Question Paper Financial Management-II (142) : July 2006
	· Answer all questions. · Marks are indicated against each question.

1.

Which of the following financial instruments are issued as quasi-equity instruments to bolster net worth of the company without loss of management control?

(a) Participating Debentures (b) Participating Preference Shares

(c) Convertible Debentures with Options (d) Mortgage-backed Securities

(e) Debt-equity Swaps.

(1 mark)

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2.

Which of the following is not a feature of preference shares?

(a) Preference shareholders have preference over equity shareholders to the pre-tax earnings in the form of dividends

(b) Preference-dividend is not tax deductible

(c) Voting rights can be given to the preference shareholders in the case of cumulative preference shares if there are arrears in dividends for two or more years

(d) Redeemable preference shares can be redeemed after a given maturity period

(e) Preference shares with call option enable the issuer company to redeem the preference shares prior to maturity.

(1 mark)

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3.

Which of the following schemes offered by financial institutions is not a deferred credit scheme?

(a) Leasing (b) Bill Rediscounting Scheme

(c) Supplier’s Line of Credit (d) Seed Capital Assistance

(e) Risk Capital Foundation Schemes.

(1 mark)

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4.

Which of the following equity valuation approaches consider the past returns on a security as a proxy for the return required by the investors?

(a) Dividend Forecast Approach

(b) Realized Yield Approach

(c) Capital Asset Pricing Model Approach

(d) Bond Yield plus Risk Premium Approach

(e) Earning Price Ratio Approach.

(1 mark)

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5.

Which of the following statements is/are not true according to the Net Operating Income Approach?

I. Overall capitalization rate remains constant for all degrees of leverage.

II. Cost of equity remains constant for all degrees of leverage.

III. Cost of debt remains constant for all degrees of leverage.

IV. The degree of leverage cannot influence the market value of the firm.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (IV) above (d) Both (II) and (IV) above

(e) Both (III) and (IV) above.

(1 mark)

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6.

Which of the following statements is/are true regarding the bankruptcy costs?

I. These costs represent certain restrictions on the firm in the form of some prospective covenants incorporated in the loan contract.

II. These costs represent a loss, which can be easily diversified away.

III. The probability of bankruptcy increases at an increasing rate as the debt-equity ratio increases.

IV. Expected cost of bankruptcy increases as debt-equity ratio decreases.

(a) Only (I) above (b) Only (III) above

(c) Both (I) and (III) above (d) (II), (III) and (IV) above

(e) All (I), (II), (III) and (IV) above.

(1 mark)

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7.

Which of the following statements is not true regarding the Walter’s model for dividend policy?

(a) The stock value usually is affected by the payment of dividends

(b) When the return on investment is greater than the cost of equity capital, a zero percent payout ratio would maximize the value of the firm

(c) When the return on investment is less than the cost of equity capital, a 100% payout ratio would maximize the value of the firm

(d) When the return on investment is equal to the cost of equity capital, there is no effect of payout ratio on the value of the firm

(e) When the return on investment is equal to the cost of equity capital, the stock value of a firm is affected by only the payment of dividend.

(1 mark)

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8.

The internal rate of return of M/s Aditya Constructions Ltd. is 10%. Its equity capitalization rate is 12%. Which of the following statements is/are true for this firm according to the Gordon’s model for dividend policy?

I. The firm’s share value is positively correlated with the payout ratio.

II. The firm’s share value is negatively correlated with the payout ratio.

III. The firm should have a higher retention ratio.

IV. The firm should have a lower retention ratio.

(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) Both (I) and (IV) above

(e) Both (II) and (III) above.

(1 mark)

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9.

Which of the following models on dividend policy assumes that the investors would prefer current dividends?

(a) Traditional Model (b) Walter’s Model

(c) Gordon’s Model (d) Modigliani-Miller Model

(e) Net Operating Income Model.

(1 mark)

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10.

Which of the following statements is true regarding the Rational Expectations Model?

(a) There will be no effect of dividend policy on the valuation of the firm as the expectations of the investors are always rational

(b) Investors will value a dividend-paying firm higher than a non-dividend paying firm

(c) Investors will value a non-dividend paying firm higher than a dividend paying firm

(d) If the declared dividends meet the expectations of the investors, there will be no effect on the valuation of the firm

(e) If the declared dividend is in accordance with the expectations of the investors, the value of the firm will fall by the extent of dividend paid.

(1 mark)

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11.

Which of the following statements is true?

(a) An aggressive approach to working capital results in lesser turnover of current assets than in a conservative approach

(b) The risk of technical insolvency tends to be low under an aggressive policy

(c) An aggressive approach to working capital results in higher profitability

(d) A conservative approach to working capital results in lower liquidity

(e) Cost of financing tends to be high under an aggressive policy.

(1 mark)

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12.

Which of the following is a measure undertaken to avoid a situation of under trading in a company?

(a) Increasing the debt equity ratio (b) Hastening the collection process

(c) Increasing the levels of inventory (d) Increasing the asset base

(e) Buying back of equity shares.

(1 mark)

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13.

Which of the following statements is true?

(a) Shorter the duration of operating cycle period, slower is the transformation of current assets into cash

(b) The lower the turnover of inventory, the better the efficiency in managing working capital

(c) Higher the turnover of working capital, lower is the rate of return on net operating capital employed

(d) Working capital to sales ratio is the reciprocal of working capital turnover

(e) Operating cycle approach is useful only for forecasting and not for controlling working capital.

(1 mark)

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14.

Under which of the following financing methods does the bank assume only the risk of default by the customer?

(a) Cash credit (b) Overdraft (c) Note lending

(d) Purchase/discounting of bills (e) Letter of credit.

(1 mark)

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15.

Under which of the following types of factoring does the client get total credit protection?

(a) Recourse Factoring (b) Non-Recourse Factoring

(c) Maturity Factoring (d) Advance Factoring

(e) Invoice discounting.

(1 mark)

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16.

Which of the following committees recommended for the bifurcation of the credit limit into a loan component and a fluctuating cash credit component?

(a) Tandon Committee (b) Chore Committee

(c) Marathe Committee (d) Kannan Committee

(e) Nayak Committee.

(1 mark)

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17.

Which of the following statements is not true regarding the alternative methods suggested by the Tandon Committee for calculating the maximum permissible bank borrowing?

I. Under Method I, the bank will finance atmost 75 percent of the working capital gap.

II. Under Method II, the bank will finance atmost 25 percent of total current assets.

III. Method I will ensure a maximum current ratio of unity.

IV. Method II will ensure a minimum current ratio of 1.33.

V. As per Method III, the amount of excess bank borrowing over the maximum permissible limit will be converted into a term loan, which is to be repaid over suitable period.

(a) Only (II) above (b) (I), (III) and (IV) above

(c) Both (II) and (III) above (d) (III), (IV) and (V) above

(e) All (I), (II), (III), (IV) and (V) above.

(1 mark)

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18.

Other things remaining the same, which of the following would increase the Economic Order Quantity (EOQ)?

I. Decrease in the fixed cost per order.

II. Decrease in the carrying cost.

III. Increase in the purchase price.

IV. Increase in the annual usage of material.

(a) Both (I) and (II) above (b) Both (I) and (III) above

(c) Both (II) and (III) above (d) Both (II) and (IV) above

(e) Both (III) and (IV) above.

(1 mark)

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19.

The purpose of which of the following kinds of inventory is to uncouple the production and sales functions?

(a) Raw Materials Inventory (b) Stores and Spares

(c) Work-in-Process Inventory (d) Finished Goods Inventory

(e) Packing Materials.

(1 mark)

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20.

Which of the following is not a carrying cost associated with holding inventories?

(a) Insurance (b) Rent paid for ware house

(c) Salaries for store keeper (d) Purchase requisition (e) Taxes.

(1 mark)

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21.

Which of the following statements is not true?

(a) Lower the quantity of safety stock, lower will be the stock-out cost

(b) Higher the quantity of safety stock, higher will be the incidence of carrying cost

(c) The total of stock-out costs and carrying costs is minimum at the reorder level

(d) Reorder level is the product of average daily usage rate and the lead time in days

(e) The stock level subsystem keeps track of the goods held by the firm, issuance of goods, and the arrival of orders.

(1 mark)

< Answer >

22.

Which of the following methods for valuing inventory uses the value that is realizable at the time of the issue for pricing the raw materials?

(a) First-In-First-Out (b) Last-In-First-Out

(c) Weighted Average Cost Method (d) Standard Price Method

(e) Replacement Method.

(1 mark)

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23.

Which of the following statements is true if the credit terms are 2/15, net 30?

(a) A discount of 2% is offered if the payment is made only on 15^th day, otherwise the full payment has to be done only on 30^th day

(b) A discount of 2% is offered if payment is made within 30 days

(c) A discount of 2% is offered if the payment is made by 15^th day, otherwise the full payment can be done by 30^th day

(d) A discount of 2% is offered if payment is made between 15^th and 30^th day

(e) A discount of 2% is offered only for first 15 customers.

(1 mark)

< Answer >

24.

Which of the following measures is not adopted to monitor the payment of receivables?

(a) Days Sales Outstanding (b) Ageing Schedule of Receivables

(c) Numerical Credit Scoring (d) Collection Matrix

(e) Average Collection Period.

(1 mark)

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25.

Which of the following statements is not true?

(a) If credit standards are made more stringent, sales are likely to decrease and less amount of money will be locked up in receivables

(b) If credit standards are made liberal, sales are likely to increase but bad debt losses are likely to increase

(c) If credit period is lengthened, sales are likely to increase but bad debt losses are likely to decrease

(d) If credit period is shortened, sales are likely to decrease and reduce the incidence of bad debt loss

(e) If cash discount is increased, discount paid is likely to increase and amount of receivables is likely to reduce.

