Financial Management Assignment - A

Question 1a: Should the titles of controller and treasurer be adopted under Indi
an context? Would you like to modify their functions in view of the company prac
tice in India? Justify your opinion?
Answer to 1a: Controller & Treasurer are independent & they have their own Persp
ectives & Drivers as detailed below: Controller Responsibilities include, Double
entry accounting, financial reporting, Fraud measure, detective controls, Finan
cial restatement, Compliance with statutory requirements like Rules, Accounting
standards, GAAP, IFRS etc., Controller works & forecasts the events for a long t
erm. Main focus income statement Ex: Cash involved event Controller looks from c
ompliance angle (how to record, what GAAP provides etc.,) Treasurer Responsible
for Liquidity management (very important function), Risk Management, More focus
on financial statements, follows leading practices & responsible for the future
performance of company (projects cash flows) Treasurer works/ forecasts the even
ts regularly (daily / weekly) focus Balance sheet & future capital structure, ca
pital expenditure etc., Treasurer concentrates more on cash availability focus i
.e. how to bring in the required cash etc,
Therefore, from the above it is clear that, controller & treasurer have differen
t roles to play. However, majority of the Indian companies works with Financial
Controller who himself takes care of the treasury department / Portfolio. Theref
ore, as far as from Indian context, it can be concluded that, controller is also
responsible for treasury jobs & there is no separate treasurer / treasury depar
tment exists Question 1b: firm 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. 1,50,0
00 for six years. What is the rate of interest to the firm? Answer to Q1b: Parti
culars Cost of Machinery Down Payment made by firm Financed through borrowings R
epayment in equal instalments every year (maximum of six years) Total interest p
aid over 6 year period Ref (a) (b) c = (ab) Year 0 800,000 150,000 650,000 Year
1 Year 2 Year 3 Rs. Year 4 Year 5 Year 6
d=6*15 0,000
900,000
150,000
150,000
150,000
150,000
150,000
150,000
e=dc
250,000
Rate of Interest = total interest / total borrowings
f=e/c
38.46%

Rate of interet per annum

Break of interest cost / principal repayment: 1) interest cost (can be apportion
ed in the ratio of no of years repayment - i.e. earlier the years more the inter
est cost & vice versa)
g=f/6 yrs
6.41%
6:5:4:3: 2:1
21
6
5
4
3
2
1
(ratio) h
(6+5+4+3+2 +1) 250000 71429 (250,000 *6/21) 59524 (250,000 *5/21) 47619 (250,00
0*4/21) 35714 (250,00 0*3/21) 23810 (250,000* 2/21) 11905 (250,00 0*1/21)
2) Principal Outstanding adjustment
i=d-h
650000
78571
90476
102381
114286
126190
138095
Yearwise Interest rates: - Principal Outstanding at year end (prinicpal o/s at y
ear beginning Principal repayment)
j
650000
571429 (650000i)
480952 (571429i)
378571 (480952 - i)

264286 (378571 - i)
138095 (264286i)
0 (138095 - i)
RATE OF INTEREST EVERY YEAR
h/ princip al o/s at year beginni ng)
11.0%
(h / 650000)
10.4%
(h / 571429)
9.9%
(h / 480952)
9.4%
(h / 378571)
9.0%
(h / 264286)
8.6%
(h / 138095)
Question 2a: Explain the mechanism of calculating the present value of cash flow
s. What is annuity due? How can you calculate the present and future values of a
n annuity due? Illustrate
Answer 2a: Calculating Present Value of Cash flows: Money has time value. For ex
: Rs.1000 received today is not the same worth after a year (actually it is less
) Present value of cash flows: It indicates the value of expected worth at curre
nt value. (Discounts the expected cash flows at appropriate discount rate (may b
e 10%, 20% etc.,) Discount rate will generally be equal to = Inflation rate + Re
qd. rate of return + risk free premium rate Details required for calculating Pre
sent Value of cash flows: Cash flows year wise, discount rate. This technique is
very useful for decision-making.

Annuity due: Uniform/ Constant/ Equal cash flows every year Present value of ann
uity Worth of Lump sum consideration today which is going to be received tomorro
w Computation: Annuity * Present value annuity factor (PVAF) PVAF is calculated
as = 1-[1/(1+r) to the power n]. Illustration: Mr. A would like to receive Rs.10
00/- every year for 10 years from now. It is assumed discount rate 10%, the pres
ent value annuity factor for 10 years 10% is 6.144. Present value of annuity = 1
000 * 6.144 = Rs.6145/Future value of annuity Value of fixed investment every ye
ar worth tomorrow. (i.e. corpus it grows) Annuity * Future value annuity factor
(FVAF) FVAF is calculated as = [(1+r) to the power n] - 1
Mr.X would like to grow a corpus by investment of Rs.10, 000 10 years from now.
Rate of interest @10%, the future value annuity factor for 10 years 10% is 1.594
Future value of annuity = 10000 * 1.594= Rs.15937/Question 2b: "The increase in the risk-premium of all stocks, irrespective of th
eir beta is the same when risk aversion increases" Comment with practical exampl
es
Answer 2b: The security's beta is a function of the correlation of the security'
s returns with the market index returns and the variability of the security's re
turns relative to the variability of the index returns. In simple, beta measures
the sensitivity of the stock with reference to broad based market index. For in
stance: a beta of 1.2 for a stock would indicate that this stock is 20% riskier
than the index & similarly beta of 0.9 for a stock indicates 10% less riskier th
an the index. Finally, a beta of 1.0 means, stock is as risky as the stock marke
t index. Therefore, the given statement is false. Expected risk-premium for stoc
k is beta times the market risk premium. For ex: let us assume beta = 1.2 times,
market risk premium = 10%, then expected risk premium = 10% * 1.2 times = 12%.
Question 3a: How leverage is linked with capital structure? Take example of a MN
C and analyze.
Answer to 3a: Leverage: It is an advantage gained (it may be anything) Leverage
is linked with Capital Structure, since an organization having a optimum capital
structure (where WACC (weighted average cost of capital) is minimum) is a great
leverage/ advantage both to the company as well for the investors. Organization
s, generally have two types of risks; operating risks impact of fixed costs & va
riability of EBIT & Financial risks impact of interest cost/financial charges &
variability of EBT. Example: XYZ ltd has the following nos: Contribution Rs.100
lacs, fixed cost Rs.25 lacs, Financial Charges/debt cost Rs.40 lacs.

