Solution to Illustration 1

Decision making
1 month 2 months 3 months
Sales (units) 10000 11500 13000
Sales Revenues 3000000 3450000 3900000
Less Variable cost 2000000 2300000 2600000
Total contribution 1000000 1150000 1300000
Less: other costs
fixed costs 300000 300000 350000
bad debts 30000 103500 195000
opportunity cost 33333.33 86666.67 147500
Profit 636666.7 659833.3 607500

Decision: the firm is advised to adopt policy option of extending credit of 2 months as it yields maximum profit.

working note
1 2 3
investment in debtors 2000000 2600000 2950000
average collection period 1 month 2 months 3 months
opportunity cost 33333.33 86666.67 147500
investment in debtors (VC+FC)
opportunity cost investment in debtors*collection period/12*rate of return
Financial Evaluation of proposed programs (A or B) relating to credit policy

Rs Rs Rs
Annual Sales 2400000 2400000 2400000
Variable cost 1680000 1680000 1680000
Fixed cost 480000 480000 480000

Particulars Existing Prog. A Prog. B

Cost of operation:
Annual collection expenditure 50000 75000 150000
Losses due to bad debts 72000 48000 24000
Opportunity cost total 72000 54000 36000
Total Cost 194000 177000 210000

Advise: GS is advised to adopt Program A as its entails minimum cost of operation.

Working Note
Investment in debtors 2160000 2160000 2160000
Collection period 2 1.5 1
Opportunity cost 72000 54000 36000
illustration 1
Calculation of EOQ
A O C
10000 50 0.16
2AO 1000000
2AO/C 6250000
EOQ 2500

illustration 2

Calculation of EOQ
A O C
40000 480 2.4
2AO 38400000
2AO/C 16000000
EOQ 4000
Illustration
Capital employed in X Ltd. is Rs 34,00,000, future maintainable profit isRs 6,00,000 and normal rate of return is 15%.
Future Maintainable profit 600000
Normal rate of return 0.15
Actual capital employed 3400000

Solution
normal capital employed 4000000
goodwill 600000
of return is 15%.
Illustration
Capital employed by A Ltd. Rs 34,00,000, Future maintainable profit Rs 7,00,000, Normal rate of return 15%, Super profit can

Future Maintainable profit 700000

capital employed . 3400000
Normal rate of return 0.15
No. of years for which super profits can be maintained 5

Solution
Normal profit 510000
Super profit 190000
Goodwill 950000
ate of return 15%, Super profit can be maintained for 5 years.
Illustration (Net Asset Method)
The following information is available from Tina Ltd. as at 31st March, 2017:
Capital : Rs
2,000, 5% Preference Shares of Rs 100 each fully paid 200000
4,000 Equity Shares of Rs 100 each fully paid 400000
Reserve and Surplus 400000
6% Debentures 200000
Current Liabilities 200000
Assets:
Fixed Assets 800000
Current Assets 600000

For the purpose of valuation of shares:

fixed assets and current assets are to be depreciated by 10%;
Interest on debentures is due for six months
preference dividend is also due for the year
Neither of these has been provided for in the balance sheet.
Calculate the value of each equity share under Net Asset Method.

Solution
Since there is only one class of equity shares and all the shares are fully paid up, the number of shares:
Value of one equity share = Net Assets available for equity shareholders ÷ Number of equity shares
Net assets available to the equity shareholders
Assets Rs
Fixed Assets (8,00,000 – 10% on Rs 8,00,000) 720000
Current Assets (6,00,000 – 10% on Rs 6,00,000) 540000
Value of Assets 1260000
Less: Liabilities:
Current Liabilities 200000
6% Debentures 200000
Interest Outstanding (Rs 2,00,000 × 6/100 × 6/12) 6000
5% Preference Share Capital 200000
Arrear Dividend (Rs 2,00,000 × 5%) 10000
Total Liabilities 616000
Net Assets available to Equity Shareholders 644000

Value of one equity share (fully paid up) 161

4000
Valuation of Shares - Dividend Yield Method

Illustration
Alpha Ltd has a paid up capital of Rs 3,00,000 divided into 20,000 Equity shares of Rs 10 each and 5%, 1,000 Prefere
The company has Rs 1,00,000 debentures; the interest payable is 10% p.a.
During the year 2018-19 the company earned a profit of Rs 1,60,000 before charging interest.
The company declared dividend at the rate of Rs 4 per share for the last year.
The normal rate of return is 20%.
Assume tax rate of 30%.
Calculate value per share under Dividend Yield Method.