(1 mark)

< Answer >

26.

Which of the following statements is true regarding ‘Numerical Credit Scoring’?

(a) It is a method for computing the cash discount to be extended to the customer

(b) It is a method of computing the credit period

(c) It is an index used to study the creditworthiness of a customer

(d) It is an index used to study the efficiency of the credit standards of the firm

(e) It is a technique for evaluating the effort of a company in collecting the receivables.

(1 mark)

< Answer >

27.

Which of the following is not an objective of cash management?

(a) To arrange for repayment/investments during periods of cash surpluses

(b) To find avenues for financing during periods of cash deficits

(c) To make long-term forecasts of cash position

(d) To minimize idle cash

(e) To effectively monitor the cash position.

(1 mark)

< Answer >

28.

Which of the following statements is true?

(a) When the net float is negative, the balance in the books of the firm is lower than the balance in the books of the bank

(b) When the net float is positive, the payment float is more than the collection float

(c) When the net float is positive, the firm cannot play the float, as the balance in the bank’s book is less than that in the firm’s books

(d) When the net float is negative, the firm can play the float and issue cheques as it has an overdrawn bank account according to its own books

(e) The amount of cheques deposited by a company in the bank awaiting clearance is called payment float.

(1 mark)

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29.

Which of the following elements of internal audit judges the efficiency and effectiveness of the system when put into operation?

(a) Totality (b) Expertize (c) Independence (d) Objectivity (e) Utility.

(1 mark)

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30.

Which of the following appraisal methods is preferred for comparing mutually exclusive projects providing similar service but having differing patterns of costs and unequal life spans?

(a) Accounting rate of return (b) Payback period

(c) Benefit cost ratio (d) Net present value

(e) Annual capital charge.

(1 mark)

< Answer >

31.

Which of the following is not an issue considered as part of the economic appraisal of projects?

(a) Impact of the project on income distribution in the society

(b) Impact of the project on the level of savings and investment in the society

(c) Impact of the project on the wealth of the shareholders

(d) Impact of the project on employment generation

(e) Impact of the project in creating self-sufficiency in the society.

(1 mark)

< Answer >

32.

Which of the following statements is not true regarding the cash flows used in capital budgeting decisions?

(a) Cash flows must be measured in incremental terms

(b) Interest on long-term loans should not be included for determining the net cash flows

(c) Cash flows should consider sunk costs and opportunity costs

(d) Allocated overhead costs should be ignored

(e) Cash flows should be defined in post-tax terms.

(1 mark)

< Answer >

33.

Which of the following appraisal criteria does not consider time value of money?

(a) Accounting Rate of Return (b) Benefit Cost Ratio

(c) Net Present Value (d) Internal Rate of Return

(e) Annual Capital Charge.

(1 mark)

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34.

The current price of a share of Indhra Pharmaceuticals Ltd. is Rs.150. The company is planning to go for rights issue. The subscription price for one rights share is proposed to be Rs.125. If the company targets that the ex-rights value of a share shall not fall below Rs.145, it should issue 1 rights share for every ________ equity shares.

(a) 2 (b) 3 (c) 4 (d) 5 (e) 6.

(1 mark)

< Answer >

35.

The prices per share of Epicurus Food Products Ltd, as on March 31, 2005 and March 31, 2006 were Rs.75 and Rs.82 respectively. The company has declared a dividend of 20% during the year 2005-06. The face value of the company’s share is Rs.10. The wealth ratio for the year 2005-06 is

(a) 1.00 (b) 1.04 (c) 1.08 (d) 1.12 (e) 1.15.

(1 mark)

< Answer >

36.

The capital structure of Vijay Textiles Ltd, as per its book values is as follows:

	Rs.
Debentures (each at face value of Rs.100)	16,00,000
Preference shares (each at face value of Rs.100)	4,00,000
Equity shares (each at face value of Rs.10)	20,00,000

All the securities are traded in the capital markets and the current market prices of the securities are as follows:

Debentures, Rs.120 per debenture

Preference shares, Rs.125 per share

Equity shares, Rs.45 per share

The costs associated with various kinds of capital are as follows:

Debentures 7.18%

Preference shares 11.25%

Equity 13.00%

What is the weighted average cost of capital for the firm using market value weights?

(a) 11.14% (b) 11.54% (c) 11.94% (d) 12.14% (e) 12.08%.

(2 marks)

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37.

Consider the following information about the debentures issued by M/s. Lalit Industries Ltd.:

Face Value = Rs.100

Coupon rate = 11% p.a.

Amount realized per debenture = Rs.95

Corporate tax rate = 40%

Debenture is redeemable at a premium of 5% after 8 years. The difference between the redemption price and the net amount realized can be written off over the life of the debenture and the amount so written off is tax-deductible. The cost of debenture capital is

(a) 7.05% (b) 7.15% (c) 7.25% (d) 7.35% (e) 7.45%.

(2 marks)

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38.

M/S Renson’s Computers Ltd, has EBIT of Rs.8,00,000. The firm currently has outstanding debts of Rs.30,00,000 at an average cost of 10%. Its cost of equity capital is estimated to be 16%. The firm is considering to issue equity capital of Rs.10,00,000 in order to redeem Rs.10,00,000 debt. The cost of debt is expected to be unaffected. However the firm’s cost of equity capital is reduced to 14% as a result of decrease in leverage. As per the traditional approach to capital structure, what is the change in the value of the firm if this proposal is implemented?

(a) Decreases by Rs. 1,60,714 (b) Increases by Rs.1,60,714

(c) Decreases by Rs.1,62,754 (d) Increases by Rs.1,62,754

(e) There is no change in the value of the firm.

(2 marks)

< Answer >

39.

M/s Lokesh Motors Ltd., has an expected net operating income of Rs.10,00,000. The firm has Rs.40,00,000 debt capital on which it pays 14% interest. The corporate tax rate applicable to the firm is 50%. If the firm plans to maintain debt perpetually in its capital structure, what is the present value of tax shield associated with interest payments?

(a) Rs.18,00,000 (b) Rs.18,25,000 (c) Rs.19,45,000

(d) Rs.20,00,000 (e) Rs.20,54,000.

(1 mark)

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40.

Techno industries Ltd., has 80,000 shares outstanding. The current market price of each share is Rs.75. The company expects a net profit of Rs.12,00,000 during the year and it belongs to a risk class for which the approximate capitalization rate has been estimated to be 20%. The company is considering dividend of Rs.10 per share for the current year.

According to the Modigliani Miller model, how many new shares must the company issue if the dividend is paid and the company needs Rs.28,00,000 for an approved investment expenditure during the year?

(a) 12,000 shares (b) 18,000 shares (c) 20,000 shares

(d) 24,000 shares (e) 30,000 shares.

(2 marks)

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41.

Consider the following information about Jyothi Laboratories Ltd.:

Opening balance of accounts receivable	Rs. 5,00,000
Closing balance of accounts receivable	Rs. 7,50,000
Annual credit sales	Rs.2,25,00,000

The average collection period, assuming 360 days in a year, is

(a) 10 days (b) 15 days

(c) 18 days (d) 20 days (e) 22 days.

(1 mark)

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42.

Abhi Solutions Ltd., has been following a dividend policy which can maximize the market value of the firm as per Walter’s model. Accordingly, each year, at dividend time, the capital budget is reviewed in conjunction with the earnings for the periods and alternative investment opportunities for the shareholders.

In the current year, the firm’s earnings are Rs.10,00,000. It is estimated that the firm can earn Rs.2,00,000 additionally in the next year if the earnings are retained. The investors have alternative investment opportunities that will earn them 10% return. The firm has 50,000 shares outstanding. What is the current market price of the share?

(a) Rs.300 (b) Rs.400 (c) Rs.500 (d) Rs.550 (e) Rs.600.

(2 marks)

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43.

Sail and Sail Shipping Private Ltd., has issued share capital of Rs.56 lakhs and retained earnings of Rs.90 lakhs. If the equity investors expect a rate of return of 14.5% and the cost of issuing fresh equity is 5%, the cost of the retained earnings and cost of issuing external equity to the company are

(a) 13.78%; 15.06% (b) 14.5%; 15.10%

(c) 14.50%; 15.26% (d) 15.26%; 15.78% (e) 15.26%; 16.0%.

(2 marks)

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44.

The following sales forecasts have been made for Navdeep Electronics for the period January to April 2006.

				(Rs.)
Particulars	January	February	March	April
Sales	1,50,000	2,10,000	3,60,000	2,10,000
Raw materials	1,40,000	2,00,000	1,60,000	1,70,000
Manufacturing expenses	20,000	40,000	58,000	32,000
Loan installment	2,000	22,000	42,000	42,000

Additional Information:

(i) All sales are made on credit basis. 2/3 of the debtors are collected in the same month and balance in the next month. There is no expected bad debt. The debtors on January 1, 2006 were Rs.60,000.

(ii) The minimum cash balance, the firm must have is estimated to be Rs.10,000. However, the cash balance on January 1, 2006 was Rs.13,000.

(iii) Borrowing can be done only in multiples of Rs.100.

What is the cash balance at the end of February 2006? How much should the firm borrow/refund to maintain the minimum cash balance at the end of February 2006?

(a) Rs.61,000; Refund Rs.51,000 (b) –Rs.61,000; Borrow Rs.71,000

(c) –Rs.65,000; Borrow Rs.75,000 (d) –Rs.71,000; Borrow Rs.61,000

(e) Rs.71,000; Refund Rs.61,000.

(2 marks)

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45.

Consider the following data regarding Pony Electronics Ltd.,

Cost of equity 14.3%

Cost of debt 11.6%

Tax rate 50%

Debt/Equity 2/3

If the debt to equity of the company is changed to 1/3, what is the amount of change in the cost of capital of the firm?