Particulars Contribution Fixed cost EBIT Interest cost EBT XYZ Ltd. has followin
g: Operating leverage Contribution / EBIT = 100 / 75 = 1.33
Value (Rs. In lacs) 100 25 75 35 40
Financial leverage EBIT / EBT = 75 / 40 = 1.87
It is always preferable to have low operating risk & high financial risk (subjec
t to Return on capital employed (ROCE) > Interest cost on debt funds) We can con
clude that, XYZ ltd (MNC) is having a optimum capital structure & manageable ris
k.
Question 3b: The following figures relate to two companies (10)
P LTD. Sales Variable costs Contribution Fixed costs Fixed Cost 500 200 ----300
150 ----150 50 ----100 Q LTD. (In Rs. Lakhs) 1,000 300 -------700 400 -------400
100 -------200
Interest Profit before tax
You are required to: (i) Calculate the operating, financial and combined leverag
es for the two companies; and Comment on the relative risk position of them
Answer 3b:
P ltd Particulars Sales Variable costs Contibution Fixed cost PBIT / EBIT Intere
st Profit before Tax / EBT Computation: a) Opearting leverage: = Contribution /
EBIT b) Financial leverage: = EBIT / EBT (in Rs. Lacs) 500 200 300 150 150 50 10
0 1000 300 700 400 300 100 200 Q ltd
2.0
2.3
1.5
1.5

c) Combined leverage: = Contirbution / EBT Comments: Operating risk is higher (i

.e. fixed costs are high) Financial risk looks low Overall risk is low as compar
ed to 'Q' ltd.
3.0 Operating risk is higher than 'P' ltd (i.e. fixed costs are high) Financial
risk looks low Overall risk is high as compared to 'P' ltd.
3.5
It is always preferable to have low Operating leverage & high Financial leverage
(provided, Return on capital employed > Interest on debt funds)
Question 4a: Define various concepts of cost of capital. Explain the procedure o
f calculating weighted average cost of capital. Answer 4a:
Concepts of Cost of Capital: a) All source of finance have its own cost. Out of
long source finance, equity mode of sourcing is costlier than debt financing bec
ause of expectation of shareholders. b) RISK VS. COST: Equity mode of finance wi
ll have low risk but costlier as against debt funds which will have high risk bu
t relatively cheaper & have tax advantage thus reducing the net cost of debt. Or
ganizations have to effectively trade off between risk, cost & control. c) Optim
um Capital Structure: When the firm / organization has a combination of debt and
equity, such that the wealth of the firm is maximum. At this point, cost of cap
ital is minimum & market price of a share is maximum. Procedure of calculating W
eighted Average Cost of Capital (WACC): It is computed by reference to proportio
n of each component of capital (book value or market value as specified) as weig
hts. WACC = Sum [proportion of each component of capital (weights) * individual
cost of capital] Note: Tax rates needs to be adjusted in respect of debt funds.
Question 4b: The following items have been extracted from the liabilities side o
f the balance sheet of XYZ Company as on 31st December 2005.
Paid up capital: 4, 00,000 equity shares of Rs each Loans: 16% non-convertible d
ebentures 12% institutional loans Other information about the company as relevan
t is given below: 31st dec 2005 Dividend Earning average market price Per share
per share per share 7.2 10.50 65 You are required to calculate the weighted aver
age cost of capital, using book values as weights and earnings/price ratio as th
e basis of cost of equity. Assume 9.2% tax rate 40,00,000
20,00,000 60,00,000

Answer 4b:
Computation of Weighted Average Cost of Capital (WACC): Weights * Cost of Capita
l
Nature of Capital
Value
Weights (basis of bookvalues O/S.)
Cost of capital
a) Equity Capital
4,000,000
33% (refer W.No.1)
16.15
5.38
b) 16% non-convertible debentures
2,000,000
17%
14.53 Interest (1-taxrate) = 16% (100%-9.2%)
2.42
c) 12% institutional loans
6,000,000
50%
10.90 Interest (1-taxrate) = 12% (100%-9.2%)
5.45
Total Working Note: 1 Cost of equity:
12,000,000
100%
13.25
Price earnings approach =
Earnings per share / Market price per share 10.50 / 65 = 16.15%
Question 5a: A company has issued debentures of Rs. 50 Lakhs to be repaid after
7 years. How much should the company invest in a sinking fund earning 12% in ord
er to be able to repay debentures? Show the procedure of loan amortization and c
apital recovery through an example. Answer 5a:
Debentures to be redeemed after 7 years Expected rate of return - on sinking fun
d investment to be created Discount rate@12%, 7 yrs Present value of expected re

payment of debentures @12% 7 yrs therefore, company has to invest Rs.22,61,746 @

12% earning in Sinking fund to cover the repayment expected 7 years from now. 5
,000,000 12% 0.452 2,261,746

