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FM Nov. 2011 University Paper Solution

Q.1. b)
i.
A Project requires an investment of 60,000. The plant and machinery required under the
project will have a scrap value of 3,000 at the end of its useful life of 5 years. The profits
after tax and depreciation are estimated to be as follows:
Year
1
5,000
2
15,000
3
20,000
4
30,000
5
20,000
Calculate the Accounting Rate of Return.
Q. 1.b i) Solution:
Year
1
2
3
4
5
Total NPAT

NPAT
5,000
15,000
20,000
30,000
20,000
90,000

Avg. NPAT = 18,000

a) ARR based on Original Investment

Avg . NPAT

x 100
O. Inv.
18,000

x 100
60,000
= 30%
O.C Scrap
Scrap W . Cap.
2
60,000 3,000

3,000 0
2
= 28,500 + 3,000 + 0
= 31,500

b) Avg. Investment

ARR based on Average Investment

Avg . NPAT

x 100
Avg . Inv.

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18,000
x 100
31,500
= 57.14%

ii.

The Xavier Corporation, a dynamic growth firm which pays no dividends, anticipates a long
run level of future earning of per shares. The current price of Xaviers shares is 55.45,
floatation costs for the sale of equity shares would average about 10% of the price of the
shares. What is the cost of new equity capital to Xavier Corporation?

Q. 1.b ii) Solution:

Xavier Corporation
Before Floatation Cost
EPS1
Ke
x 100
P0
7

x 100
55.45
= 12.62%
After Floatation Cost
12.62
Ke
1 Floatation Cost
12.62
1 0.10
= 14.02%

iii.

Texas Manufacturing Company Ltd. is to start production on 1st January, 2012. The prime
cost of a unit is expected to be 40 out of which 16 is for materials and 24 for labour.
In addition variable expenses per unit are expected to be 8, and fixed cash expenses per
month 30,000. Payment for materials is to be made in the month following the purchase.
One-third of sales will be for cash and the rest on credit for settlement in the following
month. Expenses are payable in the month in which they are incurred.
The selling price is fixed at 80 per unit. The number of units manufactured and sold are
expected to be as under:
January
900
February
1,200
Draw up a statement showing requirements of cash for a month of February, ignoring the
question of stocks.

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Q. 1.b iii) Solution:

Texas Manufacturing Company
Requirement of Cash for month of February
Particulars
Cash Receipt
32,000
Cash Sales
48,000
Collection from debtor
(a)
80,000
Cash Payment
14,400
Payment for materials
28,800
Labour
9,600
Variable expenses
30,000
Fixed cash expenses
(b)
82,800
(b a)
2,800
Cash requirement
W.N.1) Cash Sale
Feb = (1200 Units 80)

1
3

= 32,000
W.N.2) Collection from debtor
Jan Sale (900 80)
(-) Cash Sale @ 1/3
Credit Sale of Jan
Recd.

