate tax rates for these three industries are 35%, 40% and 45% respectively. The
risk-free return is 10% and the return on the market portfolio is 15%. The cost of debt (K
d
)
for each of these 3 divisions are _______ , _______ and _______ respectively.
a. 9.1%, 8.4% and 7.7%
b. 10.6%, 9.3% and 5.6%
c. 7.8%, 4.9% and 7.77%
d. 5.6%, 6.2% and 8.4%
e. 11.4%, 7.9% and 6.7%.
26. The cost of preference shares (k
p
) for all divisions is __________. Assume preference shares
have no maturity date.
a. 10.91%
b. 14.70%
c. 12.77%
d. 16.92%
e. 14.07%.
27. The cost of equity (K
e
) for each of these 3 divisions are ______ , _______ and ________
respectively. If the floatation cost for the equity issue is 3%. The risk free return is 10% and
the return on market portfolio is 15%.
a. 17.3%, 13.12% and 16.34%
b. 12.56%, 16.74% and 13.71%
c. 10.75%, 20.09% and 16.52%
d. 14.43%, 15.36% and 15.98%
e. 12.45%, 16.20% and 12.56%.
576
28. The Weighted Average Cost of Capital (WACC) for each of these 3 divisions are ________ ,
_______ and ________ respectively.
a. 11.56%, 11.23%, 11.43%
b. 12.33%, 12.5%, 12.53%
c. 14.5%, 14.44%, 14.61%
d. 10.88%, 18.61%, 12.75%
e. 12.57%, 15.61%, 13.67%.
29. A company is going for a bond issue. Each bond has a face value of Rs.500, pays interest at
the rate of 12% and the maturity period is 6 years. The company is planning to sell the bonds
at a discount of 3% on the face value. If the cost of marketing the issue is 3% of the par
value, __________ is the after tax cost of a bond. Assume tax rate =40%.
a. 8.45%
b. 9.99%
c. 10.34%
d. 6.65%
e. 7.81%.
30. If the company sells each bond at a premium of 3% on the face value, the after tax cost of a
bond is __________.
a. 6.8%
b. 5.7%
c. 7.2%
d. 9.01%
e. 8.29%.
A firm has the following capital structure:
Particulars Rs.
30,000 equity shares of Rs.10 par value 3,00,000
Term loan @ 12% 1,00,000
8% preference shares of Rs.100, which are currently sold at Rs.95 and
maturity period of 6 years.
1,00,000
The company expects to pay a dividend of Rs.5 next year and expects to grow @7%
continuously. The current market price of the firms share is Rs.25. Assume tax rate of 50%.
31. The book value Weighted Average Cost of Capital (WACC) is __________.
a. 20.45%
b. 19.21%
c. 28.11%
d. 17.89%
e. 15.51%.
32. If the preference shares are irredeemable, then the book value Weighted Average Cost of
Capital (WACC) is __________.
a. 19.0%
b. 28.11%
c. 16.87%
d. 17.00%
e. 18.45%.
Part II
577
33. If the firm raises an additional amount of Rs.2,00,000 by way of terms loans @6%, then the
book value Weighted Average Cost of Capital (WACC) is __________.
a. 14.58%
b. 21.67%
c. 17.90%
d. 18.54%
e. 11.23%.
34. If the growth rate in dividends is 10%, then the book value Weighted Average Cost of
Capital (WACC) is __________.
a. 19.05%
b. 20.77%
c. 21.01%
d. 18.54%
e. 16.78%.
35. The total market value of a firm is Rs.30 lakh and its overall capitalization rate is 25%. The
firm has a debt component of Rs.15 lakh on which it pays interest @10%. If the corporate
and personal taxes are 40% and 25% respectively, the combined income of stockholders and
debt holders after personal taxes is __________.
a. Rs.5,67,800
b. Rs.4,55,000
c. Rs.3,55,700
d. Rs.3,82,500
e. Rs.3,60,000.
36. La Femme Pvt. Ltd., is an unlevered firmwith a profit after tax of Rs.1,44,000. If the overall
capitalization rate for the firmis 24% and its corporate tax is 40%, the value of the firmis ____.
a. Rs.10,000
b. Rs.1,00,000
c. Rs.10,00,000
d. Rs.11,00,000
e. Rs.1,10,000.
37. If the firm is having a debt of Rs.80,000, the value of the firm is __________, if the personal
taxes on debt income and equity are 35% and 30% respectively. Corporate tax rate =40%.
a. Rs.10,28,308
b. Rs.11,50,000
c. Rs.12,00,429
d. Rs.12,76,740
e. Rs.11,28,503.
38. If the personal taxes on the debt income and equity income are reversed, the value of the firm
is __________.
a. Rs.11,21,450
b. Rs.14,23,533
c. Rs.10,35,429
d. Rs.15,45,362
e. Rs.14,26,300.
578
The overall capitalization rates for two firms A&B are 20% each and their net operating
incomes are Rs.7,00,000 each. For firm A, the market values of debt and equity are in the
ratio of 50:50 while for that of B, it is 40:60. Both firms have to pay tax at the rate of 50%,
and they borrow debt at the rate of 15%.
39. The rate of return on equity for firm A is ________.
a. 10.5%
b. 11.5%
c. 12.5%
d. 13.5%
e. 14.5%.
40. The rate of return on equity for firm B is _____.
a. 9.81%
b. 11.67%
c. 10.75%
d. 12.42%
e. 10.50%.
41. A ten-year, 8 percent, Rs.1,000 par value bond sold at Rs.950, excluding 4 percent
underwriting commission. The corporate tax rate can be assumed to be 30%. The post-tax
cost of funds in this case is __________.
a. 5.55%
b. 5.67%
c. 6.78%
d. 6.11%
e. 5.43%.
42. A preference share is sold at the face value of Rs.100 with a 9% dividend and a redemption
price of Rs.110, redeemable after five years. The corporate tax rate can be assumed to be
30%. The post-tax cost of funds in this case is ______.
a. 11.22%
b. 12.67%
c. 10.48%
d. 10.31%
e. 9.75%.
43. An ordinary share of a company, which engages no external financing, is selling for Rs.50.
The EPS is Rs.7.50 of which 60% is paid in dividends. The dividend growth rate is estimated
to be 4%. The corporate tax rate can be assumed to be 30%. The post-tax cost of funds in this
case is __________.
a. 10.11%
b. 11.87%
c. 13.36%
d. 12.54%
e. 16.21%.
Part II
579
Software Solutions Ltd. is earning an annual EBIT of Rs.100 lakh. The company has Rs.200
lakh of 15% debentures in its capital structure. The equity capitalization rate for the company
is 14%. The company desires to redeem the debentures by issuing the additional equity
shares. The additional shares can be issued in the market at a premium of Rs.10.
44. According to the net income approach, the total value of the firm is __________.
a. Rs.550 lakh
b. Rs.670 lakh
c. Rs.700 lakh
d. Rs.720 lakh
e. Rs.610 lakh.
45. According to the net income approach, the overall capitalization rate is _______.
a. 14.29%
b. 12.67%
c. 11.55%
d. 15.32%
e. 13.45%.
46. According to the net income approach, the value of the firm after redemption of the
debentures is ________ approximately, assuming that the equity capitalization rate remains
the same.
a. Rs.714.30 lakh
b. Rs.854.10 lakh
c. Rs.655.15 lakh
d. Rs.890.00 lakh
e. Rs.736.89 lakh.
Mahindra Hitek Ltd. has the following capital structure based on market values:
Particulars (Rs.)
Equity capital (80,000 shares of Rs.10 face value) 100,00,000
15% Preference capital (6000 shares of Rs.100 par value) 6,21,000
14% Debentures (Face value of Rs.1,000) 9,70,000
16% Term loan 8,00,000
The dividend per share expected for the next year is Rs.3.50 and is expected to grow at the
rate of 12 percent. It is presently selling at Rs.125. Preference shares are redeemable after 5
years at a premium of 5% and debentures are redeemable after 10 years at face value. They
are presently selling at Rs.103.50 and Rs.970 respectively.
47. The applicable tax rate for the company is 40%. The cost of equity for the company is _____.
a. 14.8%
b. 15.4%
c. 12.77%
d. 18.91%
e. 11.54%.
48. The cost of preference capital for the company is __________.
a. 16.51%
b. 14.68%
c. 15.55%
d. 13.65%
e. 12.11%.
580
49. The cost of debenture capital and cost of term loan for the company are ______ and _______.
a. 8.83%, 9.60%
b. 10.06%, 0.96%
c. 9.37%, 0.096%
d. 11.15%, 9.60%
e. 15.81%, 96%.
50. The Weighted Average Cost of Capital is __________ using market value as weights.
a. 14%
b. 12%
c. 16%
d. 13%
e. 15%.
Brilliant Industries Ltd., is planning for a capital expenditure of Rs.10 crore in new
equipments. The existing capital structure is as follows.
Book-Value
(Rs. In lakh)
Market Value per
share (Rs.)
Equity capital (40,00,000 shares of FV Rs.10) 400 45
11% Preference capital
(FV Rs.100; remaining maturity 5 years)
250 97
Retained earnings 750
Term loan @ 14% 500
The next expected dividend on the companys stock is Rs.2.50. The company expects growth
rate of 8% in the future. Additional equity can be issued at a premium of Rs.30 only.
Company is planning to finance the investment proposal through equity, debentures and term
loans in the proportion of 5:2:3 respectively. Retained earnings up to Rs.200 lakh are to be
utilized for the purpose. The interest rate on term loan is 15% up to Rs.1 crore, 16% for next
Rs.1 crore and 17% for the rest of the amount. Debentures carry an interest rate of 18%.
Floatation cost for the debenture is 2% and redeemable at a premium of 5% after 7 years. The
tax rate applicable for the company is 35%.
51. The required costs of equity and preference capital of the company are _______and _______.
a. 13.14%, 10.90%
b. 13.56%, 11.78%
c. 12.66%, 8.74%
d. 15.90%, 10.52%
e. 9.76%, 17.12%.
52. The required cost of term loan is __________.
a. 10.71%
b. 12.7%
c. 15.06%
d. 8.34%
e. 9.1%.
Part II
581
53. The average cost of capital using the market value as weights is __________.
a. 16.08%
b. 13.45%
c. 12.51%
d. 10.55%
e. 12.67%.
Dr. Martins Healthcare Products Ltd., has the following balance sheet.
(Amount in lakh)
Sources of funds
Shareholders funds:
Fully paid-up equity share capital 300
Reserves and surplus 600 900
Loan funds:
Secured loans
12% non-convertible debentures 400
14% term loan from IDBI 528
Working capital loan from SBI 150 1,078
Unsecured loans
Fixed deposits 50 50
2,028
Application of funds
Fixed assets (net) 1,250
Investments 250
Current assets loans and advances 750
Less: Current liabilities and provisions 350
Net current assets 400
Miscellaneous expenditures and losses 128
2,028
The following information is further provided:
i. The equity share capital consists of 30 lakh equity shares of par value Rs.10. The
market value of the equity capital is Rs.450 lakh. The dividend per share expected a
year hence is Rs.1.50 per share. The dividends are expected to grow at a rate of 5% per
annum.
ii. 12% non-convertible debentures consist of 4 lakh debentures, which were issued at par
(Rs.100). The issue cost was Rs.28 lakh. The difference between the redemption price
and the net amount realized after issue will be written off evenly over the life of the
debentures; it is assumed that the amount so written-off will be a tax-deductible
expense. The debentures will be redeemed after 10 years at a premium of 3 percent. The
market value of the debenture capital is Rs.384 lakh, debentures are currently being sold
at Rs.93.
iii. The market value of the term loan can be considered equal to its book value.
iv. The tax rate of the company is 35%.
54. The cost of equity capital for the company is __________.
a. 15%
b. 10%
c. 11.5%
d. 12.86%
e. 13%.
582
55. The cost of retained earnings (K
r
) of the company is __________.
a. 15%
b. 10%
c. 11.5%
d. 12.86%
e. 13%.
56. The cost of debenture capital (K
d
a. 7.43%
b. 8.62%
c. 7.90%
d. 10.11%
e. 8.11%.
57. The cost of term loan (K
t
a. 14.63%
b. 12.1%
c. 10.8%
d. 9.1%
e. 11.53%.
58. The Weighted Average Cost of Capital using market values of the long-term sources of
finance as weights is __________.
a. 0.1091%
b. 1.091%
c. 10.91%
d. 0.091%
e. 11.091%.
59. The beta of equity shares of Bhartiya Chemicals Limited is 1.0 while the risk premium is 8
percent. The company is planning to issue external equity to finance an expansion program.
The cost of issuing external equity as a percentage of the current market price is 2 percent. If
the risk free rate of return is 6 percent, the cost of external equity capital to the company is
approximately.
a. 12.0 percent
b. 14.0 percent
c. 14.3 percent
d. 18.0 percent
e. 22.4 percent.
60. The market value of debt and equity of a firm are Rs.100 lakh and Rs.200 lakh respectively
while the costs of equity and debt are 12 percent and 9 percent respectively. Assume that the
firm maintains 100 percent dividend payout ratio and absence of all types of taxes. What is
the net operating income for the firm?
a. Rs.9 lakh.
b. Rs.12 lakh.
c. Rs.27 lakh.
d. Rs.33 lakh.
e. Rs.36 lakh.
Part II
583
61. For Deluxe Furniture Ltd, the face value of the irredeemable preference share is Rs.100
where the dividend payable per annum is equal to Rs.12. If the applicable tax rate is 40
percent, the cost of the preference share to the company is
a. 4.80 percent
b. 7.20 percent
c. 12.00 percent
d. 15.00 percent
62. Analytical Engineers issued long-term bonds few years back, which presently offer a return
of 10 percent. The equity investors expect a risk premium of 2 percent. If 60 percent of the
cost of the assets is financed by debt capital, what would be the weighted average cost of
capital? (Assume the applicable tax rate is 40 percent)
a. 8.20 percent
b. 8.40 percent
c. 8.80 percent
d. 9.60 percent
63. The following information is given about the debentures issued by Darwin Ltd.:
Face Value = Rs.100
Coupon Rate = 9 percent
Amount realized per debenture = Rs.97.50
Corporate tax rate = 40 percent
Debenture is redeemable at a premium of 5 percent after 5 years. The difference between the
redemption price and the net amount realized can be written off over the life of the debenture
and the amount thus written off is also tax-deductible. The cost of debenture capital to the
company by the approximation method is:
a. 6.12 percent
b. 6.22 percent
c. 6.32 percent
d. 6.42 percent
e. 6.52 percent.
64. Regarding the long-term sources of finance for Shanbagh Ltd. following details are obtained
from their merchant bankers:
Sources of Finance
Range of new financing from
various sources (in Rs. lakh)
Cost
(percentage)
0-150 14.00
150-400 15.00 Equity
400 and above 16.00
0-20 15.00
Preference
20 and above 16.00
0-100 8.00
100 - 350 9.00 Debt (Post-tax cost)
350 and above 10.00
The company is critically considering expanding its operations and needs Rs.500 lakh for the
same. Its capital structure is in the proportions of Equity capital 40 percent, Preference capital
10 percent and Debt capital 50 percent. If the company actually invested an amount of
Rs.600 lakh what will be the weighted marginal cost of capital of new financing?
a. 10.50 percent.
b. 11.10 percent.
c. 11.60 percent.
d. 12.10 percent.
e. 12.60 percent.
584
65. The debenture of Veena Beverages Ltd., is presently trading at a premium of 5 percent on its
face value. The debentures were issued at a coupon rate of 10 percent where the coupons are
paid annually. The next interest will be paid one year hence. The debenture will be redeemed
at its face value at the end of six years from now. What would be the implicit cost of
debenture capital to the company? (Assume the tax rate applicable for the company is
40 percent) (Hint: Do not use the approximation method)
a. 5.0 percent
b. 5.5 percent
c. 6.0 percent
d. 6.5 percent
e. 6.67 percent.
66. For a firm, the interest rate on term loan is 12 percent and the tax rate applicable is
35 percent. What is the cost of the term loan for the company?
a. 3.5 percent.
b. 4.2 percent.
c. 7.8 percent.
d. 8.5 percent.
e. 15.5 percent.
67. The following data pertain to M/s Alka Engineers:
Source Market Value (Rs. lakh) Cost (percentage)
Equity 200 16 (post-tax cost)
Debt 120 12 (pre-tax cost)
If the applicable tax rate is 40 percent, what is the Weighted Average Cost of Capital?
a. 12.00 percent.
b. 12.70 percent.
c. 13.00 percent.
d. 13.30 percent.
e. 13.90 percent.
68. The current market price of the shares of Tractor India Ltd., is Rs.60. The company recently
paid a dividend of Rs.3.00 per share that is expected to grow at a rate of 8 percent. If the
floatation cost will be 2 percent of the current market price, what will be the cost of external
equity to Tractor India?
a. 13.00 percent.
b. 13.67 percent.
c. 14.34 percent.
d. 15.00 percent.
e. 15.67 percent.
69. The dividend history of Gujarat Heavy Chemicals Ltd. is as follows:
Month and Year March 2000 March 2001 March 2002 March 2003
Dividend per share (Rs.) 1.80 2.40 3.20 4.50
Dividend Yield (percentage) 2.50 3.00 3.80 5.00
If the market price per share for GHCL is Rs.67 on March 2000, what is the amount of
realized yield?
a. 10.70 percent.
b. 11.50 percent.
c. 11.95 percent.
d. 13.35 percent.
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585
70. The debentures of Prudential Corporation (presently selling at 5 percent premium on its face
value) were issued at a coupon rate of 10 percent where the issue expenses were 3 percent of
the face value. These will be redeemed after a period of 5 years at their face value. What is
the cost of the debenture capital for the company, if the applicable tax rate is 40 percent?
a. 5.80 percent.
b. 6.70 percent.
c. 7.60 percent.
d. 8.50 percent.
e. 9.40 percent.
71. Lakhani Chemicals is planning to invest Rs.800 crore in a new project, although the actual
amount may vary in future due to uncertainties. The mode of financing is expected to be done
through equity capital, preference capital and term loan in the ratio of 4:2:4. The investment
banker and financial institutions have given the following information:
Source of finance Range of financing (in Rs. lakh) Post-tax Cost (%)
Equity Capital Up to 160
160 to 320
320 and above
14
15
16
Preference Capital Up to 100
100 to 200
200 and above
12
13
14
Term loan Up to 120
120 and above
8
10
What should be the weighted average cost of capital, if the actual amount invested reached at
Rs.900 lakh?
a. 11.50 percent.
b. 12.00 percent.
c. 12.50 percent.
d. 13.00 percent.
e. 14.50 percent.
72. XYZ Ltd., has taken a term loan of Rs.12 lakhs at an interest rate of 15% p.a. If the tax rate
applicable to the company is 40%, the cost of the term loan is
a. 4.8%
b. 6%
c. 7.2%
d. 9%
e. 15%.
73. A company has retained earnings of Rs.72 lakhs and equity capital of Rs.38 lakhs. If the
equity investors expect a rate of return of 17% and the cost of issuing fresh equity is 6%, the
cost of the external equity is
a. 16.4%
b. 17.4%
c. 17.7%
d. 18.1%
e. 19.1%.
586
74. If the market value of debt of a firm is Rs.40 lakhs, that of equity is Rs.60 lakhs and the costs
of equity and debt are 16% and 14% respectively, the net operating income for the firm, if the
firm has 100% dividend payment and no taxes, is
a. Rs.13.8 lakhs
b. Rs.14.2 lakhs
c. Rs.15.2 lakhs
d. Rs.15.8 lakhs
e. Rs.16.2 lakhs.
75. Equity shares of Phonex Ltd., are quoted in the market at Rs.17.00. The dividend expected a
year hence is Rs.1.50. The expected rate of dividend growth is 8%. The cost of equity capital
to the company is
a. 11.08%
b. 13.88%
c. 15.46%
d. 16.82%
e. 20.00%.
76. If the corporate tax rate is 40%, market value of debt is Rs.500 lakh and interest on debt is
16%, then the present value of tax shield according to MM proposition is
a. Rs.80 lakh
b. Rs.100 lakh
c. Rs.200 lakh
d. Rs.300 lakh
77. According to Net Operating Income approach the equity capitalization of a firm whose cost
of capital is 20%, cost of debt capital is 15% and debt-equity ratio is 0.67 is
a. 13.55%
b. 21.60%
c. 23.35%
d. 28.40%
e. 30.05%.
78. Ravi & Co., issues 10% irredeemable preference shares. The face value of each share is
Rs.100 and net amount realized per share is Rs.96. The cost of the preference capital is
a. 9.6%
b. 10%
c. 10.42%
d. 14.32%
e. 14.58%.
79. The cost of term loans if interest rate is 15% and tax rate is 40% is
a. 6%
b. 8.5%
c. 9%
d. 10.5%
e. 12%.
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587
80. Alpha Company paid a dividend of Rs.4.50. The current market price of an equity share is
Rs.90. Dividends are expected to grow at the rate of 7%, the cost of equity capital is
a. 11.5%
b. 12.35%
c. 14.25%
d. 16%
e. 18.5%.
Source Market value (Rs.) Cost (%)
Equity 10,00,000 18
Debt 5,00,000 13
If the tax rate is 35%, the weighted average cost of funds taking market value as weighted is
a. 13.00%.
b. 13.82%.
c. 14.00%.
d. 14.62%.
e. 14.82%
82. If the last dividend declared is Rs.2 per share, the growth rate in dividend is 12% and the
price per share is Rs.80, the cost of equity capital is:
a. 14.8%.
b. 16.5%.
c. 17.6%.
d. 18.5%.
e. 19.4%.
83. If the interest rate on long-term debt is 18% p.a. and the tax rate of the company is 35%, the
cost of debt is:
a. 10.70%
b. 11.70%
c. 12.85%
d. 12.70%
e. 13.00%.
84. How much is added to a firms weighted average cost of capital for 50% debt financing with
a required rate of return of 12% and a tax rate of 35%?
a. 3.9%.
b. 4.2%.
c. 6.0%.
d. 7.8%.
e. 12.0%.
85. The Board of Directors is dissatisfied with last years ROE of 16%. If the profit margin and
asset turnover remain unchanged at 8% and 1.25% respectively, by how much must the asset
to equity ratio increase to achieve 20% ROE?
a. Must increase by 0.4.
b. Must increase by 4.
c. Must increase by 4%.
d. Must increase by 10%.
588
86. Given the following information about a debenture, the post-tax cost of the debenture using
the approximation formula is
Par value =Rs.100; Coupon rate =10%
Redemption price =Rs.102 per debenture
Net amount realized =Rs.98 per debenture
Tax rate =0.35; Number of years to maturity =8
a. 5.5%
b. 6.5%
c. 7.0%
d. 7.5%
e. 8.0%.
87. The equity stock of J etset Company is presently selling for Rs.60 per share. Dividends per
share have grown from Rs.1.50 to the current level of Rs.4.00 over the past 10 years and this
dividend growth is expected to continue in the future. The required rate of return of the
company will be
a. 15%
b. 20.5%
c. 17.66%
d. 40%
88. If the flotation cost of equity shares is 4%, the required rate of return to the equity holders is
16.67%, the cost of external equity will be:
a. 15.99%
b. 16.00%
c. 17.21%
d. 17.36%
89. If the cost of equity is 18%, and the cost of debt is 15% what would be the cost of capital, at a
tax rate of 35% and a debt-equity ratio of 2:1?
a. 13.50%.
b. 13.25%.
c. 12.50%.
d. 16.0%.
e. 17.01%.
90. Axis Ltd., is issuing 15% debentures (face value Rs.60). The net amount realized per
debenture is Rs.54, and they are redeemable at par after 6 years. At a corporate tax rate of
40%, what is the cost of debt?
a. 16.54%.
b. 17.54%.
c. 11.23%.
d. 14.74%.
e. 16.50%.
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589
91. The current market price of Venus Filters Ltd., is Rs.67. The expected dividend after a year is
Rs.1.40, and this dividend is expected to grow at a constant rate of 10% p.a. What is the
required rate of return for shareholders?
a. 14%.
b. 10%.
c. 30.9%.
d. 13.09%.
e. 11.09%.
92. If the required rate of return on Excel Ltd.s shares is 16%, risk-free rate of return is 8%, and
the rate of return on market portfolio is 11%, what is the beta of the stock?
a. 1.67.
b. 2.67.
c. 0.38.
d. 2.87.
e. 1.00.
93. If the personal income tax rate is 30%, personal long-term capital gains tax is 20% and the
required rate of return for equity investors is 22%, what is the cost of retained earnings?
a. 25.14%.
b. 22.00%.
c. 19.25%.
d. 19.00%.
e. 18.05%.
94. If assets to equity ratio is 2, post-tax cost of debt capital is 10%, and the weighted average
cost of capital is 12%, then cost of equity capital would be
a. 11%
b. 14%
c. 16%
d. 16.4%
e. 16.2%.
Dividend Policy
A pharmaceutical company belongs to a risk class of which the appropriate capitalization rate
is 15%. It currently has 5,00,000 shares selling at Rs.150 each. The firm is contemplating the
declaration of a Rs.9 dividend at the end of current fiscal year, which has just begun.
95. Based on the MM model, the price of the shares is Rs. __________ at the end of the year if
dividend is not declared and the assumption of no taxes.
a. 165.10
b. 172.50
c. 118.80
d. 100.00
e. 97.45.
590
96. The price of the shares is Rs. __ at the end of the year if dividend is declared and the
assumption of no taxes.
a. 163.50
b. 165.92
c. 112.45
d. 85.90
e. 100.00.
97. Assuming that the firm pays dividend, has net income of Rs.48,00,000 and makes new
investment of Rs.50,00,000 during the period. The __________ new shares must be issued.
a. 32,000
b. 41,756
c. 28,746
d. 52,775
e. 12,888.
98. The Reliance Company, which earns Rs.7 per share, is capitalized at 15% and has a return of
18%. Using the Walter model, the optimum pay out ratio is __________.
a. As, r <k, the company should not retain the profits and payout should be 10%
b. As, r >k, the company should not retain the profits and payout should be 20%
c. As, r >k, the company should retain the profits and payout should be 40%
d. As, r >k, the company should not retain the profits and payout should be 0%
e. As, r >k, the company should retain the profits and payout should be 0%.
99. Using the Walter Model, the price of share at this optimum pay out is Rs. ___.
a. 21.34
b. 46.67
c. 56.00
d. 36.89
e. 28.99.
ABC and XYZ are the two fast growing companies. They are close competitors. The primary
difference between the companies from a financial management perspective is their dividend
policy. Company ABC tries to maintain a non-decreasing dividend per share, while the
company XYZ maintains a constant dividend payment ratio. Their recent earnings per share,
dividend per share and average share price are as follows:
Company ABC Company XYZ
Year EPS DPS Avg. Price EPS DPS Avg. Price
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
1 8.54 1.00 75.6 8.75 0.90 65.00
2 6.89 1.25 89.45 6.5 1.10 54.78
3 10.56 1.50 92.4 10.11 1.65 100.00
100. The average dividend payout ratio and price earnings ratios for company ABC for all the
years are ________ and ________.
a. 14.42% and 9.90
b. 12.76% and 8.45
c. 11.55% and 6.78
d. 9.98% and 5.45
e. 10.77% and 7.91.
Part II
591
101. The average dividend payout ratio and price earnings ratios for XYZ company for all the
years are ________ and ________.
a. 10.42% and 9.95
b. 18.45% and 7.89
c. 14.39% and 8.66
d. 16.73% and 6.77
e. 12.45% and 5.78.
102. Given the following information about Nile Ltd. The market price of its shares using the
Walters model is Rs. __________.
Equity capitalization rate (k
e
) =16%
Earnings per share (E) =Rs.13
Dividend pay out ratio =25%
Assume return on investment is 14%.
a. 73.60
b. 56.45
c. 80.30
d. 71.22
e. 95.27.
103. If the return on investment is 18% then the market price of its shares using the Walters
model is Rs. __________.
a. 75.50
b. 88.80
c. 66.64
d. 50
e. 100.
Use the data in the above question, and based on the following information for
Nile Ltd., Answer Questions 104 to 105
If k
e
=14% and E =Rs.18
D/P ratio =40%
Retention ratio =60%
r =15%
104. Then according to Gordons dividend capitalization model, the stock value of Nile Ltd., is ---.
a. Rs.100
b. Rs.54
c. Rs.144
d. Rs.140
e. Rs.121.
105. The D/P ratio is 60% then according to Gordons dividend capitalization model, the stock
value of Nile Ltd., is __________.
a. Rs.135
b. Rs.140
c. Rs.145
d. Rs.200
e. Rs.175.
592
Based on the following information Answer Questions to 106 to 107
106. The capitalization rate of Surana Industries Ltd. is 14%. This company has outstanding shares
to the extent 1,00,000 shares selling at the rate of Rs.140 each. Anticipating a net income of
Rs.5,00,000 for the current financial year. Surana Industries Ltd., plans to declare a dividend of
Rs.6 per share. The company also has a new project the investment requirement for which is
Rs.7,50,000. Under the MM model the value of the firm when dividends are paid is ---------.
a. 1,40,00,000
b. 14,00,000
c. 1,40,000
d. 40,00,000
e. 14,40,000.
107. Under the MM model the value of the firm when dividends are not paid is __________.
What is the inference from the problem given above?
a. 1,40,00,000, value of the firm remains the same.
b. 14,00,000, value of the firm differs.
c. 1,40,000, value of the firm remains the same.
d. 40,00,000, value of the firm differs
e. 14,40,000, value of the firm remains the same.
108. The earnings per share of a company are Rs.20. The market rate of discount applicable to the
company 15%. Retained earnings can be employed to yield a return of 13%. If the company
is considering a payout of 10% then the value of the share is __________.
a. Rs.111.11
b. Rs.122.22
c. Rs.100.50
d. Rs. 117.33
e. Rs. 144.44.
109. If the company is considering a payout of 30% then the value of the share is Rs. ________.
a. 135.66
b. 114.23
c. 118.99
d. 99.78
e. 120.88.
110. If the company is considering a payout of 60% then the value of the share is Rs. __________.
a. 134.52
b. 121.10
c. 181.45
d. 126.22
e. 200.21.
111. If dividend payout ratios of 10%, 30%, and 60% were considered then which of these would
maximize the wealth of shareholders?
a. 10%.
b. 30%.
c. 60%.
d. Both (a) and (b).
e. Both (b) and (c).
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593
112. A firms present market price of the share is Rs.55 and its EPS is Rs.18. The firm is planning
to declare 55% of this as dividends. If the firm reinvests its retained earnings at the rate of
13%, the cost of its equity according to Gordon dividend capitalization model is _________.
a. 20%
b. 40%
c. 41.55%
d. 23.85%
e. 37.50%.
113. Sigma Ltd., belongs to a risk class of which the capitalization rate is 17%. Presently it has
3,00,000 shares selling at Rs.150 each. The company is considering the declaration of a Rs.9
dividend at the end of current fiscal year, which has just begun. Based on the MM model, the
price of the shares is Rs. __________ at the end of the year if dividend is not declared.
Assume that there are no taxes.
a. 200.00
b. 175.50
c. 156.77
d. 120.45
e. 145.45.
114. The price of the shares is Rs. __________ at the end of the year if dividend is declared.
Assume no taxes.
a. 100.80
b. 120.43
c. 78.99
d. 166.50
e. 85.70.
115. A firms present market price of the share is Rs.40 and its EPS is Rs.12. The firm is planning
to declare 45% of this as dividends. If the firm reinvests its retained earnings at the rate of
14%, the cost of its equity according to Gordon dividend capitalization model is __________.
a. 20%
b. 21.2%
c. 22%
d. 26.2%
e. 23%.
Based on the following information for Gypsy Foods Ltd., Answer Questions 116 to 122
Earnings per share = Rs.20
cost of equity = 14%
Rate of return on investment = 12%
116. Calculate the market price per share if the entire earnings are paid out as dividends.
a. Rs.150.00
b. Rs.167.80
c. Rs.145.21
d. Rs.142.85
e. Rs.117.89.
594
117. Calculate the market price per share if the retention ratio is 25%
a. Rs.143.45
b. Rs.121.22
c. Rs.116.40
d. Rs.136.36
e. Rs.170.00.
a. Rs.87.50
b. Rs.130.40
c. Rs.166.91
d. Rs.95.25
e. Rs.110.70.
a. Rs.120
b. Rs.115.5
c. Rs.99
d. Rs.90
e. Rs.125.
a. Rs.130
b. Rs.100
c. Rs.96
d. Rs.125
e. Rs.175.
a. Rs.0
b. Rs.100
c. Rs.200
d. Rs.50
e. Rs.90.
122. What inference can be drawn from the results of problems 116 to 121?
a. When the retention ratio is increasing, the market price per share is falling down.
b. When the retention ratio is decreasing, the market price per share is falling down.
c. When the retention ratio is decreasing, the market price per share is constant.
d. When the retention ratio is increasing, the market price per share is also increasing.
123. A company has 40,000 shares, selling at Rs.30 per share. The company is expecting a net
profit of Rs.25,000 and plans to declare a dividend of Rs.2, towards the end of the year. The
company has appraised a project and is going to invest Rs.1,00,000, for which the company
proposes to issue new shares. If the capitalization rate of the company is 15%, the expected
market price at the end of the year is __________.
a. Rs.25.7
b. Rs.29
c. Rs.32.5
d. Rs.30
e. Rs.27.11.
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595
124. Assuming MM model holds good, calculate the number of shares the company has to issue.
a. 5,000 shares
b. 5,500 shares
c. 4,500 shares
d. 4,769 shares
e. 3,985 shares.
125. An analysis about the share price of a firm revealed that it is growing at the rate of 6% per
year. The firm has 30,000 outstanding shares and it is planning to issue shares one-tenth of
this size to partly meet an investment of Rs.85,000. If the present market price of the share is
Rs.25 and the company is planning to pay a dividend of Rs.3 towards the end of the year, the
earnings of the firm during the period are ________. Assume no taxes and MM model holds
good.
a. Rs.95,500
b. Rs.90,000
c. Rs.85,000
d. Rs.80,000
e. Rs.1,00,000.
126. The earnings per share of a company are Rs.20. The Company is examining to adopt payout
ratios of 20%, 40% or 60%. The market values of the companys share using Walters model
are ______ , ______ and ______. It is given that the retained earnings of the company earn a
return of 20%, and the cost of capital of the company is 10%.
a. Rs.300, Rs.320, Rs.260
b. Rs.360, Rs.320, Rs.280
c. Rs.360, Rs.300, Rs.250
d. Rs.260, Rs.320, Rs.380
e. Rs.340, Rs.320, Rs.300.
127. The market value of the companys share using Walters model are _____, ______ and ____,
if the productivity of the retained earnings of the company is 15%.
a. Rs.220, Rs.240, Rs.260
b. Rs.300, Rs.320, Rs.340
c. Rs.280, Rs.260, Rs.240
d. Rs.300, Rs.280, Rs.260
e. Rs.300, Rs.320, Rs.300.
128. The market values of the companys share using Walters model are ______ , _____ and
____, if the productivity of the retained earnings of the company is 6%.
a. Rs.136, Rs.152, Rs.168
b. Rs.168, Rs.152, Rs.136
c. Rs.152, Rs.168, Rs.136
d. Rs.136, Rs.168, Rs.152
e. Rs.168, Rs.136, Rs.152.
596
The following information is available regarding ICICI Ltd., for last 5 years.
Year EPS (Rs.) DPS (Rs.) RONW (%)
Average Market
Price (Rs.)
1999 12.7 3.0 23.2 117.0
2000 16.1 3.5 22.0 115.0
2001 14.3 3.7 21.3 83.0
2002 15.6 4.5 20.9 90.5
2003 22.5 5.5 25.4 61.5
129. Calculate the pay-out ratios of ICICI Ltd., for all the years respectively.
a. 0.236, 0.217, 0.259, 0.288, 0.244
b. 0.245, 0.222, 0.218, 0.276, 0.211
c. 0.231, 0.245, 0.267, 0.289, 0.277
d. 0.189, 0.267, 0.259, 0.119, 0.215
e. 0.288, 0.216, 0.222, 0.212, 0.256.
130. Calculate the P/E ratios of ICICI Ltd., for all the years respectively.
a. 9.00, 8.67, 7.64, 6.57, 5.42
b. 9.21, 7.14, 5.80, 5.80, 2.73
c. 9, 7, 5, 4, 3
d. 9.01, 8.22, 5.14, 4.67, 3.89
e. 8.77, 7.15, 6.43, 5.42, 4.21.
131. Calculate the multipliers according to the traditional approach of dividend policy for all the
years respectively.
a. 18.19, 13.77, 7.89, 7.89, 5.63
b. 17.45, 15.62, 9.55, 8.12, 4.33
c. 16.17, 12.97, 9.80, 9.33, 4.73
d. 16.17, 12.97, 8.12, 7.89, 4.33
e. 18.19, 12.97, 9.81, 9.33, 4.73.
The following information pertains to MM Company Limited:
Particulars Rs.
Earnings of the company Rs.5,00,000
Dividend pay-out ratio 60%
Number of outstanding shares 1,00,000
Rate of return on investment 15%
Cost of equity capital 12%
132. The market value of equity shares of the company as per the Walters model.
a. Rs.45.83
b. Rs.51.70
c. Rs.27.88
d. Rs.40.12
e. Rs.35.50.
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597
133. The optimal dividend pay-out ratio for the above company as per the Walters model is ____.
a. 0.305
b. 0.411
c. 0.218
d. 0.444
e. Nil.
134. The market value of the companys share at that pay-out ratio is __________.
a. Rs.47.88
b. Rs.37.35
c. Rs.52.08
d. Rs.44.55
e. Rs.67.90.
135. Consider the following information related to Praxa Ltd.:
Net sales =Rs.240 lakh
Net profit margin =12.50 percent
Outstanding Preference shares =Rs.100 lakh @12 percent per annum
Number of equity shares =450,000
Cost of equity shares =12 percent
Retention ratio =40 percent
Return on investment =16 percent.
What should be the approximate share price as per Gordons model? (Round off your answer
to the nearest integer)
a. Rs.100
b. Rs.43
c. Rs.39
d. Rs.36
e. Rs.21.
136. The following information is relating to Makkara Ltd.
Year 1 Year 2 Year 3 Year 4
DPS (Dividend Per Share) Rs.1.50 Rs.2.00 Rs.2.00 Rs.2.50
Price per share at the beginning of the year Rs.10 Rs.12 Rs.13 Rs.15
If the price per share at the beginning of the fifth year is Rs.18, what would be the realized
yield from an investment in that share, over the above period of 4 years? (Round off your
answer to the nearest integer)
a. 24 percent
b. 26 percent
c. 28 percent
d. 30 percent
e. 32 percent.
598
137. The following figures are collected from the annual report of Prafati Pharmaceuticals Ltd.:
Net profit =Rs.30 lakh
Outstanding Preference shares =Rs.100 lakh @ 12 percent per annum
Number of equity shares =300,000
Cost of equity shares =16 percent
Return on Investment =20 percent.
What should be the approximate dividend pay out ratio so as to keep the share price at Rs.42
by using Walter model?
a. Zero percent.
b. 20 percent.
c. 36 percent .
d. 52 percent .
e. 68 percent.
138. The following information is collected from the annual report of MM Ltd.:
Net profit Rs. 5.00 crore
Dividend pay out ratio 40 percent
Equity capitalization rate 12 percent
Rate of return on investment 16 percent
What is market price per share according to Walters model on dividend policy?
a. Rs.40.
b. Rs.60.
c. Rs.80.
d. Rs.100.
e. Rs.120.
139. The following information is collected from the annual reports of J ay Kay Ltd.:
Profit before tax Rs. 2.50 crore
Tax rate 40 percent
Retention ratio 40 percent
Equity capitalization rate 12 percent
Rate of return on investment 15 percent
What should be the market price per share according to Gordons model on dividend policy?
a. Rs.25
b. Rs.30
c. Rs.35
d. Rs.40
e. Rs.45.

Part II
599
140. Hardillia Enterprises Ltd., operates in the electrical spares industry. The income statement of
the company is given below:
(Rs. in lakh)
Sales 100
Cost of sales 60
Net operating income 40
Interest 12
Earnings to equity shareholders 28
The capitalization rate for debt is 10% and the overall capitalization rate for the entire firm
is 12.5%. If other things remain the same, then what is the maximum amount of funds that
the firm can borrow in terms of market value so that its equity capitalization rate does not
exceed 16%?
(Assume that the net operating income approach to capital structure is applicable.)
a. Rs.56.67 lakh
b. Rs.66.67 lakh
c. Rs.76.67 lakh
d. Rs.86.67 lakh
e. Rs.96.67 lakh.
141. According to Gordons dividend capitalization model, if the share price of a firm is Rs.43, its
dividend pay-out ratio is 60%, the cost of equity and return on investment are 9% and 12%
respectively and if the number of shares is 12,000, the net profit of the firm is
a. Rs.15,480
b. Rs.23,220
c. Rs.36,120
d. Rs.54,180
e. Rs.58,640.
142. If the required return on equity capital of a firm is 14%, the current market price of the share
is Rs.180, the dividend to be paid is Rs.20 and the market price a year hence will be
a. Rs.185
b. Rs.190
c. Rs.195
d. Rs.205
143. If the earnings per share is Rs.4, dividend pay-out ratio is 40%, cost of equity capital is 20%
and growth rate in the rate of return on investment is 15%, then the value of the stock
according to the Gordons dividend capitalization model is
a. Rs.16
b. Rs.24
c. Rs.32
d. Rs.40
e. Rs.60.
600
144. If the earnings per share is Rs.15, the retention ratio is 25%, the return on investment is 8%
and cost of equity capital being 18%, the price of share as per Gordons dividend
capitalization model is:
a. Rs.70.31
b. Rs.68.00
c. Rs.70.00
d. Rs.89.00
e. Rs.76.00.
145. Consider the following information:
Equity capitalization rate : 18%
Earnings per share : Rs.20
Dividend pay-out ratio : 25%
Return on investment : 12%
The price per share as per the Walters model is:
a. Rs. 83.33
b. Rs. 95.00
c. Rs.101.00
d. Rs.120.00
e. Rs.183.33.
146. XYZ corporation has 1000 shares outstanding and retained earnings of Rs.25,000.
Theoretically, what would happen to the price of the stock, currently selling for Rs.50 per
share, if a 20% stock dividend is declared
a. Price should increase to Rs.60 per share
b. Price should decrease to Rs.40 per share
c. Price should decrease to Rs.41.67 per share
d. Price should increase to Rs.62 per share
e. Price should remain at Rs.50.
147. If the market price of an equity share of Pee Cee Ltd., is Rs.35 whose face value is Rs.10,
dividend per share is 20%, internal rate of return on investments is 24%, cost of capital is
18%, what is the earnings per share? (Hint: Use Walter model)
a. Rs.5.78.
b. Rs.4.78.
c. Rs.5.23.
d. Rs.7.73.
e. Rs.6.78.
148. Millers Indias current share price is Rs.45. Its retention ratio is 60 percent, cost of equity and
rate of return on its investments are 10 percent and 15 percent respectively and the number of
shares outstanding is 1,00,000.
Assuming that no preference shares are outstanding, using Gordons model the companys
net profit is
a. Rs.1,45,213
b. Rs.1,12,500
c. Rs.2,13,452
d. Rs.1,00,000
e. Rs.45,00,000.
Part II
601
The following information is available in respect to the Zee Ltd.
Sales Rs.500 lakhs
Cost of goods sold 40%
Total Purchases Rs.450 lakhs
Other balances:
Years 1-1-2003 31-12-2003
Inventory Rs. 34 lakhs Rs. 46 lakhs
Debtors Rs. 45 lakhs Rs. 62 lakhs
Creditors Rs. 26 lakhs Rs. 36 lakhs
Assure that all sales are credit sales.
149. The finished goods storage period is __________.
a. 67 days
b. 58 days
c. 73 days
d. 81 days
e. 62 days.
150. The average collection period is __________.
a. 45 days
b. 39 days
c. 26 days
d. 60 days
e. 54 days.
151. Average payment period is __________.
a. 20 days
b. 30 days
c. 40 days
d. 25 days
e. 35 days.
152. The net operating cycle of the firm is __________.
a. 91 days
b. 100 days
c. 117 days
d. 75 days
e. 87 days.

602
Kiran International Ltd.s Profit and Loss A/C and Balance Sheet for the year ended
31.12.2003 are given below.
Profit and Loss A/c
Particulars Rs. Particulars Rs.
To opening stock: By Credit sales 1,10,000
Raw materials 30,000 By Closing stock:
Work in progress 20,000 Raw materials 10,000
Finished goods 15,000 Work in progress 32,500
To Credit purchases 15,000 Finished goods 17,500
Wages & Manufacturing exp. 20,000
To Gross profit c/d 70,000
1,70,000 1,70,000
To Administrative expenses 20,000 By gross profit b/d 65,000
To Selling and Distribution exp. 15,000
To Net profit: 30,000
65,000
Balance sheet as at 31.12.2002
Share capital (16,000 equity
shares of Rs. each)
2,20,000 Fixed assets 1,50,000
Profit and loss a/c 30,000 Closing stock:
Creditors 10,000 Raw materials 10,000
Work in progress 32,500
Finished goods 17,500
Debtors 35,000
Cash and Bank 15,000
2,60,000 2,60,000
Opening debtors and opening creditors were Rs.8,000 and Rs.5,000 respectively. Consider
360 days in a year respectively.
153. The Raw material storage period and conversion period are _________ and _________.
a. 206 days, 222 days
b. 200 days, 236 days
c. 100 days, 156 days
d. 109 days, 212 days
e. 245 days, 231 days.
a. 106 days
b. 99 days
c. 78 days
d. 116 days
e. 81 days.
Part II
603
a. 50 days
b. 60 days
c. 70 days
d. 80 days
e. 90 days.
156. The average payment period is __________.
a. 118 days
b. 125 days
c. 147 days
d. 180 days
e. 167 days.
157. The net operating cycle is __________.
a. 396 days
b. 312 days
c. 422 days
d. 350 days
e. 299 days.
158. The following information is available for Radha Textiles Ltd.
Duration of operating cycle 140 days
Creditors payment period 60 days
Credit sales for the year Rs.280 lakh
Raw material consumed Rs.160 lakh
Cost of production Rs.250 lakh
Cost of sales Rs.180 lakh
Average stock of raw materials Rs.40 lakh
Average stock of work in progress Rs.15 lakh
Average stock of finished goods Rs.40 lakh
Opening balance of accounts receivable Rs.25 lakh
Average accounts receivable for the company assuming 360 days in a year is __________.
a. 3.5
b. 4.5
c. 7.5
d. 8.5
e. 6.25.
Given below is the information about Olympic Ltd. (Rs. in 000)
i. Opening balance of
a. Raw materials and stores 280
b. Work-in-process 120
c. Finished goods 140
d. Accounts receivable 240
e. Trade creditors 180
604
ii. Closing balance of
a. Raw material and stores 260
d. Accounts receivable 225
e. Trade creditors 195
iii. Purchase of raw materials and stores, etc. 420
iv. Production costs 330
v. Depreciation 90
vi. Excise duty 140
vii. Selling, administration expenses 600
viii. Total sales 1800
159. Calculate the raw materials storage period in operating cycle.
a. 241 days
b. 221 days
c. 265 days
d. 280 days
e. 212 days.
160. The work in process conversion period is __________.
a. 60 days
b. 62 days
c. 53 days
d. 56 days
e. 44 days.
a. 36 days
b. 43 days
c. 50 days
d. 29 days
e. 51 days.
a. 55 days
b. 47 days
c. 52 days
d. 57 days
e. 35 days.
163. The average payment period is __________.
a. 156 days
b. 161 days
c. 170 days
d. 171 days
e. 175 days.

Part II
605
164. If the investment in purchase of raw materials and stores is doubled and as a result, the total
sales increase to Rs.30 lakh, by how many days the operating cycle increases/decreases?
a. 45 days
b. 55 days
c. 65 days
d. 75 days
e. 85 days.
Cedilla Ltd., manufacturer of suitcases, makes 700 boxes per annum. Selling price of each
suitcase is Rs.1000 and the variable cost is Rs.400 per piece. It incurs fixed expenses of
Rs.1,20,000 per year. Only 10% of its sales are made in cash. Every year the firm spends
Rs.20,000 on advertising and this year its investment in the purchase of raw materials is 20%
of its total turnover.
Additional information is given below:
(in Rs. 000)
i. Opening balance of
a. Raw materials and stores 40
d. Debtors 90
e. Creditors 120
ii. Closing balance of
a. Raw material and stores 45
d. Debtors 100
e. Creditors 70
v. Depreciation 30
vi. Excise duty 30
vii. Selling, administration expenses 40
165. Assuming uniform production and sales throughout the year, raw material storage period and
stock in process period for Cedilla Ltd., are __________ and __________ respectively.
a. 113 days, 20 days
b. 113 days, 30 days
c. 123 days, 30 days
d. 123 days, 35 days
e. 125 days, 40 days
a. 51 days
b. 52 days
c. 53 days
d. 54 days
e. 55 days.
606
167. The average collection period and the average payment period are ______ and _______.
a. 54 days and 244 days
b. 68 days and 156 days
c. 46 days and 144 days
d. 32 days and 200 days
e. 60 days and 125 days.
Micro Computers Ltd., is planning to sell 10,000 personal computers on a monthly basis in the
current financial year. The average sales price of a PC is Rs.36,000 per unit with an expected
net profit margin of 20 percent. The raw material and manufacturing expenses are equal and
together consist of 60% of the total costs. The balance costs are selling and administrative
expenses. The duration of various component periods of operating cycle are as follows:
Raw material storage period 10 days
Work-in-progress 12 days
Finished goods storage period 18 days
Average collection period 3 months
168. The total investment in raw materials and manufacturing expenses are_______and ________.
a. Rs.37.44 cr and 32.83 cr
b. Rs.46.115 cr and 36.715 cr
c. Rs.32.981 cr and 40.211 cr
d. Rs.56.98 cr and 32.513 cr
e. Rs.29.22 cr and 37.881 cr.
169. The investment in selling and administrative costs and profit in debtors are _______ and ______.
a. Rs.44.551 cr and 24.7 cr
b. Rs.32.897 cr and 28.77 cr
c. Rs.41.472 cr and 21.6 cr
d. Rs.37.89 cr and 22.75 cr
e. Rs.49.81 cr and 37.88 cr.
170. The Gross working capital required is __________.
a. Rs.156.77 cr
b. Rs.167.23 cr
c. Rs.139 cr
d. Rs.133.34 cr
e. Rs.127.56 cr.
Precision Cables Ltd., has planned to sell 6,00,000 units of output in the coming year. The
cost structure of the companys product for the desired level of production is given below.
Particulars Cost per unit (Rs.)
Raw materials 30
Manufacturing expense 10
Other overheads 25
Total cost 65
Selling price 80
Profit 15
Part II
607
Examination of the past trend reveals:
i. Raw materials are held in stock for 1 months
ii. Work-in-process inventory is equal to half months production
iii. Finished goods remain in the warehouse for a month
iv. Three months credit is allowed to the debtors
v. Manufacturing expenses are expected to occur evenly during the year.
171. The investment in various current assets is __________.
a. Rs.176.70 lakh
b. Rs.185.00 lakh
c. Rs.200.01 lakh
d. Rs.217.81 lakh
e. Rs.196.25 lakh.
172. The gross working capital requirement is __________, if the desired cash balance is 5% of
gross working capital.
a. Rs.219.04 lakh
b. Rs.100.56 lakh
c. Rs.194.74 lakh
d. Rs.256.51 lakh
e. Rs.177.79 lakh.
173. The following information is available for Sai Textiles Ltd.
Credit sales for the year Rs.300 lakh
Raw material consumed Rs.120 lakh
Cost of sales Rs.240 lakh
Average stock of raw materials Rs.35 lakh
Average stock of work-in-progress Rs.10 lakh
Average stock of finished goods Rs.30 lakh
The closing balance of accounts receivable for the company assuming 360 days in a year is ___.
a. Rs.5.0 lakh
b. Rs.5.5 lakh
c. Rs.5.75 lakh
d. Rs.6.0 lakh
e. Rs.6.5 lakh.
174. Considering the following data relating to Yaksha Manufacturing Corporation:
Annual sales value =Rs.150 lakh
Amount sold against cash =Rs.30lakh
Accounts receivable at the beginning of the year =Rs.8 lakh
Accounts receivables at the end of the year =Rs.12 lakh
The average collection period is, assuming 360 days in a year,
a. 5 days
b. 10 days
c. 20 days
d. 30 days
e. 40 days.
608
175. American Bakers formulates its credit policy on the basis of average Days Sales Outstanding
(DSO) at the end of every quarter. The finance manager has already stipulated that the
average collection period in any quarter should not exceed 45 days; else corrective measures
are to be taken. The monthly sales and outstanding receivables for the year 2003 are as
follows: (Sales and receivables figures are in Rs. Lakh)
Month Sales Receivables Month Sales Receivables
J anuary 480 1000 J uly 500 800
February 540 860 August 550 850
March 550 750 September 600 850
April 400 700 October 500 650
May 450 750 November 600 950
J une 450 700 December 600 800
In which quarters, the sales manager was required to take the corrective measure in order to
reduce the average collection period?
a. First quarter.
b. Second quarter.
c. Third quarter.
d. Fourth quarter.
176. The following information is related to Beta Company:
Annual Consumption of raw materials =Rs.700 lakh
Inventory of Raw materials at the beginning of the year =Rs.30 lakh
Inventory of Raw materials at the end of the year =Rs.50 lakh
The outstanding balances for the creditors at the beginning of the year =Rs.79 lakh
The outstanding balances for the creditors at the end of the year =Rs.93 lakh.
The average payment period for the company (Assuming one year is equal to 360 days and
all purchases are made on credit only) will be
a. 39 days
b. 43 days
c. 47 days
d. 51 days
e. 55 days.
177. A firm with daily credit sales of Rs.50,000 reduced its average collection period by 5 days.
What would be the annual benefit? (Assume that the cost of funds as 12 percent)
a. Rs.10,000
b. Rs.15,000
c. Rs.20,000
d. Rs.25,000
e. Rs.30,000.
178. The probability that a customer pays for the first order is 85 percent. In case the customer
pays for the first order, the probability of default in case of a repeat order is likely to be
5 percent. If the price of the product is Rs.90,000 and the associated cost is Rs.72,000, what
will be the total net weighted benefit from the order?
a. Rs.11,475.
b. Rs.12,875.
c. Rs.13,500.
d. Rs.14,675.
e. Rs.15,475.
Part II
609
179. The following information is related to the operations of a firm:
Average conversion period 8 days
Finished Goods storage period 18 days
Average payment period 45 days
The operating cycle of the firm is:
a. 180 days
b. 135 days
c. 90 days
d. 88 days
e. 45 days.
180. The following figures are collected from annual report of Hyderabad Textiles:
2002
(in Rs. 000s)
2003
(in Rs.000s)
Raw materials inventory Closing Balance 180 212
Work in process inventory Closing Balance 25 45
Purchases of raw materials during the year 1085 1192
Manufacturing expenses during the year 1165 1280
Depreciation 75 100
What should be the average conversion period of Hyderabad Textiles for the year 2003?
(Assume 360 days in a year)
a. 3 days
b. 5 days
c. 7 days
d. 9 days
e. 11 days.
181. The following figures are collected from annual report of Hyderabad Ceramics Ltd.:
2002
(in Rs. 000s)
2003
(in Rs.000s)
Raw materials inventory Closing Balance 160 192
Work in process inventory Closing Balance 25 45
Finished Goods inventory Closing Balance 30 50
Purchases of raw materials during the year 1135 1242
Manufacturing expenses during the year 1125 1230
Depreciation 75 100
Selling, administration and financial expenses during the year 200 230
Excise Duty paid during the year 120 150
What should be the average finished goods storage period of Hyderabad Ceramics for the
year 2003?
a. 2 days.
b. 3 days.
c. 4 days.
d. 5 days.
e. 6 days.
610
182. Homemaker, a reputed washing machine manufacturer, plans to manufacture 12,000 sets of
washing machines for the next year. The cost components are as follows:
Item Unit Cost (Rs.)
Raw Material 5000
Manufacturing Expenses 2000
Selling, administrative and financial expenses 1000
The selling price per unit is Rs.10,000 and sales may be assumed to be uniform throughout
the year while the manufacturing expenses are expected to be incurred evenly throughout the
month. The durations at various stages of the operating cycle are given below:
Raw material stage = 2 months
Work in process stage = 1 month
Finished goods stage = 1 month
Debtors stage = 3 months
If the minimum cash balance required is Rs.10,00,000, what is the estimate for the working
capital requirement of the company?
a. Rs.350 lakh
b. Rs.400 lakh
c. Rs.450 lakh
d. Rs.500 lakh
e. Rs.550 lakh.
183. If the current assets and current liabilities are Rs.2,000 lakh and Rs.1,200 lakh respectively.
How much amount can be borrowed on a short-term basis without reducing current ratio
below 1.5?
a. Rs.400 lakh.
b. Rs.1000 lakh.
c. Rs.1200 lakh.
d. Rs.1400 lakh.
e. Rs.2000 lakh.
184. If average balance of sundry creditors is Rs.75,000 and annual credit purchases is Rs.24 lakh,
then average payment period (assume 360 days a year) is
a. 5 days
b. 8.25 days
c. 11.25 days
d. 14.50 days
e. 32 days.
185. What is the cash conversion cycle for a firm with a receivables period of 35 days, a payables
period of 40 days and an inventory period of 55 days?
a. 20 days.
b. 50 days.
c. 60 days.
d. 80 days.
e. 130 days.
Part II
611
186. Given the following information the raw material storage period is:
Annual raw material consumption Rs.13,500
Opening stock of raw materials Rs.2,500
Closing stock of raw materials Rs.2,000
Assume 1 year =360 days.
a. 45 days
b. 50 days
c. 55 days
d. 60 days
e. 65 days.
187. The following information pertains to the operations of a firm:
Raw materials storage period 80 days
Conversion period 5 days
Average payment period 60 days
The operating cycle of the firm is
a. 60 days
b. 70 days
c. 80 days
d. 90 days
e. 100 days.
The financial position of Bharat Industries Ltd. has been projected for the forthcoming year
as summarized below:
Current Liabilities Current Assets
*

Rs.
in lakh
Rs. in lakh
Accounts payable 200 Raw materials 300
Other Current liabilities 150 Work in process 50
350 Finished goods 200
Bank borrowings (including
bills discounted with banks)
400 Receivables (including bills
discounted with banks)
150
Other current assets 50
750 750
As per suggested norms or past practice, whichever is lower, in relation to projected
production for the forthcoming year.
Assume core current assets are Rs. 200 lakh.
188. The maximum permissible of bank finance under Tandon Committee Method I is _______.
a. Rs.400 lakh
b. Rs.300 lakh
c. Rs.250 lakh
d. Rs.450 lakh
e. Rs.350 lakh.
612
189. The maximum permissible of bank finance under Tandon Committee Method II is________.
a. Rs.212.50 lakh
b. Rs.280.44 lakh
c. Rs.222.88 lakh
d. Rs.167.83 lakh
e. Rs.250.87 lakh.
190. The maximum permissible of bank finance under Tandon Committee Method III is _______.
a. Rs.88.99 lakh
b. Rs.54.65 lakh
c. Rs.51.89 lakh
d. Rs.77.55 lakh
e. Rs.62.50 lakh.
191. The current ratios under Tandon Committee Methods I, II and III are ________, _______and
__________.
a. 1.00, 1.67, 1.88
b. 1.23, 1.55, 1.77
c. 1.21, 1.43, 1.92
d. 1.15, 1.33, 1.81
e. 1.09, 1.45, 1.96.
Polaris India Ltd., has provided the following information for the current year:
Liabilities Rs. in lakh Assets Rs. in lakh
Equity shares of Rs. 15 each 300 Fixed assets 800
Retained earnings 300 Current assets:
14% debentures 500 Raw materials 300
Public deposits 150 Work in progress 200
Trade creditors 150 Finished goods 100
Bills payable 300 Debtors 100
Cash at Bank 200 900
1700 1700
Assume the level of core current assets to be Rs.100 lakhs.
192. The maximum permissible of bank finance under Tandon Committee Method I is ________.
a. Rs.88.90 lakh
b. Rs.362.50 lakh
c. Rs.337.50 lakh
d. Rs.412.50 lakh
e. Rs.333.50 lakh.
193. The maximum permissible of bank finance under Tandon Committee Method II is________.
a. Rs.434.50 lakh
b. Rs.300.50 lakh
c. Rs.225 lakh
d. Rs.250 lakh
e. Rs.375 lakh.
Part II
613
a. Rs.250 lakh
b. Rs.150 lakh
c. Rs.350 lakh
d. Rs.200 lakh
e. Rs.450 lakh.
195. The current ratios under Tandon Committee Methods I, II and III are ________, __________
and __________.
a. 1.14, 1.33, 1.50
b. 1.21, 1.42, 1.56
c. 1.33, 1.45, 1.67
d. 1.18, 1.28, 1.65
e. 1.12, 1.55, 1.75.
The following is the projected balance sheet of Rhizome India Ltd. as on 31-3-2004.
Balance sheet as on 31-3-2004
(Rs. in lakh)
Share capital 200 Fixed assets 600
Reserves & Surplus 150 Current assets 1100
Secured loans 350 Miscellaneous expenditure 150
Unsecured loans 850
Current liabilities 300
1850 1850
Assume that core current assets constitute 25% of the current assets.
196. The maximum permissible of bank finance under Tandon Committee Method I is ________.
a. Rs.500 lakh
b. Rs.600 lakh
c. Rs.700 lakh
d. Rs.400 lakh
e. Rs.800 lakh.
197. The maximum permissible of bank finance under Tandon Committee Method II is ________
a. Rs.600 lakh
b. Rs.575 lakh
c. Rs.550 lakh
d. Rs.525 lakh
e. Rs.500 lakh.
a. Rs. 455.65 lakh
b. Rs. 617.02 lakh
c. Rs. 318.75 lakh
d. Rs. 445.50 lakh
e. Rs. 565.75 lakh.
614
199. The current ratios under Tandon Committee Methods I, II and III are _________, _________
and __________.
a. 1.11, 1.44, 1.88
b. 1.05, 1.35, 1.65
c. 1.24, 1.45, 1.88
d. 1.22, 1.33, 1.77
e. 1.09, 1.50, 1.87.
The following is the balance sheet of XYZ Ltd.,
(in Rs.000)
Liabilities Assets
Share Capital 150 Machinery 80
Retained earnings 51 Buildings 96
Medium-term loans 36 Plant 105
Accounts payable 24 Land 81
Cash in bank 9
Provision for tax 47 Raw materials 43
Provision for purchase of market yard 40 Work-in-progress 30
Finished goods 35
Provision for dividend 18 91-day T-Bills 18
Long-term loan 160 Investments in CP&CD 20
Trade creditors 63 Inter-corporate deposits
(Maturity Dt.1.4.06)
15
Premium on debentures 70 Deep-discount bonds
(Maturity Dt.1.4.05)
28
Provision for depreciation 19 Outstandings from export sales 14
Interest payable 9 Patents and trademarks 26
Accounts receivable 87
687 687
200. Based on Tandon Committee Method I, the maximum permissible bank finance is ________.
a. Rs.55,500
b. Rs.21,600
c. Rs.67,500
d. Rs.70,000
e. Rs.65,000.
201. Based on Tandon Committee Method II, the Maximum Permissible Bank finance is _______.
a. Rs.22,500
b. Rs.34,000
c. Rs.46,700
d. Rs.12,900
e. Rs.45,000.
Part II
615
202. Total current assets of a company are Rs.960 lakh while the current liabilities (other than
bank borrowings) are Rs.300 lakh. If the company borrowed Rs.350 lakh, what will be the
amounts of Maximum Permissible Bank Finance (MPBF) under the methods I and II of the
Tandon committee recommendations?
a. Rs.495 lakh and Rs.420 lakh.
b. Rs.500 lakh and Rs.410 lakh.
c. Rs.505 lakh and Rs.405 lakh.
d. Rs.510 lakh and Rs.400 lakh.
e. Rs.515 lakh and Rs.395 lakh.
203. If credit terms is 2/10 net 30, the cost of trade credit if payment is made after 10th day but
before 30th day of purchase is:
a. 2%
b. 20%
c. 36.73%
d. 40%
e. 42%
204. With terms of 4/15, net 45, what is the implied interest rate for foregoing a cash discount and
paying at the end of the period?
a. 25.63%.
b. 39.29%.
c. 50.00%.
d. 64.32%.
e. 70.00%.
205. If the terms of credit are 2/15 net 45 then the cost of trade credit is
a. 21.2%
b. 22.5%
c. 23.6%
d. 24.5%
e. 25.2%.
206. The following information is extracted from the balance sheet of Apex Company.
Current Liabilities Rs. in lakh Current Assets

