Dokumen - Tips - Prasanna Chandra Financial Management

7/27/2019 prasanna chandra financial management
Chapter
TIME VALUE OF7 MONEY
1. Value five years hence of a deposit of Rs.1,000 at various interest rates is as follows:
r = 8% FV5 = Rs.1!"
r = 10% FV5 = Rs.1!11
r = 1#% FV5 = Rs.1$!#
r = 15% FV5 = Rs.#011
#. 0 years
. &n 1# years Rs.1000 'rows to Rs.8000 or 8 ti(es. )his is # ti(es the initial deposit. *ence
dou+lin' taes place in 1# -  =  years.
ccordin' to the Rule of !", the dou+lin' period is:
0.5 / !" - &nterest rate
uatin' this to  and solvin' for interest rate, we 'et
&nterest rate = 18."%.
. 2avin' Rs.#000 a year for 5 years and Rs.000 a year for 10 years thereafter is euivalent to
savin' Rs.#000 a year for 15 years and Rs.1000 a year for the years ! throu'h 15.
*ence the savin's will cu(ulate to:
#000 3 FV&F 410%, 15 years / 1000 3 FV&F 410%, 10 years
= #000 3 1.$$# / 1000 3 15."$ = Rs.$"81.
5. 6et  +e the annual savin's.
 3 FV&F 41#%, 10 years = 1,000,000

 3 1$.5" = 1,000,000
2o,  = 1,000,000 - 1$.5" = Rs.5!,"8.
!. 1,000 3 FV&F 4r , ! years = 10,000
FV&F 4r , ! years = 10,000 - 1000 = 10
http://slidepdf.com/reader/full/prasanna-chandra-financial-management 1/164
Fro( the ta+les we find that
FV&F
FV&F 4#0%,
4#%, !
! years
years =
= "."0
10."80
7sin' linear interpolation in the interval, we 'et:
#0% / 410.000  "."0

r = 3 % = #0.%
410."80  "."0
$. 1,000 3 FV&F 4r , 10 years = 5,000

FV&F 4r ,10 years = 5,000 - 1000 = 5
FV&F 41!%, 10 years = .11

FV&F 418%, 10 years = 5.#
7sin' linear interpolation in the interval, we 'et:
45.000  .11) 3 #%
r = 1!% / = 1$.%
45.#  .11
8. )he present value of Rs.10,000 receiva+le after 8 years for various discount rates 4r  are:
r = 10% 9V = 10,000 3 9V&F4r = 10%, 8 years
= 10,000 3 0.!$ = Rs.,!$0
r = 1#% 9V = 10,000 3 9V&F 4r = 1#%, 8 years

= 10,000 3 0.0 = Rs.,00
r = 15% 9V = 10,000 3 9V&F 4r = 15%, 8 years

= 10,000 3 0.#$ = Rs.,#$0
". ssu(in' that it is an ordinary annuity, the present value is:

#,000 3 9V&F 410%, 5years
= #,000 3 .$"1 = Rs.$,58#
10. )he present value of an annual pension of Rs.10,000 for 15 years when r = 15% is:
10,000 3 9V&F 415%, 15 years
= 10,000 3 5.8$ = Rs.58,$0
)he alternative is to receive a lu(psu( of Rs.50,000.
+viously, ;r. <in'o will +e +etter off with the annual pension a(ount of Rs.10,000.
11. )he a(ount that can +e withdrawn annually is:
100,000 100,000
 =   =  = Rs.10,!08
9V&F 410%, 0 years ".#$
1#. )he present value of the inco(e strea( is:

1,000 3 9V&F 41#%, 1 year / #,500 3 9V&F 41#%, # years
/ 5,000 3 9V&F 41#%, 8 years 3 9V&F41#%, # years
= 1,000 3 0.8" / #,500 3 0.$"$ / 5,000 3 ."!8 3 0.$"$ = Rs.##,!8.
1. )he present value of the inco(e strea( is:

#,000 3 9V&F 410%, 5 years / 000-0.10 3 9V&F 410%, 5 years
= #,000 3 .$"1 / 000-0.10 3 0.!#1
= Rs.#!,#1#
1. )o earn an annual inco(e of Rs.5,000 +e'innin' fro( the end of 15 years fro( now, if the
deposit earns 10% per year a su( of
Rs.5,000 - 0.10 = Rs.50,000
is reuired at the end of 1 years. )he a(ount that (ust +e deposited to 'et this su( is:
Rs.50,000 - 9V&F 410%, 1 years = Rs.50,000 - .$"$ = Rs.1,1!5
15. Rs.#0,000 = Rs.,000 3 9V&F 4r , 10 years