(a) Increase by 1.145% (b) Increase by 1.275%

(c) Decrease by 1.145% (d) Decrease by 1.275%

(e) Decrease by 1.325%.

(2 marks)

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46.

M/s. Ruchi Dairy Products Ltd., was offered credit on the terms 4/20, net 45. What is the cost of trade credit if payment is made after 20^th day but before 45^th day? (Assume 360 days in a year)

(a) 25% (b) 44% (c) 60% (d) 68% (e) 72%.

(1 mark)

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47.

Consider the projected financial position of Dimple Ancillary Industries Ltd. is given below:

Current Liabilities	Rs. in lakhs	Current Assets	Rs. in lakhs
Accounts payable	240	Raw material	360
Other current liabilities	60	Work-in-progress	100
Bank borrowing	500	Finished goods	200
		Receivables	300
		Other current assets	40
Total	800	Total	1,000

Core current assets from long-term sources are Rs.400 lakhs

What is the maximum permissible bank finance under the methods II and III as suggested by the Tandon Committee?

(a) Rs.350 lakhs, Rs.150 lakhs (b) Rs.450 lakhs, Rs.150 lakhs

(c) Rs.450 lakhs, Rs.160 lakhs (d) Rs.480 lakhs, Rs.150 lakhs

(e) Rs.500 lakhs, Rs.165 lakhs.

(2 marks)

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48.

Veena Electronics Ltd., a trading concern has provided the following information:

Elements of cost

Material 40% of cost

Direct Labour 20% of cost

Overheads 20% of cost

The following further information is available:

(i) It is proposed to maintain a level of activity of 4,00,000 units.

(ii) Selling price is Rs.30 per unit.

(iii) Raw materials are expected to remain in stores for an average period of one month.

(iv) Materials will be in process, an average for half a month.

(v) Finished goods are required to be stock for an average period of one month.

(vi) Credit allowed to debtors is two months.

(vii) Credit allowed by suppliers is one month.

(viii) The company maintains a profit of 20% on sale price.

What is the amount of working capital required? (Assume that sales and production follow a consistent pattern)

(a) Rs.22,35,000 (b) Rs.29,60,000 (c) Rs.31,42,000

(d) Rs.32,45,000 (e) Rs.34,45,500.

(3 marks)

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49.

If the average annual usage of material is 1,80,000 units, lead-time for procuring material is 5 days, the average number of units per order is 2,500 units and the stock out acceptance factor considered is 1.5, what is the reorder level? (Assume 360 days in a year)

(a) 6,250 units (b) 6,260 units (c) 6,270 units

(d) 6,275 units (e) 6,280 units.

(1 mark)

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50.

The cost of capital of Mona Banking Corporation is 16% and its cost of debt is 11%. If the equity capitalization rate of the firm according to the net operating income approach is 20%, what is the proportion of equity in the total assets of the firm?

(a) 45.0% (b) 47.5% (c) 50.0%

(d) 55.5% (e) 57.5%.

(1 mark)

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51.

A retailer sells 3,200 pen sets a year. The unit cost of each pen set is Rs.60 and the inventory carrying costs are 10% per annum. If the cost of procurement is Rs.50, what is the optimal size the retailer has to order to minimize the total cost? Also what is the total annual carrying cost for the retailer at that size?

(a) 23 pens; Rs.489 (b) 231 pens; Rs.693

(c) 231 pens; Rs.831 (d) 231 pens; Rs.978

(e) 277 pens; Rs.1,386.

(2 marks)

< Answer >

52.

Cost of an investment is Rs.10,000 and it pays Rs.850 p.a. in perpetuity. If the implicit rate of interest is 10%, the net benefit-cost ratio (NBCR) of the investment is_______; and the proposal should be ___________.

(a) – 0.15; Rejected. (b) – 0.10; Rejected (c) 0; Indifferent

(d) 0.10; Accepted (e) 0.15; Accepted.

(1 mark)

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53.

The average daily usage rates of an inventory, lead time and their respective probabilities are as follows:

Average Daily Usage (Units)	Probability	Lead Time (days)	Probability
1,200	0.4	6	0.3
800	0.3	4	0.5
500	0.3	5	0.2

What are the possible usage levels at which stock-outs can occur and the probability of stock-out respectively?

(a) 2,000 units, 2,500 units, 3,000 units; 30%

(b) 3,200 units, 4,000 units, 4,800 units; 30%

(c) 2,000 units, 2,500 units, 3,200 units; 36%

(d) 4,000 units, 4,800 units, 6,000 units; 23%

(e) 4,800 units, 6,000 units, 7,200 units; 49%.

(2 marks)

< Answer >

54.

The annual usage of a raw material for Entrage Computers Ltd. is 50,000 units. The ordering cost is Rs.500 per order and the unit price is Rs.10 per unit. The storage cost of the raw material is 20% of the unit price. What is the net incremental benefit the company gets, if it avails a discount of 5% for placing an order for 5,500 units and above?

(a) Rs.25,129.0 (b) Rs.25,229.5 (c) Rs.25,429.5

(d) Rs.26,229.5 (e) Rs.26,429.5.

(2 marks)

< Answer >

55.

Bhaskar Lights Ltd., is considering offering credit to a customer. The probability that the customer would pay is 0.7. The revenues from the sale are expected to be Rs.5,000, and the cost of sale is expected to be Rs.1,400. What would be the expected profit/loss to the company if credit is offered to this customer?

(a) Rs.1,900 (profit) (b) Rs.1,950 (profit)

(c) Rs.2,100 (profit) (d) Rs.2,050 (loss)

(e) Rs.2,150 (loss).

(1 mark)

< Answer >

56.

Saturn Shipping Corporation is planning to invest in a new project. The total outlay on the project will be financed by a combination of long term and short-term funds. The following information is available:

Total outlay : Rs.200 lakhs

Total short term financing required : Rs.64 lakhs

Duration of the project : 5 years

Post tax net cash flows relating to long-term funds for the years 1 through 5 are as under:

Year	1	2	3	4	5
Net Cash Flow (Rs. lakhs)	20	60	70	50	20

The cost of long-term funds for the project will be 16%. What is the Net Present Value of the project?

(a) Rs.7.41 lakhs (b) Rs.7.61 lakhs (c) Rs.7.81 lakhs

(d) Rs.7.95 lakhs (e) Rs.8.00 lakhs.

(2 marks)

< Answer >

57.

The following are the details regarding the operation of a firm during a period of 12 months:

Sales Rs.48,00,000

Selling price per unit Rs.20

Variable cost per unit Rs.14

Total cost per unit Rs.18

Credit period allowed to customers One month

The firm is considering a proposal for a more liberal credit by increasing the credit period from one month to two months. This relaxation is expected to increase the sales by 25%. What is the return on additional investment in receivables?

(a) 62% (b) 68% (c) 72% (d) 75% (e) 77%.

(2 marks)

< Answer >

58.

Franklin Transports Ltd. is presently using a truck that has a book value of Rs.13 lakhs. It is being depreciated on a straight-line basis and it will be written off over the next six years. Presently the salvage value of the truck is Rs.6,00,000 and the salvage value after six years will be Rs.1,00,000. The company is planning to replace the old truck with a new one, which is improvised and more efficient. The new truck costs Rs.28 lakhs. It will be depreciated on a straight-line basis over the period of next six years and will be fully written off at the end of the six-year period. The new truck will have a salvage value of Rs.7,00,000 at the end of the six-year period. The cost of capital for the company is 12% and the tax rate applicable to it is 30%. The incremental depreciation and incremental salvage value are __________ and ______ respectively.

(a) Rs.1,25,000; Rs.5,55,000 (b) Rs.1,40,000; Rs.5,75,000

(c) Rs.1,45,000; Rs.5,92,000 (d) Rs.1,47,500; Rs.5,95,000

(e) Rs.1,50,000; Rs.6,00,000.

(2 marks)

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59.

The share of M/s. Sai Technologies Ltd., is currently trading at Rs.25. The EPS of the company is Rs.18. If the dividend yield for the company’s shareholders is 8%, the multiplier for this company according to the Traditional Approach for dividend policy is

(a) 2.145 (b) 2.545 (c) 2.725 (d) 3.125 (e) 3.275.

(1 mark)

< Answer >

60.

M/s. Aniket Electricals Ltd., sells 7,500 MCBs in a year. Each MCB costs Rs.45 and the inventory carrying costs are 15% per annum. If the cost of procurement is Rs.38, what should be the optimal time (in days) between two consecutive orders?

(a) 12 days (b) 14 days (c) 16 days

(d) 21 days (e) 24 days.

(1 mark)

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61.

High Vision Ltd. has current sales of Rs.20,00,000. The company is planning to introduce a cash discount policy of 2/10, net 30. As a result, the company expects the average collection period to go down by 10 days from the present average collection period of 30 days, and 80% of the sales would opt for the cash discount facility. If the company’s required return on investment in receivables is 20%, what is the amount of net gain or net loss incurred by the company if the cash discount is introduced? (Assume 360 days in a year).

(a) Rs.18,887.8 (b) Rs.19,588.8 (c) – Rs.20,888.8

(d) Rs.21,488.8 (e) – Rs.21,998.8.

(2 marks)

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62.

Shares of Aditi Laboratories Ltd. paid a dividend of Rs.1.20 per share last year and the dividend is expected to grow at 8% indefinitely. The stock currently sells for Rs.45 per share. If Aditi Laboratories Ltd. has a target debt-equity ratio of 50%, its cost of debt is 9% before taxes, and the tax rate is 40%, what is the weighted average cost of capital (WACC)?

(a) 8.330% (b) 8.680% (c) 8.953%

(d) 9.053% (e) 9.503%.

(1 mark)

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63.