Rs. in lakh
Trade Creditors 180 Bills receivable 225
Bank borrowings (including bills discounted) 375 Other current assets 525
Other current liabilities 45
The maximum permissible bank finance for the Apex Company under Method I of Tandon
Committee recommendation is
a. Rs.110.50 lakh
b. Rs.112.50 lakh
c. Rs.114.50 lakh
d. Rs.116.50 lakh
e. Rs.118.50 lakh.
616
207. On the assumption of 360 days in a year what will be the cost of trade credit to a company
which purchases materials under the terms 2/10, net 45?
a. 16.00%.
b. 20.57%.
c. 20.99%.
d. 16.33%.
e. 36.00%.
208. The annual demand for an item is 4,800 units. The unit cost is Rs.9 and inventory carrying
charges 45% p.a. If the cost of one procurement is Rs.300, the EOQ is __________.
a. 767.4 units
b. 545.9 units
c. 666.8 units
d. 807.7 units
e. 843.3 units.
209. The number of orders per year is __________.
a. 2 orders
b. 3 orders
c. 4 orders
d. 5 orders
e. 6 orders.
210. Time between two consecutive orders is __________.
a. 3.4 months
b. 3.5 months
c. 2.1 months
d. 2.5 months
e. 1.5 months.
211. Smart Software Ltd., buys in lot of 150 boxes, which is a four months supply. The cost per
box is Rs.150 and the ordering cost is Rs.300 per order. The inventory carrying cost is
estimated at 25% of unit value per annum. The total annual cost of the existing inventory
policy is __________.
a. Rs.82,000
b. Rs.71,212.50
c. Rs.88,500.50
d. Rs.67,890.55
e. Rs.87,000.
212. The economic order quantity is __________.
a. 55 units
b. 65 units
c. 75 units
d. 85 units
e. 95 units.
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617
213. Indigo International Company wants an annual output of 55,000 units. The setup cost for
each production run is Rs.120. The cost of carrying inventory per unit per annum is Rs.8.
The optimal production quantity per production run is __________.
a. 1,500 units
b. 2,125 units
c. 1,285 units
d. 1,565 units
e. 2,000 units.
214. The annual usage of a raw material is 1,50,000 units for the Detroitte Company Ltd., the
price of the raw material is Rs.90 per unit. The ordering cost is Rs.450 per order and the
carrying cost 25% of the average value of inventory. The supplier has recently introduced a
discount of 6% on the price of material for orders of 3500 units and above. The companys
EOQ prior to the introduction of discount is __________.
a. 2,450 units
b. 3,500 units
c. 2,800 units
d. 4,000 units
e. 3,650 units.
215. The total amount of discount available with an order size of 3500 units is __________.
a. Rs.8,10,000
b. Rs.9,00,000
c. Rs.7,50,000
d. Rs.6,70,000
e. Rs.8,75,000.
216. The savings due to reduction in ordering costs is __________.
a. Rs.8,280
b. Rs.9,350
c. Rs.7,300
d. Rs.6,800
e. Rs.6,500.
217. The incremental carrying cost and net incremental benefits are ________ and ________.
a. Rs.8,760 and Rs.9,00,500
b. Rs.9,450 and Rs.8,08,830
c. Rs.7,000 and Rs.10,00,000
d. Rs.9,000 and Rs.6,75,000
e. Rs.8,745 and Rs.6,50,000.
218. The estimated annual usage of a material is 3600 units and the cost per order is Rs.225. If the
carrying cost is Rs.200 per unit, the EOQ is __________.
a. 99 units
b. 90 units
c. 9 units
d. 96 units
e. 900 units.
618
219. If the safety stock is 10% of the EOQ which is 90 units, the reorder point for the material is
_________. The estimated daily usage is 15 units and the lead-time is 8 days.
a. 9 units
b. 32 units
c. 87 units
d. 129 units
e. 210 units.
220. The optimum production quantity for a certain material is 114 units. The set up cost for each
production run is Rs.361. The purchase price per unit is Rs.160 and the carrying cost per year
is 20% of the inventory value. The monthly output for the material is __________.
a. 48 units
b. 576 units
c. 57 units
d. 77 units
e. 12 units.
221. Because of implementation of Total Quality Control (TQC) methods, a company expects to
save Rs.6,000. However, as a result, the inventory turnover period is expected to increase by
15 days from 30 days. If the cost of goods sold is Rs.4,80,000 and the companys expected
rate of return on inventory is 10% should it implement TQC.
a. Since the opportunity cost is more than its savings of Rs.6,000, the company should
implement its TQC program.
b. Since the opportunity cost is equal to its savings of Rs.6,000, the company should
c. Since the opportunity cost is less than its savings of Rs.6,000, the company should not
d. Since the opportunity cost is equal to its savings of Rs.6,000, the company should not
e. Since the opportunity cost is less than its savings of Rs.6,000, the company should
222. Proxima Century Ltd., is considering the trade discount of 1% offered by one of its suppliers
if it orders 3500 units. The annual usage is 7000 units and the cost per order is Rs.700, which
is fixed. The cost of each unit is Rs.100 and the cost of carrying each unit is 5% of the
inventory value. The EOQ of the company is __________.
a. 1000 units
b. 1100 units
c. 1200 units
d. 1300 units
e. 1400 units.
223. Should the company accept the trade discount?
a. Since the change in profit is positive, the company can go in for the trade discount.
b. Since the change in profit is negative, the company can go in for the trade discount.
c. Since the change in profit is positive, the company cannot go in for the trade discount.
d. Since the change in profit is negative, the company cannot go in for the trade discount.
e. Provided data is insufficient.
Part II
619
224. Given below are the usages and their probabilities for a firm. If the normal consumption
during lead-time is 2000 units, the optimumsafety stock for the firmis __________. The stock-
out cost =Rs.5 per unit and the carrying cost =50 paise/unit.
Usage in units Probability
1200 0.01
1400 0.03
1600 0.04
1800 0.12
2000 0.45
2200 0.15
2400 0.12
2600 0.08
Assume that the consumption is uniform over a period of time and lead time is known what
certainty.
a. 300 units
b. 400 units
c. 280 units
d. 380 units
e. 260 units.
Alpha Laminates Limited is concerned about fixing the reorder level for an expensive
chemical used by it. The executives of the company, based on past experience, have come out
with the following probability table for various eventualities.
Average Daily
Usage Rate (units)
Probability of
Occurrence
Lead Time
(no. of days)
Probability of
Occurrence
200 0.30 13 0.35
600 0.45 16 0.50
800 0.25 22 0.15
225. The stock-out cost is estimated to be Rs.90 per unit and the carrying cost for the period under
consideration is Rs.35 per unit. The normal consumption during lead time is __________.
a. 5,400 units
b. 6,700 units
c. 7,100 units
d. 8,480 units
e. 7,650 units.
226. The Safety stock level at which the total cost (stock-out and carrying costs) is minimum, is _.
a. 1,000 units
b. 2,000 units
c. 1,150 units
d. 1,120 units
e. 1,620 units.
227. The optimal reorder point is __________.
a. 9,600 units
b. 9,100 units
c. 9,990 units
d. 8,999 units
e. 7,900 units.
620
Mothers Inn requires disposable drums of 3,60,000 units per annum. The cost per order is
Rs.500 and carrying costs are 20% of the cost of the stock held. The cost of the drum is
Rs.200. Find the economic order quantity. Assume the economic order quantity is equal to
the average consumption of the firm, the stock-out cost is Rs.100 per unit and the probability
distribution of the different levels of usage is as follows:
Usage in units Probability
1,000 0.06
1,500 0.15
1,800 0.08
2,000 0.09
2,200 0.06
2,700 0.20
3,300 0.15
3,600 0.12
4,400 0.09
228. The levels of safety stock to be analyzed are __________.
a. 0, 300, 600 and 1400 units.
b. 0, 310, 450 and 1350 units
c. 0, 450, 700 and 1500 units
d. 0, 400, 650 and 1450 units
e. 0, 280, 500 and 1400 units.
229. The probability of stock-out is __________.
a. 25%
b. 28%
c. 30%
d. 36%
e. 44%.
230. The reorder level is __________.
a. 1000 units
b. 2000 units
c. 3000 units
d. 4000 units
e. 5000 units.
231. A firm is expecting the following probability of different stock-out positions:
Stock-out (units) Probability
1000 3%
700 5%
500 8%
300 10%
100 15%
0 59%
Part II
621
To avoid the chances of stock-out, the firm wants to maintain some minimum level of stock,
which involves the following two costs:
i. The carrying cost of stock per unit at Rs.75
ii. Cost of stock-out per unit at Rs.250.
Advise the firm about the optimum safety stock level.
a. The optimumsafety stock level is 100 units, as the total cost is minimumfor that level.
b. The optimumsafety stock level is 300 units, as the total cost is minimumfor that level.
c. The optimum safety stock level is 500 units, as the total cost is minimum for that level.
d. The optimum safety stock level is 700 units, as the total cost is minimum for that level.
e. The optimum safety stock level is 1000 units, as the total cost is minimum for that level.
232. Ganesh Trading Company requires 75,000 units of a certain item per annum. The cost per
unit of the item is Rs.25. The ordering cost is Rs.250 per order and the inventory carrying
cost is Rs.10 per unit per year. The EOQ is __________.
a. 1,277 units
b. 1,789 units
c. 1,936 units
d. 1,655 units
e. 1,846 units.
233. Find out what the company should do if the supplier of the item offers a cash discount of 2%
for a minimum order size of 3500 units.
a. Rs. 34,375, since the change in profit is negative, the company should avail the
quantity discount.
b. Rs. 34,355, since the change in profit is positive, the company should avail the quantity
discount.
c. Rs.34,375, since the change in profit is negative, the company should not avail the
quantity discount.
d. Rs.34,375, since the change in profit is positive, the company should avail the quantity
discount.
e. Provided data is insufficient.
234. Samur Sports Company sells 1500 cricket bats each year. The average cost of purchasing
each bat is Rs.250. The cost for Samur to place an order for bats is Rs.50 and it incurs 5% of
the average cost to carry them in inventory. The economic order quantity of cricket bats is __.
a. 110 units
b. 120 units
c. 118.45 units
d. 131.5 units
e. 100 units.
235. The total number of orders it should place each year is __________.
a. 11.55
b. 12.8
c. 14
d. 15
e. 16.
622
236. The average inventory value of cricket bats is __________.
a. Rs.12,500
b. Rs.13,750
c. Rs.11,000
d. Rs.16,300
e. Rs.15,500.
237. The annual inventory costs if it orders the quantity is arrived.
a. Rs.14,70.41
b. Rs.9,450.55
c. Rs.5,500
d. Rs.1,369.32
e. Rs.2,350.10.
United Metal Works Ltd., manufactures steel bolts. The probability distributions of daily
usage rate of the raw material (steel) and the lead time are given below these distributions
are independent of each other:
Daily usage rate (in tones) Probability Lead time (in days) Probability
5 0.20 20 0.60
10 0.60 25 0.40
15 0.20
238. The stock-out cost is estimated to be Rs.10,000 per tonne and the carrying cost is Rs.1,500
per tonne for the period under consideration. The normal usage during procurement period is
__________ tonnes.
a. 200
b. 210
c. 220
d. 230
e. 240.
239. The probability of stock-out when no safety stock is maintained is __________.
a. 44%
b. 50%
c. 69%
d. 38%
e. 72%.
240. The optimal level of safety stock is __________.
a. 90 tonnes
b. 80 tonnes
c. 125 tonnes
d. 60 tonnes
e. 100 tonnes.
Part II
623
241. A company requires a maximum inventory of 1000 units of a material where the carrying
cost per unit is Rs.25, the cost per order is Rs.250 and there are 6 orders per year. The total
costs related to the inventories is (Assume the assumptions of EOQ holds good)
a. Rs.12,000
b. Rs.14,000
c. Rs.16,000
d. Rs.18,000
e. Rs.20,000.
242. Sundar Electricals needs 60,000 pieces of aluminum bars to produce switchgears. The price
of each bar is Rs.100, cost of placing an order is Rs.1200 and the carrying cost is 1 percent.
The purchase manager has set the economic order quantity based on the EOQ model, as
12,000 units. Recently, a supplier has offered discounts of 3 percent against an order size of
20,000 units or more. What will be the incremental benefit to the company, if such discount
is availed?
a. Rs.186,100.
b. Rs.183,700.
c. Rs.181,200.
d. Rs.178,700.
e. Rs.1,300.
243. The average daily usage rates of an inventory, lead time and their respective probabilities are
as follows:
Daily Usage Rate
(in units)
Probability
Lead time
(in days)
Probability
180 0.25 20 0.30
300 0.45 30 0.40
400 0.30 40 0.30
The possible usage levels at which stock-outs can occur and the probability of stock-out
respectively are
a. 6000 units, 8000 units and 22.50 percent
b. 9000 units, 12000 units and 30.00 percent
c. 9000 units, 16000 units and 18 percent
d. 12000 units, 16000 units and 30.90 percent
e. 12000 units, 16000 units and 34.50 percent.
244. The following figures are projected by the production manager of Kajaria Iron:
Average Daily Usage
(Units)
Probability Lead Time
(in days)
Probability
300 0.25 6 0.30
500 0.50 8 0.40
700 0.25 10 0.30
What is the amount of normal consumption during the lead-time?
a. 3000 units.
b. 4000 units.
c. 5000 units.
d. 6000 units.
e. 7000 units.
624
245. The following information is applicable to Kaul Electronics Ltd.:
Annual sales of television =2500 units
Fixed cost per order =Rs.2000
Purchase price per unit =Rs.8000
Carrying cost =20 percent of the inventory value
What will be its economic order quantity for the television sets? (Round off your answer to
the nearest integer)
a. 59 units
b. 69 units
c. 79 units
d. 89 units
e. 99 units.
246. For J ackpot Ltd., the average usage per day is 30 units for the raw material J ack and the
lead-time is 15 days. If the stock out acceptance factor is 1.25, what will be the reorder point?
(Assume that the average quantity per order is 400 units and round off your answer to the
nearest integer)
a. 930 units
b. 980 units
c. 1030 units
d. 1080 units
e. 1130 units.
247. The following figures are projected by the production manager of Kajaria Iron:
Average Daily Usage (Units) Probability Lead Time (in days) Probability
300 0.25 6 0.30
500 0.50 8 0.40
700 0.25 10 0.30
The stock out cost is estimated to be Rs.10,000 per unit and the carrying cost is Rs.2000 per
unit for the period under consideration. What is the probability of stock out when no safety
stock is maintained?
a. 0.30.
b. 0.35.
c. 0.40.
d. 0.45.
e. 0.50.
248. The following figures are projected by the production manager of Kajaria Iron for one raw
material:
Average Daily Usage (Units) Probability Lead Time (in days) Probability
300 0.30 6 0.20
500 0.40 8 0.60
700 0.30 10 0.20
The average number of units per order is 200 while the stock out acceptance factor is 1.20. What
should be the reorder point for Kajaria Iron? (Round off your answer to the nearest integer)
a. 5013 units
b. 5033 units
c. 5053 units
d. 5073 units
e. 5093 units.
Part II
625
249. Mardia Automobiles Ltd. is trying to determine the optimal order quantity for a critical spare
part with the following particulars:
Annual usage =25,000 units, Price of each unit =Rs.60, Fixed cost per order =Rs.500,
Inventory carrying cost =20 percent.
Recently, a supplier of the company has offered a discount of Rs.5 per unit, provided the
quantity ordered in a single purchase should be at least 5000 units. What will be the net
incremental benefit of ordering 5000 units in comparison to the economic order quantity?
a. Rs.112,321 gain.
b. Rs.112,321 loss.
c. Rs.110,321 gain.
d. Rs.110,321 loss.
e. No change in position.
250. The following information regarding material VIP has been collected from the stores
register of Sunny Products Ltd.
Opening stock 100 units @ Rs.9 per unit
Purchases:
September 3 50 units @ Rs.12 per unit
September 15 150 units @ Rs.15 per unit
If 100 units was issued on September 25, then according to the weighted average method of
pricing, the value of the issue was
a. Rs.900
b. Rs.1,050
c. Rs.1,200
d. Rs.1,250
e. Rs.1,500.
251. If the daily usage rate ranges between 60 units and 110 units with an average value of
90 units/day and if the lead time varies between 45 days and 75 days with an average value of
50 days, the optimal safety stock in units should be
a. 3,750
b. 3,150
c. 1,800
d. 1,250
e. Cannot be calculated.
252. Average Daily Usage (Units) Probability Lead Time (No. of
days)
Probability
400 0.30 4 0.20
600 0.40 5 0.50
800 0.30 6 0.30
Normal consumption during lead time will be
a. 2000 units
b. 3060 units
c. 3100 units
d. 3600 units
e. 3840 units.
626
253. Annual output =100,000 units
Set-up cost for each production run =Rs.4000
Cost of producing per unit =Rs.100
Carrying cost =2%
The optimum production quantity is
a. 5,000 units
b. 10,000 units
c. 12,000 units
d. 20,000 units
e. 25,000 units.
254. If the annual demand is 10 lakh units, fixed cost per order is Rs.5,000 and cost of carrying per unit
per annumis Rs.25, then economic order quantity is
a. 10,000 units
b. 12,000 units
c. 15,000 units
d. 20,000 units
e. 25,000 units.
255. If the average daily usage of material is 1,000 units, lead time for procuring material is
10 days, the average number of units per order is 500 units and the stock out acceptance
factor considered is 1.2, the reorder level is:
a. 12,683 units
b. 10,000 units
c. 9,950 units
d. 8,750 units
e. 1,000 units.
256. If for a firm, the annual output is 40,000 units, and the set up cost for each production run is
Rs.10,000 with the cost of carrying inventory per annum being Rs.1,000, the optimum
production quantity per production run is:
a. 894 units
b. 1,000 units
c. 1,895 units
d. 2,000 units
e. 3,000 units.
257. If a firm expects a total demand for its product over the planning period to be 20,000 units,
while the ordering cost per unit is Rs.1,000 and carrying cost per unit is Rs.500, the EOQ of
the firm is:
a. 200 units
b. 283 units
c. 300 units
d. 383 units
e. 400 units.
Part II
627
258. What is the total cost of maintaining an inventory of 100 units if the carrying cost per unit is
Rs.3, the cost per order is Rs.14 and there are 5 orders per year?
a. Rs.150.
b. Rs.220.
c. Rs.300.
d. Rs.370.
e. Rs.400.
259. What is the average inventory level based on EOQ, for a firm that has annual sales of 2000
units, costs per order of Rs.48 and carrying cost of Rs.6 per unit?
a. 89 units.
b. 179 units.
c. 350 units.
d. 354 units.
e. 1000 units.
260. The existing sales of Intergraph solutions are Rs.18,60,000. The current customers are drawn
from companies having elevated or excellent credit rating. With partially liberalized credit
standards, the companys sales are likely to go up by Rs.5,70,000, the mix of new customers
being 54% and 42% from the groups rated fair and imperfect respectively. The average
collection period is likely to be 55 days and the incidence of bad debt losses 20% for the new
customers. The contribution to sales ratio for Intergraph Solutions is 25% and the cost of
funds is 20%. The additional contribution from increased sales and additional receivables are
_______ and _______ respectively.
a. Rs.1,56,787, Rs.55,709
b. Rs.2,78,960, Rs.48,567
c. Rs.2,70,833, Rs.67,708
d. Rs.1,42,500, Rs.87,083
e. Rs.1,89,000, Rs.51,987.
261. The additional investment in receivables and cost of financing the additional investment in
receivables are __________ and __________.
a. Rs.65,312.25, Rs.13,062.45
b. Rs.77,658.25, Rs.22,167.45
c. Rs.48,675.50, Rs.17,062.95
d. Rs.65,005.25, Rs.15,777.45
e. Rs.71,552.75, Rs.19,888.88.
262. The total additional cost and net additional benefit are _________and ________ respectively.
a. Rs.1,27,062.45, Rs.15,437.55
b. Rs.1,65,642.25, Rs.22,167.45
c. Rs.1,89,555.50, Rs.14,762.55
d. Rs.2,55,765.75, Rs.18,717.58
e. Rs.1,88,525.75, Rs.19,888.88.
628
263. The effect of relaxing the credit standards on profit is __________.
a. Rs.12,678
b. Rs.11,050.75
c. Rs.15,617.25
d. Rs.18,885.40
e. Rs.15,437.50.
Escarp Limited is contemplating to relax its collection effort deliberately with a view to increasing
its sales. Its existing sales are Rs.180 lakh, average collection period 30 days, bad debt losses 8%
of sales, contribution to sales ratio 25% and cost of funds 20%. After relaxing the collection effort
sales are expected to increase by 72 lakh. Average collection period increases to 55 days and bad
debt losses to 6 percent.
264. The increase in contribution due to increase in sales is __________.
a. Rs.15.5 lakh
b. Rs.11 lakh
c. Rs.12.5 lakh
d. Rs.18 lakh
e. Rs.16 lakh.
265. Increase in the investment in receivables on existing sales is __________.
a. Rs.15 lakh
b. Rs.11 lakh
c. Rs.9.375 lakh
d. Rs.18 lakh
e. Rs.16.5 lakh.
266. Cost of financing additional investments in receivables is __________.
a. Rs.3.525 lakh
b. Rs.3.95 lakh
c. Rs.5.55 lakh
d. Rs.4.85 lakh
e. Rs.5.95 lakh.
267. A net incremental benefit is __________.
a. Rs.13.75 lakh
b. Rs.18.12 lakh
c. Rs.16.71 lakh
d. Rs.15.41 lakh
e. Rs.19.70 lakh.
268. Mahindra Ltd.s current sales are Rs.65,00,000. The current collection period in 45 days. The
company is planning to introduce a cash discount policy of 3/10 net 45. As a result, the
company expects the average collection period to go down by 15 days and 75% of the
customers opt for the cash discount facility. The accounts receivable before and after cash
discount are __________ and __________.
a. Rs.6,72,900, Rs.4,56,785
b. Rs.8,12,500, Rs.5,41,667
c. Rs.6,82,550, Rs.5,96,445
d. Rs.7,12,750, Rs.6,54,555
e. Rs.7,72,500, Rs.5,56,785.
Part II
629
269. The decrease in accounts receivable investment is _________, if the companys required
return on investment in receivables is 25%, and the cost saved on this reduced investment is
__________.
a. Rs.1,56,787, Rs.55,709
b. Rs.2,78,960, Rs.48,567
c. Rs.2,70,833, Rs.67,708
d. Rs.1,42,500, Rs.87,083
e. Rs.1,89,000, Rs.51,987.
270. What is the cash discount should it introduce the new discount policy?
a. Rs.1,50,000, should be implemented.
b. Rs.92,000, should not be implemented.
c. Rs.1,66,000, should be implemented.
d. Rs.1,46,250, should not be implemented.
e. Rs.1,12,4000, should be implemented.
271. Fog Cutter Ltd., is offering credit to Derby Prince Ltd. The revenue from the sale is
Rs.2,00,000 and the cost is Rs.1,60,000. Assuming it to be a repeat order, if the probability of
non-payment in the second order is one-third of that of payment in the first order, calculate
the probability of non-payment in the first order. The expected profit from the deal is
Rs.2,000.
a. 0.9
b. 0.09
c. 0.1
d. 0.01
e. 0.45.
272. J ubilee Products Ltd., has annual sales of Rs.8,00,000 and the variable costs are Rs.6,00,000.
At present the company gives terms of net 15 days and its average collection period is 30
days. On the occasion of its silver jubilee celebrations, it plans to give terms of net 25 days
and anticipates its sales increase by 20%. However, this change results in the average
collection period, increased by another 30 days. The additional receivables associated with
new sales are __________.
a. Rs.44,000
b. Rs.26,667
c. Rs.40,000
d. Rs.19,567
e. Rs.22,399.
273. If the company does not want any change in its rate of return of 25% on investment in
receivables, the cost of additional investment is _______ , should it extend the credit period?
a. Rs.17,500, the company may go in for extending the credit period.
b. Rs.31,333, the company may go in for extending the credit period.
c. Rs.44,000, the company should not go in for extending the credit period.
d. Rs.66,600, the company should not go in for extending the credit period.
e. Rs.18,777, the company may go in for extending the credit period.
630
274. A firm is considering two credit policies X and Y. The collection period will be 3 months in
policy X and 4 months in policy Y. At present the firms sales are Rs.20,00,000 and they are
expected to increase by 20% and 25% under these 2 policies, and the bad debt losses will
stand at 4% and 6% respectively. At present the total costs for the firm are Rs.16,00,000 and
the firm wants to maintain the same profitability level. If the firms required return on
receivables is 18%, the incremental profitability of policy X is __________.
a. 50,000
b. 46,000
c. 36,700
d. 64,890
e. 49,600.
275. The incremental profitability of policy Y is __________.
a. 50,000
b. 46,000
c. 36,700
d. 64,890
e. 49,600.
Cosmopolitan India Ltd.s current sales are Rs.24,00,000. The company is planning to
introduce a cash discount policy of 2.5/10 net 35. As a result, the company expects the
average collection period go down by 15 days and 70% of the sales opt for the cash discount
facility. The profit is 20% and is maintained after the cash discount too.
276. The accounts receivable before cash discount is __________.
a. Rs.2,00,000
b. Rs.2,43,000
c. Rs.2,33,333
d. Rs.2,50,000
e. Rs.2,77,500.
277. The accounts receivable after cash discount is __________.
a. Rs.3,00,000
b. Rs.1,33,333
c. Rs.2,33,333
d. Rs.3,33,333
e. Rs.2,55,000.
278. The decrease in accounts receivable investment is __________.
a. 8,00,000
b. 3,33,333
c. 3,66,666
d. 2,77,000
e. 2,00,000.
279. If the companys required return on investment in receivables is 22%, cost saved on this
reduced investment is __________.
a. Rs.17,600
b. Rs.44,000
c. Rs.36,000
d. Rs.20,000
e. Rs.31,000.
Part II
631
280. What is the amount of loss incurred to the firm if all the 70% of customers avail the offer?
a. Rs.50,000.
b. Rs.52,000.
c. Rs.44,000.
d. Rs.42,000.
e. Rs.34,000.
281. Titanic Instruments Ltd.s present level of sales is Rs.45,00,000. The cost of capital for the
firm is 24% and the contribution is Rs.1, on a selling price of Rs.10. The present credit period
is 30 days and the firm plans to increase it to 40 days. As a result, the bad debt proportion on
the additional sales will be 6%. If Rs.10,00,000 additional sales are expected because of the
change in credit period, the new level of receivables associated with original sales is __________.
a. Rs.10,00,000
b. Rs.5,00,000
c. Rs.2,50,000
d. Rs.5,50,000
e. Rs.7,00,000.
282. The old level of receivables with original sales is __________.
a. Rs.3,75,000
b. Rs.2,00,000
c. Rs.5,25,000
d. Rs.6,00,000
e. Rs.2,70,000.
283. What is the effect on the gross profit of the firm?
a. Gross profit will increase by Rs.15,600 as a result of implementation of new credit
policy.
b. Gross profit will decrease by Rs.10,000 as a result of implementation of new credit
policy.
c. Gross profit will decrease by Rs.14,000 as a result of implementation of new credit
policy.
d. Gross profit will decrease by Rs.14,000 as a result of implementation of new credit
policy.
e. Gross profit will decrease by Rs.14,000 as a result of implementation of new credit
policy.
284. Debtlow Company is considering changing its credit policy from net 30 to 2/10 net 45. Its
current sales are Rs.8,00,000 and variable cost to sales ratio is 0.6. Administrative and
collection costs are Rs.60,000 and Rs.40,000 respectively. Its present bad debts to sales ratio
is 0.01. With the change in credit terms it expects an increase in sales and operating costs by
Rs.4,00,000 and Rs.20,000 respectively. The new bad debts to sales ratio would be 0.03.
Assume 40% of the customers avail the discount and the remaining pay by 60 days
amounting to an average collection period of 40 days. Also, assume the cost of financing
receivables is 14%. What is the change in profits because of the change in credit terms?
a. Rs.0.956 lakh.
b. Rs.10.956 lakh.
c. Rs.9.56 lakh.
d. Rs.0.956 lakh.
e. Rs.10.956 lakh.
632
Fine Chemicals is dealing in Caustic soda and their customers are spread throughout the
country. The company currently provides a credit period of 30 days to its customers. 25% of
the customers pay on the 15th day while 50% of the customer pays on the 30th day. The
balance of customers pays on the 85th day.
For the year ended March 31, 1999 the company recorded sales of Rs.10 crore out of which
the credit sales are 80%. Its variable cost to sales ratio is 80%. The company financed its
receivables using bank finance at an interest rate of 18% p.a. and with a margin
requirement of 40%.
Mr. Raja Ram, the marketing manager of the company, proposed to change the credit terms
from net 30 to 1/10 net 45. He expects that this change would improve the credit sales by
Rs.2 crore and also change the payment pattern of the customers.
If this credit policy is introduced, as per his market survey, 75% of customers pay on the 10th
day, 10% of the customers will pay on the 45th day and the balance 15% of the customers
will pay on the 120th day. He considers that these 15% customers are also long standing
customers and hence need not be discouraged. The bank will provide finance as per the
existing terms for the additional credit sales also.
Out of the additional sales of Rs.2 crore, however there is a risk of bad debts to the extent of 5%.
The cost of capital of the company is 16% and the tax rate applicable to it is 35%.
285. What is the total cost of bank finance and own funds?
a. Rs.0.0755 crore.
b. Rs.0.0155 crore.
c. Rs.0.155 crore.
d. Rs.0.755 crore.
e. Rs.0.1455 crore.
286. You are required to suggest whether the change in credit terms is advisable.
a. As the profit decreases by Rs.0.2405 crore, changing the credit policy is not advisable.
b. As the profit increases by Rs.4.2405 crore, changing the credit policy is advisable.
c. As the profit increases by Rs.0.2405 crore, changing the credit policy is advisable.
d. As the profit increases by Rs.2.405 crore, changing the credit policy is advisable.
e. As the profit decreases by Rs.0.2405 crore, changing the credit policy not advisable.
Mr. Saurav Basu, finance director of Shaw Bearings Co., is evaluating the present credit
policy of his company. Under the present policy, the company is offering 3% discount for
payment within 10 days. The analysis of accounts receivable shows an average collection
period of 30 days. Mr. Basu is of the opinion that the discount should be discontinued as it is
affecting the Profitability of the company in the present scenario of rising manufacturing
costs. It is estimated that if the discount is discontinued the average collection period would
increase to 35 days. Presently 30% of the total customers are availing discount and if the
discount is withdrawn, these customers can also be expected to pay along with the other
customers. The marketing manager informed him that as a result, sales might drop from
210,000 to 200,000 units per year. The selling price per unit is Rs.45. The average cost per
unit is Rs.40 and variable cost to sales ratio is 75%. The required rate of return on the companys
investments is 20%.
287. The loss of contribution due to increase in sales is __________.
a. Rs.1,22,500
b. Rs.1,05,250
c. Rs.1,12,500
d. Rs.1,00,000
e. Rs.1,50,500.
Part II
633
288. Increase in investment in receivables is __________.
a. Rs.1,12,500
b. Rs.1,21,250
c. Rs.1,20,450
d. Rs.1,31,250
e. Rs.2,00,300.
289. Savings in receivable investment due to decrease in sales and cost of financing the increased
investment in receivables are ________ and ________ respectively.
a. Rs.23,665.1, Rs.20,221.7
b. Rs.32,812.5, Rs.19,687.5
c. Rs.34,888.2, Rs.18,215.5
d. Rs.20,345, Rs.16,789.2
e. Rs.56,643.8, Rs.22.5671.
290. Which of the following statement is true?
a. As the change in profit is negative, Mr. Basu should not go for withdrawing discount.
b. As the change in profit is negative, Mr. Basu should not go for withdrawing discount.
c. As the change in profit is positive, Mr. Basu should go for withdrawing discount.
d. As the change in profit is negative, Mr. Basu should not go for withdrawing discount.
e. As there is no change in profit, Mr. Basu should go for withdrawing discount.
291. Ganesh Traders Ltd., currently sells on terms of net 30 days. All the sales are on credit basis
and average collection period is 35 days. Currently, it sells 500,000 units at an average price
of Rs.50 per unit. The variable cost to sales ratio is 75% and bad debts to sales ratio is 3%. In
order to expand sales, the management of the company is considering to change the credit
terms from net 30 to 2/10, net 30. Due to the change in policy, sales are expected to go up by
10%, bad debt loss on additional sales will be 5% and bad debt loss on existing sales will
remain unchanged at 3%. 40% of the customers are expected to avail the discount and pay on
the tenth day. The average collection period for the new policy is expected to be 34 days. The
company requires a return of 20% on its investment in receivables. The impact of the change
in credit policy on the profit of the company is __________. Ignore taxes.
a. Rs.2.585 lakh
b. Rs.3.7445 lakh
c. Rs.2.155 lakh
d. Rs.4.883 lakh
e. Rs.3.508 lakh.
292. In order to reach the sales target quickly, the sales manager of Deccan Gold contemplating to
take a liberal credit standard by offering discount of 5 percent on the selling price to those
who are buying against cash. He is also considering to reduce the collection effort at the same
time. As a result, the sales volume is expected to go up by 40 percent from the present level
of Rs.250 lakh but the average collection period will be lengthened from 36 days to 45 days.
While the amount of bad debt losses will increase from 2 percent to 4 percent of the total
sales value. The contribution margin is 25 percent, the cost of funds is 12 percent and
20 percent of the customers are expected to make cash purchase under the new scheme. The
incremental benefit will be (Assume 360 days in a year)
a. Rs. 17.875 lakh
b. Rs.14.375 lakh
c. Rs.12.50 lakh
d. Rs.10.625 lakh
e. Rs.8.75 lakh.
634
293. If the terms of credit are 1/10 net 40, what will be the implicit cost of trade credit? (Assume
360 days in a year)
a. 11.11 percent
b. 12.12 percent
c. 13.13 percent
d. 14.14 percent
e. 15.15 percent.
294. Prudential Suppliers Ltd. (an FMCG company) targets to limit its average collection period to
30 days. For the financial year 2004, it targets a sales turnover of Rs.720 lakh. What should
be the maximum amount of average receivables? (Assume that one year is equal to 360 days
and all sales are on credit basis)
a. Rs.20 lakh
b. Rs.40 lakh
c. Rs.60 lakh
d. Rs.80 lakh
e. Rs.100 lakh.
295. Shaw Oil Company presently sells 300,000 liters of its product Shawmin in a year at a
price of Rs.100 per liter. The variable cost is Rs.80 per liter. The company presently sells at
credit terms of net 30 and its average collection period is 40 days. Bad debt losses amount
to 1 percent of sales and the cost of funds invested in the receivables is 12 percent. The
Director of the company feels that the company should expand its sales volume by increasing
the credit period to 40 days. As a result of increasing the credit period, the sales volume is
expected to increase by 20 percent. The average collection period for the company may
increase to 50 days while bad debt losses on the new sales will be 5 percent (the percentage
of bad debt losses on the existing sales will be unchanged). What will be overall impact on
the profit of the company due to the change in credit period? (Ignore taxes and assume
360 days in a year)
a. Rs.620,000 (increase in profit)
b. Rs.720,000 (increase in profit)
c. Rs.820,000 (increase in profit)
d. Rs.720,000 (decrease in profit)
e. Rs.620,000 (decrease in profit).
296. Hicare Pharma Ltd., is planning to relax its receivable collection efforts that may be expected
to propel a pickup in sales. Its current monthly sales is Rs.25 lakh at a contribution margin of
20 percent and the average collection period is 30 days. Presently, the amount of bad debts is
on an average 1 percent of sales. With the relaxation of the collection efforts, the sales value
is expected to increase by 20 percent but the average collection period would go up to
45 days and the bad debts may rise to 2.5 percent of total sales. What would be the change in
profits of the company owing to the relaxation in the collection efforts? (Assume cost of
capital =14 percent, one year =360 days and ignore taxes)
a. Increase by 3.11 lakh
b. Increase by 3.41 lakh
c. Increase by 3.71 lakh
d. Decrease by 3.11 lakh
e. Decrease by 3.41 lakh.
Part II
635
297. The sales turnover of Manish Textiles is Rs.60 lakh. The variable cost is 75 percent of sales
revenue. The company does not offer any cash discount for early repayment. The credit
period offered by the company is 30 days and the average collection period is 34 days. The
amount of bad debts is 1.5 percent of sales value. The sales manager of the company is
planning to increase the sales turnover by changing the existing credit policy by offering a
cash discount at the terms of 2/10 net 30. If it is implemented, the sales volume is expected
go up by 10 percent and 30 percent of the total sales will be on cash discount, thereby
reducing the average collection period by 6 days. It may be assumed that there will be no bad
debt on new sales while the bad debt percentage on the existing sales will remain unchanged.
If the cost of funds is 10 percent, what will be the impact of the new credit policy on the
profits of the company? (Assume one year is equal to 360 days and ignore taxes)
a. Rs.112, 500 increase in profit
b. Rs.113,600 increase in profit
c. Rs.114,700 decrease in profit
d. Rs.115,800 increase in profit
e. Rs.116,900 increase in profit.
298. Sabra Machineries Ltd. (SML) purchases components from Monark Engineers Ltd. (MEL)
on terms of 1/10, net 45. SML requested MEL to increase the cash discounts to 2 percent
without changing the discount period. MEL wants to modify the terms in such a way that
after obtaining the requested discount rate of 2 percent, SML faces at least three times the
cost of not paying within the discount period as before. Which of the following alternatives
represents the correct course of action for MEL?
a. Decrease the credit period by 12 days.
b. Decrease the credit period by 10 days.
c. Increase the discount period by 11 days.
d. Decrease the discount period by 5 days.
e. Increase the credit period by 13 days.
299. The terms of a credit purchase transaction is 2/10, net 40, the implicit cost of trade credit is
(assume one year is equal to 360 days)
a. 36.70 percent
b. 24.50 percent
c. 20.99 percent
d. 18.18 percent
e. 14.69 percent.
300. Amit Enterprises Ltd. (AEL) has placed two orders to Tapti Machineries Ltd. (TML) in order
to purchase lathe machines from them. Each machine is sold at a price of Rs.500,000 at a
profit margin of 20 percent. It is estimated that the probability of default is 10 percent for the
first order and 5 percent for the second order. What is the expected profit to TML from
granting the second credit to AEL, assuming the payment for the first order has been paid?
a. Rs.95,000.
b. Rs.90,000.
c. Rs.85,000.
d. Rs.75,000.
e. Rs.67,500.
636
301. Consider the following figures:
Opening balance of book debts Rs.1,00,000
Ending balance of book debts Rs.1,50,000
Annual Sales Rs.45,00,000
The average collection period, considering 360 days year is:
a. 15 days
b. 12 days
c. 10 days
d. 18 days
e. 6 days.
302. What is the benefit for a firm with daily sales of Rs.15,000 speeds up collections by 2 days,
assuming an 8% p.a. of cost of funds?
a. Rs.2,400 daily benefit.
b. Rs.2,400 annual benefit.
c. Rs.15,000 annual benefit.
d. Rs.30,000 annual benefit.
e. Rs.50,000 annual benefit.
303. What is the sales volume in the current month if beginning accounts receivables at Rs.1,000
is lower by Rs.500 than ending and Rs.10,000 was collected?
a. Rs.9,500.
b. Rs.10,500.
c. Rs.11,000.
d. Rs.12,500.
e. Rs.14,000.
304. Given the following information calculate the expected profit of granting credit to a customer
Profit arising out of the order if the customer pays Rs.20,000
Cost of the order Rs.50,000
Probability that the customer will pay 0.80
a. Rs.4,000
b. Rs.5,000
c. Rs.6,000
d. Rs.7,000
e. Rs.8,000.
305. Dowell Financial Services is considering offering credit to Mr.Vyas. The probability that he
pays is 0.85. If the cost of sales is 0.8 of sales, the net profit or loss to the firm if it offers
credit is
a. Loss of 5% of sales
b. Profit of 5% of sales
c. No profit no loss
d. Loss of 20% on sales
e. Profit of 17% on sales.
Part II
637
306. If the revenues and cost of sale are Rs.50,000 and Rs.40,000 and the probability that a
customer would pay is 75%, the expected profit/loss from extending credit to the customer is
a. Gain of Rs.7,500
b. Gain of Rs.2,500
c. No profit and no loss
d. Loss of Rs.2,500
e. Loss of Rs.7,500.
Cash Management
307. ECIT Ltd., a household name for the manufacture of electrical appliances, has 18 area offices
in major cities in India. The company has an agreement with a multinational bank, whereby
the bank branches will collect money from the companys area offices and send it by
Telegraphic Transfer (TT) to the companys main branch account in Delhi. It takes, on an
average, ten days for the main account to be credited this way. A local bank, which has a fast
collection system, offers its services, which take only two days for the accounts to be
credited. For this, the company has to maintain a minimum of Rs.50,00,000 in the main
branch account. The firms total collections per day are Rs.9,00,000 and its opportunity cost
of funds is 14%. If the multinational bank does not charge any fee, should the firm accept the
local banks scheme? Why?
a. Since the amount paid as interest is more than what the company could save, firm
should accept the scheme of local bank.
b. Since the amount lost as interest is more than what the company could save firm should
not accept the scheme of local bank.
c. Since the amount paid as interest is less than what the company could save firm should
accept the scheme of local bank.
d. Since the amount paid as interest is less than what the company could save firm should
not accept the scheme of local bank.
308. If instead of Rs.50,00,000 minimumbalance, if the local bank asks for an annual fee of
Rs.60,000, should the firmaccept it?
a. Since the amount paid as banks annual fee is more than what the company could save,
firm should accept the proposal.
b. Since the amount paid as banks annual fee is more than what the company could save
firm should not accept the proposal.
c. Since the amount paid as banks annual fee is less than what the company could save
firm should accept the proposal.
d. Since the amount paid as banks annual fee is less than what the company could save
firm should not accept the proposal.
309. During the four busiest days in the month of March, the firms cash outflows were Rs.20,000,
Rs.30,000, Rs.40,000, and Rs.50,000. The Finance Manager desires sufficient cash to cover
payments for 4 days during the peak periods. The safety level is Rs. __________.
a. 1,10,000
b. 1,40,000
c. 1,20,000
d. 1,00,000
e. 85,000.
638
310. Deccan Enterprises Ltd., started the business on 1.1.2003 with a capital of Rs.50,000. The
estimated sales and purchases for the next 6 months are as follows:
Particulars J anuary February March April May J une
Purchases 24,000 50,000 58,000 58,000 62,000 58,000
Sales - 42,000 70,000 68,000 68,000 80,000
50% of purchases are paid for in the same month. The balance is paid during the next month.
Of the sales, 40% is on cash basis. The balance is realized in the next month. Expenses of
manufacture come to Rs.10,000 every month. It purchased a machine for Rs.12,000 during
February, payment for which is made during the same month. Closing balance for the month
of February is _______.
a. () Rs. 14,200
b. () Rs.16,800
c. Rs.14,200
d. Rs.18,900
e. Rs.22,000.
311. The closing balance for the month of April is __________.
a. Rs.42,000
b. Rs.68,000
c. () Rs.28,000
d. () Rs.23,800
e. Rs.16,000.
312. The closing balance for the month of J une is __________.
a. () Rs.23,000
b. () Rs.40,000
c. () Rs.58,000
d. Rs.23,000
e. Rs.54,000.
Sherton Ltd., has total revenue of Rs.25 lakh a year, of which 60% are credit sales. The
collections occur at an even rate and the total working days of the firm in the year are 300.
The Accounts department ties up 5 days worth of remittance checks.
313. The credit sale per day is __________.
a. Rs.600
b. Rs.6,000
c. Rs.5,000
d. Rs.2,000
e. Rs.2,500.
314. If the internal delays are arrested, this could be reduced by two days. If the release funds
could earn a rate of 6% p.a. What are the annual savings for the firm?
a. Rs.600.
b. Rs.6,000.
c. Rs.5,000.
d. Rs.2,000.
e. Rs.2,500.
Part II
639
315. Indiana Ltd. has an excess cash of Rs.50 lakh, which can be invested in short-term
marketable securities. For these transactions, the firm incurs an expenditure of Rs.1,00,000. If
the securities invested have an annual yield of 12%, the minimum period for the firm to
break-even its investment expenditure is __________.
a. 99 days
b. 110 days
c. 117 days
d. 60 days
e. 75 days.
316. Bombay Bulbs Ltd., a household name for the manufacture of electrical appliances, has 16
area offices in major cities in India. The company has an agreement with a nationalized bank,
whereby the bank branches will collect money from the companys area offices and send it
by Telegraphic Transfer (TT) to the companys main branch account in Mumbai. It takes, on
an average, five days for the main account to be credited this way. A private bank, which has
a fast collection system, offers its services, which take only one day for the accounts to be
credited. For this, the company has to maintain a minimum of Rs.10,00,000 in the main
branch account. The firms total collections per day are Rs.6,00,000 and its opportunity cost
of funds is 10%. If the nationalized bank does not charge any fee, should the firm accept the
private banks scheme?
a. Since the amount paid as interest is more than what the company could save, firm
should accept the scheme of private bank.
b. Since the amount lost as interest is more than what the company could save firm should
not accept the scheme of private bank.
c. Since the amount paid as interest is less than what the company could save firm should
accept the scheme of private bank.
d. Since the amount paid as interest is less than what the company could save firm should
not accept the scheme of private bank.
317. If instead of Rs.10,00,000 minimum balance if the private bank asks for an annual fee of
Rs.40,000, should the firm accept it?
a. Since the amount paid as annual fee is more than what the company could save, firm
should accept the proposal.
b. Since the amount paid as annual fee is more than what the company could save Firm
should not accept the proposal.
c. Since the amount paid as annual fee is less than what the company could save firm
should accept the proposal.
d. Since the amount paid as annual fee is less than what the company could save firm
should not accept the proposal.
318. A company has a total revenue of Rs.600 lakh a year, of which 80% are credit sales. The
collections occur at an even rate and the total working days of the firm in the year are 300.
The Accounts department ties up 4 days worth of remittance checks. The credit sales per day
is __________.
a. Rs.3,00,000
b. Rs.2,00,000
c. Rs.1,60,000
d. Rs.1,50,000
e. Rs.2,40,000.
640
319. If the internal delays are arrested, this could be reduced by two days. If the release funds
could earn a rate of 9% p.a., what are the annual savings for the firm?
a. Rs. 20,400.
b. Rs. 28,800.
c. Rs. 32,000.
d. Rs. 56,000.
e. Rs. 37,500.
320. Western Cosmetics Ltd., has an excess cash of Rs.20,00,000 which can be invested in
short-term marketable securities. For these transactions the firm incurs an expenditure of
Rs.50,000. If the securities invested have an annual yield of 8%, the income for 15 days and one
month are _________ and _________.
a. Rs.6,667, Rs.13,333
b. Rs.5,555, Rs.12,222
c. Rs.4,044, Rs.10,700
d. Rs.7,500, Rs.11,115
e. Rs.4,070, Rs.14,333.
321. The income for two months and 4 months are _________ and __________.
a. Rs.18,354, Rs.44,440
b. Rs.26,666, Rs.53,333
c. Rs.12,777, Rs.32,222
d. Rs.17,988, Rs.56,677
e. Rs.25,000, Rs.55,000.
322. The income for 6 months and one year are __________ and __________.
a. Rs.80,000, Rs.1,60,000
b. Rs.40,000, Rs.80,000
c. Rs.60,000, Rs.1,20,000
d. Rs.50,000, Rs.1,00,000
e. Rs.1,00,000, Rs.2,00,000.
323. Which of the following periods can be chosen for investment i.e., in 15 days, one month, two
months, 4 months, 6 months and one year?
a. Firm may invest for 15 days, 4 or 6 months.
b. Firm may invest for 4, 6 or 12 months.
c. Firm may invest for 2, 6 or 12 months.
d. Firm may invest for 2, 4 or 6 months.
e. Firm may invest for 6 or 12 months.
324. The minimum period for the firm to break-even its investment expenditure is __________.
a. 132.5 days
b. 116.8 days
c. 149.5 days
d. 112.5 days
e. 100 days.
Part II
641
A company has provided the following information:
(Rs. in lakh)
Month Sales Material
purchases
Salaries and
wages
Production
overheads
Office and
selling
overheads
J anuary 72,000 25,000 10,000 6,000 5,500
February 97,000 31,000 12,100 6,300 6,700
March 86,000 25,500 10,600 6,000 7,500
April 88,600 30,600 25,000 6,500 8,900
May 102,500 37,000 22,000 8,000 11,000
J une 108,700 38,800 23,000 8,200 11,500
The opening cash balance for the year may be taken as Rs.72,500 lakh. 50 percent of sales
can be assumed as credit sales. Assets are to be acquired in the month of February and April.
Therefore provisions are to be made for the payment of Rs.8,000 and Rs.25,000 respectively
for the same. An application has been made to a bank for the grant of a loan of Rs.30,000 and
it is expected that the loan amount will be received in the month of May. There is a dividend
payment liability of Rs.35,000 in the month of J une. The debtors are allowed one-month
credit. The creditors for material purchases and overheads can be paid after one month from
the date of purchase/incurring the expenditure. A commission of 3% of sales is paid to the
sales men on a monthly basis.
325. The closing balance for the month of March is __________ in the cash budget based on the
above information.
a. Rs.1,55,650
b. Rs.96,700
c. Rs.1,14,560
d. Rs.1,08,500
e. Rs.1,34,450.
326. The closing balance for the month of J une is __________.
a. Rs.2,05,000
b. Rs.1,76,900
c. Rs.1,94,106
d. Rs.2,77.484
e. Rs.1,55,000.
Hindustan Tools Ltd. manufactures a single tool, which is sold for Rs.75 per unit. The cost
data for the company is as follows:
a. Variable manufacturing costs are Rs.35 per unit.
b. Variable selling expenses are Rs.5 per unit.
c. Fixed manufacturing costs requiring cash are Rs.250,000 per month. Fixed expenses
are Rs.200,000 per month, all requiring cash. Depreciation is Rs.60,000 per month.
d. The firm maintains a two-month supply of finished products. The opening inventory
(J anuary 1) is 42,000 units.
e. The firm does not hold raw material inventory and purchases raw materials as needed.
The cost of raw material is included in the variable manufacturing cost.
f. The firm makes all sales on credit and collects 30% in the month of sale and the balance
in the following month. There are no bad debts and overdue accounts. The beginning
debtors balance is Rs.700,000.
g. The firm pays all manufacturing costs in the month incurred.
642
h. The firm pays 80% of the selling expenses in the month of sale and the balance in the
following month. On J anuary 1, the firm owed Rs.30,000 for expenses incurred in last
December.
i. The minimum desired cash balance is Rs.80,000, which is also the amount the firm has
on 1st J anuary. Borrowings are possible and can be made in multiples of Rs.10,000. It
must borrow at the beginning of the month and repay at the end if sufficient cash is
available. The interest rate is 10% and the firm pays interest when it repays loans or a
portion thereof.
j. The sales budget for the first six months is:
(Units) (Units)
J anuary 20,000 April 32,000
February 26,000 May 30,000
March 30,000 J une 28,000
k. The desired levels of closing inventory at the end of J anuary, February and March are as
follows:
(Units)
J anuary 56,000
February 62,000
March 62,000
327. The closing balance for the month of March in cash budget is __________.
a. Rs.97,500
b. Rs.84,500
c. Rs.67,300
d. Rs.81,000
e. Rs.85,000.
328. The total cost of production for the month of J anuary is __________.
a. Rs.14,40,000
b. Rs.15,50,000
c. Rs.22,65,000
d. Rs.18,74,890
e. Rs.11,00,000.
329. The total cost of production for the month of February is __________.
a. Rs.18,90,000
b. Rs.27,89,700
c. Rs.16,45,000
d. Rs.13,70,000
e. Rs.12,00,000.
330. The total cost of production for the month of March is __________.
a. Rs.12,00,000
b. Rs.13,00,000
c. Rs.14,00,000
d. Rs.15,00,000
e. Rs.16,00,000.
Part II
643
331. Avanti Paperboard Ltd., issues cheques worth Rs.15,000 and also receives cheques worth
Rs.28,000 daily. Normally the cheque issued by the company takes 6 days to be cleared while
the bank takes about 3 days for the cheques deposited by the company to be realized. Assume
that the opening credit balance of the company with the bank is Rs.20,000. The day, which
the steady state condition will be reached, is __________.
a. 7
b. 5
c. 2
d. 8
e. 9.
332. The net float is __________.
a. Rs.6,000
b. ()Rs.6,000
c. Rs.7,000
d. Rs.8,000
e. ()Rs.8,000.
333. The following are the sales forecast for Pretty Toy Ltd. for the next three months:
Month Expected sales
J anuary Rs.20,00,000
February Rs.16,00,000
March Rs.10,00,000
The following additional information is provided:
Thirty percent of the companys sales are for cash and the remaining are collected in the
month following the sale.
Cost of sales amount to 75 percent of sales. Out of which 40 percent are raw material
costs and 60 percent are direct labor costs.
Direct labor costs are paid in the month incurred.
Raw materials are paid in the month following the purchase.
Total of other operating expenses amount to Rs.3,00,000 per month.
A capital expenditure of Rs.1,50,000 has been planned in February.
Tax payments of Rs.1,80,000 are to be made in March.
The company maintains a cash balance equal to 10 percent of the previous months cost
of sales. The surplus cash is invested in bank deposits based on the future requirements.
Sales in the month of December were Rs.21,00,000.
The desired closing balance and the investment for the month of March from the cash budget
are __________ and __________.
a. 65,000 and 45,000
b. 1,20,000 and 1,45,000
c. 67,000 and 87,000
d. 75,000 and 55,000
e. 1,00,000 and 1,20,000.
644
334. Gamma International had bank balance of Rs.100,000 on 1st J anuary, 2004 according to both
the companys account and bank pass book. From that day, it issues daily cheques for
Rs.25,000 that are cleared on the 3rd working day and deposits daily cheques of Rs.18,000
which are realized on the 2nd working day. The amount of net float on 3rd J anuary is
a. Rs.42,000
b. Rs.38,000
c. Rs.32,000
d. Rs.42,000
e. Rs.32,000.
335. Miraj Engineering Co., has planned its sales during Oct-Dec 2003 as follows:
Month October November December
Sales (Rs.) 500,000 600,000 650,000
The products are sold on credit where 50 percent is realized in the month of sale whereas the
rest portion is recovered by the next month. The purchases (amounting to 50% of the months
sales) are paid in the following month of purchase. Wages and administrative expenses per
month amount to Rs.150,000 and Rs.80,000 respectively and are paid in the following month
in which they are incurred. Depreciation and amortization of preliminary expenses amount to
Rs.80,000 and Rs.50,000 respectively. On October 1, a testing equipment worth of Rs.20,000
has been procured with a credit period of 45 days while on December 31, a fixed deposit will
mature (maturity value Rs.150,000). If the closing cash balance at the end of October is
Rs.100,000, the closing cash balance by the end of the month of November is
a. Rs.300,000
b. Rs.220,000
c. Rs.210,000
d. Rs.150,000
e. Rs.20,000.
336. During the four busiest days in a month, the finance manager estimates the cash outflows to
be Rs.10,000, Rs.19,000, Rs.35,000 and Rs.25,000. The safety level is:
a. Rs.22,250
b. Rs.28,000
c. Rs.35,000
d. Rs.25,000
e. Rs.19,000.
337. If the contribution to sales ratio is 0.2 and there is an increase of sales to the tune of
Rs.1,00,000, then the profit generated by increase in sales is:
a. Rs.5,00,000
b. Rs.4,00,000
c. Rs.40,000
d. Rs.20,000
e. Rs.10,000.
338. ABC Corporation shows a ledger balance of Rs.50,000 prior to writing a cheque for Rs.2,000
and depositing Rs.750 in cheques. What is the amount of net float?
a. Rs.750.
b. Rs.1,250.
c. Rs.2,000.
d. Rs.2,750.
e. Rs.51,250.
Part II
645
Reliance Ltd., is considering 4 projects A, B, C and D with the following characteristics:
Rs. in lakh
Projects Initial Investment (Year 0) Annual net cash flow (Years 1 to 5)
A 18 6.5
B 5 2.0
C 6.5 3.5
D 9 4.5
339. The funds available for investment are limited to Rs.21 lakh and the cost of funds to the firm
is 17%. Rank the projects in terms of the NPV respectively.
a. III, IV, II, I
b. I, II, III, IV
c. I, IV, II, III
d. IV, II, III, I
e. II, III, IV, I.
340. Rank the projects according to BCR criteria respectively.
a. IV, III, I, II
b. II, I, III, IV
c. I, II, III, IV
d. III, II, I, IV
e. II, III, IV, I.
341. Which projects will you recommend based on NPV and BCR criteria, given the limited
supply of funds?
a. Project A only
b. Project B and C
c. Project B, C or D
d. Project A, B and C
e. Project D only.
A pharmaceutical company has the following pattern of cash flows:
Year Cash flow (Rs. in lakh)
0 13
1 6
2 7.2
3 2.25
342. The average annual net cash flow is __________
a. 5.75
b. 6.22
c. 8.91
d. 5.15
e. 7.70.
646
343. The IRR of this project is __________.
a. 12%
b. 11%
c. 10%
d. 15%
e. 14%.
344. A company gets 50,000 bolts annually from one of its suppliers at a cost of Rs.5 per bolt.
The materials manager of the firm says if the firm itself starts producing the bolts, it incurs a
cost of Rs.4.00 per bolt (depreciation not being accounted for). The machinery costs
Rs.40,000 and needs to be depreciated at the rate of 25% per annum on WDV basis. The
machines expected life period is 3 years. If the firms tax rate is 55% and its cost of capital is
14%, should the firm adopt materials managers proposal? Assumption: Scrap value of the
machine is nil at the end of 3 years.)
a. Since NPV is Rs.22,310 the proposal should not be accepted.
b. Since NPV is Rs.17,540 the proposal should be accepted.
c. Since NPV is Rs.28,310 the proposal should be accepted.
d. Since NPV is Rs.17,540 the proposal should be accepted.
e. Since NPV is Rs.32,098 the proposal should be accepted.
The following information is available regarding a project being under consideration by Ram
Industries Ltd.
Initial Outlay =Rs. 65 lakh
Operating costs and cash flows:
Year Operating costs (In Rs. lakh) Operating cash flows (in Rs. lakh)
1 3.05 7.5
2 2.06 11.8
3 3.09 12.5
345. Cost of capital is 18 percent. The present value of costs is __________.
a. Rs.66.535 lakh
b. Rs.70.945 lakh
c. Rs.54.567 lakh
d. Rs.81.900 lakh
e. Rs.50.540 lakh.
346. The annual capital charge is __________.
a. Rs.66.53 lakh
b. Rs.54.12 lakh
c. Rs.32.631 lakh
d. Rs.41.67 lakh
e. Rs.55.67 lakh.
Part II
647
A government owned research organization needs sophisticated equipment for its research
purposes. Three companies came forward to supply the machine whose quotations are as
given below.
Company A: Initial cost is Rs.62,000 and annual maintenance cost is Rs.4,000 in the first
year and increases by Rs.1,000 every year for the next 5 years. At the end of sixth year the
machine can be sold for Rs.12,000.
Company B: The maintenance cost is Rs.3,000 per year. But in the 4th year additional
Rs.9,000 should be spent for overhauling. Its scrap value at the end of 6th year is Rs.15,000
and it costs Rs.75,000.
Company C: The machine costs Rs.48,000 but its life period is only 3 years with an annual
maintenance cost of Rs.2,500. At the end of year 3, the company replaces the old machine
with a new machine for Rs.24,000. The new machine will last for another 3 years with an
annual maintenance cost of Rs.1,000 and a salvage value of Rs.14,000.
Since it is a research organization it does not pay taxes but its cost of funds is 10%.
347. The annual capital charge associated with Company A is __________.
a. 22.1
b. 18.91
c. 11.90
d. 16.87
e. 25.08.
348. The annual capital charge associated with Company B is __________.
a. 19.69
b. 22.77
c. 20.86
d. 15.56
e. 18.55.
349. The annual capital charge associated with Company C is __________.
a. 18.45
b. 18,91
c. 15.20
d. 11.32
e. 17.56.
350. Which option the organization should go for?
a. Company A.
b. Company B.
c. Company C.
d. Both (a) and (b).
e. Both (b) and (c).
648
351. Anish Shroff wishes to purchase a motor cycle costing Rs.40,000. The dealer has an
installment scheme, under which Rs.1,000 should be paid every month for four years. The
dealer also claims that the interest rate in his scheme is only 5% per annum. He supports his
argument this way:
Rs.40,000 +Rs.40,000 x 4 x
5
100
=Rs.48,000.
The cost of capital or the opportunity cost of funds for the buyer is 8% p.a. Since the interest
rate is lower than this rate, Anish is thinking of buying the vehicle by installments. Is his
decision correct?
Note: Here the cost of capital for the buyer means the interest rate he gets if he deposits the
money in a bank.
a. Since implied interest rate is less than his cost of capital, the decision of the buyer is
wrong and he should not go for the installment scheme.
b. Since implied interest rate is less than his cost of capital, the decision of the buyer is
correct and he should go for the installment scheme.
c. Since implied interest rate is more than his cost of capital, the decision of the buyer is
correct and he should go for the installment scheme.
d. Since implied interest rate is more than his cost of capital, the decision of the buyer is
wrong and he should not go for the installment scheme.
e. Data provided is insufficient.
Pioneer India Ltd. is contemplating to implement Business Process Re-engineering (BPR) in
all its divisions and plants. Also, it plans to install SAP system in the company. For this the
company expects its cash revenues to increase annually at the rate of 18% p.a. for the first 5
years, then by 15% for next 6 years, after which they stabilize and maintain the same level.
For these changes the company is required to spend Rs.6 lakh now, and Rs.1 lakh annually
and its time horizon is 15 years. If its present cash inflow is Rs.1,00,000 and the cost of
capital for the company is 20%.
352. The total profit net cash inflow is __________.
a. 6,68,923
b. 5,54,500
c. 4,47,800
d. 6,50,000
e. 3,88,999.
353. The NPV is __________, if the whole system is implemented.
a. 68,923
b. 54,500
c. 47,800
d. 50,000
e. 88,999.