9V&F 4r ,10 years = Rs.#0,000 - Rs.,000 = 5.00
Fro( the ta+les we find that:

9V&F 415%, 10 years = 5.01"
9V&F 418%, 10 years = ."
7sin' linear interpolation we 'et:

5.01"  5.00
r = 15% /  3 %
5.01"  ."
= 15.1%
1!. 9V 42trea(  = Rs.100 3 9V&F 41#%, 1 year / Rs.#00 3

9V&F 41#%, # years / Rs.00 3 9V&F41#%,  years / Rs.00 3

9V&F 41#%,  years / Rs.500 3 9V&F 41#%, 5 years /

Rs.!00 3 9V&F 41#%, ! years / Rs.$00 3 9V&F 41#%, $ years /
Rs.800 3 9V&F
Rs.1,000 41#%,
3 9V&F 8 years
41#%, / Rs."00 3 9V&F 41#%, " years /
10 years
= Rs.100 3 0.8" / Rs.#00 3 0.$"$ / Rs.00 3 0.$1#

/ Rs.00 3 0.!! / Rs.500 3 0.5!$ / Rs.!00 3 0.50$
/ Rs.$00 3 0.5# / Rs.800 3 0.0 / Rs."00 3 0.!1
/ Rs.1,000 3 0.##
= Rs.#5"0."
2i(ilarly,
9V 42trea( > = Rs.,!#5.#
9V 42trea( ? = Rs.#,851.1
1$. FV5 = Rs.10,000 @1 / 40.1! - A53

= Rs.10,000 41.0#0
= Rs.10,000 3 #.1"1
= Rs.#1,"10
18. FV5 = Rs.5,000 @1/4 0.1#-A 53

= Rs.5,000 41.0#0
= Rs.5,000 3 1.80!
= Rs.",00
1" A B C
2tated rate 4% 1# # #
Freuency of co(poundin' ! ti(es  ti(es 1# ti(es
ffective rate 4% 41 / 0.1#-!! 1 41/0.#- 1 41 / 0.#-1#1#1
= 1#.! = #!.# = #!.8
Bifference +etween the

effective rate and stated
rate 4% 0.! #.# #.8
#0. &nvest(ent reuired at the end of 8th year to yield an inco(e of Rs.1#,000 per year fro( the
end of "th year 4+e'innin' of 10th year for ever:
Rs.1#,000 3 9V&F41#%, C 

= Rs.1#,000 - 0.1# = Rs.100,000
th
)o have a su( of Rs.100,000

Rs.100,000 at the end of 8 year , the a(ount to +e deposited
Rs.100,000 now is:
= = Rs.0,88
9V&F41#%, 8 years #.$!
#1. )he interest rate i(plicit in the offer of Rs.#0,000 after 10 years in lieu of Rs.5,000 now is:
Rs.5,000 3 FV&F 4r ,10 years = Rs.#0,000
Rs.#0,000
FV&F 4r ,10 years = = .000
Rs.5,000

FV&F 415%, 10 years = .0!
)his (eans that the i(plied interest rate is nearly 15%.

& would choose Rs.#0,000 for 10 years fro( now +ecause & find a return of 15% uite
accepta+le.
##. FV10 = Rs.10,000 @1 / 40.10 - #A 103#

= Rs.10,000 41.05#0
= Rs.10,000 3 #.!5
= Rs.#!,50
&f the inflation rate is 8% per year, the value of Rs.#!,50 10 years fro( now, in ter(s of
the current rupees is:
Rs.#!,50 3 9V&F 48%,10 years
= Rs.#!,50 3 0.! = Rs.1#,#8
#.  constant deposit at the +e'innin' of each year represents an annuity due.
9V&F of an annuity due is eual to : 9V&F of an ordinary annuity 3 41 / r 
)o provide a su( of Rs.50,000 at the end of 10 years the annual deposit should
+e
Rs.50,000
 = FV&F41#%, 10 years 3 41.1#
Rs.50,000
= = Rs.#5
1$.5" 3 1.1#
#. )he discounted value of Rs.#0,000 receiva+le at the +e'innin' of each year fro( #005 to
#00", evaluated as at the +e'innin' of #00 4or end of #00 is:
= Rs.#0,000 3
Rs.#0,000 3 9V&F
.!05 = 41#%, 5 years
Rs.$#,100.
)he discounted value of Rs.$#,100 evaluated at the end of #000 is

