Chapter 1

No problems, only review questions

Chapter 2
PROBLEMS

1.

Determinethefuturevaluesutilizingatimepreferencerateof9percent:
(i) ThefuturevalueofRs15,000investednowforaperiodoffouryears.
(ii) ThefuturevalueattheendoffiveyearsofaninvestmentofRs6,000nowandofaninvestment
ofRs6,000oneyearfromnow.
(iii) ThefuturevalueattheendofeightyearsofanannualdepositofRs18,000eachyear.
(iv) ThefuturevalueattheendofeightyearsofannualdepositofRs18,000atthebeginningofeach
year.
(v) ThefuturevaluesattheendofeightyearsofadepositofRs18,000attheendofthefirstfour
yearsandwithdrawalofRs12,000peryearattheendofyearfivethroughseven.
2. Computethepresentvalueofeachofthefollowingcashflowsusingadiscountrateof13percent:
(i) Rs2,000cashoutflowimmediately.
(ii) Rs6,000cashinflowoneyearfromnow.
(iii) Rs6,000cashinflowtwoyearsfromnow.
(iv) Rs4,000cashoutflowthreeyearsfromnow.
(v) Rs7,000cashinflowthreeyearsfromnow.
(vi) Rs3,000cashinflowfouryearsfromnow.
(vii) Rs4,000cashinflowattheendofeachofthenextfiveyears.
(viii) Rs4,000cashinflowatthebeginningofeachofthenextfiveyears.
3. DeterminethepresentvalueofthecashinflowsofRs3,000attheendofeachyearfornext4years
andRs7,000andRs1,000respectivelyattheendofyears5and6.Theappropriatediscountrateis14
percent.
4. Assume an annual rate of interest of 15 per cent. The sum of Rs 100 received immediately is
equivalenttowhatquantityreceivedintenequalannualpayments,thefirstpaymenttobereceivedone
yearfromnow.Whatcouldbetheannualamountifthefirstpaymentwerereceivedimmediately?
5. Assumearateofinterestof10percent.WehaveadebttopayandaregivenachoiceofpayingRs
1,000noworsomeamountXfiveyearsfromnow.WhatisthemaximumamountthatXcanbeforus
tobewillingtodeferpaymentforfiveyears?
6. WecanmakeanimmediatepaymentnowofRs13,000orpayequalamountofAforthenext5years,
firstpaymentbeingpayableafter1year.(a)Withatimevalueofmoneyof12percent,whatisthe
maximumvalueofAthatwewouldbewillingtoaccept?(b)WhatmaximumvalueofAwewouldbe
willingtoacceptifthepaymentsaremadeinthebeginningoftheyear?
7. AssumethatyouaregivenachoicebetweenincurringanimmediateoutlayofRs10,000andhavingto
payRs2,310ayearfor5years(firstpaymentdueoneyearfromnow);thediscountrateis11percent.
Whatwouldbeyourchoice?WillyouranswerchangeifRs2,310ispaidinthebeginningofeachyear
for5years?
8. ComputethepresentvalueforabondthatpromisestopayinterestofRs150ayearforthirtyyearsand
Rs1,000atmaturity.Thisfirstinterestpaymentispaidoneyearfromnow.Usearateofdiscountof8
percent.
9. ExactlytwentyyearsfromnowMrAhmedwillstartreceivingapensionofRs10,000ayear.The
paymentwillcontinuefortwentyyears.Howmuchispensionworthnow,assumingmoneyisworth
15percentperyear?
10. Usinganinterestrateof10percent,determinethepresentvalueofthefollowingcashflowseries:
Endofperiod
0
16
7
8
912

(eachperiod)
(eachperiod)

Cashflow(Rs)
10,000
+2,000
1,500
+1,600
+2,500

11. Findtherateofreturninthefollowingcases:
(i) YoudepositRs100andwouldreceiveRs114afteroneyear.

12.
13.
14.
15.
16.

17.
18.

19.
20.

21.

22.

23.
24.

25.

26.

(ii) YouborrowRs100andpromisetopayRs112afteroneyear.
(iii) YouborrowRs1,000andpromisetopayRs3,395attheendof10years.
(iv) YouborrowRs10,000andpromisetopayRs2,571eachyearfor5years.
Abankhasofferedadepositscheme,whichwilltripleyourmoneyin9years;thatis,ifyoudepositRs
100today,youcanreceiveRs300attheendof9years.Whatrateofreturnwouldyouearnfromthe
scheme?
YouhaveRs6,000toinvest.Howmuchwouldittakeyoutodoubleyourmoneyiftheinterestrateis
(a)6%,(b)10%,(c)20%,and(d)30%?Assumeannualcompounding.Wouldyouranswerchangeif
compoundingisdonehalfyearly?Showcomputations.
YouhadannualearningsofRs45,000in19X1.By19X8,yourannualearningshavegrowntoRs
67,550.Whathasbeenthecompoundannualrateofgrowthinyourearnings?
Youareplanningtobuya200squaremetersoflandforRs40,000.Youwillberequiredtopaytwenty
equalannualinstalmentsofRs8,213.Whatcompoundrateofinterestwillyoubepaying?
JaiChandisplanningforhisretirement.Heis45yearsoldtoday,andwouldliketohaveRs3,00,000
whenheattainstheageof60.Heintendstodepositaconstantamountofmoneyat12percentateach
yearinthepublicprovidentfundintheStateBankofIndiatoachievehisobjective.Howmuchmoney
shouldJaiChandinvestattheendofeachyearforthenext15yearstoobtainRs3,00,000attheendof
thatperiod?
(a)Atage20,howmuchshouldoneinvestattheendofeachyearinordertohaveRs10lakhatage
50,assuming10percentannualgrowthrate?(b)Atage20,howmuchlumpsumshouldoneinvest
nowinordertohave10lakhattheageof50,assuming10percentannualgrowthrate?
Yourgrandfatheris75yearsold.HehastotalsavingsofRs80,000.Heexpectsthathewilllivefor
another10years,andwillliketospendhissavingsbythen.Heplaceshissavingsintoabankaccount
earning10percentannually.Hewilldrawequalamounteachyearthefirstwithdrawaloccurring
oneyearfromnowinsuchawaythathisaccountbalancebecomeszeroattheendof10years.How
muchwillbehisannualwithdrawal?
YoubuyahouseforRs5lakhandimmediatelymakecashpaymentofRs1lakh.Youfinancethe
balanceamountat12percentfor20yearswithequalannualinstalments.Howmucharetheannual
instalments?Howmuchoftheeachpaymentgoestowardsreducingtheprincipal?
You plan to buy a flat for Rs 200,000 by making Rs 40,000 down payment. A house financing
companyoffersyoua12yearmortgagerequiringendofyearpaymentsofRs28,593.Thecompany
alsowantsyoutopayRs5,000astheloanprocessingfee,whichtheywilldeductfromtheamountof
loangiventoyou.Whatistherateofinterestonloan?
AninvestmentpromisestopayRs2,000attheendofeachyearforthenext3yearsandRs1,000at
the end of each year for years 4 through 7. (a) What maximum amount will you pay for such
investmentifyourrequiredrateis13percent?(b)Ifthepaymentsarereceivedatthebeginningof
eachyear,whatmaximumamountwillyoupayforinvestment?
MrSundaramisplanningtoretirethisyear.Hiscompanycanpayhimalumpsumretirementpayment
ofRs2,00,000orRs25,000lifetimeannuitywhicheverhechooses.MrSundaramisingoodhealth
andestimatestoliveforatleast20moreyears.Ifhisinterestrateis12percent,whichalternative
shouldhechoose?
Whichalternativewouldyouchoose:(a)anannuityofRs5,000attheendofeachyearfor30years;
(b)anannuityofRs6,600attheendofeachyearfor20years;(c)Rs50,000,incashrightnow?In
eachcase,thetimevalueofmoneyis10percent.
Ms.Punamisinterestedinafixedannualincome.Sheisofferedthreepossibleannuities.Ifshecould
earn8percentonhermoneyelsewhere,whichofthefollowingalternatives,ifany,wouldshechoose?
Why?(i)PayRs80,000nowinordertoreceiveRs14,000attheendofeachyearforthenext10
years.(ii)PayRs1,50,000nowinordertoreceiveRs14,000attheendofeachyearforthenext20
years.(iii)PayRs1,20,000nowinordertoreceiveRs14,000attheendofeachyearforthenext15
years.
Youhavecomeacrossthefollowinginvestmentopportunity:Rs2,000attheendofeachyearforthe
first5yearsplusRs3,000attheendofeachyearfromyears6through9plusRs5,000attheendof
eachyearfromyears10through15.
(a)
Howmuchwillyoubewillingtopayforthisinvestmentifyourrequiredrateofreturnis14
percent?
(b)
Whatwillbeyouranswerifpaymentsarereceivedatthebeginningofeachyear?
YouhaveborrowedacarloanofRs50,000fromyouremployer.Theloanrequires10percentinterest
andfiveequalendofyearpayments.Preparealoanamortisationschedule.

27. Ifthenominalrateofinterestis12percentperannum,calculatetheeffectiverateofinterestwhena
sumiscompounded(a)annually,(b)semiannually,(c)quarterly,and(d)monthly.
28. WhatamountwouldaninvestorbewillingtopayforRs1,000,tenyeardebenturethatpaysRs75
interesthalfyearlyandissoldtoyield18percent?
29. TheMaduraBankpays12percentinterestandcompoundsinterestquarterly.IfoneputsRs1,000
initiallyintoasavingsaccount,howmuchwillithavegrownin7years?
30. AnalreadyissuedgovernmentbondpaysRs50interesthalfyearly.Thebondmaturesin7years.Its
facevalueisRs1,000.Anewlyissuedbond,whichpays12percentannually,canalsobebought.
Howmuchwouldyouliketopayfortheoldbond?Howmuchwouldyoupayforthebondifitis
redeemedatapremiumof10percent?
31. IfyoudepositRs10,000inanaccountpaying8percentinterestperyearcompoundedquarterlyand
youwithdrawRs100permonth,(a)Howlongwillthemoneylast?(b)Howmuchmoneywillyou
receive?
32. XYCompanyisthinkingofcreatingasinkingfundtoretireitsRs800,000preferencesharecapital
thatmatureson31December19X8.Thecompanyplanstoputafixedamountintothefundattheend
ofeachyearforeightyears.Thefirstpaymentwillbemadeon31December19X1,andthelaston31
December 19X8. The company expects that the fund will earn 12 per cent a year. What annual
contributionmustbemadetoaccumulatetoRs8,00,000asof31December19X8?Whatwouldbe
youransweriftheannualcontributionismadeinthebeginningoftheyear,thefirstpaymentbeing
madeon31December19X0?
33. InJanuary19X1,XLtdissuedRs10croreoffiveyearbondstobematuredon1January19X6.The
interest waspayablesemiannuallyonJanuary1andJuly1;theinterestratewas14percentper
annum.Assumethaton1January19X2,newfouryearbondofequivalentriskcouldbepurchasedat
facevaluewithaninterestrateof12percentandthatyouhadpurchasedaRs1,000XLtdbondwhen
thebondswereoriginallyissued.WhatwouldbeitsmarketvalueonJanuary1,19X2?
34. Youwanttobuya285litrerefrigeratorofRs10,000onaninstalmentbasis.Adistributorofvarious
makesofrefrigeratorsispreparedtodoso.Hestatesthatthepaymentswillbemadeinfouryears,
interestratebeing13%.Theannualpaymentswouldbeasfollows:
Rs
Principal

10,000

Fouryearsofinterestat13%,i.e.,
Rs10,0000.134

5,200
15,200

Annualpayments,Rs15,200/4

3,800

Whatrateofreturnthedistributorisearning?
35. YouhaveapproachedaloanandchitfundcompanyforaneightyearloanofRs10,000;paymentsto
thecompanytobemadeattheendofyear.Theloanofficerinformsyouthatthecurrentrateof
interestontheloanis12%andthattheannualpaymentwillbeRs2,013.Showthatthisannualcash
flowprovidesarateofreturnof12%onthebanksinvestmentofRs10,000.Is12%thetrueinterest
ratetoyou?Inotherwords,ifyoupayinterestof12%onyouroutstandingbalanceeachyear,willthe
remainderoftheRs2,013paymentsbejustsufficienttorepaytheloan?
36. IfapersondepositsRs1,000onanaccountthatpayshim10percentforthefirstfiveyearsand13per
centforthefollowingeightyears,whatistheannualcompoundrateofinterestforthe13yearperiod?

Chapter 3
PROBLEMS

1. SupposeyoubuyaoneyeargovernmentbondthathasamaturityvalueofRs1,000.Themarket
interestrateis8percent.(a)Howmuchwillyoupayforthebond?(b)Ifyoupurchasedthebondfor
Rs904.98,whatinterestratewillbeyouearnonyourinvestment?
2. TheBrightwaysCompanyhasaperpetualbondthatpayRs140interestannually.Thecurrentyieldon\
thistypeofbondis13percent.(a)Atwhatpricewillitsell?(b)Iftherequiredyieldrisesto15per
cent,whatwillbethenewprice?
3. TheNutmateLimitedhasatenyeardebenturethatpaysRs140annualinterest.Rs1,000willbepaid
onmaturity.Whatwillbethevalueofthedebentureiftherequiredrateofinterestis(a)12percent,
(b)14percentand(c)16percent?

4. Whatwillbetheyieldofa16percentperpetualbondwithRs1,000parvalue,whenthecurrentprice
is(a)Rs800,(b)Rs1,300or(c)Rs1,000?
5. Youareconsideringbondsoftwocompanies.Taxcosbondpaysinterestat12percentandMaxcos
at6percentperyear.BothhavefacevalueofRs1,000andmaturityofthreeyears.(a)Whatwillbe
thevaluesofbondsifthemarketinterestrateis9percent?(b)Whatwillbethevaluesofthebondsif
themarketinterestrateincreasesto12percent?(c)Whichbonddeclinesmoreinthevaluewhenthe
interestraterises?Whatisthereason?(d)Iftheinterestratefallsto6percent,whatarethevaluesof
bonds?(e)Ifthematurityoftwobondsis8years(ratherthan3years),whatwillbethevaluesoftwo
bondsifthemarketinterestrateis(a)9percent,(b)6percentand(c)12percent?
6. ThreebondshavefacevalueofRs1,000,couponrateof12percentandmaturityof5years.Onepays
interestannually,onepaysinteresthalfyearly,andonepaysinterestquarterly.Calculatethepricesof
bondsiftherequiredrateofreturnis(a)10percent,(b)12percentand(c)16percent.
7. On31March2003,HindTobaccoCompanyissuedRs1,000facevaluebondsdue31March2013.
Thecompanywillnotpayanyinterestonthebonduntil31March2008.Thehalfyearlyinterestis
payablefrom31December2008;theannualrateofinterestwillbe12percent.Thebondswillbe
redeemedat5percentpremiumonmaturity.Whatisthevalueofthebondiftherequiredrateof
returnis14percent?
8. Determinethemarketvaluesofthefollowingbonds,whichpayinterestsemiannually:
Bond
A
B
C
D

9.
10.

11.

12.

13.

14.

15.
16.

InterestRate RequiredRateMaturityPeriod(Years)
16%
14%
12%
12%

15%
13%
8%
8%

25
15
20
10

IftheparvaluesofbondsareRs100andiftheyarecurrentlysellingforRs95,Rs100,Rs110andRs
115,respectively,determinetheeffectiveannualyieldsofthebonds?Alsocalculatethesemiannual
yields?
A20year10%Rs1,000bondthatpaysinteresthalfyearlyisredeemable(callable)intwelveyearsat
abuyback(call)priceofRs1,150.Thebondscurrentyieldtomaturityis9.50%annually.Youare
required to determine (i) the yield to call, (ii) the yield to call if the buyback price is only
Rs1,100,and(iii)theyieldtocallifinsteadoftwelveyearsthebondcanbecalledineightyears,buy
backpricebeingRs1,150.
Afertilizercompanyholds15year15%bondofICICIBankLtd.Theinterestispayablequarterly.
ThecurrentmarketpriceofthebondisRs875.Thecompanyisgoingthroughabadpatchandhas
accumulatedasubstantialamountoflosses.Itisnegotiatingwiththebanktherestructuringofdebt.
Recentlytheinterestrateshavefallenandthereisapossibilitythatthebankwillagreeforreducingthe
interestrateto12percent.Itisexpectedthatthecompanywillbeableservicedebttthereduce
interestrates.Calculatestatedandtheexpectedyieldstomaturity?
YouarethinkingofbuyingBISCOsapreferenceshareRs100parvaluethatwillpayadividendof12
percentperpetually.(a)Whatpriceshouldyoupayforthepreferenceshareifyouareexpectinga
returnof10percent?(b)SupposethatBISCOcanbuybacktheshareatapriceofRs110inseven
years.Whatmaximumpriceshouldyoupayforthepreferenceshare?
TheshareofPremierLimitedwillpayadividendofRs3pershareafterayear.Itiscurrentlysellingat
Rs50,anditisestimatedthatafterayearthepricewillbeRs53.Whatisthepresentvalueoftheshare
iftherequiredrateofreturnis10percent?Shouldthesharebebought?Alsocalculatethereturnon
shareifitisbought,andsoldafterayear.
Aninvestorislookingforafouryearinvestment.TheshareofSkylarkCompanyissellingforRs75.
TheyhaveplanstopayadividendofRs7.50pershareeachattheendoffirstandsecondyearsandRs
9andRs15respectivelyattheendofthirdandfourthyears.Iftheinvestorscapitalisationrateis12
percentandthesharespriceattheendoffourthyearisRs70,whatisthevalueoftheshare?Wouldit
beadesirableinvestment?
AcompanysshareiscurrentlysellingatRs60.Thecompanyinthepastpaidaconstantdividendof
Rs1.50pershare,butitisnowexpectedtogrowat10percentcompoundrateoveraverylongperiod.
Shouldthesharebepurchasedifrequiredrateofreturnis12percent?
Theearningsofacompanyhavebeengrowingat15percentoverthepastseveralyearsandare
expectedtoincreaseatthisrateforthenextsevenyearsandthereafter,at9percentinperpetuity.Itis

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20.

21.

currentlyearningRs4pershareandpayingRs2pershareasdividend.Whatshallbethepresentvalue
ofthesharewithadiscountrateof12percentforthefirstsevenyearsand10percentthereafter?
Acompanyretains60percentofitsearnings,whicharecurrentlyRs5pershare.Itsinvestment
opportunitiespromiseareturnof15percent.Whatpriceshouldbepaidfortheshareiftherequired
rateofreturnis13percent?Whatisthevalueofgrowthopportunities?Whatistheexpectedrateof
returnfromtheshareifitscurrentmarketpriceisRs60?
ThetotalassetsofRs80,000ofacompanyarefinancedbyequityfundsonly.Theinternalrateof
returnonassetsis10percent.Thecompanyhasapolicyofretaining70percentofitsprofits.The
capitalisationrateis12percent.Thecompanyhas10,000sharesoutstanding.Calculatethepresent
valuepershare.
AprospectiveinvestorisevaluatingtheshareofAshokaAutomobilesCompany.Heisconsidering
threescenarios.Underfirstscenariothecompanywillmaintaintopayitscurrentdividendpershare
without any increase or decrease. Another possibility is that the dividend will grow at an annual
(compound)rateof6percentinperpetuity.Yetanotherscenarioisthatthedividendwillgrowata
highrateof12percentperyearforthefirstthreeyears;amediumrateof7percentforthenextthree
yearsandthereafter,ataconstantrateof4percentperpetually.ThelastyearsdividendpershareisRs
3andthecurrentmarketpriceoftheshareisRs80.Iftheinvestorsrequiredrateofreturnis10per
cent,calculatethevalueoftheshareundereachoftheassumptions.Shouldthesharebepurchased?
VikasEngineeringLtdhascurrentdividendpershareofRs5,whichhasbeengrowingatanannual
rateof5percent.Thecompanyisexpectingsignificanttechnicalimprovementandcostreductionin
itsoperations,whichwouldincreasegrowthrateto10percent.Vikascapitalisationrateis15per
cent.Youarerequiredtocalculate(a)thevalueoftheshareassumingthecurrentgrowthrate;and(b)
thevalueoftheshareifthecompanyachievestechnicalimprovementandcostreduction.Doesthe
pricecalculatedin(b)makealogicalsense?Why?
Considerthefollowingdataoffourauto(two/threewheelers)companies.

Companies
1.Bajaj
2.HeroHonda
3.Kinetic
4.MaharashtraScooters

22.
23.

24.

25.

26.

EPS
(Rs)

DIV
(%)

SharePrice
(Rs)

11.9
10.2
12.0
20.1

50
22
25
25

275.00
135.00
177.50
205.00

The face value of each companys share is Rs 10. Explain the relative performance of the four
companies.
ThedividendpershareofSkyjetCompanyhasgrownfromRs3.5toRs10.5overpast10years.The
shareiscurrentlysellingforRs75.CalculateSkyjetscapitalisationrate.
RamaToursandTravelsLimitedhascurrentearningspershareofRs8.60,whichhasbeengrowingat
12percent.Thegrowthrateisexpectedtocontinueinfuture.Ramahasapolicyofpaying40percent
ofitsearningsasdividend.Ifitscapitalisationrateis18percent,whatisthevalueoftheshare?Also
calculatevalueofgrowthopportunities.
Acompanyhasthefollowingcapitalinitsbalancesheet:(a)12year12%secureddebenturesofRs
1,000 each; principal amount Rs 50 crore (10 million = crore); the required rate of return (on
debentures ofsimilarrisk)10per cent; (b)10year 14%unsecured debentures ofRs1,000each;
principalamountRs30crore;interestpayablehalfyearly;therequiredrateofreturn12percent;(c)
preference share of Rs 100 each; preference dividend rate 15%; principal amount Rs 100 crore;
required rate of return 13.5 per cent; and (d) ordinary share capital of Rs 200 crore at
Rs100eachshare;expecteddividendnextyear,Rs12;perpetualdividendgrowthrate8percent;the
requiredrateofreturn15percent.Calculatethemarketvaluesofallsecurities.
SatyaSystemsCompanyhasmadenetprofitofRs50crore.Ithasannouncedtodistribute60percent
ofnetprofitasdividendtoshareholders.Ithas2croreordinarysharesoutstanding.Thecompanys
shareiscurrentlysellingatRs240.Inthepast,ithadearnedreturnonequityof25percentand
expectstomainthisprofitabilityinthefutureaswell.WhatistherequiredrateofreturnonSatyas
share?
AcompanyhasnetearningsofRs25million(1crore=10million).ItspaidupsharecapitalisRs200
millionandtheparvalueofshareisRs10.Ifthecompanymakesnonewinvestments,itsearningsare
expected to grow at 2 per cent per year indefinitely. It does have an investment opportunity of
investingRs10millionthatwouldgenerateannualnetearningsofRs2million(1million=10lakh)

fornext15years.Thecompanysopportunitycostofcapitalis10percent.Youarerequired:( a)to
findtheshare value ifthecompany doesnot make theinvestment; (b)tocalculate the proposed
investmentsNPV;and(c)todeterminethesharevalueiftheinvestmentisundertaken?
27. GujaratBijaliLtdhasearningsofRs80croreandithas5croresharesoutstanding.Ithasaprojectthat
willproducenetearningsofRs20croreafteroneyear.Thereafter,earningsareexpectedtogrowat8
percentperannumindefinitely.Thecompanysrequiredrateofreturnis12.5percent.FindtheP/E
ratio.
28. SymphonyLimitedisanallequityfinancedcompany.Ithas10millionsharesoutstanding,andis
expectedtoearnnetcashprofitsofRs80million.Shareholdersofthecompanyhaveanopportunity
costofcapitalof20percent.(a)Determinethecompanysharepriceifitretained40percentofprofits
andinvestedthesefundstoearn20percentreturn.Willthesharepricebedifferentifthefirmretained
60percentprofitstoearn20percent?(b)Whatwillbethesharepriceifinvestmentsmadebythe
companyearn24percentanditretains40percentofprofits?Willsharepricechangeifretentionis60
percent?
29. SonataCompanyhasnoinvestmentopportunities.ItexpectstoearncashearningspershareofRs10
perpetuallyanddistributeentireearningsasdividendstoshareholders.(a)Whatisthevalueofthe
shareifshareholdersopportunitycostofcapitalis15percent?(b)Supposethecompanydiscoversan
opportunitytoexpanditsexistingbusiness.Itestimatesthatitwillneedtoinvest50percentofits
earningsannuallyfortenyearstoproduce18percentreturn.Managementdoesnotforeseeanygrowth
afterthistenyearperiod.WhatwillbeSonatassharepriceifshareholdersopportunitycostofcapital
is15percent?

Chapter 4
PROBLEMS

1.

2.
3.

4.

5.
6.

7.

On1January2009,MrY.P.Sinhapurchased100sharesofL&TatRs212each.Duringtheyear,he
receivedtotaldividendsofRs700.MrSinhasoldallhissharesatRs215eachon31December2009.
Calculate Mr Sinhas (i) capital gain amount, and (ii) total return in (a) rupee amount and (b)
percentage.
TheclosingpriceofsharelastyearwasRs50.ThedividendpersharewasRs5duringtheyear.The
currentyearclosingpriceisRs57.Calculatethepercentagereturnontheshare,showingthedividend
yieldandthecapitalgainrate.
YouacquiredTelcos200sharesatRs87eachlastyear.TheparvalueofashareisRs10.Telcopaid
adividendof15percentduringtheyear.Yousold200sharesatatotalvalueofRs18,500afterone
year.Whatisyour (i)dividendyield, (ii)rateofcapitalgain,and(iii)totalrupeeandpercentage
returns.
YouboughtInfosysshareforRs4,250twoyearsago.Youheldthestockfortwoyears,andreceived
dividendpershareofRs90andRs125respectivelyattheendofthefirstandthesecondyears.You
soldtheshareforRs4,535aftertwoyears.WhatwasyourtwoyearholdingperiodreturnonInfosys
share?
Youexpecttoearnareturnof17percentonashare.Iftheinflationrateis5.5percent,whatisyour
realrateofreturn?
SupposesharesofHindLtdandNirmalaLtdweresellingatRs100twoyearsago.Hindspricefellin
thefirstyearby12percentandroseby12percentinthesecondyear.Thereversewasthecasefor
Nirmalassharepriceitincreasedby12percentandthendecreasedby12percent.Wouldthey
havethesamepriceaftertwoyears?Whyorwhynot?Showcomputations.
Anassetisexpectedtoearnthefollowingratesofreturnfortheperiod200410:
Year
2004
Return(%) 15.3

2005
5.6

2006
17.3

2007
25.0

2008
16.8

2009
9.5

2010
28.8

Whatisthesevenyearholdingperiodreturnfromtheasset?Howmuchistheannualcompoundrate
ofreturn?
8.

ThefollowingarethereturnsontheshareofReliableCompanyforpastfiveyears:
Year
Return(%)

1
5.3

2
15.6

3
7.3

4
15.0

5
19.8

Calculatetheaveragereturnforthefiveyears.Alsocalculatethestandarddeviationandvarianceof
thereturnsfortheperiod.

9. Theeconomyofacountrymayexperiencerapidgrowthormoderategrowthorrecession.Thereis
0.15probabilityofrapidgrowthandthestockmarketreturnisexpectedtobe19.5percent. The
probabilityofmoderategrowthis55percentwitha14percentexpectationofthestockmarketreturn.
There is 0.30 probability of recession and the stock market return is expected to be 7 per cent.
Calculatetheexpectedstockmarketreturnandthestandarddeviationofthereturn.
10. Anassethasthefollowingpossiblereturnswithassociatedprobabilities:
Possiblereturns
Probability

20%
0.10

18%
0.45

8%
0.30

0
0.05

6%
0.10

Calculatetheexpectedrateofreturnandthestandarddeviationofthatrateofreturn.
11. SecuritiesXandYhavethefollowingcharacteristics:
SecurityX

SecurityY

Return

Probability

Return

Probability

30%
20%
10%
5%
10%

0.10
0.20
0.40
0.20
0.10

20%
10%
20%
30%
40%

0.05
0.25
0.30
0.30
0.10

Youarerequiredtocalculatetheexpectedreturnandstandarddeviationofreturnforeachsecurity.
Whichsecuritywouldyouselectforinvestmentandwhy?
12. ThedistributionofreturnsforsharePandthemarketportfolioisgivenbelow:
Returns(%)
Probability

ShareP

Market

0.30
0.40
0.30

30
20
0

10
20
30

Youarerequiredtocalculatetheexpectedreturns,standarddeviationandvarianceofthereturnsof
sharePandthemarket.
13. Thefollowingarethereturnsduringsevenyearsonamarketportfolioofsharesand91dayTreasury
Bills:
Youarerequiredtocalculate(i)therealisedriskpremiumofsharesovertreasurybillsineachyearand
(ii)theaverageriskpremiumofsharesovertreasurybillsduringtheperiod.Cantherealisedpremium
benegative?Why?
Portfolioof

Treasury
YearShares(%)

Bills(%)

.5

6.8

11.4
9.8

26.8

10.5

24.6

9.9

3.2

9.2

15.7

9.2

12.3

11.2

14. Thestockmarketandtreasurybillsreturnsareexpectedtobeasfollows:
Economic
Conditions

Probability

Market
Return(%)

Treasury
Bills(%)

Growth

0.20

28.5

9.7

Decline

0.30

5.0

9.5

Stagnation

0.50

17.9

9.2

Youarerequiredtocalculate(i)theexpectedmarketandtreasurybillsreturnsand(ii)theexpected
riskpremium.
15. SupposethatreturnsofSunshineCompanyLimitedssharearenormallydistributed.Themeanreturn
is20percentandthestandarddeviationofreturnsis10percent.Determinetherangeofreturnsin
whichabout2/3rdofthecompanysreturnsfall.
16. SupposetheratesofreturnonManeklalEngineeringLtdssharehaveanormaldistributionwitha
meanof22percentandastandarddeviationof25percent.Whatistheprobabilityofthereturnbeing
30percent?