The management of Unnati Machineries Ltd. is considering an investment project costing Rs.1,50,000 and it will have a scrap value of Rs.10,000 at the end of its 5 years life. Transportation charges and installation charges are expected to be Rs.5,000 and Rs.25,000 respectively. If the project is accepted, a spare part inventory of Rs.10,000 must also be maintained. It is estimated that the spare parts will have an estimated scrap value of 60% of their initial cost after 5 years. Annual revenue from the project is expected to be Rs.1,70,000; and annual labour, material and maintenance expenses are estimated to be Rs.15,000, Rs.50,000 and Rs.5,000 respectively. The depreciation and taxes for five years are as follows:

Year	Depreciation (Rs.)	Tax (Rs.)
1	72,000	11,200
2	43,200	22,720
3	32,400	27,040
4	21,600	31,360
5	800	39,680

What is the NPV of the project, if discount rate is 20%?

(a) Rs.41,552 (b) Rs.43,662 (c) Rs.44,222

(d) Rs.44,662 (e) 45,332.

(2 marks)

< Answer >

64.

following is the data relating to Koundinya Industries Ltd.(KIL) and Vasishta Industries Ltd. (VIL) belonging to the same risk class :

	KIL	VIL
No. of equity shares	3,00,000	5,00,000
Market price per share	Rs. 25	Rs. 12
9% Debentures	Rs. 9,00,000	–
Earnings before interest	Rs. 2,50,000	Rs. 2,50,000
Dividend payout ratio	100%	100%

Mr. Ashok holds 15% shares in KIL. If he shifts to VIL using the arbitrage concept as explained by MM-model, how much of capital funds would be at his disposal after investing in VIL? (Assume that he holds 15% of shares even in VIL)

(a) Rs.2,60,000 (b) Rs.3,25,000 (c) Rs.3,60,000

(d) Rs.4,20,000 (e) Rs.4,80,000.

(2 marks)

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65.

Consider the following information regarding Saket Industries Ltd.,

Earnings of the company	Rs.10,00,000
Dividend paid	Rs.6,00,000
No. of shares outstanding	1,00,000
P/E ratio	8
Return on investment	15%

Using Walter’s model, by how much amount should the price of the company’s share increase so that it is maximized? What is the optimal dividend-payout ratio for Saket Industries Ltd.?

(a) Rs.12, Zero payout (b) Rs.14; Zero payout

(c) Rs.16; Zero payout (d) Rs.16; 100% payout

(e) Rs.18; 100% payout.

(2 marks)

< Answer >

66.

Given below are the estimates of the cost of debt and cost of equity capital at various levels of debt-equity mix for M/s. Super Industries Ltd.

% of Debt	Cost of Debt (%)	Cost of Equity (%)
0	5.0	12.0
10	5.25	12.25
20	5.5	12.5
30	6.0	13.0
40	6.5	13.5
50	7.0	14.0
60	7.5	15.5

What is the optimal debt equity ratio for the company on the basis of the overall cost of capital?

(a) 1:1 (b) 1:5 (c) 2:5 (d) 3:5 (e) 3:10.

(2 marks)

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67.

Indian Associates Inc. has Rs.50,00,000 in assets with the debt equity ratio of 3:1. The face value of each share is Rs.10 with the current market price of Rs.20. The firms EBIT is expected to be Rs.15,00,000 at year end i.e. at t = 1. The corporate tax rate is 40 percent. Indian Associates expects to pay out a dividend at year-end, which is 55 percent of its net income. It is planning to redeem at part of its debt with the issue of fresh equity at the current market price in such a way that its debt equity ratio comes down to 1:1 with out any change in its total assets. The average cost of debt is 10%. The cost of equity capital after the change in capital structure will be 12 percent. If the expected growth rate in dividends is 6% and payout ratio doesn't change, what is the expected price after the change in capital structure?

(a) Rs.17.25 (b) Rs.15.00 (c) Rs.18.86

(d) Rs.20.98 (e) Rs.36.67.

(2 marks)

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68.

Grateway Inc. has a weighted average cost of capital of 13%. Its target capital structure is 65% equity and 35% debt. The company has sufficient retained earnings to fund the equity portion of its capital budget. The pre-tax cost of debt is 10% and the company’s tax rate is 40%. If the expected dividend next period (D₁) and current stock price are Rs.6 and Rs.52 respectively, the company’s growth rate is

(a) 2.68% (b) 3.44% (c) 5.23% (d) 6.75% (e) 8.16%.

(1 mark)

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69.

A stock analyst has obtained the following information about J-Mart, a large retail chain.

The company has non-callable bonds with 20 years maturity remaining and a maturity value of Rs.1,000. The bonds have a 12 percent annual coupon and a YTM of 9%.

The current risk-free rate is 6.35 percent and the expected return on the market is 11.35 percent. The company’s tax rate is 35 percent.

The company anticipates that its proposed investment projects will be financed with 70 percent debt and 30 percent equity. What is the company’s estimated weighted average cost of capital (WACC), if its beta is 1.3585?

(a) 8.04% (b) 9.00% (c) 10.25% (d) 12.33% (e) 13.14%.

(2 marks)

< Answer >

70.

Vison Corporation is determining whether to support Rs.50,000 of its permanent working capital with a bank note or a short-term bond. The firm’s bank offers a two-year note for which the firm will receive Rs.50,000 and repay Rs.59,405 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Vision can sell 8.5 percent annual coupon bonds with a 2-year maturity and Rs.1,000 par value at a price of Rs.973.97. How much percent lower is the interest rate on the less expensive debt instrument?

(a) 0.0% (b) 0.6% (c) 1.0% (d) 1.2% (e) 1.8%.

(2 marks)

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71.

The following is the balance sheet of Prabhat Industries Ltd. as on 31^st March 2006.

Liabilities	Rs.	Assets	Rs.
Share Capital	6,00,000	Fixed Assets	10,00,000
Debentures	5,00,000	Current Assets	2,00,000
Current liabilities	1,00,000
	12,00,000		12,00,000

The firm is earning 12% return on fixed assets and 2% return on current assets. If current assets increase by 25% from the present level without changing total assets, the earnings to total assets ratio and current assets to total assets ratio respectively are

(a) 8.82%, 16.8% (b) 9.92%, 19.2% (c) 9.92%, 20.8%

(d) 10.18%, 20.8% (e) 10.82%, 20.6%.

(2 marks)

< Answer >

72.

The following is the information taken from the books of a manufacturing concern. The net operating cycle would be

Period covered	365 days
Average period of credit allowed by suppliers	16 days
	(Rs. in ‘000)
Average debtors outstanding	480
Raw materials consumption	4,400
Total production cost	10,000
Total cost of goods sold	10,500
Sales for the year (All credit sales)	16,000
Value of average stock maintained:
Raw materials	320
Work-in-progress	350
Finished goods	260

(a) 28.3 days (b) 32.3 days (c) 39.3 days

(d) 43.3 days (e) 48.3 days.

(2 marks)

< Answer >

73.

The following information pertains to XYZ company:

Total Earnings	Rs. 2,00,000
Number of equity shares (of Rs. 100 each)	20,000
Dividend paid	Rs.1,50,000
Price/Earning ratio	12.5

The company’s return on investment is 10%. What is the change in the price of the company’s share according to Walter’s model if P/E ratio is 8 instead of 12.5 and the company follows 100% dividend pay out policy?

(a) Rs.48.81 (b) –Rs.48.81 (c) – Rs.52.81

(d) Rs.52.81 (e) Rs.58.81.

(1 mark)

< Answer >

Suggested Answers
Financial Management-II (142) : July 2006

1.

Answer : (b)

Reason : a. Participating debentures are unsecured corporate debt securities, which participate in the profits of a company. Alternative (a) is not true.

b. Participating preference shares are quasi-equity instruments to bolster net worth of the company without loss of management control. Alternative (b) is true.

c. Convertible Debentures with Options are convertible debentures with embedded options, providing flexibility to the issuer as well as the investor to exit from the terms of the issue.

d. Mortgage-backed Securities are synthetic instruments used for securitization of debt. These are backed by pooled assets like mortgages, credit card receivables and the like.

e. Debt-equity Swaps are an offer from an issuer of debt to swap it for common stock.

Therefore (b) is the answer.

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2.

Answer : (a)

Reason : Preference shares have the following features:

i. Preference shareholders earn a fixed rate of dividend.

ii. The dividends received by preference shareholders are not tax-deductible.

iii. Preference shareholders have preference over equity shareholders to the post-tax earnings in the form of dividends, and assets in the event of liquidation.

iv. Preference shares come with a call option wherein the issuer company has an option to redeem the preference shares prior to the maturity date and at a certain price.

v. With the commencement of Companies Act, 1956, the issue of preference shares with voting rights has been restricted to the following cases:

– When there are arrears in dividends for two or more years in case of cumulative preference shares.

– When preference dividend is due for a period of two or more consecutive preceding years.

– When in the preceding six years including the immediately preceding financial year, the company has not paid the preference dividend for a period of three or more years.

vi. For cumulative preference shares, the dividends will be paid on a cumulative basis, incase they remain unpaid in any financial year, the company will have to pay up all the arrears of preference shares before declaring any dividends. The non-cumulative shareholders do not enjoy any such right.

Therefore statement (a) is the answer.

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3.

Answer : (a)

Reason : The deferred credit facility is offered by the supplier of machinery, whereby the buyer can pay the purchase price in installments spread over a period of time. The interest and the repayment period are negotiated between supplier and the buyer and there are no uniform norms. Bill Rediscounting Scheme, Supplier’s Line of Credit, Seed Capital Assistance, and Risk Capital Foundation Schemes offered by financial institutions are examples of deferred credit schemes.

Leasing is a contractual agreement, wherein the companies can enter into a lease deal with a manufacturer of the equipment. This deal will give the company a right to use the asset till the maturity of the deal and later return the asset or buy it from the manufacturer.