Part II
649
Captain Xavier has recently retired from merchant navy. He received Rs.12,00,000 as
terminal benefits. He has two options:
I. Deposit the terminal benefits in a bank and accept the job offered that gets him (a net
revenue of) Rs.75,000 per year. The contract is for 10 years.
II. Start shipping business in inland waters. It requires purchasing of 3 ships, which
collectively cost the terminal benefits he received. The business gives him an annual
revenue of Rs.5,00,000 for the first 5 years and Rs.7,00,000/year for the next 5 years.
The annual business costs are Rs.2,00,000 for the first 5 years and Rs.4,50,000 for the
next 5 years. If he deposits the amounts received in both the options in bank, he will get
a compound interest of 14%. The scrap value of each ship at the end of 10 years is
estimated at Rs.1,50,000. Advise him.
354. The total sum at the end of 10 years with bank option is __________.
a. Rs.23,45,704
b. Rs.45,98,452
c. Rs.58,98,963
d. Rs.61,40,500
e. Rs.55,00,000.
355. The total sum at the end of 10 years with business option is __________ ; and he should opt
for __________ option.
a. Rs.53,50,483, bank
b. Rs.45,98,720, business
c. Rs.39,45,895, business
d. Rs.59,20,683, business
e. Rs.31,44,444, bank.
356. In business option, if the scrap value is Rs.3,00,000/ship at the end of 10 years the total
amount he gets is __________ , what is your advice?
a. Rs.63,70,683, opt for the business.
b. Rs.55,67,888, opt for the job.
c. Rs.49,87,567, opt for the business.
d. Rs.32,89,973, opt for the job.
e. Rs.52,00,483, opt for the job.
357. Given below are the profits after taxes for three projects. The initial investment for all the
three projects is Rs.10,00,000 each. Recommend the project based on the pay-back period.
(in Rs. Lakh)
Years A B C
1 2 0 4
2 3 0 1
3 2 3 2
4 2 6 0
5 3 4 6
6 4 3 3
16 16 16
a. Project A
b. Project B
c. Project C
d. Both (a) and (b)
e. Both (a) and (c).
650
Eureka Ltd., gets 10,000 bolts annually from one of its suppliers at a cost of Rs.3 per bolt.
The materials manager of the firm says if the firm itself starts producing the bolts it incurs a
cost of Rs.2.50 per bolt (depreciation not being accounted for). The machinery costs
Rs.15,000 and needs to be depreciated at the rate of 20% per annum on WDV basis. The
machines expected life period is 5 years.
358. If the firms tax rate is 50% and its cost of capital is 10%, should the firm adopt materials
managers proposal? (Assumption: Scrap value of the machine is nil at the end of 5 years.)
a. Since NPV is ()Rs.1,540 the proposal should not be accepted.
b. Since NPV is ()Rs.1,670 the proposal should not be accepted.
c. Since NPV is Rs.1,540 the proposal should be accepted.
d. Since NPV is Rs.1,670 the proposal should not be accepted.
e. Since NPV is Rs.1,540 the proposal should be accepted.
359. If the machine has a scrap value equal to its book value, what happens?
a. New NPV is Rs.1,200, proposal can be accepted.
b. New NPV is Rs.1,512, proposal can not be accepted.
c. New NPV is Rs.1,200, proposal cannot be accepted.
d. New NPV is Rs.1,512, proposal can be accepted.
e. New NPV is Rs.1200, proposal can be accepted.
A company is considering three ad campaigns, which boost the image of the company among
the general public. The company has estimated the expenditures for these three campaigns if
they are implemented. Given below are the cash outflows for these ads. The cost of capital
for the company is 14%.
(in Rs.)
Years Ad-1 Ad-2 Ad-3
Initial expenditure 16,000 18,000 12,000
1 5,000 7,000 4,000
2 6,000 4,000 5,000
3 6,500 9,000 6,000
4 8,000 7,000
5 8,000
360. The Annual capital charge of Ad-1 is __________.
a. Rs.10,900
b. Rs.14,540
c. Rs.11,711
d. Rs.12,333
e. Rs.17,567.
361. The annual capital charge of Ad-2 and Ad-3 are __________ and __________.
a. Rs.14,338 and Rs.9,236
b. Rs.21,456 and Rs.4,345
c. Rs.30,670 and Rs.4,567
d. Rs.26,876 and Rs.7,305
e. Rs.27,777 and Rs.8,567.
Part II
651
362. Select a suitable appraisal criterion to determine which one of the company has to select.
a. Ad-1
b. Ad-2
c. Ad-3
d. Both (b) and (c)
e. All three (a), (b) and (c).
Calculate the net benefit-cost ratios for the following two projects.
(in Rs.)
C
0
C
1
C
2

Project A 9,000 6,000 5,000
Project B 12,000 8,000 7,000
Required rates of return are
(i) 12% (ii) 15% (iii) 20%
363. Project A should be accepted should be accepted at the rate of __________.
a. 12%
b. 15%
c. 20%
364. Project B should be accepted at the rate of __________.
a. 12%
b. 15%
c. 20%
The dealer of Popular Televisions Ltd., has announced a new scheme. The name of the scheme
is TV at no cost. If a person gives his old TV in working condition and pays Rs.15,000 a
brand new Popular Television will be given. And after 6 years Rs.15,000 will be refunded. If
you assume the cost of a new popular TV is Rs.16,000 and the resale price of your old TV is
Rs.4,000, A private bank offers you an interest rate of 13% p.a. on 30-day deposits.
365. The effective interest rate is __________.
a. 14.2%
b. 13.8%
c. 15.6%
d. 12.7%
e. 10.5%.
366. Do you feel the offer is worthwhile to subscribe to?
a. Since PV of inflows is greater than that of outflows, the person can subscribe to the
scheme.
b. Since PV of inflows is lesser than that of outflows, the person cannot subscribe to the
scheme.
c. Since PV of inflows is greater than that of outflows, the person cannot subscribe to the
scheme.
d. Since PV of inflows is lesser than that of outflows, the person can subscribe to the
scheme.
e. Since PV of inflows is equal to the outflows, the person can subscribe to the scheme.
652
367. If the resale price of your old TV is Rs.9,000, what is your decision?
a. Since the PV of outflows is greater than PV of inflows, the person can be better off by
purchasing a new television with the offer.
b. Since the PV of outflows is lesser than PV of inflows, the person can be better off by
purchasing a new television without the offer and investing the rest of the money in the
bank.
c. Since the PV of outflows is lesser than PV of inflows, the person can be better off by
purchasing a new television with the offer.
d. Since the PV of outflows is greater than PV of inflows, the person can be better off by
purchasing a new television without the offer and investing the rest of the money in the
bank.
e. Since the PV of outflows is equal to the PV of inflows, the person can be better off by
purchasing a new television with the offer or invest the rest of the money in the bank.
368. Given below are the cash flows of a project. The profitability index is __________,
if discount rate is 12%. Write accept-reject decision.
Years Y0 Y1 Y2 Y3
Cash flows (Rs.) 11,000 5,000 6,000 2,000
a. 0.971, the project is liable to be rejected
b. 0.888, the project is liable to be rejected
c. 1.033, the project is liable to be accepted
d. 1.12, the project is liable to be rejected
e. 1.090, the project is liable to be accepted.
369. If the discount rate is 8%, What is the decision?
a. 0.971, the project is liable to be rejected.
b. 0.888, the project is liable to be rejected.
c. 1.033, the project is liable to be accepted.
d. 1.12, the project is liable to be rejected.
e. 1.090, the project is liable to be accepted.
The cost of a machine is Rs.2,00,000. Its life period is 5 years, after which it has no scrap value.
The PBDT for the 5 years are given below.
Years 1 2 3 4 5
PBDIT (Rs.) 80,000 80,000 90,000 90,000 75,000
It is to be depreciated at 20% WDV basis. The applicable tax rate is 50%.
370. The depreciation at 5th year is Rs. __________.
a. 15,100
b. 16,755
c. 16,384
d. 12,456
e. 14,100.
371. The IRR is __________.
a. 13.67%
b. 12.08%
c. 11.55%
d. 14.89%
e. 11.71%.
Part II
653
Munoth Decoratives Ltd. is considering a proposal to replace one of its machines. The
following data is available regarding the same:
I. The machine was purchased 4 years ago for Rs.15 lakh and has been depreciated at
25% p.a. as per the WDV method. The machine has a remaining life of 5 years, after
which its salvage value is expected to be Rs.0.80 lakh. Its present salvage value is
Rs.6.0 lakh.
II. The new machine costs Rs.22 lakh, and would be depreciated at 40% p.a. as per WDV
method. Its expected life is 8 years and after 5 years, it is expected to fetch Rs.6 lakh.
The installation of this machine will increase the annual revenue by Rs.5.0 lakh, apart
from decreasing the operational costs by Rs.1.10 lakh per annum. If the company uses a
discounting factor of 17% p.a. Marginal tax rate of the company is 20%.
Assume no change in the depreciation rate if old machine is continued to use.
372. The depreciation on old machine for 9th year is __________.
a. 0.21 lakhs
b. 0.45 lakhs
c. 0.38 lakhs
d. 0.35 lakhs
e. 0.50 lakhs.
373. The depreciation on new machine for the 5th year is __________.
a. 1.14 lakhs
b. 1.25 lakhs
c. 1.41 lakhs
d. 1.52 lakhs
e. 1.11 lakhs.
374. The present value of future cash flows is __________, should it go for the replacement of
existing machine with the new machine?
a. Rs.3.33 lakh, firmcan go for the replacement
b. Rs.4.46 lakh, firmcan go for the replacement
c. Rs.3.56 lakh, firm cannot go for the replacement
d. Rs.2.77 lakh, firm cannot go for the replacement
e. Rs.5.00 lakh, firm cannot go for the replacement.
Flyaway Copies Ltd., is considering replacing two of their old machines with a new, more
efficient one. The old machines could be sold for Rs.70,000 in the secondary market. The
depreciated book value of the two machines is Rs.1,20,000 with a remaining useful and
depreciable life of 8 years. The company uses the straight line method of depreciation. The
new machine can be purchased for Rs.4,50,000. Installation charges are expected to be
Rs.30,000. It has a useful life of 8 years, at the end of which a salvage value of Rs.40,000 is
expected. Due to its greater efficiency, the new machine is expected to result in incremental
annual saving of Rs.1,20,000. The company is in the 40% tax bracket and is allowed to
set-off any loss it incurs against the profits of the coming 8 years for determining tax.
375. The incremental cash flow of the replacement proposal for last year is __________.
a. 1.44
b. 1.22
c. 1.28
d. 1.11
e. 1.50.
654
376. The amount of incremental investment is __________.
a. 4.81
b. 5.67
c. 3.50
d. 4.10
e. 2.88.
377. The net present value of the proposal is __________ if the required rate of return is 14%.
Should the company replace the existing machine?
a. Rs.0.123 lakh, Company should replace.
b. Rs.0.234 lakh, company should not replace.
c. Rs.0.345 lakh, company should not replace.
d. Rs.0.133 lakh, company should replace.
e. Rs.1.234 lakh, company should not replace.
Excel Operations Ltd., is proposing to replace its fully depreciated machine by a new one
costing Rs.1,50,000. The current market value of the old machine is Rs.20,000 and the
salvage value after 6 years is zero. The salvage value of the new machine after 6 years is
expected to be Rs.16,000. With the use of new machine, sales are expected to increase by
Rs.20,000 per annum and operating expenses to decrease by Rs.12,000 per annum. If the
company follows a 30% WDV depreciation policy, has a marginal cost of capital of 12% and
attracts a marginal tax rate of 30%.
378. The cash flow for the 6th year is Rs. __________.
a. 33,778
b. 45,765
c. 40,669
d. 51,864
e. 39,007.
379. The NPV is Rs. __________.
a. 500
b. 450
c. 400
d. 350
e. 300.
Alpha Projects Ltd., is considering two independent projects A and B. The cash flows
associated with the two projects are as under:
(Rs. In crore)
Year 0 1 2 3 4 5
Project A (40) 12 14 15 18 9
Project B (45) 10 14 15 18 23
The companys debt equity ratio is 2. While the debt can be raised at the rate of 15% under
pre-tax terms, the equity can be raised at 25.5%. The company is in the tax bracket at 35%.
Part II
655
380. Using the concept of NPV, you are required to advise whether the company should
implement Project A or Project B.
a. Project A is preferable as its NPV is higher
b. Project B is preferable as its NPV is higher
c. Project B is preferable as its NPV is lower
d. Project B is preferable as its NPV is lower
e. Both project A and B are preferable.
381. If both the projects are implemented the total investment in the projects comes down by Rs.5
crore. Which of the following alternatives is preferable?
a. Project A only.
b. Project B only.
c. Both the Projects A and B.
d. Either Projects A or B.
382. The combined IRR is __________, assuming both the projects are implemented.
a. 31.2%
b. 18.67%
c. 22.79%
d. 20.11%
e. 16.5%.
Following cash flow details are available for two projects A and B having an initial outlay of
Rs.5.4 crore and Rs.4.7 crore respectively.
Project A (Rs. In lakh) Project B (Rs. in lakh)
Year
PAT Depreciation Interest PAT Depreciation Interest
0 (540) (470)
1 185 50 60 160 45 50
2 110 50 50 105 45 40
3 195 50 40 135 45 30
4 225 50 30 125 45 20
5 175 50 20 175 45 10
383. The tax rate applicable is 30% for both the projects. The cost of capital is 20%. The benefit
cost ratio of the project A is __________.
a. 1.41
b. 1.32
c. 0.98
d. 1.67
e. 1.99.
384. The benefit cost ratio of the project B is __________. In project A and B, which one is
preferable.
a. 1.41, project A is preferable
b. 1.32, project A is preferable
c. 0.98, project B is preferable
d. 1.67, project B is preferable
e. 1.99, both project A and B are preferable.
656
385. The internal Rate of Return for project A is __________.
a. 38%
b. 28.5%
c. 37.62%
d. 41.90%
e. 34.13%.
386. The internal Rate of Return for project B is __________, also which project is preferable
according to IRR criteria.
a. 38%, project B is preferable
b. 28.5%, project B is preferable
c. 37.02%, project B is preferable
d. 41.90%, project A is preferable
e. 34.13%, project A is preferable.
The following information is available regarding a project being under consideration by
Don-Bosco Industries Ltd.
Initial Outlay =Rs.25 lakh
Operating costs and cash flows:
Year Operating costs
(in Rs. Lakh)
Operating Inflows
(in Rs. Lakh)
1 4.7 8.5
2 3.2 10.7
3 4.9 13.6
4 3.8 16.8
5 5.6 12.5
387. Cost of capital is 14 percent. The benefit-cost ratio is __________.
a. 1.05
b. 1.98
c. 2.05
d. 3.45
e. 1.67.
388. The annual capital charge is Rs. __________.
a. 12.77 lakh
b. 11.67 lakh
c. 10.76 lakh
d. 14.55 lakh
e. 15.87 lakh.
Part II
657
Deepak Pharma Ltd. is considering to invest in a new line of pharmaceuticals. The company
has a plan that after five years it will sell the unit at a good profit to a pharmaceutical major.
The project outlays are as follows:
(Rs. in lakh)
Land 80
Building 100
Plant and Machinery 500
Other fixed assets 100
Technical know-how fees 160
Gross working capital 450
The project to be financed is as follows:
(Rs. in lakh)
Equity share capital 500
12% Preference share capital 250
16% Term loan 300
18% Bank loan for working capital 340
The unit is expected to generate sales value of Rs.10 crore in the first year, Rs.12 crore in the
second year and Rs.15 crore for the next three years. The cost of production excluding
depreciation would be to the extent of 70% of the sales. The applicable rate of depreciation
on building is 4% on straight line method and 33 1/3% written down value method on plant
and machinery and other fixed assets. The technical know-how fees will be written-off over
the period of five years. The salvage value of plant and machinery after five years would be
20% of the acquisition cost, nil for other fixed assets and book value for land and building.
The term loan for the project will be repaid after five years when the project would be sold.
The effective tax rate for the company is 30%.
389. The total depreciation on plant and machinery and other fixed assets in last year and net
salvage value are __________ and __________.
a. 43.51, 280
b. 51.47, 320
c. 45.89, 225
d. 38.99, 368
e. 19.07, 275.
390. The net cash flow of the 5th year, for the investment proposal from the long-term funds point
of view is __________.
a. 445.87
b. 389.67
c. 786.9
d. 690.55
e. 684.81.
391. The net present value at a cost of capital of 20% is __________. Comment on the investment
proposal of Deepak Pharma Ltd.
a. ()Rs.80.19 lakhs, the project is not viable.
b. Rs.99.2 lakhs, the project is viable.
c. ()Rs.87.45 lakhs, the project is not viable.
d. Rs.54.80 lakhs, the project is viable.
e. ()Rs.72.15 lakhs, project is not viable.
658
392. Will your recommendation change, if an additional cash flow of Rs.5 crore arise by disposing
of the project?
a. The project is giving a positive NPV of Rs.128.79 lakhs, so project is accepted.
b. The project is giving a negative NPV of () Rs.120.75 lakhs, so project is not accepted.
c. The project is giving a positive NPV of Rs.210.45 lakhs, so project is accepted.
d. The project is giving a negative NPV of () Rs.210.75 lakhs, so project is not accepted.
e. The project is giving a positive NPV of Rs.300.75 lakhs, so project is accepted.
A manufacturing company is planning to install either of the following two machines, which
are mutually exclusive. The details of their purchase price and operating costs are as given
below:
Machine I (Rs.) Machine II (Rs.)
Purchase price +Cost of installation 100,000 80,000
Operating cost: Year 1 20,000 25,000
2 20,000 25,000
3 20,000 25,000
4 25,000 36,000
5 25,000 36,000
6 25,000 36,000
7 30,000
8 30,000
9 30,000
10 30,000
393. The salvage value of Machine I is expected to be Rs.15,000 at the end of its life of ten years,
while for Machine II it is Rs.10,000 at the end of the sixth year. The cost of capital is 15%.
You can assume that technically both the machines are equally useful. The present value of
costs for Machine I is __________.
a. Rs.2,16,511.15
b. Rs.3,11,525.20
c. Rs.1,86,834.70
d. Rs.2,56,777.10
e. Rs.3,20,189.56 .
394. The present value of costs for Machine II is __________.
a. Rs.2,16,511.15
b. Rs.3,11,525.20
c. Rs.1,86,834.70
d. Rs.2,56,777.10
e. Rs.3,20,189.56.
395. The annual capital charge for Machine I is __________.
a. Rs.29,567.50
b. Rs.34,510.98
c. Rs.49,374.92
d. Rs.43,138.30
e. Rs.52.221.45.
Part II
659
396. The annual capital charge for Machine II is _______, which machine is cheaper?
a. Rs.29,567.50, Machine I is cheaper.
b. Rs.34,510.98, Machine II is cheaper
c. Rs.49,374.92, Machine I is cheaper.
d. Rs.43,138.30, Machine II is cheaper
e. Rs.52,221.45, Machine II is cheaper.
Innovative Engineers Ltd. is considering the replacement of a lathe machine. The existing machine
is in good operating condition but is smaller than required if the company is to expand its
operation. The following comparative financial information relating to the existing machine and
the new machine are provided below.
Rs.
Existing machine
Current salvage value 60,000
Book value 50,000
Depreciation (SLM) 5,000
Estimated salvage value at the end of 10 years Nil
Annual sales 2,00,000
Operating expenses (excluding depreciation) 1,20,000
New machine
Cost of the asset 2,50,000
Depreciation (WDV)% 20%
Estimated salvage value at the end of 10 years 50,000
Annual sales 2,50,000
Operating expenses (excluding depreciation) 1,30,000
The tax rate applicable for the company is 40% and its cost of capital is 12%.
397. The closing WDV on new machine for 10th year is __________.
a. 26,800
b. 27,900
c. 32,150
d. 54,650
e. 47,800.
398. The incremental depreciation on new machine for 10th year is __________.
a. 2,500
b. 1,900
c. 1,400
d. 1,700
e. 2,200.
399. The present value of 10th year net cash flow associated with replacement proposal is ______.
a. 24,047
b. 28,987
c. 21,777
d. 17,777
e. 19,456.
660
400. The NPV is Rs. __________, you are required to advise Innovative Engineers whether it
should replace the existing machine or not.
a. 10,780, it can invest in new machine
b. ()11,560, it cannot invest in new machine
c. 12,340, it can invest in new machine
d. ()11,990, it cannot invest in new machine
e. 16,800, it can invest new machine.
Micro Ltd., is considering to invest in a plant requiring outflow of Rs.250 lakh. The plant has
an economic life of 5 years. The financial analyst of the company has projected the following
cash flows for the project:
(Rs. Lakh)
Year Cash flow
0 (250)
1 50
2 65
3 80
4 90
5 125
401. But he later realized that depreciation was erroneously taken as 10% on original cost instead
of 20% on book value. The cost of capital for the company is 16% and the applicable tax rate
is 30%. The revised cash flow after adjustment for the 5th year is __________.
a. 145.67 lakh
b. 120.44 lakh
c. 123.68 lakh
d. 115.43 lakh
e. 100.07 lakh.
402. The discounted pay-back period is __________.
a. 1 year
b. 2 years
c. 3 years
d. 4 years
e. 5 years
403. The net present value is __________.
a. 10.5 lakh
b. 11 lakh
c. 11.5 lakh
d. 12 lakh
e. 12.5 lakh
404. The internal rate of return is __________.
a. 15.67%
b. 11.35%
c. 17.88%
d. 21.54%
e. 19.01%.
Part II
661
The cash flows associated with a project are given below:
Year 0 1 2 3 4 5 6
Cash flows
(Rs. 000s)
(2500) 750 800 650 600 550 450
The cost of capital is 12%.
405. The net present value of the project is Rs. _________, and according to NPV the project is
accepted or not.
a. 191.75, project can be accepted.
b. () 208.45, project cannot be accepted.
c. 225.57, project can be accepted.
d. () 218.36, project cannot be accepted.
e. 155.67, project can be accepted.
406. The appraisal of the project using Benefit-Cost Ratio (BCR) is __________.
a. 1.56, since the BCR is greater than 1 the project can be accepted
b. 1.22, since the BCR is greater than 1 the project can be accepted
c. 1.08, since, the BCR is greater than 1 the project can be accepted
d. 2.12, since the BCR is greater than 1 the project can be accepted
e. 1.45, since the BCR is greater than 1 the project can be accepted.
407. The appraisal of the project using Internal Rate of Return (IRR) is __________.
a. 14.93%, project can be accepted
b. 17.67%, project can be accepted
c. 21.77%, project can be accepted
d. 18.91%, project can be accepted
e. 25.47%, project can be accepted.
408. State whether the project will be accepted or not if the cost of capital changes to 14%.
a. The project can be accepted only on the basis of BCR and IRR
b. The project can be accepted only on the basis of NPV
c. The project can be accepted on the basis of NPV and BCR
d. The project can be accepted on the basis of NPV, BCR and IRR
e. The project cannot be accepted on the basis of NPV, BCR and IRR
409. The initial outlay for a project is Rs.20 crore. The project manager projected the following
annual cash flows that is expected to be generated uniformly over the years:
Year 0 1 2 3 4 5 6
Cash flow (in Rs. crore) (20) 4 5 5 5 4 7
The pay-back period for this project will be
a. 4.00 years
b. 4.25 years
c. 4.50 years
d. 4.75 years
e. 5.00 years.
662
410. The following projections have been made by the project manager of Vector Technologies
Ltd., with respect to the changes in their automatic systems:
Year 0 1 2 3
Investments Rs.150,000
Net Cash Flows including depreciation Rs.46,000 Rs.52,000 Rs.55,000
Depreciation Rs.30,000 Rs.30,000 Rs.30,000
The accounting rate of return for this investment will be
a. 10 percent
b. 15 percent
c. 20 percent
d. 25 percent
e. 30 percent.
411. The cash flows from a project is estimated as follows:
Year 0 1 2 3
Cash flows Rs.160 lakh Rs.60 lakh Rs.80 lakh Rs.116 lakh
The benefit cost ratio for the above project is (Assume the cost of capital as 12 percent):
a. 0.25
b. 0.80
c. 1.25
d. 1.80
e. 2.25.
412. If the cost of an investment is Rs.25,000 and it results in a net cash inflow Rs.1800 per
annum forever, the Net Benefit Cost Ratio of that investment is (Assume a discount rate of
8 percent)
a. 0.072
b. 0.10
c. 0.90
d. 0.10
413. Kirmani Industries Limited is planning for a capital investment at a cost of Rs.100 lakh
where the projected cash inflows are as follows:
(Rs. in lakh)
Year 1 2 3 4
Cash inflows 25.0 30.0 40.0 48.0
The Internal Rate of Return (IRR) of the project is
a. 12.54 percent
b. 13.84 percent
c. 14.24 percent
d. 15.84 percent
e. 17.64 percent.
Part II
663
414. Other things remaining the same, if the contribution margin for a one year project of a firm
increases from Rs.200 lakh to Rs.300 lakh, what will be its impact on the NPV of the project?
(Assume, the applicable tax rate is 35 percent and the cost of capital is 10 percent. Round off
your answer to the nearest integer)
a. Increase by Rs.59 lakh
b. Increase by Rs.65 lakh
c. Increase by Rs.70 lakh
d. Increase by Rs.75 lakh
e. Increase by Rs. 80 lakh.
415. The present value of the cash flows from a project is Rs.6.72 crore while its net benefit cost
ratio is 0.2. What will be its net present value?
a. Rs.1.12 crore.
b. Rs.1.20 crore.
c. Rs.3.40 crore.
d. Rs.5.60 crore.
e. Rs.6.72 crore.
416. The net cash flows from a project (with initial investment of Rs.16,20,000) are as follows:
Year 1 2 3 4 5 6 7
Cash Flows (Rs.) 200,000 400,000 500,000 520,000 525,000 540,000 650,000
What is the pay back period for the above project?
a. 2.00 years
b. 3.00 years
c. 4.00 years
d. 5.00 years
e. 6.00 years.
417. The price of a machine is Rs.450,000 while its annual maintenance costs are Rs.100,000 for
the first three years and Rs.150,000 for the next six years. After six years, the salvage value
of the machine is expected to be zero. What is the annual capital charge for this machine?
(Assume the applicable cost of capital is 12 percent and round off your answer to the nearest
integer)
a. Rs.127,188
b. Rs.127,488
c. Rs.127,788
d. Rs.128,088
e. Rs.128,488.
418. The cash flows associated with a project are as follows:
Year 0 1 2 3 4
Cash Flows (in Rs. lakh) (50) 16 17 15 23.50
What is the IRR of this project? (Round off your answer to the nearest integer)
a. 12 percent
b. 13 percent
c. 14 percent
d. 15 percent
e. 16 percent.
664
419. Reddy Industries is planning to replace one of their old machines with a new one. The old
machine can be presently sold at Rs.50,000 although book value is Rs.70,000 with a useful
life of 4 years. The old machine will be depreciated by the SLM over the remaining life at the
end of which the salvage value will be zero. The new machine can be installed at a cost of
Rs.350,000 with a useful life of 4 years. The new machine will be depreciated by the SLM
over the 4 years period at the end of which the salvage value will be nil. Due to greater
efficiency, savings of expenses will be Rs.40,000 per year while better quality of output will
increase the revenue by Rs.60,000 per year. If the applicable tax rate is 40 percent, what is
the net present value of the proposal, if the required rate of return is 12 percent?
a. Rs.35,744.
b. Rs.32,744.
c. Zero.
d. Rs.32,744.
e. Rs.35,744.
420. Rao Constructions Ltd., has a debt of Rs.70 lakh at an interest rate of 14 percent. The
applicable tax rate for the company is 40 percent. Assuming the debt to be perpetual, the
present value of the tax shield from debt is equal to:
a. Rs.5.60 lakh
b. Rs. 9.80 lakh
c. Rs.28.00 lakh
d. Rs. 40.00 lakh
e. Rs.56.00 lakh.
421. Vega India Ltd., is planning to purchase a punching machine having the following details:
Cost of machine Rs.30,00,000
Annual cost of operations Rs.2,50,000 for the first four years
Rs.3,00,000 for the subsequent years
Useful life 10 years
The annual capital charge of the machine at a cost of capital of 10 percent is
a. Rs.762,182
b. Rs.762,282
c. Rs.762,382
d. Rs.762,482
e. Rs.762,582.
422. If the cost of an investment is Rs.1,900 and it pays Rs.165 in perpetuity at an interest rate of
9%, the net present value of the investment is
a. Rs.171
b. Rs.67
c. Rs.67
d. Rs.164
e. Rs.171.
423. If the present value of cost associated with a machine of life 5 years is Rs.2,20,000, then the
annual capital charge if cost of capital 15% is
a. Rs.45,844
b. Rs.58,348
c. Rs.65,632
d. Rs.72,459
Part II
665
424. If the present value of cash in flows from a project is Rs.4.50 crore, initial outlay is Rs.3.75
crore then the net benefit-cost ratio is
a. 0.17
b. 0.20
c. 0.75
d. 0.83
e. 1.20
425. A project has the following cash flows:
Year Cash flow (Rs. lakh)
0 25
1 30
2 15
3 40
If the discount rate is 20%, then the NPV of the project is
a. Rs.6.57 lakh
b. Rs.8.24 lakh
c. Rs.10.58 lakh
d. Rs.12.73 lakh
426. A project requires initial outlay of Rs.500 lakh and produces cash flows of Rs.100 lakh for
first two years and Rs.200 lakh for last three years, the Net Present Value (NPV) of the
project if discount rate is 15% is
a. Rs.36.95 lakh
b. Rs.7.80 lakh
c. Rs.59.84 lakh
d. Rs.119.20 lakh
427. If the present value of cash inflows from the project is Rs.25,000 and the initial investment is
Rs.15,000 then the benefit to cost ratio is:
a. 1.67
b. 0.67
c. 0.48
d. 0.57
e. 2.67.
428. For an initial outlay of Rs.10,000 a machine generates the following cash inflows:
Year 1 2 3
Inflows Rs.5000 Rs.5000 Rs.5000
If the required rate of return is 10%, the NPV of the project is:
a. Rs.12,435
b. Rs.10,435
c. Rs.8,435
d. Rs.2,435
e. Rs.(2,435).
666
429. Consider the following cost and benefits of a project:
Year 0 1 2 3 4 5
Cash flows Rs.1,00,000 Rs.20,000 Rs.25,000 Rs.35,000 Rs.20,000 Rs.20,000
The pay-back period of the project is:
a. 4 years
b. 5 years
c. 3 years
d. 2 years
e. 4.5 years.
430. What will happen to the NPV of a one year project if fixed costs are increased fromRs.200 to
Rs.300, the firm is profitable, has a 35% tax rate and employs a 12% cost of capital?
a. NPV decreases by Rs.100.
b. NPV decreases by Rs.89.29.
c. NPV decreases by Rs.65.00.
d. NPV decreases by Rs.58.04.
e. Cant be deduced from the data given.

667
Part II: Solutions
1. (d) The value of a share after the rights issue is given by P =
0
NP S
N 1
+
+
Here, N = 4,
P
0
= Rs.140 and S = Rs.100.
The ex-rights price of the share will be P =
4 140 100
4 1
+
+
=
660
5
= Rs. 132.
2. (b) Ex-rights price of the share is the value of share, after the rights issue
= (NP
0
+ S)/N + 1 = (5 x 70 + 50)/5 + 1 = 66.67.
3. (c) Ex-rights share price is given by
V
0
= (NP
0
+ S)N + 1= (4 x 50 + 45)/4 + 1 = 49.
4. (a) Theoretical value of the right = (P
0
S)/N + 1 = 80 60/4 + 1 = 4.
5. (a) Cost of existing equity Capital:

1
e
0
D
K g
P
= +
2.5
= 0.08 0.13 or 13%
50
+ =
Cost of capital of new equity:

1
e
0
D
K g
P
= +
2.7
= 0.08 0.14 or 14%.
45
+ = i.e. (2.5 x 1.08)
6. (a) Cost of debt:

d
(F P)
I (l t) +
n
K =
F+ P
2

I = Annual Interest to be paid = Rs.10
t = 0.45
F = Rs.108; P = 90
n = 12 years
d
108 90
10 (1 0.45) +
5.5 1.5
12
K 0.0707(or)
108+90
99
2
+
= = = = 7.07%.
7. (b) The Cost of Preference Share (Face Value = Rs.100) may be found as follows:

P
F P
D+
n
K
F P
2
=

D = 12%
F = 100
P = 100 4 = Rs.96

P
(100 96)
12+
12.4
10
K 0.1265 (or) 12.65%.
100+96
98
2
= = = =
668
8. (b)
1
c
0
D
K g
P
= +
25% =
0
5
0 (since growth rate is zero)
P
+

0
5
P 100
25
= X = Rs.20.
9. (d) Earning Per Share =
Earnings after Interest and Taxes
No. of Shares
=
Rs. 25,700
Rs.25.7.
Rs.1,000
=
10. (b) Cost of debt (K
d
) = I (1t) = 13 (10.60) = 5.2%.
11. (b) Cost of equity =
e
K =
DPS
100
MP

Where
E
e
DPS = Dividend Per Shares; (DPS = 60% of EPS = 0.6 x 25.7 = 15.42)
MP = Market Price of Share

e
15.42
K 100 = 12.336% 12.34%.
125
=
12. (b) Weighted Average Cost of Capital
Source of
Capital
Amount Specific Cost Total Cost
Debt 64,000 5.2% 3,328
Equity 1,10,000 12.34% 13,574
Reserves 18,000 12.34% 2,221.20
1,92,000 19,123.20
WACC =
19,123.20
x 100 = 9.96%
1,92,000

13. (d) K
d
=
F P
I (1 t) +
n
F P
2

=
110 90
14(1 0.45)+
5
11.7%.
110+90
2

=
14. (a) Net Income Approach
Company A
EBIT @18% on Rs.45,00,000 8,10,000
Less: Interest on debentures 3,75,000
4,35,000
Less: Tax @45% 1,95,750
Earnings available for equity shareholders 2,39,250
Capitalized value of equity @20%
2,39,250
100
11, 96, 250
20
=
11,96,250
Add: Value of debit 25,00,000
Total Value of the company 36,96,250

Part II
669
15. (d) Net Income Approach
Company B
EBIT @18% on Rs.45,00,000 8,10,000
Less: Interest on debentures
8,10,000
Less: Tax @45% 3,64,500
Earnings available for equity shareholders 4,45,500
Capitalized value of equity @20%
4,45,500 x
100
22, 27, 500
20
=
22,27,500
Add: Value of debt
Total Value of the company 22,27,500
16. (e) Calculation of Earning Per Share
EPS =
Profit after tax
No. of equity shares
=
78,00,000
Rs. 5.20.
15,00,000
=
17. (a) Cost of equity, Ke=
Expected earnings per share
Market price per share
=
5.20
100 40%.
13
=
18. (c) Cost of Debenture Funds
At Book Value (Rs. Lakh)
Value of 15% debentures 150.00
Interest cost for the year 22.50
Less: Tax @ 50% 11.25
11.25
Cost of debenture funds% =
11.25
x 100
150
= 7.5%.
19. (c) I = 14%, t = 0.5, P = 95 and n = 10 years, F= Rs.98.1(i.e., 90 1.09)
The cost of debenture (K
d
) =
F P
I(1 t)+
n
F+P
2

=
98.1 95
14 (1 0.5)+
10
98.1+95
2
=
7 + 0.31
0.075 or 7.57%.
96.55
=
20. (d) The Average Cost of Capital
(K
0
) = K
d
(B/B + S) + K
e
(S/B + S)
K
0
= 10% x
0 3,00,000
15% 15%.
3, 00, 000 3, 00, 000
+ =
21. (c) The average cost of capital for firm Raj Ltd.:
K
0
= 10% x
50, 000 2,33,333
15%x
2, 83, 333 2, 83, 333
+ = 1.76 + 12.35% = 14.11%.
22. (d) The equity capitalization rate of firm Peers Ltd.:
=
Equity earnings
Market Value of equity
=
53,000
0.334 or 33.4%.
1,58,667
=
670
23. (a) The equity capitalization rate of firm Serena Ltd.:
=
Equity earnings
Market Value of equity
=
50, 500
= 0.339 or 33.9%.
1, 48, 667

24. (c)
(Rs.)
Market value of the firm = 70,00,000
Overall capitalization rate K
0
= 28%
Net operating income
(Rs.70,00,000 x 28%)
= 19,60,000
Less: On debt component of
Rs.25,00,000 @ 14%
=
3,50,000
Profit before tax = 16,10,000
Less: Corporate tax @35% = 5,63,500
PAT available to shareholders = 10,46,500
Combined income of
shareholders and debt holders
= 10,46,500.
+3,50,000
13.96,500
Less: Personal taxes @ 25% = 3,49,125
Combined income of
shareholders and debt holders
= 10,47,375

25. (a) Cost of debt (k
d
)
k
d
= i(1 t)
where i is the interest rate and t is the tax rate.
Given, i = 14% and
Tax rate for paper = 35%
Airlines = 40%
Mineral water = 45%
k
d
for paper = 14(1 0.35)% = 9.1%
k
d
for airlines = 14(1 0.4)% = 8.4%
k
d
for mineral water = 14(1 0.45)% = 7.7%.
26. (c) Cost of Preference Shares (k
p
)
Dividend received on preference shares at 12% rate on Rs.50 par value = Rs.6
Since these shares have no maturity date,
k
p
=
Dividend paid
100
Net proceeds
=
Rs.6
100
Rs.47
= 12.77% (for all divisions).
The cost of preference shares (k
p
) for all divisions is 12.77%.
27. (d) Cost of equity (k
e
)
Given risk-free return = 10% = r
f

Return on market portfolio = 15% = r
m

We have k
e
= r
f
+ (r
m
r
f
),
using CAPM
k
e
for paper = 10% + 0.8 (15% 10%) = 14%
k
e
for airlines = 10% + 0.98 (15% 10%) = 14.9%
k
e
for mineral water = 10% + 1.1 (15% 10%) = 15.5%
Part II
671
But since the flotation cost for raising equity is 3% the external costs of equity for these three
divisions become:
k
e
for Paper =
14%
1 0.03
= 14.43%
k
e
for Airlines =
14.9%
1 0.03
= 15.36%
k
e
for Mineral water =
15.5%
1 0.03
= 15.98%
The costs of equity (k
e
) for each of these 3 divisions are 14.43%, 15.36% and 15.98%
respectively.
28. (b) The Weighted Average Cost of Capital (WACC)
for paper division = 0.3 9.1 + 0.3 12.77 + 0.4 14.43 = 12.33%
for airlines division = 0.3 8.4 + 0.3 12.77 + 0.4 15.36 = 12.5%
for mineral water division = 0.3 7.7 + 0.3 12.77 0.4 15.98 = 12.53%
The Weighted Average Cost of Capital (WACC) for each of these 3 divisions are 12.33%,
12.5%, 12.53% respectively.
29. (a) Cost of bond (k
b
):
cost of a bond = k
b
=
F P
(1 t) I +
n
F+P
2

where, I = Interest on the bond
F = Face value or redemption value
P = Amount realized on the issue of the bond
t = Tax rate
n = Maturity period in years.
Given, I = 12% 500 = Rs.60
t = 40%; F = Rs.500; n = 6.
Since the bond is sold at 3% discount, its market price would be
Rs.500 (3% 500) = Rs.485.
Since the cost of marketing the issue is 3% per bond, the net proceeds would be
Rs.(485 15) = Rs.470.
Hence, P = Rs.470.
Hence, k
b
=
500 470
(1 0.4) 60+
6
500+470
2
=
36 5
485
+
= 8.45%.
30. (c) If the bond is sold at a premium of 3% on the face value, since the cost of marketing the
issue is also 3% on the face value, the net proceeds would be Rs.500.
Hence, k
b
=
(1 0.4)60
500+500
2

= 7.2%.

672
31. (b)
i. Cost of equity k
e
=
1
0
D
+g
P

where, D
1
= Dividend a year hence; P
0
= Current market price;
g = Growth rate in dividends.
k
e
=
5
+7%
25
(or) k
e
= 27%
ii. Cost of Term loan = k
d
= 12(1 50%)% = 6%
iii. Cost of preference shares = k
p
=
F P
D+
n
F+P
2

where, D = Preferred dividend; F = Face value (or) redemption value;
P = Discount price; n = Maturity period in years.
k
p
=
100 95
8
6
100 95
2
+
+

= 9.06%
WACC = (3,00,000 x 27% + 1,00,000 x 6% + 1,00,000 x 9.06%) 5,00,000 = 19.21%.
32. (a) If the preference shares are irredeemable, their cost
8
x100
95
= 8.42
Hence,
WACC = (3,00,000 x 27% + 1,00,000 x 6% + 1,00,000 x 8.42) 5,00,000 = 19.08%.
33. (a) Cost of term loan @ 6% with a tax rate of 50%
k
d
= 6% (1 0.5%) = 3%
WACC = (3,00,000 x 27% + 1,00,000 x 6% + 1,00,000 x 9.06% + 2,00,000 x 3%) 7,00,000
WACC = 14.58%.
34. (c) If g = 10%, cost of equity k
e
becomes

k
e
=
5
10%
25
+ = 30%
Hence,
WACC = (3,00,000 x 30% + 1,00,000 x 6% + 1,00,000 x 9.06%) 5,00,000 = 21.01%.
35. (d) Given,
Market value of the firm = Rs.30,00,000
Overall capitalization rate k
o
= 25%
Net operating income
(Rs.30,00,000 x 25%) = Rs.7,50,000
Less: On debt component
of Rs.15,00,000 @10%

=

Rs.1,50,000
Profit before tax = Rs.6,00,000
Less: Corporate tax @40% = Rs.2,40,000
PAT available to shareholders = Rs.3,60,000
Part II
673
Combined income of shareholders and debt holders
Rs.3,60,000 + Rs.1,50,000 = Rs.5,10,000
Less: Personal taxes @25% = Rs.1,27,500
Combined income of shareholders and debt holders after personal taxes = Rs.3,82,500.
36. (c) Profit after tax = Rs.1,44,000
Hence profit before tax (tax @40%) =
Rs.1,44,000
1 0.4
= Rs.2,40,000
Since La Femme is an unlevered firm, it will not have debt component and hence the profit
before tax will be its net operating income
Therefore, at an overall required rate of 24%,
the market value of the firm =
Rs.2,40,000
0.24
= Rs.10,00,000.
37. (a) If the firm has a debt component, the total value of the firm will be the sum of the value
of unlevered firm and the tax shield associated with debt.
The tax shield associated with debt =
(1 t ) (1 t )
c ps
1 B
(1 t )
pd

where, B = Debt component; t
c
= Corporate income tax;
t
ps
= Personal tax on equity income; t
pd
= Personal tax on debt income.
Given, B = Rs.80,000; t
ps
= 30%, t
pd
= 35%, t
c
= 40%
Hence tax shield with debt =
(1 0.4) (1 0.3)
1 Rs.80,000
(1 0.35)

= 0.3538 Rs.80,000
= Rs.28,308
Total value of the firm = Rs.10,00,000 + Rs.28,308 = Rs.10,28,308.
38. (c) Given personal taxes on debt income = t
pd
= 30%
Personal taxes on equity income = t
ps
= 35%
Corporate tax = t
c
= 40%
Value of the firm = Rs.10,00,000 +
(1 0.4) (1 0.35)
1 Rs.80,000
(1 0.30)

= Rs.10,00,000 + Rs.35,429 = Rs.10,35,429.
The total value of the firm increases when the personal tax on equity income is more than
that on the debt income.
39. (c) ( For Firm A)
Net operating income = Rs.7,00,000
Overall capitalization rate = 0.20
Total market value of the firm = Rs.35,00,000
Market value of equity (50%) = Rs.17,50,000
Market value of debt (50%) = Rs.17,50,000
Interest at (15%) = Rs.2,62,500
674
Profit before tax = NOI-Interest = Rs.4,37,500
Less: Tax @ 50% = Rs.2,18,750
Profit After Tax (PAT) = Rs.2,18,750
Return on equity =
PAT
100
Market valueof equity

=
2,18, 750
x100
17, 50, 000
= 12.5%.
40. (b) For firm B
Total market value of the firm = Rs.35,00,000
Market value of equity (60%) = Rs.21,00,000
Market value of debt (40%) = Rs.14,00,000
Interest at 15% = Rs.2,10,000
Profit before tax = (NOI - Interest) = Rs.4,90,000
Less: Tax @ 50% = Rs.2,45,000
PAT = Rs.2,45,000
Return on equity =
PAT
100
Market valueof equity

=
2, 45, 000
x100
21, 00, 000
= 11.67%.
41. (c) The after tax cost of bond will be

F P
I(1 T) +
n
F+P
2

The realized price of the bond by the company P = 950 (1 0.04) = Rs.912
Cost of bond =
1000 912
80(1 0.3) +
10
1000+912
2
=
56 8.8
956
+
= 6.78%.
42. (c) Assumed that there are no flotation costs in this case. Let the cost of preference capital be i.
i =
110 100
9
5
110 100
2
+
+
=
11
105
= 10.48%.
43. (c)
P
0
= 50; EPS = 7.50;
DPS
EPS
= 0.6; g = 0.04
k
e
=
1
0
D
P
+ g =
7.50 0.6(1+0.04)
+0.04
50
= 13.36%.

Part II
675
44. (c)
(Rs. in lakh)
EBIT 100
Less: Interest on debentures
(15% of Rs.200 lakhs)

30
70
Market value of equity =
Equityearnings
Equitycapitalization rate
=
70
0.14
= Rs.500 lakhs
Market value of debt = Rs.200 lakhs
Total value of the firm = Rs.700 lakhs.
45. (a) Overall capitalization rate: =
EBIT
Valueof firm
=
100
700
= 14.29%.
46. (a) Value of the firm after the redemption of debentures =
Equityearnings
Equitycapitalization rate

EBIT = Equity earnings = Rs.100 lakh

Rs.100lakh
0.14
= Rs.714.30 lakh (Approx).
47. (a) Cost of equity capital (k
e
) =
1
0
D
P
+ g
D
1
= Rs.3.50 per share
P
0
= Rs.125 per share
g = 12% = 0.12
k
e
=
3.50
125
+ 0.12 = 0.148 i.e., 14.8%.
48. (b) Cost of preference capital (K
p
) =
F P
D +
p
n
F+P
2

D
p
= Rs.15 per preference share
F = Rs.105 per preference share
P = Rs.103.50 per preference share
n = 5
K
p
=
( ) 105 103.50
15 +
5
105+103.50
2
=
15 0.30
104.25
+

K
p
= 14.68%.
49. (a)
Cost of debenture capital (K
d
) =
F P
I(1 t) +
n
F+P
2

I = Rs.140 per debenture
F = Rs.1000
P = 970 per debenture

676
It is assumed that the number of debentures is 1000
n = 10
t = 40% = 0.40
K
d
=
( ) 1000 970
140 (1 0.40) +
10
1000+970
2
=
84 3
985
+
= 8.83%
Cost of term loan (K
t
) = 0.16 (1 0.40) = 0.096 i.e., 9.60%.
50. (a) Weighted Average Cost of Capital = W
e
K
e
+ W
p
K
p
+ W
d
K
d
+ W
t
K
t

Total market value of capital = 1,00,00,000 + 6,21,000 + 9,70,000 + 8,00,000
= Rs.1,23,91,000
W
e
=
1, 00, 00, 000
1, 23, 91, 000
= 0.81
W
p
=
6, 21, 000
1, 23, 91, 000
= 0.05
W
d
=
9, 70, 000
1, 23, 91, 000
= 0.08
W
t
=
8, 00, 000
1, 23, 91, 000
= 0.06
W = 1.00
Weighted Average Cost of Capital using market value weights
= (0.81)(14.8) + (0.05)(14.68) + (0.08)(8.83) + (0.06)(9.60) = 14.0%.
51. (b) Cost of equity,
k
e
=
1
0
D
P
+ g =
2.50
45
+ 0.08 = 13.56%
Cost of preference capital,
k
p =
F P
D +
n
F+P
2
=
100 97
11 +
5
100+97
2
= 11.78%.
52. (e) Cost of term loan,
k
t
= I(1 t) = 14 (1 0.35) = 9.1%.
53. (c)
Market value proportions (Rs. in lakh) Weights
Equity capital 1800 0.71
Preference capital 242.5 0.09
Term loan 500 0.20
2542.5 1.00
Average cost of capital = 0.71 x 13.56% + 0.09 x 11.78% + 0.20 x 9.1% = 12.51%.

Part II
677
e
):
k
e
=
1
0
D
P
+ g
D
1
= Rs.1.50 per share (given)
P
0
=
450
30
= Rs.15 per share
g = 5% (given)
k
e
=
1.50
15
+ 0.05 = 0.15 i.e., 15%.
55. (a) Cost of retained earnings (k
r
):
Cost of retained earnings = Cost of equity capital
k
r
= k
e
= 15%.
56. (b) Cost of debenture capital (k
d
):
k
d
=
F P
I(1 t) + (1 t)
n
F+P
2

I = 100 12% = Rs.12 per debenture
F = 100 (1.03) = Rs.103 per debenture
P = Rs.93 per debenture.
n = 10 years (given)
t = 0.35 (given)
k
d
=
103 93
12(1 0.35) + (1 0.35)
10
103+93
2

=
12(0.65) 1(0.65)
98
+
=
(12 1) (0.65)
98
+

= 0.0862 i.e., 8.63% (approx.).
57. (d) Cost of term loan (k
t
):
K
t
= (0.14)(1 0.35) = (0.14)(0.65) = 0.091 i.e., 9.1%.
58. (c)
Long-term source of finance Market value
(Rs. In lakh)
Weight (W)
Equity share capital and retained
earnings
450 (given) W
0
= 450/1362 = 0.330
12% non-convertible debentures 384 (given) W
1
= 384/1362 = 0.282
14% term loan 528 W
2
= 528/1362 = 0.388
Total 1,362 Total 1,000
Weighted Average Cost of Capital using market value weights = w
e
k
e
+ w
d
k
d
+ w
t
k
t

= (0.330)(0.15) + (0.282)(0.0862) + (0.388)(0.091) = 0.1091 i.e., 10.91%.
59. (c) The required rate of return for the shareholders = Risk-free rate of return + Risk premium
= 6 + 8 = 14 percent while the cost of issuing external equity is 2 percent as a percentage of
the current market price. Therefore, the cost of external equity capital to the company is
approximately 14/0.98 = 14.3%.

678
60. (d) The overall capitalization rate for the company is given by,

k
e
= k
e

B S
k
e
B S B S
+
+ +

= 9

100 200
12 3 8 11
100 200 300
+ = + =
+
percent
While the overall capitalization rate is also defined as:
K
e
=
Net Operating income of the firm
Market value of the firm

Here, the market value of the firm is Rs.100 lakh + Rs.200 lakh = Rs.300 lakh
Net operating income = Rs.300 11 percent = Rs.33 lakh.
61. (c) Cost of irredeemable preference share = Dividend rate = 12 percent.
62. (b) The cost of equity capital to the company is = 10 + 2 = 12 percent while the cost of debt
capital is given as 10 percent. As per the question, the debt equity ratio is 1.5.
Therefore, the weighted average cost of capital is given by:
K
e
= 12 0.40 + 10 0.60 (1 0.40) = 4.80 + 3.60 = 8.40 percent
Hence, the required weighted average cost of capital is 8.40 percent.
63. (b) Face Value = Rs.100 while the redemption price is Rs.105.
Coupon interest amount payable by the company is Rs.9.00 per year.
So, the approximate cost of debenture capital to the company is:
k
d
=
( )
105 97.50
9 1 0.40
5
(105 97.50) / 2

+

+
=
10.50 0.60
101.25
= 0.0622 percent = 6.22 percent.

Hence, the required cost of debentures to the company is 6.22 percent.
64. (d) Calculation of breaking points:
Source of
Finance
Cost
(percentage)
Range of new
financing
(in Rs. lakh)
Breaking Point
Range of total
new financing
(in Rs. lakh)
14.00 0 150 150/0.4 = 375 0 375
15.00 150 400 400/0.4 = 1000 375 1000 Equity
16.00 400 and above 1000 and above
15.00 0 20 20/0.1 = 200 0 200
Preference
8.00 0 100 100/0.5 = 200 0 200
9.00 100 350 350/0.5 = 700 200 700 Debt
Hence the required marginal cost of capital for the
new financing = 15 0.40 + 16 0.10 + 9 0.50 = 6 + 1.60 + 4.50 = 12.10 percent.
Alternative Method:
The amount of equity capital required
= Rs.600 lakh 40 percent
= Rs.240 lakh preference capital
= Rs.600 lakh 10 percent
= Rs.60 lakh and debt capital
= Rs.600 lakh 50 percent = Rs.300 lakh.
Part II
679
In the respective ranges, the costs of funds will be = 15 percent for the equity shares, 16
percent for the preference shares and 9 percent for the debt capital.
Hence, the weighted average cost of capital for the
new financing will be = 15 0.40 + 16 0.10 + 9 0.50 = 6 + 1.60 + 4.50 = 12.10%.
65. (a) Let the issue price of the debentures be Rs.100 and the realized yield be k. The amount to
be invested at present is Rs.105 as the debentures are selling at 5 percent premium.
So, by the condition, we get as:
Rs.105 = Rs.10.00 (1 0.40) PVIFA
(k, 6)
+ Rs.100 PVIF
(k, 6)

At k = 5 percent, the RHS = 105.056 that may be approximately equated to 105
Hence, the cost of debenture funds to the company is = 5.00 percent.
66. (c) The cost of the term loan for the company is K
t
= 12 (1 0.35) = 12 0.65 = 7.80%.
67. (b) The post tax weighted average cost of capital for the company is obtained from the
following
K
c
= W
e
K
e
+ W
d
K
d
Where K
e
and K
d
are the post-tax costs of equity and debt respectively.
= ( )
200 120
16 12 1 0.4
200 120 200 120

+

+ +

=
200 120
16 12 0.6
320 320
+ = 12.70 %.
68. (b) The cost of equity for Tractor India is:
K
e
=
( )
0 1
0 0
D 1 g D
g g
P P
+
+ = + =
3 1.08
0.08 0.1340
60
+ = = 13.40%
Hence, the cost of external equity will be =
0.134
0.98
= 0.1367 = 13.67 percent.
69. (b) The share price for the company is given as:
Year March
2000
March
2001
March
2002
March
2003
Share Price at the beginning (Rs.) 67.00 72.00 80.00 84.21
Share Price at the end (Rs.) 72.00 80.00 84.21 90.00
Dividend (Rs.) 1.80 2.40 3.20 4.50
From the above table, the wealth ratio is obtained as:
=
t t t t t t t t
t 1 t 1 t 1 t 1
2000 2001 2002 2003
D P D P D P D P
P P P P

+ + + +

=
1.80 72 2.40 80 3.20 84 4.50 90.00
67 72 80 84.21
+ + + +

= 1.1015 1.1444 1.09 1.125 = 1.5457
So the realized yield = ( )
{ }
1/ 4
1.5457 1 100% = 11.50% (approximately)
The required amount of realized yield = 11.50 percent.
70. (b) Let, the cost of the debenture capital be Rs. 100.
Here, P = Rs.97, F = Rs.100, C = Rs.10, t = 40 percent and n = 5 years.
680
Now, the approximate cost of debenture capital is given as:
K
d
=
( )
F P
C 1 t
n
F P
2
+
+

So, the approximate cost of debenture capital
K
d
=
( )
100 97
10 1 0.40
6.6 5
0.067
100 97 98.5
2

+

= =
+

or K
d
= 6.70 percent
Hence, the required cost of the debenture capital is = 6.70 percent.
71. (d) Calculation of the breaking points:
Source Cost (%) Range (in Rs. lakh) Breaking Point
(Rs. in lakh)
Range of total
new financing
14 0 160 160/0.40 = 400 0 400
15 160 320 320/0.40 = 800 400 800
Equity
16 320 and above 800 and above
12 0 100 100/0.20 = 500 0 500
13 100 200 200/0.20 = 1000 500 1000
Preference
Capital
14 200 and above 1000 and above
8 0 120 120/0.4 = 300 0 300 Term loan
10 120 and above - 300 and above
Here, the amount actually invested is Rs.900 lakh comprising of Rs.360 lakh of equity
capital, Rs.180 lakh of preference capital and term loan of Rs.360 lakh.
Hence, the weighted cost of capital = 16 0.4 + 13 0.20 + 10 0.40 = 13.00 percent.
72. (d) Cost of debt = I (1 t) = 9%.
73. (d) Cost of external equity
1
e e
K =K /1 f
Where

1
e
K = cost of external equity
K
e
= required rate of return
f = cost of issue

1
e
K
=
0.17/ 1 0.06 = 18.10%.
74. (c)
K
0
= O/V = Net operating income/Market value of the firm

K
0
= K
d
(B/B+ S) + K
e
(S/B+S)

= 0.14(40/100) + 0.16(60/100)
= 0.056 + 0.09 = 0.152
Net operating income = K
0
x Market value of the firm = 0.152 x 100 = 15.2%.
75. (d) The cost of equity
1
e
0
D
K g
P
= +
= 1.5/17 + 0.08 = 16.82%.
Part II
681
76. (c) Present value of tax shield = t
c
Br/r
where, t
c
= corporate tax rate
B = market value of debt
r = interest rate on debt
= (0.4 x 500 x 0.16)/ 0.16 = 200 lakhs.
77. (c) Cost of equity can be expressed as K
e
= K
0
+ (K
0
K
d
) B/S
= 0.2 + (0.2 0.15) 0.67 = 23.35%.
78. (c) The cost of preference share capital which is perpetual or irredeemable is equal to K
p
the
following equation P = D / (1 + K
p
)t where P = net amount realized per share of preference
capital, D = Preference dividend per share payable annually and K
p
= D/P

Hence cost of preference share = 10/ 96 = 10.42%.
79.

(c) Cost of debt = I (1 t) = 0.15 (1 0.4) = 9 %.
80. (b) The cost of equity
1
e
0
D
K g
P
= +
Where D
1
= dividend expected at the end of year 1
g = constant growth rate applicable to dividends
P
0
= price per equity share
D
1
= D
0
(1 + g)
Cost of equity = 4.5 (1 + 0.07) / 90 + 0. 07 = 12.35%.
81. (e) Weighted average cost of capital = W
e
K
e
+ W
d
K
d
(1 t)
= 10,00,000/15,00,0 0 x 0.18 + 5,00,000/15,00,000 x 0.13 (1 0.35) = 14.82%.
82. (a)

The cost of equity
1
e
0
D
K g
P
= +
Where D
1
P = price per equity share
D
1 = D
0
(1 + g)

Cost of equity = 2 (1 + 0.12) / 80 + 0.12 = 14.8%.
83. (b) Cost of debt = I(1 t) = 0.18 (1 0.35) = 11.7%.
84. (a) Weight W = 50% or 0.5
Addition to firms weighted average = K
d
W
d
(1 t)
Where K
d = cost of debt

W
d
= Weight

t = Tax rate
= 0.12 x 0.5 (1 0.35) = 3.9%.
85. (a) ROE = NP margin x Asset turnover x Assets/equity
0.16 = 0.08 x 0.0125 x Assets / Equity
Assets/Equity = 1.6
0.2 = 0.08 x 0.0125 x Assets/Equity
Assets/Equity = 2
Increase in Assets/Equity ratio = 2 1.6 = 0.4.
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682
86. (c) Post-tax cost of debt is given by
d
I(1 t) (F P) / n
K
(F P) / 2
+
=
+

where,
I is the annual interest payment per debenture capital

d
10(1 0.35) + (102 98)/8
K
(102 + 98)/2

=
Cost of debt = 7%.
87. (c) D
10
= D
1
(1 + g)
10

4 = 1.5 (1 + g)
10

g = 10.31%
P = D
11
/ r g
60 = (4 + 0.4124) / r 0.1031
r = 17.66%.
88. (d) Cost of external equity
1
e e
K K /1 f =
Where
1
e
K

K
e
= Required rate of return
f = Cost of issue
K
e
= 16.67 (1 0.04) = 17.36%.
89. (e)
K
0
= 0.18 x 0.67 + 0.15 x 0.33
= 17.01%

90. (b) Post-tax cost of debt is given by

d
I (1 t) (F P) / n
K
(F P) / 2
+
=
+

I is the annual interest payment per debenture capital

(60 54)
15(1 0.40)
6
(60 54)
2
+
=
+

Cost of debt = 17.54%.
91. (c) The cost of equity
1
e
0
D
K g
P
= +
Where

D
1
P
0
= price per equity share
Cost of equity = 1.4/ 67 + 0.10 = 30.09%.
Deleted: e
Part II
683
92. (b)
Where
K
j
The CAPM is represented by
k
j
= R
f
+ j (k
m
R
f
)
R
f
j = beta coefficient of security j
K
m
Required rate of return 0.16 = 0.08 + j (0.11 0.08) = 2.67.
93. (b) The cost of retained earnings is equal to the rate of return expected by the equity investors.
K
e = K
r
. Hence the cost of retained earnings = 22% which is the rate of return for equity
investors.
94. (b) Cost of equity can be expressed as
K
e
= K
0
+ (K
0
K
d
) B/s = 0.12 + (0.12 0.10)2 = 14%.
Cost of equity can be expressed as
K
e
= K
0
+ (K
0
K
d
) B/S = 0.12 + (0.12 0.10)2 = 14%.
Dividend Policy
95. (b) Price of the share, when dividend is not declared:

1 1
0
e
D +P
P
(1+K )
=
P
1
= P
0
(1 + K
e
)D
1
= 150(1 + 0.15) 0 = 172.5.
96. (a) P
1
= P
0
(1 + K
e
) D
1
= 150 (1 + 0.15) 9 = 163.5
Price of the share is Rs.163.5, when dividend is declared.
97. (c)
1
1
I (E nD )
M =
P

=
50, 00, 000 (48, 00, 000 5, 00, 000 x 9)

163.5

= 28,746 shares
No. of shares to be issued are 28,746.
98. (e) Rate of return (r) = 18%
Capitalization rate (K
e
) = 15%
As r > K, the company should retain the profits and payout should be 0%.
99. (c) Price per share when dividend payout is 0%.
P =
e
e e
r(E D)/K D
K K
+ =
0 0.18(7 0)/0.15
0.15 0.15
+ = 0 + 56 = Rs.56.
100. (a) Calculation of DP ratio and PE ratio of Company ABC
Year EPS DPS DP ratio Avg. Price PE Ratio
1 8.54 1.00 11.7% 75.6 8.85
2 6.89 1.25 18.1% 89.45 12.98
3 10.56 1.50 14.2% 92.4 8.75
25.99 3.75 257.45
The average DP ratio for Company ABC = 3.75 25.99 = 0.1442 or 14.42%
The average PE ratio for Company ABC = 257.45 25.99 = 9.90.

Deleted:
Deleted: Ke
Deleted: P1
684
101. (c) Calculation of DP ratio and PE ratio of Company XYZ
Year EPS DPS DP ratio Avg. Price PE Ratio
1 8.75 0.90 10.28% 65.00 7.42
2 6.5 1.10 16.92% 54.78 8.42
3 10.11 1.65 16.32% 100.00 9.89
25.36 3.65 219.78
The average DP ratio for Company XYZ = 3.65 25.36 = 0.1439 or 14.39%
The average PE ratio for company ABC = 219.78 25.36 = 8.66.
102. (a) DP ratio = 25%, dividend per share = 3.25; r 0.14
P =
0.14
0.16
3.25 ( )(13 3.25)
0.16
+
=
3.25 (0.875)(9.75) 11.78
73.6.
0.16 0.16
+
= =
103. (b) If r = 18% = 0.18
P =
0.18
0.16
3.25 ( )(13 3.25)
0.16
+
=
3.25 (1.125)(9.75) 14.21
88.8.
0.16 0.16
+
= =
104 (c) K
e
= 14%
E = Rs.18
(1b) D/P ratio = 40%
(b) Retention ratio = 60%
P =
e
E(1 b)
K br
=
18(1 0.60)
0.14 (0.60)(0.15)
=
7.2
Rs.144
0.05
= .
105. (a) If D/P ratio = 60%, b= 40%
P =
e
E(1 b)
K br
=
18(1 0.4)
0.14 (0.40)(0.15)
=
10.8
Rs. 135.
0.08
=
106. (a) The value of the firm, when dividends are paid:
P
0
=
1 1
e
1
(D +P )
(1+K )

140 =
1
1
(6+P )
(1.14)

P
1
= Rs.153.6
Price per share at the end of year 1 = Rs.153.6
Amount to be raised by the issue of new shares

1 1
n P = I (E nD
1
) = 7,50,000 (5,00,000 (1,00,000)6) = 8,50,000
Number of additional shares to be issued
n
1
=
8, 50, 000
153.6
shares
Value of the firm
nP
0
=

1 1
e
(n+n )P I+E
(1+K )

=
_ _
(1,00,000+8,50,000/153.6) 153.6 (7.50,000 5,00,000)
1.14

Value of the firm, nP
0
= Rs.1,40,00,000.

Deleted:
Part II
685
107. (a) Value of the firm when dividends are not paid:
Price per share at the end of the year 1
P
0
=
1 1
e
1
(D +P )
(1+K )

140 =
1
P
(1.14)

P
1
= Rs.159.6
Amount to be raised from the issue of new shares n
1
P
1
= (7,50,000 5,00,000) = 2,50,000
Number of new shares to be issued n
1
= 2,50,000/159.6
Value of the firm: nP
0
=

1 1
e
(n+n )P I +E
(1 K )
+

=
(1,00,000+2,50,000/159.6)159.6 (7,50,000 5, 00,000)
(1.14)

= Rs. 1,40,00,000
108. (d) P =
e
e e
r(E D)/K D
K K
+ when payout ratio is 10% or dividend is Rs.2.

P =
2 0.13(20 2)/0.15
0.15 0.15
+ when 13.33 + 04 = Rs.117.33.

109. (e) When payout ratio is 30%, dividend is Rs.6
P =
6 0.13(20 6)/0.15
0.15 0.15
+ = 40+80.88 = Rs. 120.88.

110. (d) When payout ratio is 60%, dividend is Rs.12
P =
12 0.13(20 12)/0.15
0.15 0.15
+ = 80 = 46.22 = Rs. 126.22.

111. (c)
Market price at dividend payout 10% = Rs.117.33
Thus, Market price per share is maximum at 60% payout which will maximize the
wealth of share holders.
112. (d) P
0
=
e
EPS(1 b)
_
K br
; K
e
=
0
EPS(1 b)
br
P

+
EPS = 18; K
e
= ?; P
0
= 55 ;
d = 0.55; b = 1 d = 0.45
br = 0.45 x 0.13 = 0.0585
K
e
=
18(1 0.45)
0.0585
55
+ = 0.2385 or 23.85%
Cost of equity capital = 23.85%.
113. (b) Price of the share at the end of the year if dividend is not declared.
P
1
= P
0
(1+K
e
)D = 150 (1+0.17) 0 = Rs.175.5.
114. (d) Price of the share when dividends are paid
P
1
= P
0
(1+K
e
)D
1
= 150 (1+0.17) 9 = Rs.166.5.
686
115. (b) According to Gordons dividend capitalization model
P
0
=
EPS(1 b)
k br
e

where, P
0
= Present market price; EPS = Earnings per share; b = Retention ratio; r = 14%;
k
e
= Cost of equity capital; br

= Growth rate (g) of earnings and dividends.
br = 0.55 0.14 = 0.077
k
e
=
0
EPS(1 b)
+br;
P

d = 0.45; b = 1 d = 0.55
=
12(1 0.55)
0.077
40
+ = 21.2%
Cost of equity capital = 21.2%.
116. (d) Gordons dividend capitalization model is
P =
e
E(1 b)
k br

where, P = Market price per share; E = Earnings per share; B = Retention ratio;
(1 b) = Dividend pay-out ratio; k
e
= Cost of equity; r = Internal rate of return.
b = 0%; P =
Rs.20(1 0)
0.14 0
= Rs.142.85.
117. (d) Gordons dividend capitalization model is
P =
e
E(1 b)
k br

b = 25%; P =
Rs.20(0.75)
0.14 0.25 0.12
= Rs.136.36.
118. (b) Gordons dividend capitalization model is
P =
e
E(1 b)
k br

b = 40%; P =
Rs.20(0.6)
0.14 0.4 0.12
= Rs.130.4.
119. (e) Gordons dividend capitalization model is
P =
e
E(1 b)
k br

b = 50%; P =
Rs.20(0.5)
0.14 0.5 0.12
= Rs.125.
120. (b) Gordons dividend capitalization model is
P =
e
E(1 b)
k br

b = 75%; P =
Rs.20(0.25)
0.14 0.75 0.12
= Rs.100.
Part II
687
121. (a) Gordons dividend capitalization model is
P =
e
E(1 b)
k br

b = 100%; P =
Rs.20(0)
0.14 0.75 0.12
= 0.
122. (a) When the retention ratio is increasing, the market price per share is falling down. This
implies that according to Gordons theory, when cost of equity is more than IRR, when the
retention ratio increases, the market price per share falls.
123. (c) Since market price of the share = Sum of present values of dividends and market price at
the end of the year.
P
0
=
1 1
e
D +P
(1+k )

where,
P
0
= Present market price
D
1
and P
1
= Dividend and market price expected a year hence
k
e
= Cost of equity capital.
Substituting, we get
Rs.30 =
1
Rs.2+P
(1.15)

or P
1
= Rs.32.5 = Market price expected at the end of the year.
124. (d) Let the number of new shares the company has to issue to meet the investment requirements = n1.
If MM theory holds good,
nP
0
=
1
e
(n +n1) P I +E
(1+k )

where,
n = Number of outstanding shares
n
1
= Number of new shares to be issued
I = Proposed investment
E = Current years earnings
On substitution, we get (40,000 Rs.30) =
1
(40,000+n )Rs.32.5 Rs.1,00,000+Rs.25,000
(1.15)

Solving, we get, n
1
= 4,769 shares.
125. (a) Present market price of the share = Rs.25
Since it is growing at the rate of 6% expected market price at the end of the year
= Rs.25 (1.06) = Rs.26.50
According to MM theory,
Additional equity capital = Proposed investment (Retained earnings)
where,
Retained earnings = Earnings during the period Dividend amount.
Symbolically,
n
1
P
1
= I (E nD
1
)
where,
n
1
= Number of new shares to be issued
688
P
1
= Market price at the end of the year
I = Proposed investment
E = Earnings during the period
n = Number of shares outstanding
D
1
= Dividend at the year-end.
On substitution,
3,000 Rs.26.5 = Rs.85,000 (E 30,000 Rs.3)
Solving, we get E = Rs.95,500
Hence the earnings of the firm during the year = Rs.95,500.
126. (b) Walters model is given by
P =
e
e e
r(E D)/k D
+
k k

Where, P = Market price of the share in Rs.
D = Dividends/share
E = EPS
k
e
r = Internal rate of return
Given EPS = Rs.20
At 20% pay-out DPS = Rs.4
When, r = 20%,
D = Rs.4
P =
Rs.4 0.2(Rs.20 Rs.4)/0.1
+
0.1 0.1
= Rs.40 + Rs.320 = Rs.360

D = Rs.8
P =
Rs.8 0.2(Rs.20 Rs.8)/0.1
+
0.1 0.1
= Rs.80 + Rs.240 = Rs.320

D = Rs.12
P =
Rs.12 0.2(Rs.20 Rs.12)/0.1
+
0.1 0.1
= Rs.120 + Rs.160 = Rs.280.

127. (c) Walters model is given by
P =
r(E D)/k D
e
+
k k
e e

Given EPS = Rs.20
When, r = 15%
i. D = Rs.4
P =
Rs.4 0.15(Rs.20 Rs.4)/0.1
+
0.1 0.1
= Rs.40 + Rs.240 = Rs.280

Part II
689
ii. P =
Rs.8 0.15(Rs.20 Rs.8)/0.1
+
0.1 0.1
= Rs.80 + Rs.180 = Rs.260

P =
Rs.12 0.15(Rs.20 Rs.12)/0.1
+
0.1 0.1
= Rs.120 + Rs.120 = Rs.240.

128. (a) When r = 6%
i. D = Rs.4
P =
Rs.4 0.06(Rs.16)/0.1
+
0.1 0.1
= Rs.136
ii. D = Rs.8
P =
Rs.8 0.06(Rs.12)/0.1
+
0.1 0.1
= Rs.80 + Rs.72 = Rs.152
iii. D = Rs.12
P =
Rs.12 0.06(Rs.8)/0.1
+
0.1 0.1
= Rs.120 + Rs.48 = Rs.168.
129. (a) The pay-out ratios are calculated as follows: =
DPS
EPS

Year EPS (Rs.) DPS (Rs.) Pay-out Ratio
1999 12.7 3.0 0.236
2000 16.1 3.5 0.217
2001 14.3 3.7 0.259
2002 15.6 4.5 0.288
2003 22.5 5.5 0.244
130. (b) The P/E ratios are calculated as follows: =
Avg. market price
EPS

Year EPS
(Rs.)
DPS
(Rs.)
Pay-out
Ratio
Average
Price
P/E Ratio
1994 12.7 3.0 0.236 117.0 9.21
1995 16.1 3.5 0.217 115.0 7.14
1996 14.3 3.7 0.259 83.0 5.80
1997 15.6 4.5 0.268 90.5 5.80
1998 22.5 5.5 0.244 61.5 2.73
131. (c)
Year EPS
(Rs.)
DPS
(Rs.)
Pay-out
Ratio
Average
Price
P/E Ratio EPS/3
EPS
DPS+
3
M =
P
D+(E/3)

1994 12.7 3.0 0.236 117.0 9.21 4.233 7.233 16.17
1995 16.1 3.5 0.217 115.0 7.14 5.367 8.867 12.97
1996 14.3 3.7 0.259 83.0 5.80 4.767 8.467 9.80
1997 15.6 4.5 0.268 90.5 5.80 5.200 9.700 9.33
1998 22.5 5.5 0.244 61.5 2.73 7.500 13.000 4.73

690
132. (a) Walter model
P =
D+(E D) (r/K )
e
K
e

where,
P = Market price per share
E = Earnings per share = Rs.5
D = Dividend per share = Rs.3
r = Return earned on investment = 15%
K
e
= Cost of equity capital = 12%
P =
0.15
3 (5 3)
0.12
0.12
+
=
3 2.5
0.12
+
= Rs.45.83.
133. (e) According to Walter model, when the return on investment is more than the cost of equity
capital, the price per share increases as the dividend pay-out ratio decreases. Hence, the
optimal pay-out ratio in this case is nil.
134. (c) According to Walter model, when the return on investment is more than the cost of equity
capital, the price per share increases as the dividend pay-out ratio decreases. Hence, the
optimal pay-out ratio in this case is nil. So, at a pay-out ratio of zero, the market value of the
companys share will be:

0.15
0 (5 0)
0.12
0.12
+
= Rs.52.08.
135. (b) Net profit for the company = Rs.240 lakh 12.50 percent = Rs.30 lakh
Profit available for the equity shareholders = Rs.30 lakh Rs.12 lakh (preference dividend)
= Rs.18 lakh and the amount of EPS is Rs.4.00
According to Gordons dividend capitalization model,
P =
c
E(1 b)
k br
=
4 (1 0.40)
0.12 0.40 0.16

Here, E = Rs.4, b = 40 percent, k
c
= 12 percent and r = 16 percent.
Or, P =
2.4
0.12 0.064
=
2.4
0.056
= Rs.42.857 = Rs.43 (approximately)
Hence, the required market price per share = Rs.43.
136. (e) Wealth ratio is defined as
t t
t 1
D P
P
+
for any year. Here, the year wise wealth ratio is given
by:
Year 1 2 3 4
Wealth Ratio
1.50 12
10
+

= 1.35
2.00 13
12
+

= 1.25
2 15
13
+

= 1.308
2.50 18
15
+

= 1.367
Now, the realized yield over the period of 4 years will be
= {(1.35 1.25 1.308 1.367)
1/4

1} 100 = (1.31797 1) 100 = 31.797
= 32% (approximately).