Chapter 5
PROBLEMS

1.

Anassethasthefollowingpossiblereturnswithassociatedprobabilities:
Possiblereturns 20%

18%

8%

6%

Probability

0.45

0.30

0.05

0.10

0.10

Calculatetheexpectedrateofreturnandthestandarddeviationoftherateofreturn.
2.

SecuritiesXandYhavethefollowingcharacteristics:
SecurityX
Return

SecurityY

Probability

Return

Probability

0.10
0.20
0.40
0.20
0.10

20%
10%
20%
30%
40%

0.05
0.25
0.30
0.30
0.10

30%
20%
10%
5%
10%

Youarerequiredtocalculate(a)theexpectedreturnandstandarddeviationofreturnforeachsecurity
and(b)theexpectedreturnandstandarddeviationofthereturnfortheportfolioof XandY,combined
withequalweights.
3.

ThedistributionofreturnsforsharePandthemarketportfolioMisgivenbelow:
Returns(%)
Probability

0.30
0.40
0.30

30
20
0

10
20
30

You are required to calculate the expected returns of security P and the market portfolio, the
covariancebetweenthemarketportfolioandsecurityPandbetaforthesecurity.
4.

Thestandarddeviationofreturnofsecurity Y is20percentandofmarketportfoliois15percent.
CalculatebetaofYif(a)Cory,m=0.70,(b)Cory,m=+0.40,and(c)Cory,m=0.25.

5.

Aninvestorholdsaportfolio,whichisexpectedtoyieldarateofreturnof18percentwithastandard
deviationofreturnof25percent.Theinvestorisconsideringofbuyinganewshare(investmentbeing
5percentofthetotalinvestmentinthenewportfolio).Thenewsharehasthefollowingdistributionof
return:
Return
40%
30%
10%

6.

Probability
0.3
0.4
0.3

Ifthecorrelationcoefficientbetweenthereturnsofthenewportfolioandthenewsecurityis+0.25,
calculatetheportfolioreturnandthestandarddeviationofreturnofthenewportfolio.
TheSunriseandSunsetcompanieshavethefollowingprobabilitydistributionofreturns:

Returns(%)
Economicconditions

Probability

Sunrise

Sunset

0.1
0.2
0.4
0.2
0.1

32
20
14
5
10

30
17
6
12
16

Highgrowth
Normalgrowth
Slowgrowth
Stagnation
Decline

Youarerequired(a)todeterminetheexpectedcovarianceofreturnsand(b)thecorrelationofreturns
betweentheSunriseandSunsetcompanies.
7.

Twoshares,PandQ,havethefollowingexpectedreturns,standarddeviationandcorrelation:
E(rp)=18%

E(rQ)=15%

E( =23%

(r =19%

Cor =0
Q

(a) DeterminetheminimumriskcombinationforaportfolioofPandQ.
(b) IfthecorrelationofreturnsofPandQis1.0,thenwhatistheminimumriskportfolioofPand
Q?

Chapter 6
PROBLEMS
1. ThereturnsontheshareofDeliteIndustriesandtheSensexforthepastfiveyearsaregivenbelow:
Sensex(%)

Delite(%)

12.5
1.7
7.2
11.5
6.3

2.

3.

5.1
6.7
7.1
18.9
11.9

CalculatetheaveragereturnonDelitesshareandSensex.WhatisDelitesbeta?
RoyalPaintsLimitedisanallequityfirmwithoutanydebt.Ithasabetaof1.21.Thecurrentriskfree
rateis8.5percentandthehistoricalmarketpremiumis9.5percent.Royalisconsideringaproject
thatisexpectedtogenerateareturnof20percent.Assumingthattheprojecthasthesameriskasthe
firm,shouldthefirmaccepttheproject?
CalculateExcelCompanyLimitedsequitybetagiventhefollowinginformation:
Correlationbetweenthereturnson
ExcelsshareandSensex=0.725
VarianceofthereturnsonExcelsshare=0.006455
VarianceofthereturnsonSensex=0.001589

4.

Thereturnsfor48months(Apr04Mar08)ontheBHELsharesandSensex(market)aregiven
below:
Months

Sensex
Returns

BHEL
Returns

Months

Sensex BHEL
Returns Returns

Apr04
May04
Jun04
Jul04
Aug04
Sep04
Oct04
Nov04

1.154
15.835
0.753
7.817
0.421
7.541
1.588
9.908

3.001
25.796
15.344
8.524
1.333
3.997
8.886
0.778

Apr06
May06
Jun06
Jul06
Aug06
Sep06
Oct06
Nov06

6.761 4.929
13.651 19.309
2.026 2.596
1.269 4.778
8.890 10.554
6.457 5.835
4.075 0.917
5.666 3.810

Dec04
Jan05
Feb05
Mar05
Apr05
May05
Jun05
Jul05
Aug05
Sep05
Oct05
Nov05
Dec05
Jan06
Feb06
Mar06

5.909
0.708
2.409
3.292
5.212
9.110
7.129
6.138
2.227
10.621
8.595
11.359
6.931
5.554
4.540
8.772

24.157
2.494
14.347
10.601
3.331
11.103
1.816
16.370
6.169
14.541
7.292
25.718
2.835
29.665
12.723
10.894

Dec06
Jan07
Feb07
Mar07
Apr07
May07
Jun07
Jul07
Aug07
Sep07
Oct07
Nov07
Dec07
Jan08
Feb08
Mar08

0.661 8.323
2.205 9.534
8.181 13.525
1.036 3.857
6.122 10.019
4.845 12.485
0.729 9.961
6.146 12.576
1.494 9.092
12.877 7.601
14.729 28.562
2.393 2.560
4.771 3.582
13.005 20.128
0.397 10.557
11.004 9.879

(a) CalculateBHELsbetausing(i)datafor48monthsfromApr04Mar08, (ii)datafor24

monthsfromApr04Mar06,and(iii)datafor24monthsfromApr06Mar08.Basedon
yourcalculations,commentonbetastability.
(b) Assumethatriskfreerateis7.9percentandriskpremiumis12percent.CalculateBHEL
expectedrateofreturn.
5.

6.

7.

Thefollowingaretheregression(characteristics)linesofthreeassets:
AssetA:rA=1.53%+0.89rM

Cor=0.78

AssetB:rB=0.65%+1.18rM

Cor=0.83

AssetC:rC=0.85%+1.29rM

Cor=0.65

(a) Whichassetisthemostrisky(systematicrisk)?
(b) Howmuchisthesystematicandunsystematicriskforeachasset?
SunliteSoapLimitedisanallequityfirm.Ithasabetaof1.21.Thecurrentriskfreerateis6.5per
centandthemarketpremiumis9.0percent.Sunliteisconsideringaprojectwithsimilarrisk,butthe
projectwillbefinanced30percentbydebtand70percentbyequity.Debtisriskfree.Whatisthe
expectedrateofreturnonequitythattheprojectshouldearntobeacceptablebythefirm?
Youhaveaportfolioofthefollowingfourshares:
Share

Beta

A
B
C
D

0.80
1.25
1.00
0.60

Investment(Rs)
100,000
100,000
075,000
125,000

Whatistheexpectedrateofreturnonyourportfolioiftheriskfreerateofreturnis9percentand the
expected market rate of return is 16 per cent?

Chapter 7
PROBLEMS

1.
2.
3.

RamJethabhaihaspurchaseda3monthcalloptiononacompanyssharewithanexercisepriceRs51.
ThecurrentpriceoftheshareisRs50.Determinethevalueofcalloptionatexpirationiftheshare
priceturnsouttobeeitherRs47orRs54.Drawadiagramtoillustrateyouranswer.
SunderLalhassolda6monthcalloptiononacompanyssharewithaexercisepriceofRs100.The
currentsharepriceisRs100.CalculatethevalueofcalloptiontoSunderLalatmaturityiftheshare
priceincreasestoRs110ordecreasestoRs90.Drawadiagramtoillustrateyouranswer.
Youhaveboughtone6monthcalloptiononasharewithanexercisepriceofRs98atapremiumof
Rs3.ThesharehasacurrentpriceofRs100.YouexpectsharetoeitherrisetoRs108orfalltoRs95
aftersixmonths.Whatwillbeyourpayoffwhenoptionmatures?Drawadiagramtoexplain.

4.
5.
6.
7.
8.
9.
10.
11.

12.
13.
14.

15.

16.
17.

18.
19.
20.

21.

RadhikaKrishnanhaspurchasedacalloptiononashareatapremiumofRs5.Thecurrentshareprice
isRs44andtheexercisepriceisRs42.AtmaturitythesharepricemayeitherincreasetoRs45orfall
toRs43.WillRadhikaexerciseheroption?Why?
MeenaVasudevanhaspurchaseda3monthputoptiononacompanyssharewithanexercisepriceRs
101.ThecurrentpriceoftheshareisRs100.Determinethevalueofputoptionatexpirationifthe
sharepriceturnsouttobeeitherRs97orRs104.Drawadiagramtoillustrateyouranswer.
S.Rammurthyhassolda6monthputoptiononacompanyssharewithanexercisepriceofRs100.
ThecurrentsharepriceisRs100.CalculatethevalueofputoptiontoRammurthyatmaturityifthe
sharepriceincreasestoRs110ordecreasestoRs90.Drawadiagramtoillustrateyouranswer.
Youhaveboughtone6monthputoptiononasharewithanexercisepriceofRs96atapremiumofRs
4.ThesharehasacurrentpriceofRs100.YouexpectsharetoeitherrisetoRs108orfalltoRs95
aftersixmonths.Whatwillbeyourpayoffwhenoptionmatures?Drawadiagramtoexplain.
Youbuya3monthEuropeanputonashareforRs4withanexercisepriceofRs50.Thecurrentshare
priceisRs52.Whenwillyouexerciseyouroptionandwhenwillyoumakeaprofit?Drawadiagram
toillustrateyouranswer.
Shyamsellsa6monthputwithanexercisepriceofRs70atapremiumofRs5.Underwhatsituation
optionwillbeexercised?WhenwillShyammakeprofit?DrawadiagramtoillustrateShyamsprofit
orlosspositionwiththesharepricesatmaturity.
V.SridharanhaspurchasedaputoptiononashareatapremiumofRs5.ThecurrentsharepriceisRs
44andtheexercisepriceisRs42.AtmaturitythesharepricemayeitherincreasetoRs45orfalltoRs
43.Willheexercisehisoption?Why?
MadanModiholds50shareofZetaZeroxCompany.HeisintendingtowritecallsonZetassshares.
Ifhewritesacallcontractfor50shareswithanexercisepriceofRs50eachshare,determinethevalue
ofhisportfoliowhentheoptionexpiresif(a)thecurrentsharepriceofRs45risestoRs65,or(b)the
sharepricefallstoRs40.
YoubuyacalloptiononasharewithanexercisepriceofRs100.Youalsobuyaputoptiononthe
samesharewithanexercisepriceofRs97.Whatprofitorlosswillyouhaveonmaturityfromyour
portfolioofcallandput?Explainwiththehelpofadiagram.
InExercise(12)above,assumethatyoupaidacallpremiumofRs3andaputpremiumofRs5.How
wouldyourprofitpatternchange?Showwiththehelpofadiagram.
R.K. Ramachandran haspurchased 3monthcall onashare withan exercise price of Rs50at a
premiumofRs4.Hehasalsoboughta3monthputonthesamesharewithanexercisepriceofRs50
atapremiumofRs2.DetermineRamchandranspositionatmaturityifthesharepriceiseitherRs52
orRs45.
TheshareofAshokEnterprisesiscurrentlysellingforRs100.Itisknownthatthesharepricewill
eitherturntobeRs108orRs90.Theriskfreerateofreturnis12percentperannum.Ifyouintendto
buya3monthcalloptionwithanexercisepriceofRs97,howmuchshouldyoupayforbuyingthe
optiontoday?Assumenoarbitrageopportunity.
AsharehasacurrentsharepriceofRs100.ThesharepriceaftersixmonthswillbeeitherRs115or
Rs90.Theriskfreerateis10percentperannum.Determinethevalueofa6monthcalloptiononthe
sharewithanexercisepriceofRs100usingtheriskneutralarguement.
ZenithCompanysshareiscurrentlysellingforRs60.Itisexpectedthataftertwomonthstheshare
pricemayeitherincreaseby15percentorfallby10percent.Theriskfreerateis9percentper
annum.WhatshouldbethevalueofatwomonthEuropeancalloptionwithanexercisepriceofRs
65?WhatisthevalueofatwomonthEuropeanputoptionwithanexercisepriceofRs65?
DeterminethepriceofaEuropeancalloptiononasharethatdoesnotpaydividend.Thecurrentshare
priceisRs60,theexercisepriceRs55,theriskfreerateis10percentperannum,thesharereturn
volatilityis40percentperannumandthetimetoexpirationissixmonths.
CalculatethevalueofaEuropeanputoptiononasharethatdoesnotpaydividend.Thecurrentshare
priceisRs86,theexercisepriceRs93,theriskfreerateis12percentperannum,thesharereturn
volatilityis60percentperannumandthetimetoexpirationisfourmonths.
AcompanyhasatotalmarketvalueofRs230crore.Thefaceofitsdebt(assumepurediscountdebt)
is
Rs95crore.Thestandarddeviationofthefirmssharereturnis25percentanddebthasamaturityof
8years.Theriskfreerateis12percent.Whatisthevalueofthecompanysequity?
On26August2002,InfosyscalloptionwithanexerciseofRs3,400issellingatapremiumofRs
186.15andcalloptionwithanexerciseofRs3,500issellingatapremiumofRs38.10.Thecurrent
sharepriceisRs3,469.Thelotsizeis100.Whatwillbeyournetprofitatsharepriceatexpiration

rangingfromRs3200toRs3700ifyoubuycallwiththeexerciseofRs3,500andsellcallwiththe
exercisepriceofRs3,400?Drawaprofitgraph.
22. VSNLssharepriceisexpectedtodeclineduetononpaymentofitsduesbytheWorldCom,lowering
marginsandothernegativesentimentsinthemarket.ThecurrentsharepriceisRs123.70andthedaily
volatilityoftheVSNLshareis2.74percent.BasedontheValueatRisk(VaR),theprobabilityofthe
sharepricegoingaboveRs142.5isquitelow.TheputontheVSNLsharewithanexercisepriceofRs
150issellingforRs7.50.Shouldyoubuytheput?Drawaprofitgraph.
23. TheputontheInfosysshareissellingwithanexercisepriceRs3,400atapremiumofRs37.50on22
August2002.Onthesameday,thecallissellingatapremiumofRs32.50withanexercisepriceofRs
3,300.ThespotpriceoftheshareisRs3,370.Thelotsizeis100.Whatwillbeyournetprofitatshare
price

at

expiration

ranging

from
Rs3,200toRs3,700ifyoubuycallwiththeexercisepriceofRs3,500andbuyputwiththeexercise
priceofRs3,300?Drawaprofitgraph.

Chapter 8
PROBLEMS

1.

Thefollowingarethenetcashflowsofaninvestmentproject:
CashFlows(Rs)
C0

C1

C2

5,400 +3,600

2.
3.
4.

+14,400

Calculatethenetpresentvalueoftheprojectatdiscountratesof0,10,40,50and100percent.
AmachinewillcostRs100,000andwillprovideannualnetcashinflowofRs30,000forsixyears.
Thecostofcapitalis15percent.Calculatethemachinesnetpresentvalueandtheinternalrateof
return.Shouldthemachinebepurchased?
AprojectcostsRs81,000andisexpectedtogeneratenetcashinflowofRs40,000,Rs35,000andRs
30,000overitslifeof3years.Calculatetheinternalrateofreturnoftheproject.
TheG.K.Companyisevaluatingaprojectwithfollowingcashinflows:
CashFlows(Rs)

5.

C1

C2

C3

C4

C5

1,000

800

600

400

200

Thecostofcapitalis12percent.Whatisthemaximumamountthecompanyshouldpayforthe
machine?
Considerthefollowingthreeinvestments:
CashFlows(Rs)
Projects

C0

C1

C2

2,500

+3,305

2,500

+1,540

+1,540

2,500

+2,875

Thediscountrateis12percent.Computethenetpresentvalueandtherateofreturnforeachproject.
6. Youwanttobuya285litrerefrigeratorforRs10,000onaninstalmentbasis.Adistributoris
preparedtoselltherefrigeratoroninstalments.Hestatesthatthepaymentswillbemadeinfour
years,interestratebeing12percent.Theannualpaymentswillbeasfollows:
Rs
Principal
Fouryearofinterestat12%,i.e.,Rs10,0000.124

10,000
4,800
14,800

Annualpayments(Rs14,8004)

3,700

7.

Whatrateofreturnisthedistributorearning?Ifyouropportunitycostofcapitalis14percentwillyou
accepttheoffer?Why?
Computetherateofreturnofthefollowingprojects:
CashFlows(Rs)
Projects
X
Q

8.

C0

C1

C2

C3

20,000
20,000

+8,326
0

+8,326
0

+8,326
+24,978

Whichprojectwouldyourecommend?Why?
Afirmisconsideringthefollowingtwomutuallyexclusiveinvestments:
CashFlows(Rs)
Projects
A
B

9.

C0

C1

C2

C3

25,000
28,000

+15,000
+12,672

+15,000
+12,672

+25,640
+12,672

Thecostofcapitalis12percent.ComputetheNPVandIRRforeachproject.Whichproject
shouldbeundertaken?Why?
Youhaveanopportunitycostofcapitalof15percent.Willyouacceptthefollowinginvestment?
CashFlows(Rs)
C0

C1

+50,000

56,000

10. Isthefollowinginvestmentdesirableiftheopportunitycostofcapitalis10percent:
CashFlows(Rs)
C0

C1

C2

C3

C4

+100,000

33,625

33,625

33,625

33,625

11. Considerthefollowingtwomutuallyexclusiveinvestments:
CashFlows(Rs)
Projects
A
B

C0

C1

C2

C3

10,000
10,000

+12,000
+10,000

+4,000
+3,000

+11,784
+12,830

(a)CalculatetheNPVforeachprojectassumingdiscountratesof0,5,10,20,30and40percent;( b)
drawtheNPVgraphfortheprojectstodeterminetheirIRR,(c)showcalculationsofIRRforeach
projectconfirmingresultsin(b).Also,statewhichprojectwouldyourecommendandwhy?
12. ForProjectsXandY,thefollowingcashflowsaregiven:
CashFlows(Rs)
Projects
X
Y

C0

C1

C2

C3

750
750

+350
+250

+350
+250

+159
+460

(a) CalculatetheNPVofeachprojectfordiscountrates0,5,8,10,12and20percent.Plottheseon
anPVgraph.
(b) ReadtheIRRforeachprojectfromthegraphin(a).
(c) WhenandwhyshouldProjectXbeaccepted?
(d) ComputetheNPVoftheincrementalinvestment(YX)fordiscountrates,0,5,8,10,12and20
percent.Plotthemongraph.ShowunderwhatcircumstanceswouldyouacceptX?
13. Thefollowingaretwomutuallyexclusiveprojects.
CashFlows(Rs)

Projects

C0

C1

25,000

+30,000

II

25,000

C2

C3

C4

43,750

Assume a 10 per cent opportunity cost of capital. Compute the NPV and IRR for each project.
Commentontheresults.
14. Considerthefollowingprojects:
CashFlows(Rs)
Projects
A
B
C
D

C0

C1

C2

1,000
1,000
1,300
1,300

+600
+200
+100
0

+200
+200
+100
0

C3

C4

+200
+600
+100
+300

+1,000
+1,000
+1,600
+1,600

(a) Calculatethepaybackperiodforeachproject.
(b) Ifthestandardpaybackperiodis2years,whichprojectwillyouselect?Willyouranswerbe
differentifthestandardpaybackis3years?
(c) Ifthecostofcapitalis10percent,computethediscountedpaybackforeachproject?Which
projectswillyourecommendifthestandardpaybackis(i)2years;(ii)3years?
(d) ComputetheNPVofeachproject?Whichprojectswillyourecommend?
15. AmachinewillcostRs10,000.ItisexpectedtoprovideprofitsbeforedepreciationofRs3,000eachin
years1and2andRs4,000eachinyears3and4.Assumingastraightlinedepreciationandnotaxes,
whatistheaverageaccountingrateofreturn?Whatwillbeyouranswerifthetaxrateis35percent?
16. Afirmhasthefollowinginformationaboutaproject:
IncomeStatement(Rs000)

Cashrevenue
Cashexpenses
Grossprofit
Depreciation
Netprofit

C1

C2

C3

16
8
8
4
4

14
7
7
4
3

12
6
6
4
2

TheinitialinvestmentoftheprojectisestimatedasRs12,000.
(a) Calculatetheprojectsaccountingrateofreturn.
(b) IfitisfoundthattheinitialinvestmentwillbeRs9,000andcashexpenseswillbemorebyRs
1,000eachyear,whatwillbetheprojectsaccountingrateofreturn.Also,calculatetheprojects
NPVifthecostofcapitalis9percent.
17. Aninvestmentprojecthasthefollowingcashflows:
CashFlows(Rs)
C0

C1

C2

150

+450

300

Whataretheratesofreturnoftheinvestment?Assumeadiscountrateof10percent.Istheinvestment
acceptable?
18. Afirmisconsideringthefollowingproject:
CashFlows(Rs)
C0

C1

50,000 +11,300

C2

C3

C4

C5

+12,769 +14,429 +16,305 +18,421

(a) CalculatetheNPVfortheprojectifthecostofcapitalis10percent.WhatistheprojectsIRR?
(b) RecomputetheprojectsNPVassumingacostofcapitalof10percentforC1andC2,of12per
centforC3andC4,and13percentforC5.Shouldtheprojectbeaccepted?Cantheinternalrateof

returnmethodbeusedforacceptingorrejectingtheprojectundertheseconditionsofchanging
costofcapitalovertime?Whyorwhynot?
19. Afinanceexecutivehascalculatedtheprofitabilityindexforanewproposaltobe1.12.Theproposals
initialcashoutlayisRs500,000.Findouttheproposalsannualcashinflowifithasalifeof5years
andtherequiredrateofreturnis8percent.
20. ProjectPhasthefollowingcashflows:
CashFlows(Rs)
C0

C1

C2

800

+1,200

400

CalculatetheprojectsIRRs.Iftherequiredrateofreturnis25percent,wouldyouacceptthe
project.Why?

Chapter 9
PROBLEMS
1. TheEssKayRefrigeratorCompanyisdecidingtoissue2,000,000ofRs1,000,14percent7year
debentures.Thedebentureswillhavetobesoldatadiscountrateof3percent.Further,thefirmwill
payanunderwritingfeeof3percentofthefacevalue.Assumea35%taxrate.
Calculatetheaftertaxcostoftheissue.Whatwouldbetheaftertaxcostifthedebentureweresoldat
apremiumofRs30?
2. AcompanyissuesnewdebenturesofRs2million,atpar;thenetproceedsbeingRs1.8million.Ithas
a13.5percentrateofinterestand7yearmaturity.Thecompanystaxrateis52percent.Whatisthe
costofdebentureissue?Whatwillbethecostin4yearsifthemarketvalueofdebenturesatthattime
isRs2.2million?
3. Acompanyhas100,000sharesofRs100atparofpreferencesharesoutstandingat9.75percent
dividendrate.ThecurrentmarketpriceofthepreferenceshareisRs80.Whatisitscost?
4. Afirmhas8,000,000ordinarysharesoutstanding.ThecurrentmarketpriceisRs25andthebook
valueisRs18pershare.ThefirmsearningspershareisRs3.60anddividendpershareisRs1.44.
Howmuchisthegrowthrateassumingthatthepastperformancewillcontinue?Calculatethecostof
equitycapital.
5. Acompanyhas5,000,000ordinarysharesoutstanding.ThemarketpriceoftheshareisRs96while
thebookvalueisRs65.ThefirmsearningsanddividendspershareareRs10andRs7respectively.
Thecompanywantstoissue1,000,000shareswithanetproceedsofRs80pershare.Whatisthecost
ofcapitalofthenewissue?
6. AcompanyhaspaidadividendofRs3pershareforlast20yearsanditisexpectedtocontinuesoin
thefuture.ThecompanyssharehadsoldforRs33twentyyearsago,anditsmarketpriceisalsoRs
33.Whatisthecostoftheshare?
7. Afirmisthinkingofraisingfundsbytheissuanceofequitycapital.Thecurrentmarketpriceofthe
firmsshareisRs150.ThefirmisexpectedtopayadividendofRs3.55nextyear.Thefirmhaspaid
dividendinpastyearsasfollows:

8.

Year

DividendperShare(Rs)

2003
2004
2005
2006
2007
2008

2.00
2.20
2.42
2.66
2.93
3.22

ThefirmcansellsharesforRs140eachonly.Inaddition,theflotationcost pershareisRs10.
Calculatethecostofnewissue.
AcompanyisconsideringthepossibilityofraisingRs100millionbyissuingdebt,preferencecapital,
andequityandretainingearnings.Thebookvaluesandthemarketvaluesoftheissuesareasfollows:
(Rsinmillions)
BookValue

MarketValue

Ordinaryshares
Reserves
Preferenceshares
Debt

30
10
20
40

60

24
36

100

120

Thefollowingcostsareexpectedtobeassociatedwiththeabovementionedissuesofcapital.(Assume
a35percenttaxrate.)
(i) Thefirmcansella20yearRs1,000facevaluedebenturewitha16percentrateofinterest.An
underwritingfeeof2percentofthemarketpricewouldbeincurredtoissuethedebentures.
(ii) The11percentRs100facevaluepreferenceissuefetchRs120pershare.However,thefirmwill
havetopayRs7.25perpreferenceshareasunderwritingcommission.
(iii) ThefirmsordinaryshareiscurrentlysellingforRs150.Itisexpectedthatthefirmwillpaya
dividendofRs12pershareattheendofthenextyear,whichisexpectedtogrowatarateof7per
cent.ThenewordinarysharescanbesoldatapriceofRs145.ThefirmshouldalsoincurRs5per
shareflotationcost.
Computetheweightedaveragecostofcapitalusing(i)bookvalueweights(ii)marketvalueweights.
9. Acompanyhasthefollowinglongtermcapitaloutstandingason31March2008:(a)10percent
debentureswithafacevalueofRs500,000.Thedebentureswereissuedin2003andaredueon31
March2010.ThecurrentmarketpriceofadebentureisRs950.(b)Preferenceshareswithafacevalue
ofRs400,000.TheannualdividendisRs6pershare.ThepreferencesharesarecurrentlysellingatRs
60pershare.(c)SixtythousandordinarysharesofRs10parvalue.TheshareiscurrentlysellingatRs
50pershare.Thedividendspershareforthepastseveralyearsareasfollow:
Year

Rs

Year

Rs

2003
2004
2005
2006

2.00
2.16
2.37
2.60

2000
2001
2002
2003

2.80
3.08
3.38
3.70

Assumingataxrateof35percent,computethefirmsweightedaveragecostofcapital.
10. AcompanyisconsideringdistributingadditionalRs80,000asdividendstoitsordinaryshareholders.
Theshareholdersareexpectedtoearn18percentontheirinvestment.Theyarein30percenttaxand
incuranaveragebrokeragefeeof3percentonthereinvestmentofdividendsreceived.Thefirmcan
earnareturnof12percent ontheretained earnings.ShouldthecompanydistributeorretainRs
80,000?
11. TheKeshariEngineeringLtdhasthefollowingcapitalstructure,consideredtobeoptimum,on31June
2008.
Rsinmillion
14%Debt
10%Preference
Ordinaryequity

93.75
31.25
375.00

Total

500.00

Thecompanyhas15millionsharesoutstanding.TheshareissellingforRs25pershareandthe
expecteddividendpershareisRs1.50,whichisexpectedtogrowat10percent.
ThecompanyiscontemplatingtoraiseadditionalfundsofRs100milliontofinanceexpansion.Itcan
sellnewpreferencesharesatapriceofRs23,lessflotationcostofRs3pershare.Itisexpectedthata
dividendofRs2persharewillbepaidonpreference.Thenewdebtcanbeissuedat10percentrateof
interest.Thefirmpaystaxesatrateof35percentandintendstomaintainitscapitalstructure.
Youarerequired(i)tocalculatetheaftertaxcost(a)ofnewdebt,(b)ofnewpreferencecapital,and
(c)ofordinaryequity,assumingnewequitycomesonlyfromretainedearningswhichisjustsufficient
forthepurpose,(ii)tocalculatethemarginalcostofcapital,assumingnonewsharesaresold,( iii)to
computethemaximumamountwhichcanbespentforcapitalinvestmentsbeforenewordinaryshares
canbesold,iftheretainedearningsareRs700,000,and(iv)tocomputethemarginalcostofcapitalif
thefirmspendsinexcessoftheamountcomputedin(iii).Thefirmcansellordinarysharesatanet
priceofRs22pershare.
12. ThefollowingisthecapitalstructureofXLtdason31December2008.