Therefore (a) is the answer.

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4.

Answer : (b)

Reason : a. According to the Dividend Forecast Approach, the intrinsic value of an equity stock is equal to the sum of the present values of the dividends associated with it. Alternative (a) is not true.

b. According to the Realized yield Approach, the past returns on a security as a proxy for the return required by the investors. Alternative (b) is true.

c. According to the Capital Assets Pricing Model Approach, the cost of equity is reflected by the equation, . Alternative (c) is not true.

d. According to the Bond Premium plus Risk Premium Approach, the return required by the investors is directly based on the risk profile of a company. This risk profile is reflected in the return earned by the bondholders. Alternative (d) is not true.

e. According to the earning Price Ratio Approach, the cost of equity can be calculated as E₁/P, where E₁ is the expected EPS for the next year, and P is the current market price per share. Alternative (e) is not true.

Therefore (b) is the answer.

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5.

Answer : (b)

Reason : According to net operating income approach, the overall capitalization rate and cost of debt remain constant for all degrees of leverage. Statements (i) and (iii) are true.

As long as k_d remains constant, the cost of equity is a constant linear function of the debt-equity ratio, and it is not constant for all degrees of leverage. Therefore statement (ii) is not true.

According the approach, the market value of the firm depends on its net operating income and business risk. The change in the degree of leverage employed by the firm cannot alter these underlying factors. Changes take place in the distribution of income and risk between debt and equity without affecting the total income and risk, which influence the market value of the firm. Hence the degree of leverage cannot influence the market value or the average cost of capital of the firm. Statement (iv) is true.

Therefore (b) is the answer.

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6.

Answer : (b)

Reason : Agency costs (not bankruptcy costs) represent certain restrictions on the firm in the form of some prospective covenants incorporated in the loan contract. Statement (a) is wrong.

The probability of bankruptcy for a levered firm is higher than for an unlevered firm. Beyond a threshold level, the probability of bankruptcy increases at an increasing rate as the debt-equity ratio increases. This means that the expected cost of bankruptcy increases when the debt-equity ratio increases. Investors expect a higher rate of return from a firm, which is faced with the prospect of bankruptcy, as bankruptcy costs represent a loss, which cannot be easily diversified away.

Therefore statement (III) is true, and statements (I), (II) and (IV) are wrong. Thus (b) is the answer.

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7.

Answer : (e)

Reason : a. According to Walter’s dividend model, dividends are relevant and they affect the share price of a firm. The model studies the relationship between the internal rate of return and the cost of capital of the firm to give a dividend policy that maximizes the shareholders’ wealth. Statement (a) is true.

b. According to the model, when the return on investment is greater than the cost of equity capital, a zero percent payout ratio would maximize the value of the firm. Statement (b) is true.

c. When the return on investment is less than the cost of equity capital, a 100% payout ratio would maximize the value of the firm. Statement (c) is true.

d. & e. When the return on investment is equal to the cost of equity capital, the firms’ dividend policy will not affect the value of the firm. Statement (d) is true and Statement (e) is not true.

Therefore (e) is the answer.

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8.

Answer : (d)

Reason : Gordon’s model explains the relevance of dividends. According to the model, the firm’s share value is positively correlated with the payout ratio when r_e < k_e, and the firm’s share value is negatively correlated with the payout ratio when r_e > k_e. Statement (i) is true and statement (ii) is wrong in the case of this firm.

Thus firms with a rate of return greater than the cost of capital should have a higher retention ratio, and firms with a rate of return lesser than the cost of capital should have a lower retention ratio. Statement (iii) is wrong and statement (iv) is true for this firm.

Therefore (d) is the answer.

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9.

Answer : (c)

Reason : Gordon’s model assumes that the investors are rational and risk-averse. They prefer certain returns to uncertain returns and put a premium to the certain returns and discount uncertain returns. Thus, investors would prefer current dividends and avoid risk. Retained earnings involve risk and so the investors discount the future dividends. Thus, the investors would prefer to pay a higher price for the stocks, which earn them current dividend income and would discount those stocks which reduce/postpone the current income. Hence (c) is the answer.

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10.

Answer : (d)

Reason : According to the rational expectations model, there would be no impact of the dividend declaration on the market price of the share as long as it is at the expected rate. It may show some adjustments in case the dividends declared are higher or lower than the expected level. The model suggests that the alterations in the market price are not necessary when the dividends meet the expectations and only in case of unexpected dividends there will be a change in the market price. Thus if the declared dividends meet the expectations of the investors, there will be no effect on the valuation of the firm.

Therefore (d) is the answer.

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11.

Answer : (c)

Reason : An aggressive approach to working capital results in a greater turnover of current assets than in a conservative approach. Statement (a) is wrong.

The risk of technical insolvency tends to be high while the cost of financing tends to be low under an aggressive policy, and the risk of technical insolvency tends to be low while the cost of financing tends to be high under a conservative policy. Statement (b) and (e) are wrong.

An aggressive approach results in greater profitability but lower liquidity and a conservative policy results in lower profitability but greater liquidity. Statement (c) is true and statement (d) is not true.

Therefore answer is (c).

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12.

Answer : (b)

Reason : Under trading indicates that the funds of the company are locked up in current assets resulting in a lower turnover of working capital. Hence in such a situation hastening of the collection process, reducing the debt-equity ratio and reducing the level of inventory will be some precautionary measures.

On the other hand, a over-trading situation can be noticed from the disproportionately high turnover of assets compared to the volume of sales. Precautionary measures can be taken by initially reducing the sales to a level commensurate with the amount of assets and a final solution lies in increasing the asset base through additional finances raised through the issuance of shares and/ or obtaining loan funds.

Hence, option (d) and (e) are precautionary measures for over-trading situation. Therefore (b) is the answer.

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13.

Answer : (d)

Reason : Shorter the duration of operating cycle period, faster is the transformation of current assets into cash. Statement (a) is not true.

Higher the turnover of inventory, it is better from the point of view of efficiency in working capital management. Statement (b) is not true.

Higher the turnover of working capital, higher is the rate of return on net operating capital employed. Statement (c) is not true

Working capital to sales ratio is the reciprocal of working capital turnover. Statement (d) is true.

Operating cycle approach is useful for both controlling and forecasting working capital. Statement (e) is not true.

Hence (d) is the answer.

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14.

Answer : (e)

Reason : a. Under the cash credit arrangement, the customer is permitted to borrow up to a prefixed limit called the cash credit limit. Alternative (a) is wrong.

b. Under the overdraft arrangement, the customer is permitted to overdraw up to a prefixed limit. Alternative (b) is wrong.

c. Note lending is for specified period ranging from two to three months. Under this a customer takes a loan against a promissory note. Alternative (c) is wrong.

d. As part of purchase/discounting of bills, the bank provides finance to the customer either by outright purchasing or discounting the bills arising out of sale of finished goods. Alternative (d) is wrong.

All the above arrangements are between the bank and the customer.

e. Letter of credit is opened by a bank in favor of its customer undertaking the responsibility to pay the supplier in case its customer fails to make payment for the goods purchased from the supplier within the stipulated time. Hence the bank bears the risk of default by the customer while the supplier provides the credit.

Hence (e) is the answer.

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15.

Answer : (b)

Reason : a. Under recourse factoring, the factor purchases the receivables on the condition that any loss arising out of irrecoverable receivables will be borne by the client. Alternative (a) is wrong.

b. Under the non-recourse or full factoring, the factor has no recourse to the client if the receivables are not recovered. The client gets total credit protection. Alternative (b) is true.

c. Under maturity factoring, the factor does not make any make any pre-payment. The factor pays the client either on a guaranteed payment date or on the date of collection from the customer. Alternative (c) is wrong.

d. Under advance factoring, the factor makes pre-payment of around 80% of the invoice value to the client. Alternative (d) is wrong.

e. Under invoice discounting, the factor provides a pre-payment to the client against the purchase of accounts receivables and collects interest for the period extending from the date of pre-payment to the date of collection. Alternative (e) is wrong.

Therefore (b) is the answer.

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16.

Answer : (a)

Reason : The Tandon Committee had identified the problems associated with cash credit system and recommended for the bifurcation of the cash limit into a loan component and a fluctuating cash credit component. The information system recommended by the committee is intended to ensure proper end use of credit besides introduction of financial discipline on the part of borrowing companies.

Hence (a) is the answer.

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17.

Answer : (c)

Reason : According to Tandon Committee recommendations,

– Under Method I, the bank will finance atmost 75 percent of the working capital gap. This method will ensure a minimum current ratio of unity.

– Under Method II, the borrower will finance atmost 25 percent of total current assets through long-term sources. This method will ensure a current ratio of 1.33.

– Under Method III, the amount of excess borrowing, which is calculated as the difference between the amount of bank borrowing and the maximum permissible bank borrowing to which the borrower is eligible will be converted into a term loan, which is to be repaid over suitable period. This will ensure further reduction in the current ratio.

Therefore (c) is the answer.

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18.

Answer : (d)

Reason : EOQ is computed as:

Where U is the annual usage, F is the fixed cost per order, P is the purchase price and C is the carrying cost expressed as a percentage of purchase price. Hence increase in the annual usage of raw material and the fixed cost per order would increase the EOQ but increase in the carrying costs (other things remaining the same) decreases the EOQ.

Hence, only alternative (ii) and (iv) will increase EOQ, all other alternatives will decrease the EOQ. Therefore (d) is the answer.

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19.

Answer : (d)

Reason : Raw material inventory is used to uncouple the production function from the purchasing function. Alternative (a) is not true.

Stores and spares are those products, which are accessories to the main products produced for the purpose of sale. Alternative (b) is not true.

