Financial Management (MB211): July 2005

Section A : Basic Concepts (30 Mars)

! "#is section consists o$ %uestions &it# serial num'er 1 ( 30)
! Ans&er all %uestions)
! *ac# %uestion carries one mar)
! Ma+imum time $or ans&ering Section A is 30 Minutes)
1) ,#ic# o$ t#e $ollo&ing is true-
(a) *$$ecti.e rate o$ interest is al&ays lo&er t#an t#e nominal interest rate
(') "#e e$$ecti.e rate o$ interest increases &it# increase in t#e $re%uency o$
compoun/ing
(c) "#e nominal interest rate increases &it# increase in t#e $re%uency o$ compoun/ing
(/) "#e e$$ecti.e an/ nominal interest rates are e%ual i$ t#e $re%uency o$ compoun/ing is
less t#an
$our
(e) "#e $re%uency o$ compoun/ing /oes not a$$ect t#e e$$ecti.e an/ nominal interest
rates)
0 Ans&er 1
2) ,#o among t#e $ollo&ing players in t#e international capital marets collect t#e rupee
/i.i/en/s on t#e
un/erlying s#ares an/ repatriate t#e same to t#e /epository in 2S /ollars3$oreign e%uity-
(a) 4ea/ Managers (') 2n/er&riters
(c) Custo/ians (/) Corporate 'orro&ers (e)
4en/ers)
0 Ans&er 1
3) ,#ic# o$ $ollo&ing statements are true regar/ing issuance o$ Commercial 5aper (C5)-
6) "#ey normally #a.e a 'uy'ac $acility)
66) Corporate nee/ prior appro.al o$ 7B6 $or C5 issue)
666) C5s are issue/ in multiples o$ 7s)1 la#)
68) 2n/er&riting o$ a C5 issue is not man/atory)
(a) Bot# (6) an/ (66) a'o.e (') (6)9 (66) an/ (666) a'o.e
(c) Bot# (6) an/ (666) a'o.e (/) Bot# (6) an/ (68) a'o.e
(e) All (6)9 (66)9 (666) an/ (68) a'o.e)
0 Ans&er 1
:) 6n a $ore+ maret i$ an in.estor &ants to #e/ge #is $ore+ payments an/ #a.e minimum
ris9 &#ic# o$ t#e
$ollo&ing s#oul/ t#e in.estor pre$er-
(a) Sell t#e $ore+ $utures
(') *nter into a $or&ar/ contract to purc#ase t#e re%uire/ $ore+
(c) *nter into a call option to purc#ase t#e re%uire/ $ore+
(/) Buy $ore+ $utures
(e) *nter into a put option to sell t#e re%uire/ $ore+)
0 Ans&er 1
5) All ot#er t#ings 'eing t#e same9 &#ic# o$ t#e $ollo&ing &ill result in an increase in
stoc price-
6) "#e $irm;s 'eta /ecreases)
66) "#e $i+e/ assets increase)
666) "#e retention ratio increases)
68) <et pro$it margin /ecreases)
(a) =nly (6) a'o.e (') =nly (66) a'o.e
(c) =nly (666) a'o.e (/) Bot# (6) an/ (68) a'o.e
(e) (6)9 (66) an/ (666) a'o.e)
0 Ans&er 1
>) 7ecently t#e 7e'el Furniture Company #as 'een $acing pro'lems) As a result9 its
$inancial situation #as
/eteriorate/) 7e'el approac#e/ t#e C#arminar Ban $or a loan9 'ut t#e loan o$$icer
insiste/ t#at t#e
current ratio (currently 0)?) 'e impro.e/ to at least close to 1)0 'e$ore t#e 'an &oul/
e.en consi/er
maing t#e loan) ,#ic# o$ t#e $ollo&ing actions &oul/ 'e t#e most appropriate to
impro.e t#e ratio in
t#e s#ort run an/ &oul/ liely 'e t#e least costly to 7e'el-
(a) 2sing some cas# to pay o$$ some long(term an/ s#ort(term lia'ilities
0 Ans&er 1
(') 5urc#asing some a//itional ra& materials on cre/it t#ere'y creating an a//itional
accounts
paya'le
(c) 5aying o$$ some notes paya'le &it# cas# to re/uce t#e $irm;s /e't
(/) Selling some $i+e/ assets $or cas#
(e) Collect some current accounts recei.a'le)
?) "#e tra/ers in a $utures e+c#ange9 &#o ten/ to carry positions $or longer perio/ o$
time are no&n as
(a) 5osition tra/ers (') @ual tra/ers (c) Scalpers (/) Ae/gers (e) Floor 'roers)
0 Ans&er 1
B) Ao& can in.estors re/uce t#e .aria'ility o$ returns in t#eir in.estment port$olio-
6) By a//ing per$ectly correlate/ securities to t#eir port$olio)
66) By a//ing securities to t#eir port$olio t#at are not per$ectly correlate/)
666) By a//ing some mutual $un/s to t#eir port$olio)
(a) =nly (6) a'o.e (') =nly (66) a'o.e
(c) =nly (666) a'o.e (/) Bot# (66) an/ (666) a'o.e
(e) All (6)9 (66) an/ (666) a'o.e)
0 Ans&er 1
C) ,#ic# o$ t#e $ollo&ing 'on/s &ill #a.e t#e greatest percentage increase in .alue i$ all
interest rates
/ecrease 'y 1 percent-
(a) 20(year9 Dero coupon 'on/ (') 10(year9 Dero coupon 'on/
(c) 20(year9 10 percent coupon 'on/ (/) 20(year9 5 percent coupon 'on/
(e) 10(year9 5 percent coupon 'on/)
0 Ans&er 1
10) 6$ t#e stoc;s current 53* ratio e+cee/s t#e e+pecte/ 53*9 t#en &#ic# o$ t#e $ollo&ing
statements is3are
true-
6) Stoc is o.erprice/)
66) 6t is time to 'uy t#e stoc)
666) "#e stoc is correctly price/)
(a) =nly (6) a'o.e (') =nly (66) a'o.e
(c) =nly (666) a'o.e (/) Bot# (66) an/ (666) a'o.e
(e) Bot# (6) an/ (66) a'o.e)
0 Ans&er 1
11) 6$ t#e net present .alue (<58) o$ an in.estment is positi.e9 t#e impact on Bene$it
Cost 7atio (BC7)9 <et
Bene$it Cost 7atio (<BC7)9 6nternal 7ate o$ 7eturn (677) an/ cost o$ capital (E) &oul/
'e
(a) 677 F E an/ <BC7 1 1 (') 677 F E an/ BC7 1 1
(c) 677 1 E an/ <BC7 1 1 (/) 677 1 E an/ BC7 1 1
(e) <BC7 1 BC7 an/ E 1 677)
0 Ans&er 1
12) ,#ic# o$ t#e $ollo&ing is a $eature o$ secure/ premium notes (S5<)-
(a) 6t is a in/ o$ non(con.erti'le /e'enture &it# an attac#e/ &arrant
(') 6t is con.erti'le /e'enture &it# options
(c) "#e &arrants attac#e/ to t#e S5< gi.es t#e #ol/er t#e rig#t to apply $or one
pre$erence s#are
(/) 6t is partly con.erti'le /e'enture &it# attac#e/ &arrants
(e) 6t is an e+ample o$ participating pre$erence s#ares)
0 Ans&er 1
13) ,#ic# o$ t#e $ollo&ing is $alse regar/ing pri.ate placement o$ securities-