Rsinmillion
Equitycapital(paidup)
Reservesandsurplus

563.50
485.66

10%IrredeemablePreferenceshares

56.00

10%RedeemablePreferenceshares

28.18

15%Termloans

377.71

Total

1,511.05

TheshareofthecompanyiscurrentlysellingforRs36.TheexpecteddividendnextyearisRs3.60per
shareanticipatedtobegrowingat 8percent indefinitely.Theredeemablepreferenceshareswere
issuedon1January2003withtwelveyearmaturityperiod.AsimilarissuetodaywillbeatRs93.The
marketpriceof10%irredeemablepreferenceshareisRs81.81.Thecompanyhadraisedthetermloan
fromIDBIin2003.Asimilarloanwillcost10%today.
Assumeanaverage tax rate of35per cent.Calculate the weightsaverage cost ofcapital for the
companyusingbookvalueweights.
13. ThefollowingcapitalstructureisextractedfromDeltaLtdsbalancesheetason31March2008:
(Rs000)
Equity(Rs25par)
Reserves
Preference(Rs100par)
Debentures
Longtermloans

66,412
65,258
3,000
30,000
5,360
170,030

Theearningspershareofthecompanyovertheperiod20042008are:
Year

Rs

Year

Rs

2004
2005
2006
2007
2008

2.24
3.00
4.21
3.96
4.80

1994
1995
1996
1997
1998

4.40
5.15
5.05
6.00
6.80

TheequityshareofthecompanyissellingforRs50andpreferenceforRs77.50.Thepreference
dividendrateandinterestrateondebenturerespectivelyare10percentand13percent.Thelongterm
loansareraisedataninterestrateof14percentfromthefinancialinstitution.Theequitydividendis
Rs4pershare.
CalculatetheweightedaveragecostofcapitalforDeltaLtd,makingnecessaryassumptions.
14. Acompanyhasthefollowingcapitalstructureattheendof31March2008:
(Rsinmillion)

ShareCapital
Reserve
Longtermloans

6,808
34,857
538,220

ThecompanysEPS,DPS,averagemarketpriceandROEforlastsevenyearsaregivenbelow:
Year

EPS

DPS

AMP

ROE

2002
2003
2004
2005
2006
2007

21.55
22.14
26.40
20.16
20.40
23.09

5.28
5.76
5.76
6.53
7.68
11.53

143.04
187.52
312.32
587.52
366.72
416.64

20.9
18.6
11.7
11.0
9.5
10.3

2008

22.00

7.68

355.20

8.4

Note:EPS,DPSandAMPadjustedforbonusissues.
Youarerequiredtocalculate:(a)growthrate g,usingalternativemethods;(b)costofequity,using
dividendgrowthmodel,and(c)weightedaveragecostofcapital,using(i)bookvalueweightsand
(ii)marketvalueweights.Assumethattheinterestrateondebtis11percentandthecorporateincome
taxrateis35percent.
15. EskayefLimitedmanufactureshumanandveterinarypharmaceuticals,bulkdrugs,skincareproducts,
andvaterinaryfeedsupplementsandmarketsbioanalyticalanddiagnosticinstruments.On31March
2003,thecompanyhasapaidupsharecapitalofRs75millionandreservesofRs325.90million.It
doesnotemploylongtermdebt.Thefollowingareotherfinancialhighlightsonthecompanyduring
20032008:
Year

EPS(Rs)

DPS(Rs)

Book
Value(Rs)

Market
Value

2003
2004
2005
2006
2007
2008

6.21
10.91
11.57
11.47
10.44
11.23

2.00
2.50
2.50
2.70
3.00
3.20

26.03
34.44
43.52
37.98
45.42
53.45

100.00
205.00
209.38
164.00
138.88
155.00

Note:(1)Years2003,2004and2005closedon30Novemberwhileyears2006,2007and2008on31
March.(2)Marketvalueistheaveragesofhighandlowshareprices.
Youarerequiredtocalculate(a)ROE,(b)dividendpayout,(c)retentionratio,(d)growthrate,(e)
dividendyield,(f)earningsyieldand(g)costofequity.

Chapter 10
PROBLEMS

1.

Followingdatarelatetofiveindependentinvestmentprojects:
Projects
A
B
C
D
E

2.

AnnualCash
Inflow(Rs)

500,000
120,000
92,000
5,750
40,000

125,000
12,000
15,000
2,000
6,000

LifeinYears
8
15
20
5
10

Assumea10percentrequiredrateofreturnanda35percenttaxrate.Rankthesefiveinvestment
projectsaccordingtoeachofthefollowingcriteria:(a)paybackperiod,(b)accountingrateofreturn,
(c)netpresentvalueindex,and(d)internalrateofreturn.
Acompanyhastochooseoneofthefollowingtwomutuallyexclusiveprojects.Boththeprojectswill
bedepreciatedonastraightlinebasis.Thefirmscostofcapitalis10percentandthetaxrateis35per
cent.Thebeforetaxcashflowsare:
Project
X
Y

3.

Initial(Rs)
Outlay

C0

C1

20,000 4,200
15,000 4,200

C2

C3

C4

C5

4,800
4,500

7,000
4,000

8,000
5,000

2,000
1,000

Whichprojectshouldthefirmacceptifthefollowingcriteriaareused:(a)paybackperiod,(b)internal
rateofreturn,(c)netpresentvalue,and(d)profitabilityindex.
Fromthefollowingdatacalculate(i)netpresentvalue,(ii)internalrateofreturn,and (iii) payback
periodforthefollowingprojects.Assumearequiredrateofreturnof10percentanda35percenttax
rate.Assumestraightlinedepreciationfortaxpurpose,andthattaxiscalculatedonbooklossorprofit
onthesaleofasset.
Project

Initialcashoutlay
Salvagevalue
Earningsbeforedepreciationandtaxes
Year1
Year2
Year3
Year4
Year5
Expectedlife

4.

O
P
Q

C0

C1

100,000
Nil

140,000
20,000

25,000
25,000
25,000
25,000
25,000
5years

40,000
40,000
40,000
40,000
40,000
5years

C3

Rateof
Return(%)
24
15
17

(b) Computethecorrespondingincrementalcashflowforprojects P and Q inproblem4(a).Which

projectismoredesirable?
Kemp&Co.isfacedwithaproblemofchoosingamongtwoalternativeinvestments.Itcaninvest
eitherinProject A rightnoworwaitforayearandinvestinProject B.Thefollowingarethecash
flowsofthetwoprojects:
A
B

(Rs)
(Rs)

C0

C1

C2

C3

6,000

8,000
8,000

2,000
12,000

2,000
4,000

Assumearequiredrateofreturnof10percent.Whichprojectshouldthefirmselect?Usethepresent
valueandinternalrateofreturnmethods.Alsocalculatetherateofreturnforincrementalcashflows.
Isthefollowinginvestmentdesirableifthefirmscostofcapitalis10percent?
(Rs)

7.

C2

(Rs) 50,000 25,270 25,270 25,270

(Rs) 25,000 5,000 5,000 25,570
(Rs) 28,000 12,670 12,670 12,670

Projects

6.

(Rs)

(a) Acompanyhastochooseoneofthefollowingthreemutuallyexclusiveprojects.Whichprojectis
themostdesirable?Assumearequiredrateofreturnof12percent.
Projects

5.

(Rs)

C0

C1

C2

C3

C4

7,000

7,000

7,000

7,000

25,000

The following data relate to a proposed new machine. Should it be acquired? Assume aftertax
requiredrateofreturnof10percentanda40percentincometaxrate.Forsimplicityassumethat
machinesaredepreciatedonstraightlinebasisfortaxpurposes.Assumenotaxontheprofitorloss
fromtherateofasset.
Rs
Purchasepriceofthenewmachine
Installationcost
Increaseinworkingcapitalatthetimeofpurchase
ofnewmachine
Cashsalvagevalueofthenewmachineinfouryears
Annualcashsavings(beforedepreciationandtaxes)
Cashsalvagevalueoftheoldmachinetoday
Cashsalvagevalueoftheoldmachineinfouryears
Currentbookvalueoftheoldmachine
Servicelifeofbothmachinesisfouryears

8.

40,000
8,000
10,000
14,000
16,000
20,000
4,000
16,000

RamSingh,45yearsofage,hasreceivedaninheritanceofRs300,000fromhisfather.Heiscurrently
workinginmaterialsmanagementinacompany,andhissalaryisRs36,000peryear,whichhedoes
notexpect tochangeifheremains inhispresent employmenttillhisretirement ageof58.Heis
consideringtwoalternativeinvestmentsofhisinheritance.Thefirstalternativeistocontinueinhis
presentemploymentandtodepositRs300,000in13yearfixeddeposityielding15percentcompound

interest.Thesecondwouldbetopurchaseandoperateageneralstore.Heknowsthattoownastore,he
willhavetospendRs240,000includingRs100,000formerchandiseandthebalanceforbuildingand
fixtures.Ifhepurchasesthestore,anadditionalRs60,000willhavetobeinvestedforworkingcapital
needs. The expected annual receipts of this store are Rs 390,000.Annual outofpocket costs are
estimatedatRs300,000.AsRamSinghwouldmanagehisownstore,hewouldhavetoleavehis
presentemployment.Attheendof13years,whenhewishestoretireinanyevent,heestimatesthe
storewouldbesoldforRs50,000.Theapplicablepersonalincometaxrateis30percent.
WhichcourseofactionwouldbemoreprofitableforRamSingh?Why?
9. TheManekshawCompanyisconsideringthepurchaseofanewmachine.Theoldmachineisingood
workingcondition,andwilllastforsixyears.However,thenewmachinewilloperateefficiently.Itis
expectedthatmaterials,labourandotherdirectexpensesoftheoperationswillbesavedtotheextent
ofRs16,000peryear.ThenewmachinewillcostRs80,000andwillbeusefulforsixyears.Theold
machinehasabookvalueofRs64,000.Theaftertaxminimumrequiredrateofreturnexpectedbythe
companyis10percent.Assumea25percentwrittendowndepreciationanda35percenttaxrateof
income.Assumethatprofitorlossfromthesaleoftheassetsaretaxedat35percent.
Whatactionshouldbetakenbythecompanyif(a)thesalvagevalueoftheoldmachineiszero;(b)the
salvagevalueoftheoldmachinetodayisRs16,000andifretainedforsixyearsithaszerosalvage
value;and(c)thesalvagevalueoftheoldmachinetodayisRs16,000,andifretainedforsixyears,its
salvagevaluewillbeRs2,000.
10. X CompanyisusingafullydepreciatedmachinehavingacurrentmarketvalueofRs20,000.The
salvage value of the machine eight years from now would be zero. The company is considering
replacingthismachinebyanewonecostingRs102,500,andhavinganestimatedsalvagevalueof
Rs12,500.Withtheuseofthenewmachine,annualsalesareexpectedtoincreasefromRs80,000to
Rs92,500.OperatingefficiencieswiththenewmachinewillsaveRs12,500peryearasoperating
expenses.Depreciationwillbechargedonwrittendownbasisat25percent.Thecostofcapitalis11
percent.Thenewmachinehasa8yearlifeandthecompanystaxationrateis35percent.Assume
thatbookprofitorlossfromthesaleoftheassetistaxableatcorporatetaxrate.Shouldthecompany
replacetheoldmachine?Showcalculationsonincrementalcashflowbasis.Howwouldyourdecision
beaffectedifanothernewmachineisavailableatacostofRs175,000withasalvagevalueofRs
25,000.ThemachineisexpectedtoincreasesalesbyRs12,500ayearandsaveRs30,000ofoperating
expensesannuallyoverits8yearlife.
11. AlphaLimitedisconsideringreplacingitsoldmachinebyanewmachine.Thenewmachinewillcost
Rs360,000.ThesupplierofthenewmachinehasagreedtoaccepttheoldmachineatavalueofRs
40,000inexchangeforthenewmachine.Oldmachinehasbeenfullydepreciatedfortaxpurposes,but
ithasabookvalueofRs20,000intheaccountingstatementsmeantforexternalreporting.Iftheold
machineissoldinthemarket,itcannotfetchmorethanRs30,000.After10years,itcanbesoldforRs
6,000.Thenewmachinehasanexpectedlifeof10yearsandasalvagevalueofRs40,000after10
years.Alphausestheoldmachineforproducingaspecialcomponentusedinitsmainproduct
Theproductionfromoldornewmachinewouldbe15,000unitseachyear.
Thefollowingaretheprojectedrevenuesandcostsfromtheoldandnewmachines:
OldMachine(Rs)
Sales

NewMachine(Rs)

1,080,000

1,080,000

240,000
180,000
90,000
75,000
120,000
2,000

195,000
120,000
100,000
50,000
130,000
36,000

707,000

631,000

Profitbeforetax
Tax

373,000
186,500

449,000
224,500

Profitaftertax

186,500

224,500

Materialcost
Directlabour
Indirectlabour
Variableoverheads
Allocatedfixedoverheads
Depreciation

Depreciationiscalculatedonastraightlinebasis.Fortaxpurposes,writtendowndepreciationat25
percentperannumisallowed.IfAlphasrequiredrateofreturnis12percent,shouldtheoldmachine
bereplaced?Whatwouldbeyourdecisionifthecomponentcouldbeboughtfromoutsideatacostof

Rs40perunit?AssumethatasperthecurrentlawsinIndia,depreciationisbasedontheblockof
assets.
12. ABCCo.isusingafiveyearoldmachine,whichwasboughtforacostofRs129,000.Themachineis
depreciatedoverits12yearoriginallife.ThecurrentmarketpriceofthemachineisRs40,000.The
salvagevalueofthemachineattheendofitslifeisestimatedtobezero.
ThecompanyisthinkingofreplacingthismachinebyanewmachinewhichwillcostRs175,000,and
wouldneedaninstallationcostofRs25,000.Thelifeofthemachineisestimatedtobe7yearswitha
disposalvalueofRs18,000attheendofitslife.Becauseofthegreatercapacityofthenewmachine,it
isexpectedthatannualsaleswillincreasefromRs1,800,000toRs1,870,000.Theoperatingefficiency
isnotlikelytochange.Thecurrentoperatingexpenses(excludingdepreciation)areRs1,080,000.The
companyexpectsanadditionalworkingcapitalinvestmentofRs25,000ifitbuysthenewmachine.
Thecompanyscostofcapitalis12percent.
Assumethatthecompanywillbeallowedtodepreciatethecostofmachineondiminishingbalance
basisat25percentfortaxpurposes.Assumeacorporatetaxrateof35percent.Youmayalsoassume
thatnotaxispaidonsalvagevalueanditisadjustedforcalculatingdepreciationaspertheincometax
rules.Would yourecommend replacement ofthemachine? What wouldbe yourconsideration in
arrivingatthedecision?
13. AcompanyhasdecidedtobuyanewmachineeitherbyanoutrightcashpurchaseatRs175,000orby
hiringitatRs42,000peryearforthelifeofthemachine.Theotherrelevantdataareasfollows:
Purchasepriceofthemachine(Rs)
Estimatedlife(years)
Estimatedsalvagevalueifthemachineis
bought(Rs)
Annualcostofmaintenance
(whetherhiredorpurchased)(Rs)

175,000
5
21,000
3,500

Forsimplicityassumethatthecompanydepreciatesitsassetsonstraightlinebasisandpaystaxat50
percent.Assumingacostofcapitalof10percent,whichalternativeispreferable?
14. Acompanyisconsideringtwomutuallyexclusiveprojects.ProjectPwillrequiregrossinvestmentof
Rs250,000,andworkingcapitalofRs50,000.Itisexpectedtohaveausefullifeoftenyearsanda
salvagevalueofRs30,000attheendoftenyears.Attheendoffiveyears,anadditionalinvestmentof
Rs45,000willhavetobemadetorestoretheefficiencyoftheequipment.Theadditionalinvestment
willbewrittenofftodepreciationoverthelastfiveyears.Theprojectisexpectedtoyieldbeforetax
cashflow(annual)ofRs90,000.
ProjectQwillrequireaninvestmentofRs300,000andworkingcapitalofRs60,000.Itisexpectedto
haveausefullifeoftenyearswitharesidualsalvagevalueofRs25,000attheendoftenyears.The
annual cash flow returns from this project before income tax have been estimated at
Rs80,000foreachofthefirstfiveyears,andatRs160,000foreachofthelastfiveyears.
Depreciationistobechargedat25percentondecliningbalanceontheblockofassetsasperthe
currenttaxlaws.Thecorporateincometaxrateis50percent,andtheopportunitycostofcapitalis18
percent.CalculatetheNPVforeachproject.Whichprojectisbetter?
15. TheBrightCompanyisevaluatingaproject,whichwillcostRs100,000andwillhavenosalvage
valueattheendofits5yearlife.TheprojectwillsavecostsofRs40,000ayear.Thecompanywill
financetheprojectbya14percentloanandwillrepayloaninequalinstalmentsofRs20,000ayear.
Ifthefirmstaxrateis50percentandtheaftertaxcostofcapitalis18percent,whatistheNPVof
theproject?Assumestraightlinedepreciationfortaxpurposes.
16. TheVikrantCorporationisconsideringanewproject,whichcostsRs50,000.Theprojectwillprovide
costsavingsofRs30,000ayearfor5years.Itwouldbefinancedbya5yearloanwiththefollowing
paymentschedule:
TotalPayment Interestat15%
14,916
7,500
14,916
6,388
14,916
5,108
14,916
3,637
14,916
1,947

Principal
7,416
8,528
9,808
11,279
12,969

Balance
42,584
34,056
24,248
12,969
0

Thecorporatetaxrateis50percent.Theprojecthasthesameriskasthefirmsrisk.Thefirmscostof
capitalis12percent.CalculatetheprojectsNPV.
17. Acompanyisconsideringreplacingitsexistingmachinebyamoreefficientnewmachine.Thecostof
productionperunitisestimatedasfollows:
Costproductionperunit(Rs)
OldMachine
Materials
Labour
Variableoverheads
Fixedoverheads

040
060
030
020
150

NewMachine
38
40
15
30
123

Fortheoldmachine,fixedoverheadsincludeallocationsfromotherdepartmentsandthedepreciation.
Incaseofthenewmachine,fixedoverheadsalsoincludeitsmaintenancecostofRs2perunit.
Theoldmachinewasbought5yearsagoforacostofRs300,000,andhasabookvalueofRs200,000
nowafterbeingdepreciatedonastraightlinebasisforbothbookaswellastaxpurposes.Ithasa
remaininglifeof10years.Ithasacapacitytoproduce3,000unitseachyear,anditscapacityisfully
utilised.
ThenewmachinewouldcostRs500,000andwouldhaveasalvagevalueofRs50,000attheendofits
lifeof10years.Thesupplierofthenewmachinehasagreedtobuybacktheoldmachineat50percent
ofitsbookvalueinexchangeforthenewmachine.Hehasalsoagreedthattheremainingamount
couldbepaidintwoinstalments:halfoftheamountnowandhalf,ayearlater.
Thenewmachineiscapableofproducing4,000unitseachyear.Thecompanyisconfidentofselling
theadditionalunitsbyreducingitscurrentpriceperunitofRs200by10percent.Itisalsoexpected
thatforoperatingthenewmachine,aworkingcapitalinvestmentofRs25,000wouldberequired.
Shouldthenewmachinebeacquired?Assumetaxrateof50percentandrequiredrateofreturnof15
percent.Further,assumethatdepreciationcanbechargedonstraightlinebasisforcomputingtax,and
ordinarytaxisapplicableonthegainorlossfromthesaleofasset.
18. AfirmisconsideringaninvestmentprojectinvolvinganinitialcostofRs200,000.Thelifeofthe
projectisestimatedas5years.TheprojectwillprovideannualnetcashinflowofRs70,000.Thecost
ofcapitalis10percent.Shouldtheprojectbeaccepted?
Asubsequentevaluationrevealedthatfirmhadnotconsideredpricelevelchangesinitsestimatesof
cashflowsandthecostofcapital.Theexpectedannualrateofinflationis5percent.Ifinflationis
accountedfor,whatwouldbethefirmsdecision?
19. TheIndopaxCompanyisconsideringinvestmentinamachinethatproducesProductX.Themachine
willcostRs500,000.Inthefirstyear10,000unitsofXwillbeproducedandthepricewillbeRs20
perunit.Thevolumeisexpectedtoincreaseby20percentandthepriceoftheproductby10percent.
Thematerialusedtomanufacturetheproductisbecomingmoreexpensive.Thecostofproductionis
thereforeexpectedtoincreaseby15percent.TheproductioncostinthefirstyearwillbeRs10per
unit.
Assumeforsimplicitythatthecompanywillchargestraightlinedepreciationonthemachinefortax
purposes.Therewillbenosalvagevaluesofthe5yearlifeofthemachine.Thetaxrateis35percent,
andthediscountrateis20percent,basedontheexpectedgeneralinflationrateof10percent.Should
themachinebebought?
20. LodhaChemicalCompanyisconsideringaprojectinvolvingacashoutlayofRs6million.Salesare
expectedtobeRs1.20millioninyear1andRs2millioninyear2andthereafter,togrowat10per
centduetogeneralriseisprice.OperatingexpensesareestimatedtobeRs600,000inyear1andto
riseat10percentthereafter.AninitialworkingcapitalofRs500,000wouldbeneededandafterwards
workingcapitalisexpectedtobe25percentofsales.Thelifeoftheprojectis7years,anditcouldbe
soldfor20percentofitsoriginalcostadjustedforinflation.Depreciationischargedat25percenton
thewrittendownvaluebasis.Thecompanypaystaxat35percent.Assumethatnotaxispayableon
thesaleoftheprojectattheendofitslife.CalculatetheprojectsNPVwhentheopportunitycostof
capitalis21percent.Wouldyouranswerchangeifyouanalyzetheprojectinrealterms?

Chapter 11
PROBLEMS

1.

TheDamodarCompanyisconsideringtwomutuallyexclusiveprojectswithdifferentlives.Thecosts
(cashflows)oftheprojectsaregivenbelow:
CashFlows(Rs000)

2.

3.

4.

5.

6.

7.

8.

9.

Project

C0

C1

C2

C3

C4

X
Y

150
75

30
40

30
40

30

30

Thediscountrateis10percent.Whichprojectshouldbeselectedandwhy?
TheK&KCompanyhastwoalternativeinvestmentprojects,AandB.A,shortlivedproject,willcost
Rs150,000initiallyandinvolveannualoperatingcashexpensesofRs40,000for4years. B,onthe
otherhand,willcostRs200,000andinvolveannualoperatingexpensesofRs25,000for7years.
Projectshavenosalvagevalue.Thediscountrateis12percent.Whichprojectdoyourecommend?
Afirmisevaluatingtwomutuallyexclusivemachines.MachinePwillrequireaninitialinvestmentof
Rs120,000andprovideannualnetcashinflowsaftertaxesofRs42,000for6years.MachineQwill
involveaninvestmentofRs300,000andprovideannualnetcashinflowsaftertaxesofRs80,000for8
years.MachineQisriskierthanmachineP.TherequiredrateofreturnofMachineQis14percent
andofMachinePis12percent.Whichmachineshouldbeselected?
Acompanyisthinkingofreplacinganoldmachine.Themachinewasbought4yearsagoforRs
100,000.Itisexpectedtolastfor3yearsmoreandtoproduceanannualnetcashinflowofRs60,000.
ThenewalternativemachinewillcostRs150,000andprovidenetcashflowsofRs90,000,Rs90,000,
Rs 80,000,Rs80,000 and Rs 70,000from year 1 through year 5.There isno salvage value for
machines.Thecostofcapitalis12percent.Shouldtheoldmachinebereplaced?
R.K.Companyhadacquired5yearsagoamachineforRs300,000.Thecurrentnetsalvagevalueof
themachineisRs60,000.Itisexpectedtolastanother3yearsandprovidenetcashinflowsofRs
70,000,Rs60,000,andRs50,000.Thesalvagevalueofthemachineafter3yearsisestimatedasRs
40,000.Atechnologicallysuperiordesignisavailablenow.ThenewmachinewillcostRs300,000and
havealifeof5years.ItwillprovideannualnetcashinflowsofRs150,000,Rs130,000,Rs120,000,
Rs100,000andRs80,000.ItisalsoexpectedthatthenewmachinewillhaveanetsalvagevalueofRs
20,000after5years.Therequiredrateofreturnis10percent.Shouldthefirmreplaceoldmachine
noworafter3years.
Radiant Engineers Ltd has two machines doing the same job. Due to improved processing and
manufacturing,thecompanyisinapositiontoselloneofthemachines.Machine Xneedsrepairing
costingRs10,000tobeoperativefornextthreeyears.ItsannualoperatingcostsareexpectedtobeRs
12,500anditcouldbesoldforRs8,000after3years.ItsmarketvaluetodayisRs20,000.MachineY
hasamarketvalueofRs45,000todayandRs10,000after8years.ItsannualoperatingcostsareRs
9,000andwouldrequirerepairscostingRs12,000after3years.ThebookvaluesofMachines XandY
areRs12,000andRs24,000respectively.Assumethatdepreciationischargedonstraightlinebasis
forcomputingtax.Thetaxrateis45percentandtherequiredrateofreturnis10percent.Which
machineshouldbesold?
AcompanymanufacturesproductXbyoperatingtwomachines,eachofwhichhasacapacityof5,000
unitsayear.Assumeforsimplicitythatmachineshaveinfinitelifeandnosalvagevalue.Thecostof
manufacturingoneunitoftheproductisRs6.ThedemandishighbetweenSeptembertoFebruary,
andmachinesworkfullcapacityduringthisperiod.DuringMarchtoJuly,thedemandislowand
machinesworkat50%ofcapacity.Thecompanyisconsideringwhethertoreplacethesemachines
withavailablenewdesignedmachines.Thenewmachineshavethesamecapacityandtherefore,two
suchmachineswouldbeneededtomeetpeakdemand.EachnewmachinecostsRs30,000andlasts
indefinitely.ThecostofproductionwouldbeRs3perunit.Shouldthecompanybuynewmachines?
The WangersLtdhaskeggedoneofitsspecialwinescostingRs150,000.Itsvalueisexpectedto
increaseovertimeinthefollowingmanner:At=Rs200,000lnt.Thefirmscostofcapitalis13per
cent.Determinetheoptimumtimeofbottlingforthewine.Assumecontinuouscompounding.
Youhaveatractoflandonwhichtreescanbegrown.TheinitialcostofplantingthetreesisRs
80,000.Thenetrevenuerealisablefromtheharvestingoftreeswouldbeasfollows:

At = Rs 80,000(1 + t )0.5
Theopportunitycostofcapitalis10percent.Whatisoptimumtimeforharvestingthetrees?Assume
continuouscompounding.

10. AfirmisconsideringthefollowingtwoProjects,MandN:
Investment(Rs)
Annualnetcashinflow(Rs)
Life(years)
Costofcapital(percent)

ProjectM

ProjectN

250,000
80,000
6
10

250,000
60,000
10
10

Becauseofcapitalrationingimposedbymanagement,thefirmcanchooseonlyoneproject.Which
projectshouldbeselected?Why?
11. Considerthefollowinginvestmentprojects:
CashFlows(Rs)
Project
L
M

C0

C1

C3

3,000
3,950

2,250
+2,700

+2,700
+3,240

(a) CalculatetheNPVandPIforeachprojectassuminga20percentcostofcapital.
(b) Whichprojectshouldbeacceptedifonlyoneprojectcanbeacceptedbecauseofcapitalrationing.
12. Afirm has abudget ceiling ofRs100,000forcapital expenditures. The followingproposal with
associatedprofitabilityindexandIRRhavebeenidentified:
Proposals
A
B
C
D
E
F

CashOutlay
(Rs)

Profitability
Index

InternalRate
ofReturn(%)

100,000
50,000
40,000
30,000
20,000
10,000

1.22
1.17
1.46
1.72
1.13
1.04

15
14
20
25
13
11

Which project(s) should be undertaken? Which method would you prefer in making your
recommendationandwhy?
13. ZeeCompanyisevaluatingthefollowingseveninvestment proposals.Thecompanyhasacapital
expenditure ceiling of Rs 150 million, and therefore, can accept just enough proposals. You are
requiredtorankproposalsaccordingtoprofitabilityindexandindicatethegroupofproposalstobe
accepted.
Project
O
P
Q
S
T
U
V

CashOutlay
NPV
(Rsmillion) (Rsmillion)
10
50
20
60
100
80
40

1.8
8.0
4.0
3.6
25.0
18.0
4.0

Chapter 12
PROBLEMS

1.

Iffollowingistheonlyavailableinformation,whichprojectshouldbeaccepted?
(i) ProjectAhasENCFRs10,000,
A=Rs500;ProjectBhas
ENCF=Rs10,000,A=Rs1,000
(ii) ProjectAhasENCF=Rs10,000
A=Rs1,000;ProjectBhas

ENCF=Rs12,000,B=Rs500
(iii) ProjectAhasENCF=Rs500
A=Rs500;ProjectBhas
ENCF=Rs12,000,B=Rs1,000
(iv) ProjectAhasENCF=Rs10,000,
A=Rs500;ProjectBhas
ENCF=Rs12,000,B=Rs600
2.

3.

4.

5.