W-I-P includes those materials that have been committed to the production process but have not been completed. Alternative (c) is not true.

Finished goods inventory is used to uncouple the production and sales functions so that it is no longer necessary to produce the goods before a sale can occur. Alternative (d) is true.

Therefore (d) is the answer.

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20.

Answer : (d)

Reason : Carrying costs are expenses fro storing goods. Once the goods have been accepted, they become part of the firm’s inventories. These costs include insurance, rent/depreciation of warehouse, salaries of storekeeper, his assistants and security personnel, financing cost of money locked-up in inventories, obsolescence, spoilage and taxes.

Purchase of requisition is not a carrying cost; it is related to ordering the goods. Therefore alternative (d) is not true and it is the answer.

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21.

Answer : (a)

Reason : Higher the quantity of safety stock, lower will be the stock-out cost and higher will be the incidence of carrying costs. Then the formula for estimating the reorder level (Average daily usage rate x lead time in days) will call for a trade-off between stock-out costs and carrying costs. The reorder level will then become one at which the total stock-out costs and carrying costs will be at their minimum.

The stock level subsystem keeps track of the goods held by the firm, issuance of goods, and the arrival of orders.

Statement (a) is not true and all statements are true. Therefore (a) is the answer.

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22.

Answer : (e)

Reason : Under FIFO, the pricing will be based on the cost of material that was obtained first. Alternative (a) is not true.

Under LIFO, the material issued will be based on the material that has been purchased recently. Alternative (b) is not true.

Under the Weighted Average Cost Method, the pricing of materials will be done on weighted average basis. Alternative (c) is not true.

Under Standard Price Method, material is priced based on a standard cost that is predetermined. Alternative (d) is not true.

Under the Replacement/Current price method, material is priced at the value that is realizable at the time of the issue. Alternative (e) is true.

Therefore (e) is the answer.

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23.

Answer : (c)

Reason : Firms generally offer cash discounts to induce prompt payments. Credit terms reflect the percentage of discount and the period during which it is available. The credit terms 2/15, net 30 means that a discount of 2% is offered if the payment is made by the 15^th day, otherwise the full payment has to be done by 30^th day.

Statement (c) is true and all other statements are wrong, Therefore (c) is the answer.

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24.

Answer : (c)

Reason : An importance aspect of receivables management is to monitor the payment of receivables. The credit manager can employ several measures for the purpose like (i) Days Sales Outstanding, (ii) Average Collection period and Ageing schedule, and (iii) Collection matrix.

Numerical credit scoring is an index based on several factors that is used to study the creditworthiness of a customer.

Alternative (c) is not a measure adopted to monitor payment of receivables. Therefore (c) is the answer.

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25.

Answer : (c)

Reason : If credit standards are made more stringent, sales are likely to reduce as the customers are expected to fulfill the rigid credit standards specified by the company. With the decrease in the sales, the money blocked in receivables also reduce. Hence statement (a) is true.

If credit standards are made liberal, sales may increase but the company is more likely to be saddled with a large 1uantum of money locked up in receivables, higher incidence of bad debt losses and increased expenses on collection front. Statement (b) is true.

If credit period is lengthened, more customers are induced to take the credit and the sales tend to increase and there are more chances of bad debts occurring. sales are likely to increase but bad debt losses are likely to decrease. Hence statement (c) is not true.

If credit period is shortened, sales are likely to decrease and reduce investment in receivables and reduce the incidence of bad debt loss. Statement (d) is true.

If cash discount is increased, the amounts of discounts paid tend to increase even when same proportion of customers avail the discount. As many customers tend to avail the discount and pay within the discount period, amount blocked in receivables will be less. Statement (e) is true.

Thus (c) is the answer.

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26.

Answer : (c)

Reason : Numerical credit scoring is an index based on several factors that is used to study the creditworthiness of a customer. It is the weighted sum of the facts that ostensibly have a bearing on the credit worthiness of the customer. Hence (c) is true, and it is the answer.

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27.

Answer : (c)

Reason : The objective of cash management can be regarded as one of making short-term forecasts of cash position, finding avenues for financing during periods when cash deficits are anticipated and arranging for repayment/investments during periods when cash surpluses are anticipated with a view to minimizing idle cash. Towards this end short-term forecasts of cash receipts and payments are made in the structured form of cash budgets, information is monitored at appropriate intervals for the purpose of control and taking suitable measures as warranted.

Statement (c) is not true and all other statements are true. Therefore (c) is the answer.

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28.

Answer : (b)

Reason : Net float = payment float – collection float. Statement (b) is true.

When net float is positive, the balance in the books of the company is less than in the bank’s books. When the net float is negative, the book balance of the company is more than that in the bank’s books. Statement (a) is not true.

When a company has a ‘positive net float’, it may issue cheques to the extent that the amount shown in the company’s books, even if the company’s books indicate an overdrawn position. The company is said to be playing the float. When the net float is negative, the company cannot play the float, as the balance in the bank’s book is less than that in the firm’s books. Statements (c) and (d) are not true.

The amount of cheques deposited by a company in the bank awaiting clearance is called collection float. Statement (e) is not true.

Therefore (b) is the answer.

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29.

Answer : (d)

Reason : Successful audit of internal audit depends on the following elements of internal audit:

Totality – This concept demands that all aspects of the organization should be considered for the purpose of review and control.

Expertize – This concept stresses that only those professional qualifications, experience are appointed as internal auditors.

Independence – This means that the internal auditors have the opportunity and permission to report directly to the senior management.

Objectivity – This aspect judges the efficiency and effectiveness of the system when put into operation.

Utility – All the systems when put into practice should be ultimate utility to the management.

Therefore (d) is the answer.

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30.

Answer : (e)

Reason : Annual capital charge is the equivalent annual cost associated with a project. It is used for evaluating mutually exclusive projects or alternatives, which provide similar service but have differing patterns of costs and often unequal life spans.

Hence (e) is the answer.

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31.

Answer : (c)

Reason : The appraisal of a project includes market appraisal, technical appraisal, financial appraisal, and economic appraisal.

Most of the projects sponsored by government authorities are subjected to a social cost benefit analysis (economic appraisal) to judge whether the project is desirable or not. Some of the issues considered in this analysis are:

- Impact of the project on distribution of income in the society.

- Impact of the project on the level of savings and investments in the society.

- Contribution of project towards socially desirable objectives like self-sufficiency, employments, etc.,

Therefore (c) is not an issue considered under economic appraisal. Thus (c) is the answer.

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32.

Answer : (c)

Reason : While computing cash flows for capital budgeting decisions the following have to be considered:

The cash flows must be measured in incremental terms. In other words, the increments in the present levels of costs and benefits that occur on account of the adoption of the project are alone relevant for the purpose of determining the net cash flows. Hence statement (a) is true.

Interest on long-term loans should not be included for determining the net cash flows. Since the net cash flows are defined from the point of view of suppliers of long-term funds, the post-tax cost of long-term funds will be used as the interest rate for discounting. The post-tax cost of long-term funds obviously includes the post-tax cost of long-term debt. Therefore if interest on long-term debt is considered, there will be an error of double counting. Statement (b) is true.

While computing cash flows, sunk costs i.e. the costs that have already been incurred should be ignored and opportunity costs should be included. Statement (c) is wrong.

Allocated overhead costs should be ignored while computing the same. Statement (d) is true.

Cash flows should be defined in post-tax terms, as they are relevant to the firm after paying taxes. Statement (e) is true.

Therefore (c) is the answer.

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33.

Answer : (a)

Reason : Accounting rate of return or the book rate of return does not take the time value of money into consideration. It is defined as Average Profit after tax divided by Average Book Value of the instrument.

Net present value (NPV) is the present value of cash inflows minus present value of cash outflows.

Benefit Cost Ratio is defined as present value of future cash flows divided by initial investment.

Internal Rate of Return is the rate of interest at which NPV is equal to zero.

Annual capital charge is the equivalent annual cost associated with a project. Hence, annual capital charge, internal rate of return, benefit cost ratio, and net present value are appraisal criteria that consider the time value of money.

Therefore answer is (a).

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34.

Answer : (c)

Reason : Ex-right price of a share = where

N = Number of equity shares required for rights issue

P₀ = Cum-rights price per share

S = Subscription price at which rights are issued

Therefore the company should issue 1 rights share for every 4 equity shares.

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35.

Answer : (d)

Reason : Wealth ratio, W_t = where

D_t = Dividend per share for year t payable at the end of year

P_t = Price per share at the end of the year t.

Therefore, W_t =

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36.

Answer : (c)

Reason :

Source of capital	Market value (MV) Rs.	Specific cost k (%)	Total costs (MV x k) Rs.
Debentures	Rs.19,20,000	7.18%	Rs.1,37,856
Preference shares	5,00,000	11.25%	56,250
Equity shares	90,00,000	13.00%	11,70,000
	1,14,20,000		13,64,106

K_O = Rs. 13,64,106/Rs. 1,14,20,000 = 0.11944 ~ 11.94%

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37.

Answer : (d)

Reason : Cost of debt capital when the difference between the redemption price and the net amount realized can be written off over the life of the debenture and the amount so written off is tax deductible is given by:

=

= 7.35%

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38.

Answer : (b)

Reason : Value of the firm as per traditional approach:

EBIT 8,00,000

- Interest (10% on Rs.30,00,000) 3,00,000

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

Net income for equity holders 5,00,000

K_e 0.16

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

Market value of equity (Net income/k_e) 31,25,000

Market value of debt 30,00,000

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

Value of the firm 61,25,000

Effect of proposed redemption of debt:

EBIT 8,00,000

- Interest (10% on Rs.20,00,000) 2,00,000

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

Net income for equity holders 6,00,000

K_e 0.14

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

Market value of equity (Net income/k_e) 42,85,714

Market value of debt 20,00,000

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

Value of the firm 62,85,714

The value of the firm increases by Rs.1,60,714.