Part II
691
137. (d) Net profit = Rs.30 lakh
Less: Preference Dividends = Rs.12 lakh
Earnings for the equity shareholders = Rs.18 lakh
Therefore, earnings per share = 18/3 = Rs.6.00
Let, the dividend pay out ratio be x and so the share price will be:
P =
c
c c
r(E D) / k D
k k
+
Here, D = 6x, E = Rs.6, r = 0.20 and k
e
= 0.16 and P = Rs.42
Hence, Rs.42 =
0.2(6 6x) 6x
0.16 0.16 0.16

Or, Rs.42 = 37.50 x + 46.875 (1 x) or, 9.375 x = 4.875 or, x = 0.52.
So, the required dividend pay-out ratio will be = 52 percent.
138. (d) Walters model on dividend capitalization states that:

( )
e
e e
r E D / K
D
P
K K
= +
Here, the earnings per share for the company = Rs.500,00,000/50,00,000 = Rs.10 and the
amount of dividend paid per share = Rs.10 40 percent = Rs.4.00 per share.
Therefore, we have, E = Rs.10, D = Rs.4, r = 16 percent and K
e
= 12 percent.
So, the market price per share, according to Walters model is given as:
P =
( ) 0.16 10 4 / 0.12
4
33.33 66.67
0.12 0.12
+ = + = Rs.100
Hence, the required market value of the share as per Walters model will be = Rs.100
139. (b) Here, the profit after tax = Rs.2.50 crore (1 0.40) = Rs.1.50 crore and the amount of
dividend paid = Rs.1.50 crore (1 0.40) = Rs.0.90 crore = Rs.90,00,000
Hence, the amount of dividend paid per share = 90/50 = Rs.1.80
According to the Gordons capitalization model,
The share price p =
( )
e
E 1 b
K br

Here, E(1 b) = Rs.1.80, K
e
= 12%, r = 15% and b = 0.40.
P =
1.80 1.80
Rs.30
0.12 0.15 0.4 0.06
= =

Hence, the share price will be P =
( )
1.80
0.12 0.40 0.15
=
1.80
0.06
= Rs.30.
140. (b) Market value of debt =
rate tion capitaliza Debt
expense Interest
=
12
0.10
= Rs.120 lakh
Total market value of the firm =
firm the for rate tion capitaliza Overall
income operating Net

=
40
0.125
= Rs.320 lakh
Market value of equity = Total market value of the firm Market value of debt
= 320 120 = Rs.200 lakh.
Equity capitalization rate =
equity of value Market
earnings Equity
=
28
200
= 0.14 i.e., 14%
692
According to the net operating income approach : k
e
= k
0
+ (k
0
k
d
) B/S
Let the market value of debt after increase be B.
Market value of equity = Total market value of the firm Market value of debt = 320 B.
k
e
16%
0.16 0.125 + (0.125 0.10)
B
(320 B)

or 0.035
0.025B
320 B

or 11.20 0.035B 0.025B
or 11.20 0.06B
or B 186.67 lakhs
Increase in market value of debt due to borrowing =186.67 120 = Rs.66.67 lakh
Hence, the firm can borrow a maximum amount of Rs.66.67 lakh in terms of market value.
141. (c) Gordons equity capitalization model
P = E (1 b) / K br
43 = E (0.6) / 0.09 (0.4 x 0.12)
E = 3.01
Net profit = EPS x Number of shares = 3.01 x 12000 = 36,120.
142. (a)
0 1 1
e
1
P (D P )
(1 K )
= +
+

180
1
1
(20 P )
(1 0.14)
= +
+

P
1
= 185.2.
143. (c) Gordons equity capitalization model
P = E (1 b) / K br
P = 4 (0.4) / 0.2 0.15
Hence, value of the stock P = 32.
144. (a) Gordons equity capitalization model
P = E (1 b) / K br
P = 15 (1 0.25) /0.18 (0.08 x 0.25)
P = 70.31.
145. (a) According to Walter model
P =
e
e
D r / K (E D)
K
+

P = {5 + (0.12/0.18)(20 5)}/ 0.18
Price of the share P = 83.33.
146. (c) When 20% stock dividend is declared the number of outstanding shares increases to
1,200. Hence the market price decreases to 41.67 i.e., MP = Total earnings/Number of shares.
147. (c) As per Walter model
P = D/k + [r (E D)/k]/k
35 = 2/0.18 + [0.24 (E 2)/0.18]/0.18
E = Rs.5.23.
Part II
693
148. (b) Gordons equity capitalization model
P = E (1 b)/K br
By using the above formula we get the Earnings per share = 1.125
Net profit = EPS x number of shares = 1.125 x 1, 00,000 = 1,12,500.
149. (c) Sales = Rs. 500 lakh
Cost of goods sold 40% = Rs.200 lakh
Finished goods storage period =
Average Inventory
x365
Annual cost of goods sold

=
(34+46)/2
x365
200
= 73 days.

Average debtors
365
Annual credit sales

=
(45+62)/2
x365
500
= 39 days.
151. (d) Average payment period =
Average creditors
x365
Total purchases

=
(26 36) / 2
365
450
+
= 25 days.
152. (e) Net operating cycle = Finished goods storage period + Avg. collection period
Avg. Payment period
= 73 days + 39 days 25 days = 87 days.
153. (a) Raw material storage period
1. Average stock of raw materials =
30, 000 10, 000
20, 000
2
+
=
2. Annual consumption of raw materials = Opening stock + purchases closing stock
= 30,000 + 15,000 10,000 = 35,000.
3. Average daily consumption of raw materials =
35, 000
97.22.
360
=
4. Raw material storage period =
20, 000
=205.7 days or 206 days
97.22

Average conversion or work-in-progress period
1. Average stock of work-in-progress =
20, 000 32, 500
26, 250
2
+
=
2. Annual cost of production
= opening work in progress + consumption of materials + manufacturing Expenses
Closing work in progress.
= 20,000 + 35,000 + 20,000 32,500 = 42,500
3. Average daily cost of production =
42, 500
118
360
=
4. Average Conversion period =
26.250
118
= 222 days.
694
154. (c) Finished goods storage period
1. Average inventory of finished goods: =
15,000 + 17,500
16, 250
2
=
2. Annual cost of sales = Opening stock of finished goods + Cost of production + Selling,
administration and financial expenses + Custom and excise
duties closing stock of finished goods.
= 15,000+42,500+20,000+15,00017,500 = 75,000
3. Average daily cost of sales =
75, 000
208.33
360
=
4. Finished goods storage period =
16, 250
78 days.
208.33
=
155. (c) Average Collection period
1. Average book debts = 500 , 21
2
000 , 35 000 , 8
=
+

2. Annual sales = 1,10,000
3. Average daily sales =
1,10, 000
305.5
360
=
4. Average collection period =
21, 500
70 days.
305.5
=
156. (d)
1. Average Creditors =
10, 000 5, 000
7, 500.
2
+
=
2. Annual Purchases = 15,000.
3. Average daily purchases =
15, 000
41.67
360
=
4. Average Payment Period =
7, 500
179.98 180days
41.67
= .
157. (a) Net operating cycle
= Raw materials storage period + Average conversion period + Finished goods storage
period + average collection period Average payment period
= 205.7 + 222 + 78 + 70 180
= 395.7 days or 396 days.
158. (e) 1. Duration of operating cycle
R + W + F + D C
R =
Average stock of raw materials
Average raw materials consumed per day
=
40
90 days
160/ 360
=
W =
Average WIP
Average cost of production per day
=
15
22 days
250/ 360
=
F=
Average stock of finished goods
Average cost of sales per day
=
40
80 days
180/ 360
=
D =
Average accounts recievable
Average credit sales per day
=
x
1.28 x
280/ 360
=
Part II
695
C =
Average accounts payable
Average credit purchases per day
= 60 days
140 = 90 + 22 + 80 + 1.28 x 60
8 = 1.28x
x = F =
8
6.25.
1.28
=
159. (b) Raw material storage period
Average inventory of raw material =
280 260
2
+
= 270
Annual consumption of raw material = Opening stock + Purchases Closing stock
= 280 + 420 260 = 440
Average daily consumption of raw materials =
440
360
= 1.222
Raw materials storage period =
270
1.222
= 220.9 days 221days.
160. (c) Work-in-process period
Average stock of WIP =
120 130
2
+
= 125
Annual cost of production = Opening WIP + Consumption of materials + Production costs +
Depreciation Closing WIP
= 120 + 440 + 330 + 90 130 = 850
Average daily cost of production =
850
360
= 2.36
Average WIP period =
125
2.36
= 53 days.
161. (d) Finished goods storage period
Average inventory of finished goods =
140 120
2
+
= 130
Cost of sales per year
= Opening inventory of finished goods + Cost of production + Selling and
administration cost + Excise duty Closing stock of finished goods
= 140 + 850 + 600 + 140 120 = 1610
Average daily cost of sales =
1610
360
= 4.47
130
4.47
= 29.08 days 29days.
Average accounts receivable =
240 225
2
+
= 232.5
Annual sales = 1,800
Daily sale =
1,800
360
= 5
232.5
5
= 46.5 days 47days.
696
163. (b) Average payment period
Average balance of trade creditors =
180 195
2
+
= 187.5
Annual purchases = 420
Average daily purchases =
420
360
= 1.167
187.5
1.16
= 160.7 161 days.
164. (c) Operating cycle without any change = 221 + 53 + 47 + 29 161 = 189 days.
If the investment in purchases is doubled to Rs.8,40,000 annual consumption of raw
material = 280 + 840 260 = 860
Average daily consumption =
860
360
= 2.39
i. Raw materials storage period
=
270
2.39
= 112.9 days 113 days.
Daily cost of production =
120 860 330 90 130
360
+ + +

= 3.53
ii. WIP period =
125
3.53
= 35.4 days 35 days.
iii. Average daily purchases =
Annual Purchases
360
=
840
360
= 2.33
iv. Average collection period =
232.5
8.33
= 27.9 days 28days.
v. Average payment period =
187.5
2.33
= 80.5 81days.
Daily sales =
3000
360
= 8.33
Incorporating these four changes in the equation for operating cycle we get
113 + 35 + 28 + 29 81 = 124 days.
Operating cycle decreases by 65 days.
165. (b)
Total sales = Rs.1,000 700 = Rs.7,00,000
Credit Sales = Rs.7,00,000 (10% of Rs.7,00,000) = Rs.6,30,000
Purchase of raw materials and stores = 20% of Rs.7,00,000 = Rs.1,40,000
Manufacturing expenses = Fixed cost + Variable cost
= Rs.1,20,000 + Rs.400 700 = Rs.4,00,000
i. Raw material storage period
Average stock of raw material =
40 45
2
+
= 42.5
Consumption of raw material per year = 40 + 140 45 = 135
Part II
697
Daily consumption =
135
360
= 0.375
Raw material storage period =
42.5
0.375
= 113.3 days 113 days.
ii. Stock-in-process period
Average stock of work-in-progress =
35 55
2
+
= 45
Annual cost of production = 35 + 135 + 400 + 30 55 = 545
545
360
= 1.51
Average conversion period =
45
1.51
166. (a) Finished goods storage period
80 90
2
+
= 85
Annual cost of sales = 80 + 545 + 40 + 30 90 = 605
605
360
= 1.68
85
1.68
= 50.57 days 51days.
167. (a)
Average collection period
Average book debts =
90 100
2
+
= 95
Annual credit sales = 630
630
360
= 1.75
95
1.75
Average payment period
120 70
2
+
= 95
Average daily purchase =
140
360
= 0.389
95
0.389
= 244 days.
168. (a) Total sales = Rs.10,000 36,000 = Rs.36,00,00,000 per month = Rs.36 crore per month
Cost of sales = Rs.0.8 36 crore = Rs.28.8 crore per month
Raw material costs = Rs.0.6 28.8 0.5 crore = Rs.8.64 crore per month
Manufacturing costs = Rs.0.6 28.8 0.5 crore = Rs.8.64 crore per month
Selling and Administrative costs = Rs.28.8 (2 8.64) crore = Rs.11.52 crore per month

698
Investments in current assets can be calculated as follows:
I. Raw material
i. in raw material = Rs.8.64
10
30
cr = Rs.2.88cr
ii. in WIP= Rs.8.64
12
30
cr = Rs.3.46cr
iii. in finished goods = Rs.8.64
18
30
cr = Rs.5.18cr
iv. in debtors = Rs.8.64 3 cr = Rs.25.92cr
Rs.37.44cr.
II. Manufacturing expenses

in WIP = Rs.
12
30
8.64 0.5 = Rs.1.728 cr

in finished goods = Rs.
18
30
8.64 = Rs.5.184 cr
in debtors = 3 Rs.8.64 = Rs.25.920 cr
Rs.32.83 cr.
169. (c)
III. Selling and administrative costs

in finished goods = Rs.11.52 x
18
30
cr = Rs.6.912cr
in debtors = Rs.11.52 3 cr = Rs.34.560cr
Rs.41.472cr.
IV. Profit in debtor = Rs.36 0.2 3 cr. = Rs.21.6 cr.
170. (d) Gross working capital required = I + II + III + IV
= 37.44 + 32.83 + 41.47 + 21.6
= Rs.133.34 crore.
171. (b) Investment in various current assets:
Input Period
(months)
RM WIP FG Debtors Total
1. Raw material
In stock 11 2 22.5 22.5
In WIP 1 2 7.5 7.5
In FG 1 15.0 15.0
In Debtors 3 45 45.0
90.0
2. Manufacturing expenses
In WIP 1/2 2.50 2.50
In FG 1 5.0 5.00
In Debtors 3 15 15.00
22.50
3. Overhead
In FG 1 12.5 12.5
In Debtors 3 37.5 37.5
50.0
4. Profit
In Debtors 3 22.5 22.5
22.5 10.00 32.5 120.0 185.00
Part II
699
Working Note:
Raw material consumed per month =
6 30
12
= Rs.15 lakh
Manufacturing expenses per month =
6 10
12
= Rs.5 lakh
Overhead per month =
6 25
12
= Rs.12.5 lakh
Profit per month =
6 15
12
= Rs.7.5 lakh
Alternatively, investment in current assets can also be worked out as follows:

(Rs. lakh)
Raw materials inventory 15 1.5 22.50
Work-in-progress inventory
Raw material content 15 0.5 7.50
Manufacturing expenses 5 0.5 2.50 10.02
Finished goods inventory
Raw material content 15 1 15.00
Manufacturing expenses 5 1 5.00
Overheads 12.5 1 12.50 32.50
Debtors
Raw material content 15 3 45.00
Manufacturing expenses 5 3 15.00
Overheads 12.5 3 37.50
Profit 7.5 3 22.50 120.00
Total investment in current assets 185.00
172. (c)
Let, gross working capital = x
Cash balance = 0.05x
x = 185 + 0.05x
or, 0.95x = 185.00
or, x = Rs.194.74 lakh.
173. (e) During of operating cycle = R + W + F + D C
R =
Averagestock of rawmaterials
Averagerawmaterials consumedper day
=
35
120 360
= 105 days
W =
Average WIP
Average cost of production per day
=
10
210 360
= 17.1 days
F =
Averagestock of finished goods
Averagecost of sales per day
=
30
240 360
= 45 days
D =
Averagecredit sales per day
=
X
300 360
= 1.2X days
C =
Average accounts payable
Averagecredit purchases per day
= 75 days
105 = 105 + 17.1 + 45 + 1.2X 75
700
X =
12.9
1.20
= 10.75
Average accounts receivable =
Opening balance+Closing balance
2

10.75 =
15+Closing balance
2

Closing balance of accounts receivable = Rs.6.5 lakh.
174. (d) The amount of credit sales = Rs.150 lakh Rs.30 lakh = Rs.120 lakh
Hence, the average credit sales per day will be = Rs.
Rs.120lakh
360
= Rs.33,333
The average accounts receivables during the year = (8 + 12) / 2 = Rs.10 lakh
So, the average collection period will be =
10, 00, 000
33, 333
= 30 days.
175. (e)
Quarter Average collection period
First 750
(480 540 550) / 90 + +
= 43 days < 45 days
Second 700
(400 450 450) / 91 + +
= 49 days > 45 days
Third 850
(500 550 600) / 92 + +
= 47.4 days > 45 days
Fourth
800
(500 600 600) / 92 + +
= 43.3 days < 45 days
The sales manager is required to take corrective measures for the second and third quarters.
176. (b) The amount of raw materials purchased during the year = 700 + 50 30 = Rs.720 lakh.
Average daily credit purchases made by the company =
720
360
= Rs.2 lakh per day while
average balance of sundry creditors is given by
79 93
2
+
= Rs.86 lakh
Hence, the average payment period will be =
86
2
= 43 days.
177. (e) Annual benefit = Rs.50,000 5 0.12 = Rs.30,000.
178. (a) The net weighted benefit from that order is given by:
0.85{0.95 18,000 0.05 72,000} = 0.85 (17,100 3600) = 0.85 13,500 = Rs,11,475.
179. (c) The operating cycle of a firm is defined as:
= Raw material storage period + Average conversion period + Finished Goods storage period
+ Average collection period Average payment period
= 70 + 8 + 18 + 39 - 45 = 90 days.
180. (b) The amount of raw materials consumed
= Opening balance + Purchases during the year Closing balance
= (180,000 + 1192,000 212,000) = Rs.1160,000
The average stock of work in process = (25,000 + 45,000)/2 = Rs.35,000
Part II
701
Annual cost of production = Opening work in process + Consumption of raw materials
+ Manufacturing expenses + Depreciation Closing work in
process
= 25,000 + 1160,000 + 1280,000 + 100,000 45,000
= Rs.25,20,000
So, the average daily cost of production = Rs.7000
Hence, the average conversion period = 35,000/7000 = 5 days.
181. (d) The amount of raw materials consumed = Opening balance + Purchases during the year
Closing balance
= (160,000 + 1242,000 192,000)
= Rs.12,10,000
Annual cost of production = Opening work in process + Consumption of raw materials
+ Manufacturing expenses + Depreciation Closing work in
process
= 25,000 + 12,10,000 + 12,30,000 + 1,00,000 45,000
= Rs.25,20,000
Annual cost of sales = Opening stock of finished goods + Cost of production
+ Selling, administration and financial expenses + Customs
and Excise duties Closing stock of finished goods
= 30,000 + 25,20,000 + 2,30,000 + 1,50,000 50,000
= Rs.28,80,000
Average cost of goods sold per day =
Rs.28,80,000
360
= Rs.8000
( ) 30,000 + 50,000
2
= Rs.40,000
So, the finished goods storage period =
Rs.40,000
8,000
= 5 days.
182. (e)
(in Rs. Lakh)
Input Period
(months)
Raw
materials
Work in
Process
Finished
Goods
Debtors Total
Raw Material
In raw material 2 100
In W I P 1 50
In finished Goods 1 50
In debtors 3 150 350
Manufacturing Expenses
In WIP @ 1/2 10
In finished goods 1 20
In debtors 3 60 90
Selling, Administrative and financial expenses
In debtors 3 30 40
Profit
In debtors 3 60 60
Total 100 60 80 300 540
Hence, the amount of working capital requirement is Rs.540lakh + Rs.10lakh = Rs.550lakh.
702
183. (a) Current ratio = Current assets / Current liabilities
Let the amount to be borrowed be X
1.5 = 2000 + X/ 1200 + X
X = 400 lakh.
184. (c) Average payment period = Average balance of sundry creditors/Average daily credit
purchases
Average daily credit purchases = 24,00,000/360 = 6,667
Average payment period = 75,000/6,667 = 11.249 or 1.25 days.
185. (b) Cash conversion Cycle = Receivables period + Inventory period Payable period
= 35 + 55 40 = 50
186. (d) Raw material storage period = Average stock of raw materials/Average daily
consumption of raw materials
Average stock of raw materials = (Opening stock + Closing stock) / 2
= (2500 + 2000)/2 = 2250
Average daily consumption = Annual consumption / 360
= 13500 / 360 = 37.5
Raw material storage period = 2,250 / 37.5 = 60 days.
187. (a) Operating cycle of the firm = Raw material storage period + Conversion period
+ Finished goods storage period + Average collection
period Average payment period
= 80 + 5 + 10 + 25 60 = 60 days.
188. (b) Tandon Committee Method I:
Rs. in lakh
Total Current Assets 750
Less: Current liabilities other than bank
borrowings
350
Working Capital gap 400
25% of above from long-term sources 100
Maximum permissible bank borrowings
(75% of 400)
300.
189. (a) Tandon Committee Method II:
Rs. in lakh
Total Current Assets 750.00
25% above from long term sources 187.50
75% of current Assets 562.50
borrowings
350.00
212.50
Working capital gap 400
Maximum permissible bank finance 212.50.
190. (e) Tandon Committee Method III:
Rs. in lakh
Total Current Assets 750.00
Less: Core Current Assets from
(long-term) sources
200.00
Real Current Assets 550.00
25% of above long-term sources 137.50
412.50
borrowings

350.00
Maximum permissible bank finance 62.50
Part II
703
191. (d) Current ratio under Tandon committee Method I:

750
1.15
650
=
Current ratio under Tandon Committee Method II:

750
1.33
562.50
=
Current ratio under Tandon Committee Method III:

750
1.81
412.50
= .
192. (c) MPBF under Tandon Committee Method I :
Current Assets (Rs.lakh)
Raw materials 300
Work-in-progress 200
Finished goods 100
Debtors 100
Cash at bank 200
Total 900

Current Liabilities (Rs. lakh)
Trade Creditors 150
Bills Payable 300
450
The MPBF under Tandon Committee method I:
Total Current assets 900.00
less: Current liabilities
other than bank borrowings
450.00
Working Capital gap 450.00
25% of above from long-term
sources
112.50
Maximum Permissible Bank
Finance (75% of 450)

337.50
193. (c) MPBF under Tandon Committee Method II:
Rs. in lakh
25% of above long term
sources
225
75% of current Assets 675
Less: current Liabilities other
than bank borrowings
450
MPBF 225
194. (b) MPBF under Tandon Committee Method III:
Rs. in lakh
Less: Core Current Assets 100
Real Current Assets 800
25% of above long-term
sources
200
600
Less: Current liabilities other

450
MPBF 150
704
195. (a) Current ratio under Tandon Committee Method I:

900
1.14
787.50
=

900
1.33
675
=
Current ratio under Tandon Committee Method III

900
1.50
600
= .
196. (b) MPBF under Tandon Committee Method I:
Rs. in lakh
Total Current Assets 1,100
Less: Current liabilities other

300
Working capital gap 800
25% of above long-term
sources

200
MPBF (75% of 800) 600
197. (d) MPBF under Tandon Committee Method II:
Rs. in lakh
Total Current Assets 1,100
Less: 25% of above long-term
sources
275
75% of Current Assets 825
Less: Current Liabilities other

300
MPBF 525
198. (c) MPBF under Tandon Committee Method III:
Rs. in lakh
Total Currents Assets 1100.00
Less: Core Current Assets 275.00
Real Current Assets 825.00
25% of above long-term sources 206.25
618.75
borrowings 300.00
318.75
199. (d) Current ratio under Tandon Committee Method I:

1100
1.22
900
=

1100
1.33
825
=
Current ratio under Tandon Committee Method III:

1100
1.77
618.75
=

Part II
705
200. (c) Method-I of Tandon Committee Recommendations:
Maximum Permissible Bank Finance (MPBF) = 0.75 (Current Assets Current Liabilities)
(in Rs. 000)
Current Assets Current liabilities
Cash in bank 9 Accounts payable 24
Raw materials 43 Provision for tax 47
Work-in-progress 30
Finished goods 35 Provision for dividend 18
91-day T-Bills 18 Trade creditors 63
Investment in CP &CD 20 Provision for depreciation 19
Deep discount bonds 28
Accounts receivable 87 Interest payable 9
270 180
MPBF = 0.75(270 180) = 67.5 or = Rs.67,500.
201. (a) Method-II of Tandon Committee Recommendations:
Margin from borrower = 25% of total current assets
MPBF = (0.75CA) CL = (0.75 x 270) 180
MPBF = Rs.22.5 or Rs. 22,500
Note: Since no additional information about Outstandings from export sales and
Provision for purchase of market yard, they have not been included under the heads current
assets and current liabilities respectively.
202. (a) Method I
Total current assets = Rs.960 lakh
Less: Current liabilities other than bank borrowings = Rs.300 lakh
Working capital Gap = Rs.660 lakh
Maximum permissible bank finance = 75 percent of the working capital gap
= Rs.660 0.75 = Rs.495 lakh
Method II
Total current assets = Rs.960 lakh
Less: 25 percent of the current assets
that is to financed by using long term funds = Rs.240 lakh
Less: Current liabilities other than bank finance = Rs.300 lakh
Working capital gap = Rs.420 lakh
Hence, the maximum permissible bank borrowings = Rs.420 lakh.
203. (c) Cost of trade credit =
Rateof discount
1 Rateof discount
x
Numberof daysin a year
(Credit period Discount period)

= 0.02 / 1 0.02 x 360 /30 10
Hence, the cost of trade credit is 36.73%.
204. (c) Implied interest rate for foregoing a cash discount or Cost of trade credit
=
Rateof discount
1 Rateof discount
x
= 0.04
= 0.04/1 0.04 x 360/45 15 = 50%
Hence, the cost of trade credit is 50%.
706
205. (d) Cost of trade credit
=
Rateof discount
1 Rateof discount
x
= 0.02/1 0.02 x 360/45 15
Hence, the cost of trade credit is 24.48%.
206. (b) Under method I, the maximum permissible bank finance
= 0.75 (Current assets Current liabilities)
150 x 0.75 = 112.5 lakh.
207. (c) Cost of trade credit
=
Rateof discount
1 Rateof discount
x

= 0.02 / 1 0.02 x 360 / 45 10
Cost of credit = 20.99%.
208. (e) EOQ =
2UF
PC

U = 4,800 units
F = 300
P = 9
C = 45%
EOQ =
2x4,800x300
843.3units
9x(45/100)
= .
209. (e) No. of orders =
Annual demand
EOQ
=
4,800
5.7orders in a year 6ordersin a year.
843.3
=
210. (c) Time between two consecutive orders
12 months
2.1 months.
5.7orders
=
211. (b)
Total present annual cost:
Buying Cost = 150 3 150 = 67,500.00
Ordering Cost = 3 orders 300 = 900.00
* Carrying Cost =
25 150
150
100 2
= 2,812.50
Total Annual cost = 71,212.50
* Carrying Cost P x C
Q
2

212. (d) Economic Order Quantity (EOQ) =
2 (150 3) 300
2UF
PC Rs.150 25/100

=

= 84.8 units or 85 units.
213. (c) The optimum production quantity per production
run (E) =
2 55,000 120
2UP
S 8

= = 1,285 units.
Part II
707
214. (a) U = 1,50,000 units
F = Rs. 450 per order
P = Rs.90 per unit
C = 25% = 0.25
D =
6
90 5.4
100
=
EOQ, without discount,
Q* =
2 1,50,000 450
2UF
PC 90 0.25

=

= 2,450 units.
215. (a) The total amount of discount available with an order size of (Q
1
) 3,500 units = UD
= 1,50,000 5.4 = 8,10,000.
216. (a) Savings due to reduction in ordering costs:
= Rs.
1
U U
F
EOQ Q

=
1, 50, 000 1, 50, 000
Rs.450
2, 450 3, 500

= (61.2 42.8) 450 = 18.4 450 = Rs. 8,280.
217. (b) Incremental Carrying Cost =
1
Q (P D)C Qx PC
2 2

=
3, 500(90 5.4)0.25 2, 450 90 0.25
2 2

= 37,012.5 27,562.5 = Rs.9450
Net incremental benefits = 8,10,000 + 8280 9450 = Rs.8,08,830.
218. (b) EOQ is calculated as =
2FU
PC

Where, U = Annual usage of the material = 3600 units
F = Cost per order = Rs.225
PC = Carrying cost = Rs.200.
Hence, EOQ =
2 225 3600
200

= 90 units.
219. (d) Reorder point = (lead time x average usage) + safety stock;
Given lead time = 8 days; average usage = 15 units;
EOQ = 90 units
Safety stock = 10% of EOQ = 9 units.
Therefore, Reorder point = (8 15) + 9 = 129 units.
220. (a) The optimum production quantity E is given by
E =
2Ux P
S

where U = Annual output; P = Set up cost for each production run;
S = Cost of carrying inventory/unit per year.
Since purchase price per unit = Rs.160 and carrying cost per year is 20% of the inventory
value.
708
The cost of carrying inventory/unit/year = Rs.160
20
100
= Rs.32.
Given E = 114 units.
114 =
2Ux361
32

Solving for U
We get U = 576 units per year
Hence, the monthly output of the material =
576
12
= 48 units.
221. (e) Assuming 360 days a year, Inventory turnover after TQC =
360
45
= 8
Cost of inventory =
4,80,000
Rs.
8
= Rs.60,000
Inventory turnover before TQC =
360
30
= 12
Cost of inventory =
4,80,000
Rs.
12
= Rs.40,000
Incremental cost of inventory after TQC = Rs.20,000.
The opportunity cost at 10% rate of return on inventory =
10
100
20,000 = Rs.2,000
Since this cost is less than its savings of Rs.6,000, the company should implement its TQC program.
222. (e) Given annual usage = 7,000 units
Fixed cost/order = Rs.700
Purchase price = Rs.100/unit
Carrying cost as a % of inventory value = 5%
EOQ =
2 7,000 700
0.05 100

= 1400 units.
223. (a) Change in profit if the company accepts trade discount of 1% for the purchase of 3500 units

*
*
U U Q (P D) C Q PC
=UD+ F
Q 2 2 Q

where,
= Change in profit
U = Annual usage/demand
D = Discount per unit when quantity discount is available
Q = Minimum order size required for quantity discount
F = Fixed cost of placing an order
P = Unit purchase price without discount
C = Inventory carrying cost expressed as a percentage.

7000 7000
= 70001+ - 700
1400 3500

3500(100 1) 0.05 1400 100 0.05
2 2

= Rs.7000 + Rs.2100 Rs.5162.5 = Rs.3937.5
Since this change in profit is positive, the company can go in for the trade discount.
Part II
709
224. (b) Given, Normal consumption during lead time = 2000 units.
Probability that usage exceeds normal consumption during lead-time
by 200 units = 0.15
by 400 units = 0.12
by 600 units = 0.08.
Optimum safety stock is the point at which the total of stock-out cost and carrying cost is
minimum.
The cost of safety stock is calculated at various points, as shown below.
Costs of safety stock
Safety
stock
(in units)
Stock-out
(in units)
Stock-out
cost at Rs.5
per unit
Probability
Expected
Stock-out
cost (Rs.)
Carrying cost
of Rs.0.50
per unit
(Rs.)
Total cost
(Rs.)
S T A = T x 5 B C = (AxB) D = S x 0.5 C + D
600 0 0 0 0 300 300
400 200 1,000 0.08 80 200 280
200 400 2,000 0.08 160 100
200 1,000 0.12 120
280 100 380
0 600 3,000 0.08 240 0
400 2,000 0.12 240 0
200 1,000 0.15 150 0
630 0 630
Since the total cost is minimum when the safety stock is 400 units, it is the optimum safety
stock.
225. (d) Expected Daily Usage Rate = 200 0.30 + 600 0.45 + 800 0.25 = 530 units
Expected Lead Time = 13 0.35 + 16 0.50 + 22 0.15 = 15.85 =16 days
Normal Consumption during Lead Time = 530 16 = 8,480 units
226. (d) Normal Consumption during Lead Time = 530 16 = 8,480 units
Daily usage rate Lead Time in days Possible levels of usage
Units Probability Units Probability Units Probability
13 0.35 2,600 0.1050
200 0.30 16 0.50 3,200 0.1500
22 0.15 4,400 0.0450
13 0.35 7,800 0.1575
600 0.45 16 0.50 9,600 0.2250
22 0.15 13,200 0.0675
13 0.35 10,400 0.0875
800 0.25 16 0.50 12,800 0.1250
22 0.15 17,600 0.0375
Situations with more than 8,480 units consumption (normal usage) are 9,600 (Prob: 0.225),
3,200 (Prob: 0.0675), 10,400 (Prob: 0.0875), 12,800 (Prob: 0.125) and 17,600 (Prob: 0.0375).
The corresponding levels of stock-out are 1120, 4720, 1920, 4320 and 9120 units respectively.
Safety stock can be maintained at any of the above levels.
710
The total cost at different safety stock levels are as follows:
(i) (ii) (iii) (iv) (v) (vi) (vii)
Safety
Stock
Stock-
outs
Probability Expected
Stock-out
(ii) x (iii)
Expected
Stock-out
Cost
(Rs.)
Carrying
Cost
(Rs.)
Total Cost
(Rs.)
(v) + (vi)
9,120 0 0 0 0 3,19,200 3,19,200
4,720 4,400 0.0375 165 14,850 1,65,200 1,80,050
4,320 4,800 0.0375 180 16,200
400 0.0675 27 2,430 1,51,200 1,69,830
1,920 7,200 0.0375 270
2,800 0.0675 189
2,400 0.1250 300
759 68,310 67,200 1,35,510
1,120 8,000 0.0375 300
3,600 0.0675 243
3,200 0.1250 400
800 0.0875 70
1,013 91,170 39,200 1,30,370
0 9,120 0.0375 342
4,720 0.0675 319
4,320 0.1250 540
1,920 0.0875 168
1,120 0.2250 252
1,621 1,45,890 0 1,45,890
As Minimum Total Cost is at a safety stock of 1,120 units, optimum safety stock is
1120 units.
227. (a) Normal Consumption during Lead Time = 8,480 units
Optimum safety stock is 1120 units.
Optimal reorder level = Normal consumption + Safety stock
= 8,480 + 1,120 = 9,600 units.
228. (a) EOQ =
2FU
PC
=
2 3,60,000 500
200 0.2

= 3,000 units
Since the average consumption is equal to EOQ, the stock levels above EOQ should be
analyzed:
Usage (units) Probability
3,300 0.15
3,600 0.12
4,400 0.09
Hence, levels of safety stock to be analyzed are 0, 300, 600 and 1400 units.
Part II
711
229. (d) Computation of total cost under different levels of safety stock:
So, the optimum safety stock level is 100 units,
Level of
safety stock
(units)
Stock-
out
(units)
Stock-out
cost (Rs.)
stock-out cost
(Rs.)
Carrying cost
(Rs.)
Total cost
(Rs.)
(1) (2) (3) = (2) x 100 (4) (5) = (3) x (4) (6) = (1) x
200 x 0.2
(7) = (5) + (6)
1400 0 0 0 0 56,000 56,000
600 800 80,000 0.09 7,200 24,000 31,200
300 1100 1,10,000 0.09 9,900
300 30,000 0.12 3,600 12,000 25,500
0 1400 1,40,000 0.09 12,600
600 60,000 0.12 7,200
300 30,000 0.15 4,500 24,300
As total cost is less when safety stock is nil, it is better not to maintain safety stock. Then the
probability of stock out is 0.09 + 0.12 + 0.15 = 36%.
230. (c) EOQ (or) Average consumption = 3000
Safety stock = 0
Reorder level = EOQ (or) Average consumption + Safety stock
= 3000 + 0 = 3000 units.
231. (a)
Safety
Stock
Expected
Demand
Stock-out
(units)
Stock-out
cost
Probability
of stock-out
Expected
cost of
stock-out
Total cost
of stock-out
1000 1000 0 0 0 0 0
700 1000 300 75,000 0.03 2,250 2,250
500 1000 500 1,25,000 0.03 3,750
700 200 50,000 0.05 2,500 6,250
300 1000 700 1,75,000 0.03 5,250
700 400 1,00,000 0.05 5,000
500 200 50,000 0.08 4,000 14,250
100 1000 900 2,25,000 0.03 6,750
700 600 1,50,000 0.05 7,500
500 400 1,00,000 0.08 8,000
300 200 50,000 0.10 5,000 27,250
0 1000 1000 2,50,000 0.03 7,500
700 700 1,75,000 0.05 8,750
500 500 1,25,000 0.08 10,000
300 300 75,000 0.10 7,500
100 100 25,000 0.15 3,750 37,500
Calculation of total cost at different levels of Safety Stock
Safety Stock (units) Expected Stock-out
Cost
Carrying
Cost
Total
Cost
0 37,500 0 37,500
100 27,250 7,500 34,750
300 14,250 22,500 36,750
500 6,250 37,500 43,750
700 2,250 52,500 54,750
1000 0 75,000 75,000
So, the optimum safety stock level is 100 units, as the total cost is minimum for that level.
712
232. (c) Economic order quantity,
Q
*
=
2FU
PC

F = Ordering cost = Rs.250 per order
U = Annual sales = 75,000 units
P = Purchase price per unit = Rs.25
PC = Carrying cost per unit = Rs.10
C =
10
25
= 0.4
Q
*
=
2 250 75,000
10

= 37, 50, 000 = 1936.49 ~ 1936 units
233. (b) Minimum order size Q > Q*
Change in profit as a result of increasing the order quantity from Q* to Q is

*
*
U U Q (P D)C Q PC
= UD+ F
Q 2 2 Q

where,
= Change in profit
D = Discount per unit = 0.02 25 = Re.0.50
C = Inventory carrying cost given as a % of price per unit
PC = Carrying cost in Rs.

75000 75000
=75000 0.50+ 250
1936 3500

3500(25 0.50)0.4 1936 10
2 2

= 37,500 + [38.7 21.4] 250 [17150 9680]
= 37,500 + 4325 7470 = Rs.34,355
Since the change in profit is positive, the company should avail the quantity discount.
234. (a) EOQ =
2FU
PC
=
2 1500 50
250 0.05

= 109.5 ~ 110 units.

235. (c) Total number of orders =
1500
110
= 13.64 ~ 14 orders.
236. (b) Value of average inventory =
Q P
2
=
110 250
2
= Rs.13,750.
237. (d)
Total cost = Ordering cost + Carrying cost
=
U Q
F + P C
Q 2

=
1500 110
50 250 0.05
110 2
+
= 681.82 + 687.50 = Rs.1,369.32.
238. (c) Normal usage = Average daily usage rate x Average lead-time
Average daily usage rate = 5(0.20) + 10(0.60) + 15(0.20) = 10 tonnes
Average lead time = 20(0.60) + 25(0.40) = 22 days
Normal usage during procurement period = Average daily usage rate Average lead-time
= 10 22 = 220 tonnes.
Part II
713
239. (a) The situations of stock-out will occur only when the usage levels exceed 220 tonnes.
This can be noted from the following table:
Daily usage rate Lead time Level of usage Stock-out
(tonnes)
Tonnes Probability Days Probability Tonnes Probability
5 0.20 20 0.60 100 0.12
25 0.40 125 0.08
10 0.60 20 0.60 200 0.36
25 0.40 250 0.24 30
15 0.20 20 0.60 300 0.12 80
25 0.40 375 0.08 155
The situations of stock-out will arise at usage levels of 250 tonnes (Probability = 0.24),
300 tonnes (Probability = 0.12), 375 tonnes (Probability = 0.08).
Probability of stock-out = 0.24 + 0.12 + 0.08 = 0.44 i.e., 44%, when no safety stock is
maintained.
240. (b) Safety stocks that can be maintained are:
250 220 = 30 tonnes; 300 220 = 80 tonnes and 375 - 220 = 155 tonnes.
Safety
stock
(Tonnes)
Stock-
outs
(Tonnes)
Stock-out
cost (Rs.)
stock-out
cost (Rs.)
Carrying
cost (Rs.)
Total cost
(Rs.)
155 0 0 0 0 2,32,500 2,32,500
80 75 7,50,000 0.08 60,000 1,20,000 1,80,000
30 50 5,00,000 0.12 60,000
125 12,50,000 0.08 1,00,000
1,60,000 45,000 2,05,000
0 30 3,00,000 0.24 72,000
80 8,00,000 0.12 96,000
155 15,50,000 0.08 1,24,000
2,92,000 0 2,92,000
From the above table it can be seen that minimum total cost is Rs.1,80,000 associated with a
safety stock of 80 tonnes. So the optimal level of safety stock is 80 tonnes.
241. (b) The total cost of maintaining inventory is given by:
Rs.
U Q C
.F Rs.
Q 2
+
Here, the average inventory = 500 units, Carrying cost (C) = Rs.25 while the number of
orders =
U
6
Q
=
So, total cost related to the inventories = 6 250 + 500 25 = 1,500 + 12,500 = Rs.14,000
Here, the ordering cost = Rs.2506 = Rs.1500 while the carrying cost is 50025 = Rs.12,500
Hence, the total cost related to the inventories = Rs.1500 + Rs.12,500 = Rs.14,000.
242. (d) The economic order quantity (EOQ) may be calculated as 12,000 units by using
U = 60,000 units, F = Rs.1,200 and PC = Rs.100 1 percent = Re.1 only.
Benefits due to the discounts = Rs.3 60,000 = Rs.180,000
Benefits due to the savings in ordering costs = Rs.1200 (5 3) = Rs.2400.
Incremental carrying costs =
1 *
Q (P D) C Q P C
2 2

=
20, 000 97 0.01 12, 000 100 0.01
2 2

= 9,700 6000 = Rs.3700.
Hence, the net amount of benefits will be = Rs.180,000 + 2400 3700 = Rs.178,700.
714
243. (e) Expected daily usage rate = 180 0.25 + 300 0.45 + 400 0.30 = 45 + 135 + 120 = 300
units and the expected lead time = 20 0.30 + 30 0.40 + 40 0.30 = 6 + 12 + 12 = 30 days.
Hence, the possible level of usage at which the stock out is expected to occur will be
= 300 30 = 9000 units.
Daily usage rate Lead time in days Possible levels of usages
Units Probability Units Probability Units Probability
20 0.30 3600 0.075
30 0.40 5400 0.100
180

0.25
40 0.30 7200 0.075
20 0.30 6000 0.135
30 0.40 9000 0.180 300 0.45
40 0.30 12000 0.135
20 0.30 8000 0.090
30 0.40 12000 0.120 400 0.30
40 0.30 16000 0.090
Therefore, the possible usage levels at which stock-out occurs will be 12,000 units and
16,000 units. The probability of stock-out will be = 0.135 + 0.120 + 0.090 = 0.3450 or
34.50 percent.
244. (b) Expected daily usage during the lead time is
300 0.25 + 500 0.50 + 700 0.25 = 500 units
while the expected lead time is 6 0.30 + 8 0.40 + 10 0.30 = 8 days.
Hence, the normal consumption during the lead time = 500 8 = 4,000 units
245. (c) The economic order quantity is defined as:

*
2UF
Q
PC
=
Here, U = 2500 units, F = Rs.2000, P = Rs.8000 and C = 20 percent of the inventory value.
So,
*
2 2, 500 2, 000
Q 79
8, 000 0.2

= =
units
Hence, the required economic order quantity is 79 units.
246. (b) The reorder point is defined as: RP = S L + F S R L
Here, S = 30 units, L = 15 days, F = 1.25 and R = 400 units
So, R = 30 15 + 1.25 30 400 15 = 980
Hence, the required reorder point is = 980 units.
247. (c) The expected daily usage = 300 0.25 + 500 0.50 + 700 0.25 = 500 units and the
expected lead time = 6 0.30 + 8 0.40 + 10 0.30 = 8 days.
So, the normal consumption during the lead time = 500 8 = 4000 units

Part II
715
Now, the probable situations may be presented in the following table as:
Daily Usage Rate (Units) Lead Time (in days) Possible levels of usage
Units Probability Probability Probability
300 0.25 6 0.30 1800 0.0750
8 0.40 2400 0.1000
10 0.30 3000 0.0750
500 0.50 6 0.30 3000 0.1500
8 0.40 4000 0.2000
10 0.30 5000 0.1500
700 0.25 6 0.30 4200 0.0750
8 0.40 5600 0.1000
10 0.30 7000 0.0750
The possibility of stock out will occur, if the probable level of usage exceeds 4000 units. It is
only possible when the possible levels of usages are 4200, 5000, 5600 or 7000 units. The
probability of its occurrence is (0.150 + 0.075 + 0.100 + 0.075) = 0.40
248. (d) The expected daily usage level = 300 0.30 + 500 0.40 + 700 0.30 = 500 units while
the expected lead time in days will be = 6 0.20 + 8 0.60 + 10 0.20 = 8 days.
The reorder point is defined as RO = S L + ( ) F S R L
= 500 8 + 1.20 (500 200 8) = 5073 units.
Hence, the required reorder point is = 5073 units.
249. (a) The economic order quantity for MAL is Q
*
=
2UF 2 25, 000 500
1443.37
PC 60 0.2

= =

= 1443 units
If the order quantity is 5000 units, net incremental benefit over
EOQ will be = UD +
( )
1 *
* 1
Q P D C Q PC U U
F
Q Q 2

Here, U = 25,000 units, Q
*
= 1443 units, Q
1
= 5000 units, P = Rs.60, D = Rs.5 and C = 20 percent.
So, the net benefit
= 25,000 5 +
25, 000 25, 000
500
1443 5, 000

5, 000 55 0.2 1443 60 0.2
2 2

= 125,000 + 6162.51 18,842 = 112,320.51= Rs.112,321 (approx)
Hence, the profit will increase by Rs.112,321.
250. (d) The weighted average price is given by:

100 9 50 12 150 15
100 50 150
+ +
+ +
=
37.50
300
= Rs.12.50
Hence, the value of the issue will be = Rs.12.50 100 = Rs.1,250.
251. (e) Safety stock = Reorder point Normal consumption during lead time
Since the reorder point is not known safety stock cannot be determined.
252. (b) Expected daily usage rate = 400 x 0.3 + 600 x 0.4 + 800 x 0.3 = 600 units
Expected lead time = 4 x 0.2 + 5 x 0.5 + 6 x 0.3 = 5.1
Normal consumption during lead time
= Expected daily usage rate x Expected lead time = 600 x 5.1 = 3060 units.
716
253. (d) EOQ = 2CP/ S
Where E = Economic order quantity or the optimum production quantity
C = Annual output
P = Set up cost for each production run
S = Cost of carrying
Hence the optimum production quantity = 2x1, 00.000x 4.000/ 2 = 20,000 units.
254. (d) EOQ = 2CP/ S
Where E = Economic order quantity
C = Annual demand
P = Fixed cost per order
Hence the Economic order quantity = (2x10, 000x5, 000) / 25 = 20,000 units
255. (a) Recorder level = S x L + F Sx R xL
L = Lead time in days
R = Average number of units per order
F = Stock out acceptance factor
Hence Reorder level = 1,000 x 10 + 1.2 1, 000x500x10 = 12,683 units
256. (a) EOQ = 2CP/ S
Where E = Economic order quantity or the optimum production quantity
C = Annual output
P = Set up cost for each production run
By using the above formula we get the Economic order quantity
= 2x 40, 000x10, 000/1, 000 = 894 units.
257. (b) EOQ = 2CP/ S
C = Annual demand
P = Ordering cost
= 2x 20, 000x1000/ 500 = 283 units.
258. (d) Total cost = Carrying cost + Ordering cost
= 100 x 3 + 14 x 5 = 300 + 70 = 370.
259. (b) EOQ = 2CP/ S
C = Annual demand
P = Ordering cost
= 2x 20, 000x 48/ 6 = 178.88 or 179 units.

Part II
717
Receivable Management
260. (d) Additional contribution from increased sales:
= Increase in sales revenues
Contribution
Sales Revenue
= Rs.5,70,000
25
Rs.1, 42, 500.
100
=
Additional Receivables
=
Additional Sales Revenue
x Collection period
360 days
=
5, 70, 000
55 days 87, 083.
360
=
261. (a) Additional investment in receivable:
=
Variable Cost
Amount of additional Receivables x
Sales Revenue
=
75
87,083 =65,312.25
100

Cost of financing the additional investment in receivables =
20
65,312.25 =13,062.45.
100

262. (a) Total amount of bad debt losses = New sales bad debt percentage
=
20
5,70,000 =1,14,000
100

Total of additional costs = Costs of financing additional investment in receivables + Amount
of bad debts losses on new sales.
= 13062.45 + 1,14,000 = 1,27,062.45
Net additional benefit = Additional contribution on new sales Cost of financing additional
investment in receivables Amount of bad debts losses on new sales.
= 1,42,500 13062.45 1,14,000 = 15,437.55.
263. (e) The effect of relaxing the credit standards on profit:

n
P S(1 V) K I b S =
P = 5,70,000 0.25 0.20
5,70,000
55 0.75 0.20 5,70,000
360

= 1,42,500 13,062.5 1,14,000 = 15,437.5.
264. (d) Increase in profit due to increase in sales = Rs.72,00,000 0.25 = Rs, 18,00,000 . (a)
265. (c) Existing amount of receivables =
Rs.1, 80, 00, 000
30
360
= 15,00,000
Amount of receivables on existing sales after
Relaxation =
Rs.1,80, 00, 000
55
360
= 27,50,000
Increase in the investment in receivables on existing sales
= 0.75(27,50,000 15,00,000) = Rs. 9,37,500 . (b)
266. (a) Amount of receivables on additional sales =
Rs.72, 00, 000
55
360

Investment in the receivables on additional sales
= Rs. 11,00,000 0.75 = Rs. 8,25,000 . (c)
Incremental investment in receivables = Increase in the investment in receivables on existing
sales + Investment in the receivables on additional sales
= (b) + (c)
= 9,37,500 + 8,25,000 = Rs.17,62,500
718
Cost of financing additional investment in receivables @ 20%
= Rs.17,62,500 0.20 = Rs.3,52,500 . (d)
267. (a) Existing bad debt losses = Rs.1,80,00,000 0.8 = Rs.14,40,000
Bad debt losses after relaxation = Rs.2,52,00,000 0.06 = Rs.15,12,000
Increase in bad debt losses = Rs.15,12,000 14,40,000 = Rs.72,000 . (e)
Incremental costs (d) + (e) = Rs.3,52,500 + Rs.72,000 = Rs.4,24,500
Net incremental benefits a (d + e) = Rs.18,00,000 Rs.4,24,500 = Rs.13,75,500.
268. (b) Accounts receivable before cash discount
= Rs.65,00,000
45
360
= Rs.8,12,500 . (a)
Accounts receivable after cash discount:
= Rs.65,00,000
30
360
= Rs.5,41,667 . (b)
(if the average collection period goes down by 15 days from 45 days, the new collection
period would be 30 days.)
269. (c) Decrease in accounts receivable investment is (a) (b)
= Rs.8,12,500 Rs.5,41,667 = Rs.2,70,833
Cost saved on this reduced investment on receivables at 25%
= Rs. 2,70,833
25
100
= Rs. 67,708.
270. (d) Loss of revenue if cash discount of 3% is used by 75% of sales
= Rs. 65,00,000 0.75 0.03 = Rs. 1,46,250.
Since loss of revenue due to this policy is more than the return on receivables investment, the
new policy should not be implemented.
271. (c) Let the probability of payment in the first order = P
Hence probability of non-payment in the first order = (1 P)
Given, probability of non-payment in the second order = P/3
Hence, probability of payment in the second order =
P
1
3

The decision tree chart can be drawn as shown below.

Hence, the expected profit from the deal
2,000 = p (40,000) (1 P)(1,60,000) + P
P P
1 Rs.40,000 (Rs.1,60,000)
3 3

2 = 40p (1p) 160 + P ( )
P P
1 40 160
3 3

Part II
719
1 = 20p 80 + 80p

+ p
20P 80P
20
3 3

1 = 100P 80 + 20P
2
100P
3

3 = 360P 240 100P
2
or 100P
2
360P + 243 = 0
Solving, we get P = 0.9
Since P is the probability of payment in the first order, the probability of non-payment in the
first order = 0.1
(Note: Rs.2,00,000 Rs.1,60,000 = Rs.40,000 is the profit the company gets when a sale is
made.)
272. (b) Assuming 360 days a year,
New receivables turnover =
360
30 30 +
= 6
New sales turnover if sales increase by 20% = Rs.8,00,000 + Rs.8,00,000 x
20
100

= Rs.9,60,000
Additional sales = Rs.1,60,000
Profitability on additional sales = Rs.1,60,000 x 25% = Rs.40,000 ..... (1)
Additional receivables associated with new sales =
1, 60, 000
6
= Rs.26,667.
273. (a) Hence, additional investment in receivables associated with new sales = 26,667 .... (2)
Since 25% is the profit content.
New level of receivables associated with original sales =
8, 00, 000
6
= Rs.1,33,333 ....(3)
Old level of receivables associated with original sales =
8, 00, 000
12*
= Rs.66,667 .... (4)
*(360 30 = 12)
Incremental receivables in the original sales due to
liberalizing credit term = (3) (4) = 1,33,333 66,667 = Rs. 66,666
Incremental receivables = (4) + (2) = Rs.26,667 + Rs.66,667 = Rs.93,334 ... (5)
Required return on additional investment (at 25% rate of return) incremental investment in
receivables 93,334 x .075 = Rs.70,000
= 0.25 70,000 = Rs.17,500
Since this cost of additional investment (=Rs.17,500) is less than the gross profit on
additional sales (= Rs.40,000), the company may go in for extending the credit period.
274. (e) Present sales = Rs.20,00,000
Cost of goods sold = Rs.16,00,000
Present profitability =
16, 00, 000
1
20, 00, 000

= 20%
720
Policy X
A Additional sales 4,00,000
B Profitability of additional sales (at 20%) 80,000
C Additional bad debt losses
(Additional sales x % bad debt)
16,000
D Additional receivables
(Additional sales/receivables turnover)
1,00,000
E Investment in additional receivables (D x 0.8) 80,000
F Cost of additional investment (E x 0.18) 14,400
G Bad debt loss + Cost of additional investment (C + F) 30,400
H Incremental profitability (B G) 49,600
Note: Receivables turnover for policy X =
12
3
= 4.
275. (b) Present sales = Rs.20,00,000
Cost of goods sold = Rs.16,00,000
Present profitability =
16, 00, 000
1
20, 00, 000

= 20%
Policy Y
A Additional sales 5,00,000
B Profitability of additional sales (at 20%) 1,00,000
C Additional bad debt losses
(Additional sales x % bad debt)
30,000
D Additional receivables
(Additional sales/receivables turnover)
1,66,667
E Investment in additional receivables (D x 0.8) 1,33,337
F Cost of additional investment (E x 0.18) 24,000
G Bad debt loss + Cost of additional investment (C + F) 54,000
H Incremental profitability (B G) 46,000
276. (c) Accounts receivable before cash discount = Rs.24,00,000
35
360
= Rs.2,33,333.
277. (b) Accounts receivable after cash discount = Rs.24,00,000 x
20
360
= Rs.1,33,333
(If the average collection period goes down by 15 days from 35 days, the new collection
period would be 20 days).
278. (a) Decrease in accounts receivable investment = Accounts receivable before cash discount
Accounts receivable after cash discount
= Rs.2,33,333 Rs.1,33,333 = Rs.1,00,000
Decreases in Investment = 1,00,000 x 0.8 = Rs.80,000
279. (a) Cost saved on this reduced investment on receivables at 22%
= Rs.80,000 x 0.22 = Rs.17,600 (Benefit).
280. (d) Loss of revenue if cash discount of 2.5% is used by 70% of sales
= 24,00,000 0.7 0.025 = Rs.42,000.
Since the loss is more than the saving, it is better not to implement the new discount policy.
Part II
721
281. (b) New receivables turnover =
360
40
= 9
New level of receivables associated with original sales =
Rs.45, 00, 000
9
= Rs.5,00,000. (A)
282. (a) Old receivables turnover =
360
30
= 12
Old level of receivables with original sales =
Rs.45,00,000
12
= Rs.3,75,000. (B)
283. (c)
Additional sales = Rs.10,00,000
Profit on additional sales = Rs.10,00,000 x 0.1
= Rs.1,00,000
Less: Loss due to bad
debts @ 6%
= 60,000
40,000
Additional receivables with new credit period =
Rs.10,00,000
9
= Rs.1,11,111
Additional investment in receivables = Rs.1,11,111 0.9 = Rs.1,00,000 (2)
Incremental investment in receivables = (A) (B) = Rs1,25,000 .... (3)
Total incremental investment = (2) + (3) = Rs.1,25,000 + Rs.1,00,000 = Rs.2,25,000 ..... (4)
Cost of this investment = 0.24 Rs.2,25,000 = Rs.54,000 ..... (5)
Net impact on gross profit = 40,000 54,000 = 14,000
i.e., Gross profit will decrease by Rs.14,000 as a result of implementation of new credit
policy.
284. (a) P = S(1 V) kI bnS costs DIS
S(1 V) = 4 0.4 = Rs.1.6 lakh
= (ACP
N
ACP
O
)
0
S
360
+ V
S
360
ACP
N
= (40 30)
8
360
+ 0.6
4
360
40 = Rs.0.489 lakh
k I = 0.489 0.14 = Rs.0.068 lakh
b
n
S = b
n
(S
o
+ S) b
o
S
o

= 0.03 12 0.01 8 = Rs.0.28 lakh
DIS = P
n
(S
o
+ S)d
n
P
o
S
o
d
o

= 0.4(8 + 4) 0.02 0 = Rs.0.096 lakh
Costs = 1.2 1 = Rs.0.2 lakh
P = 1.6 0.068 0.28 0.096 0.2 = Rs.0.956 lakh
As P is positive, the change can be recommended.
285. (b) KI:
Cost of bank finance = Rs.0.09 crore 0.60 0.18 = Rs.0.0097 crore
Cost of own funds = Rs.0.09 crore 0.40 0.16 = Rs.0.0058 crore
Total = 0.0097 + 0.0058 = Rs.0.0155 crore.

722
286. (c)
=
0
S
360
(ACP
O
ACP
N
) + V
S
360
ACP
N

ACP
0
= 0.25 15 + 0.50 30 + 0.25 85 = 40.00
ACP
N
= 0.75 10 + 0.10 45 + 0.15 120 = 30.00
=
8
360
(40 30) 0.80
2
360
30 = 0.22 0.13 = Rs.0.09 crore
NP [S(1 V) DIS] + KI BD
= [2 (1 0.80) 0.01 10 0.75] + 0.0155 2 0.05
= 0.325 + 0.0155 0.1000 = Rs.0.2405 crore
As the profit increases by Rs.0.2405 crore, changing the credit policy is advisable.
287. (c) Loss of contribution due to decrease in sales = S (1 V)
= 10,000 45 (1 0.75) = Rs.1,12,500.
288. (d)
ACP
O
= 30 days, ACP
N
= 35 days
Increase in investment in receivables
= 35
2,10,000 45
360

30
2,10,000 45
360

= 35(26,250) 30(26,250) = 9,18,750 7,87,500 = Rs.1,31,250.
289. (b) Savings in receivable investment due to decrease in sales
=
10, 000 45
360
0.75 35 = Rs.32,812.5
Cost of financing the increased investment in receivables
= (1,31,250 32,812.5) 0.20 = Rs.19,687.5.
290. (a) Savings in discount = 2,10,000 x 45 x 0.03 x 0.30 = Rs.85,050
Change in profit = 85,050 1,12,500 19,687.5 = Rs.47,137.5
As the change in profit is negative, Mr. Basu should not go for withdrawing discount.
291. (a) P = S(1 V) + kI b
n
S DIS
S = Rs.250 lakhs
S = 250 0.10 = Rs.25 lakhs
V = 0.75
k = 0.20
b
n
= 0.05
P
n
= 0.40
d
n
= 2% = 0.02
S(1 V) = 25(1 0.75) = 6.25
ACP
N
= 0.40 10 + 0.60 50 = 34 days
k =
0
S S
k (ACPO ACPN) V ACPN
360 360

=
250 25
0.20 (35 34) 0.75 34
360 360

= 0.20 [0.6944 1.7708] = 0.215
Part II
723
b
n
S = 0.05 25 = 1.25
DIS = P
n
(S
0
+ S) d
n
= 0.40 275 0.02 = 2.2
P = 6.25 0.215 1.25 2.2 = Rs.2.585 lakhs
Ignoring taxes the change in credit terms is expected to increase profit of the company by
Rs.2.585 lakh.
292. (d)
Present sales value = Rs.250 lakh Expected sales = Rs.350 lakh
Bad debt losses = Rs.250 lakh 0.02
= Rs.5 lakh
Discount cost = Rs.350 0.20 0.05 = Rs.3.50 lakh
Bad debt losses = Rs.350 0.04 = Rs.14 lakh
Incremental contribution = Rs.100 0.25 = Rs.25 lakh
Incremental cost of funds
= Rs.250 lakh (45 36)/360 0.12 + Rs.100 lakh 45/360 0.75 0.12 = Rs.1.875 lakh
Net incremental benefits = 25 1.875 (14 + 3.50 - 5) = Rs.10.625 lakh.
293. (b) The cost of trade credit is defined as

( )
Rateof discount Number of daysin a year
1 Rateof discount Credit Period Discount period
=

=
0.01 360 .01 360
0.1212
1 0.01 40 10 0.99 30
= =

= 12.12 percent
294. (c) The average collection period is defined as: =
Average Accounts Re ceivable

Here, the average daily credit sales, as targeted, is Rs.720/360 = Rs. 2.00 lakh
Hence, the maximum amount of average accounts receivable for the year 2004 will be
= Rs.2.00 lakh 30 days = Rs.60 lakh.
295. (b) Increase in contribution = 300,000 20 percent Rs.20 = Rs.12,00,000
Additional investment in the receivables due to the increase in credit period
= ( )
o
N o N
S S
ACP ACP V.ACP
360 360
+
=( )
3, 00, 000 100 60, 000
50 40 0.8 50 100
360 360
+ = Rs.15,00,000
So, increase in the cost of funds invested in the receivables = Rs.15,00,000 0.12
= Rs.1,80,000
Increase in the cost of bad debts = Rs. 100 300,000 20% 5 percent = Rs.300,000.
Hence, the profit of the company will increase by
Rs.12,00,000 1,80,000 3,00,000 = Rs.7,20,000.
296. (b) If the collection program is relaxed, the following financial impacts are possible:
The increase in contribution owing to the increased sales is 0.20 25 12 0.20 = Rs.12 lakh
Increase in the cost of funds invested in the receivables will be
= ( )
0
N o N
S s
ACP ACP ACP V K
360 360

+

724
= ( )
25 12 300 0.2
45 30 45 0.8 0.14
360 360

+

= (12.50 + 6.00) 0.14 = Rs.2.59 lakh
Increase in bad debts will be = Rs.360 2.5 % - Rs.300 1.0% = 9 3 = Rs.6 lakh
Hence, the profit of the company will increase by (12 2.59 6) = Rs.3.41 lakh.
297. (e) Incremental contribution = Rs.60 lakh 0.10 25 percent = Rs.1,50,000
Decrease in the cost of funds blocked in the receivables
= ( )
0
0 N N
S S
k ACP ACP V ACP
360 360

=
60, 00, 000 6, 00, 000
0.10 6 0.75 28
360 360

= 0.10(100,000 35,000) = Rs.6,500
Incremental discount cost = 66 0.30 2 percent = Rs.39,600
So, the profit will increase by = Rs.150,000 + Rs.6,500 Rs.39,600 = Rs.116,900.
298. (a) Existing cost faced by SML of not paying within the discount period
=
period Discount period Credit
360
x
discount of Rate 1
discount of Rate

=
) 10 45 (
360
x
) 01 . 0 1 (
01 . 0

= 0.1039 i.e., 10.39%
Given: Proposed discount = 2%
Discount period = 10 days
Minimum cost to SML of not paying within the discount period = 3 0.1039 = 0.3117
i.e., 31.17%.
Since the values of cash discount percentage and discount period are known, the only
variable that can be modified is the credit period.
Let the modified credit period be C.

