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Attempt Any Four Case Study Case 1: Zip Zap Zoom Car Company
Attempt Any Four Case Study Case 1: Zip Zap Zoom Car Company
Marks:100
Marks:100
600
100
400
200
1,200
1,000
250
750
190
940
200
40
10
10
260
-1200
Exhibit 2 Profit and Loss Account for the year ended March 31, 200x
(Amount in Rs. Crore)
Sales revenue (80,000 units x Rs. 2,50,000)
Operating expenditure :
Variable cost :
Raw material and manufacturing expenses
Variable overheads
Total
Fixed cost :
R&D
Marketing and advertising
Depreciation
Personnel
Total
2,000.0
1,300.0
100.0
1,400.0
20.0
25.0
250.0
70.0
365.0
Marks:100
The loans have to be retired in the next ten years and the firm redeems Rs. 40 crore every year.
The company is faced with the problem of deciding how much to invest in up
gradation of its plans and technology. Capital investment up to a maximum of Rs. 100
crore is required. The problem areas are three-fold.
The company cannot forgo the capital investment as that could lead to reduction in its market share as
technological competence in this industry is a must and customers would shift to manufactures
providing latest in car technology.
The company does not want to issue new equity shares and its retained earning are not enough for
such a large investment. Thus, the only option is raising debt.
The company wants to limit its additional debt to a level that it can service without taking undue
risks. With the looming recession and uncertain market conditions, the company perceives that
additional fixed obligations could become a cause of financial distress, and thus, wants to determine
its additional debt capacity to meet the investment requirements.
Mr. Shortsighted, the companys Finance Manager, is given the task of determining the additional debt
that the firm can raise. He thinks that the firm can raise Rs. 100 crore worth debt and service it even in years
of recession. The company can raise debt at 15 per cent from a financial institution. While working out the
debt capacity. Mr. Shortsighted takes the following assumptions for the recession years.
a)
b)
Mr. Shorsighted prepares a projected income statement which is representative of the recession years.
While doing so, he determines what he thinks are the irreducible minimum expenditures under
Marks:100
recessionary conditions. For him, risk of insolvency is the main concern while designing the capital
structure. To support his view, he presents the income statement as shown in Exhibit 3.
Exhibit 3 projected Profit and Loss account
(Amount in Rs. Crore)
Sales revenue (72,000 units x Rs. 2,35,000)
1,692.0
Operating expenditure
Variable cost :
Raw material and manufacturing expenses 1,170.0
Variable overheads
90.0
Total
1,260.0
Fixed cost :
R&D
--Marketing and advertising
15.0
Depreciation
187.5
Personnel
70.0
Total
272.5
Total operating expenditure
1,532.5
EBIT
159.5
Financial expenses :
Interest on existing Debentures
7.0
Interest on existing institutional borrowings
10.0
Interest on commercial loan
30.0
Interest on additional debt
15.0
62.0
EBT
97.5
Tax (@ 35%)
34.1
EAT
63.4
Dividends
-Debt redemption (sinking fund obligation)
50.0*
Contribution to reserves and surplus
13.4
* Rs. 40 crore (existing debt) + Rs. 10 crore (additional debt)
Assumptions of Mr. Shorsighted
R & D expenditure can be done away with till the economy picks up.
Keeping in mind the investor confidence that the company enjoys, he feels that the company can
forgo paying dividends in the recession period.
Marks:100
He goes with his worked out statement to the Director Finance, Mr. Arthashatra, and advocates raising
Rs. 100 crore of debt to finance the intended capital investment. Mr. Arthashatra does not feel comfortable
with the statements and calls for the companys financial analyst, Mr. Longsighted.
Mr. Longsighted carefully analyses Mr. Shortsighteds assumptions and points out that insolvency should
not be the sole criterion while determining the debt capacity of the firm. He points out the following :
Apart from debt servicing, there are certain expenditures like those on R & D and marketing that
need to be continued to ensure the long-term health of the firm.
Certain management policies like those relating to dividend payout, send out important signals to the
investors. The Zip Zap Zooms management has been paying regular dividends and discontinuing
this practice (even though just for the recession phase) could raise serious doubts in the investors
mind about the health of the firm. The firm should pay at least 10 per cent dividend in the recession
years.