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39.

Answer : (d)

Reason : Corporate taxes are one of the major criticisms of the Modigliani-Miller proposition to capital structure.

The present value of tax shield associated with interest payments, assuming debt to be perpetual in nature =

where, t_c = corporate tax rate = 50%

B = market value of debt = Rs.40,00,000

r = interest rate on debt.

Present value of tax-shield = 0.5 x 40,00,000 = Rs.20,00,000

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40.

Answer : (e)

Reason : As per MM model, the current market price of the share, P₀ is

Step 1:Since the firm pays a dividend of Rs.10, the price at the end of year 1, P₁ is

Step 2: Amount to be raised by the issue of new shares:

The company has to issue 30,000 new shares.

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41.

Answer : (a)

Reason : Average Accounts receivable = = Rs.6,25,000.

Annual credit sales = Rs.2,25,00,000

Average daily sales = 2,25,00,000/360 = Rs.62,500

Average collection period = Average Accounts receivable / Average daily sales = 6,25,000/62,500

= 10 days.

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42.

Answer : (b)

Reason : The firm is expecting to earn an income of Rs.2,00,000 on the investment of the profits of the current year, i.e., Rs.10,00,000. So the rate of return, r is 20% (i.e., 2,00,000/10,00,000). The opportunity cost of the shareholders is given as 10%. It means that the rate of return of the firm, r is greater than the opportunity cost of capital, k_e.

The EPS is Rs.20 (Rs.10,00,000/50,000). Since r > k_e, the optimal D/P ratio, in order to maximize the wealth of the shareholders, is that the firm need not distribute any dividend, i.e., D/P ratio is zero.

According to the Walter’s model, market price of the share:

=Rs.400

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43.

Answer : (c)

Reason : Retained earnings are the amount due to equity holder, which have not been paid to them. Therefore, the cost of retained earnings will be equal to expected return of equity holder. And as there is no cost of issue involved, it will be 14.5% for the Sail and Sail Shipping Private Ltd.

Cost of external equity where f is the issue expense.

In the case of this company,

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44.

Answer : (b)

Reason :

Rs.

	January	February	March	April
Opening balance	13,000	11,000	10,000	10,000
Inflows:
Debtors (previous month)	60,000	50,000	70,000	1,20,000
Debtors (current month)	1,00,000	1,40,000	2,40,000	1,40,000
Total cash available (A)	1,73,000	2,01,000	3,20,000	2,70,000
Outflows:
Raw materials	1,40,000	2,00,000	1,60,000	1,70,000
Manufacturing expenses	20,000	40,000	58,000	32,000
Loan installment	2,000	22,000	42,000	42,000
Total outflows (B)	1,62,000	2,62,000	2,60,000	2,44,000
Cash balance (A-B)	11,000	-61,000	60,000	26,000
Borrowings (Refund)	-	71,000	(50,000)	(16,000)

Therefore the cash balance is – Rs.61,000 in the month of February and the firm has to borrow Rs.71,000 to maintain a cash balance of Rs.10,000 at the end of February.

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45.

Answer : (d)

Reason : The weighted average cost of capital is given by:

When debt/equity is 2/3:

When debt/equity ratio is altered to 1/3:

Therefore the overall cost of capital is decreased by 1.275%.

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46.

Answer : (c)

Reason : Cost of trade credit =

=

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47.

Answer : (b)

Reason : The maximum permissible bank finance (MPBF) for the firm under methods II and III suggested by the Tandon Committee:

Method II:

MPBF = 0.75(Current assets) – Current liabilities

= 0.75 (1000) – 300

= 750 - 300

= Rs.450 lakhs

Method III:

MPBF = 0.75 (Current assets – Core current assets) – current liabilities

Core current assets = 0.75(1000 – 400) – 300

= Rs.150 lakhs.

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48.

Answer : (b)

Reason : Selling price = Rs.30; Gross profit = 20% of Rs.30 = Rs.6

\Cost Rs.24

Total cost = 4,00,000 units × 24 = Rs.96,00,000

Total sales = 4,00,000 units × 30 = Rs.1,20,00,000

Statement of working capital
	Rs.	Rs.
Current Assets ………(a)
Stock of raw materials (1 month) Work-in-process (1/2 month) Materials Labour Overheads Stock of finished goods (1 month) Materials Labour Overheads Debtors (2 months) at selling price	1,60,000 80,000 80,000 3,20,000 1,60,000 1,60,000	3,20,000 3,20,000 6,40,000 20,00,000
Total		32,80,000
Less: Current Liabilities ………(b)
Creditors (1 month)		3,20,000
Net Working Capital required (a – b)		29,60,000

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49.

Answer : (a)

Reason : Reorder level =

where,

S – Daily usage in units = 1,80,000/360 = 500 units

L – Lead time in days

R – Average number of units per order

F – Stock-out acceptance factor

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50.

Answer : (d)

Reason : According to the Net Operating Income Approach,

0.04 = 0.05 x B/S

Therefore total assets of the firm comprises of 55.5% equity.

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51.

Answer : (b)

Reason : The optimal size is the Economic order quantity.

EOQ =

Where U – Annual usage = 3,200

F – Fixed cost per order = Rs.50

P – Purchase price per unit = Rs.60

C – Carrying cost = 10%

The retailer has to order a minimum of 231 pens to minimize the total cost.

At this level, the total carrying costs are equal to Rs.= = Rs.693.

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52.

Answer : (a)

Reason : Present value of perpetual inflow of Rs.850 = Perpetuity/interest rate

=

BCR = PV of inflows/Initial investment

=

NBCR = BCR – 1 = 0.85 – 1 = - 0.15

The proposal should be rejected as NBCR < 0.

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53.

Answer : (e)

Reason : Normal consumption during lead time = (Average daily usage rate) x (Average time in days)

Average daily usage rate = 1200 x 0.4 + 800 x 0.3 + 500 x 0.3

= 870 units

Average time in days = 6 x 0.3 + 4 x 0.5 + 5 x 0.2

= 4.8 days

Normal consumption during lead time = 870 x 4.8 = 4,176 units

Possible usage levels at which stock-outs can occur:

Daily Usage Rate		Lead Time		Possible levels of usage
Units (1)	Probability (2)	No. of days (3)	Probability (4)	Possible usage levels (1) x (3)	Probability (2) x (4)
1200	0.4	6 4 5	0.3 0.5 0.2	7,200 4,800 6,000	0.12 0.20 0.08
800	0.3	6 4 5	0.3 0.5 0.2	4,800 3,200 4,000	0.09 0.15 0.06
500	0.3	6 4 5	0.3 0.5 0.2	3,000 2,000 2,500	0.09 0.15 0.06

Since the Normal consumption during lead time = 870 x 4.8 = 4,176 units, stock-outs would occur if eth usage levels are above 4,176 units. Thus stock-outs would occur at 7,200 units, 4,800 units, and 6,000 units.

Probability of stock-out = 0.12 + 0.20 + 0.08 + 0.09 = 0.49 = 49%.

Hence (e) is the answer.

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54.

Answer : (b)

Reason :

Given that Q` = 5,500 units.

Total amount of discount available:

UD = 50,000 x 0.5 = Rs.25,000 ….. (1)

Savings due to reduction in ordering costs:

=

….. (2)

Incremental carrying cost:

=

….... (3)

Net incremental benefits = (1 + 2 - 3)

= Rs.25,000 + Rs.454.5 - Rs.225

= Rs.25,229.5

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55.

Answer : (c)

Reason : Expected profit/loss from offering credit = p(Revenue – cost)- (1-p)(cost)

= 0.7 (5,000-1,400) – (0.3)(1,400)

= Rs.2,100

The company would get a profit of Rs.2,100 by offering credit.

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56.

Answer : (c)

Reason : Total long term funds invested in the project = Total outlay – Total short term financing

= 200 – 64= Rs.136 lakhs.

Net present value = Present value of net cash flows relating to long term funds

– Total long term funds invested in the project

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57.

Answer : (c)

Reason : Present cost of sales (2,40,000 x 18) = Rs.43,20,000

Cost of additional sales (60,000 x 14) = Rs. 8,40,000

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

Rs. 51,60,000

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

New average cost per unit =

Average investment in receivable under new sales pattern:

Total Annual sales in units = 3,00,000 units

Cost of sales (3,00,000 x 17.2) = Rs.51,60,000

Average collection period = 2 months

Amount invested in receivables =

Additional investment in receivables = New investment – existing investment*

= 8,60,000 – 3,60,000

= Rs.5,00,000

Profitability of additional sales = Additional units sold x contribution per unit

= 60,000 x 6

= Rs.3,60,000

Return on additional investment in receivables =

Existing investment in receivables = Rs.

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58.

Answer : (e)

Reason : Existing depreciation (on old truck) per year over the next six years =

Depreciation on the new truck for each year over next 6 years =

\ Incremental depreciation = Rs.1,50,000

Incremental salvage value = Rs.7,00,000 – Rs.1,00,000 = Rs.6,00,000

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59.

Answer : (d)

Reason : According to the Traditional Approach, the relationship between market price and dividends is given by:

Hence (d) is the answer.

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60.

Answer : (b)

Reason : Optimal time between two consecutive orders = Q/U, where Q is the EOQ and U is the number of orders in a year.

U = 7,500

F = Rs.38

P = Rs.45

C = 15%

Therefore optimal quantity = 291 MCBs.

Optimal time =

Hence (b) is the answer.

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61.