Loan Amortization A loan amortization schedule is a repayment plan that is calcu

lated before repayment of a loan begins. Amortization schedules are used for fix
ed interest long term loans such as mortgages, expenses like R& D expenses, Purc
hase of Goodwill, Voluntary Retirement payment expenses, Amalgamation expenses e
tc. Procedure with Ex: M/s.XYZ ltd has incurred a Rs.50, 00,000 as lump sum paym
ent towards voluntary retirement separation charges during the accounting year 2
009-2010. XYZ ltd have planned to amortize the above expenses for a period of 10
years commencing from FY.09-10 Therefore, the schedule of amortization for 10 y
ear period as follows: Rs. 500,000/- per years for 10 years
Capital Recovery The reciprocal of Present value annuity factor (PVAF) is the ca
pital recovery. Below example will clarify better the meaning:
Procedure with Ex: Mr.X plan to lend Rs.1 lac today for a period of 5 years @ in
t.rate of 12%, how much income Mr.X should receive each year to recover investme
nt & principal back. The result is known as capital recovery & which can be arri
ved by capital recovery factor. Calculation: Present value = Annuity * PVAF @12%
,5years Capital Recovery PVAF@12%,5years = Annuity * 1 /
Therefore, capital recovery = 100,000 * 0.27739 = Rs.27,740 each year for 5 year
s.
Question 5b: A bank has offered to you an annuity of Rs. 1,800 for 10 years if y
ou invest Rs. 12,000 today. What is the rate of return you would earn? . Answer
5b:
Particulars Return expected per annum Fixed return/annuity for no of years Total
return expected Investment required today Nett return expected from investment
Percentage of return for 10 years Percentage of return per annum Rs. 1800 10 180
00 12000 6000 50% 5%

Assignment - C
Question 1: The proforma of cost-sheet of HLL provides the following data:
Cost (perunit): Raw materials Direct labour Overheads Total cost (per unit): Pro
fit Selling price The following is the additional information available: Average
raw material in stock: one month; Average materials in process: half month; Cre
dit allowed by suppliers: one month; Credit allowed to debtors: two months; Time
lag in payment of wages: one and half weeks; Overheads: one month. One-fourth o
f sales are on cash basis. Cash balance expected to be Rs. 12,000. You are requi
red to prepare a statement showing the working capital needed o finance a level
of activity of 70,000 units of output. You may assume that production is carried
on evenly throughout the year and wages and overheads accrue similarly. Rs. 52.
0 19.5 39.0 110.5 19.5 130.0
Answer 1:
Particulars Cost/unit Production = 70,000 units cost (Rs.) for 70000 units 36400
00 1365000 5005000 2730000 7735000 1365000 9100000
Raw Material Direct Labour Prime cost Overheads Total cost Profit Sales
52 19.5 39 110.5 19.5 130
Statement of Working Capital for HLL - 70,000 units production per year: No of m
onths
Particulars Current Assets: (A) Raw material stock Process stock - Work in progr
ess (WIP) Debtors - customers Cash balance expected to maintain Total of CURRENT
ASSETS - (A) Current Liabilities: (B)
Computation
Rs.
1 0.5 2
36,40,000/12*1month 50,05,000/12*0.5 months 91,00,000*3/4 (credit sales)/12*2
303333 208542 1137500 12000 1661375

Creditors - suppliers Wages Outstanding

Overheads outstanding Total of CURRENT LIABILITIES - (B) NETT WORKING CAPITAL RE
QUIRED
1 36,40,000/12*1month 1.5 weeks or 13,65,000/12*0.34 0.34 month 1 27,30,000/12*1
303333 38675
227500 569508
1091867
Question 2a: Through quantitative analysis prove that PI is a better technique t
han NPV in Capital Budgeting. Answer 2a:
PI Profitability Index & NPV Net Present Value both are capital budgeting techni
ques. Profitability Index (PI) PI = Present value of inflows / Present value of
outflows Ideal = should be > 1 Quantitative analysis: Present value of inflows =
Rs. 200,000 Present value of outflows = Rs. 100,000 PI = 2 Present value of inf
lows = Rs. 200,000 Present value of outflows = Rs. 100,000 NPV = Rs.100,000 Net
Present Value (NPV) NPV = Present value of inflows Present value of outflows Ide
al = NPV should be positive, it shows absolute present value of tomorrows wealth
NPV technique is better than PI technique for capital budgeting decisions. NPV s
hows wealth at the end in absolute amount, which will be helpful to make decisio
ns clearly, whereas the same advantage is not available with PI technique. Howev
er, PI shows return over investment in times, which will be very useful for imme
diate decision making. Generally, over the years, organizations prefer NPV techn
ique for capital budgeting decisions than PI technique.
Question 2b: A company is considering the following investment projects:
Projects Cash Flows (Rs.) Co A B C D - 10,000 -10,000 - 10,000 -10,000 C1 + 10,0
00 + 7,500 + 2,000 + 10,000 C2 C3
----+ 7,500 + 4,000 + 3,000
--------+ 12,000 + 3,000
I. according to each of the following methods: (1.) Payback, (2.) ARR, (3.) IRR,
(4.) NPV assuming discount rates of 10 and 30 percent. II. Assuming the project
is independent, which one should be accepted? If the projects are mutually excl
usive, which project is the best?