(a) 6t in.ol.es selling out a signi$icant portion o$ securities to an in.estor or a group o$
in.estors
(') 5ri.ate placement is ma/e &it# a .ie& to mae a pu'lic issue &it#in an agree/ time
$rame
(c) 6t in.ol.es $e&er proce/ural /i$$iculties
(/) 6t ena'les t#e companies to #a.e $aster access to $un/s
(e) 5ri.ate placement is not restricte/ to e%uity only)
0 Ans&er 1
1:) "#e term Gagency costs; in t#e conte+t o$ capital structure means
(a) "#e commission paya'le 'y a company to its purc#asing agents
(') "#e commission paya'le 'y a company to its selling agents
(c) "#e e+penses incurre/ in /istri'ution o$ t#e pro/ucts o$ t#e company
(/) "#e costs on account o$ restricti.e co.enants impose/ on a company 'y its len/ers
(e) "#e /i.i/en/s pai/ 'y a company to its s#are#ol/ers)
0 Ans&er 1
15) ,#en #ig# /egree o$ uncertainty is associate/ &it# t#e $uture cas# $lo&s o$ a $irm 0
Ans&er 1
(a) "#e $irm s#oul/ in.est all t#e cas# in e%uity s#ares
(') "#e $irm s#oul/ maintain a/e%uate cas# 'alance or #a.e an o.er/ra$t arrangement
&it# a 'an
(c) "#e $irm s#oul/ postpone t#e loan repayments &#ic# $all /ue a$ter t#e current perio/
(/) "#e $irm s#oul/ mae less cas# sales
(e) "#e $irm s#oul/ maintain #uge cas# 'alance an/ #a.e an o.er/ra$t arrangement &it#
a 'an)
1>) ,#ic# o$ t#e $ollo&ing proHects &ill you select t#at &ill gi.e t#e ma+imum
a/.antage to t#e $irm-
(a) 5roHect GA; &#ic# #as a positi.e internal rate o$ return
(') 5roHect GB; &#ic# #as a <et Bene$it Cost 7atio less t#an one 'ut more t#an Dero
(c) 5roHect GC; &#ic# #as a cost o$ capital #ig#er t#an t#e internal rate o$ return
(/) 5roHect G@; &#ic# #as t#e #ig#est annual capital c#arge compare/ to all ot#er proHects
(e) Bot# (c) an/ (/) a'o.e)
0 Ans&er 1
1?) ,#ic# o$ t#e $ollo&ing &ill cause a /ecrease in t#e net operating cycle o$ a $irm-
(a) 6ncrease in t#e a.erage collection perio/
(') 6ncrease in t#e a.erage payment perio/
(c) 6ncrease in t#e $inis#e/ goo/s storage perio/
(/) 6ncrease in t#e ra& materials storage perio/
(e) 6ncrease in t#e &or(in(progress perio/)
0 Ans&er 1
1B) ,#en t#e realiDe/ yiel/ approac# is applie/ $or $in/ing out t#e cost o$ e%uity capital9
one o$ t#e implicit
assumptions is t#at
(a) 7etaine/ earnings #a.e no cost
(') "#e e%uity s#are#ol/ers re%uire a premium o.er t#e return re%uire/ 'y 'on/#ol/ers
(c) "#e e%uity s#are#ol/ers re%uire a premium o.er t#e return re%uire/ 'y pre$erence
s#are#ol/ers
(/) "#e e%uity s#are#ol/ers re%uire a premium o.er t#e ris($ree rate o$ return
(e) "#e e%uity s#are#ol/ers &ill continue to e+pect t#e same returns $rom t#e s#are as in
t#e past)
0 Ans&er 1
1C) ,#ic# o$ t#e $ollo&ing can 'e sai/ to 'e a spontaneous source o$ $inancing current
assets-
(a) Accrue/ &ages an/ salaries (') Commercial paper
(c) 5u'lic /eposits (/) Cas# cre/it (e) "erm loan)
0 Ans&er 1
20) ,#ic# o$ t#e $ollo&ing is3are true regar/ing aggressi.e approac# to in.estment in
current assets-
(a) "#e in.estment in current assets $or a gi.en le.el o$ sales $orecast &ill 'e #ig#er
(') A company $ollo&ing t#is approac# is su'Hecte/ to a #ig#er /egree o$ ris t#an a
company
$ollo&ing conser.ati.e approac#
(c) "#e turno.er o$ current assets &ill 'e less
(/) "#e current assets un/er t#is approac# are generally $inance/ 'y long(term sources
(e) "#e current ratio in t#is approac# is generally #ig#)
0 Ans&er 1
21) ,#ic# o$ t#e $ollo&ing statements is true &it# respect to t#e ABC system o$
in.entory management-
(a) "#e GA; category items are t#ose &#ic# #a.e t#e lo&est rupee in.estment
(') Category GA; items are t#ose &#ic# #a.e t#e #ig#est rupee in.estment
(c) Category GA; items are t#ose &#ic# #a.e t#e least count in terms o$ num'ers
(/) 2nit cost un/er category GA; item is .ery costly
(e) 2nit cost un/er category GA; item is .ery c#eap)
0 Ans&er 1
22) Consi/er t#e $ollo&ing
=pening stoc o$ $inis#e/ goo/s F 7s)29B29000
Closing stoc o$ $inis#e/ goo/s F 7s)29509000
Cost o$ pro/uction F 7s)591>9B00
Selling a/ministration an/ $inancial e+pen/itureF 7s) 29C50
Custom an/ e+cise /uty F 7s) 59000
Finis#e/ goo/s storage perio/ (in /ays) $or t#e company assuming 3>0 /ays in a year is
(a) 3C /ays (') 153 /ays (c) 1?2 /ays (/) 1C2 /ays (e)
3>5 /ays)
0 Ans&er 1
23) 6$ t#e cum(rig#t price per s#are is 7s):B9 t#e t#eoretical .alue o$ t#e rig#t is 7s)2 an/
su'scription price
at &#ic# t#e rig#ts are issue/ is 7s)2> per s#are9 t#e num'er o$ e+isting s#ares re%uire/
$or a rig#t s#are
is
0 Ans&er 1
(a) 5 (') 10 (c) 15 (/) 20 (e)
25)
2:) "#e operating e+posure
(a) 7epresents t#e e+posure t#at arises $rom t#e nee/ o$ a $irm to con.ert .alues o$
$oreign currency
/enominate/ assets an/ lia'ilities into /omestic currency .alues
(') 7epresents t#e e+posure t#at arises $rom $oreign currency /enominate/ transactions
&#ic# a $irm
is committe/ to complete
(c) 7epresents t#e e+posure o$ current pro$its o$ a $irm to t#e mo.ements in e+c#ange
rates
(/) 7epresents a notional e+posure9 as t#ere is no real gain or loss arising out o$
e+c#ange rate
mo.ements
(e) Arises out o$ t#e economic conse%uences o$ e+c#ange rate mo.ement on t#e .alue o$
a $irm)
0 Ans&er 1
25) ,#ic# o$ t#e $ollo&ing is a part o$ t#e $inancing /ecision o$ a company-
(a) 5rocuring ne& mac#ineries $or t#e 7 I @ acti.ities