Rs.$#,100 3 9V&F 41#%,  years
= Rs.$#,100 3 0.$1# = Rs.51,5
&f  is the a(ount deposited at the end of each year fro( 1""5 to #000 then
 3 FV&F 41#%, ! years = Rs.51,5
 3 8.115 = Rs.51,5
 = Rs.51,5 - 8.115 = Rs.!#!
#5. )he discounted value of the annuity of Rs.#000 receiva+le for 0 years, evaluated as at the
end of "th year is:
Rs.#,000 3 9V&F 410%, 0 years = Rs.#,000 3 ".#$ = Rs.18,85
)he present value of Rs.18,85 is:
Rs.18,85 3 9V&F 410%, " years
= Rs.18,85 3 0.#
= Rs.$,""
#!. 0 per cent of the pension a(ount is
0.0 3 Rs.!00 = Rs.180
ssu(in' that the (onthly interest rate correspondin' to an annual interest rate of 1#% is
1%, the discounted value of an annuity of Rs.180 receiva+le at the end of each (onth for 180
(onths 415 years is:
Rs.180 3 9V&F 41%, 180
41.01180  1
Rs.180 3  = Rs.1,""8
.01 41.01180
&f ;r. Ra(esh +orrows Rs. P today on which the (onthly interest rate is 1%
P 3 41.01!0 = Rs.1,""8

P 3 1.81$ = Rs.1,""8
Rs.1,""8
P =  = Rs.8#5
1.81$
#$. Rs.00 3 9V&F4r , # (onths = Rs.!,000

9V&F 4%,# = Rs.!000 - Rs.00 = #0
Fro( the ta+les we find that:

9V&F41%,# = #1.#
!
9V&F 4#%, # = 18."1
7sin' a linear interpolation

#1.#  #0.000
r = 1% /  3 1%
#1.#  18,"1
= 1.5%
)hus, the +an char'es an interest rate of 1.5% per (onth.

)he correspondin' effective rate of interest per annu( is
@ 41.0151#  1 A 3 100 = #0%
#8. )he discounted value of the de+entures to +e redee(ed +etween 8 to 10 years evaluated at
the end of the 5th year is:
Rs.10 (illion 3 9V&F 48%,  years
/ Rs.10 (illion 3 9V&F 48%,  years
/ Rs.10 (illion 3 9V&F 48%, 5 years
= Rs.10 (illion 40.$" / 0.$5 / 0.!81

= Rs.#.#1 (illion
&f  is the annual deposit to +e (ade in the sinin' fund for the years 1 to 5,
then
 3 FV&F 48%, 5 years = Rs.#.#1 (illion
 3 5.8!$ = Rs.#.#1 (illion
 = 5.8!$ = Rs.#.#1 (illion
 = Rs.#.#1 (illion - 5.8!$ = Rs.0.$$ (illion
#". 6et DnE +e the nu(+er of years for which a su( of Rs.#0,000 can +e withdrawn annually.
Rs.#0,000 3 9V&F 410%, n = Rs.100,000

9V&F 415%, n = Rs.100,000 - Rs.#0,000 = 5.000

9V&F 410%, $ years = .8!8
9V&F 410%, 8 years = 5.5
)hus n is +etween $ and 8. 7sin' a linear interpolation we 'et
5.000  .8!8
n = $ /  3 1 = $. years
5.5  .8!8
0. uated annual install(ent = 500000 - 9V&F41%,

= 500000 - #."1
= Rs.1$1,585
Loan Amortisation Schedule
Beginning Annual Principal Remaining

Year amount installment Interest repaid balance
------ ------------- --------------- ----------- ------------- -------------
1 500000 1$1585 $0000 101585 "815
# "815 1$1585 55$$8 11580$ #8#!08
 #8#!08 1$1585 "5!5 1#0#0 150588
 150588 1$1585 #108# 15050 85
4 roundin' off error
1. Befine n as the (aturity period of the loan. )he value of n can +e o+tained fro( the
euation.
#00,000 3 9V&F41%, n = 1,500,000

9V&F 41%, n = $.500
Fro( the ta+les or otherwise it can +e verified that 9V&F41,0 = $.500