Afirmisconsideringtwoinvestmentprojects,Project A requiresanetcashoutlayofRs6,000; B
requiresRs5,000.Bothprojectshaveanestimatedlifeof3years.Thenetcashinflowshavebeen
estimatedas:ForProjectA,year1,a0.40chanceofRs2,000anda0.60chanceofRs3,000;year2,a
0.30chanceofRs4,000anda0.70chanceofRs2,000;year3a0.50chanceofRs3,000anda0.50
chanceofRs2,200;ForProjectB,year1,a0.30chanceofRs1,000anda0.70chanceofRs2,000;
year2,a0.20chanceofRs2,000anda0.80chanceofRs1,000;year3,a0.40chanceofRs2,000,
anda0.60chanceofRs4,000.Assumea10percentdiscountrate.Whichprojectshouldbeaccepted
andwhy?
TheWalchandCompanyisconsideringtwomutuallyexclusiveprojects.Theexpectedcashflowsand
theassociatedcertaintyequivalentcoefficientsforeachprojectareasfollows:
Year

ProjectA
Rs

Certainty
Equivalent

ProjectB
Rs

Certainty
Equivalent

0
1
2
3
4
5

5,000
1,000
2,000
3,300
4,000
1,000

1.00
0.90
0.80
0.70
0.60
0.30

8,000
6,000
5,000
4,000
3,000
1,000

1.00
0.90
0.70
0.60
0.50
0.25

Toaccountfortheriskinessoftheprojects,thecompanyusesthecertaintyequivalentapproach.
Whichofthetwoprojectsshouldbeselectediftheriskfreediscountrateis6percent?Ifthefirm
weretouseriskadjusteddiscountratesinsteadofcertaintyequivalentapproach,whatrateswouldbe
usedinordertoobtainanequivalentsolution?
TheLalchandCo.isanalysingtwomutuallyexclusiveproposals,eachcostingRs30,000andhavinga
fiveyearexpectedlife.EachprojectwillhaveexpectedcashflowswhichwillincreasebyRs3,000
eachyearafterthefirstyear,andwillnothaveanyvalueafterthefifthyear.Thefirstyearpossiblenet
cashinflowsforproject1areRs10,000,Rs14,000andRs16,000withassociatedprobabilitiesof
0.25,0.50and0.25,respectively.ThefirstyearpossiblenetcashinflowsforProject2areRs4,000,Rs
12,000andRs25,000withassociatedprobabilitiesof0.20,0.50and0.30,respectively.Project1is
consideredlessriskyandcanbeevaluatedat8percent,whileProject2ismoreriskyandcanbe
evaluatedat10percentrateofdiscount.Whichprojectshouldbechosen?
TheWestonCo.isthinkingofbuildingaplanttomanufactureanewproductrecentlydevelopedbyits
R&Ddepartment.Severalalternativesareavailabletothefirmregardingthesizeoftheplant.The
companycanconstructalargeplant,whichwillcostRs500,000.Underdifferentdemandconditions
thecashflowswithassociatedprobabilitiesareexpectedtobeasfollows:
LargePlant
Demandcondition
High
Medium
Low

Probability
0.50
0.40
0.10

Cashinflow(Rs)
year110
125,000
100,000
50,000

ThealternativetobuildingalargeplantistobuildasmallerplantforRs200,000now,withan
optiontobuildanadditionalplantaftertwoyears,iftheproductachievessufficientsuccess.Thesmall
planthasacapacitytomaintainRs80,000incashflows.Underhighormediumdemandtheplantwill
befullyutilised.

Theexpectedcashflowswithassociatedprobabilitiesareasfollows:
SmallPlant
Demandcondition

Cashinflow(Rs)
year12

Probability

High
Medium
Low

0.50
0.40
0.10

80,000
80,000
40,000

Aftertwoyears,thecompanycanreviewthesituationtoexpandthesmallerplant.Ifthecompany
experiences a high initial demand for the first two years, a Rs 300,000 addition could be built,
increasingyearlyrevenuepotentialbyRs60,000.
Thecompanyestimatesthenetcashflowswithassociatedprobabilitiesunderdifferentdemand
conditionsasfollows:
HighInitialDemand:AdditionalPlantofRs300,000
Demand
condition

Probability

High
Medium
Low

0.60
0.30
0.10

Cashinflow(Rs)
year310
140,000
110,000
80,000

IfonlymediumdemandwasachievedinthefirsttwoyearsthenaRs150,000additionwouldbe
considered.Theexpectedcashflowsandprobabilitiesareasfollows:
MediumInitialDemand:AdditionalPlantofRs150,000

6.

Demand
condition

Probability

High
Medium
Low

0.60
0.30
0.10

Cashinflow(Rs)
year310
110,000
80,000
25,000

Thecompanyalsoconsidersthepossibilityofnotbuildinganyadditionregardlessofthelevelof
demand.
Designadecisiontreeandsolveforthemostprofitablealternative.Assumea10percentdiscount
rateandthattheplantsdonothaveanysalvagevalue.
Amanagementgroupofacompanyhasdetermineditsrelativeutilityvaluesforcashflowsasfollows:
CashFlowRs

Utilities

20,000
10,000
1,000
0
+10,000
+9,000
+8,000
+7,000

100
40
3
0
+30
+25
+18
+10

Giventhisutilityfunction,whichofthefollowingprojectsshouldbeaccepted?Why?
ProjectA

ProjectB

CashflowRs
Prob.

Prob.

20,000
10,000
9,000
8,000

0.10
0.20
0.25
0.30

Cashflow(Rs)
10,000
7,000
8,000
9,000

0.15
0.25
0.40
0.20

7,000

7.

0.15

A company is considering buying an equipment for a new process. The equipment will cost Rs
245,700. The company has made the following estimates of the aftertax cash flows over the
equipmentspossiblelifeoftwoyears:
Year1

8.

Year2

NCF

Prob.

NCF

Prob.

153,500

0.5

125,000

0.5

122,800
184,300
240,500
307,000

0.7
0.3
0.4
0.6

Theoutcomeofyear2isdependentontheoutcomeofyear1.Useadecisiontreeapproachto
answerthefollowingquestions(assume12percentdiscountrate):
(a) Whatistheequipmentsexpectednetpresentvalue?
(b) Iftheworstoutcomeoccurs,thenwhatwouldbetheprojectsnetpresentvalue?
(c) Whatnetpresentvaluewillberealisedifthebestoutcomeoccurs?Whatisitsprobability?
(d) Whatistheprobabilityofthecompanyrealisinganetpresentvaluelessthanzero?
TheR&Ddepartmentofacompanyhasdevelopedanewproductwithanexpectedlifeofsixyears.
ThemanufacturingoftheproductwillrequireinvestmentofRs3lakh.Thefollowingannualprofit
fromtheinvestmentisexpected:
Sellingprice
Less:Unitvariablecost
Materials
Labour
Overheads

25
8
4
3

Contribution

15
10

Salesrevenue(30,000units)
Less:Variablecosts

750,000
450,000

Contribution
Less:Fixedcosts
(includingdepreciationRs50,000) 120,000

300,000

Profitbeforetax
Less:Taxat50%

180,000
90,000

Profitaftertax

90,000

Assume that the company can charge depreciation on straightline basis for tax purpose. If the
companyhasadiscountrateof10percent,calculatetheinvestmentsNPV.Identifythefactorswhichare
mostcriticaltothedecision.Toanswerthisquestion,calculatethevolume,sellingprice,unitvariablecost,
andcashoutlay,atwhichtheinvestmentsNPVwouldbezero,otherthingsremainingthesame.

Chapter 13
PROBLEMS

1.

2.

ACCisconsideringbuildingacementmanufacturingplantinSriLanka.TheprojectwillcostRs800
croreandthepresentvalueofthecashflowswillbeRs700crore.Thefinancedirectorisnotinfavour
oftheproposalsinceithasanegativeNPV.Themarketingdirector,ontheotherhand,thinksthatthe
potentialmarketforcementinSriLankaisenormous.Hearguesthatthecompanyshouldbuildthe
plantnowtoestablishitcompetitivepositionandexpandafter3years.Thecostofexpansionwillbe
Rs2,000crore andthepresent value ofcash flowswill beRs2,100.Thedemandforcement is
expectedtofluctuate.Thestandarddeviationofthevaluesofcashflowsisestimatedtobe32percent.
Theriskfreerateis7.5percent.Whatisthevalueoftheoptiontoexpand?
L&Tisthinkingofentering intoajointventuretobuildamultipurpose commercial complexin
Dehradun,thecapitalofUttaranchalwithalocalrealestatedeveloper.Thedevelopmentisexpectedto
costRs1,200crore,andhaveapresentvalueofcashflowsofRs1,000crore.Theeconomiclifeofthe
projectis30years.Thejointventurewillbeon5050percentbasiswheretwopartnerswillshare
costsandbenefitsequally.L&Twillhavearighttosellthecomplextothelocaldeveloperanytime

3.

4.

overthenextsevenyearsforRs450crore.L&Tsfinancemanagerfindsthatthestandarddeviationin
thevalueofrealestatecompaniesis35percent.Assumethattheriskfreerateis7.8percent.Whatis
thevalueofL&Tsrighttoabandon?WhatshouldL&Tdo?
Acompanyisanalysinganinvestmentproject.ItwillcostRs185crore,andwillgenerateannualcash
flowsofRs24croreforever.Thecompanyscostofcapitalis10percent.Asimulationonthe
projectscashflowsshowsthatthevalueoftheprojectwillhaveastandarddeviationof25percent.
Suppose that the company has rights to this project for 25 years. The current yield on 25year
governmentbondis5percent.WhatistheprojectsDCFvalue?Whatisthevalueoftheprojectasan
option?Whyisthereadifferencebetweenthesetwovalues?
AfirmisconsideringaprojectthatisexpectedtocostRs50crore.Theproject,onanaverage,will
generateaftertaxcashflowsofRs7.50croreperannumoveritsestimatedeconomiclifeof15years.
Thefirmscostofcapitalis15percent,andtheriskfreerateis8percent.Thefirmthinksthatthe
cashflowswillfluctuateandvarianceofthevalueofthecashflowswillbe0.0676.Asanalternative
totakinguptheprojectnow,itisthinkingofdelayingtheproject.Whatshouldthefirmdo?

Chapter 14
PROBLEMS

1.

2.

3.

AcompanyhasassetsofRs1,000,000financedwhollybyequitysharecapital.Thereare100,000
shares outstanding with a bookvalue ofRs10 per share. Last years profit before taxes was Rs
250,000.Thetaxrateis35percent.Thecompanyisthinkingofanexpansionprogrammethatwill
costRs500,000.Thefinancialmanagerconsidersthethreefinancingplans:(i)selling50,000sharesat
Rs10pershare,(ii)borrowingRs500,000ataninterestrateof14percent,or(iii)sellingRs500,000
ofpreferenceshareswithadividendrateof14percent.Theprofitbeforeinterestandtaxareestimated
tobeRs375,000afterexpansion.
Youarerequiredtocalculate:(a)theaftertaxrateofreturnonassets,(b)theearningspershare,
and (c)therateofreturnonshareholdersequityforeachofthethreefinancingalternatives.Also,
suggestwhichalternativeshouldbeacceptedbythefirm.
AcompanyisconsideringtoraiseRs200,000tofinancemodernisationofitsplant.Thefollowing
threefinancingalternativesarefeasible:(i)Thecompanymayissue20,000sharesatRs10pershare,
(ii) The company may issue 10,000 shares at Rs 10 per share and 1,000 debentures of Rs 100
denominationbearinga14percentrateofinterest.(iii)Thecompanymayissue5,000sharesatRs10
pershareand1,500debenturesofRs100denominationsbearinga14percentrateofinterest.
Ifthecompanysprofitsbeforeinterestare(a)Rs5,000,(b)Rs12,000,(c)Rs25,000,whatarethe
respectiveearningspershare,rateofreturnontotalcapitalandratesofreturnontotalequitycapital,
foreachofthethreealternatives?Whichalternativewouldyourecommendandwhy?Ifthecorporate
tax rate is 35 per cent, what are your answers to the above questions? How do you explain the
differenceinyouranswers?
TheApexLimitedisanewlyincorporatedcompanyandwantstoplananappropriatecapitalstructure.
Itcanissue15percentdebtand11percentpreferencecapitalandhasa35percenttaxrate.The
firmsinitialrequirementforfundsisRs400lakhandequitysharescanbesoldforanetpriceofRs25
pershare.Thepossiblecapitalstructuresare:
Alternatives
1
2
3
4
5
6

4.

Equity
100%
75%
75%
50%
50%
30%

Preference

25%
20%

20%

Debentures

25%

30%
50%
50%

(i) ConstructanEBITEPSchartforthesixalternativesoveranEBITrangeofRs10lakhtoRs80
lakh.
(ii) Determine the indifference points for first and fourth alternatives and for fourth and sixth
alternatives.
(iii) IsthemaximisationofEPSataspecificlevel ofEBITtheonlyfunctionofafirmscapital
structure?Ifnot,arethepointsdeterminedin(ii)trulyindifferencepoints?
EmpireLtdneedsRs1,000,000tobuildanewfactorywhichwillyieldEBITofRs150,000peryear.
Thecompanyhastochoosebetweentwoalternativefinancingplans:75percentequityand25percent

5.

6.

debtor50percentequityand50percentdebt.UnderthefirstplansharescanbesoldatRs50per
share,andtheinterestrateondebtwillbe14percent.UnderthesecondplansharescanbesoldforRs
40per share andtheinterest rate ondebt will be16per cent. Determine theEPS for each plan
assuminga35percenttaxrate.
HowardCompanyisconsideringthreefinancingplans:allequity;60percentequityand40percent
debt;and40percentequityand60percentdebt.TotalfundsneededareRs300,000.EBITisexpected
tobeRs45,000.SharescanbesoldattherateofRs20percentshare.Fundscanbeborrowedas
follows:uptoandincludingRs60,000at14percent;Rs60,000toRs150,000at16percentandover
Rs150,000at18percent.ComputetheEPSofeachplan.Assumeataxrateof35percent.
XYZLtdwishestoraiseRs1,000,000tofinancetheacquisitionofnewassets.Itisconsideringthree
alternativewaysoffinancingassets:(i)toissueonlyequitysharesatRs20pershare,(ii)toborrowRs
500,000at14percentrateofinterestandissueequitysharesatRs20pershareforthebalanceor( iii)
toborrowRs750,000at14percentrateofinterestandissueequitysharesatRs20pershareforthe
balance. The following are the estimates of the earnings from the assets with their probability
distribution:

7.

EBIT(Rs)
80,000
120,000
160,000
200,000
320,000

Probabilities
0.10
0.20
0.40
0.20
0.10

Youarerequiredto(i)calculatetheearningspershare(ii)computetheindifferencepoints,and
(iii)determinethefinancialrisk,foreachofthethreealternatives.Assumeataxrateof35percent.
ForXLtdthefollowingdataisavailable:
EBIT Rs200
Contribution
Interest

8.
9.

400
100

Ifthecompanyssalesareexpectedtodeclineby5percent,determinethepercentagechangein
EPS.
TheexpectedearningsoffirmsAandBareRs120,000withastandarddeviationofRs30,000.FirmA
isnonlevered.FirmBisleveredandhastopayannualinterestchargesofRs30,000.Whichfirmis
morerisky?Why?
RastogiLtdisconsideringtwoplans(a)15%debtor(b)issueof100,000sharesofRs10eachto
financeaproposedexpansionatacostofRs1,000,000.ThecompanyexpectsEBITwithassociated
probabilitiesasfollows:

EBIT(Rs)

Probabilities

100,000
150,000
200,000
250,000
300,000
400,000

0.05
0.10
0.30
0.40
0.10
0.05

DeterminetheexpectedEBITandcoefficientofvariationofEBIT.AlsocalculateexpectedEPS
and its variability under two plans. Comment on your results. The company has 100,000 shares
outstanding,andthecorporatetaxrateis35percent.
10. A large chemical company is considering acquiring two small companies. The following is the
financialdataabouttwocompanies:
(Rsinlakh)
Sales
Less:Variablecost

Company1

Company2

108.65

108.65

43.46

35.85

Contribution

65.19

72.80

Less:Fixedcost

52.69

61.40

EBIT

12.50

11.40

Less:Interest

9.27

6.95

PBT

3.23

4.45

Less:Tax(35%)

1.13

1.56

PAT

2.10

2.89

Totalassets

92.70

92.70

Equity

30.90

46.35

Debt

61.80

46.35

Whatwouldbetheeffectoncompaniesprofitabilityandriskifsalesfluctuateby10percent?If
thechemicalcompanyintendstoacquirealessriskyfirm,whichoneshoulditbuy?Givereasons.
11. IndusEngineeringCompanyhasgrosssalesofRs137.5croreandprofitaftertaxofRs7.15crorein
theyear2008.Thecompanyisconsideringexpandingitscapacitybyadding30percentmoretoits
existingfixedassets.SalesarelikelytoincreasebyRs55crore.Fortheproposedexpansion,PBITto
salesratiois18percent.Thecompanyhasnever borrowedinthepast.Thefinancedirectorhas
recommended that the company should raise 15 per cent interest bearing debt for financing the
expansion.Inhisopinion,given35percentcorporateincometaxrate,theeffectivecostofdebtwillbe
9.75percent,andconsideringthecurrentnetworth(seebalancesheetgivenbelow),debtequityratio
will beonly0.22,whichisquitelowforanengineering firm.Indusisahighlycapital intensive
company; its fixed costs are 70 per cent of the total costs. It is notable that the performance of
engineeringindustryisquitesusceptibletoeconomicchanges.Shouldthecompanyborrow?Giveyour
analysisbymakingappropriateassumptions.
BalanceSheetason31December2008 (Rsincrore)
Sharecapital
(4croresharesatRs10) 40.0
Reserve
95.0
Networth
135.0
Currentliabilities
35.5
Cash
170.5

Fixedassets
Currentassets:
Debtors
Inventory
20.5
170.5

100.0
20.0
30.0

12. Volgaisalargemanufacturingandmarketingcompanyintheprivatesector.In2008,thecompanyhad
agrosssalesofRs980.2crore.Theotherfinancialdataforthecompanyaregivenbelow:
SomeFinancialDataforVolga,2008
Items
Networth
Borrowing
EBIT
Interest
Fixedcosts(excludinginterest)

Rsincrore
152.31
165.47
43.17
34.39
118.23

You are required to calculate (a) debtequity ratio; (b) debt ratio; (c) interest coverage, (d)
operating leverage, (e) financial leverage and (f) combined leverage. Interpret your results and
commentontheVolgasdebtpolicy.

Chapter 15
PROBLEMS
1. XCo.hasanetoperatingincomeofRs200,000onaninvestmentofRs1,000,000inassets.Itcan
raisedebtata16percentrateofinterest.Assumethattaxesdonotexist.
(a) UsingtheNIapproachandanequitycapitalisationrateof18percent,computethetotalvalueof
thefirmandtheweightedaveragecostofcapitalifthefirmhas(i)nodebt,(ii)Rs300,000debt,
(iii)Rs600,000debt.
(b) UsingtheNOIapproachandanoverallcapitalisationrateof12percent,computethetotalvalue
ofthefirm,valueofsharesandthecostofequityifthefirmhas( i)nodebt,(ii)Rs300,000debt,
(iii)Rs600,000debt.
2. FirmLandFirmUareinthesameriskclassandareidenticalineveryrespectexceptthatFirmLis
leveredandFirm U isunlevered.Firm L has12percentRs400,000debenturesoutstanding.Both
firmsearn18percentbeforeinterestandtaxesontheirtotalassetsofRs800,000.Assumeacorporate
taxrateof50percentandapureequitycapitalisationrateof15percent.
(a) Computethetotalvalueofthefirmsusing(i)theNIapproach,(ii)theNOIapproach.
(b) UsingtheNOIapproach, calculate theaftertaxweightedaverage costofcapitalforboththe
firms.Whichofthetwofirmshasanoptimumcapitalstructureandwhy?
(c) AccordingtotheNOIapproach,thevaluesforFirmsAandBcomputedinpart(a)usingtheNI
approacharenotinequilibrium.Undersuchasituation,aninvestorcansecuresamereturnat
lowercashoutlaythroughthearbitrageprocess.Assumethataninvestorowns5percentofLs
shares,showthearbitrageprocess.Whenwouldthisarbitrageprocessstop?
3. ThevaluesfortwofirmsXanunleveredfirmandYaleveredfirmwithRs600,000debtat6per
centrateofinterestaregivenasbelow.AninvestorholdsRs20,000worthof Ysshares.Showthe
processbywhichhecanearnsamereturnatalessercost.
X
Rs
Netoperatingincome,
Costofdebt,INT=kdD

200,000

200,000
36,000

Netincome,NI

200,000

164,000

X
Rs
Equitycapitalisationrate,ke
Marketvalueofequity,E
Marketvalueofdebt,D
Totalvalueoffirm,V=E+D
Overallcapitalisationrate,ko

4.

Y
Rs

0.111

Y
Rs
0.125

1,800,000 1,312,000
600,000
1,800,000 1,912,000
0.1111
0.1046

TwofirmsAandBareidenticalinallrespectexceptthatBhasRs500,000debtoutstandingata6per
centrateofinterest.Thevaluesofthetwo

Netoperatingincome

A
Rs

B
Rs

150,000

150,000

Costofdebt,kd

30,000

NetincomeNI

150,000

120,000

0.10

0.15

1,500,000

800,000

Equitycapitalisationrate,ke
Marketvalueofequity,E
Marketvalueofdebt,D
Totalvalueoffirm,V=E+D

500,000

1,500,000

1,300,000

Overallcapitalisationrate,ke

0.10

0.1154

Assumethataninvestorowns10percentofAsshares.Howcantheinvestorobtainsamereturnata
lowercost?
5. SpposeX=Rs50,000,kd=0.06,Eu=Vu=Rs500,000,El=Rs280,000.Dl=Rs250,000andVl=Dl
+El=Rs530,000.Calculatethecostofequityandtheweightedaveragecostofcapitalfortwofirms.
Ifaninvestorowns5percentoftheleveredfirmsshares,howcanhebebenefitedbyresortingtothe
arbitrageprocess?
6. AnewcompanyproposestoinvestRs10lakhinassetsandwillmaintainitscapitalstructureatbook
value.ItisexpectedtoearnanetoperatingincomeofRs160,000.Thecompanywantstohavean
optimummixofdebtandequity.Thecostofdebtandtheequitycapitalisationrateatdifferentdebt
equityratioareasfollows:
(a) Whatistheoptimumcapitalstructureforthiscompany?
(b) IftheMMhypothesisisvalid,whatshouldbetheequitycapitalisationrateatdifferentdebtequity
ratios?

7.

DebtEquityRatio

CostofDebt

Equitycapitalisation
Rate

10:90
20:80
30:70
40:60
50:50
60:40

0.05
0.05
0.06
0.07
0.08
0.10

0.125
0.130
0.136
0.143
0.160
0.180
0.200

ThevaluesforthetwofirmsXandYinaccordancewiththetraditionaltheoryaregivenbelow:
X
Rs

Y
Rs

Expectednetoperatingincome,
Totalcostofdebt,kdD=INT

50,000
0

50,000
10,000

Netincome,INT

50,000

40,000

Costofequity,ke
Marketvalueofshares,E
Marketvalueofdebt,D
Totalvalueoffirm,V=E+D
Averagecostofcapital,ko=X/V
Debtequityratio

8.

0.10

0.11

500,000
0
500,000
0.10

360,000
200,000
560,000
0.09

0.556

ComputethevaluesforfirmsXandYaspertheMMthesis.Assumethat(i)corporateincome
taxesdonotexistand(ii)theequilibriumvalueofkois12.5percent.
ThefollowingaretheequilibriumvaluefortwofirmsMandNaspertheModiglianiMillerapproach:
MRs

NRs

Netoperatingincome,
Totalcostofdebt,INT=kdD

12,000
0

12,000
2,000

Netincome,INT
Overallcapitalisationrate,ko

12,000
0.08

10,000
0.08

MRs

NRs

Totalvalueoffirm,V=X/ko

1,50,000

1,50,000

Marketvalueofdebt,D
Marketvalueofshares,E=VD
Costofdebt,kd=INT/D

0
1,50,000
0

40,000
1,10,000
0.05

0.08

0.091

Costofequity,ke=(INT)/E

RecomputethevaluesforfirmsMandNinaccordancewiththetraditionaltheory.Assumethatthe
costofequityoffirmMis10percentandforfirmNitis10.5percent.
9.

Firm L and U have same expected earnings before interest and taxes of Rs 25,000. Firm U has
employed100percentequityofRs100,000whilefirm L hasemployedRs50,000equityandRs
50,000debtatanexpectedrateofreturn(costofdebt)of15percent.Youarerequiredtocalculatefor
each firm: (a) earnings of all investors and (b) value of interest tax shield under the following
alternatives:(i)nocorporateandpersonaltaxes;(ii)50percentcorporatetaxesandzeropersonal
taxes;(iii)50percentcorporatetaxesand30percentpersonaltaxes;and(iv)50percentcorporate
taxes,20percentpersonaltaxesondividendincomeand40percentpersonaltaxesoninterestincome.
10. Acompany hasset itstarget debtequity ratio at 1:1 and target payout ratio at 40 per cent. The
companywantstoachieveagrowthrateof20percentperannum.Thecompanyisexpectingbefore
taxreturnonassetsof21percent.Itssalestoassetsratiois1.8times.Thecurrentinterestrateis12
percent.Thecorporatetaxrateforthecompanyis35percent.Canthecompanysustainitsintended
growth?Whatshoulditdotoachievethegrowthrate?
11. HindustanLeverLimited(HLL):Fromthefollowingfinancialdataforyearsfrom1992to2002(year
ending31December)forHLLinTable15.14,criticallyreviewthecompanysfinancingpractice.
12. PhilipsIndiaLimited:Table15.15givesdataforPhilipsIndiaLimitedfortheyearsfrom1990to
2002.TheCompanychangeditsaccountingperiodfromMarchtoDecemberin1993,thus,datafor
theyear1993arefor9months.Commentonthecompanysinvestmentandfinancingpolicy.
Table 15.14: Hindustan Lever Limited
NS

(Rsincrore)

Year

GFA

NCA

INVST

NW

Debt

PBIT

INT

PAT

1992
1993
1994
1995
1996
1997
1998
1999
2000
2001

330.5
365.6
491.8
563.8
953.6
1035.2
1273.4
1349.7
1539.4
1778.3

323.1
285.8
299.7
193.0
168.9
567.2
895.3
1151.8
1087.1
1349.7

12.3
51.0
191.5
122.8
328.8
544.6
729.5
1068.1
1832.2
1668.9

333.3
385.7
538.3
638.3
937.5
1260.8
1712.4
2102.6
2487.6
3043.0

200.3
115.2
146.5
160.2
260.1
186.6
264.3
177.3
111.6
83.7

1221.1
1505.0
1721.3
2039.4
2798.8
3337.8
6560.7
7736.8
9426.1
10116.5

197.0
244.9
327.4
385.2
654.2
874.2
1130.5
1420.1
1668.4
1865.6

32.2
60.0
27.2
79.8
29.5
97.3
20.2 122.1
57.0 185.2
33.9 232.0
29.3 404.7
22.4 570.3
13.2 808.2
7.7 1079.8

2002 1836.9

1639.0

2397.7

3658.2

58.3

10588.2

2154.4

9.2 1300.3

Table 15.14: Philips India Limited

(Rsincrore)
Year GFA

NCA

INVST

1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

82.1
97.1
122.9
112.8
141.3
223.4
194.3
175.8
217.8
213.1
134.1
40.0
67.6

2.1
7.6
12.2
13.8
13.2
14.7
19.6
16.7
15.5
14.0
14.0
17.3
1.9

154.7
162.1
181.8
232.1
253.1
319.2
376.1
386.0
414.8
330.4
363.3
334.7
605.4

NW

TD

STBB

LTB

DEBN

NS

PAT

41.3
63.6
76.5
129.3
175.9
187.4
190.9
171.7
176.2
191.6
167.8
147.3
306.4

116.5
101.8
114.6
69.3
62.5
169.7
186.9
168.3
195.7
159.9
127.3
66.1
48.0

12.1
16.0
31.1
6.4
12.8
91.3
71.5
47.6
44.8
35.4
25.8
45.9
5.5

104.4
85.8
83.6
52.9
39.6
63.4
100.3
80.7
110.9
104.5
86.5
20.2
42.5

56.7
48.3
41.2
22.8
3.2
3.0
32.7
32.7
72.2
50.0
53.8
0.0
8.3

391.2
523.1
689.5
672.0
1092.7
1454.4
1438.8
1509.4
1620.1
1662.9
1444.4
1459.5
1492.8

8.2
26.7
21.5
9.0
33.7
22.1
11.8
44.6
39.2
41.4
3.1
40.4
85.5

GFA=grossfixedassets;NCA=netcurrentassets;INVST=investment;NW=networth;TD=total
debtborrowings;STBB=shorttermbankborrowings;LTB=longtermborrowingsincludingdebentures;
DEBN=debentures;NS=netsales;PAT=profitaftertax.

Chapter 16
Problems

1.

2.

3.
4.
5.

Acompanysequitybetais1.84andithasadebtratioof50percent.Theriskfreerateis9percent
andtheaveragemarketpremiumis8.5percent.Thecompanyisconsideringaprojectthathaszero
debtcapacityandtheexpectedrateofreturnoftheprojectis18percent.Thebusinessriskofthe
projectissimilartothefirm.Shouldthecompanyaccepttheproject?
Apowerequipmentcompanyhas85percentdebttoassetsratioandanequitybetaof1.25.Therisk
freerateis6.5percentandtheexpectedmarketrateofreturnis12.5percent.Thecorporatetaxesare
35percent.Whatistheopportunitycostofcapitalofthecompany?Howmuchistherequiredreturn
ontheequity?
Asoftwarecompanyhasnodebt.Itsunleveredbetais1.0.Assumethatthecorporatetaxrateis30per
cent.Ifthecompanywantsitsbetatoincreaseto2.50,howmuchleverageshouldittake?
Afirmsdebtratiois60percent.Theriskfreerateis8percentandtheexpectedmarketreturnis14
percent.Theassetbetaofthecompanyis1.10.Calculatethefirmscostofequity.Howmuchisthe
businessriskpremiumandthefinancialriskpremiumforthefirmsequity?
Supposetheriskfreerateis8percent,themarketriskpremiumis9percentandthetaxrateis30per
cent.Afirmhasthefollowingmarketvaluesandbetabasedonthemarketdataandthecompanys
ownanalysisforvarioussourcesoffinancing:
SourceofCapital

6.

7.

8.

9.
10.