(') Spen/ing #ea.ily $or t#e a/.ertisement o$ t#e pro/uct o$ t#e company
(c) A/opting state(o$(t#e(art tec#nology to re/uce t#e cost o$ pro/uction
(/) 5urc#asing a ne& 'uil/ing at @el#i to open a regional o$$ice
(e) @esigning an optimal capital structure 'y using suita'le $inancial instruments)
0 Ans&er 1
2>) 6$ a security;s return is plotte/ a'o.e t#e security maret line9 t#en
(a) "#e ris $ree rate is e%ual to t#e re%uire/ rate o$ return on t#e security
(') "#e security;s rate o$ return is more t#an t#e return on t#e maret port$olio
(c) "#e security;s 'eta is less t#an one an/ #ence it is a conser.ati.e security
(/) "#e security is sai/ to 'e o.er.alue/
(e) "#e security is to 'e 'oug#t imme/iately)
0 Ans&er 1
2?) ,#ic# o$ t#e $ollo&ing are not a source o$ long(term $inance-
(a) *%uity s#ares (') @e'entures
(c) 5re$erence s#ares (/) Commercial papers
(e) 7eser.es an/ surplus)
0 Ans&er 1
2B) ,#ic# o$ t#e $ollo&ing issues is consi/ere/ un/er tec#nical aspects o$ proHect
appraisal-
(a) 5ast an/ present consumption tren/s
(') A.aila'ility o$ t#e re%uire/ %uality an/ %uantity o$ ra& materials an/ ot#er inputs
(c) 6mpact o$ t#e proHect on t#e /istri'ution o$ income in t#e society
(/) 5rice an/ cross(elasticity o$ /eman/
(e) 5ro/uction constraints)
0 Ans&er 1
2C) ,#ic# o$ t#e $ollo&ing &ill /ecrease &it# an increase in t#e interest rate-
(a) Future 8alue 6nterest Factor
(') Future 8alue 6nterest Factor $or Annuity
(c) Capital 7eco.ery Factor
(/) 5resent 8alue 6nterest Factor $or a 5erpetual Annuity
(e) 6n.erse o$ 5resent 8alue 6nterest Factor $or Annuity)
0 Ans&er 1
30) ,#ic# o$ t#e $ollo&ing is an assumption in t#e economic or/er %uantity mo/el-
(a) Carrying cost per unit increases as t#e num'er o$ units or/ere/ increases
(') @eli.ery o$ t#e material taes place &it#in a certain time as t#e or/er is place/
(c) 5urc#ase price per unit o$ t#e ra& material increases as t#e num'er o$ units or/ere/
/ecreases
(/) =r/ering cost is constant
(e) 6n.entory le.el /uring t#e year .aries as per t#e 'oom p#ase an/ recessionary p#ase
in 'usiness)
0 Ans&er 1
*<@ =F S*C"6=< A
Section B : 5ro'lems (50 Mars)
"#is section consists o$ %uestions &it# serial num'er 1 J 5)
Ans&er all %uestions)
Mars are in/icate/ against eac# %uestion)
@etaile/ &orings s#oul/ $orm part o$ your ans&er)
@o not spen/ more t#an 110 ( 120 minutes on Section B)
1) "#e e%uity s#ares o$ Cargil 6n/ustries 4t/)9 a $oo/ processing company9 are presently
tra/ing at 7s)C> per s#are)
"#e company #as recently pai/ a /i.i/en/ o$ 7s)3)00 per s#are) A security analyst #as
proHecte/ t#e $ollo&ing
in$ormation $or t#e ne+t year:
Kou are re%uire/ to
a) Fin/ out t#e e+pecte/ return an/ ris $or t#e e%uity s#ares o$ t#e company)
') Fin/ out t#e e+pecte/ return an/ ris $or t#e maret)
(5 L : F C mars) 0 Ans&er 1
2) Sonal *nterprises 4t/) (S*4)9 a tra/ing concern9 #a/ t#e $ollo&ing receipts o$ an item9
co/e/ "F059 o.er t#e last
%uarter:
"#e opening 'alance o$ t#e item in January &as 7s)5:9000 an/ t#e closing 'alance o$ t#e
item in Marc# &as
7s)C09000) "#e purc#ase price o$ t#e item is 7s)1B per unit an/ t#e carrying cost is 25M
o$ t#e a.erage in.entory
.alue per annum) "#e cost $or placing an or/er is $i+e/ an/ it is 7s)C00 per or/er) "#e
purc#ase price per unit o$ t#e
item #as not c#ange/ in t#e last %uarter an/ it is not e+pecte/ to c#ange in t#e ne+t si+
mont#s9 &#ic# is t#e
planning perio/) "#eir supplier9 7e//y 6n/ustries 4t/) (764)9 #as o$$ere/ a /iscount o$
2)5M on or/er siDes o$ >9000
units an/ a'o.e) 6t is assume/ t#at t#e /eman/ $or t#e item is e.enly /istri'ute/ o.er t#e
entire year)
Kou are re%uire/ to $in/ out t#e $ollo&ing:
a) "#e economic or/er %uantity o$ t#e item)
') "#e optimal or/er siDe $or t#e item) Clearly s#o& t#e rele.ant costs an/ 'ene$its
in.ol.e/) 6gnore ta+es)
(5 L ? F 12 mars) 0 Ans&er 1
3) "#e e%uity capitaliDation rate o$ Ayus#i 6n/ustries 4t/) is 12 percent) "#e company #as
509000 s#ares outstan/ing
&#ic# #a.e a maret price o$ 7s)200 eac#) "#e company e+pects a net income o$
7s)?9009000 at t#e en/ o$ one year
an/ plans to /eclare a /i.i/en/ o$ 7s)> per s#are at t#at time) "#e company also plans to
in.est 7s)109009000 in a
proHect a$ter one year) 6t is assume/ t#at t#e assumptions un/erlying t#e Mo/igliani(
Miller mo/el on /i.i/en/
policy are applica'le)
Kou are re%uire/ to s#o& t#at t#e Mo/igliani(Miller mo/el on /i.i/en/ policy #ol/s
goo/ irrespecti.e o$ &#et#er
/i.i/en/s are pai/ or not)
(C mars) 0 Ans&er 1
:) Mr) 5ras#ant is planning to purc#ase a #ouse &#ic# costs 7s)B9009000) Ae #as
contacte/ t&o #ousing $inance
companies .iD9 Metro Aousing Finance 4t/) (MAF4) an/ <ort#ern Finance Company
4t/) (<FC4)) MAF4 #as
o$$ere/ 100M $inancing $or a perio/ o$ ? years) Mr) 5ras#ant #as to repay t#e loan along
&it# interest in e%uate/
mont#ly installments o$ 7s)1B9500 eac#9 paya'le at t#e en/ o$ e.ery mont# o.er a perio/
o$ ? years)
<FC4 #as o$$ere/ to pro.i/e C0M $inance $or a perio/ o$ B years) Mr) 5ras#ant #as to
'ring in 10M o$ t#e cost o$
t#e #ouse at t#e time o$ purc#ase) Ae &ill 'orro& t#e amount o$ #is contri'ution $rom
one o$ #is relati.es an/ &ill
pay 'ac #is relati.e 7s):09000 an/ 7s)509000 (&#ic# inclu/e t#e amount 'orro&e/ an/
