Question Paper
Financial Management – II (142) : October 2003

Section A : Basic Concepts (40 Points)

1.

Which of the following statements is false?

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.

< Answer >

2.

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.

< Answer >

3.

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.

< Answer >

4.

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

e.      All of the above.

< Answer >

5.

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.

< Answer >

6.

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.

< Answer >

7.

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.

< Answer >

8.

An increase in the ordering costs will

a.      Decrease the economic order quantity

b.      Increase the economic order quantity

c.      Not affect the economic order quantity

d.      Increase the reorder point

e.      Increase the carrying cost.

< Answer >

9.

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.

< Answer >

10.

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

e.      All of the above.

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11.

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.

< Answer >

12.

Which of the following concepts of dividend policies considers the changes in dividend payment vis-à-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.

< Answer >

13.

Which of the following is a spontaneous source of financing current assets?

a.      Cash credit

b.      Provision for taxes

c.      Owner’s equity

d.      Letter of credit

e.      Overdraft.

< Answer >

14.

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

e.      All of the above.

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15.

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.

< Answer >

16.

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

e.      None of the above.

< Answer >

17.

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.

< Answer >

18.

Which of the following statements is true with respect to ‘day’s 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 the average collection period for a company for various time periods

e.      It represents the percentage of receivables outstanding on a daily basis.

< Answer >

19.

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.

< Answer >

20.

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.

< Answer >

21.

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

e.      Cannot be determined.

< Answer >

22.

Which of the following factors does not affect the working capital management of a company?

a.      Nature of business

b.      Seasonality of operations

c.      Amount invested in the fixed assets

d.      Process used

e.      Degree of competition in the market.

< Answer >

23.

A company may raise capital from the primary market through

a.      Public issue

b.      Rights issue

c.      Bought out deals

d.      Private placements

e.      All of the above.

< Answer >

24.

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.

< Answer >

25.

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.

< Answer >

26.

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.

< Answer >

27.

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.

< Answer >

28.

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.

< Answer >

29.

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.

< Answer >

30.

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 = mD/3 + E.

< Answer >

31.

The pattern of collections associated with the credit sales is represented by

a.      Day’s sales outstanding

b.      Ratio analysis

c.      Average collection period analysis

d.      Collection matrix

e.      Ageing schedule.

< Answer >

32.

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.

< Answer >

33.

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.

< Answer >

34.

Which of the following is not a feature of the optimal capital structure?

a.      Profitability of the company

b.      Flexibility of changing the structure

c.      Liquidity

d.      Control by the owners

e.      Solvency of the firm.

< Answer >

35.

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

e.      None of the above.

< Answer >

36.

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).

< Answer >

37.

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.

< Answer >

38.

Which of the following statements is an assumption of the Walter’s 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.

< Answer >

39.

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.

< Answer >

40.

Which of the following models on dividend policy stresses on the investor’s preference for the current dividends?

a.      Traditional Model

b.      Walter Model

c.      Gordon Model

d.      Miller and Modigliani Model

e.      Rational expectation model.

< Answer >

Section B : Problems (60 Points)

41.

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.

 (1 point)

< Answer >

 42.

The following figures are projected by the production manager of Kajaria Iron:

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.

(1 point)

< Answer >

43.

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.

 (1 point)

< Answer >

44.

The following data pertain to M/s Alka Engineers:

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.

(1 point)

< Answer >

45.

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.

(1 point)

< Answer >

46.

 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.

(1 point)

< Answer >

47.

 The following information is related to the operations of a firm:

The operating cycle of the firm is:

a.      180 days

b.      135 days

c.      90 days

d.      88 days

e.      45 days.

(1 point)

< Answer >

48.

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.

(1 point)

< Answer >

49.

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.

(1 point)

< Answer >

50.

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.

(1 point)

< Answer >

51.

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.

(1 point)

< Answer >

52.

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.

(1 point)

< Answer >

53.

The net cash flows from a project (with initial investment of Rs.16,20,000) are as follows:

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.

(1 point)

< Answer >

54.

For Jackpot Ltd., the average usage per day is 30 units for the raw material ‘Jack’ 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.