*ence the (aturity period of the loan is 0 years.
#. 3pected value of iron ore (ined durin' year 1 = Rs.00 (illion
3pected present value of the iron ore that can +e (ined over the ne3t 15 years assu(in' a
price escalation of !% per annu( in the price per tonne of iron
1  41 / g n - 41 / in
= Rs.00 (illion 3 
i  g
= Rs.00 (illion 3 1  41.0! 15 - 41.1! 15

0.1!  0.0!
= Rs.00 (illion 3 40.$15 - 0.10

= Rs.### (illion
8
MINICASE
Solution:
1. *ow (uch (oney would Ra(esh need 15 years fro( nowG
500,000 3 9V&F 410%, 15years

/ 1,000,000 3 9V&F 410%, 15years
= 500,000 3 $.!0! / 1,000,000 3 0.#"
= ,80,000 3 #",000
= Rs.,0#,000
#. *ow (uch (oney should Ra(esh save each year for the ne3t 15 years to +e a+le to (eet his
invest(ent o+HectiveG
Ra(eshEs current capital of Rs.!00,000 will 'row to :
!00,000 41.1015 = !00,000 3 .1$$ = Rs #,50!,#00
)his (eans that his savin's in the ne3t 15 years (ust 'row to :
,0#,000  #,50!,#00 = Rs 1,55,800
2o, the annual savin's (ust +e :

1,55,800 1,55,800
= = Rs.8,8
FV&F 410%, 15 years 1.$$#
. *ow (uch (oney would Ra(esh need when he reaches the a'e of !0 to (eet his donation
o+HectiveG
#00,000 3 9V&F 410% , yrs 3 9V&F 410%, 11yrs
= #00,000 3 #.8$ 3 0.1$ = 15$,!$!
. Ihat is the present value of Ra(eshEs life ti(e earnin'sG
00,000 00,00041.1# 00,00041.1#1
!
1 # 15
"
15
1.1#
1
1.08
= 00,000
0.08  0.1#
= Rs.$,#5,"!#
10
Chapter 8
VALUATION OF BONS AN STOC!S
1. 5 11 100
P = ∑ /
t =1 41.15 41.155
= Rs.11 3 9V&F415%, 5 years / Rs.100 3 9V&F 415%, 5 years

= Rs.11 3 .5# / Rs.100 3 0."$
= Rs.8!.$
#.4i Ihen the discount rate is 1%

$ 1# 100
P = ∑ /
t =1 41.1 t 41.1$
= Rs.1# 3 9V&F 41%, $ years / Rs.100 3 9V&F 41%, $ years

= Rs.1# 3 .#88 / Rs.100 3 0.
= Rs."1.!
4ii Ihen the discount rate is 1#%

$ 1# 100
P = ∑ / = Rs.100
t =1 41.1# t 41.1#$
Jote that when the discount rate and the coupon rate are the sa(e the value is eual to
par value.
. )he yield to (aturity is the value of r that satisfies the followin' euality.
$ 1#0 1,000
Rs.$50 = ∑ / = Rs.100
t =1 41/r  t 41/r $
)ry r = 18%. )he ri'ht hand side 4R*2 of the a+ove euation is:
Rs.1#0 3 9V&F 418%, $ years / Rs.1,000 3 9V&F 418%, $ years
= Rs.1#0 3 .81# / Rs.1,000 3 0.1
= Rs.$$1.
)ry r = #0%. )he ri'ht hand side 4R*2 of the a+ove euation is:
Rs.1#0 3 9V&F 4#0%, $ years / Rs.1,000 3 9V&F 4#0%, $ years
= Rs.1#0 3 .!05 / Rs.1,000 3 0.#$"
= Rs.$11.!0
11
)hus the value of r at which the R*2 +eco(es eual to Rs.$50 lies +etween 18% and #0%.
7sin' linear interpolation in this ran'e, we 'et
$$1.  $50.00
Kield to (aturity = 18% / $$1.  $11.!0 3 #%
= 18.$%
.
10 1 100
80 = ∑ /
t =1 41/r  t 41/r 10
)ry r = 18%. )he R*2 of the a+ove euation is
Rs.1 3 9V&F 418%, 10 years / Rs.100 3 9V&F 418%, 10 years

= Rs.1 3 ." / Rs.100 3 0.1"1 = Rs.8#
)ry r = #0%. )he R*2 of the a+ove euation is