Mr. Shortsighted has used the accounting profits to determine the amount available each year for
servicing the debt obligations. This does not give the true picture. Net cash inflows should be used
to determine the amount available for servicing the debt.
Net Cash inflows are determined by an interplay of many variables and such a simplistic view should
not be taken while determining the cash flows in recession. It is not possible to accurately predict the
fall in any of the factors such as sales volume, sales price, marketing expenditure and so on.
Probability distribution of variation of each of the factors that affect net cash inflow should be
analyzed. From this analysis, the probability distribution of variation in net cash inflow should be
analysed (the net cash inflows follow a normal probability distribution). This will give a true picture
of how the companys cash flows will behave in recession conditions.
The management recognizes that the alternative suggested by Mr. Longsighted rests on data, which are
complex and require expenditure of time and effort to obtain and interpret. Considering the importance of
capital structure design, the Finance Director asks Mr. Longsighted to carry out his analysis. Information on
the behaviour of cash flows during the recession periods is taken into account.
The methodology undertaken is as follows :
(a) Important factors that affect cash flows (especially contraction of cash flows), like sales volume, sales
price, raw materials expenditure, and so on, are identified and the analysis is carried out in terms of
cash receipts and cash expenditures.
Marks:100
(b) Each factors behaviour (variation behaviour) in adverse conditions in the past is studied and future
expectations are combined with past data, to describe limits (maximum favourable), most probable
and maximum adverse) for all the factors.
(c) Once this information is generated for all the factors affecting the cash flows, Mr. Longsighted comes
up with a range of estimates of the cash flow in future recession periods based on all possible
combinations of the several factors. He also estimates the probability of occurrence of each estimate
of cash flow.
Assuming a normal distribution of the expected behaviour, the mean expected
value of net cash inflow in adverse conditions came out to be Rs. 220.27 crore with standard deviation of Rs.
110 crore.
Keeping in mind the looming recession and the uncertainty of the recession behaviour, Mr.
Arthashastra feels that the firm should factor a risk of cash inadequacy of around 5 per cent even in the most
adverse industry conditions. Thus, the firm should take up only that amount of additional debt that it can
service 95 per cent of the times, while maintaining cash adequacy.
To maintain an annual dividend of 10 per cent, an additional Rs. 35 crore has to be kept aside.
Hence, the expected available net cash inflow is Rs. 185.27 crore (i.e. Rs. 220.27 Rs. 35 crore)
Question:
Analyse the debt capacity of the company.
Marks:100
1991
1992
1993
1994
(Rupees in crore)
1995
1996
1997
Sales
13.54
15.60
18.03
37.04
37.96
48.24
60.48
69.66
0.52
0.70
1.11
3.80
4.43
6.66
7.70
9.23
0.61
0.49
0.88
2.37
2.36
3.57
4.84
5.49
11.85
15.48
16.35
25.54
31.60
41.40
45.74
48.64
Depreciation
1.85
1.72
1.52
4.62
5.99
8.53
9.30
11.53
4.86
5.67
5.14
5.17
9.67
10.81
12.44
16.98
Change in stock
1.18
3.10
4.93
0.48
- 1.13
5.63
11.86
- 5.87
Other Expenses
Total Op Expenses
Operating Profit
Marks:100
11.61
13.70
18.90
19.29
15.48
28.15
55.95
69.36
Other Income
2.14
3.69
4.97
4.24
7.72
14.35
11.35
13.08
Non-recurring Income
1.30
2.28
0.10
10.98
16.44
0.46
0.52
1.75
15.10
19.67
23.97
34.51
39.64
42.98
65.67
82.64
Interest
PBT
5.56
9.54
6.77
12.90
11.92
12.05
19.62
14.89
17.17
22.47
21.48
21.50
28.25
37.42
27.54
55.10
Tax
3.00
3.60
4.90
0.00
4.00
7.00
8.60
15.80
PAT
6.54
9.30
7.15
14.89
18.47
14.50
28.82
39.30
Dividend
1.80
2.00
2.30
4.06
7.29
8.58
12.85
14.18
Retained Earnings
4.74
7.30
4.85
10.83
11.18
5.92
15.97
25.12
PBIT
Exhibit 2
GREAVES LTD.
