FM & Int Fin-Compodium

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First Edition : May 2011
Published :
Directorate of Studies
The Institute of Cost and Works Accountants of India
12, Sudder Street, Kolkata-700 016
Printed at :
Repro India Limited
50/2, T.T.C. MIDC Industrial Area, Mahape, Navi Mumbai - 400 710.
Copyright of this Compendium is reserved by the Institute of Cost and

Works Accountants of India and prior permission from the Institute is
necessary for reproduction of the whole or any part thereof.
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Question 8
C developed original specification of a product and founded C Manufacturing Ltd. In 2009 the firm
manufactured 980 Nos. at an average price of ` 900 each. In 2010 due to continuous price rise of the
inputs, he raised his prices at an average of 12%, since he knew he could sell his plants full capacity of
980 Nos. per year. In spite of price rise for the product, which sold for over ` 1,000 for the first time,
C was surprised to learn in late 2010 (as may be seen from the financial statements) that C
Manufacturing Ltd. show a decline in earnings and still worse, decline in cash flow.

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produced by one of its existing manufacturing process to be converted into a marketable product. At
present, the waste is removed by a contractor for disposal on payment by the company of ` 50 lakhs
per annum for the next four years. The contract can be terminated upon installation of the aforesaid
machine on payment of a compensation of ` 30 lakhs before the processing operation starts. This
compensation is not allowed as deduction for tax purposes.
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(i) Construct a decision tree for the proposed investment project.
(ii) What net present value will the project yield if worst outcome is realized?
probability of occurrence of this NPV?
(iii) What will be the best and the probability of that occurrence?
(iv) Will the project be accepted?
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(ii) If the worst outcome is realized the Net present value which the project will yield is
` 8,111 (negative). The probability of occurrence of this Net present value is 8%.
(iii) The best outcome will be path 6 when Net present value is higher i.e. ` 10,703 (positive).
The probability of occurrence of this Net present value is 6%.
(iv) Yes, the project will be accepted since the Expected Net present value probability sum
total is positive.
(b) In most of the situations the Net present value method (NPV) and Profitability Index (PI) yield
same accept or reject decision. In general terms, under PI method a project is acceptable if
profitability index value is greater than 1 and rejected if it is less than 1. Under NPV method a
project is acceptable if Net present value of a project is positive and rejected if it is negative.
Clearly a project offering a profitability index greater than 1 must also offer a net present value
which is positive. But a conflict may arise between two methods if a choice between mutually
exclusive projects has to be made. Consider the following example:
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* 25% of total cost i.e.
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6,58,950
Costs
Materials (i)
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Cutting (ii)
62,500
1,01,700
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1,25,000
1,73,730
(2,500 dresses ` 50)
Total costs : (B) = [(i) + (ii) + (iii)]
7,37,500
9,34,380
Operating profit : (A) (B)

2,62,500
3,76,800
Others (iii)
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40 - ` 10

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3,52,00,000

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Path No.

50,000
Joint probability
Year 1 x year 2
24,000
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32,000
0.12
44,000
0.20
40,000
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60,000
50,000
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^ W s Ws /

Y
&
`d

&&d
&&
Z

>

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d^
100 .35
1

(1.12)
100 .35
1

(1.12) 2
100 .35
1

(1.12)3
/
z
W
Ws

Therefore 3.2401 x = 215.94 OR x = ` 66.6460 lakhs

Year-wise lease rentals:
` in lakhs
Year 1
3 66.6460 lakhs
= 199.938
2 66.6460 lakhs
= 133.292
1 66.6460 lakhs
= 66.6460
Question 29
ABC Ltd. is considering a proposal to acquire a machine costing ` 1,10,000 payable ` 10,000 down and
balance payable in 10 annual equal instalments at the end of each year inclusive of interest chargeable at
15%. Another option before it is to acquire the asset on a lease rental of ` 15,000 per annum payable at
the end of each year for 10 years. The following information is also available.
d^`
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z
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d
>
EWs