Rs.1 3 9V&F4#0%, 10 years / Rs.100 3 9V&F 4#0%, 10 years
= Rs.1 3 .1" / Rs.100 3 0.1!#
= Rs.$."
7sin' interpolation in the ran'e 18% and #0% we 'et:
8#  80
Kield to (aturity = 18% /  3 #%
8#  $."
= 18.5!%
5.
1# ! 100
P = ∑ /
t =1 41.08 t 41.081#
= Rs.! 3 9V&F 48%, 1# years / Rs.100 3 9V&F 48%, 1# years

= Rs.! 3 $.5! / Rs.100 3 0."$
= Rs.8."#
!. )he postta3 interest and (aturity value are calculated +elow:
1#
Bond A Bond B
 9ostta3 interest 4?  1#41  0. 10 41  0.

=Rs.8. =Rs.$
 9ostta3 (aturity value 4; 100  100 

@ 4100$03 0.1A @ 4100  !03 0.1A
=Rs."$ =Rs."!
)he postta3 K);, usin' the appro3i(ate K); for(ula is calculated +elow
8. / 4"$$0-10
>ond  : 9ostta3 K); = 
0.! 3 $0 / 0. 3 "$
= 1.$%
$ / 4"!  !0-!
>ond > : 9ostta3 K); = 
0.!3 !0 / 0. 3 "!
= 1$. $%
$.
1 ! 100
P = ∑ /
t =1 41.08 t 41.081
= Rs.! 3 9V&F48%, 1 / Rs.100 3 9V&F 48%, 1

= Rs.! 3 8.# / Rs.100 3 0.1
= Rs.8.5!
8. Do = Rs.#.00, g = 0.0!, r = 0.1#
P o = D1 - 4r  g  = Do 41 / g  - 4r  g 
= Rs.#.00 41.0! - 40.1#  0.0!

= Rs.5.
2ince the 'rowth rate of !% applies to dividends as well as (aret price, the (aret
price at the end of the #nd year will +e:
P # = P o 3 41 / g # = Rs.5. 41.0!#

= Rs.".$0
1
". P o = D1 - 4r  g  = Do 41 / g  - 4r  g 

= Rs.1#.00 41.10 - 40.15  0.10 = Rs.#!
10. P o = D1 - 4r  g 
Rs.# = Rs.# - 0.1#  g

g = 0.05$5 or 5.$5%
11. P o = D1- 4r  g  = Do41/ g  - 4r  g 

Do = Rs.1.50, g = 0.0, P o = Rs.8
2o
8 = 1.50 41 .0 - 4r  4.0 = 1. - 4r / .0
*ence r = 0.1 or 1 per cent
1#. )he (aret price per share of ?o((onwealth ?orporation will +e the su( of three
co(ponents:
: 9resent value of the dividend strea( for the first  years

>: 9resent value of the dividend strea( for the ne3t  years
?: 9resent value of the (aret price e3pected at the end of 8 years.
= 1.50 41.1# - 41.1 / 1.50 41.1## - 41.1# / 1.5041.1# - 41.1 /

/ 1.50 41.1# - 41.1
= 1.!8-41.1 / 1.88 - 41.1# / #.11 - 41.1 / #.! - 41.1

= Rs.5.$
>= #.!41.08 - 41.15 / #.! 41.08# - 41.1! / #.! 41.08 - 41.1$ /

/ #.! 41.08 - 41.18
= #.55 - 41.15 / #.$5 - 41.1 ! / #."$ - 41.1$ / .#1 - 41.18

= Rs..8"
8
? = P 8 - 41.1
P 8 = D" - 4r  g  = .#1 41.05- 40.1  0.05 = Rs.$.5
2o
? = Rs.$.5 - 41.18 = Rs.1.1
)hus,
P o =  / > / ? = 5.$ / .8" / 1.1

1
= Rs.#.$$
1. )he intrinsic value of the euity share will +e the su( of three co(ponents:
: 9resent value of the dividend strea( for the first 5 years when the
'rowth rate e3pected is 15%.
>: 9resent value of the dividend strea( for the ne3t 5 years when the
'rowth rate is e3pected to +e 10%.
?: 9resent value of the (aret price e3pected at the end of 10 years.
#.00 41.15 #.00 41.15# #.00 41.15 #.0041.15 #.00 41.155