Balance Sheet
1990
1991
1992
(Rupees in crore)
1993
1994
1995
1996
1997
ASSETS
Land and Building
3.88
4.22
4.96
21.70
30.82
39.71
42.34
11.98
12.68
12.98
33.49
50.78
75.34
92.49 104.45
3.64
4.14
4.38
5.18
6.95
8.53
8.87
10.35
Capital WIP
0.09
0.26
10.25
11.27
34.84
14.37
13.92
14.36
19.59
21.30
23.57
12.91
14.56
15.79
19.84
25.74
6.68
6.74
7.78
51.80
0.21
0.19
0.05
4.40
6.89
6.93
7.83
22.03
33.90
22.45
42.56
20.04
43.07
53.87
21.11
Marks:100
Raw Materials
5.26
6.91
7.26
21.05
28.13
44.03
53.62
50.94
Finished Goods
29.37
33.72
38.65
53.39
52.26
58.09
69.97
64.09
Inventory
34.63
40.63
45.91
74.44
Accounts Receivable
38.16
53.24
67.97
Other Receivable
32.62
40.47
49.19
24.54
59.12
64.32
76.57 107.31
Investments
3.55
14.95
15.15
27.58
73.50
75.01
75.07
76.45
8.36
8.91
12.71
13.29
18.38
30.08
33.46
48.18
Current Assets
Total Assets
9.86
9.86
9.86
18.84
29.37
29.44
44.20
44.20
Preference Capital
0.20
0.20
0.20
0.20
0.20
0.20
0.20
0.20
27.60
32.57
Net Worth
Bank Borrowings
37.66
14.81
42.63
19.45
Institutional Borrowings
4.13
3.43
9.17
38.09
38.76
69.69
89.26
63.60
Debentures
4.77
16.57
19.99
4.56
4.37
4.37
2.92
1.49
12.31
14.45
15.03
14.08
15.57
17.75
20.81
19.29
Commercial Paper
0.00
0.00
0.00
0.00
15.00
0.00
0.00
0.00
Other Borrowings
2.33
3.22
3.10
3.18
17.08
1.97
2.36
2.57
0.00
0.00
0.08
0.12
15.08
0.02
1.49
1.57
Borrowings
Sundry Creditors
38.35
37.52
57.12
49.40
73.72
59.34
Other Liabilities
5.70
10.16
10.70
3.59
1.42
1.99
1.70
3.04
3.18
3.82
5.14
0.31
4.40
7.70
12.19
21.43
Proposed Dividends
1.80
2.00
2.30
4.06
7.29
8.58
12.85
14.18
0.00
0.00
0.08
0.12
15.08
0.02
1.49
1.57
Fixed Deposits
Current Liabilities
TOTAL LIABILITIES
Additional information:
Share premium reserve
93.35
93.35
Marks:100
Revaluation reserve
Bonus equity capital
8.51
8.51
8.51
8.91
8.70
8.50
8.31
8.15
8.51
8.51
8.51
23.25
23.25
Exhibit 3
GREAVES LTD.
Share Price Data
1990 1991 1992
1993
27.19 34.74 121.27 66.67
90.00 100.01
90.00
85.00
26.78 21.61
42.67
45.00
43.75
EPS (Rs)
Book value (Rs)
4.79
34.36
48.34
1994
1995
1996
78.34 71.67 47.5
68.34
1997
48.25
6.82
9.73
1.93
2.66
7.16
5.03
9.01
35.64 37.22
42.54
57.75
40.61
64.98
45.35
50.73
Questions
1. How profitable are its operations? What are the trends in it? How has growth affected the profitability
of the company?
2. What factors have contributed to the operating performance of Greaves Limited? What is the role of
profitability margin, asset utilisation, and non-operating income?
3. How has Greaves performed in terms of return on equity? What is the contribution of return on
investment, the way of the business has been financed over the period?
Marks:100
Marks:100
Star Engineering Company (SEC) produces electrical accessories like meters, transformers,
switchgears, and automobile accessories like taximeters and speedometers.
SEC buys the electrical components, but manufactures all mechanical parts within its factory which is
divided into four production departments Machining, Fabrication, Assembly, and Paintingand three service
departmentsStores, Maintenance, and Works Office.
Though the company prepared annual budgets and monthly financial statements, it had no formal cost
accounting system. Prices were fixed on the basis of what the market can bear. Inventory of finished stocks
was valued at 90 per cent of the market price assuming a profit margin of 10 per cent.