Answer 2b:
I) Project A Methods (1) Payback @10% discount rate @30% discount rate (2) Accou
nting rate of return (ARR) (3) NPV @10% discount rate @30% discount rate (4) IRR
Project B Project C Project D
1 + years 1 + years 100%
1.13 years 1.25 years 150%
2.14 years 3 + years 180%
1.7 years 2.8 years 160%
(909) (2308) 0%
3017 207 32%
4140 (633) 26%
3824 833 38%
Independent project: Project with higher NPV needs to be selected, which shows w
ealth in absolute value at the end of the project Therefore, Project C needs to
be accepted. II) In case projects are mutually exclusive: First disparity betwee
n projects needs to be resolved. NPV selects Project C whereas IRR selects Proje
ct D, therefore, disparity exists. Since cash outflows (Rs.10, 000/-) are same f
or both the projects, the disparity arisen is called as Cash flow disparity. It
can be resolved by using Incremental cash flow technique. After resolving, the r
ight project can be accepted. Workings are as follows: PROJECT A: The following
has been calculated assuming discount rates of 10% & 30% separately: 1) Payback
period: time period to recover initial investment a) Discounted @10% Unrecover e
d Discount Discounted discounte rate * cash flows d cash flows @ 10% (4) = (2) *
(3) b) Discounted @30% Unrecove red Discou Discounted discounte nt rate cashflo
ws d cash * flows @ 30% (4) = (2) * (3)
Years
Cash flows
Years
Cash flows
(1)
(2)
(3)
(5)
(1)
(2)
(3)
(5)
0

(10,000)
1.000
(10,000)
(10,000)
0
(10,000) 10,000
1.000 (10,000) 0.769 7,692
(10,000) (2,308)
1 10,000 0.909 9,091 (909) 1 * disocunt rate computed using formule = 1 / (1+r)
to the power n; where r = disocunt rate & n = year
Payback period = Base year + [(unrecovered disocunted cash flow of base year /

disocunted cash flows of next year) *12]

Payback period exceed 1 year, since unrecovered cash flows turns positive only f
rom IInd yr onwards where base year = year in which unrecovered cash flows turns
0 or +ve Payback period @ 10% & 30% discount rate = 1 + years =1+ years 2) Acco
unting rate of return: rate of return on initial investment made: given as: Aver
age profit after depreciation & Tax / Initial investment Since no information on
profits, depreciation & taxes, it is treated cash inflows considered as profits
after depreciation & taxes therefore (10,000 (inflow) / 10,000 = (investment))
* 100 accounting rate of return = 100%; effectively 0% return (whatever invested
taken back)
4) NPV (net present value): a) Discounted @10% Cash flows Discoun t rate * @ 10%
(4) = (2) * (3) Discounte d cashflows b) Discounted @30% Cash flows Discoun t r
ate * @ 30% (4) = (2) * (3) Discounte d cashflows
Years
Years
(1)
(2)
(3)
(1)
(2)
(3)
0 1 NPV
(10,000 ) 10,000
1.000 0.909
(10,000) 9,091 (909)
0 1 NPV
(10,000) 10,000
1.000 0.769
(10,000) 7,692 (2,308)
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year
3) IRR (Internal rate of return): which is the rate of return at which NPV = 0 I
n project A , IRR is 0 % at which NPV =0 (i.e. there is no return from the proj
ect)

PROJECT B: The following has been calculated assuming discount rates of 10% & 30
% separately: 1) Payback period: time period to recover initial investment a) Di
scounted @10% Unrecover ed discounte d cash flows b) Discounted @30% Unrecove re
d Discounted discounte cashflows d cash flows
Years
Cash flows
Discoun t rate *
Discounte d cashflows
Years
Cash flows
Discou nt rate * @ 30%
@ 10% (4) = (2) * (3)
(1)
(2)
(3)
(5)
(1)
(2)
(3)
(4) = (2) * (3)
(5)
0 1 2
(10,000) 7,500 7,500
1.000 0.909 0.826
(10,000) 6,818 6,198
(10,000) (3,182) 3,017
0 1 2
(10,000) 7,500 7,500
1.000 0.769 0.592
(10,000) 5,769 4,438
(10,000) (4,231) 207
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis

ocunt rate & n = year Payback period = Base year + [(unrecovered disocunted cash
flow of base year / disocunted cash flows of next year) *12] where base year =
year in which unrecovered cash flows turns 0 or +ve Payback period @ 10% discoun
t rate= 1 + [(3182/3017)*12] =1.13 years Payback period @ 30% discount rate= 1 +
[(4231/207)*12] =1.25 years
2) Accounting rate of return: rate of return on initial investment made: given a
s: Average profit after depriciation & Tax / Initial investment Since no informa
tion on profits, depreciation & taxes, it is treated cash inflows considered as
profits after depreciation & taxes therefor e= (15,000 (inflow) / 10,000 (invest
ment)) * 100
accounting rate of return = 150%; effectively 50% return

4) NPV (net present value): a) Discounted @10% Cash flows Discoun t rate * @ 10%
(4) = (2) * (3) Discounte d cashflows b) Discounted @30% Cash flows Discoun t r
ate * @ 30% (4) = (2) * (3) Discounted cashflows
Years
Years
(1)
(2)
(3)
(1)
(2)
(3)
0 1 2
(10,000) 7,500 7,500
1.000 0.909 0.826
(10,000) 6,818 6,198
0 1 2
(10,0 00) 7,500 7,500
1.000 0.769 0.592
(10,000) 5,769 4,438
NPV
3,017
NPV
207
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year
3) IRR (Internal rate of return): which is the rate of return at which NPV = 0 F
or project B , IRR is calculated as below: IRR = L1 + [NPVL1 / (NPVL1 - NPVL2)]
* (L2 - L1) where L1 = guess rate (depend on NPV, disocunted at given required r
ate of return) L2 = one more guess rate Relationship between discount rate and N
PV: inverse relationship: Discount rate goes up Discount rate comes down
NPV falls NPV goes up
Let us assume L1 = 30% (why, because as could be seen at 30% @ discount rate NPV
is +ve by applying the relationship, increased disocunt rate) Let us calculate
L2 = 32% Discounted @32% (assumed rate) Years Cash flows Discoun t rate * Discou
nte d

cashflows @ 32% (4) = (2) * (3)