Marketvalue
(Rsincrore)

Beta

Ordinary share capital

500

1.45

Debentures

400

0.30

Public deposits

100

0.15

Youarerequiredtocalculate(i)therequiredrateofreturnforeachsourceoffinance;(ii)theweighted
averagecostofcapital;(iii)theassetbeta;and(iv)theopportunitycostofcapitalonthefirmsassets.
Anengineeringcompanyhasadebttomarketvalueratioof40percent.Thecompanycanraisenew
debtat12percent.Thecorporatetaxrateforthecompanyis35percent.Thecompanyhasestimated
therequiredreturnonequityas22percent.Whatisthecompanysweightedaveragecostofcapital?
Thecompanyisthinkingofraisingitsdebttomarketvalueratioto60percent.Whatwillbethe
companysnewweightedcostofcapital?
AprojectwillrequireaninvestmentofRs100,000andgenerateposttaxfreecashflowsofRs15,000
inperpetuity.Theprojectsallequitycostofcapitalis15percent.Theprojectwillsupportaperpetual
10percentdebtofRs50,000.(i)CalculateprojectsNPV.(ii)Supposethetaxrateis35percent.
CalculatetheprojectsAPV.(iii)Calculatetheprojectsminimumrequiredrateofreturn?
Afirmsallequitycostofcapitalis15percent.Thecostofdebtis10percentanddebtratiois35
percent.Thecorporatetaxrateis35percent.CalculateMMstaxadjustedleveredcostofcapital.
WhatwillbetheadjustedleveredcostofcapitalundertheMilesEzzellformula?Whytheadjusted
costofcapitalundertheMMandtheMilesEzzellformulaediffer?
Afirmscostofequityis20percent.Thecostofdebtis10percentanddebtratiois40percent.The
corporatetaxrateis35percent.CalculateMMstaxadjustedleveredcostofcapital.Whatwillbethe
adjustedleveredcostofcapitalundertheMilesEzzellformula?
TorrentAutomotiveCompanysdebtcapacityis50percentofthemarketvalueofitsassets.The
companysequitybetais1.40.Theriskfreerateis9percentandtheaveragemarketpremiumis12
percent.Thecorporatetaxrateis30percent.Thecompanyisconsideringaninvestmentprojectinthe
existinglineofbusinessrequiringaninvestmentofRs100crore.Theprojectisexpectedtogenerate
theaftertaxfreecashflowsofRs15croreinperpetuity.WhatistheprojectsNPVifithasthezero

debtcapacity?Supposethatthecompanycanborrow30percentofthecostoftheprojectforan
indefiniteperiod,howwillyouevaluatetheproject?Showcalculations.
11. Delhi Transport Company is intending to expand its fleet of trucks. It is considering buying 30 Tata
trucks for Rs 600 lakh. The company expects the fleet to have a useful life of six years and generate
earnings before interest, taxes and depreciation of Rs 120 lakh per year. Delhi Transport Company is a
zero-debt company. Assume that the corporate tax rate is 34 percent and straight-line depreciation is
allowed for tax purposes. The companys all-equity opportunity cost of capital is 20 percent. (a) What
is the NPV of the new fleet of trucks? (b) Suppose that Delhi Transport Company will raise 5-year debt
of Rs 300 lakh at 10 percent rate of interest per year. The principal will be paid entirely at the end of
the sixth year. What is the project APV?
12. ABC Ltd is an all-equity financed company. The firm is thinking of investing in a project that will
involve an initial outlay of Rs 20 crore. It is expected that the project will generate free cash flows (net
of taxes) of Rs 3 crore each year over a period of five years. The project has business risk similar to the
firm. The firms unlevered cost of capital is 16 percent. ABC Ltd is contemplating to borrow a fiveyear 10 percent loan of Rs 20 crore from a financial institution to finance the project. The principal is
repayable in four equal instalments starting from the end of year two. The firm will have to incur
flotation cost of Rs 20 lakh to raise debt from the financial institution. The corporate tax rate is 34
percent. Calculate the projects APV.
1.

IndoSoftwareCompanyhascostofequityof20percent,costofdebtof10percentanddebttototal
assetsratioof20percent.Thecompanyisconsideringanexpansionproject.Theprojectwillneeda
cashoutlayofRs80crore.ItisexpectedtogenerateannualEBDITofRs20crorefor8years.The
projectwillrequireRs1croreeachyearfornetworkingcapitalandcapitalexpenditure.IndoSoftware
willbeabletoborrow40percentoftheprojectscostfromafinancialinstitution.Theinterestrateis
10percentp.a.,andtheloanamountwillberepaidinequalannualinstalmentsovereightyears.The
corporate tax rate is 34per cent. Assume straightline depreciation for computing taxes and zero
terminalvalueoftheproject.Shouldthecompanyaccepttheproject?

2. Delite Manufacturing Company is expanding its business in the rural area of Andhra
Pradesh. The expansion will cost the company Rs 24 crore. It is expected that
expansion benefits will last for 12 years and it will increase revenue by Rs 10 crore
growing at 10 percent each year for three years, then at 5 percent each year for next
four years followed by no growth period of the last four years. The cost of goods sold
is expected to be 60 percent and other expenses 15 percent of revenue. Depreciation
will be charged on straight-line basis. Working capital is estimated to be 25 percent of
the revenue to be incurred at the end of the previous period. The corporate tax rate is
34 percent. The firm has debt-equity ratio of 1:1 and its levered beta and the cost of
equity are 1.20 and 22 percent, respectively. The risk-free rate of return is 10 percent.
The project has 1.5 times of the firms business risk. The market cost of debt is 10
percent per annum. The firm will be able to raise subsidised loan of Rs 12 crore from
the government of Indias rural development funds at 8 percent annual interest. The
loan will be paid at the end of year 12. Find out projects APV. What is the value of
the subsidised loan?
12. DhatuIndustriesLimitedisamanufacturerofironandsteel.Ithasanequitybetaof1.10.Thetarget
debtequityratioofthecompanyis2:1.Thecompanyisintendingtodiversifyintodifferentlinesof
businesses.ItisconsideringacementprojectrequiringaninvestmentofRs105crore.Thecompany
willbeabletoraiseRs70crore loanfrom afinancial institutionat10percentp.a.Theloanis
repayableattheendof5years.Theprojectisexpectedtogenerateannualprofitbeforeinterestand
taxesofRs22crorefor7years.Assumethattheprojectscostcanbedepreciatedoveritslifeof7
yearsonthestraightlinebasis.Thecompanyhasidentifiedonepubliclimitedcementcompanyasa
proxyfortheproject.Thiscompanyhasanequitybetaof1.3anddebtequityratioof1.5:1.Therisk
freerateis7percentandthemarketriskpremiumis8percent.Thecorporatetaxrateis30percent.
ShouldDhatuundertakethecementproject?
13. Suppose that Dhatu Industries Limited in (9) above decides to locate the cement project in an
economically backward area. Asa consequence, it isable to negotiate the loan amount from the
financialinstitutionat8percentinsteadofthemarketrateofinterestof10percent.Evaluatethe
viabilityoftheprojectshowingthesourcesofvaluefortheproject.

14. SupposethatDhatuIndustriesLimitedin(9)abovedoesnothavetopayanytaxesontheincomeof
thecementprojectsinceitislocatedinthebackwardarea.Howdoesthisaffecttheprofitabilityofthe
project?
15. A firm has debt capacity equal to debt-equity ratio of 1:1. The firms interest payments are Rs 5 lakh
per year. The risk-free rate is 8 percent and the market risk premium is 9 percent. The unlevered beta of
the firm is 1.20 and beta of debt is zero. The firms annual revenues are estimated as Rs 100 lakh each
year; the cost of goods sold will be Rs 45 lakh and general and administrative expenses will be Rs 20
lakh. All revenues and expenses are on cash basis and are expected to remain same forever. The
corporate tax rate is 34 percent. What is the value of the firms equity? What is the total value of the
firm?
16. PQR Ltd is an all-equity firm. It has unlevered cost of equity of 20 percent, corporate tax rate of 30
percent, and annual cash flows of Rs 40 crore in perpetuity. The firm is thinking of restructuring its
capital. It wants to replace its equity by issuing perpetual debt of Rs 25 crore at 12 percent annual
interest rate. Calculate (i) PQRs total value and equity value before restructuring; (ii) PQRs total
value and equity value after restructuring.
17. Brite Ltd is considering a project unrelated to its existing business. The firm collected the following
information of similar firms in the industry to determine the risk of the project: Average debt-equity:
0.8:1; average equity beta: 1.6 and average cost of debt: 12 percent. The projects target debt-equity is
0.5:1. The risk-free rate is 6 percent and the market risk premium is 9 percent. Brites corporate tax rate
is 35 percent. The initial outlay on project is estimated as Rs 50 crore. (i) The expected post-tax free
cash flows at the end of the first year are Rs 5 crore which will remain constant thereafter for indefinite
period. Should the investment be made? (ii) Suppose that the expected post-tax free cash flows of Rs 5
crore at the end of the first year will grow at 8 percent per year until the end of sixth year and will
remain constant thereafter for indefinite period. What is the value of investment? (iii) Suppose that the
expected post-tax free cash flows of Rs 5 crore at the end of the first year will grow at 6 percent per
year until the end of sixth year and at 2 percent thereafter for indefinite period. What is the value of
investment?
18. The following information relate to NM Company: target debt-equity ratio 0.75:1; the unlevered cost
of capital 18 percent; the annual interest rate 10 percent; corporate tax rate 35 percent; expected pre-tax
cash flows for indefinite period Rs 10.80 crore. (i) What is the value of NM Company if it is entirely
financed by equity? (ii) If the firm is levered, what is its cost of equity? (iii) Calculate the levered
firms weighted average cost of capital. What is the value of the firm under the FCF approach? (iv)
Calculate the value of the firms equity using flow-to-equity approach and APV approach.
19. The market value of equity of XYZ Ltd is Rs 140 crore. It has 10 crore outstanding shares. The market
value of the firms debt is Rs 70 crore. The firm intends to maintain the current market value debt ratio
forever. The expected interest rate is 12 percent. The firms equity beta is 1.20 and the corporate tax
rate is 30 percent. The risk free rate is 6 percent and the risk premium is 8.5 percent. The firms
expected post-tax free cash flows next year are Rs 25 crore. The free cash flows are expected to grow
at 10 percent for eight years and thereafter, at 5 percent for ever. How much is the value of the firm?
What is the value of equity? How much is the value per share?
20. The market value of equity of a firm is Rs 200 crore. It has one crore outstanding shares. The firm
intends to maintain the market value debt ratio of 40 percent forever. The expected interest rate is 10
percent. The firms equity beta is 1.50 and the corporate tax rate is 30 percent. The risk free rate is 6
percent and the risk premium is 8.5 percent. The firms expected post-tax free cash flows next year are
Rs 40 crore. The free cash flows are expected to grow at 12 percent for five years, at 8 percent for next
five years and thereafter, at 5 percent forever. How much is the value of the firm? What is the value of
equity? How much is the value per share?

Chapter 17
Problems
1. AcompanyearnsRs10pershareataninternalrateof15percent.Thefirmhasapolicyofpaying40
percentofearningsasdividends.Iftherequiredrateofreturnis10percent,determinethepriceofthe
shareunder(i)Waltersmodel,(ii)Gordonsmodel.
2. SaraswatiGlassWorkshasaninvestmentofRs30croredividedinto30lakhordinaryshares.The
profitabilityrateofthefirmis20percentandthecapitalisationrateis12.5percent.Whatisthe
optimumdividendpayoutforthefirmifWaltersmodelisused?Whatshallbethepriceoftheshareat

3.
4.

5.

6.

7.

optimumpayout?Shallyouranswerchangeiftheprofitabilityrateisassumedtobe15percent?What
wouldhappenifprofitabilityrateis10percent?Showcomputations.
Thefollowingdatarelatetoafirm:earningspershareRs10,capitalisationrate10percent,retention
ratio40percent.DeterminethepricepershareunderWaltersandGordonsmodelsiftheinternalrate
ofreturnis15percent,10percentand5percent.
ManexCompanyhasoutstanding50lakhsharessellingatRs120pershare.Thecompanyisthinking
ofpayingadividendofRs10pershareattheendofcurrentyear.Thecapitalisationratefortherisk
classofthisfirmis10percent.UsingModiglianiandMillersmodelyouarerequired:(i)tocalculate
thepriceoftheshareattheendofthecurrentyearifdividendsarepaidandiftheyarenotpaid;( ii)to
determinethenumberofsharestobeissuedifthecompanyearnsRs9crore,paysdividendsand
makesnewinvestmentsofRs6.60crore?
Acompanyhasoutstanding10lakhshares.ThecompanyneedsRs5croretofinanceitsinvestments,
forwhichRs1croreisavailableoutofprofits.Themarketpriceofpershareattheendofcurrentyear
isexpectedtobeRs120.Ifthediscountrateis10percent,determinethepresentvalueofashare
usingtheMMmodel.
ThecurrentmarketpriceofacompanyssharesisRs125pershare.Theexpectedearningspershare
anddividendpershareareRs10andRs5respectively.Theshareholdersexpectedrateofreturnis15
percent.Supposethecompanydeclaresthatitwillswitchto100percentpayoutpolicy,issuingshares
asnecessarytofinancegrowth.Usetheperpetualgrowthmodeltoshowthatcurrentpriceofshareis
unchanged.
Thefollowingdatarelatetoafirminthecottontextileindustry:
Rsincrore
Sharecapital(atRs10pershare)
Reserve
Profitaftertax
Dividendspaid
P/Eratio

12.50
7.50
1.85
1.50
13.33

Youarerequired(a)tocommentonthefirmsdividendpolicyusingWaltersmodel;(b)todetermine
theoptimumpayoutratiousingWaltersmodel;(c)todeterminethepriceearningsratioatwhich
dividendpayoutwillhavenoeffectonshareprice.
8. TurantPharmaisthinkingofdiversifyingitsbusinessinthefieldofenergy.Thefirmhasdecidedto
makeacapitalexpenditureofRs35croreinanenergyproject.Theprojectisexpectedtoyielda
positivenetpresentvalueofRs25crore.ThefirmisalsoconsideringapaymentofdividendsofRs20
crore.TheinternalfundsavailablewiththefirmareRs10crore.IthasapaidupsharecapitalofRs50
croredividedinto5croresharesofRs10each.ThecurrentpriceofthefirmsshareisRs25.Thefirm
hasnotborrowedfundsinthepast,andwouldcontinuewiththispolicyinthefuture.
Giventhefirmscapitalexpenditureandthepolicyofzeroborrowing,showtheimplicationsofthe
paymentofdividendsfortheshareholdervalue.WillyouranswerbedifferentifTurantdecidesnotto
payanydividends?Assumenotaxesandnoissuecosts.
9. TheshareofXCompanyissellingforRs100.Itisanotaxpayingcompany.ThepriceofXsshareis
expected

to

be

Rs115afteroneyear.CompanyYisidenticaltocompanyXintermsofriskandthefutureearnings
potential.Itisadividendpayingcompany,andisexpectedtopayadividendofRs10pershareafter
oneyear.Assumedividendincomeistaxedat35percentandthereisnotaxoncapitalgains.What
shouldbethecurrentpriceofBsshareandhowmuchshouldbeitsbeforetaxexpectedreturn?
10. ThesharesofFirmAandFirmBhaveidenticalrisk.Bothhaveanaftertaxrequiredrateofreturnof
15percent.FirmApaysnodividend,whileFirmBisahighdividendpayingfirm.ThepriceofFirm
AsshareisexpectedtobeRs60afteroneyearandthepriceofFirmBRs50withRs10dividendper
share.Assumethattheincometaxrateis40percentandcapitalgaintaxrateis20percent.Determine
thecurrentpricesofFirmAsandFirmBsshares.
11. Theexpectedbeforetaxincomes(consistingofdividendandcapitalgains)onsharesoffirmsX,Yand
Zaregivenbelow:
Share

Dividendincome(Rs)

Capitalgain(Rs)

X
Y

0
5

10
5

10

SupposethatthecurrentpriceofeachshareisRs60.Further,aninvestorisin50percenttaxbracket
andcapitalgaintaxrateis20percent.Whichsharewillgivehighestaftertaxreturntotheinvestor?
Nowsupposethattheeachsharewasexpectedtohaveexpectedaftertaxyieldof12percentforthe
investor.Determinethepriceofeachshare.

Chapter 18
PROBLEMS
1. B. Das Co. has been a fast-growing firm and has been earning very high return on its investment in the
past. Because of the availability of highly profitable investment internally, the company has been
following a policy of retaining 70 per cent of earnings and paying 30 per cent of earnings as dividends.
The company has now grown matured and does not have enough profitable internal opportunities to
reinvest its earnings. But it does not want to deviate from its past dividend policy on the ground that
investors have been accustomed to it and any change may not be welcome by them. The company,
thus, invests retained earnings in the short-term government securities. Is the company justified in
following the current dividend policy? Give reasons to support your answer.
2. D. Damodar Co. is a fast-growing firm in the engineering industry. In the past, the firm has earned a
return of 25 per cent on its investments and this trend is likely to continue. The firm has been retaining
25 per cent of its earnings and paying 75 per cent of earnings as dividends. This policy has been
justified on the grounds that dividends are generally preferred over retained earnings by shareholders.
Is the current dividend policy justified if most of the shareholders are wealthy persons in high tax
brackets? Will your answer change if most of the shareholders of the company were (a) retired persons
with no other source of income and (b) the financial institutions?
3. The following data relate to the Brown Limited and the Crown Limited which belong to the same
industry and sell the same product:
Brown Ltd
Market Price
Year
Rs

EPS
Rs

DPS
Rs

High

2005
2006
2007
2008
2009

3.60
3.90
3.70
3.20
3.80

2.00
2.00
2.00
2.00
2.00

48
53
51
59
60

Low Book value

Rs
Rs*
52
34
30
31
35

37.20
38.80
40.60
42.30
43.20

*The face value per share is Rs 10.

Crown Ltd
Market Price

4.

Year
Rs

EPS
Rs

DPS
Rs

High

2005
2006
2007
2008
2009

3.50
3.00
2.50
6.00
5.00

1.75
1.50
1.25
3.00
2.50

38
42
42
50
48

Low Book value

Rs
Rs*
34
32
28
30
27

30.50
32.50
33.75
36.50
38.50

*The face value per share is Rs 10.

Calculate payout ratio, dividend yield, earnings yield and priceearning ratio. Which company is
more profitable? Explain the reason for the difference in the market prices of the two companies
shares.
A multinational pharmaceutical company in India has following information about its EPS and
dividends payment from 1987 to 2004.
You are required to answer the following questions: (a) What minimum annual percentage dividend
increase the company intends to give to its shareholders? (b) Is there any relationship between the
earnings increase and the rise in dividends? (c) Do you think that the company has a long-term target

payout ratio? (d) The companys payout in 2003 was 150 per cent. How will you explain this? (e) What
clientele does the company have?
EPS Change in DPS Change in Payout
Year
Rs
EPS (%)
Rs
DPS (%)
(%)
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
5.

13.9
15.9
16.4
18.4
19.8
23.6
24.7
25.9
27.8
30.7
30.1
31.2
33.9
34.9
81.8
44.9
53.6
36.5

7.2
14.2
3.1
12.8
7.4
19.3
4.7
4.5
7.6
10.2
2.0
3.7
8.7
2.9
134.5
45.1
19.5
32.0

5.3
5.9
6.5
7.4
8.3
9.4
10.5
11.5
13.0
14.2
15.1
15.9
17.2
19.1
21.6
23.5
80.5
28.2

11.7
11.7
10.5
14.3
11.7
13.4
11.8
9.4
12.9
9.5
6.1
5.7
7.7
11.5
12.9
8.6
243.1
65.0

37.9
37.0
39.7
40.2
41.8
39.7
42.4
44.4
46.6
46.3
50.1
51.1
50.7
54.9
26.4
52.3
150.1
77.2

Ashoka Ltd has a capital structure shown below:

Rs (crore)
Equity share capital (Rs 10 par, 5 crore shares) 50
Preference share capital (Rs 100 par, 50 lakh shares)50
Share premium
50
Reserves and surpluses
80
Net worth
230

6.

Show the changed capital structure if the company declares a bonus issue of shares in the ratio of
1:5 to ordinary shareholders when the issue price per share is Rs 100. How would the capital structure
be affected if the company had split its stock five-for-one instead of declaring bonus issue?
Polychem Co.s current capital structure as on 31 March, 2009 is as follows:
Rs (crore)
Share capital (Rs 100 par, 2 crore shares)
Share premium
Reserves and surpluses

7.

200
100
190
490

The current market price of the companys shares is Rs 140 per share. The earnings per share for the
year 2008 was Rs 17. The company has been paying a constant dividend of Rs 6.50 per share for the
last ten years.
What shall be the effect on earnings per share, dividend, share price and the capital structure if the
company (i) splits its shares two-for-one or (ii) declares a bonus issue of one-for-twenty?
Surendra Auto Limited is considering a bonus shares issue. The following data are available:
Rs (crore)
Paid up share capital
Reserves
Previous three years pre-tax profit

Year 1
Year 2
Year 3

12
16
8.0
8.6
8.3

Recommend the maximum bonus ratio. Give reasons.

Chapter 19
Only review Questions

Chapter 20
PROBLEMS
1. AfirmisthinkingofarightsissuetoraiseRs5crore.Ithasa5lakhsharesoutstandingandthecurrent
marketpriceoftheshareisRs170.ThesubscriptionpriceonthenewsharewillbeRs125pershare.
(i)Howmanysharesshouldbesoldtoraisetherequiredfunds?(ii)Howmanyrightsareneededto
purchaseonenewshare?(iii)Whatisthevalueofoneright?
2. Acompanyisconsideringarightsofferingtoraisefundstofinancenewprojects,whichrequireRs4.5
crore.Theflotationcostwillbe10percentoffundsraised.Thecompanycurrentlyhas20lakhshares
outstandingandthecurrentmarketpriceofitsshareisRs100.Thesubscriptionpricehasbeenfixedat
Rs50pershare.(i)Howmanysharesshouldbesoldtoraisethefundsrequiredforfinancingthenew
projects?(ii)Howmanyrightsarerequiredtobuyonenewshare?(iii)Whatisthevalueofoneright?
(iv)Showtheimpactonashareholderswealthwhoholdsrequiredrightstobuyonenewshareif(a)
heexercisesrights,or(b)sellshisrights,or(c)doesnotexerciserights.
3. GCompany,startedin1922,isadiversifiedcompany.Havingcommencedoperationastradingand
servicingofengineeringequipments,itdiversifiedintomanufacturingandmarketing.Thecompanys
proposedcapitalexpendituresinclude(a)expansionofthecapacityofdieselenginefrom22,500units
to32,500unitsin200910,40,000unitsin201011and55,000unitsin20112012atacostofRs37.9
crore,(b)manufactureof3wheelerdieselunit,aforwardintegrationproject,atacostofRs18.8crore,
withinstalledcapacityof8,000unitsin200910,10,000unitsin201011and20,000unitsin201112,
(c)manufactureofvibratorycompactorsatacostofRs2.06crore,(d)R&DcapitalexpenditureofRs
3.62crorefordevelopingaportablediesellownoise,smallerHPengines,(e)investmentofRs49.4
crore in the equity of three companies, (f) investment of Rs 73.0 crore in a subsidiary for the
manufacture of engineering plastics and (g) normal capital expenditure of Rs 35 crore for the
enhancementoflongtermresources.OfthefirstprojectonlycostequaltoRs30.1crorewillbemetof
thepresentissue.
Thecompanyhasproposedtoissue144lakhequitysharesofRs10eachatapremiumofRs70
eachtotallingtoRs115.21croreintheratioof1:1onrightsbasis.TheRs10paidupshareofthe
companyhasamarketpriceofRs102.50andanetassetvalue(NAV)ofRs44.80.Thecompanyhas
madethefollowingprojections:
100910

201011

201112

Revenues(Rscrore)

360.00

420.00

563.00

Netprofit(Rscrore)

17.10

18.10

25.30

EPS(Rs)

11.78

7.38

9.00

NAV(Rs)

62.96

71.87

78.86

Thefollowingareafewindicatorsofthecompanysperformanceduringlasttwoyears:
200708
Revenues(Rscrore)

250.0

285.0

Pretaxprofits(Rs)

10.7

12.0

Equitydividend(%)

20.0

23.0

Borrowing(Rscrore)

57.0

74.0

Interest(Rscrore)

7.0

12.0

EPS(Rs)

7.2

Source:TheEconomicTimes.
CriticallyevaluateGCompanysrightsissue.

1.

200809

Source:TheEconomicTimes,4January1993.

Chapter 21
PROBLEMS
1. InJanuary2004,acompanyannouncedtwotypesofconvertibledebentures.First,itissued50lakh10
percentfullyconvertibledebenturesofRs1000eachatpar.Eachconvertibledebenturewasfully
convertibleinto5sharesofRs200(i.e.,Rs100parplusapremiumofRs100)aftertwoyearsfromthe
dateofallotmentofdebentures.Thecompanyalsoannouncedapublicissueof50lakh10percent
partlyconvertibledebenturesofRs2000each.Likethefirstissue,Rs1000ofthedebenturesface
valuewasconvertibleinto5shares.Thenonconvertibleportionofthedebenturewastoberedeemed
attheendof10yearsfromthedateofallotment.Atthetimeoftheseissues,thecompanyssharewas
sellingforRs120.Analyzebothtypesofdebenturesbymakingappropriateassumptions.
2. KamaniLimitedhastotalassetsRs1000crore.Itsequity,dividedin25croreoutstandingshares,has
marketvalueofRs800crore.CurrentlythecompanyhasdebtofRs400crore.Thecompanyhasjust
madeanissueofdebentures(Rs100each)ofthetotalamountofRs400croreplusonewarrantofRe
10foreachdebenture.Awarrantwillentitlethedebentureholderstoapplyforoneequityshareatan
exercisepriceofRs15attheendoftwoyears.Theannualstandarddeviationoftheshareprice
variabilitybeforethedebentureissueis:=4.5.Assumethattheinterestrateis10percent.Whatis
thevalueofawarrant?

Chapter 22
PROBLEMS
1. AcompanywantstoleaseaRs10lakhequipment.Thelessorrequireseightannualendoftheyear
lease payments of Rs 175,000. The companys marginal tax rate is 35 per cent. If it buys the
equipment,itcanwriteoffthewrittendowncostofassetat25percent.Thecompanysborrowing
rateis15percent.Shouldthecompanyleasetheequipment?Useequivalentloanmethodtoanswer
thequestion.
2. AcementmanufacturerisconsideringtoleaseadryingequipmentwhichisworthRs75lakh.Itwill
havetopayfiveannualbeginningoftheyearleaserentalsofRs20lakh.Thetaxrateis35percent
andthemanufacturercanwriteoffthecostofequipmentat25percentwrittendownbasisfor5years.
Themanufacturerseffectiveborrowingrateis16percent.Shouldtheequipmentbeleased?Showthat
equivalentloanmethodandnetadvantageofleasemethodwillleadtothesameanswer.
3. ReadymadeGarmentsLimitedwantstoleaseacomputersystemforthepurposeofcolourmatching.
ThesystemwillcostRs30lakh,andifboughtcanbedepreciatedoveritslifeof5years.Theannual
rentals,payable attheendofyear for5years, will beRs8.4lakh.Theapplicable writtendown
depreciationrateis25percent.Thelessorwillmaintainthecomputersystematitscostwhichworks
outtobeRs50,000peryear.Attheendofitsusefullife,thesystemcanbesoldfor50percentofits
depreciatedvalue.Thecompanysborrowingrateis14percentandtaxrateis35percent.Shouldthe
systembeleased?Showyourcalculations.
4. AfirmproposestoleaseanassetofRs20lakh.Theannual,endoftheyear,leaserentalswillbeRs5
lakhfor5years.Thefirmisnotinapositiontopaytaxfornext5years.Thedepreciationrate(WDV)
is25percentperannum.Thelessorsmarginaltaxrateis35percent.Calculatethenetpresentvalue
ofleasetothelesseeandthelessor.Whatarethebreakevenrentalstothelesseeandthelessor?How
canbothbenefitfromthedeal?Showyourcomputations.Assumethatthelesseesposttaxborrowing
rateis14percent.
5. YouareplanningtobuyorleaseanIBMnotebook.ItwillcostyouRs1,50,000.Youcanleaseitfor8
yearsforRs2,500permonthpayableinthebeginningofthemonth.Asperthetaxrules,youcan
neitherclaimdepreciationnordeductinterestonyourpersonalborrowingsfromyourincome.Your
friendiswillingtolendyouRs1,50,000at10percentperannum.Shouldyouleasethenotebookor
borrowfromyourfriendandbuyit?
6. AcompanyisconsideringwhetheritshouldbuyorleaseequipmentthatcostsRs80lakh.Afinance
companyhasofferedtoleasetheequipmentfor5yearsatannualleasepaymentsRs20lakhatthe
beginningofeachyear.Theowneroftheequipmentcanclaimdepreciationonwrittendownbasisat
25percenteachyear.Thecompanys(lessees)taxrateis35percent,anditscostofborrowingis14
percent,andthecostofcapitalis16percent.
(a) Shouldthecompanybuytheassetorleaseit?

(b) Whatwouldyouranswerbeif(a)weassumethattheequipmenthasasalvagevalueofRs10
lakhattheendofitslife,andthatthelessorwillmaintaintheequipmentwhichwouldotherwise
costthelesseeRs1lakheachyear?(b)Insteadofleasethecompanygoesforahirepurchase,
howmuchmaximumhirepurchaseinstalmentshoulditbepreparedtopayeachyear?