(1 point)

< Answer >

55.

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.

(2 points)

< Answer >

56.

The dividend history of Gujarat Heavy Chemicals Ltd. is as follows:

If the market price per share for GHCL is Rs.67 on March 1999, what is the amount of realized yield?

a.      10.70 percent

b.      11.50 percent

c.      11.95 percent

d.      13.35 percent

e.      Cannot be determined.

(2 points)

< Answer >

57.

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.

 (1 point)

< Answer >

58.

The following information is collected from the annual report of MM Ltd.:

What is market price per share according to Walter’s model on dividend policy?

a.      Rs.40

b.      Rs.60

c.      Rs.80

d.      Rs.100

e.      Rs.120.

(1 point)

< Answer >

59.

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).

(3 points)

< Answer >

60.

The cash flows associated with a project are as follows:

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.

(2 points)

< Answer >

61.

The following figures are projected by the production manager of Kajaria Iron:

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.

(2 points)

< Answer >

62.

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.

(3 points)

< Answer >

63.

The following figures are projected by the production manager of Kajaria Iron for one raw material:

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.

 (2 points)

< Answer >

64.

The following figures are collected from annual report of Hyderabad Textiles:

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.

(2 points)

< Answer >

65.

The following information is collected from the annual reports of JayKay Ltd.:

What should be the market price per share according to Gordon’s model on dividend policy?

a.      Rs.25

b.      Rs.30

c.      Rs.35

d.      Rs.40

e.      Rs.45.

(2 points)

< Answer >

66.

The following figures are collected from annual report of Hyderabad Ceramics Ltd.:

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.

(3 points)

< Answer >

67.

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.

(3 points)

< Answer >

68.

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.

(3 points)

< Answer >

69.

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:

The selling prce 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.

(3 points)

< Answer >

70.

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:

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.

(3 points)

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71.

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.

 (3 points)

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72.

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.

 (2 points)

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73.

Hardillia Enterprises Ltd. operates in the electrical spares industry. The income statement of the company is given below:

                                                                                                                (Rs. in lakh)

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.

 (3 points)

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74.

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.

(1 point)

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1.

Answer :   (d)

Reason :    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.

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2.

Answer :   (b)

Reason :    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.

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3.

Answer :   (a)

Reason :    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.

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4.

Answer :   (e)

Reason :    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.

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5.

Answer :   (c)

Reason :    A ‘float’, in the context of cash management, arises when a bank does not credit its customer’s account in its book despite a cheque was being deposited or does not debit its customer’s account against the issue of a cheque. This fact is mentioned in the option (c).

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6.

Answer :   (c)

Reason :    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.

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7.

Answer :   (d)

Reason :    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.

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8.

Answer :   (b)

Reason :    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.

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9.

Answer :   (c)

Reason :    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.

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10.

Answer :   (d)

Reason :    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.

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11.

Answer :   (d)

Reason :    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.

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12.

Answer :   (e)

Reason :    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.

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13.

Answer :   (b)

Reason :    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.

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14.

Answer :   (c)

Reason :    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.

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15.

Answer :   (a)

Reason :    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.

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16.

Answer :   (c)

Reason :    The credit policy variables are: cash discounts, credit standards, collection efforts and credit period. Therefore, the option (c) is the correct one.

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17.

Answer :   (a)

Reason :    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.

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18.

Answer :   (d)

Reason :    Day’s 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.

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19.

Answer :   (d)

Reason :    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.

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20.

Answer :   (a)

Reason :   Net working capital is defined as the current assets minus current liabilities.

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21.

Answer :   (a)

Reason :    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.

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22.

Answer :   (c)

Reason :    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. The amount invested in the fixed assets does not play in the formulation of the working capital management policy of any company.

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23.

Answer :   (e)

Reason :    A company may adopt any of the techniques given in the question to raise money from the primary markets.

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24.

Answer :   (d)

Reason :    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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25.

Answer :   (c)

Reason :    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.

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26.

Answer :   (e)

Reason :    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.

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27.

Answer :   (d)

Reason :    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.

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28.

Answer :   (b)

Reason :    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.