) 10 C (
360
x
) 02 . 0 1 (
02 . 0

0.3117
or
3117 . 0
360
x
98 . 0
02 . 0
C 10
or 10 +
3117 . 0 x 98 . 0
360 x 02 . 0
C
or C 33.6 days.
Hence MEL should allow a maximum credit period of 33 days to SML i.e. MEL should
reduce the credit period by 12 days. (Here, 33.6 have not been rounded off to the higher
integral value 34 because doing that will reduce the cost faced by SML below three times the
cost as before. Hence 33.6 have been rounded off to 33 days).
299. (b) The implicit cost of trade credit is given by :

Rateof discount Number of daysin a year
1 Rateof discount Credit period Discount period
=

0.02 360
0.2449 24.50
0.98 40 10
= = =
percent.
Part II
725
300. (e) The expected profit from granting the second credit to AEL, assuming the payment for the
first order has been made by AEL, is:
0.90 {0.95 100,000 0.05 400,000} = 0.9 75,000 = Rs.67,500.
301. (c) Average collection period = Average balance of sundry debtors / Average daily credit sales
= 1,25,000 / 12,500 = 10 days
302. (b) Benefit for a firm = 15,000 x 2 x 0.08 = 2,400 annual benefit.
303. (a) Sales volume = Opening stock + Receivables Closing stock
= 1,000 + 10,000 1,500 = 9,500.
304. (c) Expected profit of granting credit to a customer is the weighted net benefit
= 20,000 x 0.8 50,000 x 0.2 = 6,000.
305. (b) Let the sales be 100
The cost of sales is 0.8 of sales i.e., 0.8 x 100 = 80
Hence the profit on sale 100 80 = 20
Net profit / loss = 20 x 0.85 80 x 0.15 = 17 12 = 5% profit.
306. (d) Profit on sale = 50,000 40,000 = 10,000
Net profit / loss = 10,000 x 0.75 40,000 x 0.25 = 7,500 10,000 = 2,500 loss.
Cash Management
307. (b) By accepting the scheme of the local bank, the company saves 8 days time.
Since collection/day = Rs.9,00,000
Cost of funds = 14%
The firm saves Rs.9,00,000
0.14
8
365
= Rs.2,762 for 8 days
If it maintains a minimum balance of Rs.50,00,000, the firm looses an interest of
Rs.50,00,000
0.14
8 Rs.15, 342 for 8 days
365
=
Since this amount is more than what the company could save, it should not accept the
proposal.
308. (c) Local banks annual fee = Rs. 60,000
Fee for 8 days = Rs.
60, 000
8 Rs.1, 315
365
=
Since this amount is less than the amount the company could save for 8 days (Rs. 2,762), the
company may accept this proposal.
309. (b) The average cash outflow =
Rs.20,000 + 30,000 + 40,000 + 50,000
4
= Rs.35,000
Safety level = 4 35,000 = Rs.1,40,000.
726
310. (a) Cash Budget of Deccan Ltd.
January
Rs.
February
Rs.
Cash balance
(opening)
50,000 28,000
A. Cash in flows:
Cash sales 16,800
Credit Sales
(Previous month)

Total (A) 50,000 44,800
B. Cash outflows:
Purchases (current month)
(Previous month)
12,000

25,000
12,000

Manufacturing expenses 10,000 10,000
Purchase Machine 12,000
Total Payments (B) 22,000 59,000
Cash balance (A-B)
(Closing balance)
28,000 14,200
311. (d)
March
Rs.
April
Rs.
Opening cash balance 14,200 25,000
A. Cash inflows:
Cash sales 28,000 27,200
Credit sales (previous
month)
25,200 44,200
Total (A) 39,000 44,200
B. Cash outflows
Purchases (current
month)
(previous month)

Manufacturing expenses

29,000
25,000

10,000

29,000
29,000

10,000
Purchase Machine
Total Payments (B) 64,000 68,000
Cash balance (A-B) 25,000 23,800
Part II
727
312. (a)
May
Rs.
June
Rs.
Opening cash balance 23,800 25,800
A. Cash inflows:
Cash sales 27,200 32,000
Credit sales 40,800 40,800
Total (A) 44,200 47,000
B. Cash outflows:
Purchases (current month)
(previous month)
31,000
29,000
29,000
31,000
Manufacturing expenses 10,000 10,000
Purchase Machine
Total Payments 70,000 70,000
Cash balance (AB) 25,800 23,000
313. (c) Total annual credit sales = Rs. 25,00,000 0.6 = Rs.15,00,000
Number of working days = 300
Credit sales per day = Rs.
15, 00, 000
300
= Rs. 5,000.
314. (a) Annual interest on Rs.5,000 @6% = Rs.5,000 0.06 = Rs.300
This amount is annual savings for one day. Since the float is being reduced by two days.
Annual savings = Rs.300 2 = Rs.600.
315. (d) Let the break even time period be t months
Hence; Rs.1,00,000 = Rs.50,00,000 0.12
t
12

t = 2 months or 60 days
Hence, the firms investment horizon should be for more than 60 days.
316. (b) By accepting the scheme of the private bank, the company saves 4 days time.
Since collections/day = Rs.6,00,000 and Cost of funds = 10%,
The firm saves Rs.6,00,000
0.1
365
4 = Rs.657.5 for four days
If it maintains a minimum balance of Rs.10,00,000 the firm looses an interest of
Rs.10,00,000
0.1
365
4 = Rs.1096 for four days
Since this amount is more than what the company could save, it should not accept the
proposal.
317. (c) Private banks annual fee = Rs.40,000
Fee for four days =
40,000
Rs. 4
365
= Rs.438.35
Since this amount is less than the amount the company could save for four days (= Rs.657.5),
the company may accept this proposal.
318. (c) Total annual credit sales = Rs.600,00,000 0.8 = Rs.480,00,000
Number of working days = 300
Credit sales per day =
480,00,000
Rs.
300
= Rs.1,60,000.
728
319. (b) Annual interest on Rs.1,60,000 @9% = Rs.1,60,000 x 0.09 = Rs.14,400
This amount is annual savings for one day.
Since the float is being reduced by two days,
Annual savings = Rs.14,400 2 = Rs.28,800.
320. (a) Income for 15 days = Rs.20,00,000 0.08
1 1
2 12
= Rs.6,667
Income for one month = Rs.20,00,000 0.08 1
1
12
= Rs.13,333.
321. (b) Income for two months = Rs.20,00,000 (0.08) 2
1
12
= Rs.26,666
Income for four months = Rs.20,00,000 (0.08) 4
1
12
= Rs.53,333.
322. (a) Income for six months = Rs.20,00,000 (0.08) 6
1
12
= Rs.80,000.
Income for one year = Rs.20,00,000 (0.08) 12
1
12
= Rs.1,60,000.
323. (b) Income for 15 days = Rs.6,667
Income for one month = Rs.13,333
Income for two months = Rs.26,666
Income for four months = Rs.53,333
Income for six months = Rs.80,000
Income for one year = Rs.1,60,000
From 4th month onwards the income is more than the expenditure of Rs.50,000. Hence the
firm may invest for 4, 6 or 12 months.
324. (d) Let the break even time period be t months.
Hence, Rs.50,000 = Rs.20,00,000 (0.08)
t
12

Solving for t, we get t = 3.75 months (or) 90 + 22 = 112.5 days
Hence, the firms investment horizon should be for more than 112.5 days.
325 (a) The cash budget is shown as follows
Item January February March
Receipts
Cash sales 36,000 48,500 43,000
Collection from debtors 36,000 48,500
Bank loan
Total 36,000 84,500 91,500
Payments
Materials 25,000 31,000
Salaries & Wages 10,000 12,100 10,600
Production overheads 6,000 6,300
Selling overheads 5,500 6,700
Sales commission 2,160 2,910 2,580
Capital Expenditure 8,000
Dividend
Total 12,160 59,510 57,180
Net cash flow 23,840 24,990 34,320
Opening balance 72,500 96,340 121,330
Closing balance 96,340 121,330 155,650
In the absence of information for amounts to be taken under collection from debtors, payment
to materials, production overheads, selling overheads for the month of January are taken as nil.
Part II
729
326. (c)
Item April May June
Receipts
Cash sales 44,300 51,250 54,350
Collection from debtors 43,000 44,300 51,250
Bank loan 30,000
Total 87,300 125,550 105,600
Payments
Materials 25,500 30,600 37,000
Salaries & Wages 25,000 22,000 23,000
Production overheads 6,000 6,500 8,000
Selling overheads 7,500 8,900 11,000
Sales commission 2,658 3,075 3,261
Capital Expenditure 25,000
Dividend 35,000
Total 91,658 71,075 117,261
Net cash flow (4,358) 54,475 (11,661)
Opening balance 155,650 151,292 2,05,767
Closing balance 1,51,292 2,05,767 1,94,106
327. (b) Cash budget
January February March
Cash inflows
Collection from sales
i. Current month 450,000 585,000 675,000
ii. Previous months sale 700,000 1,050,000 1,365,000
Total inflow (I) 1,150,000 1,635,000 2,040,000
Cash outflows
Production cost
1

1,440,000 1,370,000 1,300,000
Fixed expenses 200,000 200,000 200,000
Selling expense
i. Current months (80%) 80,000 104,000 120,000
ii. Previous months 30,000 20,000 26,000
Total outflow (II) 1,750,000 1,694,000 1,646,000
Opening cash balance 80,000 80,000 81,000
Net cash flow (I II) (600,000) (59,000) 394,000
Borrowings required (at the
end of month)
600,000 60,000*
Repayment of loan 3,80,000
Interest (6,00,000 x 0.10 x
x 0.10 x )
10,500
Closing cash balance 80,000 81,000 84,500
328. (a) Calculation of cost of production
January
Desired closing inventory (units) (A) 56,000
(+) Current months sale (B) 20,000
() Opening inventory (C) 42,000
Required production (units)
(A) + (B) (C)
34,000
Production cost:
Fixed 250,000
Variable cost @Rs.35 1,190,000
Total cost of production 1,440,000
*Assumed that repayments should also be in multiples of Rs.10,000.
730
329. (d) Calculation of cost of production
February
(A) + (B) (C)
32,000
Production cost:
Fixed 250,000
330. (b) Calculation of cost of production
March
(A) + (B) (C)
30,000
Production cost:
Fixed 250,000
331. (a) Balance as per passbook
Day 1 2 3 4 5 6 7 8 9
Opening balance 20,000 20,000 20,000 20,000 48,000 76,000 104,000 117,000 130,000
Cheques realized 28,000 28,000 28,000 28,000 28,000 28,000
Cheques debited 15,000 15,000 15,000
Closing balance 20,000 20,000 20,000 48,000 76,000 104,000 117,000 130,000 143,000
The steady state condition is reached on day 7.
332. (a) Balance as per companys book
Day 1 2 3 4 5 6 7 8 9
Opening balance 20,000 33,000 46,000 59,000 72,000 85,000 98,000 111,000 124,000
Cheques deposited 28,000 28,000 28,000 28,000 28,000 28,000 28,000 28,000 28,000
Cheques issued 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000
Closing balance 33,000 46,000 59,000 72,000 85,000 98,000 111,000 124,000 137,000
From the day 6, the balance as per passbook is greater than the balance as per companys
book by a sum of Rs.6,000. Therefore, the net float is Rs.6,000. Here the net float is positive.
333. (d)
Month January February March
Sales 20,00,000 16,00,000 10,00,000
Inflows
Collections: Current months 6,00,000 4,80,000 3,00,000
Previous months 14,70,000 14,00,000 11,20,000
Total cash receipts 20,70,000 18,80,000 14,20,000
Outflows
Raw material cost 6,30,000 6,00,000 4,80,000
Direct labor cost 9,00,000 7,20,000 4,50,000
Other operating expenses 3,00,000 3,00,000 3,00,000
Capital expenditure 1,50,000
Tax payments 1,80,000
Total cash payments 18,30,000 17,70,000 14,10,000
Net cash flow 2,40,000 1,10,000 10,000
Opening cash balance 1,57,500 1,50,000 1,20,000
Desired closing cash balance 1,50,000 1,20,000 75,000
Investment 2,47,500 1,40,000 55,000
Part II
731
334. (c)
Balance as per the cash book
Day 1st January 2nd January 3rd January
Opening balance Rs.100,000 Rs.93,000 Rs.86,000
Cheques Deposited Rs.18,000 Rs.18,000 Rs.18,000
Cheques Issued Rs.25,000 Rs.25,000 Rs.25,000
Closing balance Rs.93,000 Rs.86,000 Rs.79,000
Balance as per the pass book
Day 1 2 3
Opening balance Rs.100,000 Rs.100,000 Rs.118,000
Cheque Deposited Rs.18,000 Rs.18,000
Cheque Issued Rs.25,000
Closing balance Rs.100,000 Rs.118,000 Rs.111,000
Net float = Rs.111,000 Rs.79,000 = Rs.32,000 and positive.
335. (d) Cash budget for the month of November 2003
November
a. Opening Balance Rs.100,000
b. Inflows:
Sales realizations: Current month
Previous month
Rs.300,000
Rs.250,000

c. Outflows:
Purchases Rs.250,000
Wages Rs.150,000
Administrative Expenses Rs.80,000
Payment for the equipment Rs.20,000
Total Rs. 500,000
d. Closing Balance (a + b c) Rs.150,000
Therefore, the required closing balance by the end of the month of November will be
= Rs.150,000.
336. (a) Safety level of cash = Desired days of cash at the business period x Average of the
highest daily cash outflows.
Since desired days of cash to the business are not given we assume that it is one day.
Thus, safety stock = 1 x 89,000/4 = 22,250.
337. (d) Contribution / Sales = 0.2
Sales Variable cost / Sales = 0.2
Variable cost = 80,000
Profit = Sales Variable cost = 20,000.
338. (b) Net float = Payment float Collection float
= 2,000 750 = 1,250.
732
339. (a) The NPVs of the 4 projects are as follows:
Project NPV Rs. in Lakh @ 17% Rank
A 6.5 3.199 18 = 2.79 III
B 2.0 3.199 5 = 1.39 IV
C 3.5 3.199 6.5 = 4.69 II
D 4.5 3.199 9 = 5.39 I
340. (a) The BCR of the 4 projects are as follows:
Project BCR Rank
A 20.79/18 = 1.15 IV
B 6.39/5 = 1.27 III
C 11.19/6.5 = 1.72 I
D 14.39/9 = 1.59 II
341. (c) Funds available is Rs.10 lakh. A is ruled out, it can be either of B, C & D.
342. (d) The average annual net cash flow = 6 + 7.2 + 2.25 / 3 = 5.15.
343. (c) Average annual net cash flow = 5.15
=
Initial outlay 10
1.94
Average annual cash flow 5.15
= =
From the PVIFA table find that interest rate at which the PV of an annuity of Re.1 will be nearby
equal to 1.94 in 3 years i.e., the duration of the project.
By the trial and error process
The NPV at r = 15% will be equal to:
= 13 + (6 0.870) + (7.2 0.756) + (2.25 0.658)
= 13 + 5.22 + 5.44 + 1.48 = 0.86.
The NPV at r = 16%
= 13 + (6 x 0.862) + (7.2 x 0.743) + (2.25 x 0.641)
= 13 + 5.17 + 5.35 + 1.44 = 1.04
The NPV at r = 14%
= 13 + (6 0.877) + (7.2 0.769) + (2.25 0.675)
= 13 + 5.26 + 5.53 + 1.52 = 0.69.
The NPV at r = 12%
= 13 + (6 0.893) + (7.2 0.797) + (2.25 0.712)
= 13 + 5.358 + 5.738 + 1.602 = 0.30
Part II
733
the NPV at r = 11%
= 13 + (6 0.901) + (7.2 0.812) + (2.25 0.731)

= 13 + 5.406 + 5.846 + 1.644 = 0.10
The NPV at r = 10%
= 13 + (6 0.909) + (7.2 0.826) + (2.25 0.751)
= 13 + 5.45 + 5.94 + 1.68 = 0
We find that at r = 10%, the NPV is zero and therefore IPR of the project is 10%.
344. (e) If the firm starts producing the bolts, it saves = 50,000 Rs.5 50,000 4
= 2,50,000 2,00,000 = Rs.50,000 annually.
Cash flow (in Rs.)
Year
0 1 2 3
Initial
expenditure
40,000
Annual savings 50,000 50,000 50,000
Depreciation (10,000) (7,500) (5,625)
PBT 40,000 42,500 44,375
PAT @45% tax 18,000 19,125 19,968
PAT + Dep 28,000 26,625 25,593
Hence NPV for the proposal (in Rs.) = 40,000 +
2 3
28, 000 26, 625 25, 593
1.14 (1.14) (1.14)
+ +
= 40,000 + 24,561 + 20,474 + 17,275 = Rs.22,310
Since NPV is Rs.22310 the proposal should be accepted.
345. (b)
0 1 2 3
Operating Costs 65 3.05 2.06 3.09
PV 65 2.583 1.479 1.882
Total PV of costs = 65 + 2.966 + 1.999 + 2.371 = Rs. 70.944 lakh.
346. (c) Annual capital charge =
70.944
PVIFA(18, 3)
=
70.944
Rs. 32.63 lakh
2.174
=
347. (b) The cash outlays for the proposal is shown below.
Given cost of capital = 10%
(Rs. In 000s)
Cash Flow
Years 0 1 2 3 4 5 6
Company A: (62) (4) (5) (6) (7) (8) (9)
12
PV of costs associated with Company As proposal
=
( )
5 2 3 4 6 6
4 5 6 7 8 9 12
62 +
1.1
(1.1) (1.1) (1.1) (1.1) (1.1)
1.1

= 62 3.64 4.13 4.51 4.78 4.97 5.1 + 6.77 = 82.36
Annual Capital Charge (ACC)
(10,6)
82.360 82.360
18.91.
PVIFA 4.355
= = =
734
348. (a) The cash outlays for the proposal is shown below.
(Rs. In 000s)
Cash Flow
Years 0 1 2 3 4 5 6
Company B: (75) (3) (3) (3) (3)
(9)
(3) (3)
15
PV of costs associated with Company Bs proposal
=
6
1 4 6
t =1
3 9 15
75 - +
(1.1) (1.1) (1.1)
= 75 13.07 6.15 + 8.47 = 85.75
ACC =
85.75
4.355
= 19.69.
349. (c) The cash outlay for the proposal is shown below.
Cash Flow
Years 0 1 2 3 4 5 6
Company C: (48) (2.5) (2.5) (2.5)
(24)
(1) (1) (1)
14
PV of cost associated with Company Cs Proposal
=
( )
5 2 3 3 4 6 6
25 25 25 24 1 1 1 1
48
1.1
(1.1) (1.1) (1.1) (1.1) (1.1) (1.1)
1.1

= 48 2.27 2.07 1.88 18.03 0.68 0.56 + 7.9 = 66.21
ACC =
66.21
4.355
= 15.20.
350. (c) Annual capital charge associated with Proposal A = 18.91
Annual capital charge associated with Proposal B = 19.91
Annual capital charge associated with Proposal C = 15.20
Since the annual capital charge associated with Proposal C is the lowest, Proposal C is
preferred.
351. (d) The interest rate the dealer claims to be offering is not implied interest rate, which can be
calculated as follows:
Let the implied interest rate = r % per annum.
Since the person pays Rs.1,000 per month for four years, the present value of these cash streams
should be equal to Rs.40,000, at the rate of r.
But since r is calculated every year and the person pays money every month, the present
value equation appears as shown below.
Rs.40,000 = 1,000 PVIFA
(r, 48)
PVIFA
(r, 48)
= 40
r = 0.77%
Effective = (1 + 0.0077)
12
1
annual r = 9.64%
Hence, the implied interest rate is 9.64%, which is more than his cost of capital of 8%.
Hence, the decision of the buyer is wrong and he should not go for the installment scheme.
Part II
735
352. (a)
Years Cash flows at 18% growth rate for first
5 years & 15%
growth for 6-11 years starting with
Rs.1,00,000
A
Net cash inflow
B = (A Rs.1,00,000)
Present value
@20% C
1 1,18,000 18,000 15,000
2 1,39,240 39,240 27,250
3 1,64,303 64,303 37,212
4 1,93,878 93,878 45,273
5 2,28,776 1,28,776 51,752
6 2,63,092 1,63,092 54,619
7 3,02,556 2,02,556 56,530
8 3,47,940 2,47,940 57,663
9 4,00,131 3,00,131 58,167
10 4,60,150 3,60,150 58,166
11 5,29,173 4,29,173 57,761
12 5,29,173 4,29,173 48,135
13 5,29,173 4,29,173 40,112
14 5,29,173 4,29,173 33,427
15 5,29,173 4,29,173 27,856
Total Cash Inflow 6,68,923
353. (a) Present outflow = Rs.6,00,000
Hence the NPV = Rs.(6,68,923 6,00,000) = Rs.68,923.
354. (c) I. Bank Option
At the end of 10 years, Rs.12,00,000 will become Rs.12,00,000 (1.14)
10
= Rs.44,48,666.
If Rs.75,000 is deposited into the bank account every year for 10 years, at the end of 10
years, he earns
Rs.75,000 FVIFA
(14%, 10)
= Rs.14,50,297
Total sum at the end of 10 years with bank option = Rs.44,48,666 + Rs.14,50,297
= Rs.58,98,963.
355. (d) II. Business Option
a. Annual income from business for the first five years = Rs.5,00,000 Rs.2,00,000
= Rs.3,00,000.
At the end of five years this income would become
Rs.3,00,000 FVIFA
(14%,4)
+ 3,00,000 = Rs.3,00,000
5
(1.14) 1
0.14

= Rs.19,83,031
In the next five years this income grows to
Rs.19,83,031 (1.14)
5
= Rs.38,18,157
Annual income for the subsequent five years = Rs.7,00,000 Rs.4,50,000 = Rs.2,50,000.
In five years this amount will grow to a sum of Rs.2,50,000 x FVIFA
(14%,5)

= Rs.2,50,000
5
(1.14) 1
0.14

= Rs.16,52,526.
In addition he gets Rs.4,50,000 at the end of 10 years by selling the ships.
736
Total future value of his income is
Rs.38,18,157 + 16,52,526 + 4,50,000 = 59,20,683
Hence, he gets an income more by Rs.21,720
(i.e. Rs.59,20,663 58,98,963) at the end of 10 years if he goes for shipping business.
Hence he should not opt for business.
356. (a) If the scrap value for the 3 ships at the end of 10 years is Rs.3,00,000,
He gets Rs.38,18,157 + Rs.16,52,526 + Rs.9,00,000 = Rs.63,70,683.
Since this amount is more than the bank option, he should opt for the business.
357. (b) By fifth year, all the three projects are crossing the Rs.10,00,000 initial investment.
Assuming the cash flows in the fifth year to be uniform,
Pay-Back (P.B) period for Project A = 12 4 +
12
3
1 = 52 months = 4.33 years
P.B period for Project B = 12 4 +
12
4
P.B period for Project C = 12 4 +
12
6
Pay-Back period for project B is the shortest of all the three, hence it should be accepted.
358. (a) If the firm starts producing the bolts, it saves
Rs.5,000 (= 10,000 x Rs.3 10,000 Rs.2.50) annually
Cash Flow (in Rs.)
Years 0 1 2 3 4 5
Initial
expenditure
15,000
Annual savings 5,000 5,000 5,000 5,000 5,000
Depreciation (3,000) (2,400) (1,920) (1,536) (1,229)
PBT 2,000 2,600 3,080 3,464 3,771
PAT at tax rate
of 50%
1,000 1,300 1,540 1,732 1,886
PAT +
depreciation
4,000 3,700 3,460 3,268 3,115
Hence NPV for the proposal (in Rs.)
= 15,000 +
2 3
4, 000 3, 700 3, 460
(1.1) (1.1) (1.1)
+ +
4 5
3, 268 3,115
(1.1) (1.1)
+ +
= Rs.(15,000 + 3,636 + 3,058 + 2,600 + 2,232 + 1,934)
= Rs.15,000 + Rs.13,460 = Rs.1,540
Since NPV is Rs.1,540 the proposal should not be accepted.
359 (d) Book value at the end of 5 years for Rs.15,000 worth machinery at the depreciation rate
of 20% on written down value basis is Rs.4,915.
Since scrap value of the machine = Book value the present value of scrap
=
5
Rs.4,915
(1.1)
= Rs.3,052
New NPV = Rs.15,000 + Rs.13,460 + Rs.3,052 = Rs.1,512
In this case the proposal can be accepted.
Part II
737
360. (c) Since all the three ad campaigns involve only expenditures and have different life periods,
the annual charges associated with the three have to be calculated and the one with the least
charge has to be selected.
Ad1
PV of expenditure
= Rs.16,000 +
2
Rs.5000 Rs.6,000
+
(1.14) (1.14)
3 4
Rs.6,500 Rs.7,000
+ +
(1.14) (1.14)
+
5
Rs.8,500
+
(1.14)

= Rs.(16,000 + 4,386 + 4,617 + 4,387 + 4,737) = Rs.34,127
Annual capital charge =
(14%, 4)
Rs.34,127
PVIFA
=
Rs.34,127
2.914
= Rs.11,711.
361 (a) Ad2
PV of expenditure = Rs.18,000 +
2 3
Rs.7000 Rs.4,000 Rs.9,000
+
(1.14) (1.14) (1.14)
+
= Rs.(18,000 + 6,140 + 3,078 + 6,075) = Rs.33,293
(14,3)
Rs.33,293
PVIFA
=
33.293
2.322
= Rs.14.338
Ad3
PV of expenditure = Rs.12,000 +
2
Rs.4000 Rs.5,000
+
(1.14) (1.14)

3 4
Rs.6,000 Rs.7,000
+ +
(1.14) (1.14)
+
5
Rs.8,000
(1.14)

= Rs.(12,000 + 3,509 + 3,847 + 4,050 + 4,145 + 4,155) = Rs.31,706
(14,5)
Rs.31,706
PVIFA
= Rs.31,706/3.433 = Rs.9,236.
362. (c) Annual capital charge for Ad1 = Rs. 11,711
Annual capital charge for Ad2 = Rs. 14,338
Annual capital charge for Ad3 = Rs. 9,236
Since Ad-3 has the least annual capital charge, it should be selected.
363. (a) Project - A
i. Present value of investment at 12%

2
Rs.6,000 Rs.5,000
+
(1.12) (1.12)

Rs. (5,357 + 3,986) = Rs.9,343
NBCR =
PV I
I
=
9, 343 9, 000
9, 000
= 0.038
ii. PV of investment at 15%
PV =
2
Rs.6,000 Rs.5,000
+
(1.15) (1.15)
= Rs.5,217 + Rs.3,781 = Rs.8,998
NBCR =
PV I
I
=
2
9, 000
= 0.00022
iii. PV of investment at 20%
PV =
2
Rs.6,000 Rs.5,000
+
(1.2) (1.2)
= Rs.5,000 + Rs.3,472 = Rs.8,472
NBCR =
PV I
I
=
528
9, 000
= 0.058
Project A should be accepted only at 12%.
738
364. (d) Project B
i. PV at 12% =
2
Rs.8,000 Rs.7,000
+
(1.12) (1.12)
= Rs.(7,143 + 5,580) = Rs.12,723
NBCR =
PV I
I
=
723
12, 000
= 0.06
ii. PV at 15% =
2
Rs.8,000 Rs.7,000
+
1.15 (1.15)
= Rs.6,957 + Rs.5,293 = Rs.12,250
NBCR =
250
12, 000
= 0.021
iii. PV at 20% =
2
Rs.8,000 Rs.7,000
+
1.2 (1.2)
= Rs.6,667 + Rs.4,861 = Rs.11,528
NBCR =
11, 528 12, 000
12, 000
= 0.04
Project B can be accepted both at 12% and 15% required rates.
365. (b) Bank interest rate = 13% p.a. on monthly deposits.
Effective interest rate =
12
0.13
1 1
12

+

= 13.8%.
366. (a) Present value of Rs.15,000 after 6 years at 13.8%
Rs.15,000 PVIF
(13.8, 6)
=
6
Rs.15, 000
(1.138)
= Rs.6,906
Hence PV of inflows = Cost of TV in Rs. + PV of Rs.15,000
= 16,000 + Rs.6,906 = Rs.22,906
PV of outflows = Rs.15,000 + Resale price of old TV
= Rs.15,000 + Rs.4,000 = Rs.19,000
Since PV of inflows is greater than that of outflows, the person can subscribe to the scheme.
367 (d) PV of inflows = Rs.16,000 + Rs.6,906 = Rs.22,906
PV of outflows = Rs.15,000 + Rs.9,000 = Rs.24,000
Since the PV of outflows is greater than PV of inflows, the person can be better off by
purchasing a new television without the offer and investing the rest of the money in the bank.
368. (a) Profitability Index (PI) =
Present valueof cashinflows
Initial investment

PV of cash inflows =
2 3
Rs.5,000 Rs.6,000 Rs.2, 000
+
(1.12) (1.12) (1.12)
+
= Rs.4,464 + Rs.4,783 + Rs.1,424 = Rs.10,671
Profitability Index =
Rs.10,671
Rs.11,000
= 0.971.
Since PI is less than 1, the project is liable to be rejected.
369. (c) PV of cash flows @8% =
2 3
Rs.5,000 Rs.6,000 Rs.2, 000
+
(1.08) (1.08) (1.08)
+ = Rs.4,630 + Rs.5,144 + Rs.1,588
= Rs.11,362
PI =
Rs.11,362
Rs.11,000
= 1.033
Since PI is greater than 1, the project can be accepted.
Part II
739
370. (c)
Years 1 2 3 4 5
Cost/WDV at 20% (Rs.) 2,00,000 1,60,000 1,28,000 1,02,400 81,920
Depreciation (Rs.) 40,000 32,000 25,600 20,480 16,384*
371. (b)
Years 1 2 3 4 5
A. PBDT (Rs.) 80,000 80,000 90,000 90,000 75,000
B. Depreciation (Rs.) 40,000 32,000 25,600 20,480 16,384
C. PBT (A B) 40,000 48,000 64,400 69,520 58,616
D. Profit after tax @50% C 20,000 24,000 32,200 34,760 29,308
E. Net Cash flow: Profit + Depreciation (D + B) 60,000 56,000 57,800 55,240 45,692
If i is the required IRR, then
Rs.2,00,000 =
2 3
Rs.60,000 Rs.56,000 57, 800
+
(1 + i) (1 + i) (1 i)
+
+

4 5
55,240 45,692
+ +
(1+i) (1+i)

Solving for i, using trial and error method, we get IRR = 12.08%.
372. (c) Depreciation on old machine
(Rs. Lakh)
1 2 3 4 5 6 7 8 9
Original Cost/Opening WDV 15.0 11.25 8.44 6.33 4.75 3.56 2.67 2.00 1.62
Depreciation 3.75 2.81 2.11 1.58 1.19 0.89 0.67 0.50 0.38
373. (a) Depreciation on new machine
1 2 3 4 5
Original Cost/Opening WDV 22.0 13.2 7.92 4.75 2.85
Depreciation 8.8 5.28 3.17 1.90 1.14
374. (b) * Depreciation of the old machine should be considered from the fifth year onwards, as
the machine was purchased four years ago.
Cash flows of the Replacement Project:
0 1 2 3 4 5
1. Net investment in new machine (16.0)
2. Increase in revenues 5.00 5.00 5.00 5.00 5.00
3. Savings in Costs 1.10 1.10 1.10 1.10 1.10
4. Depreciation on old machine* 1.19 0.89 0.67 0.50 0.38
5. Depreciation on new machine 8.80 5.28 3.17 1.90 1.14
6. Incremental depreciation (5) (4) 7.61 4.39 2.50 1.40 0.76
7. Net incremental salvage value 5.20
8. Incremental profit before tax
[(2) + (3) (6)]
(1.51) 1.71 3.60 4.70 5.34
9. Incremental profit after tax [(8) (1 0.2)] (1.21) 1.37 2.88 3.76 4.27
10. Operating Cash Flow (6) + (9) 6.40 5.76 5.38 5.16 5.03
11. Net Cash Flow [(1) + (7) + (10)] (16.0) 6.40 5.76 5.38 5.16 10.23
PV (Cash Flows) = 16 +
2 3
6.4 5.76 5.38
1.17 (1.17) (1.17)
+ + +
4 5
5.16 10.23
(1.17) (1.17)
+
= 16 + 5.472 + 4.211 + 3.357 + 2.755 + 4.665 = 4.46 lakh
Since the PV (Cash flows) is +ve, the firm can go for the replacement of existing machine.
740
375. (c) Incremental cash flows relating to replacement of the machines will be as follows:
(Rs. lakh)
1 2 3 4 5 6 7 8
1. Annual Savings 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20
2. Depreciation on new machine 0.55 0.55 0.55 0.55 0.55 0.55 0.55 0.55
3. Depreciation on old machine 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15
4. Incremental depreciation = (2) (3) 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40
5. Incremental PBT = (1) (4) 0.80 0.80 0.80 0.80 0.80 0.80 0.80 0.80
6. Incremental Tax = (0.4) x (5) 0.32 0.32 0.32 0.32 0.32 0.32 0.32 0.32
7. Incremental PAT = (5) (6) 0.48 0.48 0.48 0.48 0.48 0.48 0.48 0.48
8. Incremental Operating Cash Flow = (7)+(4) 0.88 0.88 0.88 0.88 0.88 0.88 0.88 0.88
9. Incremental Salvage Value 0.40
10. Incremental Cash Flow = (8) + (9) 0.88 0.88 0.88 0.88 0.88 0.88 0.88 1.28
Working notes:
i. Depreciation on new machine =
4.5 0.3 0.4
8
+
=Rs.0.55 lakh
ii. Depreciation on old machine =
1.2
8
= Rs.0.15 lakh.
376. (d) Computation of incremental investment
(Rs lakh)
Cost (4.5 + 0.3) 4.80
Less: Sale of old machine 0.70
4.10
377. (a) NPV of the replacement option = 4.1 + 0.88 PVIFA
(14,7)
+ 1.28 PVIF
(14,8)

= 4.1 + 3.773 + 0.45 = Rs.0.123 lakh
Since NPV is positive, the company should replace the old machines with the new machine.
378. (c)
Year (0) (1) (2) (3) (4) (5) (6)
A. Initial Investment
(1,50,000 20,000)
1,30,000
B. Increase in sales 20,000 20,000 20,000 20,000 20,000 20,000
C. Savings in Operating Expenses 12,000 12,000 12,000 12,000 12,000 12,000
D. Increase in Depreciation 45,000 31,500 22,050 15,435 10,805 7,563
E. Increase in PBT(B + C D) 13,000 500 9,950 16,565 21,195 24,437
F. Increase in Tax(E 0.3) 3,900 150 2,985 4,970 6,359 7,331
G. Increase in PAT(E F) 9,100 350 6,965 11,595 14,836 17,106
H. Salvage value 16,000
I. Cash flow A + G + D + H 1,30,000 35,900 31,850 29,015 27,030 25,641 40,669
Working Notes:
Increase in Depreciation:
As the old machine is fully depreciated, depreciation on old machine for the next 6 years will
be nil. Hence, the increase in depreciation will be equal to the depreciation on new machine.
(1) (2) (3) (4) (5) (6)
Depreciation on new machine 45,000 31,500 22,050 15,435 10,805 7,563

Part II
741
379. (b) Net present value
= 1,30,000 +
2 3 4 5 6
35, 900 31, 850 29, 015 27, 030 25, 641 40, 669
1.12 (1.12) (1.12) (1.12) (1.12) (1.12)
+ + + + +
= 1,30,000 + 32,059 + 25,384 + 20,659 + 17,191 + 14,538 + 20,619 = Rs.450.
380. (b) DER = 2; Debt = 2; Equity = 1
WACC = 15 0.65
2
3
+ 25.5
1
3
= 6.5 + 8.5 = 15%
NPV of A: 40 +
2 3
12 14 15
1.15 1.15 1.15
+ +
4 5
18 9
1.15 1.15
+ + = Rs.5.65 lakhs
B: 40 +
2 3
10 14 15
1.15 1.15 1.15
+ +
4 5
18 23
1.15 1.15
+ + = Rs.5.88 lakhs.
Project B is preferable as its NPV is higher.
381. (c) NPV of A : 5.65
B : 5.88
NPV (A + B) = 5.65 + 5.88 + 5 = 16.53.
Since NPV (A + B) is more than the sum of the individual options, company may choose to
implement both.
382. (c) 80 =
2 3
22 28 30
+ +
(1+k) (1+k) (1+k)
+
4 5
36 32
+
(1+k) (1+k)

k = 22.79%.
383. (a)The cash flows are as follows:
Project A
0 540
1 185 + 50 + 60 0.7 = 277
2 110 + 50 + 50 0.7 = 195
3 195 + 50 + 40 0.7 = 273
4 225 + 50 + 30 0.7 = 296
5 175 + 50 + 20 0.7 = 239
PV of inflows of A =
2 3 4 5
277 195 273 296 239
1.20 1.20 1.20 1.20 1.20
+ + + + = Rs.762.98 lakh
BCR =
762.98
540
= 1.41.
384. (b)
PV of inflows of B =
2 3 4 5
240 178 201 184 227
1.20 1.20 1.20 1.20 1.20
+ + + + = Rs.619.77 lakh
BCR =
619.77
470
= 1.32
Project A is preferable as it gives a higher BCR.
385. (c) The IRR of both the projects is calculated as follows:
Project A
IRR = () 540 +
1 2 3
277 195 273
(1 r) (1 r) (1 r)
+ +
+ + +

4 5
296 239
(1 r) (1 r)
+ +
+ +

742
Taking r = 37%, RHS = 5.80
Taking r = 38%, RHS = ()3.63
By interpolation, IRR = 37% + (38 37)%
5.80
9.43
= 37.62%.
386. (e) Project B
IRR = () 470 +
1 2 3
240 178 201
+ +
(1+r) (1+r) (1+r)

4 5
184 227
+ +
(1+r) (1+r)

Taking r = 34%, RHS = 0.08
Taking r = 35%, RHS = ()7.01
By interpolation, IRR = 34% + (35 34)%
0.08
8.09
= 34.13%.
According to the IRR criteria, project A is preferable.
387. (a)
Year 0 1 2 3 4 5
Net cash flows (Rs. lakhs) (25) 3.8 7.5 8.7 13.0 6.9
PV =
2 3
3.8 7.5 8.7
+ +
(1.14) (1.14) (1.14)

4 5
13 6.9
(1.14) (1.14)
+ +
= 3.333 + 5.771 + 5.872 + 7.697 + 3.584 = Rs.26.257 lakh
BCR =
PV
I
=
26.257
25
= 1.05.
388. (b)
(Rs. in lakh)
Year 0 1 2 3 4 5
Operating costs 25 4.7 3.2 4.9 3.8 5.6
PV 25 4.123 2.462 3.307 2.250 2.908
Total PV of costs = 25 + 4.123 + 2.462 + 3.307 + 2.250 + 2.908 = Rs.40.05 lakh
(14, 5)
40.05
PVIFA
=
40.05
3.433
= Rs.11.67 lakh.
389. (a) Plant and Machinery and Other Fixed Assets:
Year 1 2 3 4 5
Opening Balance 600 400 266.67 177.78 118.52
Depreciation @ 33
1
3
% 200 133.33 88.89 59.26 39.51
Closing Balance 400 266.67 177.78 118.52 79.01
Total Depreciation 204 137.33 92.89 63.26 43.51
Net salvage value:
Land 80
Building 100
P & M (500 x 20%) 100
280
Part II
743
390. (e)
(Rs. in lakh)
Year 0 1 2 3 4 5
A. Fixed assets and Technical know-
how fees
(940)
B. W.C. Margin (110)
C. Revenues 1000 1200 1500 1500 1500
D. Operating costs 700 840 1050 1050 1050
E. Depreciation (Note 1) 204 137.33 92.89 63.26 43.51
F. Interest on term loan 48 48 48 48 48
G. Interest on W.C. Loan 61.2 61.2 61.2 61.2 61.2
H. Technical know-how fees written-off 32 32 32 32 32
I. PBT = C (D + E + F + G + H) (45.2) 81.47 215.91 245.54 265.29
J. Tax @ 30% (13.56) 24.44 64.77 73.66 79.59
K. PAT (31.64) 57.03 151.14 171.88 185.70
L. NSV of fixed assets (Note 2) 280
M. Net recovery of W.C. margin 110
N. Initial Investment (1050)
O. Operating cash flow
[K + E + F(1 t) + H] 237.96 259.96 309.63 300.74 314.81
P. Terminal cash flow (L + M) 370
Q. Net cash flow (1050) 237.96 259.96 309.63 300.74 684.81
Student may note that technical know-how written off yearly is a non-cash item like
depreciation.
Note 1: Depreciation Schedule (Rs. in lakh)
Building 100
Depreciation @4% as per SLM 4
391. (e)
Year 0 1 2 3 4 5
Cash flows (1050) 237.96 259.96 309.63 300.74 684.81
PVIF @20% 1.0 0.833 0.694 0.578 0.482 0.402
PV (1050) 198.22 180.41 178.97 144.96 275.29
NPV = Rs.72.15 lakhs
The project is not viable for the company as it has a negative NPV.
392. (a) If an additional cash flow of Rs.5 cr. Arises, the new NPV will be
NPV = 72.15 +
5
500
(1.20)
= 80.19 + 200.94 = Rs.128.79 lakh
Now, the project is giving a positive NPV of Rs.120.75 lakhs, so in such a case the project
can be accepted.
393. (a) Since initial outflow and operating costs are given, the appropriate method to be applied
is Annual Capital Charge.
PV of costs for Machine I
= 1,00,000 + [20,000 PVIFA
(15%, 3)
] + [25,000 PVIFA
(15%, 3)
PVIF
(15%, 3)
]
+ [30,000 PVIFA
(15%, 4)
PVIF
(15%, 6)
]- 15,000 PVIF
(15%, 10)

= 1,00,000 + 20,000 2.283 + 25,000 2.283 0.658 + 30,000 2.855 0.432 - 15,000 0.247
= Rs.2,16,511.15.
744
394. (c) PV of costs for Machine II
= 80,000 + 25,000 PVIFA
(15%, 3)
+ 36,000 PVIFA
(15%, 3)
PVIF
(15%, 3)
- 10,000 PVIF
(15%, 6)
= 80,000 + 25,000 2.283 + 36,000 2.283 0.658 10,000 0.432
= Rs.1,86,834.70.
395. (d) Annual capital charge for Machine I =
(15%,10)
2,16,511.15
PVIFA
=
2,16, 511.15
5.019
= Rs.43,138.30.
396. (c) Annual capital charge for Machine II =
(15%, 6)
1,86,834.70
PVIFA
=
1, 86, 834.70
3.784
= Rs.49,374.92.
As annual capital charge for Machine I is low, Machine I is cheaper.
397. (a) Depreciation on new machine
Year 1 2 3 4 5 6 7 8 9 10
Opening WDV 250 200 160 128.0 102.4 81.9 65.5 52.4 41.9 33.5
Depreciation 50 40 32 25.6 20.5 16.4 13.1 10.5 8.4 6.7
Closing WDV 200 160 128 102.4 81.9 65.5 52.4 41.9 33.5 26.8
398. (d) Depreciation on old machine
Year 1 2 3 4 5 6 7 8 9 10
Depreciation 5 5 5 5 5 5 5 5 5 5
Incremental
depreciation
45 35 27 20.6 15.5 11.4 8.1 5.5 3.4 1.7
399. (a)

Year 0 1 2 3 4 5 6 7 8 9 10
A. Net investment (190)
B. Incremental sales 50 50 50 50 50 50 50 50 50 50
C. Incremental op. cost 10 10 10 10 10 10 10 10 10 10
D. Incremental depreciation 45 35 27 20.6 15.5 11.4 8.1 5.5 3.4 1.7
E. Incremental pre- tax profit (5) 5 13 19.4 24.5 28.6 31.9 34.5 36.6 38.3
F. Tax @40% (2) 2 5.2 7.76 9.8 11.44 12.76 13.8 14.64 15.32
G. Incremental post-tax Profit (3) 3 7.8 11.64 14.7 17.16 19.14 20.7 21.96 22.98
H. Net salvage value 50
I. Initial flow (190)
J. Operatingflow(D+G) 42 38 34.8 32.24 30.2 28.56 27.24 26.2 25.36 24.68
K. Terminal flow 50
L. Net cash flow (190) 42 38 34.8 32.24 30.2 28.56 27.24 26.2 25.36 74.68
M. PVIF @12% Value 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322
N. PV of NCF = L x M (190) 37.506 30.286 24.778 20.504 17.123 14.480 12.312 10.585 9.155 24.047
400. (a) NPV = 190 + 37.506 + 24.778 + 20.504 + 17.123 + 14.480 + 12.312 + 10.585 + 9.155 + 24.047
= Rs.10.776 or 10,780.
As NPV is positive, it can invest in new machine.
Part II
745
401. (c)
(Rs. in lakh)
Year 0 1 2 3 4 5
A. Cash flow before adjustment (250) 50.00 65.00 80.00 90.00 125.00
B. Less: Depreciation (10% on original cost) 25.00 25.00 25.00 25.00 25.00
C. PAT before adjustment 25.00 40.00 55.00 65.00 100.00
D. PBT = 35.71 57.14 78.57 92.86 142.86
E. Add: Depreciation (10% on original cost) 25.00 25.00 25.00 25.00 25.00
F. Less: Depreciation (20% on book value) 50.00 40.00 32.00 25.60 20.48
G. PBT after adjustment = D + E F 10.71 42.14 71.57 92.26 147.38
H. PAT after adjustment = G x (1 0.30) 7.50 29.50 50.10 64.60 103.20
I. Cash flow after adjustment = H + F (250) 57.50 69.50 82.10 90.20 123.68
402. (e)
(Rs. in lakh)
Year (t) 0 1 2 3 4 5
A. Cash flow adjusted (250) 57.50 69.50 82.10 90.20 123.68
B. PVIF(16%, t) 1.000 0.862 0.743 0.641 0.552 0.476
C. Present value of cash
flows = A x B
(250) 49.57 51.64 52.63 49.79 58.87
D. Cumulative present value
of cash flows
(250) (200.43) (148.79) (96.16) (46.37) 12.50
From the cumulative present value of the cash flows it can be seen that the discounted pay-
back occurs at the end of 5 years. So the discounted pay-back period is 5 years. (4.79 yrs)
403. (e) = 250 + 49.57 + 51.64 + 52.63 + 49.79 + 58.87 = 12.50 lakh.
404. (c) Let internal rate of return (IRR) be equal to r
250 =
2 3
57.50 69.50 82.10
+ +
(1+r) (1+r) (1+r)

4 5
90.20 123.68
+ +
(1+r) (1+r)

For r = 17%, RHS = 57.50(0.855) + 69.50(0.731) + 82.10(0.624) + 90.20(0.534)
For r= 18%, RHs = 57.50(0.847) + 69.50(0.718) + 82.10(0.609) + 90.20(0.516)
+ 123.68(0.437)
r = 17% +
(18% 17%)
(255.76 250)
(255.76 249.19)
= 17.88%
IRR = 17.88%.
405. (a)
Appraisal of the project using Net Present Value (NPV)
(Rs. 000)
Year (t) 0 1 2 3 4 5 6 Total
A. Cash flow
(Rs. 000s) (2,500) 750 800 650 600 550 450
B. PVIF(12%,6) 1.000 0.893 0.797 0.712 0.636 0.567 0.507
C. Present value
= A x B (Rs. 000s)
(2,500) 669.75 637.60 462.80 381.60 311.85 228.15 (A x B)
= 191.75
NPV =
6
t
t
t =0
Cash flow
(1.12)
= 191.75, i.e., Rs.191.75
(i.e.,) = Rs.1,91,750.
Since, the NPV is positive the project can be accepted.
746
406. (c)
Appraisal of the Project using Benefit-Cost Ratio (BCR)
BCR =
Present valueof benefits
Initial investment

Present value of benefits =
6
t
t
t =0
Cash flow
(1.12)
= 269.75
Initial investment = 2,500 (given)
BCR =
2691.75
2, 500
= 1.0767 ~ 1.08
Since, the BCR is greater than 1 the project can be accepted.
407. (a)
Appraisal of the Project using Internal Rate will be the value of r in the following equation:
Let the IRR be denoted by r. Then IRR will be the value of r in the following equation:
For, r = 15%, RHS = 2495.521
For, r = 14%, RHS = 2558.115
r lies between 14% and 15%
r = 14% + (15 14)
(2, 558.115 2, 500)
(2, 558.115 2, 495.521)
= 14.93%
The internal rate of return of the project is 14.93%
Since, the IRR is greater than the cost of capital (12%) the project can be accepted.
408. (d) If the cost of capital is 14% the IRR of the project still remains unchanged at 14.93%.
Further, since the IRR is greater than the cost of capital (14%) the project can be accepted.
Again, since the IRR is greater than the cost of capital (14%) the NPV at 14% will be
positive because the NPV is zero when the discount rate is equal to IRR (14.93%). So the
project can be accepted on the basis of NPV also. Lastly, since the NPV is positive the
present value of benefits will be greater than the initial investment. So the BCR will be
greater than 1. Hence, the project can be accepted on the basis of BCR too. Therefore,
although the cost of capital is increased to 14% the project can be accepted on the basis of all
the three measures.
409. (b) The pay back period of a project is defined as the time required generating sufficient cash
flows so as to recover the initial investment made in the project, by duly ignoring the time
value of money. Here the amount of cash generated for the first four years is Rs.19 crore
against an investment of Rs.20 crore. This amount can be recovered by the first quarter of the
fifth year as the cash flows occur uniformly. Hence, the pay back period is 4.25 years.
410. (c) The average annual income for these three years
=
16, 000 22, 000 25, 000
3
+ +
=
Rs.63, 000
3
= Rs.21,000
Average net book value of investment =
1, 50, 000 60, 000
2
+
= Rs.105,000
So, the accounting rate of return will be =
21, 000
100
1, 05, 000
= 20 percent.
411. (c) The present value of all the cash flows will be
= Rs.60 lakh x 0.893 + Rs.80 lakh x 0.797 + Rs.116 lakh 0.712
= 53.58 + 63.76 + 82.59
= Rs.199.932 lakh = Rs.200 lakh (approximately).
Benefit cost ratio of a project is given by:
=
Pr esent values of the benefits 200 5
Initial investment 160 4
= = = 1.25.
Part II
747
412. (b) The present value of the cash flows will be =
Rs.1800
0.08
= Rs.22,500 and so the NPV of
that investment is = Rs.22,500 Rs.25,000 = Rs.2500.
Hence, the net benefit cost ratio for that investment will be =
Rs.2500
0.1
Rs.2500
= = 0.10
So, the option (b) is the correct choice.
413. (c) Initial Investment = Rs.100 lakh
Let the IRR of the project be k
So, Rs.100 lakh = 25 PVIF (k,1) + 30 PVIF (k,2) + 40 PVIF (k,3) + 48 PVIF (k,4)
At k = 12 percent, the RHS = 105.243 while at k = 15 percent, the RHS = 98.206
By interpolation,

k 12
15 12
=
100 105.243
98.206 105.243
=
5.243
7.037
= 0.745
K = 12 + 3 0.745 = 14.24 percent.
414. (a)
Contribution margin increases by Rs.100 lakh and hence the corresponding amount of net
cash flow will also go up by Rs.100 lakh (1 - 0.35) = Rs.65 lakh.
Hence, the NPV of the project will also increase by
Rs.65
1.10
= Rs.59.09 lakh or Rs.59 lakh.
415. (a) The net benefit cost ratio for the project is 0.2 and so the benefit cost ratio for the project
will be = 1 + 0.2 = 1.20. The benefit cost ratio is defined as the ratio:

The present value of the cash flows
Initial investment

Hence the amount of initial investment will be =
Rs.6.72crore
1.20
= Rs.5.60 crore.
Therefore, the net present value of the project will be = Rs.6.72 crore Rs.5.60 crore
= Rs.1.12 crore.
416. (c) The payback period of a project is defined as the amount of time required to recover the
amount invested in a project, by neglecting the time value of money. In this project, the
amount invested is Rs.16,20,000 that will be recovered within a time span of 4.00 years.
Hence, the payback period is 4.00 years.
417. (b) The present value of the maintenance costs is = Rs.100,000 PVIFA(12%, 3 years) +
Rs.150,000 PVIFA(12, 6 years) PVIF(12%, 3 years)
= Rs.100,000 2.402 + Rs.150,000 4.111 0.712
= Rs.240,200 + Rs.439,054.80 = Rs. 679,254.80
Hence, the annual capital charge will be =
Rs.679, 254.80
PVIFA(12%, 9 years)
=
Rs.679, 254.80
5.328

= Rs.127,487.76 or, Rs.127,488 (approx.)
418. (d) Let r be the IRR of the project.
So, 50 =
( ) ( ) ( )
2 3 4
16 17 15 23.5
1 r
1 r 1 r 1 r
+ + +
+
+ + +

At r = 15 percent, the right hand side of the above equation = 50.066.
So, approximately, the required IRR is 15 percent.
748
419. (b) The depreciation for the old machines is Rs.70,000/4 = Rs.17,500 while the same for the
new one is Rs.350,000/4 = Rs.87,500. Hence, the incremental depreciation = Rs.87,500
Rs.17,500 = Rs.70,000.
The expected cash flows, from this investment will be:
Year 0 1 2 3 4
A. Initial Invest (300,000)
B. Incremental revenue 60,000 60,000 60,000 60,000
C. Operational savings 40,000 40,000 40,000 40,000
D. Incremental Depreciation 70,000 70,000 70,000 70,000
E. Incremental profit 30,000 30,000 30,000 30,000
F. Incremental taxes 12,000 12,000 12,000 12,000
G. Incremental PAT 18,000 18,000 18,000 18,000
Incremental Cash flow 88,000 88,000 88,000 88,000
The NPV for this proposal will be -300,000 + 88,000 PVIFA (12 percent, 4 years)
= 300,000 + 267,256 = Rs.32,744.
420. (c) The present value of the tax shield on debt is given as: t
c
B = 0.40 70 = Rs.28 lakh.
421. (c) Present value of the costs associated with the machine will be
Rs.30,00,000 + Rs.250,000 PVIFA(10 percent, 4 years) + Rs.300,000 PVIFA(10 percent,
6 years) PVIF(10 percent, 4 years)
= Rs.30,00,000 + Rs.250,000 3.170 + Rs.300,000 4.355 0.683
= Rs.46,84,839.50
The required annual capital charge will be

(10%, 10 years)
Rs.46, 84, 839.50 Rs. 46, 84, 839.50
Rs.762, 382(approx.).
PVIFA 6.145
= = =

422. (b) Net present value for a perpetual investment = (Cash flow / K) Investment
= (165 /0.09) 1,900 = 67.
423. (c) Annual capital charge = Present value of cash/PVIFA
n,

k

= 2,20,000 / PVIFA
5, 15%
= 2,20,000 / 3.352 = 65, 632.
424. (b) NBCR = NPV/I
= (PV I) / I = (4.5 3.75) / 3.75 = 0.2.
425. (d) NPV = CF
1
x PVIF
1
,
20%
+ CF
2
x PVIF
2, 20%
+ CF x PVIF
3, 20%
Initial Investment
= 24.99 10.41 + 23.16 25 = 12.74
426. (b) NPV = CF x PVIFA
2, 15% + CF x PVIFA
(5-2), 15%
initial investment

= 100 x 1.626 + 200 x 1.726 500 = 507.8 500 = 7.8 lakh.
427. (a) BCR = PV / I = 25,000 / 15,000 = 1.6666 or 1.67.
428. (d) NPV = CF x PVIF I
(10%,3)
= 5,000 x 2.487 10,000 = 2,435.
429. (a) Initial outlay = 1,00,000
Number of years taken to recover the initial outlay will be 4 years.
i.e., 20,000 + 25, 000 + 35,000 + 20,000 = 1,00,000
430. (d) Here the increase in fixed costs = 300 200 = 100
Since interest payments are exempt from tax actual increase in fixed costs = 100 (1 t)
= 100 (1 0.35) = 65
Net present value = 65/1.12 = 58.035 or 58.04
Since increase in outflow (inflow remaining the same) decreases NPV, the decrease in
NPV = Rs.58.04.

749

The model question paper consists of two parts A and B. Part A is intended to test the
conceptual understanding of the students. It contains 40 multiple-choice questions carrying one
point each. Part B contains problems with an aggregate weightage of 60 points. Students are
requested to note that this is an indicative format of the question paper in general and that
The ICFAI University reserves the right to change, at any time, the format and the pattern without
any notice. Hence, the students are advised to use the model question papers for practice
purposes only and not to develop any exam-related patterns out of these model question papers.
The suggested answers given herein do not constitute the basis of evaluation of the students
answers in the examination. These answers have been prepared by the faculty members of
The ICFAI University with a view to assist the students in their studies. And, they may not be
taken as the only answers for the questions given.

a. Reserves and surplus.
b. Equity capital.
c. Certificate of deposit.
d. Preference capital.
e. Debenture capital.
2. Which of the following features distinguishes a cumulative preference share from non-
cumulative preference shares?
a. It enjoys a right to participate in surplus profits after equity dividends have been paid.
b. It is eligible to get all the arrears of preference dividends before any equity dividend is
declared.
c. It will be redeemed by the company after a specified maturity period.
d. It will not be redeemed by the company at any time.
e. It is eligible to receive dividends at a variable rate not exceeding a specified limit.
3. Which of the following is a method of raising additional finance from existing shareholders
by offering them securities on a pro rata basis?
a. Public issue.
b. Rights issue.
c. Bonus issue.
d. Euro issue.
e. Private placement.
4. Which of the following approaches towards estimation of cost of equity capital assumes that
the future expectations of the investors are similar to their past expectations?
a. Dividend forecast approach.
b. Realized yield approach.
c. Capital asset pricing model approach.
d. Bond yield plus risk premium approach.
e. Earnings price ratio approach.
750
5. The earnings price ratio approach provides an accurate measure of rate of return required by
the equity investors when
a. The earnings per share is equal to the expectations of the investors
b. The market price per share is equal to the expectations of the investors
c. The dividend per share is equal to the expectations of the investors
d. The dividend payout ratio is less than 100% and retained earnings are expected to earn the
rate of return required by the equity investors
e. The equity shares under consideration are actively traded in the market.
6. Which of the following is not a merit of using book values as weights for calculating the
weighted average cost of capital?
a. The calculation of weights is simple.
b. The book value weights are not affected by fluctuations in market prices.
c. The book value weights are suitable when the firm is not listed.
d. The book value weights are suitable when the securities of the firmare not actively traded.
e. The book values of various sources of finance bear very close relationship to their
present economic values.
7. Which of the following is not an assumption in Miller and Modigliani approach to capital
structure?
a. All securities traded in the financial markets are infinitely divisible.
b. Information is freely available to some privileged investors only.
c. Investors are rational.
d. There are no transaction costs.
e. There is no corporate or personal income tax.
8. Walters model on dividend policy does not assume that
a. The internal rate of return on the firms investments is constant
b. The cost of capital of the firm is constant
c. The firm has an infinite life
d. The firm can finance its investments by raising debt from outside
e. The retained earnings are the only source of finance available to the firm.
9. Which of the following is not true with regard to aggressive working capital policy?
a. Low level of investment in current assets.
b. Greater reliance on short-term sources to finance current assets.
c. Cost of financing the current assets tends to be low.
d. Higher risk of technical insolvency faced by the firm.
e. High level of investment in current assets and greater reliance on long-term sources to
finance current assets.
10. Which of the following does not indicate the use of short-term funds to finance long-term
investments?
a. Net working capital is negative.
b. Total long-term financing exceeds total long-term investment.
c. Current ratio is less than one.
d. Current liabilities exceed current assets.
e. Total long-term investment exceeds total long-term financing.

Part III
751
11. Which of the following does not influence the composition of working capital?
b. Nature of raw material used.
d. Degree of competition in the market.
e. Amount invested in fixed Assets.
12. A financial manager facing a capital budgeting decision must decide whether to
a. Issue stock or debt securities
b. Use the money market or capital market
c. Sell bonds at a premium or a discount
d. Invest in a capital asset
e. Invest in a current asset.
13. Which of the following changes would be likely to increase the NPV calculated for a project?
a. Increasing the firms opportunity cost of capital.
b. Permitting a net decrease in working capital.
c. Spreading the total cash inflows over a longer interval.
d. Increasing the projects estimated expenses.
e. Decreasing the projects estimated revenues.
14. Which of the following would not be included among the costs of carrying inventory?
a. Obsolescence.
b. Opportunity cost of capital.
c. Raw material cost.
d. Risk of pilferage.
e. Rent/depreciation of warehouse.
15. Cheques that have been deposited may not be immediately available for use due to
a. Collection float
b. Payment float
c. Net float
d. Float management
e. Playing the float.
16. A firm can raise capital from the primary market by the issue of securities in which of the
following ways?
a. Private placement.
b. Bought-out deals.
c. Euro issues.
d. Rights issues
17. An implicit cost of increasing the proportion of debt in a firms capital structure is that
a. The firms asset beta will increase
b. Equity holders will demand a higher rate of return
c. The tax-shield will not apply to the added debt
d. The equity-to-book value ratio will decrease
e. The firms rate of return decreases.
752
18. Capital gains may be preferred by investors over dividends even if their tax rates are equal
because
a. Taxes on dividends are withheld from pay cheques
b. Taxes on capital gains are paid annually
c. Taxes on capital gains can be timed
d. After tax dividends represent an inconsequential amount of money
e. Taxes on capital gains are lesser than that on dividends.
19. Which one of the following is not a source of long-term finance?
a. Equity capital.
e. Term loan.
20. The cost of preference share is
a. The rate of dividend
b. After tax rate of dividend
c. The discount rate which equates the payments from the preference shares to the initial
proceeds after issue
d. All of the above
21. Which of the following factors vitiate MMs approach to capital structure?
a. Personal Taxes.
b. Bankruptcy Costs.
c. Imperfect Capital Markets.
22. A company should look into this factor to estimate working capital requirements
a. Seasonality of operations
b. Production policy
c. Economic environment
23. The net working capital as per static view is
a. [All Current Assets +Loans and Advances] [All Current Liabilities +Provisions]
b. Net Current Asset Current Liabilities
c. Gross Working Capital Net Current Assets
24. Negative net working capital means that
a. The net current assets are less than current liabilities
b. The gross current assets are less than current liabilities
c. Some fixed assets are financed by short-term borrowings
d. Some current assets are realized to repay long-term borrowings
Part III
753
25. Which of the following is not a lag associated with inventory?
a. Creation lag.
b. Storage lag.
c. Sales lag.
26. Usually cash management includes
a. Short-term forecasting
b. Arranging for repayments/investments when cash surpluses are anticipated
c. Keeping a tab on the cash reserve requirements of banks
27. Which of the following is not a current asset?
a. Cash.
b. Receivables.
c. Inventories.
d. Short-term investments.
e. Plant.
28. Other things remaining the same, if the average stock of raw materials is increased to two
times its original level, then the raw materials storage period
a. Reduces to half of the original period
b. Increases to two times the original period
c. Reduces unpredictably
d. Increases to four times the original period
e. Reduces to one-fourth of the original period.
29. Under the operating cycle method the working capital requirement of a company is arrived at
using the operating cycle by
a. Multiplying the daily sales with the operating cycle period
b. Multiplying the cost of each component per period with the corresponding period
c. Multiplying the cost of sales with the operating cycle period
d. By subtracting spontaneous liabilities from gross current assets
30. Which of the following variables does not involve bad debts losses?
a. Credit Period.
b. Cash Discount.
c. Collection Effort.
d. Credit Standards.
31. The term capital structure refers to
a. The manner in which a firm obtains its long-term sources of funding
b. The length of time needed to collect accounts receivable
c. Whether the firm can remain profitable in the long run
d. Which specific assets the firmshould invest in
e. How the firm uses the capital at its disposal.

754
32. In a world with corporate taxes but no possibility of financial distress, the value of the firm is
maximized when the
a. Firm uses no debt in its capital structure
b. Firm uses no equity in its capital structure
c. Firm uses a debt-equity ratio of 1.0
d. Corporate tax rate approaches 100%
e. Firm uses an equal proportion of debt and equity.
33. What happens to a firm whose uses of cash exceed its sources of cash during an accounting
period?
a. It borrows on a short-term basis.
b. It declares a net loss on the income statement.
c. It experiences an increase in cash balance.
d. It experiences a decrease in cash balance.
e. It declares itself insolvent.
34. Which of the following would not be included in inventory carrying cost?
a. Insurance expense for the inventory.
b. Opportunity cost of capital for inventory investment.
c. Cost of inventory.
d. Cost of shelf space.
e. Rent/depreciation of the warehouse.
35. Which of the following is an example of restructuring the firm?
a. Dividends are increased from Rs.1 to Rs.2 per share.
b. A new investment increases the firms business risk.
c. New equity is issued and the proceeds repay debt.
d. A new Board of Directors is elected to the firm.
e. The firm issues debt instruments.
36. The method of raising equity capital from existing members by offering securities on pro rata
basis is referred to as
a. Public issue
b. Rights issue
c. Bonus issue
e. Bought-out deal.
37. Which of the following typically justifies the offering of off-season discounts?
a. The firm earns interest on the receivables.
b. Product demand is increased during the low-sales months of the year.
c. The firm does not prepare an ageing schedule.
d. The firm develops repeat business.
e. The buyer is not extended credit.
38. The theories of capital structure try to study
a. The existence of relationship between trading on equity and market value of the equity
b. The relationship between the financial leverage and cost of capital
c. The relationship between the cost of debt and cost of equity
d. The relationship between the market value of the firm and the cost of capital
e. The relationship between the net operating income and the market value of the firm.
Part III
755
39. The pattern of financing the current assets in a broad way is based on
a. The behavior of current assets
b. The capital structure
c. The cost of debt capital
d. The interest rate in the economy
40. This is not an advantage of inventory storage
a. Avoiding lost sales
b. Reducing liquidity
c. Reducing order costs
d. Avoiding production shortages
e. Gaining discounts.
41. Standard Industries Ltd., has the following capital structure:
Equity share capital:
There are 1,50,00,000 equity shares of Rs.10 each fully paid-up. Presently the shares have a
market price of Rs.27 per share. The company has recently paid dividends to its equity
shareholders amounting to Rs.4.05 crore. The dividends have been growing at the rate of 4%
over the years and this growth rate is expected to continue in future.
Term loan:
The amount of term loan is Rs.80 crore and carries an interest rate of 12.5%. The market
value of the term loan is equal to its book value.
The tax rate applicable to the company is 30%.
The difference between the cost of equity capital and cost of term loan is
a. 5.65%
b. 3.45%
c. 2.34%
d. 1.90%
e. (5.65)%.
(2 points)
42. The book values of various sources of long-term finance for Access Ltd., are given below:
Sources Book values (in Rs.)
Equity Capital 1,50,00,000
Retained Earnings 2,00,00,000
Preference Capital 30,00,000
Debentures 1,00,00,000
The cost of equity share capital is 15% and the cost of preference capital is 20.25%. The
debentures are redeemable at face value after 6 years. The face value of the debentures is
Rs.100 and the interest rate applicable is 15%. The net amount realized per debenture is Rs.90.
756
The tax rate applicable for the company is 50%. The approximate weighted average cost of
capital for the firm based on the book value weights is
a. 8.97%
b. 9.60%
c. 14.30%
d. 16.34%
e. 17.54%.
(3 points)
43. Consider the following data of M/s. Startrack Ltd., for the year 2003-2004
Market Value of Debt Rs.5, 00,000.
Interest Rs.30, 000.
Net Operating income Rs.1, 00,000.
Cost of Equity 14%.
If debt-equity ratio increases to 5:4, the revised equity capitalization rate according to net
operating income approach is
a. 10%
b. 12%
c. 14%
d. 15%
e. 20%.
(2 points)
44. Sukhi Ltd., sells entirely on credit basis. It is considering a change in its credit terms from
2/15 net 30 to 3/10 net 45. On account of this change, the percentage of customers currently
taking the discount is expected fall from 85% to 70%. The average collection period is
expected to increase from 18 to 22 days. Total sales are expected to rise from Rs.6,00,000 to
Rs.6,85,000, while the 12% gross profit margin on sales is expected to remain constant. The
firm has an 8% opportunity cost of funds tied up in receivables. The expected costs of
increasing the cash discount period and the collection period are (Assume 1 year =360 days)
a. Rs.4,185 and Rs.965.04
b. Rs.5,185 and Rs.780.50
c. Rs.3,565 and Rs.750.04
d. Rs.2,915 and Rs.500.04
e. Rs.4,185 and Rs.899.04.
(2 points)
45. The following information is available about Avanti Ltd.:
Month Sales (Rs. in lakh) End of quarter receivables
(Rs. in lakh)
Ist Quarter J anuary 55.0 4.0
February 40.0 15.0
March 65.0 45.0
The Daily Sales Outstanding (DSO) at the end of first quarter for averaging periods of 30
days is
a. 29.5 days
b. 36.5 days
c. 59.5 days
d. 62.5 days
e. 70.5 days.
(2 points)
Part III
757
46. Western Alloys Ltd., uses copper for its manufacturing operations. The probability
distributions for the daily usage rate and the lead time for the procurement of copper are
given below:
Daily usage rate (tons) Probability Lead time (days) Probability
30 0.25 10 0.20
40 0.50 15 0.60
50 0.25 20 0.20
The normal usage during lead time is given by
a. 40 tons
b. 15 tons
c. 600 tons
d. 500 tons
e. 300 tons.
(2 points)
47. Pertaining to the above problem the probability of stock-out for Western Alloys Ltd., is
a. 30%
b. 40%
c. 45%
d. 70%
e. 72%.
(2 points)
48. For Verdana Ltd., the stock-out cost is estimated to be Rs.12,000 per ton and the carrying
cost is Rs.2,000 per ton. The possible safety stock levels for the company are 150 tons,
200 tons and 400 tons. The probability that there will be a stock-out of 150 tons, 200 tons and
400 tons is 15%, 10% and 5% respectively. If the company does not maintain a safety stock,
the total cost that the company will have to bear will be
a. Rs.3,00,000
b. Rs.7,50,000
c. Rs.8,40,000
d. Rs.9,90,000
e. Rs.9,94,500.
(3 points)
49. The normal usage level for a firm is 2,000 units. The probability that the actual usage will be
2,300 units is 0.20 and the probability that the actual usage will be 2,700 units is 0.25. If the
expected stock-out costs and the expected carrying costs are estimated to be Rs.1,500 and
Rs.1,800 respectively, the optimal safety stock level for the company is
a. 700 tons
b. 400 tons
c. 300 tons
d. 150 tons
e. The firm should not maintain any safety stock.
(3 points)
758
50. Northern Transports Ltd., is presently using a truck that has a book value of Rs.6.50 lakh. It
is being depreciated on a straight line basis and it will be written off over the next six years.
Presently the salvage value of the truck is Rs.3,00,000 and the salvage value after six years
will be Rs.50,000. The company is planning to replace the old truck with a new one which is
improvised and more efficient. The new truck costs Rs.14 lakh. It will be depreciated on a
straight line basis over the period of next six years and will be fully written off at the end of
the six year period. The new truck will have a salvage value of Rs.3,50,000 at the end of the
six year period. The general manager of the company has collected the following additional
information:
The savings in annual operating and maintenance costs will be Rs.1,50,000.
The income from the operations will increase by Rs.2,50,000 per year.
The cost of capital for the company is 12% and the tax rate applicable to it is 30%.
The cash flows in the second year and the sixth year are
a. Rs.5,40,000 and Rs.4,20,000
b. Rs.4,30,000 and Rs.4,98,000
c. Rs.3,02,500 and Rs.6,02,500
d. Rs.3,02,500 and Rs.6,20,500
e. Rs.2,45,000 and Rs.6,50,000.
(3 points)
51. A company is considering investing in a new machine with an expected life of 3 years. The
after tax cash flow resulting from this investment are given below.
Year Cash Flow (Rs.)
0 (15,000)
1 8,000
2 7,000
3 5,000
The cost of capital for the firm is 10%.
The net present value for the project is
a. Rs.1,809
b. Rs.3,000
c. Rs.4,356
d. Rs.5,670
e. Rs.6,000.
(2 points)
52. National Instruments Ltd. (NIL) purchases components from Pioneer Electronics Ltd. (PEL) on
the terms 1/10, net 45. NIL has requested for an increase in the cash discount by 1%. The period
of cash discount will remain unchanged. PEL wants to modify the terms in such a way that after
obtaining the requested increase in cash discount by 1% NIL faces at least three times the cost
of not paying within the discount period as before.
The minimum cost to NIL if it does not pay within the discount period is
a. 10.39%
b. 20.18%
c. 31.17%
d. 40.00%
e. 42.54%.
(2 points)
Part III
759
53. CK Ltd., is offering a discount of 2% if the customer pays within 10 days. The existing cost
of trade credit for the customer is 10.39%. The maximum credit period that it should extend
to its customer such that the customer faces at least three times the cost of not paying within
the discount period is (Assume 1 year =360 days)
a. 40 days
b. 35 days
c. 33 days
d. 32 days
e. 30 days.
(3 points)
54. Honeydew Ltd., has 1 lakh equity shares outstanding which are selling at Rs.100 each. Its
capitalization rate is 14%. The company is expecting Rs.65 lakh income for the current year
and is planning to pay dividends amounting to Rs.4 lakh. The company wants to invest in a new
project which will cost Rs.75 lakh. It is assumed that the Miller and Modigliani model on
dividend policy is applicable to the company. The additional number of shares that the
company has to issue to finance the new project is
a. 11,050 shares
b. 12,727 shares
c. 13,456 shares
d. 15,678 shares
e. 16,000 shares.
(3 points)
55. The expected earnings for Orion Ltd., are Rs.65 lakh. Currently the firm has 1 lakh outstanding
shares which are selling at Rs.100 each. The company is planning to invest in a project costing
Rs.75 lakh. The capitalization rate for the company is 14%. Assuming Modigliani and Miller
approach, the additional number of shares and the price per share at the end of the current year
if no dividends are paid are
a. 4,000 shares and Rs.89
b. 5,500 shares and Rs.93
c. 6,900 shares and Rs.95
d. 7,075 shares and Rs.112
e. 8,772 shares and Rs.114.
(3 points)
56. The following information is available regarding a project being under consideration by
Bosco Industries Ltd.
Initial Outlay =Rs.25 lakh
Operating costs
Year
Operating Costs
(Rs. In lakh)
1 4.7
2 3.2
3 4.9
4 3.8
5 5.6
Cost of capital is 14%.
The annual capital charge associated with the project is
a. Rs.7.89 lakh
b. Rs.11.67 lakh
c. Rs.15.05 lakh
d. Rs.16.45 lakh
e. Rs.17.81 lakh.
(3 points)
760
57. The current price of a share of ABC Ltd., is Rs.50. The company issues one rights share for
every four shares held at Rs.45 per share. The ex-rights price of the share would be
a. Rs.45
b. Rs.48
c. Rs.49
d. Rs.50
e. Rs.51.
(1 point)
58. The following information is given about Ferro Ltd.
Average Daily Usage (Units) Probability
Lead Time
(No. of days)
Probability
600 0.6 4 0.3
800 0.4 6 0.7
a. 1,776 units
b. 2,720 units
c. 3,672 units
d. 4,080 units
e. 4,800 units.
(1 point)
59. Consider the following data for Beta Ltd:
Year 1 2 3 4 5
Earnings Per Share (Rs.) 4.80 4.00 3.00 5.00 4.50
Dividend Per Share (Rs.) 3.00 3.00 2.00 3.00 3.00
Payout (%) 63 75 67 60 67
Price per share at the end (Rs.) 42.00 45.00 33.00 38.00 36.00
If the price at the beginning of year 1 is Rs.40, the realized yield over the five year period is
a. 4.75%
b. 5.03%
c. 5.25%
d. 6.25%
e. 7.00%.
(2 points)
60. The value of a share after the rights issue was found to be Rs.60. The theoretical value of the
right is Rs.4. The number of existing shares required for a rights share is 2. The subscription
price at which rights were issued is
a. Rs.18
b. Rs.52
c. Rs.66
d. Rs.81
e. Rs.84.
(1 point)