t#e interest) at t#e en/ o$
t#e $irst year an/ t#e secon/ year respecti.ely) "#e amount 'orro&e/ $rom <FC4 #as to
'e repai/ along &it#
interest in e%uate/ mont#ly installments o$ 7s)129B00 eac#9 paya'le at t#e en/ o$ e.ery
mont# o.er a perio/ o$ B
years)
Kou are re%uire/ to $in/ out t#e e$$ecti.e rates o$ interest $or 'ot# t#e $inancing
alternati.es an/ a/.ise Mr) 5ras#ant
accor/ingly)
Scenario =ptimistic <ormal 5essimistic
5ro'a'ility 30M :0M 30M
5roHecte/ s#are price 7s)110)00 7s)105)00 7s)CC)00
5roHecte/ /i.i/en/ 7s):)00 7s)3)00 7s)3)00
5roHecte/ maret return 15M 12M BM
Mont# January Fe'ruary Marc#
7eceipts (7s)) >39000 ?29000 B19000
Suggeste/ Ans&ers
Financial Management (MB211): July 2005
Section A : Basic Concepts
(11 mars) 0 Ans&er 1
5) Central 6n/ustries 4t/) (C64) is consi/ering in.esting in a lat#e mac#ine) "#ere are
t#ree mac#ines o$$ere/ 'y
t#ree /i$$erent manu$acturers) "#e price %uotations an/ operational costs $or t#e t#ree
mac#ines are gi.en 'elo&:
"#e cost o$ capital $or t#e company is 15M)
Kou are re%uire/ to $in/ out t#e mac#ine t#at s#oul/ 'e selecte/ $or in.estment 'y C649
using a suita'le appraisal
criterion)
(C mars) 0 Ans&er 1
*<@ =F S*C"6=< B
Section C : Applie/ "#eory (20 Mars)
"#is section consists o$ %uestions &it# serial num'er > ( B)
Ans&er all %uestions)
Mars are in/icate/ against eac# %uestion)
@o not spen/ more t#an 25 (30 minutes on section C)
>) Brie$ly e+plain t#e .arious sources o$ ris to any $inancial asset
(> mars) 0 Ans&er 1
?) Brie$ly e+plain t#e p#enomena o$ o.ertra/ing an/ un/ertra/ing in t#e conte+t o$
&oring capital
management an/ t#e precautionary measures $or pre.enting t#e same)
(? mars) 0 Ans&er 1
B) @iscuss t#e signi$icance o$ collection program in t#e management o$ recei.a'les)
(? mars) 0 Ans&er 1
*<@ =F S*C"6=< C
*<@ =F N2*S"6=< 5A5*7
Manu$acturers
*astern *ngineering
4t/)
(**4)
,estern *ngineering 4t/)
(,*4)
Sout#ern 6n/ustries
4t/)
(S64)
Cost o$ mac#ine (7s)) B9009000 129009000 1B9009000
Annual cost o$ operations
(7s)) 19>09000 19209000 19009000
2se$ul li$e (years) 5 B 10
1) Ans&er : (')
7eason : "#e interest rate usually speci$ie/ on an annual 'asis in a loan agreement or
security is no&n as t#e nominal rate o$ interest) 6$ compoun/ing is /one
more t#an once a year9 t#e actual rate o$ interest pai/ (or recei.e/) is calle/
0 "=5
1
e$$ecti.e interest rate) *$$ecti.e interest rate &oul/ 'e #ig#er t#an t#e nominal interest
rate)
"#e e$$ecti.e rate o$ interest increases &it# increase in t#e $re%uency o$
compoun/ing) For e+ample9 t#e e$$ecti.e rate o$ interest un/er %uarterly
compoun/ing &ill 'e more t#an t#e e$$ecti.e rate o$ interest un/er semiannual
compoun/ing) Aence option (') is correct)
2) Ans&er : (c)
7eason : Custo/ians #ol/ t#e un/erlying s#ares an/ collect rupee /i.i/en/s on t#e
un/erlying s#ares an/ repatriate t#e same to t#e /epository in 2S
/ollars3$oreign e%uity)
Aence (c) is t#e ans&er)
4ea/ managers un/ertae acti.ities lie preparation o$ o$$er circular9
mareting t#e issues etc)
2n/er&riters o$ t#e issue 'ear interest rate or maret riss mo.ing against
t#e issuer 'e$ore t#ey #a.e place/ 'on/s or /epository receipts)
0 "=5
1
3) Ans&er : (/)
7eason : C5s are normally issue/ in multiples o$ 7s)5 la#s) Aence9 666 is not true) "#e
issuance o$ C5s /oes not re%uire t#e appro.al o$ 7B6) Aence9 66 is not true)
2n/er&riting o$ a C5 issue is not man/atory an/ t#e issuers generally #a.e a
'uy 'ac $acility) Aence9 6 an/ 68 are true an/ t#e ans&er is (/))
0 "=5
1
:) Ans&er : (c)
7eason : Call option is a contract t#at con$ers t#e rig#t9 'ut not an o'ligation to t#e
#ol/er to 'uy an un/erlying asset at a price agree/ on a speci$ic /ate or 'y a
speci$ic e+piry /ate) 6n t#e gi.en case9 t#e in.estor is intereste/ to #e/ge #is
$ore+ payments an/ #a.e a minimum ris position) Aence9 it is 'etter $or #im
to enter into a call option to purc#ase t#e re%uire/ $ore+ at an agree/ price on
t#e e+pecte/ $uture /ate) "#us i$ t#e e+c#ange rate 'e#a.es against t#e
e+pectation t#e in.estor s#all not e+ercise #is rig#t an/ t#e loss t#at &ill 'e
incurre/ &ill 'e only t#e premium pai/ 'y #im to t#e &riter o$ t#e option)
Aence9 t#e ans&er is (c))
"#oug# payment can 'e #e/ge/ t#roug# purc#asing t#e $ore+ $utures or entering
into a $or&ar/ contract to purc#ase9 t#ere is no /o&nsi/e limit to t#e loss t#at
can 'e incurre/
0 "=5
1
5) Ans&er : (a)
7eason : 6ncrease in stoc price is /irectly relate/ to /i.i/en/s (or /ecrease in
retention ratio) an/ /ecrease in re%uire/ rate o$ return (or /ecrease in 'eta))
Aence9 6 &ill increase t#e stoc price &#ile 66 /oes not /etermine t#e stoc
price an/ 666 /ecreases t#e stoc price) "#e correct ans&er is (a))
0 "=5
1
>) Ans&er : (')
7eason : "o impro.e t#e current ratio 7e'el Furniture Company is e.aluating t#e
$ollo&ing alternati.es:
(i) 2sing some cas# to pay o$$ some long term an/ s#ort term lia'ilities J
6t &ill $urt#er /eteriorate t#e current ratio as t#e amount o$ current assets
re/uce/ is more t#an t#e amount o$ current lia'ilities)
(ii) 5urc#asing some a//itional ra& materials on cre/it an/ t#ere'y creating
an a//itional accounts paya'le J Current assets an/ current lia'ilities