Answer : (c)

Reason : Accounts receivable before cash discount = 20,00,000 x 30/360 = Rs.1,66,667

Accounts receivable after cash discount = 20,00,000 x 20/360 = Rs.1,11,111

(When average collection period goes down by 10 days from 30 days, the new collection period would be 20 days)

Decrease in accounts receivable investment = Rs. 1,66,667 - Rs.1,11,111 = Rs.55,556

\ Return on decreased investment in receivables = 20% of Rs. 55,556 = Rs.11,111.20

Discount at 2% used by 80% of sales = 20,00,000 x 0.8 x 0.02 = Rs.32,000

Net loss due to introduction of cash discount = Rs.11,111.20 - Rs.32,000 = Rs.20,888.8

Hence the answer is (c).

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62.

Answer : (d)

Reason : Dividend per share = Rs.1.20

Expected growth (g) = 8%

Sale price P₀ = Rs.45 per share

Target debt equity ratio = 50%

Cost of debt before taxes = 9%

Tax rate = 40%

According to dividend growth model, projected dividend = D₀ x(1+g) = 1.20 x 1.08 = 1.296. So the expected return using this approach is:

K_e =

Aditi Laboratories Ltd., Cost of equity = 10.88%.

The target debt equity ratio = 50%. In other words, Aditi Laboratories Ltd.’s target capital structure is 1/3 debt and 2/3 equity. The Weighted Average Cost of capital is thus:

WACC = K_e x 2/3 + K_d x (1-t) x 1/3 = 10.88 x 2/3 + 9 x (1-0.4) x 1/3 = 9.053%

Hence answer is (d).

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63.

Answer : (b)

Reason : Project cost: Rs.

Cost of machine 1,50,000

Transportation 5,000

Installation charges 25,000

Investment in machinery 1,80,000

Investment in spare parts 10,000

Total initial investment 1,90,000

Scrap value of the following after 5 years

Machinery 10,000

Spare parts (60% of initial cost) 6,000

Total 16,000

Gross cash flow before depreciation = Annual Revenue – (Labour + Material + Maintenance expenses)

= 1,70,000 – (15,000 + 50,000 + 5,000) = Rs.1,00,000

Year	Gross cash flow	Depreciation	Tax	Net cash flow
1	1,00,000	72,000	11,200	88,800
2	1,00,000	43,200	22,720	77,280
3	1,00,000	32,400	27,040	72,960
4	1,00,000	21,600	31,360	68,640
5	1,16,000	800	39,680	76,320

NPV:

PV of net cash flows = = 2,33,662

NPV = PV of Net cash flows – Initial investment

= Rs.2,33,662 – 1,90,000 = Rs.43,662

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64.

Answer : (c)

Reason : Both the firms have an EBIT of Rs.2,50,000.

KIL – Has to pay an interest of Rs.81,000 (9% of Rs.9,00,000). Remaining Rs.1,69,000 is distributed among the shareholders.

VIL – Has no debentures. Therefore Rs.2,50,000 is distributed among the shareholders.

Thus Mr.Ashok would be better off by selling the shares of KIL and shifting to the shares of VIL through the arbitrage process as follows:

Mr.Ashok owns 15% shares in KIL = 0.15 x 3,00,000 = 45,000 shares. If he sells these shares, he gets Rs.11,25,000 (25 x 45,000). He can take a loan of Rs.1,35,000 (15% of Rs.9,00,000) at 9%.

\Total funds available = Rs.11,25,000 + Rs.1,35,000 = Rs.12,60,000

Funds required to purchase 15% shares in VIL = Rs.9,00,000 (0.15 x 5,00,000 x 12)

Funds available with Mr.Ashok = Rs.3,60,000.

Mr.Ashok’s position with regard to companies KIL and VIL is as follows:

KIL VIL

Dividends (15% of profits) 25,350 37,500

- Interest (9% on Rs.1,35,000) - 12,150

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

Net Income 25,350 25,350

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

Thus, by shifting from KIL to VIL, Mr.Ashok is able to get same income of Rs.25,350 and still would be having funds of Rs.3,60,000 at his disposal so that he can invest elsewhere.

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65.

Answer : (c)

Reason : Given:

P/E ratio =

EPS = Earnings/No. of shares = 10,00,000/1,00,000 = Rs.10

DPS = Total dividend paid / No. of shares

Market Price = P/E ratio x EPS = 8 x 10 = Rs.80

D/P ratio =

Now according to Walter’s formula, market price =

As P/E ratio is 8, k_e =

Given that r = 15%

For this firm, r = 15% > k_e = 12.5%. Therefore the company can maximize its market price if it retains 100% of its profits (i.e. zero pay-out). The current market price of Rs,80 (based on P/E ratio) can be increased by decreasing the pay-out ratio.

As per Walter’s model,

Therefore the market price should increase from Rs.80 to Rs.96 by Rs.16 so that it is maximized.

Hence (c) is the answer.

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66.

Answer : (a)

Reason : The overall cost of capital, WACC, may be defined as:

K_o = k_d(D/D+E) + k_e(E/D+E)

Now, WACC for different D/E ratios:

Kd (%)	Ke (%)	D/D+E	E/D+E	Ko (%)
5.0	12.0	0	1.0	12.00
5.25	12.25	0.1	0.9	11.55
5.5	12.5	0.2	0.8	11.10
6.0	13.0	0.3	0.7	10.90
6.5	13.5	0.4	0.6	10.70
7.0	14.0	0.5	0.5	10.50
7.5	15.5	0.6	0.4	10.70

The optimal debt equity mix for the company occurs at a point when the overall cost of capital k_o is minimum. The above calculations show that the k_o is minimum at a point when the debt is 50% of the total capital employed. Therefore the firm should employ 50% of debt and 50% of equity in its capital structure and its k_o would be 10.5%. Thus the D/E ratio is 1:1, and (a) is the answer.

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67.

Answer : (e)

Reason :

The amount of equity to be issued to redeem debt and to reach D/E ratio of 1:1	37,50,000 – debt to be redeemed = 12,50,000 + equity to be issued (since debt to be redeemed is equal to the equity to be issued) i.e Rs.12,50,000
Number of equity shares to be issued at Rs.20	Rs.12,50,000/Rs.20 = 62,500
Number of equity shares after issue	(12,50,000/10) + 62,500 = 1,87,500
EBIT	Rs.15,00,000
Less: Interest on debt (25 lakh × 0.1)	Rs.2,50,000
EBT	Rs.12,50,000
Less: Tax @40%	Rs.5,00,000
PAT	Rs.7,50,000
EPS (Rs.7,50,000/1,87,500)	Rs.4
DPS Rs.4 ×0.55	Rs.2.2
Price per share	2.2/(0.12-0.06) = Rs.36.67

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68.

Answer : (c)

Reason : Weighted average cost of capital (K_o) = W_e´K_e + W_d ´ K_d ´ (1-T)

13%=0.65´K_e + 0.35´10%´(1-0.4)

K_e = 16.77%

Solve for g: 16.77% = D₁/P₀ + g

0. 1677 = Rs.6/Rs.52 + g

g = 5.23%.

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69.

Answer : (a)

Reason : Weighted average cost of capital = [(0.7)(K_d)(1 - T)] + [(0.3)(K_e)].

By using CAPM equation,

So K_e = 0.0635 + (0.1135 - 0.0635)(1.3585) = 0.1314 = 13.14%.

By substituting these values into the WACC equation and solving

K_o = [(0.7)(0.09)(1 - 0.35)] + [(0.3)(0.1314)] = 0.0804 = 8.04%.

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70.

Answer : (c)

Reason : Two year note:

= 50,000 (1+r)² = 59,405

By simplification, r= 9%

Coupon bond = 973.97 = 85/(1+r) +1,085/(1+r)²

By simplification, r= 10%

Less expensive debt instrument is two year note, since it’s cost is 1% lower thant that of coupon bond.

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71.

Answer : (c)

Reason : The present earnings of the firm may be ascertained as follows:

12% return on fixed assets	Rs. 1,20,000
2% return on current assets	4,000
Total Return	1,24,000
Total Assets	Rs. 12,00,000
Rate of return (Earnings/Total assets)	10.33%
Ratio of current assets to total assets (2,00.,000/12,00,000)	16.7%

Evaluation of effect on Liquidity and Profitability:

	Present CA	Increase in CA
Current Assets	Rs. 2,00,000	Rs. 2,50,000
Fixed assets	10,00,000	9,50,000
Return on fixed assets @ 12%	1,20,000	1,14,000
Return on current assets @2%	4,000	5,000
Total return	1,24,000	1,19,000
Ratio of CA to TA	16.7%	20.8%
Current liabilities	1,00,000	1,00,000
Ratio of CA to CL	2	2.5
Return as a % of TA	10.33%	9.92%

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72.

Answer : (d)

Reason : Operating ycle of XYZ Ltd.

1. Raw material

2. Work-in-progress

3. Finished Goods

4. Debtors

The credit allowed by Creditors = 16 days

TOCP = RMCP+WPCP+FGCP+RCP

= 26.55 + 12.775 + 9.04 + 10.95 = 50.315 Days

NOC = TOCP-DP

= 50.315-16 = 43.3 Days

Therefore, the firm has a NOC of 43.3 Days.

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73.

Answer : (c)

Reason : The EPS of the firm is Rs. 10(i.e., Rs. 2,00,000/20,000). The P/E Ratio is given at 12.5 and the cost of capital, k_e, may be taken at the inverse of P/E ratio, Therefore, k_e is 8 (i.e., 1/12.5). The firm is distributing total dividends of Rs.. 1,50,000 among 20,000 shares, giving a dividend per share of Rs. 7.50. The value of the share as per Walter’s model may be found as follows:

= Rs. 132.81

If P/E is 8, instead of 12.5 the k_e = 1/8 = 12.5%.

Here k_e > r.

\The optimum D/P ratio is 100%

P = = Rs.80

Change in the price of the share = Rs.80 – Rs.132.81 = –Rs.52.81

There (c) is the answer.

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