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29.

Answer :   (e)

Reason :    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.

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30.

Answer :   (d)

Reason :    According to the Traditional Approach, market price and dividend are related as P = m(D + E/3).

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31.

Answer :   (d)

Reason :    In collection matrix, the payment behavior of the customers is studied through the pattern of collections associated with the credit sales. In day’s 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.

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32.

Answer :   (a)

Reason :    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

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33.

Answer :   (c)

Reason :    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.

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34.

Answer :   (c)

Reason :    The liquidity of the business entity is not a feature of the optimal capital structure, which is featured by the investments of the company. But the other facts as mentioned in the other options are the features of the optimal capital structure. Hence, the option (c) is correct.

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35.

Answer :   (e)

Reason :    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.

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36.

Answer :   (c)

Reason :    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)

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37.

Answer :   (d)

Reason :    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.

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38.

Answer :   (d)

Reason :    The assumptions of the Walter’s 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

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39.

Answer :   (b)

Reason :    Except the composition of current assets, all the factors as mentioned in the question may affect the capital structure of a company.

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40.

Answer :   (c)

Reason :    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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41.

Answer :   (d)

Reason :    The value of a share after the rights issue is given by  P =  Here, N = 4, P₀ = Rs.140 and S         = Rs.100.

                   The ex-rights price of the share will be P =   =  = Rs. 132

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42.

Answer :   (b)

Reason :    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

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43.

Answer :   (c)

Reason :   The cost of the term loan for the company is  K_t = 12 ´  (1 – 0.35) = 12 ´  0.65 = 7.80 percent

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44.

Answer :   (b)

Reason :   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.

                   =

                   =

                   = 12.70 percent.

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45.

Answer :   (a)

Reason :    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.59.09 lakh or Rs.59 lakh

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46.

Answer :   (b)

Reason :    The cost of trade credit is defined as

                            =         

                            =       12.12 percent

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47.

Answer :   (c)

Reason :    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

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48.

Answer :   (e)

Reason :    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

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49.

Answer :   (b)

Reason :    The cost of equity for Tractor India is:

                   K_e = 

                   = 0.1340 = 13.40%

                   Hence, the cost of external equity will be = = 0.1367 = 13.67 percent

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50.

Answer :   (a)

Reason :    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:

                   Hence the amount of initial investment will be =  = 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

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51.

Answer :   (c)

Reason :    The economic order quantity is defined as:

Here, U = 2500 units, F = Rs.2000, P = Rs.8000 and C = 20 percent of the inventory value.

So,  units

Hence, the required economic order quantity is 79 units

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52.

Answer :   (c)

Reason :    The average collection period is defined as:

                   =

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

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53.

Answer :   (c)

Reason :    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

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54.

Answer :   (b)

Reason :    The reorder point is defined as: RP = S ´ L + F ´ 

Here, S = 30 units, L = 15 days,  F = 1.25 and R = 400 units

So, R = 30 ´ 15 + 1.25 ´   = 980

Hence, the required reorder point is =980 units

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55.

Answer :   (b)

Reason :    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.127,487.76    or, Rs.127,488 (approx.)

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56.

Answer :   (b)

Reason :    The share price for the company is given as:

                   From the above table, the wealth ratio is obtained as:

                   =

                   =       

                   =       1.1015 ´ 1.1444 ´1.09 ´ 1.125

                   =       1.5458

                   So the realized yield =

                   = 11.50% (approximately)

The required amount of realized yield = 11.50 percent

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57.

Answer :   (b)

Reason :    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.

Now, the approximate cost of debenture capital is given as:

K_d =

So, the approximate cost of debenture capital

K_d =

Or K_d =  6.70 percent

Hence, the required cost of the debenture capital is = 6.70 percent

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58.

Answer :   (d)

Reason :    Walter’s model on dividend capitalization states that:

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 Walter’s model is given as:

P =    = Rs.100

Hence, the required market value of the share as per Walter’s model will be = Rs.100

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59.