increase 'y same amount an/ as t#e e+isting ratio is less t#an t#e one t#e
increase in t#e 'ot# t#e components &ill impro.e t#e current ratio)
(iii) 5aying o$$ some notes paya'le &it# cas# J Current assets an/ current
lia'ilities &ill /ecrease 'y t#e same amount an/ as t#e e+isting ratio is
less t#an one t#e /ecrease in 'ot# t#e components &ill $urt#er re/uce t#e
current ratio)
(i.) Selling $i+e/ assets $or cas# J "#is &ill /e$initely impro.e t#e current
ratio)
(.) Collect some accounts recei.a'le J "#e components o$ t#e current assets
&ill c#ange 'ut t#is &ill not c#ange t#e current ratio)
0 "=5
1
Aence9 o$ t#e $i.e alternati.es9 ii an/ i. &ill impro.e t#e current ratio 'ut ii is
least costly an/ t#e ans&er is ('))
?) Ans&er : (a)
7eason : "#e tra/ers in a $utures e+c#ange9 &#o ten/ to carry positions $or longer
perio/s are no&n as Gposition tra/ers;)
0 "=5
1
B) Ans&er : (e)
7eason : 8aria'ility o$ returns o$ a port$olio is re/uce/ 'y a//ing securities to t#e
port$olio) "#e re/uction &oul/ 'e more i$ t#e securities #a.e negati.e
correlation) Aence9 all t#e t#ree statements are true an/ t#e ans&er is (e))
0 "=5
1
C) Ans&er : (a)
7eason : 4onger t#e term to maturity9 #ig#er &ill 'e t#e price c#ange) =$ t#e 20(year
Dero coupon 'on/ an/ 10(year Dero coupon 'on/9 price c#ange is #ig# in case
o$ 20 year 'on/) Smaller t#e coupon rates #ig#er are t#e price c#ange &it# a
c#ange in K"M) Aence9 o$ (a)9 (c) an/ (/)9 t#e c#ange in price is #ig#er in
case o$ (a))
0 "=5
1
10) Ans&er : (a)
7eason : 6$ t#e e+pecte/ 53* e+cee/s t#e current 53*9 t#e stoc is sai/ to 'e currently
o.erprice/ an/ it is time to sell t#e stoc) Aence9 only 6 is correct)
0 "=5
1
11) Ans&er : (/)
7eason : ,#en <58 is positi.e 9t#e 6nternal rate o$ return is greater t#an t#e cost o$
capital an 'ene$it cost ratio is greater t#an 1) Aence option (/) is correct)
,#en <58 is positi.e 677 cannot 'e e%ual to cost o$ capital) An/ <BC7 is
not greater t#an 1)cost o$ capital is not greater t#an 677) "#ere$ore option (a)9
(')9(c)an/ (e) are incorrect)
0 "=5
1
12) Ans&er : (a)
7eason : S5< is a in/ o$ non(con.erti'le /e'enture &it# an attac#e/ &arrant) 6t is
neit#er a con.erti'le or partly con.erti'le /e'enture nor any option can 'e
attac#e/ to it) "#e &arrants attac#e/ to t#e S5< /oes not gi.es #ol/ers t#e
rig#t $or t#e pre$erence s#ares) 6t is also not an e+ample o$ participating
pre$erence s#ares) "#ere$ore only option (a) is correct) 7est is incorrect)
0 "=5
1
13) Ans&er : (')
7eason : 5ri.ate placement o$ securities in.ol.es selling out a signi$icant portion o$
securities to an in.estor or a group o$ in.estor an/ 6t in.ol.es $e&er
proce/ural /i$$iculties) 6t ena'les t#e companies to #a.e $aster access to
$un/s) 5ri.ate placement is not restricte/ to e%uity only it can 'e $or any ot#er
in/ o$ securities) But pri.ate placements are not ma/e &it# a .ie& to mae
pu'lic issue) Aence ' is t#e ans&er)
0 "=5
1
1:) Ans&er : (/)
7eason : Agency cost are cost on account o$ restriction impose/ 'y cre/itors on t#e
$irm in t#e $orm o$ some protecti.e co.enants) Commission paya'le 'y t#e
company to its purc#asing an/ selling agents9 t#e e+penses incurre/ in
/istri'ution o$ t#e pro/ucts o$ t#e company9 or t#e /i.i/en/s pai/ 'y t#e
company /oes not come un/er t#e agency cost)
0 "=5
1
15) Ans&er : (')
7eason : 6n.esting all cas# in s#ares &oul/ 'e more risier) 5ostpone o$ loan
repayment an/ maing less cas# sales is also /angerous) "#e $irm s#oul/
eit#er maintain a/e%uate cas# 'alance or #a.e an o.er/ra$t arrangement &it#
a 'an) "#e $irm s#oul/ not eep #uge cas# 'alance as i/le)
0 "=5
1
1>) Ans&er : (')
7eason : 5roHect B &ill gi.e t#e ma+imum a/.antages to t#e $irm &#ic# #as a <et
'e$it cost ratio is less t#an 1 'ut more t#an Dero) So proHect GB; s#oul/ 'e
selecte/) "#e 677 o$ t#e proHect s#oul/ 'e #ig#er t#an t#e cost o$ capital)
5roHect GC; is opposite to t#at) So it s#oul/ not 'e selecte/) 5roHect GA; #as a
positi.e 677) 6t is not clear &#et#er it is more t#an or less t#an t#e cost o$
capital o$ t#e proHect) So it s#oul/ not 'e selecte/) For t#e selection annual
capital c#arge s#oul/ 'e lo&est9 'ut in case o$ proHect G@; it is #ig#est
0 "=5
1
compare/ to ot#er pro/ucts) So it s#oul/ not 'e selecte/) Aence option G'; is correct)
1?) Ans&er : (')
7eason : 6ncrease in t#e a.erage collection perio/9 increase in t#e $inis#e/ goo/s
storage perio/9 increase in t#e ra& materials storage perio/ an/ increase in t#e
&or(in process perio/ all result in increasing t#e operating cycle o$ t#e
$irm) =nly increase in t#e a.erage payment perio/ /ecreases t#e net operating
cycle o$ t#e $irm) Aence option (') is correct)
0 "=5
1
1B) Ans&er : (e)
7eason : 6n t#e realiDe/ yiel/ approac# one o$ t#e implicit assumptions is t#at t#e
e%uity s#are#ol/ers &ill continue to e+pect t#e same returns $rom t#e s#are as
in t#e past) Aence option (e) is t#e correct ans&er)
0 "=5
1
1C) Ans&er : (a)
7eason : Spontaneous lia'ilities generally occur /uring t#e normal course o$ 'usiness
operations &#ere a company &ill usually #a.e a rea/y access to certain
sources $or $inancing its current assets) But a company is re%uire/ to tae
proper initiati.e $or t#e sources o$ $inance as mentione/ in t#e ot#er options