Part III
761
61. Consider the following data for XLNC Ltd.
Earnings Per Share (EPS) Rs.7.50
Dividend Payout Ratio 40%
Equity Capitalization Rate 14%
Rate of Return on Investments 15%
If the number of shares outstanding for the firm is 2,50,000 the market value of equity is
a. Rs.1, 28,57,500
b. Rs.1, 38,57,500
c. Rs.1, 39,67,500
d. Rs.1, 48,57,500
e. Rs.1, 49,57,500.
(1 point)
62. M/s Food Crafts is purchasing its requirements from M/s Spicy n Spicy. The credit terms
offered by the suppliers are 2/10, net 45. However, Food Crafts usually pays the bills on 30th
day. The cost of credit for M/s Food Crafts is
(Assume 1 Year =360 Days)
a. 7.27%
b. 10.39%
c. 14.69%
d. 18.18%
e. 20.99%.
(1 point)
63. A firm has 80,00,000 ordinary shares outstanding. The current market price per share is
Rs.33 and the book value per share is Rs.18. The firms EPS is Rs.3.60 and dividend per
share is Rs.3.00. The growth rate, assuming that past performance will continue is
a. 7%
b. 8%
c. 9%
d. 10%
e. 11%.
(1 point)
64. Morton Internationals balance sheet shows debt of Rs.222.60 million. The firm has
49 million outstanding shares, and the market price of each share is Rs.85 (Face Value
Rs.100). It is considering to issue Rs.850 million more debt and use the cash to repurchase its
equity. Management estimates that as a result of this restructuring, the market price per share
will jump to Rs.100. The value lost if the firm doesnt take up the restructuring is
a. 0
b. Rs.387.6 million
c. Rs.512 million
d. Rs.585 million
e. Rs.735 million.
(2 points)
762
65. The Vexser company has the following capital structure:
Equity Shares (2,00,000) Rs.40,00,000
10% Preference Shares Rs.10,00,000
14% Debentures Rs.30,00,000
The current market price of the share is Rs.20. The expected dividend next year is Rs.2 per
share, which will grow at 7% forever. If the company raises an additional Rs.2,00, 000 debt
by issuing 15% debentures, the expected dividend increases to Rs.3 and the price of share
falls to Rs.15. The growth rate remains the same. The weighted average cost of capital for the
firm, assuming a tax rate of 50% is
a. 12.37%
b. 15.40%
c. 16.60%
d. 17.00%
e. 27.00%.
(2 points)
66. Consider the following data about Pearl Enterprises:
Current Assets =Rs.760 lakhs
Current Liabilities including bank borrowings =Rs.480 lakhs
Bank borrowings =20% of current assets
The maximum Permissible Bank Finance (MPBF) under the Methods I and II of the Tandon
committee are
a. Rs.108 lakhs and Rs.242 lakhs
b. Rs.190 lakhs and Rs.108 lakhs
c. Rs.242 lakhs and Rs.324 lakhs
d. Rs.324 lakhs and Rs.242 lakhs
e. Rs.328 lakhs and Rs.432 lakhs.
(2 points)
67. Deccan Paints Ltd., had 10 lakh equity shares outstanding at the beginning of J uly 2002 and
these shares were traded in NSE at Rs. 150 each. The rate of capitalization appropriate to the
risk class to which the firm belongs is 12%. The net income for the year is Rs.2 crores and
the investment budget is Rs.4 crores. Assume that no dividend is declared and the additional
fund requirement is financed by new issue of equity shares. If Modigliani-Miller hypothesis
holds good, the number of equity shares to be issued by the company is
a. 1,09,048
b. 1,09,248
c. 1,19,048
d. 1,19,248
e. 1,29,348.
(2 points)
68. The dividend payout ratio of a firm is 40%. The firm follows traditional approach to dividend
policy with a multiplier of 6. The P/E ratio of the firm is
a. 4.4
b. 5.2
c. 6.7
d. 8.1
e. 9.5.
(1 point)
Part III
763
69. Glamour Ltd., earned a profit of Rs.20 lakhs before providing for interest and tax. The
companys capital structure consists of 4,00,000 equity shares of Rs.10 each and 25,000, 14%
secured redeemable debentures of Rs.150 each. The cost of equity is 16%. The value of the
firm under net income approach is
a. Rs.37,50,000
b. Rs.50,37,000
c. Rs.92,18,750
d. Rs.92,81,750
e. Rs.129,68,750.
(2 points)
70. The average daily cost of production is Rs.35 lakhs and average conversion period is 3 days.
The closing stock of work in process is 10% higher than the opening stock of work in
process. The value of closing stock of work in process is
a. 100 lakh
b. 110 lakh
c. 120 lakh
d. 130 lakh
e. 150 lakh.
(1 point)

764
Suggested Answers
1. (c) Certificate of deposit is a short-term instrument which helps in raising short-term funds.
All other alternatives except (c) represent long-term sources of finance.
2. (b) A cumulative preference share is entitled to get all the arrears of preference dividends
before any equity dividend is paid.
3. (b) In rights issue, new shares will be issued to existing shareholders in the proportion of
shares held by them.
4. (b) The realized yield approach assumes that future expectations of investors are similar to
their past expectations.
5. (d) One of the conditions in which the realized yield approach provides an accurate measure
of the rate of return required by equity shareholders is that the dividend payout ratio is less
than 100% and retained earnings are expected to earn the rate of return required by the equity
shareholders.
6. (e) The present economic values of various sources of finance may not bear any relationship
to the book values.
7. (b) Miller and Modigliani approach to capital structure assumes that information is freely and
readily available to all investors (and not to some privileged investors only). All other
alternatives represent assumptions made in the Miller and Modigliani approach.
8. (d) Walters model on dividend policy does not assume that the firm can finance its
investment by raising outside debt. (It assumes, inter alia, that retained earning is the only
source of finance available to the firm; no external debt or equity is used.)
9. (e) High level of investment in current assets and greater reliance on long-term sources to
finance current assets is true with regard to the conservative working capital policy.
All other alternatives except (e) are true with regard to aggressive working capital policy.
10. (b) When total long-term financing exceeds total long-term investment the excess of long-
term financing over total long-term investments is used to finance the other uses which are
not of a long-term nature. All other alternatives than (b) represent the use of short-term funds for
long-term investments.
11. (e) All the alternatives other than (e) represent factors which influence the composition of
working capital.
12. (d) Capital budgeting decisions have long-term consequences, involve substantial outlays and
it is difficult to reverse capital expenditure decisions. The finance manager facing a capital
budgeting decisions must decide whether to invest in a capital asset.
13. (b) Permitting a net decrease in working capital reduces the opportunity cost of current assets
and thus helps to increase NPV.
14. (c) Raw material cost is a procuring cost.
15. (a) The amount deposited by a company in the bank, and which is awaiting clearance is
called collection float.
16. (e) A firm can raise capital from the primary market by issue of securities through all the
above ways.
17. (b) Increased use of debt increases the fixed commitments of the company in the form of
interest and repayments and thus increases the risk of the equity shareholders, so they
demand higher returns.
18. (c) Capital gains may be preferred by investors over dividends even if their tax rates are equal
because tax on capital gains can be timed.
Part III
765
19. (d) Commercial paper is a short-term money market instrument.
20. (c) The cost of preference shares is given by k
p

=
D (F P) / n
(F P) / 2
+
+

where P is the net amount realized per debenture.
F is the redemption price per debenture.
It is defined as that discount rate which equates the proceeds from preference capital issue to
the payments associated with the same i.e., dividend payment and principal payments.
21. (e) MM theory assumes that there are no transaction costs, personal taxes and the markets are
perfect.
22. (d) Working capital is the funds required for the smooth functioning of the business
operations hence economic environment need not be considered.
23. (a) As per the static view of working capital net working capital is defined as the difference
between gross working capital and current liabilities where gross working capital is equal to
the total of all current assets including loans and advances and current liabilities include
provisions.
24. (e) As per the static view of working capital, net working capital is defined as the difference
between gross working capital and current liabilities.
Hence, when there is a negative net working capital, it means that the gross current assets are
less than liabilities and some fixed assets are financed by short-term borrowings.
25. (e) Creation lag, storage lag and sales lag are all liquidity lags associated with inventory.
26. (d) The objective of cash management can be regarded as one of making short-term forecasts
of cash position, finding avenues for financing during periods when cash deficits are
anticipated and arranging for repayment/investment during periods when cash surpluses are
anticipated with a view to minimizing idle cash as far as possible.
27. (e) Current assets are those liquid assets of the company which are either held in the form of
cash or can be easily converted into cash within one accounting period.
28. (b) If the average stock of raw materials is increased to two times its original level then the
raw materials storage period increases to two times the original level.
29. (a) Operating cycle period = Raw material storage period + Conversion period + Finished
goods storage period + Average collection period Average daily sales
Working Capital requirement = Operating cycle period x Daily sales
30. (b) Cash discount is the discount which can be availed when the net payment is made within
a specified period.
31. (a) Capital structure of a company refers to mix of the long-term finance used by the firm. It
is the financing plan of the company.
32. (b) The cost of equity is most expensive as the equity dividends are not tax-deductible
expenses. Hence, the value if the firm is maximized when the firm uses no equity in its
capital structure.
33. (d) Decrease in cash balance occurs whenever the applications of funds are more than the
sources of funds.
34. (c) Cost of inventory is a procuring cost and is included in the ordering costs.
35. (c) This involves repayment of long-term liabilities by issuing of new shares where the
capital structure of the firm is changed. Hence it is an example of restructuring of the firm.
36. (b) Under Section 81 of the Companies Act, 1956, when a firm additional equity capital, it
has to first offer such securities to the existing shareholders on a pro rata basis. This method
of raising equity capital from the existing members is called the rights issue.
766
37. (b) Increase in the demand for the product in off-season indicates that there was an offer of
discount thus increasing the demand to avail discount.
38. (b) Capital structure theories study the proportion of equity and debt in the capital structure
of a firm. It explains the relationship between financial leverage and firm valuation, i.e. the
cost of capital.
39. (a) The behavior of current assets in terms of fixed and fluctuating components has an
important bearing on the pattern of financing to be normally adopted.
40. (b) Inventory storage involves blockage of cash funds resulting in reduced liquidity which
serves as a disadvantage.

Part B: Problems

e
):
k
e
=
1
0
D
g
P
+
D
1
= D
0
(1 + g)
D
0
= Current dividend per share
=
Rs.4.05 crore
1.5 crore
= Rs.2.70
(Number of equity shares = 1,50,00,000 = 1.5 crore)
k
e
=
2.70(1.04)
0.04
27
+ = 0.144 i.e., 14.4%.
k
e
= 14.4%
Cost of term loan (k
t
):
k
t
= 12.5(1 0.30) = 8.75%
Hence, the difference between the cost of equity capital and term loan
= 14.4% 8.75% = 5.65%.
42. (c) Cost of debenture capital,

d
F P
I(1 t)
n
k
F P
2
+
=
+
=
100 90
15(1 0.50)
6
100 90
2
+
+
= 9.65%.
Weights based on book values:
w
e
=
1, 50, 00, 000
4, 80, 00, 000
= 0.32
w
r
(Retained earnings) =
2, 00, 00, 000
4, 80, 00, 000
= 0.42
w
d
=
30, 00, 000
4, 80, 00, 000
= 0.06
w
t
=
1, 00, 00, 000
4, 80, 00, 000
= 0.21.
Part III
767
Weighted average cost of capital
= w
e
k
e
+ w
r
k
r
+ w
p
k
p
+ w
d
k
d

= (0.15 x 0.32) + (0.15 x 0.42) + (0.2025 x 0.06) + (0.0965 x 0.21)
= 0.143 or 14.3%.
43. (d) As per Net Operating Income Approach
k
e
=
NOI INT
S

where symbols are in their standard use
S =
1, 00, 000 30, 000
Rs.5, 00, 000
0.14
=
Market value of Debt = Rs.5,00,000 (given)
Value of the firm = Rs.10,00,000
Overall cost of capital

o
NOI 1, 00, 000
k 1
V 10, 00, 000
= = = 0%
As per NOI approach, overall cost of capital will remain constant even if the debt-equity ratio
changes.
( )
e o o d
D
k k k k
E
= +
( )
e
5
k 0.10 0.10 0.06
4
= +
= 0.10 +0.05 = 0.15 = 15%.
44. (e) Cost of increasing cash discount
= P
n
(S
0
+ )d S
n
P
0
S
0
d
0
= Rs.(0.7 x 6,85,000 x 0.03 0.85 x 6,00,000 x 0.02) = Rs.4,185.
Cost of increasing the collection period
= k x
0
S S
(ACP(new) ACP(old)) V ACP(new)
360 360

+

= 0.08 x
6,00,000 85,000
x 4 0.88 x x 22
360 360
+

= Rs.899.04.
45. (a)
End of Quarter 1
A Receivables Rs.64 lakh
B Daily sales (30 days averaging) 65/30 lakh = Rs.2.17 lakh
C DSO (30 days average) 64/2.17 = 29.5 days
46. (c) Expected daily usage rate = 30 (0.25) + 40 (0.50) + 50 (0.25) = 40 tons
Expected lead time = 10 (0.20) + 15 (0.60) + 20 (0.20) = 15 days
Normal usage during lead time = Expected daily usage rate Expected lead time
= 40 x 15 = 600 tons.
768
47. (a) The possible levels of usage are as shown below:
Daily usage rate Lead time (days) Possible usage levels
Tons Probability Days Probability Tons Probability
10 0.20 300 0.05
30 0.25 15 0.60 450 0.15
20 0.20 600 0.05
10 0.20 400 0.10
40 0.50 15 0.60 600 0.30
20 0.20 800 0.10
10 0.20 500 0.05
50 0.25 15 0.60 750 0.15
20 0.20 1000 0.05
Stockout occurs in those situations when the usage level exceeds the normal usage i.e., 600
tons. The lead time usage above 600 tons are: 750 tons, 800 tons and 1,000 tons.
Probability of stockout
= Probability of usage level of 750 tons + Probability of usage level of 800 tons
+ Probability of usage level of 1,000 tons
= 0.15 + 0.10 + 0.05 = 0.30 i.e., 30%.
48. (b) The levels of safety stock are 150 tons, 200 tons, and 400 tons.
Levels of safety stock and the related costs
Safety
Stock
Stockout
(tons)
Probability Stockout cost
(Rs.)
Expected
stockout cost
(Rs.)
Carrying cost
(Rs.)
Total cost
(Rs.)
(1) (2) (3) (4) =
(2) 12,000
(5) =
(3) (4)
(6) =
(1) 1 ,000
(7) =
(5) + (6)
0 150 0.15 18,00,000 2,70,000
200 0.10 24,00,000 2,40,000
400 0.05 48,00,000 2,40,000 0 7,50,000
Hence the total costs when no safety stock is maintained will be Rs.7,50,000.
49. (e) It is given that the actual usage can be 2,300 units and 2,700 units. The normal usage is
given to be 2,000 units. Hence the level of stock-outs are 300 units and 700 units.
Levels of safety stock and the related costs
Safety
Stock
Stockout
(tons)
Probability
Stockout
cost
(Rs.)
Expected
stockout cost
(Rs.)
Carrying cost
(Rs.)
Total cost
(Rs.)
(1) (2) (3)
(4) =
(2) 1,500
(5) =
(3) (4)
(6) =
(1) 1,800
(7) =
(5) + (6)
700 0 0.25 0 0 12,60,000 12,60,000
300 400 0.20 6,00,000 1,20,000 5,40,000 6,60,000
0 700 0.25 10,50,000 2,62,500 0 2,62,500
300 0.20 4,50,000 90,000 90,000
3,52,500
From the above table we find that the total costs will be minimum when no safety stock is
maintained.

Part III
769
50. (c) Cash flows associated with the replacement project:
Years 0 1-5 6
A Net investment in new truck
1
(11,00,000)
B Savings in costs 1,50,000 1,50,000
C Incremental Income 2,50,000 2,50,000
D Incremental depreciation
2
75,000 75,000
E Pre-tax profit (E: B + C D) 3,25,000 3,25,000
F Taxes 97,500 97,500
G Post-tax profit 2,27,500 2,27,500
H Initial flow (11,00,000)
I Operating flow: G + D 3,02,500 3,02,500
J Terminal flow
3
3,00,000
K Net cash flow: H + I + J (11,00,000) 302,500 6,02,500
Working Notes:
1. Net investment in new truck = 14 3 = Rs.11 lakh
2. Existing depreciation (on old truck) per year over the next six years:

6, 50, 000 50, 000
6
= Rs.1,00,000
Depreciation on the new truck for each year over the next six years:

14, 00, 000 3, 50, 000
6
= Rs.1,75,000
Incremental depreciation in each year
= 1,75,000 1,00,000 = Rs.75,000.
3. Terminal flow = Incremental salvage value
= 3,50,000 50,000 = Rs.3,00,000
Hence cash flow in the second year is Rs.3,02,500 and the cash flow in the 6th year is
Rs.6,02,500.
51. (a) Net Present Value
Year Cash flow PVIF
@ 10%
Present Value of
Cash Flow
0
1
2
3
(15,000)
8,000
7,000
5,000
1.000
0.909
0.826
0.751
(15,000)
7,272
5,782
3,755
Net Present Value 1,809
52. (c) Existing cost faced by NIL of not paying within the discount period
=
Rateof discount 360
x
1 Rateof discount Credit Discount period

=
0.01 360
x
(1 0.01) (45 10)
= 0.1039 i.e., 10.39%
Given: Proposed discount = 2%
Discount period = 10 days
Minimum cost to NIL of not paying within the discount period = 3 0.1039 = 0.3117
i.e., 31.17%.
770
53. (c) Minimum cost to customer for not paying within the discount period = 3 0.1039 =
0.3117 i.e., 31.17%. Since the values of cash discount percentage and discount period are
known, the only variable that can be modified is the credit period.
Let the modified credit period be C.

0.02 360
x
(1 0.02) (C 10)
0.3117
or
0.02 360
x
0.98 0.3117
C 10
or 10 +
0.02x360
0.98x 0.3117
C
or C 33.6 days.
Hence PEL should allow a maximum credit period of 33 days to the customer. (33.6 have not
been rounded off to the higher integral value 34 because doing that will reduce the cost faced by
customer below three times the cost as before. Hence 33.6 have been rounded off to 33 days).
54. (b) According to the MM Model
When dividends are paid:
P
0
=
1
(1 k) +
(D
1
+ P
1
)
P
0
= Rs.100 per share (given)
k = 0.14
D
1
=
4
1
= Rs.4.00 per share
P
1
= ?
100 =
1
4 P
1.14
+
or P
1
= 100 1.14 4 = Rs.110
Amount of additional investment required
= I (E n D
1
) = 75 (65 1 4.00) = Rs.14 lakh = n
1
P
1
Number of equity shares to be issued additionally (n
1
)
=
1
14
P
=
14
110
= 0.12727 lakh.
Thus 12,727 shares have to be issued.
55. (e) When dividends are not paid.
P
0
=
1
(1 k) +
(D
1
+ P
1
)
D
1
= 0, P
0
= Rs.100 (given); k = 0.14 (given)
100 =
1
0 P
1.14
+
=
1
P
1.14

or P
1
= Rs.114
Amount of additional investment required
= I (E nD
1
) = 75 (65 0) = Rs.10 lakh = n
1
P
1
Number of equity shares to be issued
additionally =
10
114
= 0.08772 lakh.
8772 equity shares have to be issued additionally.
Part III
771
56. (b)
(Rs. in lakh)
Year 0 1 2 3 4 5
Operating Costs 25 4.7 3.2 4.9 3.8 5.6
Present Value 25 4.123 2.462 3.307 2.250 2.908
Total present value of costs
= 25 + 4.123 + 2.462 + 3.307 + 2.250 + 2.908 = Rs.40.05 lakh.
Therefore, annual capital charge
=
40.05 40.05
PVIFA(14, 5) 3.433
= = Rs.11.67 lakh.
57. (c) Ex-rights price of a share =
0
NP S
N 1
+
+
=
4(50) 45
4 1
+
+
= Rs.49.
58. (c) Expected average daily usage = 600 0.6 + 800 0.4 = 680 units
Expected lead time = 4 0.3 + 6 0.7 = 5.4 days
Hence, normal consumption during lead time = 680 5.4 = 3,672 units.
59. (b) Wealth ratio (w
t
) =
t t
t 1
D P
P
+

Yield for an n-year period is (W
1
W
2
. W
n
)
1/n
1
The wealth ratios for Beta Ltd will be as follows:
1 2 3 4 5
Wealth
Ratio
1.125 1.143 0.78 1.242 1.026
Yield = (1.125 1.143 0.78 1.242 0.026)
1/5
1
= 1.0503 1 = 0.0503 = 5.03%.
)
t
V =
0
NP S
N 1
+
+
60. (b) Value of a share after the rights issue (
where symbols are in standard use
Theoretical value of a right ( = )
t
V
o
P S
N 1
+

In the question V
t
= Rs.4, V
0
= Rs.60 N=2
Substituting the values we get
60 =
0
0
2P S
180 2P S
3
+
= + = P
0
4 =
0
0
12 P S 12 S
= +
( ) 180 2 12 S S 24 3S S 52 = + + = + =
P S
3

61. (c) According to Walters Model
P
0
=
( )
r
E D
D
k
k k
+ , where symbols are in standard use.

Substituting the given values we get
=
( )
0.15
7.5 3
3
0.14
0.14 0.14

+ = 21.43 + 34.44 = 55.87
Number of shares outstanding = 2,50,000
Market value of equity = P
0
N = 55.87 2,50,000 = Rs. 1,39,67,500.
772
62. (e) Cost of Credit
=
( )
Rate of Discount Number of days in year
1 Rateof Discount Credit Period Discount Period

=
( )
0.02 360
100 = 20.99%.
0.98 45-10

63. (d) Cost of equity =
PAT PAT/N EPS
NW NW/ N BVPS
= =
Substituting the given values, we get

c
3.60
k 2
18
= = 0%
According to Dividend Discount Model

1 1
0 e
e 0
D D
P k
k g P
= =
g +
0.20 =
( ) 3 1 g
g 6.6 3 36g
33
+
+ = +
g =
3.6
0.10.
36
=
( ) Rs. 49 85 222.60 million + = Rs.4387.60 million 64. (e) Current market value of the firm =
Market value after restructuring = Rs.(39 100 + 1222.60) million = Rs.5122.60 million
Value lost if the firm doesnt go for restructuring
= Rs.(5122.60 4387.60) million = Rs.735 million.
65. (b) The capital structure of Vexser after the issue of 15% debentures will be
Source Amount (in Rs.)
Ordinary shares 40,00,000
10% Preference shares 10,00,000
14% Debentures 30,00,000
Total: 100,00,000
Cost of equity prior to this change can be calculated as follows:

1
e
0
D 2
k g 0.07 17%
P 20
= + = + =
Cost of equity after the change in capital in capital structure

e
3
k 0.07 2
15
= + = 7%
( )
e e p p d d
WACC w k w k w k 1 T = + +
WACC = 0.40 0.27 + 0.10 0.10 + 0.30 0.07 + 0.20 0.075 = 0.154 = 15.40%.
Part III
773
66. (d) Maximum Permissible Bank Finance (MPBF) as per Tandon Committee can be
calculated as follows:
I Method
MPBF = 75% of (CA-CL other than bank borrowings)
Current Assets = 760 lakh
Bank borrowings 20% of CA = 0.20 760 = 152 lakh
Current Liabilities other than bank borrowings = 480 152 = 328 lakh
MPBF = 0.75 (760 328) = 324 lakh
II Method
MPBF = 75% of CA CL other than Bank borrowings
= 0.75 760 328 lakh = 570 328 lakh = 242 lakh
67. (c) The market price per share is given by

1
0
e
P D
P
1 k
+
=
+
1
where symbols are in standard use.
If no dividends are declared
150
1
p 0
1.12
+
=
P
1
= 168
Net Income = Rs.2 crore
Investments budget = Rs.4 crore
Amount to be raised by issue of new shares = Rs.2 crore
Number of shares to be issued =
2, 00, 00, 000
1,19, 048.
168
=
68. (a) According to the Traditional approach

E
P m D
3

= +

Substituting the values, we get
( )
E
P 6 0.40E E 2.4 2
3

= + = +

P
4.4.
E
=
69. (e) Market value of Debt = 150 25,000 = Rs.37,50,000
Market value of Equity =
e
Net income 20, 00, 000 5, 25, 000
k 0.16
= = Rs.92,18,750
Market value of the firm = Rs.92,18,750 +37,50,000 = Rs.1,29,68,750.

774
70. (b) Average conversion period =
Average stock of WIP
Averge daily cost of production

Opening WIP + Closing WIP
2

x 1.10x
1.05x
2
+
=
Substituting the values in the formula, we get
3 =
1.05x
x 100lakhs
35
=
Closing stock of WIP = Rs.110 lakh.

775
a. Public deposits.
b. Short-term bank finance.
d. Trade credit.
e. Certificate of deposit.
2. Which of the following is not true with regard to cash credit?
a. The customer is allowed to borrow up to a pre-specified limit.
b. The customer is charged interest on the amount actually borrowed.
c. The customer is required to pay a minimum charge.
d. No security is required from the customer against the borrowed amount.
e. The customer can borrow as often as required.
3. Which of the following is not a direct form of finance provided by banks?
a. Cash credit.
b. Overdraft.
c. Purchase/Discount of bills.
d. Letter of credit.
4. Which of the following is not true with regard to factoring?
a. It is a continuous arrangement between a seller and the factor.
b. Factor purchases the accounts receivables of the seller.
c. Factor administers the sales ledger of the seller.
d. Factor follows up the customers of the seller for making the collections.
e. The arrangement of factoring is a cost-free source of finance to seller.
5. Which of the following is not a benefit of holding inventories?
a. Avoiding lost sales.
b. Getting quantity discounts.
c. Reduction in ordering costs.
d. Avoiding the risk of production shortages.
e. Reducing carrying cost.
6. Opportunity cost of funds tied up with inventory results from
a. Material costs
b. Ordering costs
c. Carrying costs
d. Loss of profits as a result of foregoing other opportunities of investment
e. Cost of running out of stock.

776
7. Which of the following is not an assumption in the economic order quantity model?
a. Constant purchase price per unit.
b. Constant demand.
c. Declining purchase price per unit.
d. Constant ordering cost.
e. Zero delivery time.
8. Which of the following does not result from liberalizing credit standards?
a. It causes an increase in sales.
b. It leads to higher bad debt loss.
c. It reduces the cost of collection.
d. It increases the investment in receivables.
e. It increases the opportunity cost of funds locked up in receivables.
9. Which of the following is not a part of the credit policy of a firm?
a. Credit standards.
b. Paying practices of customers.
c. Credit period.
d. Cash discounts.
e. Collection effort.
10. Which of the following is not a technique for monitoring collection of receivables?
a. Ageing schedule.
b. Days sales outstanding.
c. Collection matrix.
d. Funds flow analysis.
11. Holding cash balance to meet cash payments on transactions is
a. A manifestation of the transaction motive
b. Caused by lack of synchronization between cash inflows and outflows
c. A manifestation of the precautionary motive
d. A manifestation of the speculative motive
e. Not necessary for small businesses.
12. The impact of a project on the society is assessed in
a. Preliminary screening
b. Market appraisal
c. Technical appraisal
d. Economic appraisal
e. Financial appraisal.
13. Which of the following is not an advantage of private placement of securities?
a. Easy access for any company.
b. Fewer procedural difficulties.
c. Lower issue cost.
d. Access to funds is faster.
e. Complete certainty of availability of funds.
Part III
777
14. If the entire debt in a company is replaced by equity capital, which of the following
consequences will logically follow other things remaining the same?
a. The shareholders will lose confidence in the company.
b. The company can never borrow any money in future.
c. The liquidity position of the company will deteriorate.
d. The earnings per share will decrease.
15. Which of the following factors is/are considered when a capital structure decision is taken?
a. Cost of capital.
b. Size of the company.
c. Dilution of control.
d. Floatation costs.
16. What are the aspects to be looked into for evaluating a customer to grant him credit?
a. Collateral.
b. Bank reference.
c. Analysis of financial statements.
d. Firms experience in the past w.r.t. the customer.
17. The simple EOQ assumes that the reorder point is
a. Equal to 0 level inventory
b. Normal consumption x lead time
c. Average usage per day x lead time
d. Normal consumption during the lead time +safety stock
18. The probability that a customer will honor the payment is P
1
and when he is given credit
again the probability of honoring is P
2
. Which of the following is true?
a. P
1
is equal to P
2
.
b. The profit on granting the credit for the first time is P
1
x (REV +COST) (1 P
1
) x
COST.
c. The revenue and cost of a repeat order are the same as the first one to grant credit.
d. The repeat order is accepted only if (1 P
1
) is (1 P
2
).
e. P
1
can also be referred to as the probability for repeat order.
19. Cost of not availing cash discount is , when rate of discount =R; credit period =CP;
discount period =DP.
a. (R/(1 R)) x 360/(CP DP)
b. (R/(1 R)) x 360/DP
c. (R/(1 +R)) x 360/(CP DP)
d. R/100 x 360/(CP DP)
e. (R/(1 R)) x 360/CP.

778
20. What can be the source of internal financing in the long-term?
a. Depreciation.
b. Premium on issue of shares.
c. Revaluation gains.
d. Increase in capital due to bonus issue.
21. Which of the following is not a service of a factor?
a. Administration of sales ledger.
b. Collecting Accounts Receivables.
c. Assuming losses due to bad debts.
d Providing finance against bills receivables.
22. Which of the following is not an example of short-term finance?
c. Invoice discounting.
d. Maturity factoring.
23. Net working capital is a measure of the companys
a. Profitability
b. Magnitude of sales
c. Estimated liquidity
d. Shareholders equity
e. Current assets.
24. Which of the following is correct for a firm that reduces its accounts receivable balance from
the previous quarter?
a. Collections exceeded beginning receivables balance.
b. Sales exceeded collections.
c. Beginning receivables balance exceeded sales.
d. Collections exceeded sales.
e. Collections and sales were equal.
a. Profitability.
b. Safety.
c. Flexibility.
d. Control.
e. Solvency.
26. Which of the following would be least expected to change as a result of a higher average of
receivables?
a. Current ratio.
b. Total collection costs.
c. Accounts payable.
d. Bad debt expenses.
e. Average collection period.
Part III
779
27. Capitalization Rate is
a. The inverse of P/E ratio
b. The inverse of Earnings Price Ratio
c. Equal to Weighted Average Cost of Capital
d. Cost of Equity Capital
e. The return expected by the market on the investment in the firm.
28. The capital structure of a firm
a. Influences the risk of the firm
b. Influences the return of the firm
c. Does not influence risk but influences return
29. The dynamic view of working capital says that
a. Working capital is the excess of current assets which are actually used for normal
business over current liabilities
b. The working capital is an amount required for the smooth conduct of the normal
business operations
c. The normal operations range from procurement of raw materials to the final realization
of debtors
30. The simple EOQ model will not hold good under which of the following situations?
a. Stochastic Demand.
b. Constant Unit Price.
c. Zero Lead Time.
d. Fixed Ordering Costs.
e. Independent Orders.
31. How is Days of Sales Outstanding different from Average Collection Period?
a. ACP measures the number of days it takes to collect a receivable, whereas DSO
measures outstanding sales.
b. ACP takes total sales in the calculation whereas DSO takes only the credit sales.
c. ACP is affected by the seasonality of sales whereas DSO is not.
d. Receivables ACP gives information about the year end position, whereas the DSO gives
information at any chosen point of time.
32. Which of the following is an assumption only under MM approach?
a. Investors are rational.
b. Homogeneous expectations of investors.
c. Absence of corporate and income tax.
d. Absence of transaction costs.

780
33. The opportunity cost of capital refers to the
a. Net present value of the investment
b. Return that is forgone by investing in a project
c. Required investment in a project
d. Future value of the investments cash flows
e. The return that is expected when capital is invested in a project.
34. When a projects internal rate of return equals its opportunity cost of capital, then
a. The project should be rejected
b. The project has no cash inflows
c. The net present value will be positive
d. The net present value will be zero
e. The net present value will be negative.
35. Proposed assets can be evaluated using the companys cost of capital provided that the
a. Firm does not pay taxes
b. Firm is all equity financed
c. Cost of debt is less than the cost of equity
d. New assets have the same risk as existing assets
e. Proposed assets are similar to existing ones.
36. Why are dividend changes rather than their absolute level perceived to be more important to
managers and shareholders?
a. Managers only change dividends under threatening conditions.
b. Dividend changes are thought to signal future expectations.
c. MM state that the absolute level of dividends is irrelevant.
d. Changes determine whether borrowing must occur.
e. Dividend changes may show increased profitability.
37. Which of the following factors does not influence capital structure decision?
a. Size of the Company.
b. Flotation Costs.
c. Dilution of Control.
d. Cost of Capital.
38. The theory which says that capital structure affects the cost of capital is
a. Net Operating Income Theory
b. Traditional Theory
c. Miller and Modigliani Approach
39. MM approach does not say
a. The market value of the firmis equal to the market value of debt +market value of equity
b. The yield on equity is equal to the discount rate appropriate to the risk class
c. The financing decision depends on the investment decision
d. Conditions of corporate leverage and home made leverage are the same
e. There are no monitoring costs.

Part III
781
b. Nature of raw material used.
d. Degree of competition.
41. Sahay Ltd., is having debenture capital worth Rs.250 lakh in its capital structure. The
debentures of the company have a face value of Rs.100 and the net amount realized after they
were issued was Rs.98 per debenture. These debentures carry a coupon rate of 11% and are
redeemable at par after ten years. It is assumed that the issue expenses on the debentures will
not be considered as tax deductible expenses. The tax rate for the company is 30%. The cost
of debenture capital for the firm is
a. 12.90%
b. 11.00%
c. 10.80%
d. 8.00%
e. 7.00%.
(2 points)
42. Following information is available about a textile manufacturing firm:
The equity shares of the company are currently selling for Rs.20 per share. The
company has recently paid a dividend of Rs.2.50 per share to its equity shareholders.
The growth rate of dividend is 6%.
The preference shares of the company have a face value of Rs.100 and the net amount
realized after they were issued was Rs.99 per share. These shares will be redeemed at
par after eight years. The rate of dividend payable on these shares is 12%.
It is assumed that the issue expenses on the preference shares will not be considered as tax
deductible expenses. The tax rate for the company is 30%.
i. The cost of retained earnings is equal to 19.25%.
ii. The cost of preference capital is greater than the cost of retained earnings by 7.06%.
iii. The cost of equity capital is greater than the cost of preference capital by 7.06%.
a. Only (i) above.
b. Only (ii) above.
(3 points)

782
43. The following information relates to the sources of long-term finance used by Pioneer
Industries Ltd.:
Source Book value
(Rs. in lakh)
Market value
(Rs. in lakh)
Paid-up equity share
capital
200 400
Reserves and surplus 400
Preference shares 150 159
Debentures 250 241
The cost of equity capital for the firm is 19%, cost of preference capital is 12% and the cost
of debenture capital is 8%. The approximate weighted average cost of capital using book
value weights and market value weights are
a. 16.18% and 15.90%
b. 15.20 and 14.30%
c. 14.56% and 15.20%
d. 13.49% and 14.30%
e. 12.00% and 15.19%.
(3 points)
44. The following information is given about KACE Ltd.
(Rs. in lakh)
Opening
balance
Closing
balance
Raw materials, stores
and spares etc.
26 24
Work-in-process 46 44
(Rs. in lakh)
Purchases of raw materials,
stores and spares etc.
504
Manufacturing expenses 180
Depreciation 60
The total number of days for which cash is locked up in the formof raw material inventory and
work-in-process inventory are (Assume 1 year =360 days)
a. 18 days
b. 22 days
c. 40 days
d. 48 days
e. 58 days.
(3 points)
45. The opening balance and the closing balance of debtors for a firm are Rs.74 lakh and Rs.66
lakh respectively. The company has credit sales worth Rs.1,260 lakh. The average time for
which cash is locked up in receivables is (Assume 1 year =360 days)
a. 18 days
b. 20 days
c. 23 days
d. 28 days
e. 30 days.
(2 points)

Part III
783
46. The following details are given about Parag Ltd.
(Rs. in lakh)
Annual cost of Production 748
Opening balance of finished goods 54
Closing balance of finished goods 46
Excise duty 120
Selling and administration expenses 80
Interest 40
(Assume 1 year =360 days)
The approximate value of finished goods storage period for the firm is
a. 8 days
b. 12 days
c. 18 days
d. 22 days
e. 36 days.
(2 points)
47. Following information is given about Vincent Ltd.
Debtors period 20 days
Annual purchases Rs.504 lakh
Opening balance of accounts
payable
Rs.55 lakh
Closing balance of accounts
payable
Rs.45 lakh
The net operating cycle of the firm is
a. 36 days
b. 42 days
c. 78 days
d. 88 days
e. 95 days.
(2 points)
48. Mehta Industries Ltd. (MIL) has placed two orders with Perfect Industries Ltd. (PIL). The
finance manager of PIL has to decide whether to grant credit to MIL or not. The first order
amounts to Rs.8 lakh and the second order amounts to Rs.10 lakh. The cost of goods sold is
75% of the amount of the order. It is estimated that the probability of default by MIL on the
first order is 10%. If MIL pays for the first order then it is expected that the probability of
default by MIL on the second order is 5%.
The net weighted benefit associated with both the orders if it is given that the first order is paid
is
a. Rs.1.2 lakh
b. Rs.1.8 lakh
c. Rs.2.5 lakh
d. Rs.3.0 lakh
e. Rs.8.0 lakh.
(3 points)

784
49. Modern Suppliers Ltd., currently allows a credit period of 30 days without any cash discount.
All the sales are on credit basis and the average collection period is 32 days. Currently, it
sells 6,00,000 units at an average price of Rs.80 per unit and the variable cost to sales ratio is
70%. In order to expand sales, the management of the company is considering changing the
existing credit terms to 1/10, net 30. Due to the change in credit policy, sales are expected to
go up by 12% and the cost to the company in the form of cash discount offered is expected to
be Rs.1,61,280. The average collection period for the new policy is expected to be 24 days.
The cost of capital of the company is 15%.
The impact on the net profit of the company if the existing credit terms are changed to 1/10
net 30 will be
a. Net profit will increase by Rs.16.86 lakh approximately
b. Net profit will increase by Rs.14.47 lakh approximately
c. The new policy will not have any impact on the net profit
d. Net profit will decrease by Rs.16.86 lakh approximately
e. Net profit will decrease by Rs.14.47 lakh approximately.
(3 points)
50. The cash flows associated with a project are given below:
Year 0 1 2 3 4 5
Cash flows (Rs.000s) (2200) 900 850 700 650 500
The cost of capital is 15%.
The net present value of the project is
a. Rs.5,55,820
b. Rs.4,56,730
c. Rs.4,07,675
d. Rs.3,05,820
e. Rs.(2,89,000).
(2 points)
51. Following are the cash flows associated with an infrastructure project.
Year 0 1 2 3 4 5 6
Cash flows (Rs.000s) (2,500) 750 800 650 600 550 450
The approximate internal rate of return earned by the project is
a. 8.34%
b. 9.00%
c. 10.80%
d. 14.93%
e. 24.00%.
(2 points)
52. The cost of capital of MN Corporation is 18% and its cost of debt is 12%. If the equity
capitalization rate of the firm according to the net operating income approach is 21%, the
debt-asset ratio of the firm is
a. 0.33
b. 0.50
c. 0.67
d. 1.50
e. 2.00.
(2 points)

Part III
785
53. Mehta Enterprises Ltd. (MEL), a trading concern, had the following receipts of an item,
coded TF05, over the last quarter:
Month J anuary February March
Receipts (Rs.) 63,000 72,000 81,000
The opening balance of the item in J anuary was Rs.54,000 and the closing balance of the
item in March was Rs.90,000. The purchase price of the item is Rs.18 per unit and the
carrying cost is 25% of the average inventory value per annum. The cost for placing an order
is fixed and it is Rs.900 per order. The purchase price per unit of the item has not changed in
the last quarter and it is not expected to change in the next six months which is the planning
period.
The Economic Order Quantity for the firm is
a. 3,200 units
b. 3,800 units
c. 4,000 units
d. 4,300 units
e. 4,500 units.
(3 points)
54. The manager of a departmental store is deliberating on the quantity of a particular bath soap
to be ordered. The EOQ for the firm is 3000 units. The sales of the bath soap over the next
six months, which is the planning period, is forecasted to be 9000 cakes. The purchase price
of the soap is Rs.8.00 per cake. The ordering cost is Rs.400 per order and the carrying cost is
20 percent of the average inventory value per annum. The company which manufactures the
soap has offered a discount of 6.25 percent on the price for orders of 4000 cakes and above.
i. The optimal order quantity for the firm is 3000 units.
ii. If the company accepts the discount offered by the supplier then its ordering costs will
reduce by Rs.300.
iii. If the company accepts the discount offered by the supplier then it will incur a net
incremental loss of Rs.4,500.
a. Only (i) above.
b. Only (ii) above.
(3 points)
55. If the average daily usage of material is 400 units, lead time for procuring material is 7 days,
the average number of units per order is 2800 units and the reorder level is 6,720 units, the
stockout acceptance factor is
a. 0.4
b. 0.8
c. 1.2
d. 1.4
e. 2.1.
(2 points)

786
56. The current price of a share of Kaykay Pharmaceuticals Ltd. is Rs.55. The company is
planning to issue one right share for every four equity shares. If the company targets that the
ex-rights value of a share shall not fall below Rs.52, the subscription price for one rights
share should be more than or equal to
a. Rs.38
b. Rs.40
c. Rs.43
d. Rs.48
e. Rs.50.
(2 points)
57. The current market price per share of XYZ Co. Ltd., is Rs.40. The last dividend declared is
Rs.3 per share and the expected growth rate in dividends is 12% per annum. If the cost of
issuing external equity as a percentage of the existing market price is 6%, the cost of external
equity to the company, according to the dividend capitalization model, is approximately
a. 19.2%
b. 20.0%
c. 20.4%
d. 20.9%
e. 21.7%.
(2 points)
58. Ignoring the time value of money, how much does a firm lose on a Rs.5,000 sale that has a
30% profit margin and a 25% probability of default when the default actually occurs?
a. Rs.875.
b. Rs.1,250.
c. Rs.2,625.
d. Rs.3,500.
e. Rs.5,000.
(1 point)
59. Consider the following data about SKF Ltd:
Annual credit purchases Rs.52, 92,500.
Opening balance of accounts payable Rs.15, 50,000.
Closing balance of accounts payable Rs.27, 00,000.
(Assume 1 Year =365 Days)
The average payment period (in days) for SKF Ltd., is
a. 126
b. 147
c. 176
d. 186
e. 196.
(1 point)
Part III
787
60. Rajani Cements Limited uses the iron slag for the production of cement. The annual usage of
the iron slag is 50 thousand tonnes. The price of the iron slag is Rs.980 per ton. The ordering
cost is Rs.200 per order and the carrying cost is 15% of average value of inventory. At
present the company procures 5 thousand tonnes of iron slag in each order and avails a
discount of 2% from the supplier. The supplier has introduced 5% discount for an order size
of 10 thousand tonnes and above. What would be the annual benefit to the company if they
switch to the new discount offered by the supplier?
a. Rs.3,37,100.
b. Rs.11,32,900.
c. Rs.14,70,000.
d. Rs.18,29,566.
e. There will not be any monetary benefit to the company.
(2 points)
61. Dell Ltd., has Rs100 preference shares redeemable at a premium of 10% with 15 years
maturity. The preference dividend rate is 12%. The cost of the preference capital assuming
that shares were issued at par with floatation cost of 5% is
a. 12.43%
b. 13.02%
c. 14.25%
d. 14.33%
e. 15.33%.
(1 point)
62. Consider the following data about Max Mart Ltd.:
Opening Stock of Finished Goods Rs. 650 lakhs.
Closing Stock of Finished Goods Rs. 1,050 lakhs.
Cost of Production Rs. 12,000 lakhs.
Selling, Admn and Financial Expenses Rs. 4,500 lakhs.
Customs and Excise duties Rs. 35,000 lakhs.
The finished goods storage period (in days) for Max Mart is
a. 2
b. 3
c. 4
d. 6
e. 8.
(1 point)
63. Saravai Ferro Alloys (P) Limited is planning for a new plant in Ganjam, Orissa with an initial
outlay of Rs.45 crore. This place has a life of 5 years. Net expected cash inflows from this
project are as follows:
(Rs. in crore)
Year 1 2 3 4 5
Cash inflows 11.00 13.50 15.50 13.00 16.50
The opportunity cost of capital of the company is 14%. The Net Present Value (NPV) of the
project is
a. Rs.9.16 crore
b. Rs.1.77 crore
c. Rs.7.31 crore
d. Rs.15.96 crore
e. Rs.24.50 crore.
(2 points)
788
64. Consider the following data about Flashlight Ltd:
Gross Operating Cycle 124 days.
Net Operating Cycle 105 days.
Average collection period 40 days.
Conversion period 3 days.
Finished goods storage period 25 days.
Average payment period 19 days.
The raw material storage period (in days) is
a. 27
b. 37
c. 48
d. 56
e. 65.
(1 point)
65. Varini Chemicals Ltd., is planning to set up a plant for the production of organic chemicals.
Profit margin it is willing to maintain is 15%. The set up cost for each production run is
Rs.6,000. Cost of carrying inventory is 9% p.a. on cost of sales of average inventory. The plant
has capacity of 2 million kg of chemical. If the sales price of the chemical is Rs.800 per kg then
the optimum production quantity for this plant would be
a. 15000 kg
b. 18803 kg
c. 19803 kg
d. 20803 kg
e. 27803 kg.
(2 points)
66. Somani Metal (P) Limited is committing a capital investment at a cost of Rs.70 lakhs. The
cash inflows from this project during its lifetime are as follows:
(Rs. in lakhs)
Year 1 2 3 4 5
Cash inflows 18.0 20.0 28.0 23.0 26.0
The Internal Rate of Return (IRR) of the project is
a. 13.77%
b. 14.91%
c. 16.33%
d. 17.94%
e. 19.12%.
(2 points)
67. Mr. M.S.Sandhu, materials manager of a transformer manufacturing company procures
annual requirement of the copper bolts from its supplier by four equal sized orders. The total
number of copper bolts the company requires in a year is 6,00,000. The fixed cost per order is
Rs.300. The market price of the each copper bolt is Rs.100. The carrying cost is 10% of the
average inventory value. If Mr. Sandhu decides to change from existing system to EOQ
system then how much annual monetary benefit this decision would bring to the company?
a. Rs. 60,000.
b. Rs.3,36,000.
c. Rs.6,91,200.
d. Rs.7,50,000.
e. Rs.7,51,200.
(2 points)
Part III
789
68. The following table contains the amount of cheques issued and the amount of cheques
deposited in the bank by a company:
Date
Monday
23,
J une
Tuesday
24,
J une
Wednesday
25,
J une
Thursday
26,
J une
Friday
27,
J une
Saturday
28,
J une
Monday
30, June
Tuesday
01,
J uly
Amount of
Cheque
issued (Rs.) 17,000 28,000 34,000 16,000 28,000 32,000 44,000 38,000
Amount of
cheque
deposited in
bank (Rs.) 23,000 33,000 50,000 40,000 25,000 15,000 21,000 35,000
On an average, cheque issued by the company takes five days for actual payment and a
cheque deposited by the company takes three days for realization. On the morning of 23rd
J une the opening balance in companys books is Rs.19,000 where as it is Rs.27,000 in the
banks book. The offices of the company were closed for some IR problem during the week
J une 16, 2003 to J une 21, 2003. The net float available to the company at the end of June 30,
2003 is
a. Rs.16,000
b. Rs.66,000
c. Rs.95,000
d. Rs.1,01,000
e. Rs.1,23,000.
(2 points)
69. LG Electronics Ltd., is on the final stage of granting credit to the Mathura Hotels, which is
likely to place a repeat order for the same number of television sets. The probability of
payment in the first order is considered to be 0.85. But in case the Mathura Hotels pays for
the first order the probability of default for the repeat order is 0.05. The revenue from each
order is Rs.10 lakhs where as the cost of sales for each of these orders is Rs.8 lakhs. The net
expected benefit from this deal to LG would be
a. Rs.0.5 lakh
b. Rs.1.0 lakh
c. Rs.1.5 lakh
d. Rs.2.0 lakh
e. Rs.2.5 lakh.
(1 point)
70. If the average daily usage of material is 144 units, lead time for procuring materials is 25
days, average number of units per order is 2,500 units and the reorder level is 8,100, the
stock-out acceptance factor is
a. 1.0
b. 1.2
c. 1.3
d. 1.5
e. 2.3.
(1 point)

790
Suggested Answers
1. (d) Spontaneous sources are the sources which arise during the normal course of business.
Trade credit is a spontaneous source of financing current assets. All other alternatives except
(d) represent those sources of financing current assets which are not spontaneous in nature.
2. (d) In a cash credit arrangement the borrower is required to offer security in the nature of
hypothecation or pledge.
3. (d) Under the Letter of Credit (LC) arrangement, credit is provided by the supplier but the
risk is assumed by the bank which opens the LC. Hence it is an indirect form of financing.
4. (e) Under the factoring arrangement the factor charges commission for the services of
collection and maintenance of sales ledger.
All other alternatives than (e) are true with regard to factoring.
5. (e) Carrying costs are associated with holding inventories. Hence, reduction in carrying costs
is not a benefit of holding inventories. All other alternatives except (e) represent benefits of
holding inventories.
6. (d) Opportunity cost of funds tied up with inventories leads to loss of profits as a result of
foregoing other opportunities of investment.
7. (c) In the Economic Order Quantity (EOQ) model the purchase price per unit is assumed to
remain constant irrespective of the order size. Hence, alternative (c) is not an assumption in
the EOQ model.
8. (c) When credit standards are liberalized the receivables increase; hence the cost of collection
increases. All other alternatives except (c) represent the consequences that result from
liberalizing credit standards.
9. (b) Paying practices of customers is not a part of the credit policy of a firm. All other
alternatives except (b) are part of the credit policy of a firm.
10. (d) Funds flow analysis is a technique of understanding the flow of funds in a business; it is
not a technique for monitoring the collection of receivables. All alternatives other than (d)
represent the techniques for monitoring the collection of receivables.
11. (a) Holding cash balance to meet cash payments on transactions is a manifestation of the
transaction motive to hold cash.
12. (d) The impact of a project on the society is assessed in the economic appraisal of the project.
13. (e) Private placement of funds cannot ensure complete certainty of availability of funds;
availability of funds is subject to the willingness of the parties to invest in the securities
which are to be placed privately. All other alternatives are advantages of private placements.
14. (e) If the entire debt is replaced by equity, the number of equity shares will increase.
However, the Earnings Per Share (EPS) may or may not fall as a result. The EPS will fall
only if the ratio of the pre-tax earnings to the number of equity shares (in the case of capital
structure consisting of equity capital only) is less than the ratio of the pre-tax earnings to the
number of equity shares (in the case of capital structure consisting of both equity and debt
capital).
15. (e) When a capital structure decision is taken all the factors stated in the alternatives are
considered.
Part III
791
16. (e) Credit evaluation of a prospective customer involves obtaining information from which
the financial capacity and paying habits can be evaluated. This information can be gathered
from all the given sources.
17. (a) As the lead time i.e., time required for procurement of material is assumed to be zero an
order for replenishment is made when the inventory level reduces to zero.
18. (c) The expected profit and net profit for first action = P
1
(Revenue Cost) (1 P
1
) (Cost).
The revenue and cost of a repeat order are the same as the first one to grant credit.
19. (a) The cost associated for not availing oneself of cash discount is given by

Rateof discount
1 Rateof discount
x
Number of daysin a year

20. (a) Depreciation is a form of financing through internal accruals.
21. (e) A factor handles all the receivables arising out of credit sales of the seller company. Hence
all the functions mentioned are services of a factor.
22. (d) Under maturity factoring, the factor does not pay any advance or prepayment but pays on
a guaranteed payment due or on the date of collection from the customer. It is not an example
of short-term finance.
23. (c) The basic objective of working capital is to provide adequate support for the smooth
functioning of the normal business operations of a company. Hence it is measure of the
company's estimated liquidity.
24. (d) Average accounts receivable = Average collection period x Average daily credit sales
25. (b) An optimal capital structure should have profitability, flexibility, control and solvency.
26. (c) Current ratio, total collection costs, bad debt expenses and average collection period are
all variables of average receivables.
27. (a) Capitalization rate = Earnings per share/Market price of the share
Price earnings multiple = Market price of the share/Earnings per share. The P/E ratio gives
the relationship between the market price of the stock and its earnings by revealing how
earnings affect the market price of the firm's stock. The capitalization rate is used to calculate
the rate of return investors expect before the purchase of the stock.
28. (d) The debt and equity proportion in the capital structure of a firm, influence the risk and the
rate of return of the firm.
29. (e) As per the dynamic view, working capital is the amount of capital required for the smooth
and uninterrupted functioning of the normal business operations of a company ranging from
the procurement of raw materials, converting the same into finished products for sale and
realizing cash along with profit from the accounts receivables that arise from the sale of
finished goods on credit.
30. (a) EOQ model assumes that the forecast wage/demand for a given period, usually one year
is known and the usage/demand is even throughout the period. Hence it will not hold good
under stochastic demand.
31. (c) Days sales outstanding = Accounts receivable at the time chosen/Average daily sales.
This gives the average number of days sales outstanding at any given time. Average
collection period = Average accounts receivable/Average daily sales. This gives the
number of days taken to collect the receivables. Hence ACP is affected by the
seasonality of sales whereas DSO is not.
32. (e) All the given alternatives are assumed in other the theories also.
33. (b) Opportunity cost of capital is the return that is foregone by investing in a project.
792
34. (d) The internal rate of return is that rate of interest at which the net present value of a project
is equal to zero, or in other words, it is the rate which equates the present value of the cash
inflows to the present value of cash outflows.
35. (d) The company cost of capital can be used for evaluating the proposed assets only when the
new assets have the same risk as the existing assets.
36. (b) Changes in the dividend give a signal that the market price is going to rise in future.
37. (e) All the given factors influence the capital structure decisions.
38. (b) The principal implication of the traditional theory is that the cost of capital is dependent
on the capital structure and there is an optimal structure which minimizes the cost of capital.
39. (c) The third proposition of MM emphasizes that the average cost of capital is not affected by
the financing decisions as both investment and financing decisions are independent.
40. (e) The composition of working capital is influenced by the following factors:
a. Nature of business
b. Nature of raw material used
c. Process technology used
d. Nature of finished goods
e. Degree of competition in the market
f. Paying habit of the customers
g. Degree of synchronization among cash inflows and outflows.

Part B: Problems

2
P) (F
n
P) (F
T) I(1
+
+
41. (d) Cost of Debentures =
Where,
P = Net amount realized per debenture
I = Annual interest payment per debenture capital.
T = Corporate tax rate.
N = Maturity period.
=
2
98) (100
10
98) (100
0.70 11
+
+
=
99
0.2 7.7 +
= 0.0798 = 8% (approximately).
42. (d) Cost of equity capital and Reserves:
k
e
=
1
0
D
P
+ g =
0
0
D (1 g)
P
+
+ g
Where, P
0
= Current market price
D
0
= Dividend paid-out in current year
G = Current growth rate
=
20
0.06) 2.5(1+
+ 0.06 = 0.1925 i.e 19.25%
Part III
793
Cost of retained earnings (reserves and surplus),
k
r
= Cost of equity capital, k
e
= 19.25%.
Cost of preference shares:
k
p
=
P)/2 (F
N
P F
D
+
+

Where,
P = Net amount realized per share
n = Maturity period
D = Preference dividend payable annually
=
99)/2 (100
99)/8 (100 12
+
+
=
99.5
12.125
= 0.1219 i.e., 12.19%.
Cost of equity is greater than the cost of preference capital by 19.25 12.19 = 7.06%.
43. (b) Weighted Average Cost of Capital (WACC) using book value weights:
Sum of book values of all sources of capital used is
200 + 400 + 150 + 250 = 1,000
Weight for equity capital (w
e
) = 200/1,000 = 0.2
Weight for reserves and surplus
(w
r
) = 400/1,000 = 0.4
Weight for preference capital
(w
p
) = 150/1,000 = 0.15
Weight for debenture capital
(w
d
) = 250/1,000 = 0.25
WACC = w
e
k
e
+ w
r
k
r
+ w
p
k
p
+ w
d
k
d

= 0.2 x 19.00 + 0.4 x 19.00 + 0.15 x 12.00 + 0.25 x 8.00 = 15.2%.
Weighted Average Cost of Capital (WACC) using market value weights:
Sum of market values of all sources of capital used = 400 + 159 + 241 = 800
Weight of equity capital = 400/800 = 0.5
Weight of preference capital = 159/800
= 0.19875 0.20
Weight of debenture capital = 241/800 = 0.30125 0.30
WACC = 0.5 x19.00 + 0.2 x12.00 + 0.3 x 8.00 = 14.30% (approx.)
Hence the WACC as per book value weights and market value weights are 15.20% and
14.30% respectively.
44. (c) Average stock of raw materials, stores and spares
=
2
balance Closing balance Opening +
=
2
24 26 +
= 25
Average daily consumption of raw materials =
360
24 504 26 +
=
360
506
= 1.4056
794
Raw material storage period =
1.4056
25
= 17.78 18 days.
2
44 46 +
= 45
Annual cost of production = 46 + 180 + 506 + 60 44 = 748
360
748
= 2.08
Average conversion period =
2.08
45
= 21.63 22 days
Total time period involved in raw material storage period and conversion period
= 22 + 18 = 40 days.
45. (b) The average time for which cash is locked up in receivables is given by the average
collection period.
Average accounts receivable balance =
2
66 74 +
= 70
Annual sales = Rs.1,260 lakh.
Average daily sales =
360
1,260
= 3.5
Average collection period = 70/3.5 = 20 days.
46. (c) Average inventory of finished goods =
2
46 54 +
= 50
Annual cost of sales = 54 + 748 + 80 + 120 + 40 46 = 996
360
996
= 2.77
2.77
50
= 18.05 18 days.
47. (b) Average balance of trade creditors =
2
45 55+
= 50
360
504
= 1.4
4 . 1
50
= 35.71 36 days
Operation cycle period = 18 + 22 + 18 + 20 36 = 42 days.
48. (d) The cost of goods sold is 75%
In the first order of Rs.8 lakh, cost of goods sold is 8 0.75 = Rs.6 lakh.
Therefore profit = 8 6 = Rs.2 lakh.
Probability of paying in the first order is 0.9 and probability of default in the first order is 0.1.
Net weighted financial benefit on the first order is 0.9 2 0.1 6 = 1.2 or Rs.1.2 lakh.
In the second order of Rs.10 lakh, cost of goods sold in 10 0.75 = Rs.7.5.
Therefore profit = 10 7.5 = Rs. 2.5 lakh.
Probability of paying in the 2nd order is 0.95 and probability of default in the second order is
Part III
795
0.05.
Given that the first order is paid with a probability of 0.9, the net weighted benefit from the repeat
order is 0.9 [2.5 0.95 0.05 7.5] = 1.8
Net benefit of both the orders given that the first order is paid = 1.2 + 1.8 = Rs.3 lakh. So,
PIL can offer the credit to MIL.
49. (a) The effect on profit ignoring taxes = S (1 V) + KI DIS
Where,
I =
360
S
0
(ACP
0
ACP
N
)
360
S V
ACP
N
and DIS = P
n
(S
0
+ S)d
n
P
0
S
0
d
0
S = 6,00,000 x 80 x 0.12 = 57,60,000
I =
360
80 x 6,00,000
(32 24)
360
60,000) (0.70)(57,
x 24
=
360
0 9,67,68,00 8 x 80 x 6,00,000
= Rs.7,97,867 (approx.)
DIS = (0.30)(6,00,000 x 80 x 1.12) (0.01) (0)(6,00,000 x 80)(0)
= Rs. 1,61,280
S(1 V) = 57,60,000(1 0.70) = Rs.17,28,000
Effect on profit ignoring taxes
= 17,28,000 + (0.15)(7,97,867) 1,61,280 = Rs.16,86,400.05 (approx.)
Thus, it can be seen that as a result of the new policy of allowing cash discount, the profit
(ignoring taxes) increases by Rs.16.86 lakh.
50. (d) NPV =
= +
5
1 t i) (1
CF
t
t
2,200
=
(1.15)
900
+
2
(1.15)
850
+
3
(1.15)
700
+
4
(1.15)
650
+
5
(1.15)
500
2,200
= 305.820 (in Rs.000s) = 305.82 x 1,000 = Rs.3,05,820.
51. (d) Let the IRR be denoted by r.
IRR is the rate at which the present value of cash inflows will be equal to the present value of
cash outflows.
Therefore, 2,500 =
= +
6
1 t
t
r) (1
flow Cash

For r = 15%, RHS = 2,495.521
For, r = 14%, RHS = 2,558.115
Therefore, r lies between 14% and 15%,
r = 14% + (15 14)
) 521 . 495 , 2 115 . 558 , 2 (
) 500 , 2 115 . 558 , 2 (

Therefore, the internal rate of return of the project is 14.93%.
52. (a) According to net operating income approach,
K
e
= k
0
+ (k
0
k
d
) B/S
0.21 = 0.18 + (0.18 0.12) B/S
0.03 = (0.06) B/S
796
B/S = 0.5 =
Equity of Value Market
Debt of Value Market

2
B
S
=
3
B
S
1 = +
(or) 3
B
B S
=
+

B S
B
+
= 0.33, i.e.
Debt
Assets
= 0.33.
53. (c) Economic Order Quantity (EOQ) =
C . P
FU 2

Usage (U) during the planning period:
Usage in the last quarter = Opening balance + Total receipts Closing balance
= 54,000 + (63,000 + 72,000 + 81,000) 90,000 = Rs.180,000.
Usage in the last quarter (in units) =
18
000 , 80 , 1
= 10,000 units
Usage (U) in the planning period of next six months = 10,000 x 2 = 20,000 units
Fixed cost per order, F = Rs.900 (given)
Unit price P = Rs.18 (given)
Carrying cost for the entire year = 25%
Carrying cost for the planning period of six months, C =
2
25
= 12.5%
) 125 . 0 ( 18
000 , 20 x 900 x 2
Economic Order Quantity (EOQ) = = 4,000 units.
54. (b) Since the minimum order size for availing the discount, Q , is 4000 which is higher than
the EOQ, Q*, the incremental benefits and costs associated with the discount offer have to be
calculated.
Total discount available in planning period if the order size is 4000 cakes
= UD = 9,000 x 8 x 0.0625 = Rs.4,500 .(1)
Savings due to reduction in ordering costs
= F x
Q
U
* Q
U
=
000 , 4
000 , 9
000 , 3
000 , 9
400 = Rs.300 .(2)
Incremental carrying cost
=
2
PC * Q
2
C ) D P ( Q

=
4, 000(8 0.50)0.10 3, 000x8x 0.10
2 2
= 1,500 1,200 = Rs.300 . (3)

Net incremental benefit = (1) + (2) (3) = Rs.4,500.
Since the net incremental benefit is positive the optimal order size would be 4,000 cakes
of the soap.
Part III
797
55. (d) Reorder level = S x L + F Sx R x L
Where,
S is usage in units
L is lead time in days
R is average number of units per order and
F is stockout acceptance factor.
i.e., 400 x 7 + F 7 x 800 , 2 x 400 = 6,720 units
Therefore, F =
2,800
2,800 6,720
= 1.4.
56. (b) Ex-rights value of a share =
0
NP +S
N+1

Where N is number of existing shares required for a rights share.
P
0
is the cum rights price per share
S is the subscription price

52
1 4
S 55 x 4
+
+

S 52 x 5 4 x 55 Rs.40.
Hence option (b) is the answer.
57. (d) Cost of external equity =
1
0
D
+g
P (1-f)

Where,
D
1
is the expected dividend per share.
P
0
is the current market price.
f is the floatation costs involved as a percentage of market price of the growth rate
in dividends
Cost of external equity = 12 . 0
) 06 . 0 1 ( 40
) 12 . 0 1 ( 3
+
+
= 0.2094 i.e., 20.9%.
Hence option (d) is the correct choice.
58. (d) Loss that the company will incur when the customer actually defaults = Cost of the unit
= (1 0.30) x 5,000 = Rs.3,500.
59. (b)
Average balance of trade creditors
Averagedailypurchase

opening creditors + closing creditors
2

= 21,25,000
Annual Credit Purchases
Number of days in a year
=
52, 92, 500
14, 500
365
=
21, 25, 000
146.55days 147days
14, 500
= .
798
60. (b) Existing cost to the company:
Cost of iron slag + Ordering cost + Carrying cost
= 50,000 980 (10.02) +
50, 000
200
5, 000
+ ( )
5000
980 1 0.02 0.15
2

= 4,80,20,000 + 2,000 + 3,60,150 = 4,83,82,150
If the company switches to the new discount then the total cost would be
= 50,000 980 (1 0.05) +
( )
50, 000 10, 000
200 980 1 0.05 0.15
10, 000 2
+
= 4,65,50,000 + 1,000 + 6,98,250
= 472,49,250
So the total benefit to the company would be
4,83,82,150 4,72,49,250 = Rs.11,32,900
61. (b) Cost of preference capital can be calculated from the following:

( ) ( )
n
t n
0 t n
t 1
p p
D P
P
1 k 1 k
=
= +
+ +

where symbols are in their standard use.
Substituting the vine values, we get
95 = 12 PVIFA (k
p
,15) + 110 PVIF (k
p
, 15)
At k
p
= 13%
RHS = 12 6.462 +110 0.160 = 95.144
AT k
p
= 14%
RHS = 12 6.142 +110 0.140 = 89.10
Interpolating, we get
k
p
=
95.144 95.00
1%
95.144 89.10

+

13% = 13.02%.
62. (d) Finished goods storage period =
Average daily cost of goods sold

Average stock of Finished goods =
( ) 650 1050 lakhs
Rs.
2
+
= Rs.850 lakhs
Average daily cost of goods sold =
650 12, 000 4, 500 35, 000 1050 lakhs
Rs.
360
+ + +

=
51, 500
Rs.
360
lakhs = Rs.141.94 lakhs
850
5.99days 6days
141.94
= .
63. (b) NPV = 45 +
2 3 4 5
11.00 13.50 15.50 13.00 16.50
1.14
(1.14) (1.14) (1.14) (1.14)
+ + + +
= 45 + 9.65 + 10.39 + 10.46 + 7.70 + 8.57 = Rs.1.77 crore.
Part III
799
64. (d) Gross operating cycle = Raw material storage period + Conversion period + Finished
goods storage period + Average collection period
124 = Raw material storage period + 3 + 25 + 40
Raw material storage period = 56 days.
65. (c) The annual output is 2 million kg or 2 10
6
kg. The set-up cost of each production run is
Rs.6,000.
Price of the chemical = Rs.800/kg.
Margin = 15%
Cost of sales = 800(1 0.15) = Rs. 680/kg.
Cost of carrying inventory = 680 0.09 = Rs.61.2
Optimum quantity of production
=
2UP
S
=
6
2 2 10 6000
61.2

= 19802.95 kg
kg. 19803 ;
66. (d)
Let the IRR be r
Then,
70 =
2 3 4 5
18 20 28 23 26
(1 r)
(1 r) (1 r) (1 r) (1 r)
+ + + +
+
+ + + +

at r = 18%, the RHS = 69.89
r = 17%, the RHS = 71.61
By interpolation we get

r 17 18 17
70 71.61 69.89 71.61

=

or r 17 =
1.61
1.72
= 0.936
or r = 17.936% 17.94%.
67. (c) Existing cost of inventory
=
1, 50, 000
300 100 0.10
2
+ 4
= 1200 + 7,50,000
EOQ =
2UP 2 6, 00, 000 300
C 100 0.1

=
= 6000
Cost of inventory in the EOQ system
=
6, 00, 000 6, 000
300 100 0.1
6, 000 2
+
= 30,000 + 30,000 = 60,000
Benefit = 7,51,200 60,000 = Rs.6,91,200.
800
68. (d)
Day Books of Company
(Rs.)
Book of the Bank
(Rs.)
Float
(Rs.)
23rd June Opening balance 19,000 27,000 8,000
Cheque issued = Rs. 17,000
Cheque deposited = Rs. 23,000 19,000W+ 23,000 17,000 = 25,000 27,000 + 0 0 = 27,000 8,000
24th June Cheque issued = Rs. 28,000
Cheque deposited = Rs. 33,000 25,000 + 33,000 28,000 = 30,000 27,000 + 0 0 = 27,000 3000
Cheque deposited = Rs. 50,000 30,000 + 50,000 34,000 = 46,000 27,000 + 0 0 = 27,000 19000
Cheque deposited = Rs. 40,000 46,000+40,000 16,000 = 70,000 27,000 + 23,000 0=50,000 20,000
Cheque deposited = Rs. 25,000 70,000+25,00028,000 = 67,000 50,000 + 33,000 0= 83,000 16,000
Cheque deposited = Rs. 15,000
67,000+1500032000 = 50,000 83,000 +50,000 17,000
= 116000
66,000
Cheque deposited = Rs21,000
50,000 + 21,000 44,000 = 27,000 116000+40,000 28,000
= 1,28,000
101000
1st July Cheque issued = Rs. 38,000
Cheque deposited -= Rs. 35,000
27,000 + 35,000 38,000=24,000 1,28,000 + 25,000 34,000
= 1,19,000
95,000
So, the net float available to the company at the end of 30th June is Rs. 1,01,000
69. (d) The net weighted/financial benefit on the initial order is 0.85 (10 8) + 0.15( 8) = 0.50
The net weighted financial benefit from the repeat order is 0.95 (2) + 0.05 ( 8) =1.5
So total net expected financial benefit is (0.5 + 1.5) or 2 lakhs.
70. (d) Reorder level = R L S F L + S
Where S is usage in units, L is lead time in days,
F is the stock-out acceptance factor and R is the average number of units per order
2500 25 144 F 25 + 144 Therefore, 8,100 =
Hence F=1.5.