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EWs

Z

z
E
Ws&
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>
E
0.8929
0.7972
0.7117
= 0.8504,
= 0.7231,
= 0.6148
1.05
1.1025
1.1576
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ts

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512.25
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d`d
`d

z

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&D/&

tE
W
`
W
>d
W

E
E.P.S. =
` 10,96,875
1,00,000
W^`
D`
Hence, P/E =
` 109.70
` 10.97
= 10

W
W
`

>
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`
W`
Rate of return EBIT =

`
` `
` 20 lakhs 100
` 42 lakhs
` 18 lakhs 100
` 32 lakhs
= 56.25%
= 47.6% W
/`
`
`
>/`
/`
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&D/&
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>d
W
E

E.P.S. =
` 13,21,125
` 1,00,000
= ` 13.21
W`
Z
`

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/ ` d
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>/
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` 14,38,125
E.P.S. =
= ` 13.07
1,10,000
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&

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h
d
K
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=
=
` 20 lakhs
` 37.50 lakhs

=
Secured loans

Share Capital + Reserves and surplus
Secured loans + Proposed debentures

Share Capital + Reserves and surplus
` 20 lakhs + ` 16 lakhs
` 37.50 lakhs
Y
d D ` d
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` ` d
` ` `
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d`
d`
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`
`
`
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(15% on ` 7,50,000)
`

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1,90,000
1,45,000
1,05,000

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Z
W

t

t
t

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^
W

Z
W

>
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&D/&
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<
Ke =
Dividend per share

+ Growth rate
Market price per share
10
+ 0.06
110
Z<
Revised K e =
12
+ 0.06
105

Y
,

> ` `
&
Kd`
Zd`
E``d
,
/`
` /d d
firm estimates even higher sales and profits in future years.
d

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d`
,
`d
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,
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/
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Z

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^È`
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d`
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625
lakhs 100 = 28.41%
2,200
W
^`K`/`
Z
Operating income
180
100 = `
lakhs 100 = 20%
investment
900

>D
W
` no. of shares to be issued

Or K e =
` 900 lakhs
i.e. 18 lakhs
` 50
15
= 3%, pre - tax cost = 7.5%
5
Div.

P0
t

W
W
<

Ke =
1.50

50

&D/&
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^

`
`
`

>/`

`
`
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W

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D
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` 700 + ` 900
``
` 700

^
` 2,200 + ` 900
` 2,200 + ` 900

/
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`
` `
`

&D/&
`
`
`

>/`
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>d
W

W
E

`

`
700 + 500
1,200
lakhs = `
lakhs = 38.7% (less than 40%)
2,200 + 900
3,100
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`d

Y
`d

d
`
` `
`
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d
d
h
market price ranges for the next three years. The historical data and the projections of the treasurer

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d ^ / ^

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&W

t

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/

d
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^
`

E
`
` 10 crores
` 400
``
`
E
` 10 crores
` 980
= 1,02,000 (rounded off)
``
`
E
` 10 crores
` 980
= 1,02,000 (rounded off)

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^ ^

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t

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d

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`

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t
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d
>d
d
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E
E

W^`
Z
Z

&D/&
^
1st year earnings after tax + 3 years Earnings after tax (1 - Dividend payout) No. of years

2
No new venteure =
` 3.52 crores + ` 4.353 crores
` 4.527 crores + ` 5.608crores
Issue of equity shares =
60% 3 years
Issue of convertible debetures =
Issue of warrant debt =
60% 3 years
`
` 4.2215 crores + ` 5.608 crores
60% 3 years `

` 4.2215 crores + ` 5.621crores
`
60% 3 years
`
^

`
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t
K
E
K
E
K
E
K
E

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&D/&
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^

^
s`
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d

`
=
=
=
=
EBIT

Debt +Market vlaue of equity shares
` 7.15 crores
( ` 9 crores + ` 3 crores) + (10 lakhs shres ` 450)
` 7.15 crores