Chapter 23

Onlyreviewquestions

Chapter 24
PROBLEMS
1. ThecomparativebalancesheetsofDobaCompanyshowedthefollowingchangesinbalancesheet
itemsfrom19X1to19X2:
Rs
Workingcapital
127,500 increase
Longterminvestments
45,000 increase
Land
48,000 increase
Machinery(lessaccumulateddepreciation) 90,000 increase
15%Debentures
240,000 increase
Sharecapital
60,000 increase
Reservesandsurplus
10,500 decrease

2.

Thefollowingadditionaldataareprovided:(i)NetprofitfortheyearwasRs157,500(ii)Accumulated
depreciationfor19X1wasRs67,500andfor19X2Rs90,000.(iii)AmachineofRs112,500was
purchasedduringtheyear;depreciationexpensesfortheyearwasRs22,500.(iv)Abonusissueof
sharesofRs60,000wasmadeduringtheyear.(v)AcashdividendofRs87,000wasdeclaredandpaid
duringtheyear.
PrepareastatementofchangesinfinancialpositionforDobaCompany.
ThecomparativebalancesheetsforSomaPvt.Ltdaregivenbelow:
Table 24.30: Soma Pvt. Ltd
ComparativeBalanceSheets
fortheyearendedon31December
Assets
Cash
Debtors
Stock
Prepaidexpenses
Plantandmachinery
Goodwill

3.

(Rs)
19X2

19X1

82,000
104,000
112,000
22,000
380,000
36,000

22,000
24,000
60,000
14,000
360,000
40,000

Total
Equities
Creditors
Provisionfordepreciation
Debentures
Premiumondebenturesissue
Sharecapital
Sharepremium
Reservesandsurplus

736,000 520,000

Total

736,000 520,000

30,000
100,000
102,000
12,000
190,000
30,000
272,000

14,000
60,000
102,000
18,000
90,000

236,000

Thecompanymadeanet profit ofRs66,000duringtheyear. Prepare astatement ofchanges in

financialpositionon(a)workingcapitalbasis,(b)cashbasis.Alsoprepareascheduleofworking
capitalchanges.
FromthefollowingdataofKamdhenuCompany,prepareastatementofchangesinfinancialposition.

Table 24.31: Kamdhenu Company

BalanceSheets
fortheyearendedon31March
Assets
Cash
Debtors
Stock
Longterminvestments
Machinery
Buildings
Land

(Rs)
19X2

19X1

30,000
45,000
20,000
15,000
20,000
45,000
10,000

22,500
40,000
16,000
25,000
12,500
37,500
10,000

Total
LiabilitiesandEquity
Provisionfordepreciation:
Machinery
Buildings
Provisionfordoubtfuldebts
Creditors
Outstandingexpenses
Loan(adjustsecurityofmachinery)
Sharecapital
Reservesandsurplus

185,000 163,500

Total

185,000 163,500

3,750 1,500
9,000 6,000
1,500 1,000
20,000 16,500
2,250 1,750
22,500 25,000
100,000 100,000
26,000 11,750

Additionaldata:
(i) Netprofitfortheyear19X2isRs27,500.
(ii) MachinerycostingRs2,500,onwhichdepreciationofRs500hasaccumulated,wassoldforRs
3,000.Thegainisincludedinnetprofit.
(iii) InvestmentscostingRs10,000weresoldduringtheyearforRs12,500.Thegainisincludedinnet
profit.
(iv) Cashdividendspaidduringtheyear,Rs13,250.
4.

Prepare(a)astatementofchangesinfinancialpositionon(i)workingcapitalbasis,(ii)cashbasis,and
(b)ascheduleofchangesinworkingcapitalfromthefollowingdata:
Table 24.32: M Company
BalanceSheet
fortheyearendedon30June

Assets

19X1

19X2 Equities

(Rs)
19X1

19X2

Cash
15,000
9,000 Creditors
60,000
Marketable
Billspayable
15,000
securities
21,000 15,000 Accruedexpenses 6,000
Debtors
30,000 45,000 Taxpayable
9,000
Stock
36,000 45,000 Longtermdebt
0
Fixedassets,net 150,000 1,65,000 Sharecapital
Othernon
including
currentassets
24,000 15,000 reserve
180,000

0
24,000
6,000
15,000
45,000

270,000 3,00,000

210,000

270,000 300,000
Table 24.33: M Company

ProfitandLossAccount
fortheyearended30June
Sale
Expenses:
Costofgoodssold
Selling,generalandadministrativeexpenses

(Rs)
150,000
75,000
15,000

Depreciation
Interest
Profitbeforetax
Less:Tax
Profitaftertax
Reserve,30June19X1

15,000
3,000

Less:Cashdividends
Reserve,30June19X2

5.

108,000
42,000
21,000
21,000
120,000
141,000
9,000
132,000

BalancesheetandprofitandlossaccountofJBSonsCompanyLimitedasonDecember31,19X1and
19X2areasfollows:
Table 24.34: JB Sons
BalanceSheet
ason31December

Liabilities

19X1

19X2 Assets

Accountspayable 15,000 25,000

Cashcredit
13,000 10,000
Outstanding
expenses
2,000 3,000
Longtermloan 30,000 20,000
Capital
30,000 30,000
Surplus
10,000 12,000
100,000 1,00,000

(Rs)
19X1

19X2

Cashbalance
5,000 2,000
Accounts
receivable
10,000 8,000
Loanand
advances
5,000

Inventories
20,000 25,000
Fixedassets(net) 60,000 65,000
100,000100,000
Table 24.35: JB Sons Company

ProfitandLossAccount
fortheyear19X2

(Rs)

Sales
Less: Costofgoodssold(including

depreciationofRs10,000)

200,000
170,000

Grossprofit
Less:Otherexpenses
Incomebeforetax
Less:Incometaxprovision
Incomeaftertax

6.

30,000
20,000
10,000
5,000
5,000

Prepareastatementofsourcesandusesoffunds.
(C.A.,adapted)
Acompanyfindson1January,19X3,thatitisshortoffundswithwhichtoimplementitsprogramme
ofexpansion.On1January,19X1,ithadacashcreditbalanceofRs180,000.Fromthefollowing
information,prepareastatementfortheboardofdirectorstoshowhowtheoverdraftofRs68,750as
atthe31December,19X2hasarisen:
19X1
Rs

19X2
Rs

19X1
Rs

19X2
Rs

Fixedassets
750,000 11,20,000 Tradecreditors 270,000 350,000
Stockandstores 190,000 3,30,000 Sharecapital
Debtors
380,000 3,35,000 (insharesof 250,000 300,000
Bankbalance 180,000
Rs10each)
Bankoverdraft

68,750 Billsreceivables 87,500 95,000

The profit for the year ended December 31, 19X2 before charging depreciation and taxation
amountedtoRs240,000.The5,000shareswereissuedon1January19X2atapremiumofRs5per
share,andRs137,500waspaidinMarch19X2bywayofincometax.Dividendwaspaidasfollows:

7.

onthecapitalon31December,19X1at10%lesstaxat25%;19X2(interim)5percentfreeoftax.
(C.A.,adapted)
FromthefollowingdataofPanditSonsLimited,prepareastatementofsourcesandusesoffunds:
Table 24.36: Pandit Sons Limited
BalanceSheet
ason31December

Liabilities

(Rs000)

19X2 19X1 Assets

Accumulated
depreciation
Creditors
Billspayable
Debentures
Equitycapital
Premiumonshares
Retainedearning

275
150
100
75
50
25
500
250
550
400
60

336
325
1,871 1,225

19X2 19X1

Cash
315
285
Marketablesecurities 106
50
Debtors
150
125
Inventories
95
70
Investments
70
110
Machinery
500
350
Buildings
600
200
Land
35
35
1,871 1,225
Table 24.37: Pandit Sons Limited

IncomeStatement
fortheyearendedDecember31,19X2
Sales
Costofgoodssold
Grossmarginonsales
Operatingexpenses:
Depreciation machinery

buildings
Otherexpenses
Netmarginfromoperations
Gainonsalesonlongterminvestments
Total
Lossonsalesofmachinery(proceedsfrom
salesRs15,000)
Netincome

8.

(Rs000)
600
337
263

50
80
100

230
33
12
45
5
40

FromthefollowingbalancesheetofAlphaLtd,make(1)statementofchangesintheworkingcapital,
and(2)fundsflowstatement:
Table 24.38: Alpha Co.
BalanceSheet

Liabilities

19X1

Equityshare
capital
300,000
8%Redeemable
Preference
capital
150,000
Capitalreserve

Generalreserve
40,000
Profitandloss
account
30,000
Proposeddividend 42,000
Sundrycreditors 25,000
Billspayable
20,000
Liabilitiesfor
expenses
30,000
Provisionfor
taxation
40,000

19X2 Assets

(Rs)
19X1

19X2

Goodwill
100,000
400,000 Landand
building
200,000
Plant
80,000
100,000 Investments
20,000
20,000 Sundry
50,000 debtors
140,000
Stock
77,000
48,000 Billsreceivable 20,000
50,000 Cashinhand 15,000
47,000 Cashatbank 10,000
16,000 Preliminary
expenses
15,000
36,000

80,000

50,000

170,000
200,000
30,000
170,000
109,000
30,000
10,000
8,000
10,000

677,000 817,000

9.

677,000 817,000

Additionaldata:(i)Apieceoflandhasbeensoldoutin19X2andtheprofitonsalehasbeencarriedto
capitalreserve.(ii)AmachinehasbeensoldforRs10,000.Thewrittendownvalueofthemachine
wasRs12,000.DepreciationofRs10,000ischargedonplantaccountin19X2.(iii)Theinvestments
aretradeinvestments;Rs3,000bywayofdividendisreceivedincludingRs1,000frompreacquisition
profitwhichhasbeencreditedtoinvestmentaccount.(iv)AninterimdividendofRs20,000hasbeen
paidin19X2.
(C.A.,adapted)
ThefollowingarethesummariesofthebalancesheetsofCVictoryLimitedason31December,19X1
and31December19X2:
Table 24.39: C Victory Ltd
(Rs)

BalanceSheet
Liabilities

19X1

Sundrycreditors 39,500
Billspayable
33,780
Bankoverdraft
59,510
Provisionfor
taxation
40,000
Reserves
50,000
Profitandloss
account
39,690
Sharecapital
200,000

19X2 Assets

19X1

19X2

41,135 Cashatbank
2,500
11,525 Sundrydebtors 87,490
Stock
111,040
Landand
50,000 building
148,500
50,000 Plantand
machinery
112,950
41,220 Goodwill

260,000
462,480 453,880

2,700
73,360
97,370
144,250
116,200
20,000
462,480 453,880

Thefollowingadditionalinformationisobtainedfromthegeneralledger:(a)Duringtheyearended
December19X2aninterimdividendofRs26,000waspaid.(b)Theassetsofanothercompanywere
purchasedforRs60,000payableinfullypaidsharesofthecompany.Theseassetsconsistedofstock
Rs22,000,machineryRs18,000,andgoodwillRs20,000.Inadditionsundrypurchasesofplantwere
madetotallingRs5,600.(c)IncometaxpaidduringtheyearamountedtoRs25,000.(d)Thenetprofit
fortheyearbeforetaxwasRs65,530.
Youarerequiredtoprepareastatementshowingthesourcesandapplicationoffundsfortheyear
19X2andaschedulesettingoutchangesinworkingcapital.
(C.A.,adapted)
10. ThecomparativebalancesheetsofBombayIndustriesLtdason31December,19X1and19X2areas
under:
Table 24.40: Bombay Industries Ltd
BalanceSheet
(Rs)
Liabilities

19X1

CurrentLiabilities
Sundrycreditors
Provisionfor
taxation
Liabilitiesfor
expenses
Totalcurrent
liabilities

19X2 Assets

40.40

43.20

10.80

12.20

2.60

1.00

53.80

56.40

LongtermLoans 22.00
Totalliabilities
75.80

19X2

21.00 FixedAssets
77.40 Plant,mach.
&bldng.
Less:Total

OwnersEquity
Paidupcapital

19X1

CurrentAssets
Cashatbank 44.60 47.80
Debtors
10.80 17.00
Stockintrade 44.00 67.20
Miscellaneous 30.20
8.00
Totalcurrent
assets
129.60 140.00

280.00 320.00

depreciation

283.40 368.00
25.80

34.20

257.60 333.80
Reservesand

Land

50.00

50.00

surplus
Totalequity

140.60 163.60 Totalfixed

420.60 483.60 assets
Investments

307.60 383.80
42.40 25.20

IntangibleAssets16.80

12.00

Totalnoncurrent
TotalCapital

assets
496.40 561.00 TotalAssets

366.80 421.00
496.40 561.00

TheincomefortheyearamountedtoRs57.80lakhafterchargingdepreciationofRs8.40lakhbut
beforemakingthefollowingadjustments:(i)profitonlandpurchasedandsoldin19X2,Rs15.60lakh;
(ii)lossonsaleofmarketablesecuritiesRs2.80lakh,includedundermiscellaneouscurrentassets;(iii)
writeoffintangibleassetsRs4.80lakh;(iv)writeofflongterminvestmentsRs17.20lakh.
ThedividenddeclaredandpaidduringtheyearamountedtoRs25.60lakh.Fromtheaboveparticulars
prepare:
(i)statementofsourcesandapplicationoffunds,and(ii)statementofchangesinworkingcapital.
(C.A.,adapted)
11. FollowingarethesummarisedbalancesofPQLimitedon30June,19X1and19X2:
Table 24.41: PQ Limited
(Rs)

Balancesason30June
19X1
Dr.
Equitysharecapital:
30,000sharesofRs10each
issuedandfullypaid
Capitalreserve
14%Debentures
Debenturediscount
Freeholdpropertyatcost
Freeholdpropertyatvaluation
Plantandmachineryatcost
Depreciationonplantand
machinery
Debtors
Stockandworkinprogress
Creditors
Profitandlossaccount
Netprofitfortheyear
Dividendinrespectof19X1
Provisionfordoubtfuldebts
Tradeinvestmentatcost
Bank

19X2
Cr.

Dr.

Cr.

300,000
300,000

49,200

50,000

1,000

122,000

165,000

223,000
283,000

107,600
122,000
104,600
154,600

124,000
162,500

37,400
49,200
112,000
112,000

76,500

30,000

3,100
6,400

47,000

13,500
77,800
573,600 573,600 843,100 843,100

Youareinformedthat:(i)Thecapitalreserveon30June,19X2representedtherealisedprofitonthe
saleofonefreeholdpropertytogetherwiththesurplusarisingonrevaluation.(ii)Duringtheyear
ended30June,19X2,plantcostingRs18,000againstwhichadepreciationprovisionofRs13,500had
beenmadewassoldforRs7,000.(iii)On1July,19X1,Rs50,000debentureswereissuedforcashata
discountofRs1,000.(iv)Thenetprofitfortheyearisarrivedataftercreditingtheprofitonthesaleof
machineryandchargingdebentureinterest.Youarerequiredtoprepareastatementwhichwillexplain
whybankborrowinghasincreasedbyRs64,300duringtheyearended30June19X2.Taxationisto
beignored.
(C.A.,adapted)
12. Fromtheinformationprovided,youare required toprepare aSource andDispositionofFunds
statementexplaininghowCDLimitedhasimprovedcashpositionintheyearended31December

19X2.ThesummarisedbalancesheetsofCDLimitedason31December19X1and31December
19X2wereasfollows:
Table 24.42: CD Ltd
(Rs)

BalanceSheet
Liabilities

19X1

19X2 Assets

19X1

19X2

Issuedshare
capital
100,000 1,50,000
Sharepremium
15,000 35,000
Profitandloss
28,000 70,000
Debentures
70,000 30,000
Bankoverdraft
14,000

Creditors
34,000 48,000
Proposeddividends 15,000 20,000
Depreciation:
Plant
45,000 54,000
Fixtures
13,000 15,000

Freehold
property
110,000 130,000
Plantand
machinery 120,000 151,000
Fixturesand
fittings,atcost24,000 29,000
Stocks
37,000 51,000
Debtors
43,000 44,000
Bankbalance
16,000
Premiumon
redeemed
debentures
1,000

334,000 422,000

334,000 422,000

Thefollowingadditionalinformationisrelevant:(i)Therehadbeennodisposaloffreeholdpropertyin
theyear.(ii)AmachinetoolwhichhascostRs8,000andinrespectofwhichRs6,000depreciation
hasbeenprovidedwassoldforRs3,000andfixtures,whichhadcostRs5,000inrespectofwhich
depreciationofRs2,000hadbeenprovided,weresoldforRs1,000.Theprofitsandlossesonthese
transactionshadbeendealtwiththroughtheprofitandlossaccount.(iii)Theactualpremiumonthe
redemptionofdebentureswasRs2,000ofwhichRs1,000hasbeenwrittenofftotheprofitandloss
account.(iv)Nointerimdividendhasbeenpaid.(C.A.,adapted)
13. GNFCInChapter2,thecomparativebalancesheetsandprofitandlossaccountsfortheyears
2000and2001forGujaratNaramadaValleyFertilisersCompanyaregiveninTables2.3and2.8.
Preparefundsflowstatementsfortheyear2001.Explainitsimplications.

Chapter 25
PROBLEMS
1. The balance sheets and trading and profit and loss accounts for the year ended 30 June, 19X2 of S Ltd
and T Ltd are given in Tables 4.30 and 4.31. You may assume that stocks have increased evenly throughout
the year. You are required to:
(a) Calculate three of the following ratios separately for each company:
(i) net profit for the year as a percentage of net assets employed at 30 June, 19X2;
(ii) net profit for the year as a percentage of sales;
(iii) gross profit for the year as a percentage of sales;
(iv) current assets to current liabilities at 30 June, 19X2;
(v) liquid ratio at 30 June, 19X2; and
(vi) stock turnover during the year.
(b) Describe briefly the main conclusions which you draw from a comparison of the ratios which you
have calculated for each company.
(C.A., adapted)
Table 25.30: S Ltd and T Ltd
Balance Sheet
as on 30 June, 19X2

(Rs)
S Ltd

Fixed assets at cost

Less: Provision for depreciation

60,000
20,000

T Ltd
30,000
10,000

40,000
Current assets
Stock
Debtors
Cash

57,000
22,000
11,000

20,000
30,000
20,000
10,000

90,000
30,000

Less: Current liabilities

Net current assets
Net assets
Paid-up share capital
Revenue reserve

60,000
30,000
60,000
100,000
95,000
5,000

30,000
50,000
45,000
5,000

100,000

50,000

Table 25.31: S Ltd and T Ltd

Trading and Profit and Loss Account
for the year ended 30 June, 19X2
S Ltd
Sales
Stock at July 1,
19X1
Add: Purchases

160,000
39,000
114,000
153,000

Less: Stock at
June 30, 19X2
Cost of goods sold
Gross profit
Less: General expenses
Net profit for the year
Add: Balance brought forward

120,000
20,000
85,000
105,000

57,000

30,000
96,000
64,000
56,000
8,000
3,000
11,000
6,000
5,000

Less: Dividend paid

5,000

2.

(Rs)
T Ltd

75,000
45,000
39,000
6,000
1,000
7,000
2,000

Balance carried forward

Extracts from financial accounts of XYZ Ltd are given below:

Table 25.32: XYZ Ltd
Year I
Assets

Stock
Debtors
Payment in advance
Cash in hand
Sundry creditors
Acceptances
Bank overdraft

3.

10,000
30,000
2,000
20,000

62,000

Year II

Liabilities Assets Liabilities

25,000
15,000

40,000

20,000
30,000

15,000

65,000

30,000
12,000
5,000
47,000

Sales amounted to Rs 350,000 in the first year and Rs 300,000 in the second year. You are required to
comment on the solvency position of the concern with the help of accounting ratios.
From the following information you are required to (a) analyze the relative position of ABC Ltd in the industry and (b) point
out the deficiencies and suggest improvements.
Table 25.33: ABC Ltd
Balance Sheet
as on 31 December, 19X1

(Rs)

Share capital
1,278,000 Fixed assets:
Current liabilities:
Equipment
600,000
Creditors
150,000 Less: Depreciation 80,000 520,000
Bank loan
300,000 Current assets:
Cash
180,000
Debtors
240,000
Stock
660,000
Prepaid expenses
128,000
Total capital
1,728,000 Total assets
1,728,000

Table 25.34: ABC Ltd

Profit and Loss
for the year ended 31 December, 19X1

(Rs)

Sales
Cost of goods sold
Gross profit
Operating expenses
Profit before interest and taxes
Interest
Profit before taxes
Tax
Profit after taxes

345,000
150,000
195,000
90,000
105,000
24,000
81,000
27,000
54,000
Table 25.35: ABC Ltd

Industry Averages
Current ratio
Quick ratio
Debt-equity ratio
Times interest earned
Inventory turnover
Fixed-assets turnover
Total assets turnover
Net profit margin
Return on assets
Return on equity

4.

2.95
1.05
50%
2.60%
0.35
0.80
0.50
16%
15%
21%

The two firms, M and N, have the following data:

Sales
Total assets
Net profit

N
Rs

M
Rs

800,000
4,000,000
750,000

200,000
600,000
420,000

Compute return on investment for both firms. Explain how the figures are similar and how they are
different.
5. The summary of the balance sheets and the profit and loss accounts from 19X1 to 19X5 for Jagan
Limited is given in Tables 25.36 and 25.37. During this period, the company undertook a major
expansion programme. You are required to calculate important ratios for the five years and assess the
financial health of the company. Also, explain the implications of the development of the financial
health of the company for the shareholders. (C.A. Engg., adapted)
Table 25.36: Jagan Ltd
Balance Sheets

(Rs 000)

19X1 19X2 19X3 19X4 19X5

Liabilities and Equity
Creditors
Debentures
Share capital
Reserves
Total
Asset
Cash
Debtors
Stock
Fixed assets, net

25
25
25
25
25
250 1,000 1,750 2,500 3,250
1,000 1,000 1,000 1,000 1,000
225
225
225 2,25 2,25
1,500 2,250 3,000 37,50 45,00
50
50
50
50
50
50
50
50
50
50
400
650
900 11,50 1,400
1,000 1,500 2,000 2,500 3,000

Total

1,500 2,250 3,000 3,750 4,500

Table 25.37: Jagan Ltd
Profit and Loss Accounts (Summary)
19X1

Sales
Cost of goods sold
Gross profit
Operating expenses
EBIT
Interest
Profit before tax
Tax
Net profit
No. of shares
P/E ratio

6.

19X2 19X3

300
450
100
150
200
300
25
50
175
250
15
67.5
160
182.5
67.55 75.35
92.45 107.15
100
100
5
5

(Rs 000)
19X4 19X5

600
750
900
200
250
300
400
500
600
100
150
200
300
350
400
127.5 195
270
172.5 155
130
73.55 65.15 53.1
98.95 89.85 76.9
100
100
100
4
3.5
3.5

Using the following data, complete the balance sheet given below:
Gross profit (Rs)
Shareholders equity (Rs)
Gross profit margin
Credit-sales to total-sales
Total assets turnover
Inventory turnover
Average collection period (a 360-day year)
Current ratio
Long-term debt to equity

54,000
600,000
20%
80%
0.3 times
4 times
20 days
1.8
40%

Balance Sheet
Creditors
Long-term debt
Shareholders equity

7.

.........
.........
.........
.........
.........

Cash
Debtors
Inventory
Fixed assets

.........
.........
.........
.........
.........

Surendra Mohan and Sons are wholesale distributors of electric goods. Tables 25.38 and 25.39 contain
their balance sheets and profit and loss statements during the period 19X1 to 19X3. You are required to
critically evaluate the firms financial performance.
Table 25.38: Surendra Mohan and Sons
Comparative Balance Sheets

Liabilities and Capital

Creditors
Accrued expenses
Total current liabilities
Owners capital
Total

Assets
Cash
Debtors
Stock
Prepaid expenses
Total current assets
Fixed assets
Investments

(Rs)

19X3

19X2

19X1

65,994
2,645
68,639
208,812
277,451

62,229
1,920
64,149
181,341
245,490

55,065
1,168
56,233
163,394
219,627

19X3

19X2

19X1

19,550
86,784
61,661
2,667
170,662
99,285
7,504

14,376
61,601
63,167
1,433
140,577
97,878
7,035

9,542
40,217
68,086
863
118,708
96,229
4,690

Total non-current assets

Total

106,789
277,451

104,913
245,490

100,919
219,627

Table 25.39: Surendra Mohan and Sons

Summarised Profit and Loss Statements
Sales
Cost of goods sold
Gross profit
Operating expenses
Net profit

8.

(Rs)

19X3

19X2

19X1

481,053
310,720
170,333
141,377
28,956

457,172
275,514
181,658
137,984
43,674

399,291
229,878
169,413
120,593
48,820

The following are the comparative financial statements for three years for Plastic Works Limited. You
are required to comment on the firms financial condition and indicate the areas which require
managements attention.
Table 25.40: Plastic Works Limited
Comparative Balance Sheets

Liabilities and Capital

Bank borrowing
Creditors
Accrued expenses
Provision for dividend
Provision for taxes
Total current liabilities
Long-term loan
Total liabilities
Share capital
Reserves and surplus
Net worth
Total Funds
Assets
Cash
Debtors
Stock:
Raw material
Work in process
Finished goods
Prepaid expenses
Total current assets
Buildings, plant and equipment
Misc. fixed assets
Total non-current assets
Total Assets

(Rs)

19X3

19X2

19X1

30,525
331,127
21,510
20,350
56,367
459,879
71,225
531,104
407,000
80,983
487,983
1019,087

10,175
147,725
14,361
20,350
88,435
281,046
Nil
281,046
407,000
88,826
495,826
776,872

113,980
20,350
20,350
86,111
240,791
Nil
240,791
407,000
67,067
474,067
714,858

99,164
215,356

35,922
207,780

13,930
211,196

133,577
47,882
266,534
17,350
779,863

107,409
50,179
177,788
13,726
592,804

98,411
42,230
174,892
12,697
553,356

19X3

19X2

19X1

229,314
9,910
239,224
1,019,087

177,047
7,021
184,068
776,872

161,502

161,502
714,858

Table 25.41: Plastic Works Limited

Summarised Profit & Loss Statements
for the year ended 31 December
Sales
Cost of goods sold
Gross profit
Operating expenses

(Rs)

19X3

19X2

19X1

1,872,937
896,953
975,984

1,599,315
767,673
831,642

1,429,818
683,597
746,221

19X3

19X2

19X1

846,059

640,048

545,750

Profit before taxes

Taxes
Net profit
Dividends

9.