(1)
(2)
(3)
0 1 2
(10,000) 7,500 7,500
1.000 0.758 0.574
(10,000) 5,682 4,304
NPV
(14)
therefore, IRR for Project B = 30% + [207 /( 207+14)]*32% - 30% 30% + 1.873
IRR
31.87%
PROJECT C: The following has been calculated assuming discount rates of 10% & 30
% separately: 1) Payback period: time period to recover initial investment a) Di
scounted @10% Unrecover ed discounte d cash flows b) Discounted @30% Disco unted
cashf lows Unrecove red discounte d cash flows
Years
Cash flows
Discoun t rate * @ 10%
Discounte d cashflows
Years
Cash flows
Discount rate * @ 30%
(1)
(2)
(3)
(4) = (2) * (3)
(5)
(1)
(2)
(3)

(4) = (2) * (3)

(5)
0 1 2 3
(10,000) 2,000 4,000 12,000
1.000 0.909 0.826 0.751
(10,000) 1,818 3,306 9,016
(10,000) (8,182) (4,876) 4,140
0 1 2 3
(10,000) 2,000 4,000 12,000
1.000 0.769 0.592 0.455
(10,0 00) 1,538 2,367 5,462
(10,000) (8,462) (6,095) (633)
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year Payback period = Base year + [(unrecovered disocunted cash
flow of base year / disocunted

cash flows of next year) *12] where base year = year in which unrecovered cash f
lows turns 0 or +ve Payback period @ 10% discount rate= 2 + [(4876/4140)*12] =2.
14 years Payback period @ 30% discount rate= exceeds 3 years =3+ years
2) Accounting rate of return: rate of return on initial investment made: given a
s: Average profit after depriciation & Tax / Initial investment Since no informa
tion on profits, depreciation & taxes, it is treated cash inflows considered as
profits after depreciation & taxes therefor e= (18,000 (inflow) / 10,000 (invest
ment)) * 100
accounting rate of return = 180%; effectively 80% return
4) NPV (net present value):
a) Discounted @10%
b) Discounted @30% Disco unt rate * @ 30% (4) = (2) * (3) (4) = (2) * (3) Discou
n ted cashflo ws
Years
Cash flows
Discoun t rate * @ 10%
Discounted cash flows
Years
Cash flows
(1)
(2)
(3)
(1)
(2)
(3)
0 1 2 3 NPV
(10,000) 2,000 4,000 12,000
1.000 0.909 0.826 0.751
(10,000) 1,818 3,306 9,016 4,140
0 1 2 3 NPV
(10,000) 2,000 4,000 12,000
1.000 0.769 0.592 0.455
(10,000) 1,538 2,367 5,462 (633)
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis

ocunt rate & n = year

3) IRR (Internal rate of return): which is the rate of return at which NPV = 0 F
or project C , IRR is calculated as below: IRR = L1 + [NPVL1 / (NPVL1 - NPVL2)]
* (L2 - L1) where L1 = guess rate (depend on NPV, disocunted at given required r
ate of return) L2 = one more guess rate Relationship between discount rate and N
PV: inverse relationship: Discount rate goes up Discount rate comes down
NPV falls NPV goes up
Let us assume L1 = 30% (why, because as could be seen at 30% @ discount rate NPV
is -ve by applying the relationship, reduced disocunt rate) Let us calculate L2
= 26% Discounted @26% (assumed rate) Cash flows Discoun t rate * @ 26% (4) = (2
) * (3) Discounte d cashflows
Years
(1)
(2)
(3)
0 1 2 3 NPV
(10,000) 2,000 4,000 12,000
1.000 0.794 0.630 0.500
(10,000) 1,587 2,520 5,999 106
therefore, IRR for Project B = 30% + [-633 /( -633106)]*26% - 30% 30% 3.43
IRR
26.57
PROJECT D: The following has been calculated assuming discount rates of 10% & 30
% separately:

1) Payback period: time period to recover initial investment a) Discounted @10%

Unrecover ed discounte d cash flows b) Discounted @30% Discou nted cashflo ws Un
recove red discounte d cash flows
Years
Cash flows
Discoun t rate * @ 10%
Discounte d cashflows
Years
Cash flows
Discoun t rate * @ 30%
(1)
(2)
(3)
(4) = (2) * (3)
(5)
(1)
(2)
(3)
(4) = (2) * (3)
(5)
0 1 2 3
(10,000) 10,000 3,000 3,000
1.000 0.909 0.826 0.751
(10,000) 9,091 2,479 2,254
(10,000) (909) 1,570 3,824
0 1 2 3
(10,000) 10,000 3,000 3,000
1.000 0.769 0.592 0.455
(10,000) (10,000) 7,692 1,775 1,365 (2,308) (533) 833
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year Payback period = Base year + [(unrecovered disocunted cash
flow of base year / disocunted cash flows of next year) *12] where base year =
year in which unrecovered cash flows turns 0 or +ve Payback period @ 10% discoun