12
crores
+ ` 45 crores
`
` 7.15 crores
` 57 crores

ZK/
^ ZK/
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`
D`

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/
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/
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/

&W
/
&W
/
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t

/
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d ,>> ` d
Income before tax + Bond Interest

remains greater than 4.
Bond Interest
Pre - tax interest coverage
E

d,>>```

^&
t

> Z
E

&D/&
Income before tax + Bond Interest

Pre - tax interest coverage
remains greater than 4.
Bond Interest
2 crores / (1 - 0.4) + 8 crores 0.1 + x 0.1

(8 crores 0.1) (x 0.1)
Or
Or
` 3.33 crores + 0.80 crores + 0.10x
(0.80 crores + ` 0.10x)
4.13 crores + 0.10x

` 0.80 crores + ` 0.10x
K```
K```
K`
K
`
K
`
`

E

i.e.
` 30 crores + 0.5x
=2
` 8 crores + x
``
``
or x =
` 14 crores
1.5

E`

i.e.
` 8 crores + x
` 40 crores
<5
``
`
^`

E^

&D/&
,

&
`

Y
^>
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`
Wd
`
&
`

Degree of combined leverage =
% change in Earning per share (EPS)

% change in sales
or Degree of operating leverage Degree of financial leverage =
or 1.625 3.5 (Refer to working notes (i) and (ii) =

or 5.687 =

% change in sales

5

5
W^
tE
Degree of operating leverage (DOC) =

=
( ` 1,120 + ` 700 lakhs)

` 1,120 lakhs
Degree of financial leverage (DOF) =

Contribution

EBIT
EBIT

PBT
` 1,120
` 320

&D/&
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yz > d
yz>
/

d
d
d
d
d
d

d
K
D
(Beta D ) + E (Beta E )
D+E
D+E
Beta A =

d
/ZW

x=
10
= 16.67 per cent
0.6

rA =
D
E
rEd +
rE
D+E
D+E
KZ rE =
.20 - .05
= .30 or 30%.
.5

&D/&
d
/ Z W
Risk Premium =
20
= 16.67%
1.2
d
d W^

E
/d
/
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d
E
E

E

WZ
Z
dW^
d

Y
`/
/ K

d
W^``
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&D/&
d
Perpetual growth model Formula : P0 =
Dividend

Ke - g
P0 =
9.00

0.18 - 0.09
W`
^
,t
d
'

`
Z
W

W^
`
`

`
`

t
D+
Vc =
Ra
(E - D)
Rc

Rc
t
s DW
Z Z
Z

&D/&
,
Vc =
9.00 +
.15
(22.50 - 9.00 )
.18

.18
20.25

.18
`
Y

W

E
D
p = equity
+ debt
D + E
D + E

ZZZZZZ
Question 14
A Ltd. is an all equity Financed Company. The current market price of share is ` 180. It has just paid
a dividend of ` 15 per share and expected future growth in dividend is 15%. Currently, it is evaluating
a proposal requiring funds of ` 20 lakhs, with annual inflows of ` 12 lakhs for 3 years. Find out the
Net Present Value of the proposal, if (i) It is financed from retained earnings; and (ii) It is financed by
issuing fresh equity at market price with a floatation cost of 5% of issue price.

EWs
&&Z
Z
Expected dividend at the end of the year
100 + Growth Rate of Dividend
Current Market Price of Share
` 15 + 2.25
100 + 15% = 24.58%
` 180

&D/&
EWsWE&
z

`

&&
D1
Cost of Equity =
100 + Growth Rate
P0 (1 - floatation cost)
+ 15 % = 25.09%
` 180 (1 - .05)
` 15 + 2.25
EWsW

z

EWs
E
`

,

Y
d ^ > `
d``
W^`/
Z
W^
K>

E^`
/d`
ROI =
EBIT
3.6
100 =
100 = 20%
Capital Employed
10 + 2 + 6

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/

d

>d
d
>W

^
Z
^W
^ZKW
^ZK
d
^
W

t

W^

d
Degree of Financial Leverage =
EBIT

EBIT - Interest - Preference dividend
3.6
= 1.4754
3.6 - .9 - .26
>&>K>
3 = 1.4754 DOL or DOL =
3

1.4754

&D/&
Y
dd``&

DzdD
YTM =
Coupon + Pro - rated disc.