=
=
=

72,000
24,000
48,000
1m
Feb

W.N.3) Payment for Material

Jan Purchase = 900 16 = 14,400
1m
Paid

Feb

W.N.4) Labour
Feb: 1200 8 = 28,800

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W.N.5) Variable Expenses
Feb: 1200 8 = 9,600
Q.2) Suhail Enterprises Ltd. is a manufacturer of high quality running shoes.
Ms. Dhinchak, President, is considering computerizing the companys ordering, inventory and
billing procedures. She estimates that the annual savings from computerization include a
reduction of ten clerical employees with annual salaries of 15,000 each, 8,000 from reduced
production delays caused by raw materials inventory problems, 12,000 from lost sales due to
inventory stockouts and 3,000 associated with timely billing procedures. The purchase price of
the system is 2,00,000 and installation costs are 50,000. These outlays will be capitalized
(depreciated) on a straight line basis to a zero book (salvage) value which is also its market value
at the end of five years. Operation of the new system requires two computer specialists with
annual salaries of 40,000 per person. Also annual maintenance and operation (cash) expenses
of 12,000 are estimated to be required. The companys tax rate is 30% and its required rate of
return (cost of capital) for this project is 12%.
You are required to:
a) Find the projects initial net cash outlay.
b) Find the projects operating and terminal value cash flows over its 5 year life.
c) Evaluate the project using NPV method.
d) Evaluate the project using PI method.
e) Evaluate projects simple payback period.
Note:
i.
Present value of annuity of 1 at 12% rate of discount for 5 years is 3.605.
ii.
Present value of 1 at 12% rate of discount, received at the end of 5 years is 0.567.
Q.2 Solution:
Calculation of Annual CIF
Particulars
Clerk : 10 15,000
Delay reduction
Inventory stock out reduction
Billing procedure

1,50,000
8,000
12,000
3,000
(a)

Co. Specialist : 2 40,000

Annual maintenance

(b)
NSBDT
(2,00,000 50,000 0
(-) Depreciation

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1,73,000
80,000
12,000
92,000
81,000
50,000

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NSBT
(-) Tax @ 30%
NSAT
(+) Depreciation
Annual CIF

31,000
9,300
21,700
50,000
71,700

a) Projects Initial Net Cash Outlay

= 2,00,000 + 50,000
= 2,50,000
b) Operating Cash Flow
= 71,700 p.a.
= 71,700 5
= 3,58,500

Terminal Cash Flow

= 0
( No scrap value & no working capital)
c) Calculation of NPV
Year
CIF
15
71,700
NPV

=
=
=

Annuity @ 12%
3.605

PVCIF
2,58,478.50

PVCIF PVCOF
2,58,478.50 2,50,000
8,478.50

Evaluation
Select the project NPV is positive
d) Calculation of PI
PVCIF
PI =
PVCOF
2,58,478.50
=
2,50,000
= 1.03
Evaluation
Select the project PI is more than 1
e) Simple Pay back Period =
=
=

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Initial Outlay
Annual CIF
2,50,000
71,700
3.49 years

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Q.3) Company X wishes to takeover Company Y. The financial details of the two companies are
as under:
Company X
Company Y
Equity Shares ( 10 per share)
Security Premium Account
Profit & Loss Account
Preference Shares
10% Debentures
Fixed Assets
Net Current Assets

1,00,000
-38,000
20,000
15,000
1,73,000
1,22,000
51,000
1,73,000

50,000
2,000
4,000
5,000
61,000
35,000
26,000
61,000

24,000
24
10

15,000
27
9

Maintainable Annual Profit (after tax)

for Equity Shareholders
Market Price per equity share
Price Earning Ratio

What offer do you think Company X could make to Company Y in terms of exchange
ratio, based on (i) Net assets value; (ii) Earning per share; and (iii) Market price per
share? Which method would you prefer from Company Xs point of view?
Q.3) Solution:
i.
Calculation of NPV
Particulars
Market Value of Asset
F.A.
Net C.A.
(a)
Agreed Value of OL
10 % Debenture
Net asset for all SH
(-) Payment to PSH
Net asset for ESH
No. of Equity Shares
EPS
Exchange ratio based on NPV
NAV of T arg et Co.

NAV pf Acq. Co.

11.2

13.8

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(b)
(a b)
(a)
(b)
(a b)

1,22,000
51,000
1,73,000

35,000
26,000
61,000

15,000
1,58,000
20,000
1,38,000
10,000
13.8

5,000
56,000
56,000
5,000
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= 0.81
Or
4

PAT PD
No. of Eqquity Shares
24,000

2.4
10,000
15,000

3
5,000

EPS

ii.

X
Y

Exchange ratio based on EPS

EPS of T arg et Co.

EPS of Acq. Co.

3

2 .4
= 1.25
Or
5

Exchange ratio based on MPS

MPS of T arg et Co.

MPS of Acq. Co.