129,925
56,367
73,558
81,400

191,594
88,435
103,159
81,400

200,471
93,050
107,421
81,400

Tata Iron & Steel Company Limited (TISCO). TISCO was established in 1907 at Jamshedpur. It is the
largest private sector company. Tables 25.42 and 25.43 give the profit and loss statements and balance
sheets for the last seven years for the company. You are required to provide an analysis of the
companys financial performance.
Table 25.42: Tata Iron and Steel Company Limited
SummarisedBalanceSheetason31March
2000
ASEETS
Gross fixed assets
10,668.33
Less: Cumulative depreciation
3,241.95
Net fixed assets
7,426.38
Investments
818.89
Current Assets
Inventories
944.85
Receivables
1,868.77
Marketable investment
342.35
Cash and bank balance
232.87
3,388.84
Misc. expenses not written off
828.12
Total Assets
12,119.88
CAPITAL & LIABILITIES
Net worth
4,558.40
Share capital
517.77
Equity capital
367.77
Preference capital
150.00
Reserves & surplus
4,040.63
Total borrowings
4,946.52
Current liabilities & provisions
2,614.96
Current liabilities
1,492.55
Sundry creditors
1,345.65
Others
146.90
Provisions
1,122.41

1995
2001

1996

1997

1998

1999

6,962.89 7,408.46 7,850.82 8,948.52 10,032.17

11,258.17
1,749.41 2,014.90 2,324.42 2,648.48 2,973.59
3,720.08
5,213.48 5,393.56 5,526.40 6,300.04 7,058.58
7,538.09
220.65
410.94
664.90
626.08
588.84
850.83
865.34 1,076.57 1,021.11 1,039.70 1,016.51
921.77
1,341.87 1,723.63 2,178.76 1,948.40 1,874.18
2,060.70
175.51
365.75
479.77
453.03
399.51
381.38
162.44
239.78

437.09

251.38

462.96

336.19

2,545.16 3,603.04 3,931.02 3,904.09 3,626.39

3,603.63
31.33
167.99
278.32
896.98 1,118.53
920.29
7,835.11 9,209.78 9,920.87 11,274.16 11,992.83
12,531.46
2,688.04
4,888.43
336.87
507.77
336.87
367.77
0.00
140.00
2,351.17
4,380.66
3,582.73
4,672.56
1,564.34
2,970.47
1,421.51
1,696.38
1,256.72
1,574.35
164.79
122.03
142.83
1,274.09

3,742.40 3,974.02 4,064.88 4,164.42

367.23

367.38

367.55

367.77

367.23

367.38

367.55

367.77

0.00

0.00

0.00

0.00

3,375.17 3,606.64 3,697.33 3,796.65

3,842.07 4,082.49 5,212.44 5,503.26
1,625.31 1,864.36 1,996.84 2,325.15
1,326.82 1,385.47 1,414.66 1,463.35
1,203.97 1,251.00 1,296.61 1,340.17
122.85

134.47

118.05

123.18

298.49

478.89

582.18

861.80

Tax provision
167.04
Dividend provision
147.11
Other provisions
808.26
Total Liabilities

21.24
180.20
118.24
183.89
3.35
910.00

18.96

111.40

150.58

185.53

156.97

165.66

147.25

147.11

122.56

201.83

284.35

529.16

7,835.11 9,209.78 9,920.87 11,274.1611,992.8312,119.8812,531.46

Table 25.43: Tata Iron and Steel Company Limited
SummarizedProfit&LossAccountfortheYearEndingon31March

(Rsincrore)
1995
2001

1996

1997

1998

1999

Income
Sales
7015.16
Less: Excise
796.86

4993.39
7822.58
440.77
920.83

6349.35

6919.4

7012.35

6885.12

592.61

696.49

724.34

710.09

Net sales
6218.3
Other income
68.51
Change in stocks
33.19
Non-recurring income
152.44
Total Income
6406.06

4552.62
6901.75
44.58
86.53
17.35
56.74
16.03
13.15
4595.88
6944.69

5756.74

6222.91

6288.01

6175.03

76.18

150.52

117.16

96.73

66.24

42.12

4.8

46.18

0.35

11.2

27.59

139.84

5899.51

6426.75

6437.56

6457.78

PBDIT (EBITDA)
1291.98
Less: Depreciation
426.54

808.1
1507.68
262.26
492.25

1212.74

1260.45

1030.38

1058.26

297.61

326.83

343.23

382.18

PBIT
865.44
Less: Interest
388.35

545.84
1015.43
281.4
412.39

915.13

933.62

687.15

676.08

348.91

390.66

323.42

360.35

PBT
477.09
Less: Tax provision
54.5

264.44
603.04
0.25
49.6

566.22

542.96

363.73

315.73

0.43

73.75

41.65

33.5

PAT
422.59

264.19
553.44

565.79

469.21

322.08

282.23

118.24
196.09
0
21.52
145.95
335.83

156.97

165.66

147.25

147.11

16.57

14.73

16.18

408.82

286.98

160.1

118.94

530.35
867.3
801.69
1045.69
681.14
638.86
881.3
1718.7
4504.29 5795.26
6238.2
6812.71
1501.19 2174.54 2205.36
2732.1
1847.01 2239.85

665.31

664.41

880.44

1007.98

6257.51

6189.62

2055.3

1998.68

2000

Appropriation of Profit
Equity Dividends
154.86
Dividend Tax
17.04
Retained earnings
250.69
Other Financial Items
Cash profit
849.13
Cash flow from business activities
1323.94
Value of output
6154.84
Gross value added
2273.55
Net value added
1238.93 1876.93 1878.53 1712.07 1616.5

10. Agro-Chemical & Pesticides Industry. The financial data in Table 25.44 related to ten agro-chemicals
and pesticides companies for the year ending on March 31, 19X2. Provide a detailed analysis of the
profitability and the market performance of the companies. How have these companies performed in
relation to the industry performance? Show computations.
11. Glass Manufacturing Companies. The financial data in Table 25.45 are for the glass manufacturing
companies for the year 19X1 and 19X2. Comment on the profitability and the market performance of
the companies. How do they compare with the industry average?
Table 25.44: Agro-Chemicals and Pesticides Companies
FinancialData
fortheyearendingon31March,19X2
Buyer Cynamide
UP straw United

Searle
Sales
1600 101.17
PBDIT
1.77 22.75
Dep.
0.50 1.34
PBIT
1.27 21.41
Int.
0.96 18.21
PBT
0.96 18.21
Tax
0.00 4.00
PAT
0.96 14.21
EPS
3.54 20.01
DPS
0.00 5.00
Book value
15.72 33.72
Market value 2100.00 280.00

(Rscrore)

Excel Khaitau Monsanto Montari Paushak

218.43

100.46

175.31

26.85

14.32

59.69

12.30

74.36

33.69

15.15

39.83

5.12

1.72

7.61

1.50

9.71

5.33

1.91

4.12

1.30

0.04

1.22

0.20

1.14

28.36

13.24

35.71

3.82

1.68

6.39

1.30

8.57

17.07

11.17

28.12

1.18

1.32

1.95

0.61

5.99

17.07

11.17

28.12

1.18

1.32

1.95

0.61

5.99

8.25

5.09

9.50

0.00

0.70

0.00

0.08

1.80

8.82

6.08

18.62

1.18

0.62

1.95

0.53

4.19

54.38

11.56

26.87

2.34

6.20

3.18

6.24

8.03

24.00

3.50

10.10

2.50

2.30

2.20

1.70

2.50

52.23

62.37

19.21

25.40

14.67

27.18

57.85

268.5
630.00

47.50

250.00

120.00

130.00

280.00

58.00

590.00

Triveni

Source: The Economics Times.

Table 25.45: Glass Manufacturing Companies

Financial Data
(Rs crore)
Alembic
Victory Industry
Sales
271.5
338.5
PBIT
39.6
56.5
Interest
13.0
15.3
Tax
5.7
15.1

Ashi

Borosil

Excel

Fgp.

Hind.

Indo.

Maha

19X1

19.8

19.3

24.7

9.7

29.4

66.2

54.3

9.7

31.5 7.8

19X2

28.2

26.4

31.1

13.5

30.8

76.7

83.0

12.4

48.2 8.2

19X1

1.6

1.9

3.8

0.7

4.7

6.3

12.3

1.0

6.2 1.0

19X2

2.7

4.2

5.9

1.2

4.0

8.2

12.6

1.5

14.9 1.4

19X1

1.3

1.5

1.9

8.4

1.4

3.0

1.6

0.5

0.8 0.6

19X2

1.7

2.1

2.1

0.6

1.6

3.0

1.3

0.6

0.7 0.0

19X1

0.0

0.1

0.7

0.1

1.2

0.0

1.7

0.0

2.0 0.0

19X2

0.0

0.0

1.8

0.1

0.4

0.0

6.0

0.4

6.3 0.0

PAT
20.9
26.1
Per Share Data
EPS
DPS
BV
MV

19X2

19X1

0.3

0.3

1.2

0.2

2.1

3.3

9.0

0.5

3.4 0.4

19X2

1.0

2.1

2.0

0.5

2.0

4.4

5.3

0.5

7.9 0.6

19X1
19X2
19X1
19X2
19X1
19X2

11.3
38.5
0.0
0.0
93.8
129.6

1.7
11.2
1.0
1.5
12.3
22.5

3.1
5.6
2.5
0.25
45.4
48.6

1.5
3.7
1.4
1.8
20.4
22.2

3.5
3.1
2.2
2.2
31.4
32.3

22.8
30.5
1.0
1.0
96.5
126.9

27.8
8.2
4.0
23.0
63.0
45.6

3.7
3.7
1.4
1.4
17.7
20.0

29.2 3.5
67.7 4.9
3.0 1.5
3.6 2.0
115.0 17.1
180.3 20.0

575.0

227.5

35.0

145.0

6.0

675.0

85.0

75.0

85.0

45.0

Chapter 26
PROBLEMS
1. Table26.17givesasummaryofBajajsfinancialitemsduringtheyearsfrom20X5to20X9.
Table 26.17: Bajaj Auto Limited: Summary of Financial Items
(Rscrore)
20X9

NetSales
PBDIT
Depreciation
Interest
OtherIncome
PBT
TaxProvision
NetProfit
EquityDividend
RetainedProfit
CurrentAssets
NetFixedAssets
CurrentLiabilities
SecuredLoans

3023.12
473.88
177.29
7.39
365.99
289.2
26.64
262.56
80.95
181.61
2061.62
1362.35
1474.34
55.97
20X9

20X8

20X7

20X6

20X5

3089.33 2961.98 2643.22 2638.47

973.4 895.57 840.94 802.23
145.31
132.7 143.62 117.87
3.17
4.67
8.47
7.41
510.4 380.29 355.57 296.89
824.92
758.2 688.85 676.95
211.19 217.68
224.7 236.38
613.73 540.52 464.15 440.57
119.39
95.51
95.51 79.59
494.34 445.01 368.64 360.98
2373.37 2197.01 1809.38 1363.55
1114.25 921.81 682.91 603.95
1740.67 1527.18 1259.83 988.27
101.58
41.08
27.54 22.04
20X8

20X7

20X6

20X5

UnsecuredLoans
457.74 394.09 308.61 230.67 191.83
TotalLiabilities
4624.58 5440.42 4578.61 3636.26 2962.84
NetWorth
2636.53 3204.08 2701.74 2118.22 1760.7
BonusRatio

1.02
EPS
25.13
50.31
44.39
38.08 54.35
DPS
8.00
10.00
8.00
8.00 10.00
BookValuePerShare 260.58 268.37
226.3 177.42 221.22
MarketValuePerShare*257.70 384.00 615.80 594.30 601.70
*ClosingpriceinMarch.

2.

Basedonthecompanyspastperformanceandappropriateassumptionsthatyoumayliketomake,
developafinancialforecastforfiveyears.Showtheimpactifyourassumptionsgowrong.
Tables26.18and26.19containRelianceIndustriesLimitedsprofitandlossaccountandbalancesheet
for seven years. You are required to identify the trends in Reliances financial performance and
policies.Usingthisinformation,prepareafinancialplanforReliance.Discusstheimplicationsofyour
plan.
Table 26.18: Reliance Industrie Ltd
Summarized Profit & Loss Account during the Year Ending at 31 March

2000

2001

1999

1998

1997

1996

1995
EARNINGS
5,388.15

Sales

23,024.17

15,847.16

10,624.15

9,719.18

6,441.65

5,726.66

2,578.91

2,451.53

1,929.46

1,893.13

1,283.85

1,507.83

20,445.26

13,395.63

8,694.69

7,826.05

5,157.80

4,218.83

976.79

976.56

629.19

363.09

318.78

271.85

21,422.05

14,372.19

9,323.88

8,189.14

5,476.58

4,490.68

PBDIT

5,561.72

4,746.61

3,317.54

2,886.54

1,947.81

1,751.91

Depreciation

1,565.11

1,278.36

855.04

667.32

410.14

336.51

PBIT

3,996.61

3,468.25

2,462.50

2,219.22

1,537.67

1,415.40

Interest

1,215.99

1,008.00

728.81

503.55

169.97

110.13

PBT

2,780.62

2,460.25

1,733.69

1,715.67

1,367.70

1,305.27

Tax

135.00

57.00

30.00

63.00

45.00

0.00

2,645.62

2,403.25

1,703.69

1,652.67

1,322.70

1,305.27

447.85

384.65

350.16

326.81

299.24

276.22

4.77

35.57

23.39

10.33

0.00

28.00

CorporateDividendTax 46.20

46.22

40.86

63.64

0.00

0.00

EPS(Rs)

22.04

17.56

16.94

28.85

27.87

Less:Excise
1,517.13
NetSales
3,871.02
OtherIncome
312.59
TotalIncome
4,183.61
1,622.60
278.24
1,344.36
279.51
1,064.85
0.00
PAT
1,064.85
AdditionalInformation
EquityDividend
199.34
PreferenceDividend
0.83
0.00

24.63

23.34
BookValue(Rs) 113.86

103.65

100.12

96.83 184.77 179.07

157.66

Table 26.19: Reliance Industries Ltd: Balance Sheet as at 31 March

2001

2000

1999

1998

1997

1996

CAPITAL&LIABILITIES
TotalShareholdersFunds
EquityShareCapital

1,053.49

1,053.45

933.39

931.90

458.45

458.23

PreferenceCapitalPaidUp

0.00

292.95

252.95

187.95

0.00

200.00

13,711.88

12,636.35

11,183.00

10,862.75

8,012.49

7,747.07

14,765.37

13,982.75

12,369.34

11,982.60

8,470.94

8,405.30

68.66

158.51

46.24

57.41

859.70

411.95

1995

455.86
5.50
Reserves&Surplus
6,731.29
7,192.65
Borrowings
TermLoansInstitutions
284.79

TermLoansBanks

0.00

1,400.94

1,527.00

200.53

950.48

607.19

3,761.98

3,779.85

3,578.04

2,413.54

2,012.98

1,780.95

237.76

648.81

327.03

65.98

425.92

591.88

6,067.39

5,532.13

5,206.98

5,509.87

3,376.40

1,329.48

TotalBorrowings
10,135.79
2,939.92
CurrentLiabilities&Provisions
Creditors
3,859.22
1,118.23
Provisions
863.50
201.57
Other
251.58
76.67
TotalCurrentLiabilities
4,974.30
1,396.47
TotalLiabilities
29,875.46
15,038.38
11,529.04
ASSETS

11,520.24

10,685.29

8,247.33

7,625.48

4,721.45

2,953.96

3,338.73

3,095.04

2,386.23

1,305.32

265.80

544.37

475.99

352.23

282.02

646.07

1,218.27

586.97

701.26

324.29

3,865.83

5,101.37

4,158.00

3,439.72

1,911.63

29,368.82

28,156.00

24,387.93

19,536.14

25,355.99

24,330.95

18,650.33

17,848.33

10,955.92

6,885.50

11,841.53

9,214.06

6,691.93

4,944.47

3,491.20

2,141.34

13,514.46

15,116.89

11,958.40

12,903.86

7,464.72

4,744.16

512.38

331.42

3,437.83

2,069.43

3,708.63

4,488.71

TotalFixedassets
14,026.84
15,448.31
15,396.23
14,973.29
6,584.71
Investments
6,726.11
6,066.56
4,294.59
4,282.33
1,993.41
CurrentAssets
9,122.51
7,853.95
8,465.18
5,132.31
2,950.92
TotalAssets 29,875.4629,368.8228,156.0024,387.9319,536.14
15,038.38

11,173.35

9,232.87

4,455.68

1,952.91

3,907.11

3,852.60

160.27
1,273.04

NonConvertibleDebentures
WorkingCapitalAdvances

405.63

OtherLoans

816.19

Fixedassets
GrossBlock
5,315.40
Less:Accum.Depreciation
1,805.78
3,509.62
3,075.09

3.

NetBlock
CapitalWorkinProgress

11,529.04

Tables26.20and26.21givebalancesheetandprofitandlossaccountofMasonIndustriesLimited.
Whatisthesustainablegrowthrateforthecompany?
Table 26.20: Mason Industries Limited
Balance Sheet, 31 December 2009
Rs000
Creditors
6,725
Borrowings
40,350
Sharecapital
40,000
Reserve&surplus 27,250

114,325

Rs000
Cash
Debtors
Inventory
Grossblock
Less:Accumulated
depreciation

4,035
9,415
20,175
107,700
27,000
114,325

Table 26.21: Mason Industries Limited: Profit & Loss Account, 31 December 2009
Sales
Less:Costofsales

40,935
10,916

Grossprofit
Less:Selling&admin.Expenses
Profitbeforeinterestandtax
Less:Interest(at12%)
Profitbeforetax

4.

30,019
15,010
15,010
4,776
10,234

FineToysLimitedhasacapitalstructurecomprising45percentdebtand55percentequityatbook
values.Thecompanyspayoutratiois60percent.Managementwantsagrowthrateof20percentper
annuminthefuture.Isthisratesustainable?Aftertaxinterestrateis5percent.

Chapter 27
PROBLEMS
1. ThefollowingcostofsalesstatementsareavailableforD.D.manufacturers:
StatementofCostofSales
Items
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.

(Rsincrore)

19X1

Openingrawmaterialinventory
Purchases
Closingrawmaterialinventory
Rawmaterialconsumed(1+23)
Wagesandsalaries
Othermfg.expenses
Depreciation
Totalcost(4+5+6+7)
Openingworkinprocessinventory
Closingworkinprocessinventory
Costofproduction
Openingfinishedgoodsinventory
Closingfinishedgoodsinventory
Costofgoodssold
Selling,administrativeandotherexpenses
Costofsales(14+15)

5.2
25.6
6.8
24.0
8.1
3.2
1.8
37.1
1.8
2.0
36.9
3.2
2.8
37.3
1.3
38.6

19X2

19X3

6.8
33.5
7.6
32.7
11.2
4.4
2.0
50.3
2.0
3.1
49.2
2.8
3.6
48.4
1.9
50.3

7.6
45.6
9.2
44.0
15.3
5.8
2.6
67.7
3.1
4.6
66.2
3.6
2.9
66.9
2.1
69.0

Thefollowingaretheadditionaldataavailable:
19X1

19X2

19X3

45.9
7.3
8.3
10.8
3.7
4.6

60.1
9.8
10.8
14.9
4.6
8.0

82.7
13.7
14.9
20.5
8.0
12.0

Sales
PBIT
Debtors:

Opening
Closing
Creditors: Opening
Closing

2.

Youarerequiredtocalculate(i)operatingcycle,(ii)netoperatingcycle,and(iii)cashconversion
cycleforeachofthethreeyears.
X &Co.isdesiroustopurchaseabusinessandhasconsultedyou,andonepointonwhichyouare
askedtoadvisethemistheaverageamountofworkingcapitalwhichwillberequiredinthefirstyears
working.
Youaregiventhefollowingestimatesandareinstructedtoadd10percenttoyourcomputedfigureto
allowforcontingencies:
Figuresfor
theYear
Rs

Averageamountbackedupforstocks:
Stocksoffinishedproduct
Stocksofstores,materials,etc.
Averagecreditgiven:

5,000
8,000
Figuresfor

theYear
Rs
Inlandsales
6weekscredit
Exportsales
1weekscredit
Laginpaymentofwagesand
otheroutgoings:
Wages
1weeks
Stocks,materials,etc.
1weeks
Rent,royalties,etc.
6months
Clericalstaff
month
Manager
month
Miscellaneousexpenses
1months
Paymentinadvance:
Sundryexpenses(paidquarterlyinadvance)
Undrawnprofitsontheaveragethroughouttheyear.

3.

3,12,000
78,000

260,000
48,000
10,000
62,000
4,800
48,000
8,000
11,000

Setupyourcalculationsfortheaverageamountofworkingcapitalrequired.(C.A.,adapted)
Aproformacostsheetofacompanyprovidesthefollowingparticulars:
Amountperunit
Rs
Rawmaterial
Directlabour
Overheads
Totalcost
Profit
Sellingprice

4.

80
30
60
170
30
200

Thefollowingfurtherparticularsareavailable:
(a) Rawmaterialinstock,onanaverageonemonth;materialsinprocess,onaveragehalfamonth;
finishedgoodsinstock,onanaverageonemonth.
(b) Creditallowedbysuppliersisonemonth;creditallowedtodebtorsistwomonths;laginpayment
ofwagesisoneandahalfweeks;laginpaymentofoverheadexpensesisonemonth;onefourth
oftheoutputissoldagainstcash;cashinhandandatbankisexpectedtobeRs25,000.
Youarerequiredtoprepareastatementshowingworkingcapitalneededtofinancealevelofactivity
of104,000unitsofproduction.Youmayassumethatproductioniscarriedonevenlythroughoutthe
year,andwagesandoverheadsaccruesimilarly.(C.A.,adapted)
Whilepreparingaprojectreportonbehalfofaclientyouhavecollectedthefollowingfacts.Estimate
thenetworkingcapitalrequiredforthatproject.Add10percenttoyourcomputedfiguretoallowfor
contingencies.
AmountperunitRs

Estimatedcostperunitofproductionis:
Rawmaterial
Directlabour
Overheads(exclusiveofdepreciation)
Totalcost
Additionalinformation:
Sellingprice
Levelofactivity
Rawmaterialinstock
Workinprogress
(assume50%completionstage)
Finishedgoodsinstock
Creditallowedbysuppliers
Creditallowedtodebtors
Laginpaymentofwages
CashatbankisexpectedtobeRs125,000.

42.4
15.9
31.8
90.1
Rs106perunit,
100,000units
ofproductionperannum
average4weeks
average2weeks
average4weeks
average4weeks
average8weeks
average1weeks

5.

Youmayassumethatproductioniscarriedonevenlythroughouttheyear(52weeks)andwagesand
overheadsaccruesimilarly.Allsalesareoncreditbasisonly.
(M.Com.,D.U.,adapted)
Thefollowingarethegivencostofliquidityandilliquidityfordifferentratiosofcurrentassetstofixed
assetsofafirm.Determinetheoptimumratioofcurrentassetstofixedassets.Alsoshowyouranswer
onagraph.
CA/FA

CostofLiquidity

0.10
0.25
0.40
0.70
1.00
1.50
2.50

6.

138,000
275,000
550,000
1,100,000
2,200,000
4,140,000
6,890,000

2,200,000
1,650,000
1,100,000
830,000
690,000
550,000
276,000

GGIndustrieshaveestimateditsmonthlyneedsofnetworkingcapitalfor19X1asfollows:
Thefirmisratedtohaveaveragerisk;therefore,workingcapitalfinancefromabankwillcostthefirm
16percentperannum.Longtermborrowingwillbeavailableat14percent.Thefirmcaninvest
excessfundsintheformofintercorporatelendingat12percentperannum.
(i) Assumethefirmfinancesthemaximumamountofitsworkingcapitalrequirementsforthenext
yearwithlongtermborrowingandinvestinganyexcessfundsintheformofintercorporate
lending.CalculateGGIndustriesnetinterestcostduring19X1.
Amount
Rslakh

Month
January
February
March
April
May
June

7.

CostofLiquidity

72.65
58.13
29.06
24.22
33.90
43.60

Amount
Rslakh

Month
July
August
September
October
November
December

58.12
72.66
82.30
87.19
92.02
87.17

(ii) Assumethefirmfinanceallitsworkingcapitalrequirementsforthenextyearwithshortterm
borrowing.DetermineGGIndustriesinterestcostduring19X1.
(iii) Discussthereturnrisktradeoffsassociatedwiththeabovetwopolicies.
Acompanywantstoanalyzetheeffectofitsworkingcapitalinvestmentandfinancingpolicieson
shareholdersreturnandrisk.AssumethatthefirmhasRs180croreinfixedassetsandRs150crorein
currentliabilities.Thecompanyhasapolicyofmaintainingadebttototalassetsratioof60percent,
wheredebtconsistsofbothshorttermdebtfrombanksandlongtermdebt.Thefollowingdatarelate
tothreealternativepolicies:

Working
Capital
Policies
Aggressive
Moderate
Conservative

Investmentin
Bank
CurrentAssets Borrowings
(Rscrore)
(Rscrore)
252
270
288

216
162
108

Projected
Sales
EBIT
(Rscrore) (Rscrore)
531
540
549

53
54
55

Assumethat bankborrowingwillcost 16percent whiletheeffective interest cost oflongterm

borrowingwillbe18percentperannum.Youarerequiredtodetermine:(a)returnonshareholdersequity,
(b)networkingcapitalposition,(c)currentratio,and(d)currentassetstototalassetsratio.Alsoevaluate
thereturnrisktradeoffsassociatedwiththesethreepolicies.

Chapter 28
PROBLEMS
1. DeltaCompanyhascurrentsalesofRs30crore.Topushupsales,thecompanyisconsideringamore
liberalcreditpolicy.Thecurrentaveragecollectionperiodofthecompanyis25days.Ifthecollection
periodisextended,salesincreaseinthefollowingmanner.

2.

3.

Credit
Policy

Increasein
CollectionPeriod

IncreaseinSales
(Rsinlakh)

15days

12

25days

27

35days

47

ThecompanyissellingitsproductatRs10each.AveragecostperunitatthecurrentlevelisRs8and
variablecostperunitRs6.Ifthecompanyrequiredareturnof12percentonitsinvestment,which
creditpolicyisdesirable?Stateyourassumptions.(Assumea360dayyear).
Thecredittermsofafirmcurrentlyisnet30.Itisconsideringchangingittonet60.Thiswillhave
theeffectofincreasingthefirmssales.Asthefirmwillnotrelaxcreditstandards,thebaddebtlosses
areexpectedtoremainatthesamepercentage,i.e.,3percentofsales.Incrementalproduction,selling
and collection costs are 80 per cent of sales and expected to remain constant over the range of
anticipatedsalesincreases.Therelevantopportunitycostforreceivablesis15percent.Currentcredit
salesareRs300croreandcurrentlevelofreceivablesisRs30crore.Ifthecredittermsarechanged,
the current sale is expected to change to Rs 360 crore and the firms receivables level will also
increase. The firms financial manager estimates that the new credit terms will cause the firms
collectionperiodtoincreaseby30days.
(a) Determinethepresentcollectionperiodandthecollectionperiodaftertheproposedchangein
creditterms.
(b) Whatlevelofreceivablesisimpliedbythenewcollectionperiod?
(c) Determinetheincreasedinvestmentinreceivablesifthenewcredittermsareadopted.
(d) Arethenewcredittermsdesirable?
TheSyntexCompanyisplanningtorelaxitscreditpolicytomotivatecustomerstobuyoncreditterms
ofnet30.Itisexpectedthatthevariablecostswillremain75percentofsales.Theincrementalsales
areexpectedtobeoncreditbasis.Fortheperceivedincreaseinriskinliberalisingthecreditterms,the
companyrequireshigherrequiredreturn.Ifthefollowingistheprojectedinformation,whichcredit
policyshouldthecompanypursue?
CreditPolicy
A
B
C
D

4.

5.

6.

RequiredReturn Collection NewSales

Period
(Rs)
20%
25%
32%
40%

40
45
55
70

600,000
500,000
400,000
300,000

X Ltd has current annual sales ofRs60 crore and an average collection period of 30 days. The
companyisconsideringofliberalisingitscreditpolicy.Ifthecollectionperiodisextended,salesand
baddebtareexpectedtoincreaseinthefollowingway:

CreditPolicy

Increasein
Collection
Period

I
II
III
IV

15days
30days
45days
60days

Increasein
Sales
PercentBad
Rs(crore) DebtLosses
4.0
4.5
5.3
6.5

1.5
1.7
2.0
2.5

ThefirmsellsitsproductforRs10perunit.Averagecostatcurrentlevelofsalesis90percentfor
salesandvariablecostis80percentofsales.Ifthecurrentbaddebtlossis1.5percentofsalesandthe
requiredreturnis18percent,whichcreditpolicyshouldbepursued?(Assumea360dayyear).State
yourassumptions.
Acompanyhasa15percentrequiredrateofreturn.Itiscurrentlysellingontermsofnet10.The
creditsalesofthecompanyareRs120croreayear.Thecompanyscollectionperiodcurrentlyis60
days.Ifcompanyofferedtermsof2/10,net30,60percentofitscustomerswilltakethediscountand
thecollectionperiodwillbereducedto40days.Shouldthetermsbechanged?
AfirmhascurrentsalesofRs7,200,000.Thefirmhasunutilisedcapacity;therefore,withaviewto
boostitssales,itisconsideringlengtheningitscreditperiodfrom30daysto45days.Theaverage
collection period will also increase from 30 to 45 days. Baddebt losses are estimated to remain

constantat3percentofsales.ThefirmssalesareexpectedtoincreasebyRs360,000.Thevariable
production,
administrativeandsellingcostsare70percentofsales.Thefirmscorporatetaxrateis35percent,
anditrequiresanaftertaxreturnof15percentonitsinvestment.Shouldthefirmchangeitscredit
period?
7. AfirmhascurrentsalesofRs720,000.Itisconsideringofferingthecreditterms2,10,net30instead
ofnet30.ItisexpectedthatsaleswillincreasebyRs20,000andtheaveragecollectionperiodwill
reducefrom30daysto20days.Itisalsoexpectedthat50percentofthecustomerswilltakediscounts
andpayon10thdayandremaining50percentwillpayon30thday.Baddebtlosseswillremainat2
percentofsales.Thefirmsvariablecostratiois70percent,corporatetaxrateis50percentand
opportunitycostofinvestmentinreceivablesis10percent.Shouldthecompanychangeitscredit
terms?
8. TheElectroLimitedisadistributorofelectricequipments.Itssalesin2004amountedtoRs22crore
andaftertaxprofitRs1.10crore.
Thecompanyhasbeenexperiencingadecliningprofitmarginforthelastthreeyears.Itisfeltthatthis
isduetotheloosecreditpolicy.Oninvestigation,agroupofslowpayingcustomerswasidentified.It
isrecommended that the credit policyshould be tightened to eliminate them.Sales tothisgroup
amountedtoabout20percentofthecompanystotalsales.
Table28.8givesinformationaboutthecompanyscoststructure.Itisexpectedthatiftheslowpaying
accounts are eliminated only variable costs would decline. It is also believed that baddebt and
collectionexpensesareentirelyattributabletotheseaccounts.Usingthisinformation,youarerequired
toallocateElectrosincomeandexpensesbetweenslowpayingaccountsandgoodaccounts.
Table 28.8: The Electro Limited: Fixed and Variable
Costs (Per cent of Sales)

Costofgoodssold
Selling
Administration
Warehousing
Baddebts
Collection

9.

Total

Fixed

Variable

85.0
4.6
2.4
2.4
0.4
0.2

2.0
0.8
1.0

85.0
2.6
1.6
1.4
0.4
0.2

Astudyofcreditfilesindicatedthatthecollectionperiodonslowpayingaccountsaverageto50
daysversus35daysforallaccounts.ThebalanceofdebtorsfortheseaccountsaveragedRs885,000
during2004.
ShouldtheElectroLimitedtightenitscreditpolicy?Makesuitableassumptions.
ThePQR CompanysannualcreditsalesareRs60crore.Thecompanysexistingcredittermsare
1/15,net40.Generally60percentofthecustomersavailthecashdiscountfacility.Theaverage
collectionperiodis45days.Thepercentagedefaultrateis0.5percent.Thecompanyisthinkingof
twoalternativechangesincreditterms:
CreditTerms

PercentageTaking Collection
Discount
Period

Default
Percentage

2/10,net35

80

20

1.0

3/10,net25

95

14

1.5

WhatstrategyshouldbefollowedbyPQRifsalesareexpectedtoremainstableandtherequiredrate
ofreturnis18percent?
10. BansaliTextilesLimitedhasannualsalesofRs200crore.Itsells80percentofitsproductsona
60daycredit.Itsaveragecollectionperiodis80days.Thecompanysbaddebts,basedonthepast
experience, couldbeestimatedas0.9percent ofcredit sales.Thecompanys annual costof
administeringcreditsalesisRs0.75crore.ItispossibletoavoidRs0.20croreofthesecostsifthe
company transfers credit administration to a factor. The factor will charge 1.75 per cent
commissionforhisservices.Hecanalsoextendadvanceagainstreceivablestothecompanyatan
interestrateof16.5percentafterwithholding10percentasreserve.Shouldthecompanyhire
servicesofthefactor?