(Redemption price + Purchase Price)/2

`
`
YTM =
6.3 + (13.5/5 )
9.00
or
= 9.30%
(103.5 + 90)/2 96.75

Question 17
M/s Transindia Ltd. is contemplating calling ` 3 crores of 30 years, ` 1,000 bond issued 5 years ago
with a coupon interest rate of 14 per cent. The bonds have a call price of ` 1,140 and had initially
collected proceeds of ` 2.91 crores due to a discount of ` 30 per bond. The initial floating cost was `
3,60,000. The Company intends to sell ` 3 crores of 12 per cent coupon rate, 25 years bonds to raise
funds for retiring the old bonds. It proposes to sell the new bonds at their par value of ` 1,000. The
estimated floatation cost is ` 4,00,000. The company is paying 35% tax and its after tax cost of debt
is 8 per cent. As the new bonds must first be sold and their proceeds, then used to retire old bonds,
the company expects a two months period of overlapping interest during which interest must be paid
on both the old and new bonds. What is the feasibility of refunding bonds?

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EWs
ZZEWs

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>
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d

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d
d

E
/
>

d

&D/&
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& `
maturity with YTM at 16% payable annually and duration 4.3202 years . Given 1.16 = 2.4364.

1.16
0.16
1.16 + 6(c 0.16)
c (c 1.16 ) 1 + 0.16
6
1.16 + 6c 0.96
= 2.9298
1.4364 c + 0.16

d``
Y
D

Z

Z
d

He is considering to invest in AA rated, `1,000 face value bond currently selling at `1,025.86. The bond
has five years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The next interest
payment is due one year from today and the bond is redeemable at par. (Assume the 364 day T-bill rate
to be 9%). You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invest in the
bond? Also calculate the current yield and the Yield to Maturity (YTM) of the bond.

dDZ

PVIF 14%
TIME
CF
PV (CF)
1
150
0.877
131.55
2
150
0.769
115.35
3
150
0.675
101.25
4
150
0.592
88.80
5
1150
0.519
596.85
PV (CF)

i.e.
W

&D/&
^D
/W
dzdD

WWs/&Ws/&
= 150 2.855 + 1150 0.497

W
zdD

Y
d
&
`
Z

zD

Z
`
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t

D
Discount or premium
Coupon interest +
Years left

YTM =
Face Value + Market value
2
zdD&s
>
(1,000 - x)
160 +

0.17 =
1,000 + x
2
`

&D/&

Ws/&Ws/&

z

Ws
160
W

W

.624
99.84
0.104
0.312

s
Volatility of the bonds =
4.236
Duration

=
(1 + yields) 1.17

d
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,
d
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:

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Interest : 11.50% P.A. =
11.50 90

365
,
2.836
` 5 crores `
100 + 2.836
E
``
`
Y
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:
td

D:``

&``
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`
20,00,000
(Refer to working note) `
1.0199452
`

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91
Interest on ` 1 for 91 days ` 0.08

365
d `
Y
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`
d

&

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&
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`
&
` 70,40,000 18 90
Interest =
100 360
`

`
```
&&
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`
d
E&``
` 9,27,200 100

67,23,200
`

`

Ed

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d
default. The factor has agreed to pay money due after 60 days and will take the responsibility of
d
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^

d
`
^

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d
`

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d

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d
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d

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&
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` 792000

&

d

E` `

Ed

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Y
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^
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& `
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D`
dW
K
* 25,20,000
2,000
30,000

>
#32,88,000
6,000
42,000

^
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Zt

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t
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Zt
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&&
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`

` 86,40,000
52 weeks
4 weeks `
&
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^
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` 1 63,20,000

8 weeks
52 weeks

`
`
`

W

`
```
Zt