t rate= 1 + [(909/1570)*12] =1.7 years Payback period @ 30% discount rate= 2 + [

(533/833)*12] = 2.8 years
2) Accounting rate of return: rate of return on initial investment made: given a
s: Average profit after depriciation & Tax / Initial investment Since no informa
tion on profits, depreciation & taxes, it is treated cash inflows considered as
profits after depreciation & taxes therefor e= (16,000 (inflow) / 10,000 (invest
ment)) * 100

accounting rate of return = 160%; effectively 60% return

4) NPV (net present value): a) Discounted @10% Cash flows Discoun t rate * @ 10%
(4) = (2) * (3) Discounte d cash flows b) Discounted @30% Cash flows Disco unt
rate * @ 30% Discounted cashflows
Years
Years
(1)
(2)
(3)
(1)
(2)
(3)
(4) = (2) * (3)
0 1 2 3 NPV
(10,000) 10,000 3,000 3,000
1.000 0.909 0.826 0.751
(10,000) 9,091 2,479 2,254 3,824
0 1 2 3 NPV
(10,000) 10,000 3,000 3,000
1.000 0.769 0.592 0.455
(10,000) 7,692 1,775 1,365 833
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year
3) IRR (Internal rate of return): which is the rate of return at which NPV = 0 F
or project C , IRR is calculated as below: IRR = L1 + [NPVL1 / (NPVL1 - NPVL2)]
* (L2 - L1) where L1 = guess rate (depend on NPV, disocunted at given required r
ate of return) L2 = one more guess rate Relationship between discount rate and N
PV: inverse relationship: Discount rate goes up Discount rate comes down
NPV falls NPV goes up
Let us assume L1 = 30% (why, because as could be seen at 30% @ discount rate NPV
is+ve by applying the relationship, increased disocunt rate) Let us calculate L
2 = 38%

Discounted @38% (assumed rate) Cash flows Discoun t rate * @ 38% (4) = (2) * (3)
Discounte d cashflows
Years
(1)
(2)
(3)
0 1 2 3 NPV
(10,000 ) 10,000 3,000 3,000
1.000 0.725 0.525 0.381
(10,000) 7,246 1,575 1,142 (37)
therefore, IRR for Project B = 30% + [833 /( 833+37)]*38% - 30% 30% + 7.66
IRR
37.66%
1) NPV (net present value): for increments cash flows a) Discounted @10% Increme
ntal Cash flows (project C project D) b) Discounted @30%
Years
Discou nt rate *
Discounted cashflows
Years
Cash flows
Discou nt rate *
Discounte d cashflows
@ 10% (4) = (2) * (3)
@ 30% (4) = (2) * (3)
(1)
(2)
(3)
(1)
(2)
(3)
0 1 2 3 NPV

0 (8,000) 1,000 9,000

1.000 0.909 0.826 0.751
(7,273) 826 6,762 316
0 1 2 3 NPV
0 (8,000) 1,000 9,000
1.000 0.769 0.592 0.455
(6,154) 592 4,096 (1,466)
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year

3) IRR (Internal rate of return): which is the rate of return at which NPV = 0 F
or project C , IRR is calculated as below: IRR = L1 + [NPVL1 / (NPVL1 - NPVL2)]
* (L2 - L1) where L1 = guess rate (depend on NPV, disocunted at given required r
ate of return) L2 = one more guess rate Relationship between discount rate and N
PV: inverse relationship: Discount rate goes up Discount rate comes down
NPV falls NPV goes up
Let us assume L1 =
is+ve by applying
2 = 13% Discounted
2) * (3) Discounte

10% (why, because as could be seen at 30% @ discount rate NPV

the relationship, increased disocunt rate) Let us calculate L
@13% (assumed rate) Cash flows Discoun t rate * @ 13% (4) = (
d cashflows

Years
(1)
(2)
(3)
0 1 2 3 NPV
0 (8,000) 1,000 9,000
1.000 0.885 0.783 0.693
(7,080) 783 6,237 (59)
therefore, IRR for Project B = 10% + [316 /( 316+59)]*13% - 10% 10% + 2.5
IRR
12.50%
Target return = 10% IRR for incremental cash flows = 12.5%

since IRR for incremental cash flows > Target return, select / accept Project C
Question 3a: "Firm should follow a policy of very high dividend pay-out Taking ex
ample of two organization comment on this statement" Answer 3a:
The statement not necessarily be true. Let us take 2 companies; High dividend pa
y out company 100% payout a) Less retained earnings b) Slower / lower growth rat
e c) Lower market price d) Cost of equity (Ke) > IRR (r = rate of return earned
by company on its investment. e) Indicates that company is declining. Low divide
nd payout company 20% payout a) More retained earnings b) Accelerated/higher gro
wth rate c) Higher market price d) Cost of equity (Ke) < IRR (r = rate of return
earned by company on its investment. e) Indicates that company is growing.
It must be noted that, dividend is a trade off between retaining money for capit
al expenditure and issuing new shares.
Question 3b: An investor gains nothing from bonus share "Critically analyse the
statement through some real life situation of recent past. Answer 3b:
The statement is false. An investor gains bonus shares at zero cost, However, th
e market price of the stock will come down & over the long period, the investor
definitely maximizes his wealth due to bonus shares. From company angle, bonus i
ssue is only an accounting entry & it doesnt change the wealth/value of the firm.
Recently, Bharti Airtel have issued bonus share 2:1, due to which, the investor
s have gained Bonus shares at zero cost & the market have come down to the exten
t of bonus issue & immediately went up & investors have cashed the bonus shares
thus maximized their wealth. However, currently it is trading down due to varied
reasons.