to $inance its current assets)
0 "=5
1
20) Ans&er : (')
7eason : 6n aggressi.e approac# company generally su'Hecte/ to #ig#er /egree o$ ris
t#an t#e company $ollo&ing conser.ati.e approac#) Aence option (') is
correct) "#e turno.er o$ current asset &ill 'e #ig#) "#e current assets un/er
t#is approac# is generally not $inance/ 'y long term sources) "#e in.estment
in current assets $or a gi.en le.el o$ sales $orecast is not #ig#)
0 "=5
1
21) Ans&er : (')
7eason : Category GA; items are t#ose &#ic# #a.e t#e #ig#est rupee in.estment) 6t
/oes not necessary t#at per unit cost un/er category GA; item s#oul/ 'e .ery
costly or .ery c#eap) 6t is also not necessary t#at category GA; items s#oul/
least count in terms o$ num'ers) Aence option (') is t#e correct ans&er)
0 "=5
1
22) Ans&er : (c)
7eason : A.erage stoc o$ $inis#e/ goo/s F
F 7s)29>>9000
Cost o$ sales F =pening stoc o$ $inis#e/ goo/s L Cost o$ pro/uction L
Selling a/ministration o$ $inancial e+pen/iture L Custom
an/ *+cise /uly J Closing stoc o$ limite/ goo/s)
F 29B29000 L 591>B00 L 29C50 L 59000 J 29509000
F 7s)595>9?50
@aily cost o$ sales F F 15:>)52
"#e $inis#e/ goo/s storage perio/
F
F F 1?2 /ays)
7s)29B29 000 29 509 000
2
L
595>9?50
3>0
A.erage stoc o$ $inis#e/ goo/s
@aily cos t o$ sales
29 >>9 000
15:>)52
0 "=5
1
23) Ans&er : (')
7eason : "#eoretical .alue o$ rig#t F
=r 2 F
=r 2< L 2 F22
o 5 S
< 1
O
L
:B 2>
< 1
O
L
0 "=5
1
=r 2< F 20
< F 10
2:) Ans&er : (')
7eason : =perating e+posure is a result o$ economic conse%uences rat#er t#an
accounting conse%uences o$ e+c#ange rate mo.ements on t#e .alue o$ a
$irm)
0 "=5
1
25) Ans&er : (e)
7eason : An optimal capital structure can satis$y t#e return e+pectations o$ t#e
stae#ol/ers at a lo&er cost t#at &ill result in s#are price o$ t#e company to a
#ealt#ier one) 6t is a $inancing /ecision) ,#ile t#e cases mentione/ in t#e
ot#er alternati.es are t#e in.estment /ecisions as t#ese may 'ring return to t#e
company o.er a perio/ o$ time)
0 "=5
1
2>) Ans&er : (e)
7eason : 6$ a security;s return plots a'o.e t#e security maret line (SM4) t#en t#e
return on t#e security is more t#an t#e re%uire/ rate o$ return on t#e security
accor/ing to t#e SM4) A greater return means a lesser price o$ t#e security
t#an its intrinsic .alue t#at implies t#e security is un/er price/ an/ #ence t#at
s#oul/ 'e 'oug#t imme/iately to 'oo pro$it in $uture as its price increases)
0 "=5
1
2?) Ans&er : (/)
7eason : Commercial papers are issue/ $or a perio/ o$ 15 /ays to one year 'y t#e
repute/ companies to $inance t#eir &oring capital re%uirements) *%uity
capital an/ reser.es an/ surplus are perpetual capital &it# an in$inite maturity
perio/ &#ile pre$erence s#ares an/ /e'entures are generally issue/ $or a long
term) Aence9 (/) is t#e ans&er)
0 "=5
1
2B) Ans&er : (')
7eason : 5ast an/ present consumption tren/s9 5rice an/ cross(elasticity o$ /eman/
an/ pro/uction constraints are t#e issues to 'e consi/ere/ maret aspects o$
proHect appraisal) 6mpact o$ t#e proHect on t#e /istri'ution o$ income in t#e
society is issue to 'e consi/ere/ un/er economic aspects o$ proHect appraisal)
A.aila'ility o$ t#e re%uire/ %uality an/ %uantity o$ ra& materials an/ ot#er
inputs is t#e issue relating tec#nical aspects o$ proHect appraisal) Aence
alternati.e (') is t#e ans&er)
0 "=5
1
2C) Ans&er : (/)
7eason : 5resent .alue $actor $or a perpetual annuity F )
Aence it /ecreases &it# an increase in t#e interest rate) Aence (/) is t#e
correct option)
Future 8alue 6nterest Factor F )
Aence it increases &it# increase in t#e interest rate)
Future 8alue 6nterest Factor For Annuity (F86FA) F ) F86FA
also increases &it# increase in t#e interest rate)
Capital 7eco.ery Factor F ) 6t is t#e in.erse o$ 586FA9 &#ic#
/ecreases &it# increase in interest rate) "#ere$ore9 Capital 7eco.ery Factor
increases &it# increase in t#e interest rate)
6n.erse o$ 586FA is capital reco.ery $actor9 &#ic# increases &it# increase in
t#e interest rate)
Aence9 options (a)9 (')9 (c) an/ (e) are incorrect)
1
i
(1L i)n
(1 i)n 1
i
L O
n
n
i(1 i)
(1 i) 1
L
L O
0 "=5
1
30) Ans&er : (/)
7eason : "#e assumptions o$ t#e economic or/er %uantities are as $ollo&s:
0 "=5
1
! Constant or uni$orm /eman/ o$ t#e pro/uct t#roug#out t#e year
! Constant unit price o$ t#e ra& material
! Constant carrying cost o$ t#e material
! Constant or/ering cost
! 6nstantaneous /eli.ery o$ t#e materials)
! Aence9 t#e option (/) is t#e correct c#oice)
Section B : 5ro'lems
1) a)
*+pecte/ rate o$ return $rom t#e s#are F Ppii
F 1B)?5 (0)30) L 12)5 (0):0) L >)25 (0)30)
F 12)5M
7is $or t#e s#are F
F Q(1B)?5 J 12)50)2 (0)30) L (12)50 J 12)50)2 (0):0) L (>)25 J 12)50)2 (0)30)R132
F Q11)?1C L 0 L 11)?1CR132
F :)B:M
') *+pecte/ return $rom t#e maret F Ppim
F 15 (0)30) L 12 (0):0) L B (0)30)
F 11)?0M
7is $or t#e maret9 Sm F QPpi (m ( )2R132
F Q(15 J 11)?0)2 (0)30) L (12 J 11)?0)2 (0):0) L (B J 11)?0)2 (0)30)R132
F Q3)2>? L 0)03> L :)10?R132
F (?):1)132 F 2)?2M)
0 "=5 1
2) a) *conomic or/er %uality (*=N) F
2sage (2) /uring t#e planning perio/:
2sage in t#e last %uarter F =pening 'alance L "otal receipts J closing 'alance
F 5:9000 L (>39000 L ?29000 L B19000) J C09000
F 7s)1B09000)
2sage in t#e last %uarter (in units) F F 109000 units