27

24
= 1.13
Or
9

8
Method to be preferred from Company Xs point of view is the one with lowest exchange
ratio i.e. (i) Net Asset Value.

iii.

Q.4) Jethalal Garments Ltd. manufactures readymade garments and sells them on credit basis
through a network of dealers. Its present sale is 60 lakhs per annum with 20 days credit period.
The Company is contemplating an increase in the credit period with a view to increase sales.
Present variable costs are 70% of sales and the total fixed costs
8 lakhs per annum. The
company expected pre-tax return on investment @ 25%. Some other details are given as under:

Proposed
Credit Policy

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Average Collection Period

(Days)

Expected annual Sales

( Lakhs)

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I
II
III
IV

30
40
50
60

65
70
74
75

Required: Which credit policy should the company adopt? (Assume 360 days in a year).
Calculations should be made upto two digits after decimal.
Q.4) Solution:
Evaluation of credit proposal
Particulars
DCP (days)
Sales
(-) Variable cost (70%)
Contribution
(-) Fixed cost
Profit (a)
Receivables
VC + FC x DCP
360
Cost of AR
Capital cost (Reci xROI)
(b)
Net profit (a b)
Incremental NP

Present
Policy
20
60
42
18
8
10
42 + 8 x 20
360
= 2.78

= 4.46

= 6.33

= 8.31

= 10.08

2.78 x 25%
= 0.70
9.30
-

4.46 x 25%
= 1.12
10.38
1.08

= 1.58
11.42
2.12

= 2.08
12.12
2.82

= 2.52
11.98
2.68

I
30
65
45.5
19.5
8
11.5

Proposed Policy
II
III
40
50
70
74
49
51.8
21
22.2
8
8
13
14.2

IV
60
75
52.5
22.5
8
14.5

Recommendation:
Select proposed policy III since it result into highest incremental net profit. i.e. 2.82 lakhs.

Q.5) From the following particulars, prepare income statement of A Ltd. and B Ltd.
A Ltd.
B Ltd.
Degree of Combined Leverage 6 times
15 times
Degree of Operating Leverage 3 times
5 times
Variable Cost as a % of Sales 40%
50%
Rate of Income Tax
35%
35%
Number of Equity Shares
1,00,000
1,00,000
Earning Per Share
1.30
0.65
Q.5) Solution:
A Ltd.

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NPAT PD
No. of Equity Shares
NPAT 0
1.30 =
1,00,000
NPAT = 1,30,000

EPS =

%
NPBT 100
(-) Tax 35
NPAT 65

?
?
.
1,30,000

NPBT = 1,30,000 x

100
65

= 2,00,000

DCL
6
C

C
PBT
C
=
2,00,000
= 12,00,000

C
PBIT
12,00,000
=
PBIT

DOL =
3

PBIT = 4,00,000

%
Sales 100
(-) VC 40
Contri 60

?
?
.
12,00,000

Sales = 12,00,000

100
60

= 20,00,000
B Ltd.

NPAT =
=

0.65 1,00,000
65,000

65,000

NPBT =

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1,00,000

DCL

15

C
PBT
C
1,00,000
15,00,000

PBIT =

C
PBIT
15,00,000
PBIT
3,00,000

Sales =

15,00,000

DOL =
5

100
50

30,00,000

Income Statement for year ending-------Particulars

Sales
(-) VC
*
Contribution
(-) FC
*
PBIT
(-) Interest
*
NPBT
(-) Tax
*
NPAT
(a)
Verification
No. of Shares
(b)
(a b)
EPS

A Ltd.
20,00,000
8,00,000
12,00,000
8,00,000
4,00,000
2,00,000
2,00,000
70,000
1,30,000

B Ltd.
30,00,000
15,00,000
15,00,000
12,00,000
3,00,000
2,00,000
1,00,000
35,000
65,000

1,00,000
1.30

1,00,000
0.65

* = bal. figure
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