` 9304615
52 weeks

4 weeks
`

>

``
Zt

1

2
`

` 31,80,000
1
1 weeks
52 weeks
2
`

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W^
`
Z

K

d

W

^

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dd

&
d
d

d`
d
dz
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t
`

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&
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` 90,00,000
1.5 weeks
52 weeks
Et>
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`

`

`
`
`
`

d`

d^
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`

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yz > /

tt

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K
Z
K
&
d

K

d

`

`
K
`
^
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d
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`

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tWW
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t
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1
`
12

1
`
12
&

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2

12
2

12
d

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1

12

1

12

E

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t

>

DW&

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d``
`

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>
>>
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Y
dDEW>
^
D

t
D
`
`
`
`

d
`

^ W
`

d
/
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^
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dD

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^
d

d`

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Z
D`
&
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t`

d>
`

t> ` `

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Y

Z

K
d
W
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d
d

d
d

`
Z
Wt

t

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//
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1,30,000 ` 100
52

t/W/ 1,30,000
0.80 212.50
52
&

1,30,000 212.50
52

/
3 4
1,30,000 212.50
4 52

/

&D/&

>

1,30,000 100
52

1,30,000 37.50
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KDWE/hD

First Edition : May 2011

Copyright of this Compendium is reserved by the Institute of Cost and

Pay back period =

Cost of the project

Profitability index (PI) =

Discounted cash inflows

Discounted cash inflows

^ Square of the deviation probabilit y

Discounted cash inflow

90,000 + 3,60,000 4,50,000

P.V. of cash inflow

  d

432 = ` 576 lakhs

= ` 4,280 per student.

(2,500 dresses ` 25)

(Refer to working note 4)

(2,500 dresses ` 50)

(Refer to working note 5)

Total costs : (B) = [(i) + (ii) + (iii)]

Operating profit : (A) (B)

407.36 crores - ` 400 crores

Cash inflow available for equity shareholders

No. of rides DD sell last year =

Total Sales of rides last year

Price - indfference point =

Break even point =

Here equity = 1.5 assets = equity

company assets = 1.5

8,00,000 `

Depreciation: ` 22,00,000 10,00,000/3 = ` 4,00,000 p.a.

Therefore 3.2401 x = 215.94 OR x = ` 66.6460 lakhs

Rate of return EBIT =

Secured loans + Proposed debentures

Dividend per share

` no. of shares to be issued

= 1,02,000 (rounded off)

= 1,02,000 (rounded off)

` 3.52 crores + ` 4.353 crores

` 4.527 crores + ` 5.608crores

Issue of equity shares =

Issue of convertible debetures =

Issue of warrant debt =

` 4.2215 crores + ` 5.608 crores

60% 3 years `

` 4.2215 crores + ` 5.621crores

( ` 9 crores + ` 3 crores) + (10 lakhs shres ` 450)

Income before tax + Bond Interest

Pre - tax interest coverage

Income before tax + Bond Interest

2 crores / (1 - 0.4) + 8 crores 0.1 + x 0.1

` 3.33 crores + 0.80 crores + 0.10x

(0.80 crores + ` 0.10x)

4.13 crores + 0.10x

Degree of combined leverage =

% change in Earning per share (EPS)

or Degree of operating leverage Degree of financial leverage =

or 1.625 3.5 (Refer to working notes (i) and (ii) =

% change in Earning per share (EPS)

% change in Earning per share (EPS)

% change in Earning per share (EPS)

( ` 1,120 + ` 700 lakhs)

Degree of financial leverage (DOF) =

Perpetual growth model Formula : P0 =

FM & Int Fin-Compodium

FM & Int Fin-Compodium

KDWE/hD

^ Square of the deviation probabilit y

d

` no. of shares to be issued

` `

< &

^ ` `