2sage (2) in t#e planning perio/ o$ ne+t si+ mont#s F 109000 T 2 F 209000 units
Fi+e/ cost per or/er9 F F 7s)C00 (gi.en)
2nit price 5 F 7s)1B (gi.en)
Carrying cost $or t#e entire year F 25M
Carrying cost $or t#e planning perio/ o$ si+ mont#s9 C F F 12)5M
*conomic or/er %uantity (*=N) F
F :9000 units
Scenario =ptimistic <ormal 5essimistic
5roHecte/ rate o$ return
F
1
5
@ 5
0
1 1 O
L
F 0)1B?5
1
C>
110 : L O
F 0)125
1
C>
105 3 L O
F 0)0>25
1
C>
CC 3 L O
i)e)9 1B)?5M i)e)9 12)5M >)25M
5ro'a'ility 0)30 0):0 0)30
Q 2 R13 2
Ppi (i O )
m
5)C
2F2
1B
1B09000
2
25
1B (0)125)
2TC00T 209000
') 4et t#e *=N 'e /enote/ as NU an/ let t#e minimum re%uire/ or/er siDe $or getting t#e
/iscount 'e /enote/
)
<et incremental 'ene$it9 VW F 2@ L F (
NU F :000 units ($rom a'o.e)
F >000 units (gi.en)
@iscount per unit9 @ F 5rice per unit T 5ercentage o$ /iscount
F F 7e) 0):5
@iscount earne/ o.er t#e entire planning perio/ F 2@ F 209000 T 0):5 F 7s)C9000
Sa.ings in or/ering cost F F F F 7s)1500
6ncrease in carrying cost F
F
F 7s)20B1)25
<et incremental 'ene$it9 VW F C9000 L 19500 J 20B1)25
F 7s)B:1B)?5 (gain)
"#us &e $in/ t#at t#ere is a gain o$ 7s)B:1B)?5) Aence t#e optimal or/er siDe s#oul/ 'e
>9000 units)
0 "=5 1
3) 8alue o$ t#e $irm &#en /i.i/en/s are pai/:
4et :
5rice per s#are a$ter one year F 51
5rice per s#are no& F 50
@i.i/en/ per s#are a$ter 1 year F @1
50 F &#ere G; is t#e e%uity capitaliDation rate)
=r 200 F
=r 51 F 1)12 T 200 J > F 7s)21B
Since /i.i/en/s &ill 'e pai/ t#e company &ill #a.e to issue ne& s#ares in or/er to raise
t#e amount o$ $un/s use/
in paying /i.i/en/s) 4et n1 an/ 51 'e t#e num'ers o$ s#are to 'e issue/ a$ter one year
an/ 51 'e t#e price per s#are
a$ter 1 year respecti.ely)
Amount to 'e raise/:
n151 F 6n.estment J (*arnings J @i.i/en/s pai/)
F 109009000 J (?9009000 J 509000 T >) F 7s)>9009000


X
X
Y
O
N
2
NU
2


X
X O
Y O
2
NU)5C
2
N (5 @)C
NY
100
1B (2)5)


X
X
Y
O
N
2
NU
2
)C00
>9000
209000
:9000
209000


X
X O


X
X O
Y O
2
NU)5C
2
N (5 @)C
( )
2
(:9000) (1B) (0)125)
2
(>9000) (1B 0):5) 0)125 O
O
1 1 @ 5
1
L
L
1 > 5
1)12
L

<um'er o$ ne& s#ares to 'e issue/ (n1) F
8alue o$ t#e $irm F
F
F 7s)19009009000)
,#ere9 n F <um'er o$ s#ares outstan/ing no&)
8alue o$ t#e $irm &#en /i.i/en/s are not pai/:
5rice per s#are at t#e en/ o$ year 1:
50 F
200 F
51 F 200 T 1)12 F 7s)22:
Amount to 'e raise/ $rom t#e issue o$ ne& s#ares)
n151 F 109009000 J ?9009000 F 7s)39009000
<um'er o$ ne& s#ares to 'e issue/ (n1)F F
8alue o$ t#e $irm F
F
F 7s)19009009000
(&#ere Gn; is t#e num'er o$ s#ares outstan/ing no&)
From a'o.e &e see t#at .alue o$ t#e $irm remains t#e same 'ot# in t#e cases &#en
/i.i/en/s are pai/ an/
/i.i/en/s are not pai/) "#ere$ore it is pro.e/ t#at MM mo/el on /i.i/en/ policy #ol/s
goo/)
0 "=5 1
:) Cost o$ #ouse F 7s)B9009000
Financing 'y MAF4:
4et t#e interest rate per mont# 'e Gr;
<um'er o$ mont#s $or &#ic# payments #a.e to 'e ma/e to MAF4 F ? T 12 F B:
Amount paya'le at t#e en/ o$ e.ery mont# to MAF4 F 7s)1B9500
B9009000 F 1B9500 586FA(r9 B:)
or 586FA F F :3)2:3
For9 r F 1)?M9 586FA F F ::)5:B
>9 009 000
21B
1 1
e
(n n ) 5 6 *
1
L OL
L
>9 009 000
509 000 21B (109 009 000 ?9 009 000)
21B
1)12
X L O O X
1
39 009 000
5
39 009 000
22:
1 1
e
(n n ) 5 6 *
(1 )
L OL
L
39 009000
509 000 22: (109 009 000 ?9 009000)
22:
1)12
X L O O X
X
1B500
B00000
B:
B:
0)01?(1)01?)
(1)01?) O1
For9 r F 1)BM9 586FA F F :3)1:1
r F F 1)?C3M
*$$ecti.e interest rate F (1 L r)12 J 1 F (1)01?C3)12 J 1 F 23)??M p)a) (appro+))
Financing 'y <FC4 an/ relati.e o$ Mr) 5ras#ant :
4et t#e interest rate 'e Gr;)
Amount o$ $inance $rom <FC4 F B9009000 T 0)C0 F 7s)?9209000
Amount o$ $inance $rom relati.e F 7s)B09000
"otal amount o$ $inancing F 7s)?9209000 L 7s)B09000 F 7s)B9009000
Amount paya'le at t#e en/ o$ e.ery mont# to <FC4 F 7s)129B00
<um'er o$ mont#s $or &#ic# payments #a.e to 'e ma/e to <FC4 F B T 12 F C> mont#s
Amount paya'le to relati.e :
At t#e en/ o$ one year (i)e) 12 mont#s) F 7s):09000
At t#e en/ o$ t&o years (i)e) 2: mont#s) F 7s)509000
B9009000 F 129B00 586FA (r9 C>) L
4et r F 1)2M9 7AS F 12B00 T
F 12B00 T 5>)B1B L 3:>>5)2 L 3?552):
F 7s)?9CC9:BB
r F 1)1M 7AS F 12B00 T
F 12B00 T 5C)10: L 350?B)C L 3B:5:)1 F 7s)B300>:)2
r F 1)1 L T (B00000 J B300>:)2) F 1)1CBM
*$$ecti.e interest rate per annum F (1 L r)12 J 1 F (1)011CB)12 J 1 F 0)153> i)e)
15)3>M)
,e $in/ $rom a'o.e t#at i$ Mr) 5ras#ant 'orro&s C0M o$ t#e cost o$ t#e #ouse $rom
<FC4 an/ 'orro&s t#e
remaining amount $rom #is relati.e #e $aces a lesser e$$ecti.e rate o$ interest (15)3>M
per annum ) t#an t#e
e$$ecti.e rate o$ interest (23)??M per annum)#e $aces i$ #e 'orro&s 100M o$ t#e cost o$
t#e #ouse $rom
MAF4) Aence #e s#oul/ 'orro& C0M o$ t#e cost o$ t#e #ouse $rom <FC4 an/ t#e
remaining amount $rom
#is relati.e)
0 "=5 1
5) Supplier: *astern *ngineering 4t/) (**4)
Cost o$ t#e mac#ine F 7s)B9009000
Annual cost o$ operation F 7s)19>09000
"#e present .alue o$ t#e annual cost o$ operation F 7s) 19>09000 T 586FA (15M9 5)
F 7s) 19>09000 T 3)352
F 7s) 593>9320
Aence t#e present .alue o$ costs F 7s) B9009000 L 593>9320 F 7s)1393>9320
"#e annual capital c#arge &ill 'e F 7s)
B:
B:
0)01B(1)01B)
(1)01B) O1
(:3)2:3 ::)5:B)
(:3)1:1 ::)5:B)
(1)B 1)?)