801
1. Walter model can be applied only to those companies which
a. Make investments without borrowing or raising external equity
b. Make investments that are financed by a small amount of debt
c. Make investments keeping the debt-equity ratio constant
d. Make investments by resorting to a high level of debt
e. Earn high profits.
2. Which of the following is not an assumption in the Walters model on dividend policy?
a. Retained earnings are the only source of finance available to the firm.
b. The firm never resorts to any type of external financing.
c. The internal rate of return and the cost of equity capital of the firm are constant.
d. The dividend per share is constant.
e. The earnings per share is variable.
3. Which of the following factors does not affect the composition of working capital
requirements?
c. Availability of raw materials.
d. Degree of competition.
e. Amount of fixed assets.
4. Which of the following can be noticed in the situation of overtrading in a company?
a. The company transacts a large volume in the stock market.
b. The assets of the company are auctioned.
c. The shares of the company witness a large trading volume in the stock exchanges.
d. The turnover of current assets is very high in comparison to the sales of the company.
e. Volume of sales exceeds that of production.
5. In which of the following arrangements with the bank, a company does not directly assume
the risk of default by its customers?
a. Cash credit.
b. Overdraft.
c. Letter of credit.
d. Pledge.
e. Hypothecation.
6. Which of the following is falsewith regard to raising money through public deposits?
a. The procedure involved is simple and relatively inexpensive.
b. Public deposits are secured by a charge on the immovable assets of the firm.
c. Post-tax cost of funds is much less compared to other sources.
d. There are no restrictive covenants with respect to dividend payments.
e. The scope for mobilization of public deposits is somewhat limited.
802
7. Which of the following is not an assumption in the economic order quantity model?
a. Constant purchase price per unit.
b. Constant demand.
c. Constant ordering cost.
d. Zero carrying cost.
e. Zero delivery time.
8. Which of the following is not a motive for the companies to hold cash?
a. Transaction motive.
b. Precautionary motive.
c. Speculative motive.
d. Lack of proper synchronization between cash inflows and outflows.
e. Capital investments.
a. If credit standards are liberalized, then sales will increase.
b. Strict credit standards will tend to reduce the incidence of bad debt loss.
c. Increase in credit period will tend to increase the investment in receivables.
d. Liberalizing cash discount policy will tend to increase the average collection period.
e. A rigoros collection effort tends to increase the collection expense.
10. When the net float is positive
a. The balance in the books of the bank is higher than the balance in the books of the firm
b. The balance in the books of the bank is less than the balance in the books of the firm
c. The current assets are more than current liabilities
d. The current assets are less than current liabilities
e. The receivables are more than current liabilities.
11. In economic appraisal of projects the project is studied from the point of view of the
a. Suppliers
b. Customers
c. Employees
d. Shareholders
e. Society.
12. In which of the following cases a project will not be accepted?
a. NPV >0.
b. 0 <BCR <1.
c. 0 <NBCR <1.
d. IRR Cost of capital >0.
13. Which of the following is not the valid reason for maintaining inventories?
b. Obtaining quantity discounts.
c. Reduction in ordering cost.
d. Reduction in carrying cost.
e. Reducing the chance of the stoppage of production.

Part III
803
14. If a company has followed a moderate overall working capital policy then
a. Its technical insolvency risk is high and cost of finance is low
b. Its technical insolvency risk is low and cost of finance is high
c. Both the technical insolvency risk and cost of finance would be moderate
d. Either (a) or (b) above
e. Either (b) or (c) above.
15. The limitations of static view of working capital is/are
a. It provides only the difference between current assets and current liabilities as on a
particular date
b. It is not dynamic
c. The Schedule VI requirement of company accounts distorts the working capital amount
d. All of the above
16. The reason underlying the transaction motive for holding cash is that
a. The firm needs cash for meeting unforeseen contingencies
b. The firm needs to hedge against the uncertainty regarding the amount of cash required
for transactions
c. The firm needs cash for routine transactions where immediate cash payment is required.
d. Adequate cash balances are required for executing speculative transactions
17. Given an ageing schedule:
Age: 316030%; Age: 619020% which of the following is true based on the above ageing
schedule?
a. The percentage in the 61-90 age group is large enough to send a point of caution to the
firm.
b. In the 31-60 age group 30% of the receivables are going to be collected between 31 to
60 days.
c. In the 61-90 age group 20% of receivables not realized even after 61 to 90 days of sale.
18. Which of the following committees has not dealt with working capital financing?
a. Dahejia Committee.
b. Tandon Committee.
c. Kannan Committee.
d. Chore Committee.
e. Marathe Committee.
19. Which of the following is not included in the calculation of gross operating cycle period?
a. Raw material stage.
b. Finished goods stage.
c. Creditors stage.
d. Receivables stage.
804
20. If Current Assets (CA) and Current Liabilities (CL) represent current assets and current
liabilities then the eligible bank finance under the second method is always lower than the
eligible bank finance under the first method by
a. 0.25 CA
b. 0.75 CA
c. 0.25 CL
d. 0.25 (CA CL)
e. 0.75 CL.
21. Which statement is true about terms of trade credit of 4/10, net 30?
a. A 10% cash discount is offered for payment before 30 days.
b. A 4% cash discount can be taken for payment before the 10th of the following month.
c. A 10% cash discount can be taken if paid by the fourth day after invoicing.
d. No cash discount is offered after the tenth day.
e. A 4% cash discount if paid on 10th of the following month; balance to pay in 30 days.
22. An ageing schedule illustrates the relationship between
a. Corporate personnel and job seniority
b. Profit and present value
c. The ratio of accounts receivable to sales
d. Accounts receivable and their average time outstanding
e. Accounts payable and their average time outstanding.
23. If a firms dividend pay-out ratio is determined after achieving a specific capital structure, then
a. Dividends are an input to the financial plan
b. Debt should be substituted for equity
c. Dividends are being used as a plug item
d. Dividend forecasts become crucial to planning
e. Equity should be substituted for debt.
24. Which of the following statements about total capital requirement is least likely to be correct
for a profitable firm?
a. Requirements remain constant over time.
b. Seasonal variations are often experienced.
c. The trend is often upward-sloping.
d. A portion of working capital is permanent.
e. The proportion of equity is higher than that of debt.
25. Which of the following assumptions, if not held, will vitiate the capital structure theories?
a. The growth of net operating income.
b. Identical subjective probability distributions of net operating income by investors.
c. Policy of retaining all the earnings.
26. The sequential operations of a business firm together are called
a. Working capital
b. Production cycle
c. Operating cycle
d. Stages of working capital
e. Business cycle.
Part III
805
27. The suppliers terms of sale without a cash discount will have ___________ for the trade
credit.
a. Explicit cost
b. Opportunity cost
c. Incremental cost
d. Marginal cost
e. No cost.
28. In a simple EOQ model
a. The EOQ will increase if the ordering costs increase
b. The EOQ will increase if the unit price increases
c. The EOQ will decrease if the annual usage increases
d. At EOQ the ordering and carrying costs are minimum
29. Cash held to meet specific payments should be invested with an emphasis on
a. Liquidity
b. Matching Maturities
c. Yield
30. The inventory management techniques revolve around the trade-off between
a. Ordering cost and carrying cost
b. Stock-out cost and carrying cost
c. Ordering cost and stock-out cost
31. The numerator of debt-equity ratio consist of
a. Long-term liabilities
b. Current liabilities
c. (a) +(b) +preference share capital
d. (a) +(b) +preference share capital redeemable within one year
32. Which of the following distributions is assumed to be followed by stock-out acceptance
factor?
a. Normal distribution.
b. Log normal distribution.
c. Poisson distribution.
d. Binomial distribution.
33. Cash of a firm includes
a. Demand deposits with bank
b. Marketable securities
c. Bank drafts
806
34. Which of the following is the subsystem of Inventory Management?
a. Reorder Point.
b. Safety Stock.
c. Economic Order Quantity.
35. To evaluate a collection program, which variables do you need?
a. Credit period.
b. Average collection period.
c. Bad debts percentage.
36. The DSO is affected by
a. Pattern of sales
b. Payment by debtors
c. The averaging period of sales
37. Which of the following will be the risks involved in holding large inventories?
a. Obsolescence.
b. Market Value Fluctuations.
c. Physical Deterioration.
d. Change of Fashion.
38. Which of the following will not affect the operating cycle period?
a. Plant break-down.
b. Shortage of raw materials.
c. Quality of debtors.
d. Investment in fixed assets.
39. The EOQ determines
a. The optimum order size to minimize the total inventory costs
b. The order size where the ordering costs are the lowest
c. The order size which will earn discounts on purchases
d. The order size where carrying costs are minimum
e. The order size with the minimum number of orders per year.
40. The payment pattern approach to receivables management
a. Tabulates the collection of receivables by plotting them against the month of origin
b. Overcomes the limitations of DSO and AS approaches
c. Requires internal data for preparation
d. Does not depend on the sales level

Part III
807

41. M/s. J J Constructions Ltd., is planning to invest in a new project. It is estimated that the total
long-term financing required by the project will be around Rs.500 lakh. However, the actual
financing requirement may vary due to the uncertainties involved.
The company has planned to finance the long-term requirements of the project using term
loan, debentures and equity capital in the following proportions:
Equity capital 40%
Term loan 40%
Debentures 20%
The following information has been collected by the company from its investment bankers
and the financial institutions:
Source of finance Range of financing
(Rs. in lakh)
Cost (%)
Up to 140 15.00
140 200 15.50
Equity capital
200 and above 16.00
Up to 150 7.50
150 220 8.00
Term loan
220 and above 8.50
Up to 90 8.00 Debentures
90 and above 8.50
Which of the following is not a breaking point in the new financing structure?
a. Rs.550 lakh.
b. Rs.525 lakh.
c. Rs.450 lakh.
d. Rs.375 lakh.
e. Rs.350 lakh.
(3 points)
42. Given below is the capital structure based on market values for Rogers Ltd.
(Rupees)
Equity Capital 1,00,00,000
Preference Capital 6,21,000
Debentures 9,70,000
Term Loan 8,00,000
The cost of equity capital is 14.8%, the cost of preference capital is 14.68% and the cost of
debentures is 8%. Interest on the term loan is to be paid at the rate of 16% and the tax rate
applicable to the firm is 40%. The weighted average cost of capital for the firm is
a. 12.00%
b. 14.00%
c. 16.80%
d. 17.00%
e. 19.20%.
(3 points)
808
43. Micro Ltd., is considering investing in a plant requiring outflow of Rs.250 lakh. The plant
has an economic life of 5 years. The financial analyst of the company has projected the
following cash flows for the project in the first and the second:
Year Cash Flow
1 Rs.50 lakh
2 Rs.65 lakh
But later he realized that depreciation was erroneously taken as 10% on original cost instead
of 20% on book value. The revised cash flows after making the required adjustment in the
first and the second year are
a. Rs.57.50 and Rs.89.08
b. Rs.89.50 and Rs.89.08
c. Rs.10.14 and Rs.42.14
d. Rs.69.50 and Rs.89.08
e. Rs.57.50 and Rs.69.50.
(3 points)
44. The preference shares of Glax Ltd., have a face value of Rs.100 and are redeemable after 5
years at a premium of 5%. There are currently 6,000 shares with a market value of
Rs.6,21,000. If the cost of preference capital is 14.68%, the approximate rate at which
dividend is paid on these preference shares is
a. 15%
b. 12%
c. 9.0%
d. 7.0%
e. 6.0%.
(2 points)
45. Zenith Industries Ltd., has an earnings per share of Rs.8.00 in the recently concluded
financial year. The cost of capital for the company is 12 percent. It is assumed that the
Walters model of dividend policy holds true for the company.
If the internal rate of return of the company is 15 percent, the price of the companys share at
dividend pay-out ratio of 50% and 75% is
a. Rs.70.83 and Rs.75 respectively
b. Rs.76.53 and Rs.69 respectively
c. Rs.74.23 and Rs.70 respectively
d. Rs.75 and Rs.70.83 respectively
e. Rs.78 and Rs.75 respectively.
(3 points)
46. Consider the following information regarding Xavier & Co. Ltd.:
Net operating income Rs.75 lakh
Overall capitalization rate 15%
Interest on debt Rs.7 lakh
Equity capitalization rate 17%
According to the net operating income approach, the debt-equity ratio of Xavier & Co. Ltd.,
is
a. 0.20
b. 0.25
c. 0.60
d. 1.22
e. 4.00.
(3 points)
Part III
809
47. Paras Ltd., had profit after tax of Rs.1,60,000. The number of outstanding shares for the
company is 20000. The capitalization rate for the company is 12%. Assuming Walters
model, which of the following statements will be true if the internal rate of return of the
company is 12%?
i. The price per share when the dividend pay-out ratio is 50% is Rs.66.67.
ii. The optimal dividend pay-out ratio in this case is 100%.
iii. The price per share when the dividend pay-out ratio is 75% is Rs.66.67.
a. Only (i) above.
b. Only (ii) above.
(3 points)
48. According to the terms of a rights issue the equity shareholders are entitled to receive one
share for every four shares held. The cum-rights price per share is Rs.36 per share and the
subscription price is Rs.31 per share. The theoretical value of a right is
a. Re.0.50
b. Re.1.00
c. Rs.1.50
d. Rs.2.00
e. Rs.2.50.
(1 point)
49. Earnings per share =Rs.8.00
Retention ratio =50%
Cost of equity capital =15%
Growth rate = 5%
According to Gordons dividend capitalization model the value of the share is
a. Rs.24
b. Rs.30
c. Rs.32
d. Rs.35
e. Rs.40.
(1 point)
50. The terms of a credit purchase transaction is 2/10, net 30 (1 year =360 days). The implicit
cost of trade credit is
a. 20.48%
b. 30.25%
c. 36.73%
d. 40.12%
e. 42.15%.
(1 point)
810
51. The market value of debt and equity of a firm are Rs.80 lakh and Rs.120 lakh and the costs of
equity and debt are 16% and 14% respectively. Assuming the firm follows 100% dividend
pay-out ratio and there is no income tax, corporate or personal, the net operating income for
the firm is
a. Rs.27.2 lakh
b. Rs.28.4 lakh
c. Rs.30.4 lakh
d. Rs.31.6 lakh
e. Rs.32.4 lakh.
(1 point)
52. Consider the following data regarding an electronic goods manufacturing company:
Cost of equity 16%
Cost of debt 12%
Tax rate 30%
Debt/Equity ratio 1:1
The increase (decrease) in the cost of capital if debt to equity of the company is changed to 0:1 is
a. (3.80)%
b. (0.18)%
c. 0.18%
d. 3.80%
e. 4.20%.
(2 points)
53. The following information is available about Harmony Ltd.:
Average Daily Usage
(Units)
Probability
Lead Time
(No. of days)
Probability
600 0.6 4 0.3
800 0.4 6 0.7
a. 1,776 units
b. 2,720 units
c. 3,672 units
d. 4,080 units
e. 4,800 units.
(2 points)
54. SELLFAST sports Ltd., sells 1500 cricket bats each year. The average cost of purchasing
each bat is Rs.250. The cost for the company to place an order for bats is Rs.50 and it incurs
5% of the average cost to carry them in inventory. The optimal units of quantity that the
company should order is
a. 110 units
b. 106 units
c. 103 units
d. 99 units
e. 95 units.
(1 point)

Part III
811
55. Mehta Steel Products Ltd., uses 4900 tonnes of steel in a year. The purchase price is
Rs.15,625 per tonne. However, the supplier has offered a discount of 0.8 percent per tonne if
the order size is at least 80 tonnes. The fixed cost per order is Rs.1,800 and carrying cost of
the inventory is 25 percent of the inventory value.
The increase in the carrying costs if the company accepts the discount offered by the supplier
will be
a. Rs.23,750
b. Rs.21,000
c. Rs.19,000
d. Rs.12,000
e. Rs.8,000.
(3 points)
56. The supplier of KR Ltd., is offering a cash discount of 2%, if the firm orders 2,800 units.
The annual usage of KR Ltd. is 8,000 units and the cost per order is Rs.650. The EOQ of
the firm is 1,700 units. The cost of each unit is Rs.90. The increase in carrying costs if the
firm accepts the suppliers offer is Rs.1,879.20. The incremental profit to the firm if it
accepts the cash discount offered by the supplier is
a. Rs.13,722.48
b. Rs.14,400.00
c. Rs.16,097.50
d. Rs.19,123.00
e. Rs.20,089.78.
(2 points)
57. Southern Investment Corporation is planning to invest in a new project. The total outlay on
the project will be financed by a mixture of long-term and short-term funds. The following
information is available:
Total outlay : Rs.100 lakh
Total short-term financing required : Rs.32 lakh
Duration of the project : 5 years
Post-tax net cash flows relating to long-term funds for the years 1 through 5 are as under:
At the end of year Net cash flow (Rs. in lakh)
1 10
2 30
3 35
4 25
5 10
The cost of long-term funds for the project will be 15%.
The NPV for the project is
a. Rs.2.78 lakh
b. Rs.3.45 lakh
c. Rs.4.56 lakh
d. Rs.5.66 lakh
e. Rs.35.66 lakh.
(2 points)
812
58. Agarwal Industries Ltd., is considering a project which will entail the following revenues and
expenses:
(Rs. in lakh)
Year 1 2 3 4 5
Sales 50 50 60 60 60
Operating cost 30 30 35 35 35
Depreciation 4 4 4 4 4
Interest on short-term bank loan 5 5 5 5 5
Interest on term loan 1.30 1.04 0.78 0.52 0.26
The tax rate applicable to the company is 30%. The project involves the following outlays:
(Rs. in lakh)
Plant and Machinery 25.00
Working capital 46.25
Total outlay 71.25
The proposed scheme of financing is given below:
(Rs. in lakh)
Equity capital 30.00
Term loan 10.00
Short-term bank loan 31.25
Total financing 71.25
At the end of 5 years the net salvage value of the current assets will be equal to their book
value and the net salvage value of the fixed assets will be equal to Rs.5 lakh. The short-term
bank loan will be repaid at the end of 5 years and the term loan will be repaid over the life of
the project in equal installments. The cost of capital for the project is 19%.
Which of the following statements is/are true?
i. The net cash flow in the 5th year is Rs.35.2 lakh.
ii. The net cash flow in the 1st and 2nd year is Rs.12.5 lakh.
iii. The net cash flow in the 3rd and 4th year is Rs.15.2 lakh.
a. Only (i) above.
b. Only (ii) above.
(3 points)
59. Following are the cash flows related to a project over a period of 6 years.
Year Cash Flows (Rs. in Lakh)
0 250
1 57.50
2 69.50
3 82.10
4 90.20
5 123.58
Part III
813
The cost of capital for the firm is 16%.
The approximate value of Benefit Cost Ratio for the project is
a. 0.59
b. 0.87
c. 1.05
d. 1.95
e. 2.81.
(3 points)
60. Consider the following data of M/s. Startrack Ltd. for the year 2003-2004
Market Value of Debt Rs.5,00,000.
Interest Rs.30,000.
Net Operating income Rs.1,00,000.
Cost of Equity 14%.
If debt-equity ratio increases to 5:4, the revised equity capitalization rate according to net
operating income approach is
a. 10%
b. 12%
c. 14%
d. 15%
e. 20%.
(2 points)
61. Consider the following data for XLNC Ltd.
Earnings Per Share (EPS) Rs.7.50
Dividend Payout Ratio 40%
Equity Capitalization Rate 14%
Rate of Return on Investments 15%
If the number of shares outstanding for the firm is 2,50,000 the market value of equity is
a. Rs.1, 28,57,500
b. Rs.1, 38,57,500
c. Rs.1, 39,67,500
d. Rs.1, 48,57,500
e. Rs.1, 49,57,500.
(2 points)
62. The probability that a customer pays for the first order is 70%. In case the customer pays for
the first order, the probability of default in case of a repeat order is likely to be 15%. If the
revenue from each order is Rs.80,000 and the associated cost is Rs.50,000, what is the total
net weighted benefit from the order?
a. Rs.12,600.
b. Rs.13,000.
c. Rs.14,546.
d. Rs.18,600.
e. Rs.19,867.
(2 points)

814
63. The following information is given about the debentures issued by M/s. X Ltd.:
Face Value = Rs.100
Rate of interest = 10% p.a.
Amount realized per debenture = Rs.96
Corporate tax rate = 40%
Debenture is redeemable at a premium of 2% after 6 years. The difference between the
redemption price and the net amount realized can be written off over the life of the debenture
and the amount so written off is tax-deductible. The cost of debenture capital is
a. 4.56%
b. 6.45%
c. 6.67%
d. 7.86%
e. 7.86%.
(2 points)
64. The Vexser company has the following capital structure:
Equity Shares (2,00,000) Rs.40,00,000
10% Preference Shares Rs.10,00,000
14% Debentures Rs.30,00,000
The current market price of the share is Rs.20. The expected dividend next year is Rs.2 per
share, which will grow at 7% forever. If the company raises an additional Rs.2,00, 000 debt
by issuing 15% debentures, the expected dividend increases to Rs.3 and the price of share
falls to Rs.15. The growth rate remains the same. The weighted average cost of capital for the
firm, assuming a tax rate of 50% is
a. 12.37%
b. 15.40%
c. 16.60%
d. 17.00%
e. 27.00%.
(2 points)
65. Consider the following data regarding a product:
Total cost of ordering and
carrying inventory Rs.785
Quantity per order 5,000 units
Carrying cost 2% of the purchase price
Fixed cost per order Rs.95
Purchase price Rs.10.
The annual usage of the material is
a. 12,000 units
b. 14,000 units
c. 15,000 units
d. 16,000 units
e. 17,000 units.
(2 points)
Part III
815
66. The cum-rights price per share is Rs.48 and the theoretical value of the right is Rs.4. The
subscription price at which the rights are issued is Rs.36 per share. The number of existing
shares required for a rights share is
a. 5
b. 4
c. 3
d. 2
e. 1.
(1 point)
67. If the average stock of work-in-process is Rs.55.75 lakhs and the average conversion period
is 3 days, the annual cost of production (assuming 360 days in a year) is
a. Rs.5,670 lakhs
b. Rs.6,690 lakhs
c. Rs.7,690 lakhs
d. Rs.8,650 lakhs
e. Rs.9,870 lakhs.
(1 point)
68. The sales figures for M/s. Y Ltd., are as follows:
Month Sales in Rs.
November 2003 60,000
December 2003 70,000
J anuary 2004 75,000
The receivables from the credit sales are expected to be collected in the following manner:
20% of the receivables are collected in the month of sales, 50% of the sales are collected
one month after the month of sale and 30% after two months from the date of sale. The
total cash receipts from sales in the month of J anuary are
a. Rs.55,000
b. Rs.35,000
c. Rs.60,000
d. Rs.68,000
e. Rs.70,000.
(1 point)
69. If the net benefit cost ratio is 0.2, the net present value is Rs.2,000, the present value of the
cash inflows associated with the project is
a. Rs. 9,800
b. Rs.10,000
c. Rs.12,000
d. Rs.13,200
e. Rs.14,000.
(2 points)
Gross operating cycle 80 days
Net operating cycle 55 days
816
Raw-material storage period 40 days
The average collection period is
a. 7 days
b. 18 days
c. 22 days
d. 25 days
e. 37 days.
(1 point)

817
Suggested Answers
1. (a) Walter model assumes that the firm does not resort to any external financing in the form
of external equity or debt. All the other alternatives are not related with any of the
assumptions of the model.
2. (e) Walter model assumes that the earnings per share is constant. All other alternatives state
the other assumptions of Walter model.
3. (e) The amount of fixed assets does not influence the composition of working capital. All
the other alternatives state the factors which affect the composition of working capital.
4. (d) In the situation of overtrading the current asset turnover is observed to be very high in
comparison to the sales.
5. (c) Under the letter of credit (L/C) arrangement the credit risk of customers is not borne by a
company; it is borne by the bank issuing the L/C.
6. (b) Public deposits are unsecured instruments. Hence, alternative (b) is false. All other
alternatives are true.
7. (d) The Economic Order Quantity (EOQ) model does not assume zero carrying cost; it
assumes constant carrying cost. All other alternatives state the assumptions under the EOQ
model.
8. (e) Capital investments decisions are special decisions and are not undertaken as routine
business activity. Hence, a company does not require readily available cash to undertake
capital investments. All other alternatives state the motives for holding cash.
9. (d) A liberal cash discount policy provides incentives to customers to make early payments
in order to avail the discount. Hence, it tends to reduce the average collection period.
10. (a) When the net float is positive the balance in the books of bank is higher than the balance
in the books of the firm.
11. (e) In economic appraisal of projects, the project is studied from the point of view of society.
12. (b) Project will not be accepted if the BCR is less than 1.
13. (d) Inventories are not maintained to reduce carrying cost (carrying costs will always
increase if inventories increase).
14. (c) A company following a moderate approach will have an investment in current assets for
a given level of forecasted sales at a moderate level. Hence the company is subjected to a
moderate degree of risk.
15. (d) As per the definition under static view of working capital the purpose of current assets is
to provide adequate cover for current liabilities. This suffers from all the mentioned
limitations.
16. (c) The reason underlying the transaction motive for holding cash is that the firm needs cash
for routine transactions where immediate cash payment is required. The company is always
entering into transactions with other firms, which may or may not result in immediate cash
inflow/outflow. Hence adequate cash is to be maintained.
17. (b) The age wise distribution of accounts receivable at a given time is depicted in the ageing
schedule.
18. (a) Dehejia Committee has not dealt with working capital financing.
19. (c) Gross operating cycle =Raw material storage period +Conversion period +Finished
goods storage period +Average collection period. Hence creditors stage is not included in
the calculation of gross operating cycle.

818
20. (c) According to the Tandon Committee recommendations, the maximum permissible bank
finance under Method I is 0.75 (Current assets Current liabilities) and under Method II is
0.75 (Current assets) Current liabilities. Hence the difference between the two methods =
0.75 (CA CL) [0.75(CA) CL] =0.75 (CA CA) 0.75 CL +CL =0.25 CL.
CA : Current Assets
CL : Current Liabilities.
21. (d) 4/10 net 30 implies that 4% cash discount can be taken for payment within 10 days
otherwise net payment has to be made within 30 days.
22. (d) The age wise distribution of accounts receivable at a given time is depicted in the ageing
schedule. Hence it illustrates the relationship between accounts receivable and their average
time outstanding.
23. (c) If the firms dividend pay-out ratio is determined after achieving a specific capital structure,
then it means dividends are being used as a plug item to maintain the capital structure.
24. (a) For a profitable firm the capital requirements increase over the period of time with
increase in the level of activity.
25. (b) To have identical subjective probability distributions of net operating income by investors is
one of the basic assumptions of capital structure theories. Hence if this is not held it will vitiate the
capital structure theories.
26. (c) Operating cycle involves business operations like raw material storage period, conversion
period, finished goods storage period and average collection period.
27. (b) The suppliers terms of sale without a cash discount will have opportunity cost for the trade credit.
28. (a) EOQ =
2UF
PC

Where U is the annual usage, F is the fixed cost per unit, P is the purchase price per unit, and
C is the carrying cost.
EOQ has a direct relationship with ordering costs. Hence EOQ increases when ordering cost
increases as it is more economical to order a larger quantity when ordering costs are high.
29. (d) Liquidity is the ability to convert into cash and matching maturities is to match the inflow
with outflows.
30. (d) Inventory management techniques involve maintaining the optimal inventory level by
taking into consideration the ordering costs, carrying costs and stock-out costs.
31. (a) The numerator in the debt equity ratio is the debt and it consists of long-term liabilities +
current liabilities. However, sometimes financial analysts considers debt-equity ratio
=
long-termdebt
equity
.
32. (c) Stockout acceptance factor depends on stockout percentage rate specified and the
probability distribution of usage (which is assumed to follow a Poisson distribution)
33. (e) Cash is the most liquid asset and includes actual cash in the form of notes and coins and
bank drafts held by a firm and the deposits withdrawable on demand.
34. (e) The inventory management systemconsists of three subsystems. EOQ subsystem, reorder
point subsystemand stock level subsystem.
35. (e) Evaluation of collection policy of a firm is done on the basis of the amount of receivables
and bad debt losses.
36. (e) Days sales outstanding is given by =
sales daily Average
chosen time the at receivable Accounts

37. (e) All the given alternatives are risks involved in holding large inventories.
Part III
819
38. (d) Gross Operating cycle period =Raw material storage period +Conversion period +
Finished goods storage period +Average collection period
39. (a) EOQ refers to the optimal order size that will result in the lowest total of order and carrying
costs for an itemof inventory given its expected usage, carrying costs and ordering costs.
40. (e) The payment pattern approach to receivables management has all the given features.
Part B: Problems
41. (b) Determination of breaking points in capital structure.
Source of
Capital
Cost
(%)
Range of new financing
from the source
Breaking point
(Rs. in lakh)
Range of total new
financing (Rs. in lakh)
Equity 15.00 0 140
140
0.40
=350 0 350
15.50 140 200
200
0.40
=500 350 500
Term loan 7.50 0 150
150
0.40
=375 0 375
8.00 150 220
220
0.40
=550 375 550
Debentures 8.00 0 90
90
0.20
=450 0 450
From the above we can find that the breaking points in the total new financing occurs at the
levels of Rs.350 lakh, Rs.375 lakh, Rs.450 lakh, Rs.500 lakh and Rs.550 lakh. That is the
weighted average cost of capital will change when the total new financing exceeds these
levels.
Hence Rs.525 lakh is not a breaking point.
42. (b) Cost of termloan =I(1 t) =16% (1 0.40) =9.6%.
Weights based on market values:

e
w
1,00,00,000
1,00,00,000 6,21,000 9,70,000 8,00,000
=
+ + +

0 1,23,91,00
0 1,00,00,00
= =0.81
=
p
w
000 , 91 , 23 , 1
000 , 21 , 6
=0.05
=
d
w
000 , 91 , 23 , 1
000 , 70 , 9
=0.08
=
t
w
000 , 91 , 23 , 1
000 , 00 , 8
=0.06.
Weighted average cost of capital =
e e p p d d t t
w k +w k +w k +w k
=(0.81)(14.8) +(0.05)(14.68) +(0.08)(8.83) +(0.06)(9.60)
=14.004% =14.00%.
820
43. (e)
Year 1 2
A. Cash flow before adjustment 50.00 65.50
B. Less: Depreciation
(10% on original cost)

25.00

25.00
C. PAT before adjustment 25.00 40.00
D.
PBT =
0.30 1
PAT
35.71 57.14
E. Add: Depreciation
(10% original cost)

25.00

25.00
F. Less: Depreciation
(20% on book value)

50.00

40.00
G. PBT after adjustment
=D +E F

10.71

42.14
H. PAT after adjustment
=G x (1 0.30)

7.50

29.50
I. Cash flow after adjustment
=H +F

57.50

69.50
44. (a) The cost of preference capital,

2
P F
n
P F
D
k
p
+
+
=
P =
000 , 6
000 , 21 , 6
=Rs.103.50
2
103.50 105
5
103.50 105
D
+
+
i.e. 14.68% =
Hence D =Rs.15 approximately.
Therefore, the rate at which dividend is paid =15/100 =0.15 or 15%.
45. (d) According to the Walters model on dividend policy the price per share is given by the
formula:
P =
k
k
r
D) (E D +

E = Rs.8.00 per share (given)
r = 15% =0.15
k = 12% =0.12
If dividend payout ratio is 50%
D = 8 (0.50) =Rs.4.00 per share
P =
0.12
0.12
0.15
) 4 (8 4 +

=
0.12
0.12
0.15 x 4
4+
=Rs.75 per share
If dividend payout ratio is 75%
D =8 (0.75) =Rs.6.00
Part III
821
P =
0.12
0.12
0.15
) 6 8 ( 6 +
=
0.12
0.12
0.15 x 2
6+
=Rs.70.83 per share.
46. (b) According to the net operating income approach Total market value of firm
=
rate tion capitaliza Overall
=
0.15
75
=Rs.500 lakh
rate tion capitaliza Equity
income Equity

=
rate tion capitaliza Equity
debt on Interest income operating Net
=
17 . 0
7 75
=Rs.400 lakh
Market value of debt =Total market value of firm Market value of equity
=500 400 =Rs.100 lakh
Debt equity ratio =
400
100

=0.25.
47. (d) According to the Walters model, when the internal rate of return is equal to the cost of
capital then there will not be any optimal dividend payout ratio as the market price at all the
dividend payout ratios will be equal.
EPS =
000 , 80
000 , 60 , 1
=Rs.8.
When dividend payout ratio =50%, D =0.50 x 8 =Rs.4

4 (0.12/ 0.12)(8 4)
P
0.12 0.12

= + =Rs.66.67.
When dividend payout ratio =75%, D =0.75 x 8 =Rs.6.

6 (0.12/ 0.12)(8 6)
P
0.12 0.12

=Rs.66.67. = +
48. (b) Theoretical value of a right is

4 1
31 36
1 N
S P
o
+
=
+
=Re.1.00.
49. (e) According to Gordons model:
P =
e
b)
k br
E(1
=
05 . 0 15 . 0
0.50) 8(1
=40 i.e. Rs.40.

50. (c) Implicit cost of trade credit
=
20
360
x
0.98
0.02
10 30
360
x =
0.02 1
0.02
=0.3673 i.e. 36.73%.

51. (c) Capitalization rate for the company,
k
0
=
S B
S
k
S B
B
k
e d
+
+
+
, where the notations are in their standard use
k
0
=
120 80
120
x 16
120 80
80
x 14
+
+
+
=15.2%
Further, k
0
=
firm of value Market
=0.152
Net operating income =0.152 x 200 =Rs.30.4 lakh.
822
52. (d) Existing cost of capital
k
0
=w
e
k
e
+w
d
(1 T) k
d
k
0
=0.5 x 16 +0.5 x (1 0.3) x 12 =12.20
If debt to equity ratio changes to 0:1 then, it becomes all equity firm, hence, k
0
=k
e
=16%.
Therefore, increase in cost of capital =16 12.2 =3.8%.
53. (c) Expected average daily usage =600 x 0.6 +800 x 0.4 =680 units
Expected lead time =4 x 0.3 +6 x 0.7 =5.4 days
Hence, normal consumption during lead time =680 x 5.4 =3,672 units.
54. (a) Economic Order Quantity =
PC
2FU
=
2 x 1,500 x 50
250 x 0.05
=109.5 110 units.
55. (a) Economic Order Quantity =
PC
2FU
=
2 x 1,800 x 4,900
15,625 x 0.25
=67.2 tonnes
The EOQ is less than the minimum order quantity that will enable the company to avail of
the discount. So we have to find out the change in profit that will arise if the quantity
discount is availed of by ordering 80 tonnes.
Let the following notations be used:
Q* = EOQ =67.2 tonnes
Q = Minimum required quantity for discount =80 tonnes
D = Discount per tonne =15,625 x
100
8 . 0
=Rs.125
Increase in carrying costs
=

2
PC * Q
2
C D) (P Q

=
80(15,625 125)0.25 67.2x15,625x0.25
2 2

=Rs.23,750.
56. (a) Net profit if the cash discount is utilized is computed as:
UD + F x
Q
U
Q
U
*
Increase in carrying cost

=8,000 x 1.8 +
8,000 8,000
x 650
1,700 2,800

1,879.20
=14,400 +1201.68 1879.20 =Rs.13,722.48.
Hence, the firm should accept the discount as the incremental profit associated with it is
positive.
57. (d) Total long-term funds invested in the project
=Total outlay Total short-term financing =100 32 =Rs.68 lakh.
Net present value =Present value of net cash flows relating to long-term funds Total long-
term funds invested in the project

1 2 3 4 5
30 35 25 10
= + + + +
(1.15) (1.15) (1.15) (1.15) (1.15)
10
68

=Rs.5.66 lakh
Since the net present value is positive the project can be accepted.
Part III
823
58. (d)
Year 0 1 2 3 4 5
A Investment
1
(40)
B Profit before tax
2
11 11 16 16 16
C Tax (30%) (3.3) (3.3) (4.8) (4.8) (4.8)
D Profit after tax 7.7 7.7 11.2 11.2 11.2
E
Net salvage value of fixed
assets
5
F
Net salvage value of current
assets
46.25
G
Repayment of short-term
bank loan
(31.25)
H Initial flow (40)
I Operating flow (D +4)
3
11.7 11.7 15.2 15.2 15.2
J Terminal flow (E +F G) 20
K Net cash flow (H +I +J ) (40) 11.7 11.7 15.2 15.2 35.2
Working notes:
1. Investment
=Total long-termfunds invested in the project
=Equity capital +Term loan
=30 +10 =Rs.40 lakh.
2. Profit before tax
=Sales Operating cost Depreciation Interest on short-term bank loan.
Interest on term loan has been excluded from the calculation of profit before tax (PBT)
and profit after tax (PAT) because the post-tax cost of long-term funds which is used
for discounting the net cash flows relating to long-term funds, includes the post-tax cost
of term loan.
3. Operating flow =PAT +Depreciation
Depreciation =4
Operating flow =PAT +4
59. (c) BCR =
Present value of cash inflows
Initial investment

Present Value of Cash flows
Year Cash Flows (Rs. in lakh)
PVIF
(16%,t)
Present value of cash
flows
1 57.50 0.862 49.57
2 69.50 0.743 51.64
3 82.10 0.641 52.63
4 90.20 0.552 49.79
5 123.58 0.476 58.87
BCR =
49.57
=
+51.64+52.63+49.79+58.87
250
262.50
250
=1.05.
824
60. (d) As per Net Operating Income Approach
k
e
=
NOI INT
S

S =
1,00,000 30,000
Rs.5,00,000
0.14
=
Market value of Debt = Rs.5,00,000 (given)
Value of the firm =Rs.10,00,000
Overall cost of capital
0
NOI 1,00,000
k 10%
V 10,00,000
= = =
As per NOI approach, overall cost of capital will remain constant even if the debt-equity
ratio changes.
( )
e 0 0 d
D
k k k k
E
= +
( )
e
5
k 0.10 0.10 0.06
4
= +
=0.10 +0.05 =0.15=15%
61. (c) According to Walters Model
P
o
=
( )
r
E D
D
k
k k
+ , where symbols are in standard use.

Substituting the given values we get
( )
=
0.15
7.5 3
3
0.14
0.14
+ =21.43 +34.44 =55.87

0.14
Number of shares outstanding =2,50,000
Market value of equity = P
0
N =55.87 2,50,000 = Rs.1,39,67,500.
62. (d) Net benefit from the first order =0.7 x 30,000 0.3 x 50,000 =Rs.6,000
Net weighted benefit from the repeat order =0.7 (0.85(30,000)0.15(50,000)) =Rs. 12,600
Total benefit =Rs.6,000 +Rs.12,600 =Rs.18,600
63. (c) Cost of debt capital when the difference between the redemption price and the net amount
realized can be written off over the life of the debenture and the amount so written off is tax-
deductible, is given by
=
2
) 96 102 (
) 40 . 0 1 (
6
) 96 102 (
) 40 . 0 1 ( 10
+

+
= 0.06666 or 6.67%.
2
) P F (
) t 1 (
n
) P F (
) t 1 ( I
+

+
k
d
=
64. (b) The capital structure of Vexser after the issue of 15% debentures will be
Source Amount (in Rs.)
Ordinary shares 40,00,000
10% Preference shares 10,00,000
Total: 100,00,000
Part III
825
Cost of equity prior to this change can be calculated as follows:

1
e
0
D 2
k g 0.07 17%
P 20
= + = + =
Cost of equity after the change in capital in capital structure

e
3
k 0.07 2
15
= + = 7%
( )
e e p p d d
WACC w k w k w k 1 T = + +
WACC =0.40 0.27 +0.10 0.10 +0.30 0.07 +0.20 0.075 =0.154 =15.40%.
65. (c) Total costs associated with inventory =Ordering cost +carrying cost
=
2
QPC
F
Q
U
+
where U is the annual usage
Q is the quantity ordered
F is fixed cost per unit
P is the purchase price per unit
C is the carrying cost expressed as a
percentage of the purchase price.
Hence,
785 =
2
0.02 10 5000
95
5,000

+
U

Hence, U =15,000 units.
66. (d) The theoretical value of a right =
1 N
S P
0
+
where P
0
is the cum-rights price, S is the
subscription and N is the number of shares required for a rights share. Hence, 4 =
1 N
36 48
+

Therefore, N =2.

67. (b) Average conversion period =
Average stock of work in process
Average daily cost of production

Average daily cost of production =55.75 lakhs/3
Hence, annual cost of production =360 x 55.75 lakhs/3 =Rs.6690 lakhs.
68. (d) Amount collected in the same month =20% x 75,000 =Rs.15,000
Amount collected from previous months sale =50% x 70,000 =Rs.35,000
Amount collected from the sales that occurred in the month of November =30% x 60,000
=Rs.18,000.
Hence, the total cash receipts in the month of J anuary =15,000 +35,000 +18,000
= Rs.68,000.
Hence, the correct option is (d).

826
69. (c) Net Benefit Cost Ratio (NBCR) =
Investment Initial
NPV

Hence initial investment = Rs.10,000.
0.2
2,000
NBCR
NPV
= =
We know that NPV =Present value of inflows Initial investment
Hence, Present value of inflows =NPV +initial investment =2,000 +10,000 =Rs 12,000.
Hence the correct option is (c).
=Gross operating cycle (RM storage period +Conversion period +FG storage period)
=80 (40 +2 +20) =18 days.

827
1. Which of the following techniques of project appraisal does not take into account the time
value of money?
a. Net present value.
b. Benefit cost ratio.
c. Payback period.
d. Internal rate of return.
e. Annual capital charge.
2. Which of the following is not a principle for determining the costs and benefits of projects?
a. Interest on long-termfunds must be excluded fromthe determination of net cash flows.
b. All revenues and costs accrued must be considered as benefits and costs respectively.
c. The cash flows must be determined in incremental terms.
d. All costs and benefits must be measured in terms of cash flows.
e. Cash flows must be defined in post-tax terms.
3. In which of the following types of factoring the bad debt loss is not borne by the factor?
a. Recourse Factoring.
b. Full Factoring.
c. Maturity Factoring.
d. Invoice Discounting.
4. Which of the following is not a relevant feature of an optimal capital structure?
a. Profitability.
b. Liquidity.
c. Flexibility.
d. Control.
e. Solvency.
5. Garima Herbal Products Limited is considering the purchase of a new mixing machine to
replace an existing machine that has a book value of Rs.1,65,000 and can be sold for
Rs.1,00,000. The estimated salvage value of the old machine in five years would be zero,
and it is depreciated on a straight-line basis. The new machine will contribute Rs.3,00,000 as
annual cash savings over the old machine. The new machine has a life of five years. The
costs of new machine is Rs.6,50,000 and can be sold for an expected amount of Rs.90,000 at
the end of fifth year. Assuming straight-line depreciation, and a 35% tax rate, in the fourth
year of operation the net cash flows associated with this replacement decision would be
a. Rs. 64,150
b. Rs.93,550
c. Rs.1,32,650
d. Rs.2,22,650
e. Rs.3,12,650.
828
6. According to the rational expectations model if the dividend declared is higher than what was
expected, then which of the following is/are true?
a. The share price will remain unchanged.
b. The share price will fall.
c. There will be expectations of higher earnings in future.
d. The share price will rise.
7. Net working capital is equal to
a. Current assets Current liabilities
b. Fixed assets Current assets
c. Current Assets Cash
d. Long-term loans Short-term loans
e. Current liabilities Provisions.
8. As a general rule, the capital structure that maximizes the market value of a company also
a. Maximizes its average cost of capital
b. Maximizes its earnings per share
c. Maximizes the chance of bankruptcy
d. Minimizes the cost of capital of the company
e. Minimizes the cost of debt capital of the company.
a. Equity capital.
e. Reserves and surplus.
10. Which of the following is trueabout equity capital as a source of finance?
a. Using equity capital to finance working capital may lead to a situation of technical
insolvency.
b. Assessing the cost of equity capital is a difficult and complex task.
c. Equity capital provides tax benefits to the issuing company.
d. Cost of equity capital is lesser than the cost of debt capital.
e. The more a company depends on equity capital the higher will be the financial risk of
the company.
11. What are the factors which make debentures attractive to investors?
a. The debenture holders enjoy a prior claim on the assets of the company over the
shareholders in the event of liquidation.
b. The rate of return is stable.
c. A trustee is appointed who ensures that the company fulfills its obligations towards the
debenture holders.
d. The principal is redeemed at maturity.
12. The cost of capital of a firm is
a. The dividend paid on the equity capital
b. The average of the dividends paid on the equity capital and the preference capital
c. The interest paid on long-term debt
d. The average of interest payments made on long-term and short-term debt
e. The weighted average cost of various sources of long-term finance used by it.

Part III
829
a. The cost of retained earnings is more than the cost of external equity.
b. The cost of external equity is always less than the cost of debt capital.
c. The cost of retained earnings is less than the cost of external equity.
d. The retained earnings are a cost free source of finance.
e. Retained earnings are invested in fixed assets only.
14. Which of the following is/are truewhen the net float is negative?
i. The balance in the books of the firm is lower than the balance in the books of the bank.
ii. The payment float is negative.
iii. The firm can play the float and issue cheques as it has an overdrawn bank account
according to its own books.
a. Only (i) above.
b. Only (ii) above.
15. The bond yield plus risk premium approach is a method of finding out the cost of
a. Preference capital
b. Equity capital
c. Debenture capital
d. Term loans
e. Short-term loans.
16. Which of the following will cause a decrease in the net operating cycle of a firm?
a. Increase in the work-in-process period.
b. Increase in the raw materials storage period.
c. Increase in the average payment period.
d. Increase in the average collection period.
e. Increase in the finished goods period.
17. A firm is operating in a stable environment and is well in control of its cash flows, which are
stable. Which tool of cash management can the manager use?
a. Monthly Cash Budget.
b. Monthly Cash Report.
c. Monthly Treasury Report.
18. Which of the following is/are used in monitoring receivables?
a. Days sales outstanding.
b. Ageing schedule.
c. Collection matrix.

830
a. The chief difference between a private placement and a bought-out-deal is the
involvement of an intermediary in a bought out-deal, which may or may not be
necessary in a private placement.
b. Private placements enable companies to raise small amounts of capital which become
uneconomical in a bought-out-deal.
c. Private placements of new companies can be listed on the OTCEI only while BODs can
be listed on both OTCEI and NSE.
20. Which of the following is/are true regarding a company following a conservative working
capital policy?
i. The company will finance its current assets more from long-term sources.
ii. The technical insolvency of the company will be high.
iii. The company will have a higher current ratio than one following an aggressive working
capital policy.
iv. The company will have a lower current assets turnover ratio than the one following an
aggressive working capital policy.
a. Only (i) above.
b. Both (ii) and (iii) above.
c. Both (iii) and (iv) above.
d. Only (i), (ii) and (iii) above.
e. Only (i), (iii) and (iv) above.
21. Which of the following are the motives for holding cash?
a. Transactionary motive.
b. Speculative motive.
c. Precautionary motive.
a. Equity shareholders enjoy the rewards of ownership and bear the risks of the ownership.
b. Post-tax cost of debentures is always less than the post-tax cost of the term loans.
c. The par value and issue price of an equity share are always equal.
d. All outstanding issues of shares are traded in the primary markets.
e. The interest payment on irredeemable debentures is a statutory obligation whereas the
interest payment on redeemable debentures is not.
23. Cost of capital is
a. The weighted average cost of all types of debt
b. The rate of return expected by the equity shareholder
c. The average IRR of the projects undertaken by a company
d. The minimum rate of return that a company has to earn
24. If the expected dividend is less than the actual dividend paid, the rational expectation
approach suggests that the
a. Share price increases
b. Value of the firm will go up
c. Dividend and the share price are not related
d. Share price will go down
Part III
831
a. Under FIFO profit will go up, if the inflationary conditions prevail.
b. Under FIFO profit will go down, if the inflationary conditions prevail.
c. Under LIFO the profits will go up, if the inflationary conditions prevail.
d. Under LIFO the profits will go down, if the deflationary conditions prevail.
e. Under weighted average method the profits will go up irrespective of whether inflationary or
deflationary conditions prevail.
26. Which of the following is not an assumption under EOQ model?
a. Purchase price does not change with the change of volumes.
b. Carrying cost does not change with the change of volume.
c. The demand is not uniform during the year.
27. The violation of assumption of constant unit price in simple EOQ model can be handled by
a. A model for variable unit price
b. Including safety stock
c. Redefining total costs and finding new EOQ
e. Any one of (a), (b) and (c).
b. Degree of competition.
c. Nature of Technology.
d. Investment in capital assets.
29. While formulating net cash flows for capital investment appraisal the interest exclusion
principle is followed because
a. The means of financing are not clearly known at the time of appraisal
b. The basic objective is to obtain a measure of financial attractiveness irrespective of the
means of financing
c. The fallacy of double counting under the discounted cash flow techniques is to be avoided
d. The average cost of capital does not consider the interest on long-term debt
e. The interest is not a cash flow expenditure.
30. A decrease in inventory order costs will
b. Increase the reorder point
c. Have no effect on the economic order quantity
d. Increase the economic order quantity
e. Decrease the holding cost percentage.
31. In which of the following means of financing the current assets does not call for security?
a. Debentures.
b. Cash credit limits from a private bank.
c. Public deposits.
d. SPNs.
e. Term loan from LIC.
832
32. The cost of debt capital, k
d
, is defined as the value which satisfies the equation
P =
n
t n
d d t 1
C(1 T) F
(1 k ) (1 k )
=
+
+ +

where P & F stand respectively for
a. Net amount realized on debt issue and redemption price
b. Redemption price and net amount realized on debt issue
c. Net proceeds received and face value of debt
d. Par value of debt and redemption price
e. Current market price and face value.
33. The theoretical value of a right is given by the formula
0
(P S)
(N +1)
where P
0
stands for
a. Ex-rights market price per share
b. Cum-rights market price per share
c. Par value per share
d. Market price, net of floating costs per share
e. The number of rights shares allotted.
34. Which of the following indicate the advantages of market value weights over book value
weights?
a. Book value weights are historical in nature.
b. It is very difficult to estimate book value weights at the time of calculating the weighted
average cost.
c. This is in conformity with the definition of cost of capital as the investors minimum
required rate of return.
d. Book value weights fluctuate violently.
e. Market value weights are fairly consistent over a period of time.
35. ABC analysis is useful for
a. Beginners to have a basic idea about management of inventories
b. Analyzing inventories based on their quality
c. Analyzing inventories based on their usage
d. Better control of inventories
e. Understanding the procurement of inventories.
36. Negative net working capital signifies that
a. The value of current ratio is negative
b. Short-term funds are diverted for long-term purposes
c. The value of current ratio is less than unity
d. There is no working capital margin
e. All of (b), (c) and (d) above.
37. Which of the following is not true while defining the costs and benefits of a capital
expenditure proposal?
a. Sunk costs must be ignored.
b. Existing overhead costs which are to be borne by the end product(s) of the proposed
project must be ignored.
c. Cash flows for the purpose of appraisal must be defined in pre-tax terms.
d. Interest on long-term loans must not be included.
e. Opportunity costs associated with the utilization of the resources available with the firm
must be considered even though such utilization does not entail explicit cash outflows.
Part III
833
38. What is true w.r.t. Bought-out-Deal?
a. Immediate finance availability to the companies.
b. Existing of new companies, which do not satisfy conditions laid down by SEBI for
premium issues, may issue at a premium through the BOD Method.
c. The issue price will be the current market price prevailing at that time.
d. The timing of the offloading is to be done within a very rigid framework.
39. A company which has invested bank borrowings in a huge amount of current assets is
following
a. Aggressive Current Assets Policy (CAP) and Conservative Current Assets Financing
Policy (CAFP)
b. Aggressive CAP and aggressive CAFP
c. Conservative CAP and aggressive CAFP
d. Conservative CAP and conservative CAFP
e. Overall conservative Working Capital Policy.
40. Which of the following is truewith regard to working capital management?
a. The concept of NPV cannot be applied to working capital.
b. The profit per period can be used to evaluate investments in working capital.
c. The NPV approach and profit per period approach for evaluation of investment in
working capital give similar results.
41. A company is considering the following project for investment. The cost of capital for the
company is 12%. The projected post-tax net cash flow stream of the project is given below:
(Rs. in lakh)
Year 0 1 2 3 4 5 6 7
Cash flow (25) 5 6 7 8 9 10 10
i. The NPV of the project is negative.
ii. As per the BCR criteria, the project should be accepted.
iii. The payback period for the firm is 4 years.
a. Only (i) above.
b. Only (ii) above.
(3 points)

834
42. M/s Sunderesh Ltd., manufactures steel nuts and bolts. The probability distributions of the
daily usage rate of the raw material (steel) and the lead time are given below:
Daily usage rate
(in tonnes)
Probability Lead time
(in days)
Probability
10 0.20 20 0.20
20 0.60 25 0.60
25 0.20 30 0.20
These distributions are independent of each other. The stockout cost is estimated to be
Rs.18,000 per tonne and the carrying cost is Rs.3,000 per tonne for the period under
consideration.
The probability that the actual usage during lead time will exceed the expected usage during
lead time is
a. 35%
b. 40%
c. 68%
d. 70%
e. 72%.
(3 points)
43. The expected usage during lead time is 475 tonnes. The actual usage levels at which stock-
outs can occur and their corresponding probabilities are given below:
Usage levels Probabilities
500
600
625
750
0.40
0.12
0.12
0.04
The total expected stock out costs if the company does not maintain any safety stock is
a. Rs.9,72,000
b. Rs.8,96,000
c. Rs.7,40,000
d. Rs.5,89,000
e. Rs.4,53,900.
(3 points)
44. The normal usage during procurement period for Akshara Ltd. is 220 tonnes. The situations
of stock-outs will arise at usage levels 250 tonnes (Probability = 0.24), 300 tonnes
(Probability =0.12) and 375 tonnes (Probability =0.08). The expected carrying cost per
tonne and stock-out cost per tonne are Rs.1,500 and Rs.10,000. If a safety stock level of 30
tonnes is maintained, the total costs involved will be
a. Rs.2,00,000
b. Rs.2,05,000
c. Rs.3,75,000
d. Rs.4,04,890
e. Rs.5,62,000.
(2 points)

Part III
835
45. Dunlop Technologies Ltd., has the following capital structure in terms of book values and
market values:
Source Market value (Rs.)
Paid-up equity share capital 40,00,000
Preference capital 12,00,000
Debentures 42,00,000
i. The equity shares of the company are currently selling for Rs.40 per share. It is
expected that a dividend of Rs.3.00 per share will be paid to the equity shareholders
after one year. The dividends on these shares are growing at a rate of 5%.
ii. The cost of preference capital for company is 11.40%.
iii. The debentures of the company have a face value of Rs.100 and the net amount realized
after they were issued was Rs.101 per debenture. These debentures carry a coupon rate
of 12% and are redeemable at par after eight years.
It is assumed that the issue expenses on the preference shares and the debentures will not be
considered as tax deductible expenses. The tax rate for the company is 35%.
The weighted average cost of capital for the firm based on market value weights is
a. 8.90%
b. 9.13%
c. 10.19%
d. 11.12%
e. 12.50%.
(2 points)
46. Baskin Technologies Ltd., has the following capital structure in terms of book values and
market values:
Source Book value (Rs.)
Paid-up equity share capital 20,00,000
Preference capital 10,00,000
Debentures 40,00,000
The weighted average cost of capital for the firm based on the book value weights is 10.45%.
The cost of preference capital and debenture capital for the firm is 11.40% and 7.64%
respectively. The cost of equity capital for the firm is
a. 8.19%
b. 12.5%
c. 14.9%
d. 15.2%
e. 18.5%.
(3 points)
47. The earnings per share of a company is Rs.20. The internal rate of return of the company is
15% and the cost of equity capital is 12%.
It is assumed that the Walters model of dividend policy holds true for the company.
i. The price of the share when no dividends are paid is Rs.208.33.
ii. The optimal dividend payout ratio for the firm is 100%.
836
iii. The increase in the price of the share when the retention ratio is reduced from 100% to
20% is Rs.33.33.
a. Only (i) above
b. Only (ii) above
c. Only (iii) above
(3 points)
48. The following information pertains to Aditya Industries Ltd.
(Rs. in lakh)
Opening balance Closing balance
Raw materials, stores and
spares etc.
22 30
Work-in-process 40 52
(Rs. in lakh)
Purchases of raw materials, stores and spares etc. 423
Manufacturing expenses 150
Depreciation 50
(Assume 1 year =360 days).
The conversion period for the firm is
a. 22.33 days
b. 18.2 days
c. 34.56 days
d. 26.15 days
e. 27.46 days.
(3 points)
49. The opening and the closing balance of debtors for Parikrama Ltd., are Rs.68 lakh and
Rs.87 lakh respectively. The company had credit sales worth Rs.900 lakh. The average
number of days for which the credit sales will be locked up in the form of receivables is
a. 31 days.
b. 40 days
c. 49 days
d. 50 days
e. 51 days.
(2 points)
50. The following information is given about Kasturi Ltd.
(Rs. in lakh)
Annual Cost of Production
Excise duty
Selling and administration expenses
Interest
Closing stock of finished goods
603
100

50
20
23
If the finished goods storage period is approximately 8 days, the opening balance of finished
goods is (Assume 1 year =360 days)
Part III
837
a. Rs.8.55 lakh
b. Rs.12.13 lakh
c. Rs.16.45 lakh
d. Rs.14.12 lakh
e. Rs.10.81 lakh.
(3 points)
51. Following details are given about Emerald Ltd.
(Rs. in lakh)
Annual raw material consumption 415
Opening balance of raw material 22
Closing stock of raw material 30
Debtors collection period 31 days
Opening balance of accounts payable 60
Closing balance of accounts payable 75
Assume that the entire purchases are made on a credit basis and 1 year =360 days.
The approximate net operating cycle for the firmis
a. 25 days
b. 31 days
c. 35 days
d. 39 days
e. 49 days.
(3 points)
52. Orient Industries Ltd., presently sells 3 lakh units of its product in a year. The selling
price per unit is Rs.100 and the variable cost per unit is Rs.75. Currently the average
collection period is 35 days. The cost of funds invested in receivables is 18%. It is
considering to implement a new policy. It is expected that as a result of the new policy,
the sales of the company will increase by 10% and the average collection period of the
company will increase to 50 days. The fixed costs of the company currently amount to
Rs.50 lakh and will not change as a result of the increase in sales volume. Taxes are
ignored. (Assume 1 year =360 days).
If the company implements its new credit policy, the change in the cost of funds blocked in
receivables will be
a. Rs.(2,81,250)
b. Rs.(2,18,520)
c. Rs.2,18,520
d. Rs.2,81,250
e. Rs.5,00,000.
(2 points)

838
53. The price per share of Elgi & Elgi Company Ltd., as on April 1, 2003 and April 1, 2004 was
Rs.30 and Rs.25 respectively. The company has declared a dividend of 25% during the year
2003-2004. The face value of each share is Rs.20. The wealth ratio for the year 2003-2004 was
a. 0.00
b. 0.92
c. 1.00
d. 1.09
e. 1.40.
(2 points)
54. XYZ Ltd., has recently made an issue of zero coupon bonds of Rs.60 lakh. The face value
and maturity value of each bond was Rs.2,500. These bonds were issued at a discount of 30%
to the face value. If the maturity period of the bonds is 5 years then the cost of the bonds to
the company is (Taxes are ignored).
a. 5.18%
b. 7.39%
c. 9.00%
d. 21.00%
e. 30.00%.
(2 points)
55. The annual interest cost associated with credit terms of 2/10, net 40 (assuming 360 days in a
year) is approximately
a. 17.65%
b. 18.37%
c. 23.53%
d. 24.49%
e. 26.53%.
(2 points)
56. Consider the following information regarding Super Toys Ltd:
Annual cost of sales : Rs.18,00,000
Opening stock of finished goods : Rs.60,000
Finished goods storage period : 10 days
Assuming 360 days in a year, the closing stock of finished goods is
a. Rs.40,000
b. Rs.50,000
c. Rs.60,000
d. Rs.1,20,000
e. Rs.1,80,000.
(2 points)

Part III
839
57. The current price of a share of Kothari Pharmaceuticals Ltd. is Rs.50. The company is
planning to go for rights issue. The subscription price for one rights share is proposed to be
Rs.45. If the company targets that the ex-rights value of a share shall not fall below Rs.49
they should issue 1 rights share for every ________ equity shares.
a. 5
b. 4
c. 3
d. 2
e. 1.
(1 point)
58. A company has retained earnings of Rs.72 lakh and equity capital of Rs.38 lakh. If the equity
investors expect a rate of return of 17% and the cost of issuing fresh equity is 6%, the cost of
the retained earnings to the company is
a. 16.4%
b. 17.0%
c. 17.7%
d. 18.1%
e. 19.1%.
(1 point)
59. The following details pertain to Alpha Enterprises Ltd.:
Rate of return required by the equity shareholders =16.15%
Issue costs of external equity as a percentage of market price =5%
The cost of external equity is
a. 15.34%
b. 16.15%
c. 17.00%
d. 18.00%
e. 20.00%.
(1 point)
60. The EOQ for a firm is 7,200 units. The minimum order size stipulated by the supplier is
9000 units for utilizing a cash discount on the purchase price. The annual usage of raw
materials is 1,80,000 units and the cost per order is Rs.100. If the company decides to utilize
cash discount, saving in the total ordering cost will be
a. Rs.1000
b. Rs.800
c. Rs.600
d. Rs.500
e. Rs.400.
(1 point)
61. The following information regarding the equity shares of M/s. Venus Ltd., is given:
Market Price = Rs.17.00
DPS = Rs. 3.00
Multiplier = 3.40
According to the traditional approach to the dividend policy, the EPS for M/s. Venus Ltd., is
a. Rs.2
b. Rs.4
c. Rs.5
d. Rs.6
e. Rs.8.
(1 point)
840
62. Following details are given about M/s. Klear Ltd.:
Annual credit sales
Opening balance of accounts
receivable
Closing balance of accounts
receivable
Rs.37,000
Rs.16,000

Rs.22,000
(Assume 1 year =360 days)
The average collection period is approximately
a. 156 days
b. 175 days
c. 185 days
d. 200 days
e. 214 days.
(1 point)
63. Following details are available about the irredeemable preference shares issued by
M/s. Peecee Ltd.:
Dividend 14%
Face value per share Rs.100 per share
Floatation costs involved 3%
The cost of preference capital is
a. 10.68%
b. 13.58%
c. 14.00%
d. 14.43%
e. 21.43%.
(1 point)
64. Dolphin Ltd., is offering one rights share at a price of Rs.50 to its existing shareholders for
every four shares held. The current market price of its share is Rs.70. What is the theoretical
value of a right?
a. Rs.2.00.
b. Rs.4.00.
c. Rs.5.00.
d. Rs.10.00.
e. Rs.20.00.
(1 point)
65. The current assets of a company are Rs.645 lakhs, current liabilities (other than bank
borrowings) are Rs.305 lakhs, bank borrowings are Rs.307 lakhs. The Maximum Permissible
Bank Finance (MPBF) under the methods I and II of the Tandon committee are respectively
a. Rs.255.00 lakhs and Rs.178.75 lakhs
b. Rs.315.67 lakhs and Rs.123.65 lakhs
c. Rs.255.00 lakhs and Rs.123.65 lakhs
d. Rs.212.34 lakhs and Rs.123.65 lakhs
e. Rs.255.00 lakhs and Rs.111.23 lakhs.
(2 points)

Part III
841
66. M/s. VG India Ltd is considering to invest in a printing machine the details of which are as
follows:
Cost of machine Rs.25,00,000
Annual cost of operations Rs. 2,00,000
Useful life 9 years
The annual capital charge of the machine at a cost of capital of 12% is
a. Rs.4,69,219
b. Rs.4,77,778
c. Rs.5,49,113
d. Rs.6,69,219
e. Rs.8,07,057.
(2 points)
67. M/s. National Instruments Ltd., (NIL) purchases components from M/s. Pioneer Electronics
Ltd. (PEL) on the terms 1/10, net 45. NIL has requested for an increase in the cash discount
to 2%, the period of cash discount remaining unchanged. PEL has accordingly increased the
cash discount and also changed the credit period. On careful verification, NIL realizes that
on account of change in the credit period, the cost of not paying within the discount period is
now three times the cost before the change in terms.
The new credit period approximately is
a. 28 days
b. 30 days
c. 34 days
d. 40 days
e. 45 days.
(2 points)
68. Currently, M/s. Fine Components Ltd., sells 30,000 units at an average price of Rs.28,000 per
unit. The variable cost is 90% of the selling price. The credit terms of the company are 1/20,
net 30. 10% of the customers avail the discount and the average collection period is 26 days.
The bad-debts to sales ratio is 0.015.
To increase the sales level, the finance manager has suggested to change the credit terms to
2/10, net 30. With the new policy sales are expected to increase by 4000 units and 40% of the
old customers and 60% of the new customers are expected to avail the discount. The average
collection period and bad debt to sales ratio are excepted to remain the same.
The net benefit (ignoring taxes) of the new policy is
a. Rs.23.00 lakhs
b. Rs.31.36 lakhs
c. Rs.39.76 lakhs
d. Rs.53.20 lakhs
e. Rs.107.00 lakhs.
(2 points)
69. The finance manager of M/s. Easy Credits Ltd. is considering to change its credit terms of
1/10, net 20 to 1/10, net 30. With the change in the credit period it expects the sales to
increase from Rs.30 lakhs to Rs.50 lakhs and average collection period from 36 days to 45
days. The contribution margin is 30% of the selling price.
Assuming a cost of capital of 12%, the increase in the cost of funds locked in receivables is
a. Rs.12,000
b. Rs.18,000
c. Rs.30,000
d. Rs.39,600
e. Rs.52,500.
(2 points)
842
70. Radhika Oil Mill is planning for its cash to be maintained during the month of August. The
manager has analysed the daily cash outgo for the month of J une. Ten largest daily cash
outflows are as follows:
Date
3rd
J une
7th
J une
10th
J une
12th
J une
15th
J une
16th
J une
18th
J une
22nd
J une
26th
J une
28th
J une
Cash
outflow (Rs.)
55,000 40,000 35,000 48,000 23,000 68,000 42,000 33,000 58,000 29,000
It is expected that the pattern of cash outflows in the month of August will remain same as
that of the month of J une but the magnitude of cash outflows will be 20% more. If the
finance manager desires sufficient cash to cover payments of 4 peak days during the month
then the safety level of cash to be maintained in the month of August would be
a. Rs.1,72,400
b. Rs.2,06,880
c. Rs.2,29,000
d. Rs.2,74,800
e. Rs.3,29,760.
(2 points)

843
Suggested Answers
1. (c) The payback period does not take into account the time value of money.
2. (b) According to the principles for determining the costs and benefits of projects, only cash
flows (cash inflows and outflows) are considered as benefits and costs. All revenues accrued
may not result in actual cash inflows and all expenses accrued may not result in actual cash
outflows.
3. (a) In recourse factoring the bad debts are not borne by the factor.
4. (b) Liquidity is not a relevant feature of an optimal capital structure. It is the feature of the
mode of deployment of capital.
5. (d) Old Machine Depreciation =
16, 500
5
= Rs.33,000
New Machine Depreciation =
6, 50, 000 90, 000
5
= Rs.1,12,000
Incremental Depreciation = Rs.79,000
Net cash flow = (3,00,000 79,000) x 0.65 + 79,000 = 2,22,650
6. (e) According to the rational expectations model if dividend declared is higher than
expectations then higher earnings will be expected in future and the share price will rise as a
result.
7. (a) Net working capital is defined as the difference between the current assets and current
liabilities of the firm.
8. (d) An optimal capital structure aims at maximizing the market value of the company and
minimizing the overall cost of capital.
9. (d) Commercial papers are instruments for raising short-term finance. All other alternatives
represent sources/instruments of long-term finance.
10. (b) Assessing the cost of equity capital is a difficult and complex task because the dividend
stream receivable by the shareholders is not specified by any legal contract as in the case of
borrowed funds.
11. (e) All the alternatives represent the advantages of debentures to the debenture holders.
Hence all the factors mentioned make the debentures attractive to investors.
12. (e) The cost of capital of a company is not the cost of a single specific source of finance used
by the firm, nor is it measured in terms of the cash flow accruing to any specific source of
finance. It is the weighted average cost of various sources of finance used by the firm.
13. (c) The cost of retained earnings is considered to be equal to the cost of the equity share
capital employed by the company. The cost of external equity is higher than the cost of the
existing equity share capital of the company because of the factors of under-pricing and issue
expenses.
Moreover, the cost of debt capital is less than the cost of internal as well as external equity.
The retained earnings are not cost free because their cost is equal to the cost of the existing
equity share capital of the company. Retained earnings may be invested in fixed as well as
current assets. Hence alternative (c) is true.
844
14. (b) Net float is the difference between payment float and collection float. Hence when net
float is negative, the payment float is less than the collection float.
Hence statement (ii) is correct.
When net float is negative, the balance in the books of the firm is more than that in the banks
books. Hence statement (i) is incorrect. The company cannot play the float if its net float is
negative as in this case the balance in the banks book is less than that in the firms books.
Hence statement (iii) is incorrect.
So option (b) is the correct choice.
15. (b) The bond yield plus risk premium approach is a method of finding the cost of equity
capital of the firm. According to this approach, as the risk borne by the equity investors is
higher than that of bondholders, the return earned by the equity holders should be higher than
that earned by bondholders. So Return = Yield on the long-term bonds of the company +
Risk premium.
16. (c) The average payment period is deducted from the gross operating cycle period which is
the total of the raw materials storage period, work-in-process period, finished goods period
and receivables period. Hence an increase in the payment period will cause a decrease in the
net operating cycle period. All the other alternatives represent changes which cause an
increase in the operating cycle period.
17. (b) As cash flows of the firm are stable, the firm need not prepare a cash budget which
forecasts the cash. Hence the cash report would suffice.
18. (e) Days sales outstanding, ageing schedule and collection matrix are some of the tools employed
in receivables management in monitoring receivables.
19. (c) Private placement refer to the direct sale by public limited company or private limited
company to a limited number of sophisticated investors like UTI, LIC etc., therefore there is
no need to be listed.
20. (e) Under a conservative working capital policy, the financing mix will consist of a higher
proportion of long-term sources of finance like equity and to some extent debentures also.
Hence statement (I) is correct.
As a conservative working capital policy involves financing of current assets more from
long-term sources, the company will have a lower debt-servicing cost compared to an
aggressive policy and consequently a lower degree of the risk of technical insolvency.
Hence statement (II) is incorrect.
A company following a conservative working capital policy will invest more in current assets than
a company following an aggressive working capital policy. Hence it will have a higher current
ratio than the one following an aggressive working capital policy. So statement (III) is correct.
Under a conservative working capital policy, a firm invests more in current assets than a firm
following an aggressive policy. Therefore, the current assets turnover ratio computed as Sales
Current assets will be lower in case of a conservative working capital policy. So statement
(IV) is also correct.
Hence option (e) is the correct choice as statements (I), (III) and (IV) are correct.
21. (e) The need for holding cash arises from various reasons like transaction motive, speculative
motive, precautionary motive, to have a synchronization between cash inflows and outflows.
22. (a) Equity shareholders are the owners of the business. Hence they enjoy the ownership as
well as the risks associated with business.
23. (d) The companys cost of capital is the weighted average of the cost of various sources of
finance that has been used by it.
24. (e) According to the rational expectations model there would be no impact of the
dividend declaration on the market price of the share as long as it is at the expected rate.
If the expected dividend is less than the actual dividend paid the rational expectation
approach suggests that the share price increases and the value goes up.
Part III
845
25. (a) Under FIFO method to price the raw material, the issue of material from the stores will be in
the order which it was received. Hence inflation causes it to understate the cost of goods sold by a
business and therefore overstate a businesss taxable income and hence the tax liability.
26. (c) EOQ model assumes that demand is even throughout the period.
27. (c) The inclusion of variable prices resulting from quality discounts can be handled quite
easily through a modification of the original EOQ model, redefining total costs and solving
for the optimum order quantity.