In March, the company received a trial order from a government department for a sample transformer
on a cost-plus-fixed-fee basis. They took up the job (numbered by the company as Job No 879) in early April
and completed all manufacturing operations before the end of the month.
Since Job No 879 was very different from the type of transformers they had manufactured in the past,
the company did not have a comparable market price for the product. The purchasing officer of the
government department asked SEC to submit a detailed cost sheet for the job giving as much details as
possible regarding material, labour and overhead costs.
SEC, as part of its routine financial accounting system, had collected the actual expenses for the
month of April, by 5th of May. Some of the relevant data are given in Exhibit A.
The company tried to assign directly, as many expenses as possible to the production departments.
However, It was not possible in all cases. In many cases, an overhead cost, which was common to all
departments had to be allocated to the various departments using some rational basis. Some of the possible
bases were collected by SECs accountant. These are presented in Exhibit B.
He also designed a format to allocate the overhead to all the production and service departments. It
was realized that the expenses of the service departments on some rational basis. The accountant thought of
distributing the service departments costs on the following basis:
a. Works office costs on the basis of direct labour hours.
b. Maintenance costs on the basis of book value of plant and machinery.
c. Stores department costs on the basis of direct and indirect materials used.
The accountant who had to visit the companys banker, passed on the papers to you for the required
analysis and cost computations.
REQUIRED
Marks:100
Based on the data given in Exhibits A and B, you are required to:
1. Complete the attached overhead cost distribution sheet (Exhibit C).
Note: Wherever possible, identify the overhead costs chared directly to the production and service
departments. If such direct identification is not possible, distribute the costs on some rational basis.
2. Calculate the overhead cost (per direct labour hour) for each of the four producing departments. This
should include share of the service departments costs.
3. Do you agree with:
a. The procedure adopted by the company for the distribution of overhead costs?
b. The choice of the base for overhead absorption, i.e. labour-hour rate?
Exhibit A
STAR ENGINEERING COMPANY
Actual Expenses(Manufacturing Overheads) for April
RS
RS
33,000
22,000
11,000
7,000
44,000
32,700
1,49,700
2,200
1,100
3,300
3,400
2,800
12,800
Others
Factory Rent
Depreciation of Plant and Machinery
Building Rates and Taxes
Welfare Expenses
1,68,000
44,000
2,400
19,400
(At 2 per cent of direct labour wages and Indirect labour and
supervision)
Power
(MaintenanceRs 366; Works Office Rs 2,200, Balance to
Producing Departments)
Works Office Salaries and Expenses
Miscellaneous Stores Department Expenses
Marks:100
68,586
1,30,260
1,190
4,33,930
5,96,930
Marks:100
Exhibit B
STAR ENGINEERING COMPANY
Projected Operation Data for the Year
Department
Machining
Fabrication
Assembly
Painting
Stores
Maintenance
Works Office
Total
Area
(sq.m)
13,000
11,000
8,800
6,400
4,400
2,200
2,200
48,000
Original Book
of Plant &
Machinery
Rs
26,40,000
13,20,000
6,60,000
2,64,000
1,32,000
1,98,000
68,000
52,80,000
Direct
Materials
Budget
Direct
Labour
Hours
Direct
Labour
Budget
10,80,000
20,000
10,000
1,000
2,000
14,40,000
5,28,000
7,20,000
3,30,000
Rs
52,80,000
25,40,000
13,20,000
6,60,000
94,80,000
33,000
30,18,000
99,00,000
Rs
62,40,000
21,60,000
Horse
Power
Rating
Note
The estimates given in this exhibit are for the budgeted year January to December where as the actuals in Exhibit A are just one monthApril of
the budgeted year.
Marks:100
Exhibit C
Departments
Overhead Costs
A. Allocation of Overhead to
all departments
A.1 Indirect Labour and
Supervision
A.2 Indirect materials and
supplies
A.3 Factory Rent
A.4 Depreciation of Plant and
Machinery
A.5 Building Rates and Taxes
Total
Amount
Actuals for
April (Rs)
1,49,700
12,800
1,68,000
44,000
2,400
19,494
68,586
1,30,260
1,190
5,96,430
Basis for
Distribution
Marks:100
5,96,430
D. Labour Hours Actuals for
April
1,20,000
E. Overhead Rate/Per Hour (D)
44,000
60,000 27,500
Marks: 100