1)? T O
O
O
L
12 (1 r)2:
509000
(1 r)
:09000
L
L
L
C> 12 2:
C>
(1)012)
50000
(1)012)
:0000
0)012(1)012)
(1)012) 1 L L
O
C> 12 2:
C>
(1)011)
50000
(1)011)
:0000
0)011(1)011)
(1)011) 1 L L
O
(?CC:BB B300>:)2)
(1)2 1)1)
O
O
1393>9320
586FA(15M95)
F F 7s)39CB9>>3 (appro+)
Supplier : ,estern *ngineering 4t/) (,*4)
Cost o$ t#e mac#ine F 7s)129009000
Annual cost o$ operation F 7s) 19209000
"#e present .alue o$ t#e annual cost o$ operation F 7s) 19209000 T 586FA (15M9 Byears)
F 7s)19209000 T :):B? F 7s)593B9::0
Aence9 t#e present .alue o$ cost F 7s) 129009000 L 7s) 593B9::0 F 7s)1?93B9::0
"#e annual capital c#arge &ill 'e F F
Supplier: Sout#ern 6n/ustries 4t/) (S64)
Cost o$ t#e mac#ine F 7s) 1B9009000
Annual cost o$ operation F 7s)19009000
"#e present .alue o$ t#e annual cost o$ operations F 19009000 T 586FA (15M910)
F19009000 T 5)01C
F 7s) 59019C00
Aence9 t#e present .alue o$ Costs F 1B9009000 L 59019C00
F 239019C00
"#e annual capital c#arge F F
"#e annual capital c#arge is least $or t#e lat#e mac#ine manu$acture/ 'y ,*4) Aence
lat#e mac#ine
manu$acture/ 'y ,*4 s#oul/ 'e selecte/)
0 "=5 1
Section C: Applie/ "#eory
>) "#e riss &#ic# arise out o$ /i$$erent sources an/ a$$ect in.estments in securities an/
port$olios are gi.en 'elo&:
6nterest 7ate 7is
6nterest rate ris is t#e .aria'ility in a securityZs return resulting $rom c#anges in t#e le.el
o$ interest rates) =t#er
t#ings 'eing e%ual9 security prices mo.e in.ersely to interest rates) "#is ris a$$ects
'on/#ol/ers more /irectly t#an
e%uity in.estors)
Maret 7is
Maret ris re$ers to t#e .aria'ility o$ returns /ue to $luctuations in t#e securities maret)
All securities are
e+pose/ to maret ris 'ut e%uity s#ares get t#e most a$$ecte/) "#is ris inclu/es a &i/e
range o$ $actors
e+ogenous to securities t#emsel.es lie /epressions9 &ars9 politics9 etc)
6n$lation 7is
,it# rise in in$lation t#ere is re/uction o$ purc#asing po&er9 #ence t#is is also re$erre/ to
as purc#asing po&er ris
an/ a$$ects all securities) "#is ris is also /irectly relate/ to interest rate ris9 as interest
rates go up &it# in$lation)
Business 7is
"#is re$ers to t#e ris o$ /oing 'usiness in a particular in/ustry or en.ironment an/ it
gets trans$erre/ to t#e
in.estors &#o in.est in t#e 'usiness or company)
Financial 7is
Financial ris arises &#en companies resort to $inancial le.erage or t#e use o$ /e't
$inancing) "#e more t#e
company resorts to /e't $inancing9 t#e greater is t#e $inancial ris)
4i%ui/ity 7is
"#is ris is associate/ &it# t#e secon/ary maret &#ic# t#e particular security is tra/e/
in) A security &#ic# can
'e 'oug#t or sol/ %uicly &it#out signi$icant price concession is consi/ere/ li%ui/) "#e
greater t#e uncertainty
a'out t#e time element an/ t#e price concession9 t#e greater t#e li%ui/ity ris) Securities
&#ic# #a.e rea/y marets
lie treasury 'ills #a.e lesser li%ui/ity risc)
0 "=5 1
?) =.er(tra/ing an/ 2n/er(tra/ing
1393>9320
3)352
1?93B9 ::0
586FA(15M9B)
7s)1?93B9::0
7s)39B?9 :3C(appro+)
:):B?
F
239019C00
586FA(15M910)
7s)239019C00
7s):95B9>3?(appro+)
5)01C
F
=.er(tra/ing: =.ertra/ing is a situation &#ic# is t#e opposite o$ un/er(tra/ing) "#e
symptoms o$ o.er(tra/ing can
'e notice/ $rom t#e /isproportionately #ig# turno.er o$ assets compare/ to t#e .olume o$
sales) 6n t#e conte+t o$
&oring capital o.er(tra/ing can 'e notice/ $rom #ig# turno.er o$ current assets
compare/ to similar companies)
,#ile increase in t#e turno.er o$ current assets is generally consi/ere/ to 'e a .irtue9
/isproportionately #ig#
turno.er is in/icati.e o$ less amount o$ cas# in.este/ in current assets &#ic# can create
pro'lems o$ li%ui/ity at t#e
time o$ maing payments $or current o'ligations) "#e pro'lem o$ o.er( tra/ing can 'e
restate/ as one o$
un/ercapitaliDation)
5recautionary measures $or o.er(tra/ing can 'e taen 'y initially re/ucing t#e sales to a
le.el commensurate &it#
t#e amount o$ assets an/ a $inal solution lies in increasing t#e asset 'ase t#roug#
a//itional $inances raise/ t#roug#
t#e issuance o$ s#ares an/3or o'taining loan $un/s)
2n/er(tra/ing: A situation o$ un/er(tra/ing arises in a company &#en t#e .olume o$
sales is muc# less t#an t#e
amount o$ assets employe/) "#is 'ecomes apparent &#en t#e per$ormance o$ t#e
company is compare/ against
similar companies) 2n/er(tra/ing also in/icates t#at $un/s o$ t#e company are loce/ up
in current assets resulting
in a lo&er turno.er o$ &oring capital) Anot#er &ay o$ stating un/er(tra/ing is t#at a
company is o.er capitalise/
compare/ to t#e .olume o$ sales) As t#is &oul/ result in lo&er turno.er9 t#e company
#as to tae precautionary
measures suc# as altering capital structure so t#at t#e /e't(e%uity ratio comes /o&n9
#astening t#e collection
process9 re/ucing t#e le.els o$ in.entory to reasona'le le.els compare/ to t#e sales
$orecast an/ pro/uction plans)
2nless t#ese measures are taen9 t#e rate o$ return on e%uity is liely to come /o&n as a
result o$ &#ic# t#e maret
price o$ t#e company can 'e a/.ersely a$$ecte/)
2nless a company taes precautionary measures once it o'ser.es symptoms o$ o.er or
un/er(tra/ing9 it may run
into serious &oring capital pro'lems as outline/ a'o.e)
0 "=5 1
B) Signi$icance o$ collection program in t#e management o$ recei.a'les
"#e collection e$$ort o$ a company is /eci/e/ 'y t#e collection policy9 &#ic# is a part o$
t#e o.erall cre/it policy
o$ t#e company) "#e o'Hecti.e o$ collection policy is to ac#ie.e timely collection o$
recei.a'les9 t#ere'y releasing
$un/s loce/ up in recei.a'les $or a longer perio/ t#an t#ey s#oul/ #a.e 'een un/er t#e
cre/it terms an/ to
minimiDe 'a/ /e't losses)
"#e collection program consists o$ t#e $ollo&ing:
! Monitoring t#e state o$ recei.a'les[
! @espatc# o$ letters to customers &#ose /ue /ate is approac#ing
! "elegrap#ic an/ telep#onic a/.ice to customers aroun/ t#e /ue /ate
! "#reat o$ legal action to o.er/ue accounts
! 4egal action against o.er/ue accounts)
,#ile $ormulating t#e collection policy a company s#oul/ recon &it# t#e $actor t#at a
.ery rigorous collection
policy may act as an irritant to customers9 t#ere'y Heopar/iDing t#e goo/ customer
relations 'uilt o.er t#e years)
Furt#er9 t#e sales o$ t#e company may /ecline as customers &it# some o.er/ues may
$ear to place $urt#er or/ers)
Ao&e.er9 t#e amount o$ recei.a'les an/ 'a/ /e't losses &ill re/uce to a certain e+tent as
t#e company increases
t#e collection e+pense associate/ &it# collection programs)
"#e general pattern o$ t#e relations#ip 'et&een collection e+penses incurre/ an/ 'a/
/e't losses &ill 'e suc# t#at
initial increase may not #a.e percepti'le impact &#ile su'se%uent amounts up to a
certain le.el &ill #a.e a
pronounce/ impact in re/ucing 'a/ /e't losses) "#is is /epicte/ in t#e $orm o$ a grap#
'elo&) "#e amount o$
e+penses incurre/ 'eyon/ t#e saturation point are liely to #a.e .ery little impact on 'a/
/e't losses)
Figure 1 : Be#a.ior o$ 'a/ /e't losses3collection e+penses
Similarly9 /eli'erate la+ity on t#e part o$ t#e company in t#e rigor o$ collection e$$ort is
liely to increase sales9
increase a.erage collection perio/9 increase 'a/ /e't losses an/ to some e+tent re/uce
collection e+penses)
=nce again9 t#e incremental $inancial 'ene$its in t#e $orm o$ t#e cost o$ $un/s release/
'y a re/uction in t#e le.el
o$ recei.a'les an/ t#e re/uction in 'a/ /e't losses #a.e to 'e compare/ &it# t#e
incremental costs associate/ &it#
a//itional collection e+penses an/ policy c#ange is &arrante/ only &#en t#e incremental
net 'ene$its are positi.e)