Answer :   (b)

Reason :    Increase in contribution = 300,000 ´ 20 percent ´ Rs.20 = Rs.1200,000

                   Additional investment in the receivables due to the increase in credit period =

                   =      

                   =      

=       Rs.1500,000

So, increase in the cost of funds invested in the receivables = Rs.1500,000 ´ 0.12 = Rs.180,000

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.1200,000 - 180,000 - 300,000 = Rs.720,000

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60.

Answer :   (d)

Reason :    Let r be the IRR of the project.

                   So, 50 =

                   At r = 15 percent, the right hand side of the above equation = 50.066.

                   So, approximately, the required IRR is 15 percent

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61.

Answer :   (c)

Reason :    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

                   Now, the probable situations may be presented in the following table as:

                   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

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62.

Answer :   (b)

Reason :    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 =

=

=

= (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

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63.

Answer :   (d)

Reason :    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 +  = 500 ´ 8 + 1.20   = 5073 units.

                   Hence, the required reorder point is = 5073 units.

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64.

Answer :   (b)

Reason :    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

                   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.2520,000

                   So, the average daily cost of production = Rs.7000

                   Hence, the average conversion period = 35,000/7000 = 5 days

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65.

Answer :   (b)

Reason :    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 Gordon’s capitalization model,

                   The share price p =

                   Here, E(1- b) = Rs.1.80, K_e = 12%, r = 15% and b = 0.40.

                   P =

                   Hence, the share price will be P = =   = Rs.30

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66.

Answer :   (d)

Reason :    The amount of raw materials consumed = Opening balance + Purchases during the year – Closing                        balance = (160,000 + 1192,000 – 192,000)  = Rs.1210,000

Annual cost of production = Opening work in process + Consumption of raw materials + Manufacturing expenses + Depreciation – Closing work in process = 25,000 + 1210,000 + 1230,000 + 100,000 – 45,000 = Rs.2520,000

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 + 2520,000 + 230,000 + 150,000 – 50,000 = Rs.2880,000

Average cost of goods sold per day = = Rs.8000

Average inventory of finished goods == Rs.40,000

So, the finished goods storage period == 5 days

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67.

Answer :   (a)

Reason :    The economic order quantity for MAL is   Q^* = = 1443 units

If the order quantity is 5000 units, net incremental benefit over EOQ will be =

= UD +

Here, U = 25,000 units,  Q^* = 1443 units, Q¹ = 5000 units, P = Rs.60, D = Rs.5 and C = 20 percent.

So, the net benefit = 25,000 ´ 5 + –

= 125,000 + 6162.51 – 18,842

= 112,320.51

= Rs.112,321 (approx)

Hence, the profit will increase by Rs.112,321

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68.

Answer :   (b)

Reason :    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:

                   The NPV for this proposal will be -300,000 + 88,000 ´ PVIFA (12 percent, 4 years) = -300,000 +       267,256 = - Rs.32,744.

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69.

Answer :   (e)

Reason :   (in Rs. Lakh)

Hence, the amount of working capital requirement is Rs.540 lakh + Rs.10 lakh = Rs.550 lakh

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70.

Answer :   (d)

Reason :    Calculation of the breaking points:

         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

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71.

Answer :   (e)

Reason :   Incremental contribution = Rs.60 lakh ´ 0.10 ´25 percent = Rs.1,50,000

Decrease in the cost of funds blocked in the receivables

=      

=      

=       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

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72.

Answer :   (a)

Reason :    Existing cost faced by SML of not paying within the discount period

                   =      

                   =       = 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’.

                            ³ 0.3117

                            or  ³ C – 10

                            or 10 +  ³ 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).

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73.

Answer :   (b)

Reason :    Market value of debt =  =  = Rs.120 lakh

Total market value of the firm     =     

                                                                            =      = 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    =        =         = 0.14 i.e., 14%

According to the net operating income approach : k_e = k₀ + (k₀ – 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 ³ 0.125 + (0.125 – 0.10)

         or      0.035 ³

         or      11.20 – 0.035B   ³      0.025B

         or      11.20                            ³       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.

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74.

Answer :   (c)

Reason :    The present value of the tax shield on debt is given as: t_c B = 0.40 ´ 70 = Rs.28 lakh

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