Chapter 29
PROBLEMS
1. AcompanyhasRs4peryearcarryingcostoneachunitofinventory,anannualusageof50,000units
andanorderingcostofRs100perorder.Calculatetheeconomicorderquantity.Whatshallbethe
totalannualcostofEOQ?IfaquantitydiscountofRe0.25perunitisofferedtothecompanywhenit
purchasesinlotsof1,000units,shouldthediscountbeaccepted?
2. Afirmsestimateddemandforamaterialduringthenextyearis2,500units.AcquisitioncostsareRs
400perorderandcarryingcostisRs50perunit.Thesafetystockissetat25percentoftheEOQ.The
dailyusageis10unitsandleadtimeis10days.Determine(a)theEOQ,(b)thesafetystock,and(c)
thereorderpoint.
3. Afirmsrequirementofmaterialsis3,000units(priceRs20perunit)for6days.Theorderingcostper
orderisRs30andthecarryingcostisRe0.50.Ifthescheduleofdiscountgivenbelowisapplicableto
thefirm,determinethemosteconomicalorderquantity.

4.

5.

LotSize

DiscountRate

1 499

none

500 699

1%

700 999

2%

1000 2,499

4%

2500 andabove

7%

ABCo.isconsideringaselectivecontrolforitsinventoriesusingthefollowingdata:
YouarerequiredtopreparetheABCplanandalsoshowtheABCplanonachart.
Units

UnitsCost

7,000
8,000
10,000
6,000
8,000
2,000
5,000
4,000

10.00
9.00
2.00
8.00
1.00
60.00
0.40
40.00

PaulsSalesIndia,alargeretailersituatedintheWesternIndia,hasbeenlosingsalesbecauseofnon
availabilityofstockmanytimes.ThecompanysaverageinventoryisRs200lakh.Itscontribution
ratiois30percent.Theinventorycarryingcostis3.5percentperannum.Inastudycarriedoutbythe
financial manager of the company, it was foundthat thecompany will lose salesif it carried an
inventorylessthanRs450lakhperannum.Therangeofinventoriescarriedandexpectedlostsalesare
givenbelow:
Expectedinventorylevel
(Rsinlakh)
200 250 300 350 400
Expectedlostsales
(Rsinlakh)
250 180 120 50 20

450
0

Thecompanysworkingcapital(excludinginventory)tosalesratiois18percent.Assumingataxrate
of35percent andanaftertaxopportunitycostof12percent,showwhichinventorypolicythe
companyshouldadopt.

Chapter 30
PROBLEMS
1. Kashiram&Co.isamanufacturerofchildrensgarments.Thesalesvaryseasonally,andarehighestin
themonthofMay.Themanagementofthecompanywishestoprepareacashbudgetfromtheperiod
JanuarythroughJune.Thefinancialmanagerstartswiththebalancesheetof1Januaryasshownin
Table30.5andpreparesacashbudget.Table30.6givesthesalesforsevenmonths.
Topreparethecashbudget,thefollowingadditionalinformationisgiven:

Table 30.5: Kashiram & Co's

Balance Sheet, 1 January
Amount
(Rs000)

Assets

Liabilities&Capital
Currentliabilities
Otherliabilities
Sharecapital

3,000
10,800
317,280

Cash
Debtors
Inventory
Fixedassets

84,480
42,000
123,000
81,600

331,080

Totalassets

331,080

Totalfunds

Amount
(Rs000)

Table 30.6: Sales Estimates

(Rs000)
December
January
February
March

60,000
84,000
156,000
132,000

(Rs000)
April
May
June
July

228,000
288,000
108,000
108,000

(a)
(b)
(c)
(d)
(i)
(f)

SalesforthemonthofDecemberwereRs60,000,000.
Creditsalesare70percentandcashsales30percentofthetotalsales.
Salesarecollectedafteronemonth.
Grossprofitmarginonsalesisexpectedtobe25percent.
Paymentsforthepurchasesaremadeonemonthinadvance.
AminimuminventoryofRs60,000,000atcostisalways maintained.Thecompanypurchases
sufficientinventoryeachmonthtotakecareofsalesofthesubsequentmonth.
(g) Othermonthlyexpensesare:
(Rs000)
Salary
9,600
Rent
2,400
Depreciation
720
Other
1%ofsales

2.

3.

(h) A16percentinterestonborrowedfundsispayableinthenextmonthofeveryquarteronthe
outstandingbalance.BorrowingispossibleeachmonthinthemultiplesofRs1,000,000.
KayCo.alwayspreparesacashbudgetforthemonthsofJanuary,FebruaryandMarch.Estimated
salesforthesemonthsareRs500,000,Rs600,000andRs750,000respectively.Actualsalesforthe
monthofDecemberwereRs520,000.About80percentofKayCo.stotalsalesareoncashbasisand
20percentcreditsalescollectibleafteronemonth.KayCo.paysitscreditors,whichareusuallyabout
40percentofsales,onemonthafterthesalemonth.
TheforecastsofsalaryexpensesforthecomingthreemonthsareexpectedtobeRs280,000permonth.
Kay Co.isexpected to spendabout Rs80,000 inFebruary and Rs 190,000in March on capital
expenditures.ApreviouslydeclareddividendofRs75,000istobepaidinJanuaryandmiscellaneous
expensesareestimatedtobeRs15,000permonth.ThecompanyalsohasRs36,000billspayablein
February.
(a) Prepareastatementshowingthesalereceipts.
(b) Assumingthatthe1JanuarycashbalanceisRs500,000 andthattheminimumcashbalance
requirementofthecompanyisRs500,000,prepareacashbudgetforthenextthreemonths.
(c) Explainthereasonforestimatedcashshortagethatappearsimminent.
(d) SupposethatKayCo.lendsanysurplusat15percentperyearforonemonthandborrowsfor
threemonthsat18percentyearwhenthereisacashshortage.Makethenecessarychangesin
yourcashbudgetpreparedin(b)tomakeitbalance.Assumethatinterestispaidattheendofany
borrowingorlendingperiod.
PrepareacashbudgetfortheKampManufacturingCompanyforthreemonthsofMay,JuneandJuly.
ThecompanyhasapolicyofmaintainingaminimumcashbalanceofRs30,000.Thecompanyscash
balanceason30AprilisRs30,000.

ActualSales(Rs)
January
February
March
April

4.
5.

6.

7.

8.

75,500
75,000
90,000
90,000

EstimatedSales(Rs)
May
June
July
August

105,000
120,000
150,000
150,000

Considerthefollowingadditionalinformation:
(a) Cashsalesare60percentofthetotalsales.Theremainingsalesarecollectedequallyduringthe
followingtwomonths.
(b) Costofgoodsmanufacturedis75percentofsales.80percentofthiscostispaidafteronemonth
andthebalanceispaidaftertwomonthsofthecostincurrence.
(c) FixedoperatingexpensesareRs15,000permonth.Variableoperatingexpensesare10percentof
saleseachmonth.
(d) Halfyearlyintereston12%Rs450,000debenturesispaidduringJuly.
(e) Rs60,000areexpectedtobeinvestedinfixedassetsduringJune.
(f) AnadvancetaxofRs15,000willbepaidinJuly.
Youarealsorequiredtodeterminewhetherornotborrowingwillbenecessaryduringtheperiod
andifyes,whenandforhowmuch.
X Co.hasaveragecreditsalesofRs1,500,000peryear.Theworkingdaysperyearare300.Ifthe
company could reduce its bill processing time by two days, what would be the annual savings,
assuminganinterestrateof18percent?
TheSirsaCompanyisalargewholesaledistributorofconsumergoodsthatsellsmostlyoncredit.
CollectionsfromaparticularlocationaverageRs200,000perday.Thetotalfloataverages6daysfor
customersinthislocation.Theopportunitycostoffundsis15percent.
(a) Thecompanyhasanofferfromabanktosetupalockboxsystemthatwillreducefloatby4days,
butthecompanywillhavetomaintainaminimumbalanceofRs400,000withthebank.Should
theofferbeaccepted?
(b) ThebankalsooffersanoptionofafixedfeeofRs20,000peryear.Whatshouldthecompanydo?
Acompanyhasacentralbillingsystem.ItsdailycollectionsonanaverageareRs500,000.Thetotal
timeforadministeringthecollectionis6days.
(a) Ifafirmsrequiredrateofreturnis10percent,whatisthecostofthesystemtothefirm?
(b) Ifthemanagementdesignsalockboxsystemthatreduceslagby3days,whatisthereductionin
cashbalances?
Garima Detergents has discovered that it takes about 10 days to collect the funds for use in the
companyoncethechequesarereceivedfromthecustomers.ThecompanysannualturnoverisRs9.70
crore.Howmuchfundsistobefreedifthecompanycouldreducethecollectiontimefrom10daysto
8days?Ifthefreedfundscouldbeusedtoreducebankborrowingswhichcosts18percentperannum,
whatwouldbethenetsavingstothecompany?Assumea360dayyearand35percentcorporatetax
rate.
AcompanylocatedinAhmedabadwantstotransferRs15lakhtoitsbranchinChennai.Itwillcostthe
companyRs10tomailthedraftbyaregisteredpost.Itwilltake10daysformoneytobefinally
transferredinChennai.Duringthese10days,thecompanyislosinganopportunityofearning12per
centp.a.Alternatively,thecompanycaninstantaneouslytransferthemoneytelegraphicallythatwill
costthecompanyRs1,000.Whatshouldthecompanydo?

Chapter 31
PROBLEMS
1. ThefollowingisthebalancesheetandproductionplanofNeoPharmaLtd:
Table 31.2: Neo-Pharma Limited Balance
Sheet as on June 30, 20X2
(Rs in lakh)
Liabilities
Share capital
Reserves

Assets
54 Fixed assets
8 Investments

31
5

Long-term loans
Current liabilities:
Sundry creditors
41
Other current liabilities 10
Bank borrowings
135
Provisions for tax
and dividends
14

4 Current assets:
Raw materials
Work-in-progress
Finished goods
Sundry debtors
200

266

64
7
49
91

Outstanding
exports sales 15
Cash and bank balances 6
Misc. current assets
11
Advance tax payment
2 230
266

Notes: (i) BillsdiscountedwithbanksandoutstandingasonJune30,20X2isRs500,000.

(ii) AninstalmentofRs100,000fallsdueonDecember31,20X2asapartrepaymentoflongtermloan.
Table 31.3: Production Plan for The Year 20X203
(Rs in lakh)
20X1(Actuals)
Salesofwhichexportsales 50
Costofproductionofwhich:
(a)Rawmaterials
151
(b)Wagesandsalaries
50

266
211

20X2(Projects)
75
173
55

20X2(Actuals)
(c)Directmanufacturing
expenses
Grossprofit
Operatingexpenses
Costofsales
Nonoperatingincome
Provisionfortaxation
Netprofit

291
238

10

20X2(Projects)
10

55
44
255
4
8
7

53
42
280
3
8
6

Table 31.4: Projected Balance Sheet as on June 30, 20X3

(Rs in lakh)
Liabilities

Assets

Sharecapital
54
Reserves
13
Longtermloans
3
Currentliabilities
ofwhich:
Workinprogress
17
Othercurrentliabilities 6
Bankborrowings
139
Provisionsfortax
anddividends
15 204

274

Fixedassets
Investments
Currentassetsofwhich:
Rawmaterials

60

Finishedgoods
Sundrydebtors

52
98

25
1

Sundrycreditors

44

Outstandingexports
sales27
Cashandbank
balances
7
Misc.currentassets 8
Advancetax
payment
6248
274

Notes: (i) BillsdiscountedwithbanksandoutstandingasonJune30,20X3,Rs1,000,000.

(ii) AninstalmentofRs250,000fallsdueonDecember31,20X3asapartrepaymentoflongtermloan.

Table 31.5: Working Capital Norms for Pharmaceutical Industry

Rawmaterialsandothers
Workinprogress
Finishedgoods
Receivablesandbillspurchased
anddiscounted.

2monthsconsumption
monthscostofproduction
2monthscostofsales
1monthsofsale

You arerequiredtocalculatethemaximumpermissiblebankfinance(MPBF)aspertheTandon
CommitteerecommendationsregardingMethod1andMethod2.
2.

3.

AnantaChemicalsLimitedisconsideringraisingofRs15crorebyissuingCPsfor120days.CPswill
besoldatadiscountof11.25percent.Stampdutychargeswillbe0.5percentofthesizeoftheissue.
TheissuingandotherchargeswillamounttoRs3.75lakhandratingchargesto0.40percentofthe
issuesize.CalculatetheeffectivecostofCP.
XYLtdisplanningtosella90dayCPofRs100forRs94.75.Thecompanywillhavetoincur
expensesasfollows:(a)ratingofissue:0.35percent,(b)stampduty0.5percent,(c)issuingcharges
0.2percentand(d)dealersfee0.15percent.WhatisthecostofCP?

Chapter 32
PROBLEMS
1. XCompanyLtdintendstotakeoverYCompanyLtdbyofferingtwoofitssharesforeveryfiveshares
inYCompanyLtd.Relevantfinancialdataareasfollows:
Earningspershare(Rs)
Marketpricepershare(Rs)
Priceearningsratio
Numberofshares(000)
Profitaftertax(Rs000)
Totalmarketvalue(Rs000)

2.

YCo.Ltd
2
40
20
250
500
10,000

Whatisthecombinedearningspershare?CalculatetheP/Eratioofthecombinedfirm.Hasanywealth
beencreatedforshareholders?
AlphaLtdisconsideringtheacquisitionofBetaLtdbymakinganofferofsharesat5timesofBetas
presentearnings.Alternatively,areversetakeoverispossiblewherebyBetacouldoffertobuyAlphas
sharesat20timesitspresentearnings.Whataretheimplicationsoftheseproposals?Therelevantdata
areasfollows:
Earningspershare(Rs)
Marketpricepershare(Rs)
Priceearningsratio
Numberofshares(000)
Profitaftertax(Rs000)
Totalmarketvalue(Rs000)

3.

XCo.Ltd
2
100
50
100
200
10,000

Alpha
2
40
20
400
800
16,000

Beta
2
20
10
400
800
8,000

CalculatetheeffectonEPS.WouldyouranswerbedifferentiftherearemergerbenefitsofRs200,000
andRs100,000inthefirstproposalandsecondproposals,respectively?
RamaCompanyisconsideringtheacquisitionofKrishnaCompanywithexchangeofitsshares.The
financialdataforthecompaniesareasfollows:
Profitaftertax(Rs000)
No.ofequityshares(000)
Earningspershare(Rs)
Priceearningsratio
Marketpricepershare(Rs)

RamaCo.

KrishnaCo.

800
200
4
15
60

600
300
2
10
20

KrishnaCompanyexpectsanofferof125percentofitscurrentmarketpricefromRamaCompany.
(a) Whatistheexchangeratioofshares?Howmanynewshareswillbeissued?
(b) WhatistheacquiringcompanysEPSafterthemerger?Assume15percentsynergybenefits
accrueduetothemerger.

4.

(c) Iftheprice/earningsratioaftermergerisat20times,whatisthemarketpricepershareofthe
survivingcompany?
ThefollowingdatarelatetoCompaniesAandB:
Profitaftertax(Rs000)
Equityshares(000)
Priceearningsratio

5.

CompanyB

100
50
20

20
05
10

(a) If A and B mergebyexchangingoneshareofCompany A foreachshareofCompany B,how

wouldearningspershareofthetwocompaniesbeaffected?Whatisthemarketvalueexchange
ratio?
(b) Iftheexchangeratiowere3sharesofAfortwosharesofB,whatwouldbetheimpactofearnings
pershareaftermerger.Assumethattherewouldbesynergybenefitsequalto20percentincrease
inthepresentearningsduetomerger.
(c) Whatexchangeratiowouldyousuggestfortheabovemerger?
XCompanywantstoacquireYCompany.Ifthemergerwereeffectedthroughanexchangeofshares,
XCompanywouldbewillingtopay40percentpremiumforYCompanysshares.Thefollowingdata
arepertinenttoCompaniesXandY:
NetProfit(Rs000)
Numberofshares(000)
Marketpricepershare(Rs)

6.

CompanyA

XCompany

YCompany

1000
500
120

200
250
030

(a) Computethecombinedearningspershare.
(b) Whatexchangeratiowouldyousuggest?
(c) Iftheexchangeratiowere1shareofCompany X foreachshareofCompany Y,whatwould
happen?
Sholapur Shoes Limited is evaluating the possibility of acquiring Kohalapur Shoes Limited. The
followingaredataforthetwocompanies:
Sholapur
Profitaftertax(Rsinlakh)
Earningspershares(Rs)
Dividendpershare(Rs)
Numberofshares(lakh)
Totalmarketcapitalization
(Rsinlakh)

7.

Kohalapur

54.75
7.30
4.20
7.50

9.90
2.20
1.20
4.50

1,000.00

135.00

(a) Calculatethepriceearningsratioofboththecompaniesbeforemerger.
(b) Kohalapursearningsanddividendsareexpectedtogrowat7.5percentwithoutmergerandat10
percentwithmerger.Youarerequiredtodetermine:(i)gainfromthemerger,(ii)thecostof
mergerifKohalapurispaidcashofRs40pershare,and(iii)thecostofmergeriftheshare
exchangeratiois0.25.
VarunChemicalsLimitedisproposingatakeoverofSiddharthPharmLimited.Varunsmainobjective
ofthetakeoveristoincreaseitssizeaswellasdiversifyitsoperations.Varunsaftertaxprofitsinthe
recent past have grown at 18 per cent per year and of Siddharth at 15 per cent per year. Both
companies pay dividends regularly. Varun retains about 70 per cent of its profits and Siddharth
50percent.
Thesummarisedfinancialinformationforthetwocompaniesaregiveninthefollowing.
SummarisedProfitandLossAccount

Netsales
PBIT
Interest
PBT
Provisionfortax
PAT

Varun

Siddharth

4545
1590
750
1440
650
790

3500
480
25
455
205
250

Dividends
Undistributedprofit

235
555

125
125

VarunsshareiscurrentlysellingforRs52andSiddharthsRs75.Theparvalueofbothcompanies
shareisRs10.Varunslandandbuildingarestatedatrecentprice.Siddharthslandandbuildings
wererevaluedthreeyearsago.Therehasbeen30percentperyearincreaseinthevalueoflandand
building.
SummarisedBalanceSheet(Rscrore)
Varun

Siddharth

FixedAssets:
Landandbuilding,net
720
Plantandmachinery,net
900
Furnitureandfixtures,net
30
1650
CurrentAssets:
Inventory
400
Debtors
350
Cashandbankbalance
25
775
Less:CurrentLiabilities
Creditors
230
Overdrafts
35
Provisionfortax
145
Provisionfordividends
60
470
Netassets
1955
Paidupsharecapital
Reservesandsurplus
Borrowing
Capitalemployed

8.

190
350
10

550

280
250
50

580

130
10
50
50

240
890

250
1050

1300
655
1955

125
660

785
105
890

Varunsmanagementwantstodeterminethepremiumoverthecurrentmarketpriceoftheshares
whichshouldbepaidfortheacquisitionofSiddharth.Varunsfinancialanalystisconsideringtwo
options.Thepriceshouldbedeterminedusing:(a)thedividendgrowthformula,or(b)thebalance
sheetnetworthadjustedforthecurrentvalueoflandandbuildingsplustheestimatedaverageaftertax
profitsforthenextfiveyears.Aftermerger,Siddharthsgrowthisexpectedtobe18percenteach
year.
Grewal IndustriesLtdisadiversifiedcompanywithmultiplebusinesses,anditalsoownsseveral
subsidiarycompanies.RichaFoodsLtdisoneofitssubsidiariesthatsellpackagedfooditems.Grewal
isintheprocessofconsolidatingitsbusinessesandtherefore,itischangingitsstrategicfocus.Inlight
ofitsnewstrategicfocus,ithasdecidedtosellRichaFoodsLtd.Anumberofcompanies,somefrom
thereputedbusinesshouses,haveshownconsiderableinterestinbuyingRichaFoods.
Table32.22andTable32.23containthemostrecentBalanceSheetandProfitandLossstatementof
RichaFoodsLtd:
32.22: Balance Sheet as at 31 December, 2004
Rsincrore
Buildings
Less:Accumulateddepreciation

930
155

Plant&Machinery
Less:Accumulateddepreciation
Furniture&Fixtures
Less:Accumulateddepreciation

124
81
39
8

Currentassets
Stockatcost
Debtors
Cashatbank

132
85
78
295

775
43
31
849

Less:Creditors
Tradecreditors
Acquiredexpenses
Netassets
13%LongtermLoan

202
54

256

ShareholdersFunds
Ordinarysharecapital(Rs10share)
Generalreserve
ProfitandLoss

39
888
388
500
233
54
213
500

Table 32.23: Profit and Loss Account for the Year Ended 31 May, 1995
(Rsincrore)
Salesturnover
Profitbeforeinterestandtaxation
Interestcharges
Profitbeforetaxation
Corporationtax
Profitaftertaxation
Dividendproposedandpaid
Transfertogeneralreserve
ProfitandLoss

1365
135
47
88
25
63
16
12
35

RichaFoodssalesandprofitshaveshownsteadygrowth.Thefollowingarethepossiblerealizable
valueofassets:
(Rsincrore)
Buildings
Plant&machinery
Furniture&Fixtures
Stock

911
31
19
140

The book values of other assets are close approximation of their realisable value. A close
competitorofRichaFoodshasapriceearningsratioof12.5anddividendyieldof5.4percent.The
corporateincometaxrateis35percent.
CalculatethevalueofRichaFoodsusingalternativemethods.Whichmethoddoyousuggestas
mostappropriate?WhyshouldGrewalIndustriesLtdsellitssubsidiary?

Chapter 33
PROBLEMS
1. Goldiscurrentlyselling$340anounce.Thepriceislikelytofluctuate.Itcouldincreaseto$360or
coulddecreaseto$320anounceafterthreemonths.Agoldminecompanywillsupply3,000ouncesin
themarketafterthreemonths.Thecompanyisconsideringhedgingitsrisk.Ithastwoalternatives
available.Itcanenterafuturescontracttodelivergoldafterthreemonthsatafuturespriceof$342.
Alternatively,thecompanycanbuy3monthputoptionatanexercisepriceof$340anounceata
premiumof$3perounce.Whatshouldcompanydo?Whatwillbetheconsequencesifthecompany
doesnothedge?
2. Aflourmillplanstopurchase100quintalsofwheatinthreemonths.ThewheatpricescanbeRs7,000
orRs7,500orRs8,000perquintal.Theowneroftheflourmillisworriedaboutthepossiblechangein
price.Howcanheprotecthimselfagainstthepricerisk?Showtheconsequencesofyoursuggestionto
him.
3. Supposewheatfuturespriceis$3.40perbushelfor3monthcontract.Thespotpricetodayis$3.00.
Theriskfreeinterestrateis12percentperyear.Thepresentvalueofstoragecostis$0.23.Whatisthe
presentvalueofwheat?

4.

InMarch2004,threemonthfutureonSensexstockindextradedat5,686.4.Thedividendyieldwas
1.4percentandinterestrate8percentperannum.Whatshouldbethespotindex?
5. Company X andcompany Y needfundstofinanceexpansionoftheiroperations. X isaAAArated
companywhileYisaBBBratedcompany.Xcanborrowfundsat11percentorLIBOR+0.03per
centfloatingrate.Ycanborrowfundsat14percentorLIBOR+1.5percent.Can XandYbenefit
fromswap?HowcanyoustructureaswaparrangementbetweenCompanyXandCompanyY?
6. FirmPcangeta5yearfixedratedollarloanat9percentandEuroloanat7percent.FirmQ,onthe
otherhand,canget5yearfixedratedollarloanat11percentandEuroloanat8percent.SupposeP
wantstotakeEuroloanandQdollarloan.Canyoustructureaswapsothattheborrowingcosttoeach
companyisless?Assumethatspotexchangerateis1.2dollartooneEuro.

Chapter 34
PROBLEMS
1. ThecurrentspotrateofBritishpoundagainsttheUSdollarisUK1.5763/US$.The90dayforward
rateisUK1.5436.CalculatetheannualforwarddiscountorpremiumfortheUSdollar.
2. The60dayforwardrateofIndianrupeerelativetotheUSdollaris:INR40.85/US$.Thespotrateis
INR38.95/US$.IsIndianrupeeatapremiumordiscount?Whatistheannualpercentage?
3. SupposeyouhaveINR10millionthatyoucaninvestforoneyearanywhereintheworldwithoutany
restriction.YouareconsideringtoeitherinvestintheUSorinIndia.Theinterestrateononeyear
bondsinIndiais15percentandononeyearbondsintheUSis10percent.Thecurrentexchangerate
isINR39.80/US$.Whatshouldbetheoneyearforwardratesothatyouearnthesamereturnwhether
youinvestinIndiaorintheUS?
4. TheexpectedinflationrateinFranceis5percentandinItaly7percent.TheoneyearloaninFrance
returns8percent.WhatshouldbethereturnononeyearloaninItaly?
5. OneyearThai bahtandUSdollarforward rateisBaht46.75/US$.Theexpected inflationratein
Thailandis9percentandintheUS4percent.Whatisthecurrentspotrateofexchange?
6. TheexpectedinflationrateinIndiais5percent.ThecurrentspotratebetweenIndianrupeeandSouth
KoreanWonis:Won1.2345/INRandoneyearforwardrateisWon1.2567.Howmuchistheexpected
inflationrateinSouthKorea?
7. TheFrenchfrancJapaneseyenexchangerateis:105.20/FF.TheFrenchfrancIndianrupeeexchange
rateis:INR6.50/FF.WhatistheJapaneseyenIndianrupeeexchangerate?
8. AThaicompanyisexpectingtoreceiveUS$5millionfromanimporterintheUSafterthreemonths.
ThecurrentspotexchangerateisBaht43.75/US$and90dayforwardrateisBaht45.35/US$.What
willbetheconsequencesiftheThaifirm(a)doesnotcoveritsexposure,(b)covers60percentand
keeps40percentexposureuncovered,and(c)covers100percentofitsexposurebyenteringintoa
forwardcontract?SupposethespotexchangerateatthetimetheThaicompanyreceivespaymentis
Baht44.10US$.Whatisthecostoftheforwardcontract(partialandfull)?
9. AnIndianfirmisconsideringthepossibilityofbuildingaplanttomanufactureanindustrialchemical
inThailand.ThecostofinvestmentisestimatedtobeBaht25million.Thelifeoftheinvestmentis
expectedtobe12years.ItisexpectedtheannualnetcashflowinrealtermswillbeBaht4million.
ThecurrentspotexchangerateisBaht1.105/INR.TheriskfreeinterestrateinThailandandIndiaare
12percentand10percent,respectively.TheexpectedinflationrateinThailandis8percent.The
Indianfirmconsiderstheopportunitycostofcapitaltobe7.25percentabovetheriskfreerate.Should
theIndianfirmmakeinvestmentinThailand?ShowNPVcalculationsinIndianrupeesusingcash
flowsin(a)bahtand(b)rupees.

Chapter 35
PROBLEMS
1. ThefollowingarethefinancialstatementsofMacroCompanyLimitedfortheyear20X1:
Capital&Liabilities Rs(lakh)

Assets

Creditors
Borrowings
Paidupsharecapital
Reserve&surplus

Cash
Inventory
Debtors
Netfixedassets

7,500
35,000
25,000
26,500
94,000

Rs(lakh)
15,000
18,000
6,000
55,000
94,000

Profit&Loss
Sales
Grossprofit
PBIT
PBT
PAT

2.

3.
4.

43,000
31,000
3,500
27,500
24,875

CalculatesustainablegrowthrateforMacroCompanyLimited.
Afirmhasgrownat15percentinthepastfewyears.ItsaftertaxROIandaftertaxinterestratehave
been,respectively,16percentand7percent.Itnowhasatargetgrowthrateof18percent.The
companyexpectsitsprofitabilityandinterestcosttoremainconstantandmaintainitspayoutratioat
60percent.Howcanthefirmachieveitstargetgrowth?Showcalculations.
AmanufacturingcompanyearnedPATofRs123crorein2004payinginterestofRs24crore.The
companysinvestedcapitalisRs1,340croreandWACC15percent.Thetaxrateis35percent.
CalculatethecompanysEVA.
Infosys Table 35.5 provides certain financial data for Infosys from year 2005 to year 2009. The
companyusesCAPMtocalculatecostofequity.Youarerequiredtocalculatethefollowing:( i)MVA,
(ii)EVA,(iii)M/Band(iv)sEconomicReturn.Commentonthecompanysmarketperformance.
Table 35.5: Infosys: Economic Value Added Analysis

2009

2008
12,527

2007

16,025

Operating profit (Rs cr)

6,434

640

3,877

2,654

2,048

Tax (Rs cr)

919

685

386

313

326

Market value of equity (Rs cr)

Add: Market value of debt (Rs cr)

75,837

82,362

1,15,307

82,154

61,073

Less: Cash & cash equivalent (Rs cr)

1,952

1,669

1,369

801

590

Enteprise value (Rs cr)

75,837

82,362

1,15,307

82,154

61,073

0
0.76
8.0
7.0

6,177

2005

Avg. capital employed (Rs cr)

Avg. debt-equity ratio
Beta variant
Risk-free rate of rturn (%)
Market premium (%)

0
0.74
7.0
7.0

9,147

2006

0
0.99
8.0
7.0

4,331
0
0.78
7.5
7.0

0
0.98
6.8
7.0