28. (d) Investment of capital assets is a long-term investment and does not influence the working
capital.
29. (c) To avoid double counting under the discounted cash flow techniques the interest
exclusion principal is followed while formulating net cash flows for capital appreciation.
30. (a) EOQ =
2CU/ S

U = Annual output
C = Inventory ordering costs
EOQ is directly proportional to C, i.e. the inventory ordering costs. Hence EOQ decreases
when ordering cost decreases as it is more economic to order a lesser quantity when ordering
costs are low.
31. (c) Public deposits are unsecured deposits solicited by small and large firms mainly to
finance their working capital requirements.
32. (a) The cost of preference shares is given by
k
d
=
I(1 t) + (F P)/n
(F + P)/2
- -

where P is the net amount realized per debenture
33. (b) Theoretical value of the right = (P
0
S)/( N + 1) where P
0
stands for cum rights price of
the share.
Rights offer is the offer made to the existing shareholders, when a firm issues additional
equity capital.
34. (c) The companys cost of capital is the weighted arithmetic average of the cost of various
sources of finance that have been used by it. Hence market value weights are more useful
than book value weights to calculate the required rate of return.
35. (c) ABC is an inventory management technique when segregation of inventory is made on
the basis of their annual usage value.
36. (e) Net working capital = Current Assets Current Liabilities.
A negative working capital indicates that the current liabilities are more than the current
assets. This may indicate that the short-term funds are diverted for long-term purposes. As
current ratio = Current assets / Current liabilities, negative working capital indicates that the
current ratio is less than 1.
37. (c) Cash flows for the purpose of appraisal must be defined in post-tax terms.
38. (e) Bought out deal is a process whereby an investor or a group of investors buy-out a
significant portion of the equity of an unlisted company with a view to take it public with in
an agreed time frame. Hence statements (a) and (b) are true regarding bought-out-deals.
846
39. (c) When the investment in current assets for a given level of forecasted sales is higher, the
management is said to be following a conservative approach. Since the company is using
more of bank borrowings to finance the current assets, it is following an aggressive financing
policy. Hence it is following a conservative current asset policy and an aggressive current
assets financing policy.
40. (d) The concept of NPV can be applied to working capital.
Part B: Problems
41. (e) NPV =
( )
7
t
t 1
CF
I
1 1
=

+

=
(1.12)
5
+
2
(1.12)
6
+
3
(1.12)
7
+
4
(1.12)
8
+
5
(1.12)
9
+
6
(1.12)
10
+
7
(1.12)
10
25
= Rs.9.011 lakh.
As the project has a positive NPV, it can be accepted.
Benefit cost ratio =
Investment
benefits of value Present
=
Investment
Investment NPV+
=
25
25 9.011+
= 1.36
Since the BCR > 1, the project should be accepted.
Payback period = 4 years since the project cash flows up to the fourth year add up to Rs.26
lakh which just exceeds the initial investment of Rs.25 lakh.
42. (c) Expected daily usage rate = 10 (0.20) + 20 (0.60) + 25 (0.20) = 19 tonnes
Expected lead time = 20 (0.20) + 25 (0.60) + 30 (0.20) = 25 days
Expected usage during lead time = 19 x 25 = 475 tonnes
Daily usage rate Lead time (in days) Possible levels of usage
Tonnes Probability Days Probability Tonnes Probability
10 0.20 20 0.20 200 0.04
25 0.60 250 0.12
30 0.20 300 0.04
20 0.60 20 0.20 400 0.12
25 0.60 500 0.36
30 0.20 600 0.12
25 0.20 20 0.20 500 0.04
25 0.60 625 0.12
30 0.20 750 0.04
Situations of stockout will occur only if the usage during the lead time exceeds the expected
usage during the lead time (i.e. 475 tonnes). This occurs when the actual usage is 500 tonnes,
600 tonnes, 625 tonnes or 750 tonnes.
The probability of stock out = (0.36 + 0.04) + 0.12 + 0.12 + 0.04 = 0.68
Part III
847
43. (a) The expected usage during lead time = 475 tonnes. The stock-outs when the actual usage
levels are 500, 600, 625 or 750 are 25, 125, 150 and 275 tonnes respectively. The total
expected stock-out costs when no safety stock is maintained are calculated below:
Safety Stock
(tonnes)
Stockouts
(tonnes)
stockout
(tonnes)
Expected
stockout
costs
1
(Rs.)
Carrying
cost
2
(Rs.)
Total
cost
(Rs.)
0 25 0.40 10
125 0.12 15
150 0.12 18
275 0.04 11
54 9,72,000 0 9,72,000
Note: (1) Expected stock out cost = Expected stockout (tonnes) x Rs.18,000
(2) Carrying cost = Safety stock (tonnes) x Rs.3,000
44. (b) When a safety stock of 30 tonnes is maintained, the total costs involved can be computed
in the following manner:
Safety
stock
Stockouts
(tonnes)
Stock-out
cost (Rs.)
stockout cost
(Rs.)
Carrying cost
(Rs.)
Total
Cost
60,000
1,00,000
30 50
125
5,00,000
12,50,000
0.12
0.08
1,60,000
45,000 2,05,000
45. (c) Cost of equity capital:
k
e
=
1
0
D
P
+ g =
40
3
+ 0.05 = 0.125 i.e 12.5%
Cost of preference capital:
k
p
= 0.1140 (given)
Cost of debentures:
k
d
=
F P
I(1 T)
n
(F P)
2
+
+
=
100 101
12(1 0.35)
8
100 101
2
+
+

=
100.5
8
1
7.8

+
= 0.0764 i.e., 7.64%(approx.)
Market value weights for the different sources of capital:
Equity capital: W
e
=
Rs.40 lakh
Rs.(40 12 42) lakh + +
=
40
94
= 0.4255
Preference capital: W
p
=
Rs.12lakh
Rs.(40 12 42) lakh + +
=
94
12
= 0.1277
Debenture capital: W
d
=
Rs.42 lakh
Rs.(40 12 42) lakh + +
=
94
42
= 0.4468
Weighted average cost of capital using market value weights
= w
e
k
e
+ w
p
k
p
+ w
d
k
d
= (0.4255) 12.50 + (0.1277) 11.40 + (0.4468) 7.64 = 10.19%.
848
46. (b) Book value weights of different sources of capital:
Paid-up equity capital
Rs.20lakh
W =
e
Rs.(20 + 30 + 10 + 40) lakh
20
= = 0.2
100
0
Reserves and surplus
Rs.30lakh
W =
r
Rs.(20 + 30 + 10 + 40) lakh

30
= = 0.30
100

Preference capital
Rs.10lakh
W =
p
Rs.(20 + 30 + 10 + 40) lakh

10
= = 0.10
100

Debenture capital
Rs.40lakh
W =
d
Rs.(20 + 30 + 10 + 40) lakh

40
= = 0.40
100

Weighted average cost of capital = w
e
k
e
+ w
r
k
r
+ w
p
k
p
+ w
d
k
d

We know that Cost of retained earnings (k
r
) = Cost of equity (k
e
)
i.e. 10.45 = (0.20) k
e
+ (0.30) k
e
+ (0.10) 11.40 + (0.40) 7.64
Therefore, k
e
= 12.508 %.
47. (e) According to Walter model,
P =
e
D
k
+
e
e
r(E D) / k
k

a. According to Walter model the optimal payout ratio for a growth-oriented firm (r > k
e
)
is 0%.
For the company r(15%) > k
e
(12%)
The optimum dividend payout ratio is 0.
b. Price of the share at 0% payout (i.e., at optimum payout ratio)
=
0.12
0
+
0.15(20 0) / 0.12
0.12
=
(0.15)(20)
2
(0.12)
= Rs.208.33
c. If the dividend payout ratio is 0.80 then
D = 20(0.80) = 16
Price of the share =
0.12
16
+
0.15(20 16) / 0.12
0.12
=
16 0.15 x 4 / 0.12
0.12
+
= Rs.175
Change in price = 175 208.33 = Rs.33.33 (i.e. the share price decreases by Rs.33.33).
Hence statements (ii) and (iii) are false.
48. (e) Conversion period
Raw material consumption = Opening stock of raw materials + Purchases Closing stock
= 22 + 423 30 = Rs.415 lakh.
= 40 + 415 + 150 + 50 52 = Rs.603 lakh
Annual cost of production
= Opening stock of work-in-progress + Raw material consumption + Other manufacturing
expenses + Depreciation Closing stock
Average daily cost of production = (5) 360 = Rs.1.675 lakh
Average stock of work-in-progress =
40 + 52
2
= Rs.46 lakh
Conversion period =
46
1.675
= 27.46 days.
Part III
849
49. (a) Average collection period
Annual credit sales = Rs.900 lakh
Average daily sales =
360
900
= Rs.2.50 lakh
Average balance of receivables =
2
balance Closing balance Opening +

=
2
87 68 +
= Rs.77.5 lakh
77.5
2.5
= 31 days.
50. (e) Annual cost of sales = Opening stock of finished goods + Annual cost of production +
Excise duty + Selling and administration expenses + Interest Closing stock of finished goods
= x + 603 + 100 + 50 + 20 23
= x + 750 lakh
x 750
360
+

Average stock of finished goods =
Opening balance Closing balance x 23
2 2
+ +
=
Average daily cost of sales

i.e. 8 =
(x 23) / 2
(x 750) / 360
+
+

Solving the above equation we get, x = Rs.10.81 lakh.
51. (b) Average raw material consumption = Opening balance + Purchases Closing balance
415 = 22 + Purchases 30
Purchases = Rs.423 lakh.
Average daily credit purchases =
423
360
= 1.175
Average balance of payables =
Opening balance Closing balance
2
+
=
60 75
2
+
= 67.5.
Average payable period =
Average balance of payables
Average daily credit purchases
=
67.5
1.175
= 57.45 days.
Net operating cycle
= raw material storage period + conversion period + finished goods storage period + average
collection period average payment period
= 23 + 27 + 8 + 31 57.45 = 30.55 days.
i.e. approximately 31 days.
52. (d) Change in cost of funds blocked in receivables
=
S
S
0
(ACP ACP ) + V(ACP )
N N 0
360 360

k
=
3,00,000 x100 0.75 x50 x 30,00,000
(50 35) + 0.18
360 360

= [12,50,000 + 3,12,500]0.18
= Rs.2,81,250 (increase).
850
53. (c) Wealth ratio = 1+ Rate of return
= 1 +
1 1 0 1
0 0
=
P P
1
D + (P P ) D + P
=
(0.25) (20) 25
30
+
= 1.00.
54. (b) Face value = Rs.2,500
Issue price = 2,500 (1 0.30) = Rs.1,750
If k is the cost of the bonds to the company then,
1,750 (1 + k)
5
= 2,500
k =
1/5
2, 500
1, 750

1 = 0.0739 i.e. 7.39%.
55. (d) Annual interest cost =
Discount rate 360
x
1 Discount rate Credit period Discount period

=
0.02 360
x
1 0.02 (40 10)
0.2449 i.e., 24.49%
56. (a) Finished goods storage period =
Average daily cost of sales

10 =
5,000

or
Average stock of finished goods = 10 x 5,000 = Rs.50,000
Average stock =
Opening stock + Closing stock
2

or
Closing stock = 2 Average stock Opening stock
= 2 x 50,000 60,000 = Rs.40,000.
57. (b) Ex-rights price of a share =

0
nP + S
n +1
,
where the notations are in their standard use. On substituting the values,by
49 =
n x 50 + 45
n +1

49n + 49 = 50n + 45
n = 4.
58. (b) Retained earnings is the amount due to equity holder which has not been paid to them.
Therefore, the cost of retained earnings will be equal to expected return of equity holder. And
as there is no cost of issue involved it will be 17%.
59. (c) The required cost of external equity =
16.15
1 0.05
=

95 . 0
15 . 16
= 17.00 percent
60. (d) If the U is the annual usage, Q
*
is the EOQ ; Q
is the order stipulated by the supplier for

availing the discount and F is the cost per order, then the savings in the total ordering costs
can be computed as: F
Q
U
Q
U
*

=
1,80,000 1,80,000
100 Rs.500
7,200 9,000

=

Hence option (d) is correct.
Part III
851
61. (d) The traditional approach to dividend policy establishes a relationship between the
market price and the dividends in the following manner:
P=m(D+E/3)
where, m is a multiplier, D is the Dividend Per Share (DPS) and E is the Earnings Per Share
(EPS).
Hence, 17 = 3.4 (3+E/3)
So E = Rs. 6.
Hence, option (d) is the correct choice
62. (c) Average Collection Period: It is computed as:

Average balance of sundry debtors

Average balance of sundry debtors
=
O

=
pening balance of accounts receivable + Closing balance of accounts receivable
2
16,000 22,000
2
+
= Rs. 19,000.
Average daily credit sales of the company =
Annual credit sales
360
=
37, 000
360
= Rs. 102.78
Hence, average collection period =
19, 900
102.78
185 days.
63. (d) Cost of irredeemable Preference Shares,
k
p
=
Preference dividend
Price realised per share

Price realised per share = 100 (1 0.03) = Rs. 97 =
14
14.433%.
97
=
64. (b) The theoretical value of a right =
0
P S
N 1
+
=
70 50
4 1
+
= Rs.4.
65. (a) The MPBF as per the Method I of the Tandon committee
= 0.75 (Current assets Current liabilities other than bank borrowings)
= 0.75 (645 305) = Rs. 255 lakhs.
MPBF under the Method-II of the Tandon committee
= (0.75 x Current assets) Current liabilities
= 0.75 x 645 305 = Rs. 178.75 lakhs.
Hence option (a) is the correct answer.
66. (d) Annual capital charge =
k,n
PV of costs
PVIFA

ACC of the machine =
12,9
12,9
25,00,000 + 2,00,000 PVIFA
PVIFA

=
12,9
25,00,000
2, 00, 000 Rs.6, 69, 219
PVIFA
+ =
Hence, (d) is the answer.
852
67. (c)
Cost of trade credit =
discount 360
1 discount Credit period discount period

=
0.01 360
10.39%
0.99 45 10
=

New cost of trade credit = 3 x 10.39 = 31.17%
=
0.02 360
31.17%
0.98 x 10
=

Solving x =
512.733
33.5
15.2733
= = 34 days.
68. (c) Net benefit = P Dis
Increase in profit = 4,000 x 0.1 x 28,000 = Rs.112 lakhs
Cost of discount (old credit terms) :
28,000 x 30,000 x 0.01 = Rs.8.4 lakhs
Cost of discount (new credit terms)
0.4 x 28,000 x 30,000 x 0.02 + 0.6 x 28,000 x 4,000 x 0.02 = 67.2 + 13.44 = Rs.80.64 lakhs
Net benefit = 112 80.64 + 8.4 = Rs.39.76 lakhs.
69. (c) Increase in the receivables =
N N 0
0
ACP ACP ACP
S VC S
360 360
+
=
45 45 36
20 0.7 30
360 360
+ = 1.75 + 0.75 = rs.2,50,000 lakhs

Cost of funds blocked = kI
= 0.12 x 2.5 = Rs.30,000.
70. (d) The average cash outflow during the 4 peak days in the month of June was

68, 000 58, 000 55, 000 48, 000
Rs.57, 250
4
+ + +
=
As the magnitude of cash out flows in the month of August is 20% more than that in the
month of June, so the expected average cash out flows during the 4 peak days in the month of
August would be Rs.57,250 1.2 = Rs. 68,700
So the safety level of cash to be maintained is 4 68,700 or Rs. 2,74,800.

853
1. Undertrading means
a. Having low amount of working capital
b. High turnover of working capital
c. Sales are less compared to the assets employed
d. Assets are less compared to the sales generated
e. Low growth in sales.
2. Which of the following is not a spontaneous liability?
b. Salary accrued but not paid.
c. Provision for payment of bonus.
d. Term loans.
e. Provision for taxes.
3. Which of the following is not truewith regard to a conservative current asset policy?
a. The level of current assets is very high in relation to sales.
b. The conservative current asset policy tends to reduce risk.
c. The chances of technical insolvency are reduced.
d. The profitability is very high.
4. Which of the following is not true with regard to an aggressive current asset financing
policy?
a. It relies more on short-term bank financing.
b. It uses equity capital to finance current assets.
c. It exposes the firmto a higher degree of risk.
d. It reduces the cost of financing.
5. Which of the following is not a type of bank finance for working capital?
a. Cash credit.
b. Overdraft.
d. Purchasing and discounting of bills.
6. Which of the following costs associated with inventories remain more or less constant
irrespective of the size of the order?
a. Material cost.
b. Ordering cost.
c. Carrying cost.
d. Cost of funds tied up with inventory.
854
7. The Economic Order Quantity is the order quantity which
a. Minimizes ordering costs
b. Minimizes carrying costs
c. Maximizes ordering costs
d. Maximizes carrying costs
e. Minimizes the total of ordering and carrying costs.
8. Which of the following is not a cost of maintaining receivables?
a. Cost of additional funds required by the company.
b. Cash discounts.
c. Administrative cost.
d. Collection cost.
e. Defaulting cost.
9. Which of the following is not a credit policy variable?
a. Collection policy.
b. Payment policy.
c. Credit standards.
d. Cash discount.
e. Credit period.
10. Which of the following is/are true regarding cumulative preference shares?
i. They enjoy a right to participate in surplus profits after equity dividends have been paid.
ii. They are eligible to get all the arrears of preference dividends before any equity
dividend is declared.
iii. In case there are arrears in dividends on these shares for two or more years, the
shareholders will be entitled to voting rights.
a. Only (ii) above.
b. Only (iii) above.
11. In which of the following arrangements, the bank assumes the risk of default while the
supplier provides the credit?
a. Cash credit.
b. Overdraft.
c. Letter of credit.
d. Pledge.
e. Hypothecation.
12. Which of the following assumptions underlie the definition of cost of capital under capital
expenditure decisions?
i. The risk characterizing the new project under consideration is not significantly different
from the risk characterizing the existing investments of the firm.
ii. The firm will finance new investments without resorting to external financing.
iii. The management of the firm will remain the same.
a. Only (i) above.
b. Only (ii) above.
Part III
855
13. Which of the following is not a relevant factor in cash management?
a. Prompt billing and mailing the same to the customers.
b. Branchwise collection of receivables.
c. Centralized purchases and payment to the suppliers.
d. Availing term loans to the maximum possible limit.
e. Prompt depositing of the cheques received from customers to bank.
14. Which of the following is not a part of the economic appraisal of projects?
a. Impact of the project on income distribution.
b. Impact of the project on the extent of savings and investment.
c. Impact of the project on the wealth of the shareholders.
d. Impact of the project on employment generation.
15. In which of the following conditions a project proposal will not be accepted?
a. Net present value is more than zero.
b. Benefit cost ratio is greater than unity.
c. Net benefit cost ratio is higher than zero.
d. Cost of capital is more than the internal rate of return.
e. Payback period is less than the cut-off period.
16. Which of the following is not the relevant purpose of maintaining inventories?
b. Obtaining quantity discounts.
c. Reduction of ordering cost.
d. Improving product quality.
e. Reducing the chance of production stoppage.
17. Which of the following is/are true regarding capital structure theory as stated by Miller &
Modigliani?
i. If the given assumptions hold, the cost of capital is minimized at the optimal capital
structure.
ii. In the presence of taxes, the market value of the firmis decreased by the tax shield of debt.
iii. If agency costs are considered, the expected agency costs decreases as the debt-equity
ratio decreases.
a. Only (i) above.
b. Only (ii) above.
18. Which of the following is not an assumption in Gordons dividend capitalization model?
a. The firm is an all-equity firm.
b. New investment proposals are financed solely by the retained earnings.
c. Cost of equity capital is constant.
d. Return on investment is variable.
e. The firm has an infinite life.
19. Which of the following need not be considered while making capital structure decisions?
a. Size of the company.
b. Dilution of control.
c. Flotation cost.
d. Projected cash flows.
856
20. Agency Costs arise due to
a. Issue Expenses to raise funds from the public
b. Commissions paid to various intermediaries who assist in procuring the funds
c. Separation of ownership and control in joint-stock companies
d. Inclusion of more debt in the capital structure
e. The redemption of the debt capital.
21. A company is having a wide distribution network in different areas spread far and wide.
Which of the following measures should be adopted proactively to manage cash?
a. Prompt billing.
b. Opening Collection Centers.
c. Centralized Collection Centers.
22. Which of the following is/are the cost of liberalizing the credit policy?
a. Bad debts.
b. Cash discount.
c. Expenses for follow-up of receivables.
23. If a company extends its credit period from 30 days to 50 days then
a. The firms bad debts losses will reduce, because the customers have more time to pay
b. The additional investment in receivables will be only on the increased sales
c. Some of the existing customers would also delay the payment availing the credit period
d. Cost of bad debts losses will not be calculated on existing and increased sales
24. A negative net float means
a. The balance in the books of banks is higher than that of the firms
b. There are more cheques issued as per the firms books than that are received
c. The firm can resort to playing the float
d. The firm has received cheques for an amount higher than the amount for which it issued
cheques
e. It represents an OD balance as per firms books.
25. Under which of the credit policy variables the terms of trade will not be altered by the
company?
a. Credit Period.
b. Cash Discount.
c. Credit Standards.
d. Collection Effort.
26. The credit policy is a trade-off between
a. Increased sales and cost of sales
b. Increased profit and cost of receivables
c. Increased profit and bad debts
d. Increased profit and opportunity cost of amount blocked in receivables and loss due to
bad debts
e. Increased sales and decrease in collection period.
Part III
857
27. Which of the following is true in the context of the Gordon Model?
a. br indicates the growth rate of EBIT.
b. b indicates the retention ratio.
c. r indicates the return earned on the firms investments.
28. Which of the following is not a disadvantage of equity share capital?
a. High cost due to risk.
b. Affects control.
c. Non-tax deductible.
d. Perpetual funds.
e. Issuing costs.
29. Which of the following is/are the essential feature(s) of an optimum capital structure?
a. Long-term solvency.
b. Low debt proportion.
c. Flexibility.
30. Which of the following is false according to the traditional approach to capital structure?
a. The average cost of capital goes on decreasing as the debt proportion is increased.
b. There is an optimal capital structure.
c. The marginal cost of debt is less than that of equity before the optimal capital structure.
d. The cost of equity rises gradually as the leverage increases.
e. There are no transaction costs in changing the capital structure.
31. What is the important characteristic of the current assets which differentiates it from fixed
assets?
a. Duration of holding.
b. Tangibility.
c. Generation of future benefits.
d. Mode of financing.
32. If the terms of sale are on cash basis then which stage of working capital is not of much
relevance
a. Raw materials
b. Receivables
c. Payables
d. Finished goods
e. Work-in-process.

858
33. Which of the following cannot be definitely said?
a. The operating cycle period tells us about the time taken for the current assets to convert
themselves to cash.
b. The increase in the creditors period will reduce the operating cycle period.
c. A decrease in the operating cycle period means that the receivables are collected faster.
d. The duration of operating cycle is affected by the efficiency of production.
e. A company selling on cash basis will have lesser stages in the operating cycle than that
of a company selling on credit basis.
34. What makes the current assets level fluctuate?
a. Demand for output.
b. Supply of a major input.
c. Level of activity.
d. Nature of product.
35. Which of the following is the recommendation of Kannan Committee?
a. Need based working capital finance.
b. Issue of working capital debentures.
c. Full working capital facility.
d. Higher discretion to lending banks w.r.t. benchmarks.
36. Which of the following will not be a part of ordering cost when the material is manufactured
internally?
a. Preparation of purchase requisition.
b. Cost of manufacturing.
c. Set-up costs.
d. Warehousing costs of user department.
e. Transportation costs.
37. The main criterion for categorization in ABC analysis is
a. Value
b. Importance of the raw material
c. Usage
d. Demand of the input
e. Procurement cost.
38. VED analysis is
a. Vital, Essential, Desirable
b. Valued, Essential, Desirable
c. Vital, Effective, Defective
d. Variable Earnings Detection

Part III
859
39. The average balance in receivables is
a. Average sales x Average collection period
b. Average daily sales x Average collection period
c. Average daily credit sales x Average collection period
d. Average daily credit sales x Operating cycle period
e. Yearly credit sales/12.
40. Which of the following are considered as the benefits of the ABC system for inventory
management?
a. It ensures control of high value items.
b. It helps in developing a scientific method of controlling inventories.
c. It helps in achieving high stock turnover.
41. Aditya Industries Ltd., has a targeted capital structure consisting of 60% equity, 40% long-
term debt. The firms marginal tax rate is 35% and it intends to raise additional funds.
The following information has been collected:
Debt:
A 7 year term loan is available on the following terms:
Funds up to Rs.2 crore are available at 12% interest.
Funds in excess of Rs.2 crore are available at 14% interest.
Equity shares:
The last dividend paid by the company on its equity shares (face value =Rs.10 per share) was
Rs.2 per share and the dividends have a growth rate of 12%. The company can issue
additional equity shares (face value =Rs.10 per share) as follows
Funds up to Rs.2 crore can be raised by issuing the shares at Rs.45 per share.
Funds in excess of Rs.2 crore can be raised by issuing the shares at Rs.40 per share.
i. The cost of equity capital in the range 02 crore is approximately 16.98%.
ii. In the range of Rs.2 crore and above, the cost of equity capital is greater than the cost of
debt by 10.50%.
iii. The cost of debt in the range 0-2 crore is 7.8%.
a. Only (i) above.
b. Only (ii) above.
(3 points)

860
42. The net cash flows associated with two projects are given below:
(Rs. in thousands)
Year Project X Project Y
0 (25,00) (2,500)
1 1,200 650
2 1,200 650
3 1,200 650
4 650
5 650
6 650
7 650
Note: The cost of capital is 12%.
i. The NPV of project X is greater than the NPV of project Y by Rs.84,200.
ii. The Benefit Cost Ratio for project X is 1.153.
iii. The Benefit Cost Ratio for the project Y is 1.187.
a. Only (i) above.
b. Only (ii) above.
(3 points)
43. The cash flows associated with a project are given below:
Year 0 1 2 3 4 5
Cash flows Rs.000s) (22,00) 9,00 8,50 7,00 6,50 5,00
The approximate internal rate of return earned by the project is
a. 12.34%
b. 14.00%
c. 19.80%
d. 21.36%
e. 24.00%.
(3 points)
44. Automotive Parts Limited uses Ferro-alloys which have a price of Rs.40,000 per tonne.
These alloys have a carrying cost of 25% per annum, an annual usage rate of 4,000 tonnes
and an ordering cost of Rs.2,000 per order. The economic order quantity for the firm and the
corresponding total costs at that level are
a. 40 tonnes and Rs.16.04 crore
b. 400 tonnes and Rs.16.04 crore
c. 40 tonnes and Rs.160.4 crore
d. 36 tonnes and Rs.15.89 crore
e. 32 tonnes and Rs.19.81 crore.
(3 points)

Part III
861
45. Ajay Industries Ltd. (AIL) has an EOQ of 4,000 units. Its supplier, Vijaya Industries Ltd.
(VIL), has offered a discount of 2.5% on order sizes of 6,000 units and above. It is assumed
that the demand for the item is evenly distributed over the entire year. The purchase price of
the item is Rs.18 per unit and the carrying cost is 25% of the average inventory value per
annum. The cost for placing an order is fixed and it is Rs.900 per order. What will be the net
impact on the profitability of the firm if the firm accepts the discount offered by the supplier?
a. Net incremental profit will decrease by Rs.10,500.00.
b. Net incremental profit will decrease by Rs.8,418.75.
a. Net incremental profit will increase by Rs.2,081.25.
d. Net incremental profit will increase by Rs.8,418.75.
e. Net incremental profit will increase by Rs.10,500.00.
(3 points)
46. The sales figures for SCI-FI Ltd., for the month J anuary, February and March are Rs.1,200,
Rs.1,200 and Rs.1,350 respectively. 20% of sales are for cash and the balance are on 30 days
credit. The total cash receipts in the month of February and March are:
a. Rs.1,200 and Rs.1,230
b. Rs.1,400 and Rs.1,230
c. Rs.1,500 and Rs.1,650
d. Rs.1,800 and Rs.2,100
e. Rs.2,000 and Rs.2,200.
(3 points)
47. The projected profit and loss account for the first three months of the financial year
2003-2004 of Boorgu India Ltd., is as follows:
(Rs. in lakh)
April May J une
Sales 1,200 1,200 1,350
Materials
Opening stock 1,800 1,800 1,890
Add: Purchases 900 990 1080
Less: Closing stock 1,800 1,890 1,980
Net consumption 900 900 990
Miscellaneous
expenses
270 270 300
Total expenses 1,170 1,170 1,290
Profit 30 30 60
Last months closing cash balance was Rs.50 lakh.
For the year ending 31st March 2003 the creditors and debtors balances were Rs.900
lakh and Rs.1050 lakh respectively.
20% of sales are for cash and the balance are on 30 days credit.
Creditors are paid in 30 days.
Miscellaneous expenses include depreciation of Rs.15 lakh per month and provision for
bonus to workers of Rs.5 lakh per month, payable in the month of October.
There is a planned capital expenditure of Rs.300 lakh in the month of June.
Tax of Rs.40 lakh is to be paid in June.
Dividend of Rs.50 lakh for the previous year is to be paid in May.
Minimum cash balance requirement is Rs.50 lakh.

862
i. There is a cash deficit of Rs.240 in the month of J une.
ii. The cash surplus in the month of April is 240.
iii. The amount of surplus cash is equal in the months of April and May.
a. Only (i) above.
b. Only (ii) above.
(3 points)
48. Ashish Enterprises Ltd. (AEL) has placed two orders with Tirupathi Suppliers Ltd. (TSL).
The finance manager of the company has to decide whether to grant credit to AEL or not.
Each order amounts to Rs.5,00,000. The cost of goods sold is 80% of the amount of the
order. It is estimated that the probability of default by AEL on the first order is 20%. If AEL
does not default on paying for the first order then it is expected that the probability of default
by AEL on the second order is 10%.
Which of the following statements is false?
a. Credit should be granted to AEL as the total net weighted benefit associated with the
first and the second order is Rs.40,000.
b. The net weighted benefit associated with the initial order is zero.
c. Credit should not be granted to AEL as a loss of Rs.40,000 is associated with the first
and the second order.
d. The expected loss associated with the initial order is Rs.80,000.
(3 points)
49. The following information is available about Bulls & Bears Ltd.:
Sales 10,00,000
Raw materials cost 4,00,000
Manufacturing expenses 3,00,000
Selling, administration and
financial expenses
1,00,000
Total cost 8,00,000
Profit 2,00,000
The durations at various stages of the operating cycle are given below:
Raw materials stage 2 months
Work-in-process stage 1 month
Finished goods stage 2 months
Debtors stage 2 months
Manufacturing expenses are expected to occur uniformly over the year. Cash balance of
Rs.75,000 needs to be maintained always.
The total investment required for raw materials and manufacturing expenses is
a. Rs.41,50,000
b. Rs.45,60,000
c. Rs.51,50,000
d. Rs.56,50,000
e. Rs.60,00,000.
(3 points)

Part III
863
50. Following details are given about Ganesh Traders Ltd.
Average stock of work-in-progress Rs.10 lakh
Cost of Sales Rs.240 lakh
Annual credit sales Rs.300 lakh
The closing balance of accounts receivables (assuming 360 days in a year) is
a. Rs.6.50 lakh
b. Rs.10.75 lakh
c. Rs.12.12 lakh
d. Rs.14.30 lakh
e. Rs.14.50 lakh.
(3 points)
51. The following information is available for Seals Trading Co.
Month Sales Receivables at the end of the
quarter
1st quarter J anuary
February
March
170
220
260
12
75
160
The Daily Sales Outstanding at the end of the first quarter for averaging period of 60 days is
a. 20.890 days
b. 30.875 days
c. 36.955 days
d. 40.156 days
e. 45.780 days.
(2 points)
52. Avanti Paperboard Ltd., issues cheques worth Rs.15,000 and also receives cheques worth
Rs.28,000 daily. Normally the cheque issued by the company takes 6 days to be cleared while
the bank takes about 3 days for the cheques deposited by the company to be realized. Assume
that the opening credit balance of the company with the bank is Rs.20,000. Which of the
following statements is true?
i. The net float is negative on the 5th day and is equal to Rs.(9,000).
ii. The net float is negative on the 7th day.
iii. The net float is positive on the 6th day and is equal to Rs.6,000.
iv. The steady state condition is reached on the 5th day.
a. Only (i) above.
b. Only (ii) above.
d. Both (ii) and (iv) above.
e. Both (iii) and (iv) above.
(3 points)
864
53. A manufacturing company is planning to install Machine A. The details about the purchase
price and operating costs associated with the machinery are given below:
Machine
A
Purchase Price +Cost of Installation
Operating cost:
80,000

Year
1 25,000
2 25,000
3 25,000
4 36,000
5 36,000
6 36,000
The salvage value of the Machine A is expected to be Rs.10,000 at the end of the sixth year.
The annual capital charge associated with the machine is
a. Rs.56,789.90
b. Rs.49,374.92
c. Rs.45,678.10
d. Rs.40,004.92
e. Rs.30,112.50.
(3 points)
54. Software Solutions Ltd., is earning an annual EBIT of Rs.100 lakh. The company has Rs.200
lakh of 15% debentures in its capital structure. The equity capitalization rate for the company
is 14%. The overall capitalization rate as per the Net Operating Income approach is
a. 14.29%
b. 16.57%
c. 18.15%
d. 20.15%
e. 22.33%.
(1 point)
55. Consider the following data regarding an electronic goods manufacturing company:
Cost of equity 16%
Cost of debt 12%
Tax rate 30%
Debt/Equity ratio 1:1
The increase (decrease) in the cost of capital if debt-equity ratio of the company is changed to
0:1 is
a. (3.80)%
b. (0.18)%
c. 0.18%
d. 3.80%
e. 4.20%.
(1 point)
56. The market value of debt is Rs.50 lakh. If the corporate tax rate and personal tax rates are
30% and 20% respectively, the tax advantage of debt is
a. Rs.3 lakh
b. Rs.5 lakh
c. Rs.12 lakh
d. Rs.15 lakh
e. Rs.25 lakh.
(1 point)
Part III
865
57. If the market price of an equity share of PC Ltd. is Rs.35, dividend per share is 20%, internal
rate of return on investments is 24% and cost of capital is 18%, the earnings per share as per
the Walter model is
a. Rs.5.78
b. Rs.5.01
c. Rs.4.97
d. Rs.7.73
e. Rs.6.78.
(1 point)
58. Shailaja Footwears, a Kanpur based business house, has started exporting to middle east
countries. Its information on sales figure is given below:
Actual Sales (Rs.) Forecasted Sales (Rs.)
May 2003 13,65,900 J uly 2003 18,50,000
J une 2003 17,42,500 August 2003 19,00,000
September 2003 19,00,000
October 2003 21,50,000
November 2003 21,50,000
December 2003 19,50,000
Cash and credit sales are expected to be 20% and 80% respectively.
Receivables from credit sales are expected to be collected as follows: 60% of
receivables, on an average, one month from the date of sale and balance 40% of
receivables, on an average, two months from the date of sale.
Miscellaneous cash purchases of Rs.5000 per month are planned from J uly to December
2003.
Rs.12,000 is expected from the sale of a machine in August 2003.
Total cash receipts forecast for August 2003 would be
a. Rs.17,97,500
b. Rs.18,32,600
c. Rs.18,37,600
d. Rs.18,42,600
e. Rs.19,12,000.
(2 points)
59. M/s. Y2K03 Industries Ltd., is considering a project which will entail the following revenues
and expenses:
(Rs. in lakhs)
Year 1 2 3 4 5
Profit before tax 12 15 18 18 16
Depreciation 4 4 4 4 4
Interest on short-term
loan
3 3 3 3 3
Interest on term loan 1.2 0.96 0.72 0.48 0.24
Repayment of term loan 2 2 2 2 2

866
The following additional information is provided for year 2:
Total expenses include allocated costs of Rs.1,00,000.
A machine if not used for this project could earn an income of Rs.50,000.
If the tax rate is 40%, the net cash flow during year 2 is
a. Rs.11.876 lakhs
b. Rs.14.860 lakhs
c. Rs.15.876 lakhs
d. Rs.16.476 lakhs
e. Rs.17.676 lakhs.
(2 points)
60. M/s. Deepak Autospares Ltd has forecast its sales to be as follows:
Month J uly August September
Sales (Rs.) 5,00,000 6,00,000 4,00,000
Purchases amount to 70% of the following months sales and are paid in the following month
of purchase. Wages and administrative expenses per month amount to Rs.50,000 and
Rs.60,000 respectively and are paid in the month in which they are incurred. Depreciation
and amortization of preliminary expenses amount to Rs.70,000 and Rs.30,000 respectively. If
the opening cash balance during J uly is Rs.50,000 and the receipts from sales during the
months J uly and August are Rs.4,50,000 and Rs.5,00,000 respectively, the closing cash
balance at the end of the month of August is
a. Rs.1,60,000
b. Rs.1,20,000
c. Rs.10,000
d. Rs.30,000
e. Rs.80,000.
(2 points)
61. For a company, the cost of debt is 10 percent and the cost of capital is 14 percent. If its debt-
equity ratio is 2, what is its equity capitalization rate according to the net operating income
approach?
a. 10%.
b. 14%.
c. 20%.
d. 22%.
e. 24%.
(2 points)
62. If the average daily usage of material is 400 units, lead time for procuring material is 7 days,
the average number of units per order is 2800 units and the stock out acceptance factor
considered is 1.4, the reorder level is
a. 4480 units
b. 5600 units
c. 5920 units
d. 6720 units
e. 7840 units.
(2 points)

Part III
867
63. The following details pertain to Zenith Industries Ltd.:
Average stock of work-in-process =Rs.16 lakh
Annual cost of production =Rs.160 lakh
Assume 360 days in a year.
The work-in-process period for the company is
a. 10 days
b. 16 days
c. 23 days
d. 36 days
e. 40 days.
(1 point)
64. Consider the following figures :
Rs.
Opening balance of book debts 1,00,000
Ending balance of book debts 1,50,000
Annual Sales 45,00,000
The average collection period, considering 360 days in a year, is
a. 15 days
b. 12 days
c. 10 days
d. 18 days
e. 6 days.
(1 point)
65. Ignoring the time value of money, how much does a firm lose on a Rs.5000 sale that has a
30% profit margin and a 25% probability of default when the default actually occurs?
a. Rs.875.
b. Rs.1,250.
c. Rs.2,625.
d. Rs.3,500.
e. Rs.5,000.
(1 point)
66. For a software company, if the expected earnings per share is Rs.4, cost of equity capital is
16%, retention ratio is 70% whereas return on investment is 17%, then the value of the stock
according to the Gordons dividend capitalization model is
a. Rs.16.24
b. Rs.24.57
c. Rs.29.27
d. Rs.40.62
e. Rs.60.57.
(1 point)
67. What is the total cost of maintaining an inventory of 200 units if the carrying cost per unit is
Rs.3, the cost per order is Rs.10 and there are 4 orders per year?
a. Rs.340
b. Rs.600
c. Rs.640
d. Rs.800
e. Rs.840.
(1 point)
868
68. Ignoring the time value of money, how much does a firm lose or gain on a Rs.1000 sale that
has a 30% profit margin if 20% probability of default occurs?
a. Gains Rs.300.
b. Gains Rs.240.
c. Gains Rs.100.
d. Loses Rs.90.
e. Loses Rs.40.
(1 point)
69. What is the annual benefit for a firm with daily sales of Rs.30,000 speeds up collections by 3
days, assuming a 6% p.a. of cost of funds?
a. Rs.90,000.
b. Rs.7,200.
c. Rs.5,400.
d. Rs.1,800.
e. Rs.15.
(1 point)
70. ABC Corporation shows a ledger balance of Rs.50,000 on a day. Subsequently, the company
writes a cheque for Rs.4,000 and deposits Rs.1500 in cheques. What is the amount of net
float?
a. Rs.1,500.
b. Rs.2,500.
c. Rs.4,000.
d. Rs.5,500.
e. Rs.47,500.
(1 point)

869
Suggested Answers
1. (c) Undertrading is a situation when sales are less compared to the level of investment in the
firm i.e., the assets employed by the firm.
2. (d) A spontaneous liability is one which emerges in the normal course of business.
Alternatives (a), (b), (c) and (e) represent spontaneous liabilities whereas alternative (d) does
not represent a spontaneous liability.
3. (d) When a conservative current asset financing policy is followed the level of investments in
current assets is high. As a result the profitability is low.
4. (b) An aggressive current asset financing policy uses short-term sources of financing to
finance current assets in order to reduce the cost of financing. Equity capital is a long-
term source of finance. Hence it is not used to finance current assets when an aggressive
current asset financing policy is followed.
5. (c) Commercial paper is a short-term instrument which is issued by financially strong
companies. Investment in CPs is open to all investors; so it is not necessarily a source of
bank finance.
6. (b) Ordering costs are independent of the size of the order; hence they remain more or less
constant irrespective of the size of the order.
7. (e) Self-explanatory.
8. (b) Cash discount is a cost item which is incurred by a firm to induce early payments by the
debtors. It is not a cost of maintaining receivables. All other alternatives represent costs of
maintaining receivables.
9. (b) Payment policy is the policy of paying the creditors. All others are the variables related to
the credit offered to the customers of the company.
10. (e) For cumulative preference shares, the dividends will be paid on a cumulative basis. In
case they remain unpaid in any financial year due to insufficient profits, the company will
have to pay all the arrears of preference dividends before declaring any equity dividends.
Hence statement (II) is correct.
According to the Companies Act, 1956, the cumulative preference shareholders will be
entitled to voting rights if there are arrears in dividends for two or more years. Hence
statement (III) is correct and (e) is the answer. The holders of cumulative preference shares
are entitled to receive dividends and any arrears in dividends but they do not have any right
to participate in the surplus profits. Hence, statement (I) is not true.
11. (c) In the letter of credit arrangement the bank undertakes the responsibility to honor the
obligation of its customer, should the customer fail to do so. Hence the bank assumes the risk
of default while the supplier provides the credit.
12. (a) The assumptions underlying the definition of cost of capital under capital expenditure
decisions are
a. The risk characterizing the new project under consideration is not different from the risk
characterizing the existing investments of the firm.
b. The firm will continue to pursue the same financing policies i.e. there will be no
deviation from the debt equity mix currently adopted by the firm.
Hence only statement (I) is correct and statement (II) is incorrect. The management of the
firm has no relevance for the definition of cost of capital. Hence, (a) is the answer.
13. (d) Whether or not to avail term loans and to what extent, is related to the borrowing policy
of a firm; it is not related with cash management.
870
14. (c) The economic appraisal of projects does not consider the impact of the project on the
wealth of the shareholders. Alternatives (a), (b) and (d) are a part of the economic appraisal
of projects.
15. (d) A project is accepted if the following conditions are true:
i. Net Present Value should be positive.
ii. Benefit Cost Ratio should be greater than one.
iii. Net benefit cost ratio should be greater than zero.
iv. IRR should be greater than the cost of capital of the project.
v. Payback period should be less than the cut-off period.
Hence option (d) is the answer.
16. (d) Improving the quality of product is not the purpose of maintaining inventories.
17. (c) Agency costs will decrease when the debt-equity ratio decreases as in such a situation the
creditors will perceive the firm to be less risky. Hence statement (III) is correct.
Therefore (c) is the correct option.
According to Modigliani and Miller approach, the cost of capital to the firm remains constant
for all degrees of leverage and is not affected by the financing decisions of the firm. So,
according to this approach, an optimal capital structure does not exist. Hence statement (I) is
incorrect.
In the presence of taxes, the market value of the firm increases when the firm resorts to debt
financing as interest on debt is a tax-deductible expense. Hence statement (II) is false.
18. (d) Gordons dividend capitalization model assumes that the return on investment is constant.
19. (e) Capital structure decisions take into consideration all the given factors.
20. (c) In a joint stock company, where managers (who are regarded as agents of shareholders)
usually have a very little stake in ownership are likely to act in ways that may be
incompatible with the interest of the shareholders and resulting in agency costs.
21. (d) Prompt billing and opening collection centers are techniques for efficient cash
management in case of a company with wide distribution network.
22. (e) When credit policy is liberalized, it results in cash discounts and increase in expenses for
follow-up of receivables and increases bad debts also.
23. (c) When the company extends its credit period from 30 days to 50 days, the existing
customers will also delay the payment availing the extended credit period.
24. (d) Net float is the difference between payment float and collection float. Hence net float is
negative whenever the firm has received more cheques than it has issued, i.e. the balance in
the books of the company is more than that in the banks books.
25. (d) Collection effort is not a term of trade.
26. (d) Credit policy involves either liberalizing the various credit variables (credit standards,
credit period, cash discount and collection program) or tightening them. Hence it is a decision
involving a trade off between increased profits and cost of investment in receivables and loss
due to bad debts.
27. (e) According to Gordon's dividend capitalization P
0
=E (1 b) / (k br), br indicates the
growth rate in the rate of return on investment and not growth rate in EBIT.
28. (d) Equity share capital provides permanent capital with limited liability for repayment.
Hence the perpetual nature of funds are an advantage of equity share capital.
29. (d) Low debt proportion is not an essential feature as debt proportion in capital structure is
firm specific.
30. (a) The average cost of capital decreases up to a certain point, remains more or less
unchanged for moderate increase in leverage thereafter and rises beyond a certain point.
Part III
871
31. (a) Current assets are assets held for a shorter period of time and long-term assets are those
which are held for relatively longer period of time.
32. (b) When the terms of sales are on cash basis then it implies that there are no credit sales and
hence no receivables.
33. (c) A decrease in operating cycle can be a result of decrease in inventory period, work-in-
progress stage, finished goods stage or due to decrease in receivables period.
34. (e) Current assets level depends on all the given factors and fluctuates with a change in these
variables.
35. (e) Kannan committee made recommendations on working capital requirements of a firm.
36. (b) Cost of manufacturing the material will not be a part of ordering cost when the material is
manufactured internally.
37. (a) ABC analysis is an inventory management technique where segregation of inventory is
made on the basis of their annual usage value.
38. (a) VED analysis is an inventory management technique for monitoring and control of stores
and spares inventory by classifying it into three categories; vital, essential and desirable.
39. (c) Average collection period=Average balance in receivables/Average daily credit sales.
40. (e) ABC analysis is an inventory management technique where segregation of inventory is
made on the basis of their annual usage value. All the statements are benefits of ABC system
of inventory management.
Part B: Problems
41. (e) Cost of Debt:
For 0 Rs.2 crore
k
d
=I(1 T) =12 x (1 0.35) =7.8%
For Rs.2 crore and above
k
d
=14 x (1 0.35) =9.1%
Cost of equity share capital
a. For 0 Rs.2 crore
k
e
=
1
0
D
P
+g
where,
k
e
=Cost of external equity
D
1
=Dividend expected at the end of year 1.
k
e
=
2 x 1.12
45
+0.12 =0.1698
i.e., 16.98%
b. For Rs.2 crore and above
k
e
=
40
1.12 x 2
+0.12 =0.176 i.e 17.6%
In the range of Rs.2 crore and above, the cost of equity is greater than the cost of debt by
(17.6 9.1) =8.5%. Hence, statement (ii) is incorrect.

872
42. (a) Calculation of NPVs
NPV
X
=2,500+
1,200
(1 0.12) +
+
2
1,200
(1.12)
+
3
1, 200
(1.12)
=2,500 +1,200 PVIFA
(12%, 3)
=2,500 +1,200 x 2.402 =382.4 i.e Rs.3,82,400
NPV
Y
=2,500 +
1.12
650
+
2
(1.12)
650
+
3
(1.12)
650
+
4
(1.12)
650
+
5
(1.12)
650
+
6
(1.12)
650
+
7
(1.12)
650

=2,500 +650 PVIFA
(12%, 7)
=2,500 +650 x 4.564 =466.60
i.e., Rs.4,66,600
Calculation of BCRs
BCR
X
=
2,500 382.40
2,500
+
=1.153
BCR
Y
=
2,500 466.60
2,500
+
=1.187.
43. (d) Let IRR be r.
2,200 =
r) (1
900
+
+
2
r) (1
850
+
+
3
r) (1
700
+
+
4
r) (1
650
+
+
5
r) (1
500
+

For r =19%; RHS =2,305.593
r =21%; RHS =2,215.496
r =22%; RHS =2,172.692
r =21 +
22 21
(2,172.692 2,215.496)
(2,200 2,215.496) =21.36%

Internal rate of return =21.36%
44. (a) EOQ =
PC
2Fu

F = 2,000
u = 4,000
P = 40,000
C = 0.25
=
0.25 x 40,000
4,000 x 2,000 x 2
=40 tonnes.
The total cost associated with ordering at EOQ
= Ordering cost +Carrying cost +Material cost
=
40
4,000
x 2,000 +
2
40
x 40,000 x 0.25 +4,000 x 40,000
= 2,00,000 +2,00,000 +16,00,00,000 =Rs.16,04,00,000.
45. (d) Let the EOQ be denoted as Q
*
and let the minimum required order size for getting the
discount be denoted
Q
.
Net incremental benefit,
=UD+
* '
U U
Q Q

F
Q' (P D)C Q*.PC
2 2

Q* = 4000 units
Part III
873

Q
= 6000 units (given)
Discount per unit, D =Price per unit Percentage of discount
=
18(2.5)
100
=Re. 0.45
Discount earned over the entire planning period =UD =20,000 0.45 =Rs.9,000
Savings in ordering cost
=
U U
F
Q* Q'

=
20,000 20,000
x900
4,000 6,000
=Rs.1,500
Increase in carrying cost
=
Q' (P D)C Q*.PC
2 2

=
(6,000) (18 0.45)(0.125) (4,000) (18) (0.125)
2 2
=Rs.2,081.25
Net incremental benefit,
= 9,000 +1,500 2,081.25
= Rs.8,418.75 (gain)
Thus we find that there is a gain of Rs.8,418.75.
Hence the optimal order size should be 6,000 units.
46. (a) Forecast of cash receipts
Item of cash receipt J anuary February March
Cash sales 240 240 270
Credit sales 960 960 1,080
Collection on credit
sales
960 960
Total Cash receipt 240 1,200 1,230

47. (d) Forecast of the cash payments
Sl. No. Item of cash payment April May J une
1. Material (Creditors are paid in 30 days) 900 900 990
2. Expenses excluding 20 lakh towards
depreciation and bonus
250 250 280
3. Tax payment 40
4. Dividend payment 50
5. Capital expenditure 300
Total cash payment 1,150 1,200 1,610
Cash budget for the period April to J une
Sl. No. Item of cash payment April May J une
1. Opening cash balance 50 190 190
2. Total receipts 1,290 1,200 1,230
3. Total payments 1,150 1,200 1,610
4. Net cash flow (2 3) 140 0 (380)
5. Closing balance 190 190 (190)
6. Minimumcash balance 50 50 50
7. Surplus or deficit 140 140 (240)
874
48. (c)

Decision
point
Alternatives
Expected
monetary
value
D
2
D
21
0.9 x 1 0.1 x 4
=0.5 lakh
D
22
0
D
1
D
11
0.8 x (1 +0.5)
0.2 x 4
=0.4 lakh
D
12
0
Therefore, D
22
and D
12
should be strucked off. Expected monetary value due to D
11
and D
21

=0.4 lakh.
Hence, extend credit to M/s AEL.
Alternatively,
i. The net weighted financial benefits on the initial order =expected benefits expected loss
= 0.8 x [5,00,000 5,00,000 x 0.8] 0.2 x 5,00,000 x 0.8
= 80,000 80,000 =0
ii. Given that the first order is paid with probability of 0.8 (as 20% is the chances of
default on the initial order), the net financial benefit from the second order.
= 0.8 [(0.9 x 5,00,000 x 0.2 0.1 x 5,00,000 x 0.8)] =0.8 [50,000] =40,000
Adding benefits of initial and repeat order the total benefit =Rs.40,000 which is higher than
individual orders hence credit can be granted to AEL.
49. (a)
(Rs. in thousands)
Input
Period
(in months)
Raw
materials
Work-in
process
Finished
goods
Debtors Total
A. Raw Materials
In stock 2 800

In work-in-
process
1 400
In debtors 2 800
2,800
B.
Manufacturing
expenses

In work-in-process 1/2 150

In finished
goods
2 600
In debtors 2 600
Part III
875
1,350
Note: Since the manufacturing expenses are expected to occur evenly we can say that on
average the manufacturing expenses component of work-in-process is equal to half-months
manufacturing expenses.
The total investment required for raw material and manufacturing expenses is
28,00,000 +13,50,000 =Rs.41,50,000.
50. (a) Conversion Period =
Average work-in-process 10
Average cost of production per day 210/ 360
= =17.1 days
Let X be closing balance of accounts receivable
Debtors collection period
=
Average accounts receivables (X 15)/2
Average credit sales per day 300/360
+
= =0.6 X + 9
Net operating cycle =Raw material storage period +Conversion Period +Finished goods storage
period +Debtors Collection Period Creditors Payment period
105 =105 +17.1 +45 +0.6 X +9 75
105 101.1 =0.6 X
X =Rs.6.5 lakh.
51. (b)
End of 1st quarter
A Receivables 247
B Daily Sales
(60 days averaging)
(260 +220)/(230)
C DSO =A/B 30.875 days
52. (c) Balance as per passbook
Day 1 2 3 4 5 6 7
Opening Balance 20,000 20,000 20,000 20,000 48,000 76,000 89,000
Cheques
Realized
- - - 28,000 28,000 28,000 28,000
Cheques Debited - - - - - 15,000 15,000
Closing Balance 20,000 20,000 20,000 48,000 76,000 89,000 1,02,000
Balance as per companys book
Day 1 2 3 4 5 6 7
Opening
Balance
20,000 33,000 46,000 59,000 72,000 85,000 98,000
Cheques
Deposited
28,000 28,000 28,000 28,000 28,000 28,000 28,000
Cheques
issued
15,000 15,000 15,000 15,000 15,000 15,000 15,000
Closing
Balance
33,000 46,000 59,000 72,000 85,000 98,000 1,11,000
From the above table, we find that from the 6th day, the balance as per passbook is lesser
than the balance as per companys book by Rs.9,000. Therefore, the net float is negative on
the 6th day. The net float on the 5th day is negative and is equal to Rs.(9,000).
On the 7th day the net float is negative and is equal to Rs.(9,000).
876
53. (b) Present value of the costs associated with the machine:
=80,000 +[25,000 x PVIFA
(15%,3)
] +36,000
x PVIFA
(15%,3)
x PVIF
(15%,3)
10,000PVIF
(15%,6)
=80,000 +25,000 x 2.283 +36,000 x 2.283 x 0.658 10,000 x 0.432
=Rs.1,86,834.70.
Annual Capital Charge for Machine A
=
(15%,6)
1,86,834.70 1,86,834.70
PVIFA 3.784
= =Rs.49,374.92.
54. (a) EBIT Rs.100 lakh
Less: Interest on debentures Rs.30 lakh
(15% of Rs.200 lakh)
Equity earnings Rs.70 lakh.
Equity Earnings
Equity Capitalization
=
70
0.14
=Rs.500 lakh.
Market value of debt =Rs.200 lakh
Total value of the firm =200 +500 =Rs.700 lakh.
Overall Capitalization Rate =
EBIT
Value of the firm
=
100
700
=14.29%.
55. (d) Existing cost of capital
k
0
= w
e
k
e
+w
d
(1 T) k
d

k
0
= 0.5 x 16 +0.5 x (1 0.3) x 12 = 12.20
If debt to equity ratio changes to 0:1 then, it becomes all equity firm, hence, k
0
=k
e
=16%
Therefore, increase in cost of capital =16 12.2 =3.8%.
56. (c) Tax advantage associated with debt is t
c
B(1 t
p
)
=0.30 x 50 lakh x (1 0.20) =Rs.12 lakh.
57. (c) As per Walter model,
e
e e
r/k (E D) D
P
k k

= +
i.e. 35 =
0.24/0.18(E 0.20E) 0.20 E
0.18 0.18
+
Solving the above equation, we get E =Rs.4.972.
58. (c) Cash sales =19,00,00 0.20 =Rs. 3,80,000
Collection of Credit sales (J uly) =18,50,000 0.60 0.8 =Rs.8,88,000
Collection of Credit sales (J une) =17,42,500 0.40 0.8 =Rs.5,57,600
Sale of machine =Rs.12,000
Total =Rs.18,37,600
Part III
877
59. (a) According to principle of costs and benefits of a project, allocated costs should be ignored
and opportunity costs should be included. In the given case, allocated costs of Rs.1,00,000
should be added to PBT and Rs.50,000 should be deducted.
NCF during year 2
= (PBT +1 0.5) 0.6 +Depreciation +Interest on TL (1 t) TL repayment
= (15 +1 0.5) 0.6 +4 +0.96 x 0.6 2 =Rs.11.876 lakhs.
60. (c)
(Rs.)
J uly August
Opening balance 50,000 40,000
+Receipts from sales 4,50,000 5,00,000
5,00,000 5,40,000
Wages and administration 1,10,000 1,10,000
Purchases paid 3,50,000 4,20,000
Closing cash balance 40,000 10,000
Closing cash balance at the end of August =Rs.10,000 and answer is (c).
61. (b) Overall capitalization rate,
k
0
=10
2
3
+14
1
3
=
34
3
= 11.33 percent
and hence, the equity capitalization rate will
k
e
=11.33 +(11.33 10) 2 =11.33 +2.66 = 13.99 14 percent.
62. (d) Reorder level =S x L +F L x R x S
Where S is usage in units
L is lead time in days
R is average number of units per order and F is stock out acceptance factor.
Reorder level =400 x 7 +1.4 7 x 2,800 x 400 =6,720 units
Hence option (d) is the correct choice.
63. (d) The required work-in-process period for the company
=
16
360
160
=36 days.
64. (c) Average book debts =
2
1,50,000 1,00,000+
=Rs.1,25,000
360
45,00,000
=Rs.12,500.
12,500
1,25,000
=10 days
Hence option (c) is the correct choice.
878
65. (d) Loss that the company will incur when the customer actually defaults =Cost of the unit
= (1 0.30) 5000 =Rs.3,500.
66. (c) As per Gordons model P
0
=
br k
E ) b 1 (
=
17 . 0 7 . 0 16 . 0
4 ) 7 . 0 1 (

= Rs.29.27.
67. (a) TC = Ordering cost +Carrying cost = 10 4 + 3 200
2
1
= 40 +300 = 340.
68. (c) Profit = 1000 0.3 0.8 700 0.2 =240 140 = Rs.100
69. (c) Annual profit =30,000 3 0.06 =Rs.5,400.
70. (b) Net float =Payment float Collection float =4000 1500 = Rs.2500.

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The ICFAI University

# 52, Nagarjuna Hills, Hyderabad - 500 082

will be = 1.3 DOL 0.8 DFL = 1.04 DTL

= = 0.1225 i.e. 12.25%.

= Rs. 75.6 million.

e. PAT +INT(1 Tax Rate).

(96.504 95.000) = 13.44%.

= = 0.1225 i.e. 12.25%.

= 5.4 = 10.8% (approximately).

44. (e) EFR = S

i.e. 0.6 S = 0.66S 1.1F

= % change in EPS/% change in output.

21. The expected yield on equity, i

Average Collection Period (ACP) x V

= 0.0622 percent = 6.22 percent.

+ when payout ratio is 10% or dividend is Rs.2.

+ when 13.33 + 04 = Rs.117.33.

+ = 40+80.88 = Rs. 120.88.

+ = 80 = 46.22 = Rs. 126.22.

= Rs.40 + Rs.320 = Rs.360

= Rs.80 + Rs.240 = Rs.320

= Rs.120 + Rs.160 = Rs.280.

= Rs.40 + Rs.240 = Rs.280

= Rs.80 + Rs.180 = Rs.260

= Rs.120 + Rs.120 = Rs.240.

= 109.5 ~ 110 units.

+ , where symbols are in standard use.

1 Rateof Discount Credit Period Discount Period

= 1,500 1,200 = Rs.300 . (3)

=40 i.e. Rs.40.

=0.3673 i.e. 36.73%.

Increase in carrying cost

+ , where symbols are in standard use.

+ =21.43 +34.44 =55.87

is the order stipulated by the supplier for

+ = 1.75 + 0.75 = rs.2,50,000 lakhs

(2,200 2,215.496) =21.36%

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