CASE STUDY
Ques 1: You are required to make these calculations and in the light thereof, ad
vise the finance manager about the suitability, or otherwise, of machine A or ma
chine B. Solution:
Advise to finance manager of Brown metals ltd, to select the appropriate machine
: Particulars 1) NPV 2) Profitability index 3) Pay Back period 4) Discounted pay
back period Machine A (Rs. In lacs) 12 1.48 2 years 3.18 years Machine B (Rs. I
n lacs) 14 1.35 3 years 3.21 years
It is advised to go in for Machine B with enhanced capacity, which will add more
value to the firm. NPV is higher in respect of Machine B as compared to Machine
A & therefore machine with higher NPV needs to be invested. Workings are as fol
lows: (a) to buy machine A which is similar to the existing machine: Cash flows
(Rs. In lacs) Unrecovered discounted cash flows
Years
Unrecovered cash flows
Discount rate * @10%
Discounted cashflows
(1)
(2)
(3)
(4) = (2) * (3)
(5)
0 1 2 3 4 5 NPV
(25) 5 20 14 14
(25) (25) (20) 14 28
1.000 0.909 0.826 0.751 0.683 0.621
(25) 4 15 10 9 12
(25) (25) (21) (6) 4 12
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year 1) Net Present value = Present value of inflows - Present
value of outflows = 12 (as computed above) 2) Profitability Index = Present valu
e of inflows / present value of outflows which should be >1 1.48 37 / 25 3) Payb
ack period = Base year + [(unrecovered cash flow of base year / cash flows of ne
xt year) *12] where base year = year in which unrecovered cash flows turns 0 or
+ve Payback period = 2 + [(20/0)*12] = 2 years

4) Discounted Payback period = Base year + [(unrecovered disocunted cash flow of

base year / disocunted cash flows of next year) *12] where base year = year in
which unrecovered cash flows turns 0 or +ve Payback period = 3 + [(6/4)*12] =3.1
8 years
(b) to go in for machine B which is more expensive & has much greater capacity:
Cash flows (Rs. In lacs) Unrecovered discounted cash flows
Years
Unrecovered cash flows
Discount rate * @10%
Discounted cashflows
(1)
(2)
(3)
(4) = (2) * (3)
(5)
0 1 2 3 4 5 NPV
(40) 10 14 16 17 15
(40) (30) (16) 17 32
1.000 0.909 0.826 0.751 0.683 0.621
(40) 9 12 12 12 9 14
(40) (31) (19) (7) 4 14
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = dis
ocunt rate & n = year 1) Net Present value = Present value of inflows - Present
value of outflows = 14 (as computed above) 2) Profitability Index = Present valu
e of inflows / present value of outflows which should be >1 1.35 54 / 40 3) Payb
ack period = Base year + [(unrecovered cash flow of base year / cash flows of ne
xt year) *12] where base year = year in which unrecovered cash flows turns 0 or
+ve Payback period = 3 + [(16/0)*12] = 3 years
4) Discounted Payback period = Base year + [(unrecovered disocunted cash flow of
base year / disocunted cash flows of next year) *12] where base year = year in
which unrecovered cash flows turns 0 or +ve Payback period = 3 + [(7/4)*12] =3.2
1 years

Assignment - C
1. The main function of a finance manager is (a) capital budgeting (b) capital s
tructuring (c) management of working capital (d) (a),(b)and(c) Answer (d) 2. Ear
ning per share (a) refers to earning of equity and preference shareholders. (b)
refers to market value per share of the company. (c) reflects the value of the f
irm. (d) refers to earnings of equity shareholders after all other obligations o
f the company have been met. Answer (d) 3. If the cut off rate of a project is g
reater than IRR, we may (a) accept the proposal. (b) reject the proposal. (c) be
neutral about it. (d) wait for the IRR to increase and match the cut off rate.
Answer (b) 4. Cost of equity share capital is (a) equal to last dividend paid to
equity shareholders. (b) equal to rate of discount at which expected dividends
are discounted to determine their PV. (c) less than the cost of debt capital. (d
) equal to dividend expectations of equity shareholders for coming year. Answer
(b) 5. Degree of the total leverage (DTL) can be calculated by the following for
mula [Given degree of operating leverage (DOL) and degree of financial leverage
(DFL)] (a) DOL + DFL (b) DOL /DFL (c) DFL-DOL (d) DOL x DFL Answer (d) 6. RiskReturn trade off implies (a) increasing the profits of the firm through increase
d production (b) not taking any loans which increase the risk of the firm (c) ta
king decisions in a way which optimizes the balance between risk and return (d)
not granting credit to risky customers Answer (c) 7. The goal of a firm should b
e (a) maximization of profit (b) maximization of earning per share (c) maximizat
ion of value of the firm (d) maximization of return on equity Answer (c)
8. Current Assets minus current liabilities is equal to (a) Gross working capita
l (b) Capital employed (c) Net worth (d) Net working capital. Answer (d) 9. (a)
(b) (c) The indifference level of EBIT is one at which EPS increases EPS remains
the same EPS decreases