Solution Rs
Profits before interest and Tax 160000
Less: Interest 10% on Rs 1,00,000 10,000
Profit after interest 150,000
Less: Tax 30% on Rs 1,50,000 45,000
Profit after Tax 105,000
Less: Preference Dividend @ 5% on Rs 1,00,000 5,000
Profit available to Equity share holders 100,000

Dividend Yield method: Under this method value of each equity share is calculated as under:
Rate of Dividend ÷ Normal rate of return x Paid up value of a share.
Rate of Dividend = Rs 4 per share or 4 ÷ 10 x100 = 40%
Value of each equity share = (40% ÷ 20%) x Rs 10 = Rs 20
Rs 10 each and 5%, 1,000 Preference Shares of Rs 100 each.
Valuation of Shares - Dividend Yield Method

Illustration
Alpha Ltd has a paid up capital of Rs 3,00,000 divided into 20,000 Equity shares of Rs 10 each and 5%, 1,000 Prefere
The company has Rs 1,00,000 debentures; the interest payable is 10% p.a.
During the year 2018-19 the company earned a profit of Rs 1,60,000 before charging interest.
The company declared dividend at the rate of Rs 4 per share for the last year.
The normal rate of return is 20%.
Assume tax rate of 30%.
Calculate value per share under Dividend Yield Method.

Solution Rs Information given in th

Profits before interest and Tax 160000 Equity share capital
Less: Interest 10% on Rs 1,00,000 10,000 Normal rate of return
Profit after interest 150,000 Paid up value of equity
Less: Tax 30% on Rs 1,50,000 45,000
Profit after Tax 105,000
Less: Preference Dividend @ 5% on Rs 1,00,000 5,000
Profit available to Equity share holders 100,000

Earning Yield method: Value of each equity share is calculated as under:

Rate of Earnings ÷ Normal rate of return x Paid up value of a share.
Rate of Earnings 50
Value of each equity share 25
ch and 5%, 1,000 Preference Shares of Rs 100 each.

Information given in the question

Equity share capital 200000
Normal rate of return 20
Paid up value of equity share 10
Illustration
AB Automotives Ltd. belongs to a risk class for which the capitalization rate is 10%.
It currently has outstanding 20,000 shares selling at Rs 100 each.
The firm is contemplating the declaration of a dividend of Rs 5/ share at the end of the current financial year.
It expects to have a net income of Rs 2,00,000 and has a proposal for making new investments of Rs 4,00,000.
CALCULATE the value of the firms when dividends (i) are not paid (ii) are paid

Solution
Given
P₀ 100
D1 5
ke 0.1
n 20000
Earnings (E) 200000
Dividend per share 5
Dividend Distributed 100000
Investment Proposal 400000

Case 1 When dividends are paid

Step 1

P1 105

Step 2
Funds required for investment Rs
Earnings 200000
Dividend Distributed 100000
Funds available for investment 100000
Total investment 400000
Balance Funds Required 300000

Step 3
Number of shares required to be issued 2857.143

Step 4
Calculation of the value of the firm

Numerator 2200000
Denominator 1.1
Value of Firm 2000000
•Thus, whether dividends are paid or not, value of the firm remains the same.
•Therefore, the above case illustrates that the shareholders are indifferent between the retention of profits and th
he current financial year.
estments of Rs 4,00,000.

Given
P₀ 100
D1 0
ke 0.1
n 20000
Earnings (E) 200000
Dividend per share 0
Dividend Distributed 0
Investment Proposal 400000

Case 2 When dividends are not paid

P1 110

Step 2
Funds required for investment Rs
Earnings 200000
Dividend Distributed 0
Funds available for investment 200000
Total investment 400000
Balance Funds Required 200000

Step 3
Number of shares required to be issued 1818.182

Step 4
Calculation of the value of the firm

Numerator 2200000
Denominator 1.1
Value of Firm 2000000
 the same.
nt between the retention of profits and the payment of dividends.