(d) EBIT=EPS. Answer (d) 10. Money has time value since (a) The value of money g
ets compounded as time goes by (b) The value of money gets discounted as time go
es by (c) Money in hand today is more certain than money in future (d) (b) and (
c) Answer (b) 11. Net working capital is (a) excess of gross current assets over
current liabilities (b) same as net worth (c) same as capital employed (d) same
as total assets employed Answer (a) 12. The internal rate of return of a projec
t is the discount rate at which NPV is (a) positive (b) negative (c) zero (d) ne
gative minus positive Answer (c) 13. Compounding technique is (a) same as discou
nting technique (b) slightly different from discounting technique (c) exactly op
posite of discounting technique (d) one where interest is compounded more than o
nce in a year. Answer (c) 14. For determining the value of a share on the basis
of P/E ratio, information is required regarding: (a) earning per share (b) norma
l rate of return (c) capital employed in the business (d) contingent liabilities
Answer (a) 15. Tandon committee suggested inventory and receivable norms for (a
) 15 major industries (b) 20 minor industries (c) 25 major and minor industries
(d) 30 major and minor industries Answer (c) 16. Capital structure of ABC Ltd. c
onsists of equity share capital of Rs. 1,00,000 (10,000 share of Rs. 10 each) an
d 8% debentures of Rs. 50,000 & earning before interest and tax is Rs. 20,000. T
he degree of financial leverage is
(a) 1.00 (b) 1.25 (c) 2.50
(d) 2.00 Answer (b) 17. The following data is given for a company. Unit SP = Rs.
2, Variable cost/unit = Re. 0.70, Total fixed cost- Rs. 1,00,000 Interest Charg
es Rs. 3,668, Output-1,00,000 units. The degree of operating leverage is
(a) 4.00
(b) 4.33 (c) 4.75 (d) 5.33 Answer (b) 18. Market price of equity share of a comp
any is Rs. 25 and the dividend expected a year hence is Rs. 10.

The expected rate of dividend growth is 5%. The cost of equal capital to company
will be (a) 40% (b) 45% (c) 35% (d) 50% Answer (b) 19. The dilemma of "liquidit
y Vs profitability" arise in case of (a) Potentially sick unit (b) Any business
organization (c) Only public sector unites (d) Purely trading companies Answer (
b) 20. The present value of Rs. 15000 receivable in 7 years at a discount rate o
f 15% is
(a) 5640
(b) 5500 (c) 5900 (d) 5940 Answer (a) 21. A bond of Rs. 1000 bearing coupon rate
of 12% is redeemable at par in 10 yrs. If the required rate of return is 10% th
e value of bond is (a) 1000 (b) 1123
(c) 1140
(d) 1150 Answer (a) 22. The EPS of ABC Ltd. is Rs. 10 & cost of capital is 10%.T
he market price of share at return rate of 15% and dividend pay out ratio of 40%
is (a) 100 (b) 120 (c) 130 (d) 150 Answer (a) 23. The credit term offered by a
supplier is 3/10 net 60.The annualized interest cost of not availing the cash di
scount is (a) 22.58% (b) 27.45% (c) 37.75% (d) 38.50% Answer (a) 24. The costlie
st of long term sources of finance is (a) Preference share capital (b) Retained
earnings (c) Equity share capital (d) Debentures Answer (c) 25. Which of the fol
lowing approaches advocates that the cost of equity capital & debit capital rema
ins the degree of leverages varies (a) Net income approach (b) Net operating inc
ome approach (c) Traditional approach (d) Modigliani-Miller approach Answer (b)
& (d) 26. (a) (b) (c) Which of the following is not a feature of an optimal capi
tal structure. Profitability Safety Flexibility

(d) Control Answer (b) 27. While calculating weighted average cost of capital (a
) Retained earnings are excluded (b) Bank borrowings for working capital are inc
luded (c) Cost of issues are included (d) Weights are based on market value or o
n book value Answer (a) 28. Which of the following factors influence the capital
structure of a business entity? (a) Bargaining power with suppliers (b) Demand
for product of company (c) Expected income (d) Technology adopted Answer (c) 29.
According to the Walters model, a firm should have 100% dividend pay-out ratio
when. (a) r = ke (b) r < ke (c) r > ke (d) g > ke Answer (a) 30. Operating cycle
can be delayed by (a) Increase in WIP period (b) Decrease in raw material stora
ge period (c) Decrease in credit payment period (d) Both a & c above Answer (d)
31. If net working capital is negative, it signifies that (a) The liquidity posi
tion is not comfortable (b) The current ratio is less then 1 (c) Long term uses
are met out of short- term sources (d) All of a, b and c above Answer (d) 32. Wh
ich of the following models on dividend policy stresses on investors preference
for the current dividend (a) Traditional model (b) Walters model (c) Gordon mode
l (d) MM model Answer (d) 33. Which of the following is a technique for monitori
ng the status of receivables (a) ageing schedule (b) outstanding creditors (c) s
election matrix (d) credit evaluation Answer (a) 34. Average collection period i
s equal to (a) 360/ Receivables Turnover Ratio (b) Average Creditors / Sales per
day (c) Sales / Debtors (d) Purchases / Debtors Answer (a) 35. (a) (b) (c) (d)
In IRR, the cash flows are assumed to be reinvested in the project at Internal r
ate of return cost of capital Marginal cost of capital risk free rate

Answer (d) 36. In a capital budgeting decision, incremental cash flow mean (a) c
ash 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 inflow
s and outflows for each and every expenditure. Answer (d) 37. The simple EOQ mod
el will not hold good under which of the following conditions (a) Stochastic dem
and (b) constant unit price (c) Zero lead time (d) Fixed ordering costs Answer (
a) 38. The opportunity cost of capital refers to the (a) net present value of th
e investment. (b) return that is foregone by investing in a project. (c) require
d investment in a project. (d) future value of the investments cash flows. Answe
r (b) 39. Which of the following factors does not influence the composition of W
orking Capital requirements (a) Nature of the business (b) seasonality of operat
ions (c) availability of raw materials (d) amount of fixed assets Answer (d) 40.
The capital structure ratio measure the (a) Financial Risk (b) Business Risk (c
) Market Risk (d) operating risks Answer (a)