=  /  / /  / 
41.1# 41.1## 41.1.# 41.1.# 41.1#5
= #.0 - 41.1# / #.!5 - 41.1## / .0 - 41.1# / .50 - 41.1# / .0#-41.1#5

= Rs.10.8
.0#41.10 .0# 41.10# .0#41.10 .0#41.10 .0# 41.105

>=  /  /  /  / 
41.1#! 41.1#$ 41.1#8 41..1#" 41.1#10

.# .8! 5.5 5.8" !.8
=  /  /  /  / 
41.1#! 41.1#$ 41.1#8 41.1.#" 41.1#10
= Rs.10.81
B11 1 !.8 41.05

?=  3  =  3 1-41.1#10
r  g 41 /r 10 0.1#  0.05
= Rs."$.#0
)he intrinsic value of the share =  / > / ?

= 10.8 / 10.81 / "$.#0 = Rs.118.85
1. )er(inal value of the interest proceeds
= 10 3 FV&F 41!%,
= 10 3 5.0!!
= $0".#
Rede(ption value = 1,000
15
)er(inal value of the proceeds fro( the +ond = 1$0".#
Befine r as the yield to (aturity. )he value of r can +e o+tained fro( the euation
"00 41 / r  = 1$0".#

r = 0.1$" or 1$."%
15. &ntrinsic value of the euity share 4usin' the #sta'e 'rowth (odel
41.18!
#.! 3 1   #.! 3 41.185 3 41.1#
41.1!!
=  / 
0.1!  0.18 40.1!  0.1# 3 41.1!!
 0.10801
= #.! 3  / !#.05
 0.0#
= Rs.$.80
1!. &ntrinsic value of the euity share 4usin' the * (odel
.00 41.#0 .00 3  3 40.10

=  / 
0.18  0.10 0.18  0.10
= !0 / #0
= Rs.80
1!
Chapter "
#IS! AN #ETU#N
1 4a 3pected price per share a year hence will +e:
= 0. 3 Rs.10 / 0. 3 Rs.11 / 0.# 3 Rs.1# = Rs.10.80
4+ 9ro+a+ility distri+ution of the rate of return is
Rate of return 4 Ri 10% #0% 0%
9ro+a+ility 4 pi 0. 0. 0.#
Jote that the rate of return is defined as:
Bividend / )er(inal price

  1
&nitial price
4c  )he standard deviation of rate of return is : L = ∑ pi 4 Ri  R#
)he L of the rate of return on ;V;Es stoc is calculated +elow:


Ri pi p I r i 4 Ri-R 4 R i- R# pi 4 Ri-R#

10 0.  8 ! #5.!
#0 0. 8 #  1.!
0 0.# ! 1# 1 #8.8

R = ∑ pi Ri ∑ pi 4 Ri-R#
= 5!
L = √5! = $.8%
# 4a For Rs.1,000, #0 shares of lphaEs stoc can +e acuired. )he pro+a+ility distri+ution of the
return on #0 shares is
Economic Condition Return 4Rs Probability

*i'h Mrowth #0 3 55 = 1,100 0.
6ow Mrowth #0 3 50 = 1,000 0.
2ta'nation #0 3 !0 = 1,#00 0.#
Recession #0 3 $0 = 1,00 0.#
3pected return = 41,100 3 0. / 41,000 3 0. / 41,#00 3 0.# / 41,00 3 0.#
1$
= 0 / 00 / #0 / #80

= Rs.1,150
2tandard deviation of the return = @41,100  1,150# 3 0. / 41,000  1,150 # 3
0. / 41,#00  1,150 # 3 0.# / 41,00  1,150 # 3 0.#A1-#

= Rs.1.18
4+ For Rs.1,000, #0 shares of >etaEs stoc can +e acuired. )he pro+a+ility distri+ution of the
return on #0 shares is:
Economic condition Return Rs! Probability
*i'h 'rowth #0 3 $5 = 1,500 0.

6ow 'rowth #0 3 !5 = 1,00 0.
2ta'nation #0 3 50 = 1,000 0.#
Recession #0 3 0 = 800 0.#
3pected return = 41,500 3 0. / 41,00 3 0. / 41,000 3 0.# / 4800 3 0.#
= Rs.1,#00
2tandard deviation of the return = @41,500  1,#00# 3 . / 41,00  1,#00 # 3 .

/ 41,000  1,#00 # 3 .# / 4800  1,#00 # 3 .#A1-# = Rs.#!.58
4c  For Rs.500, 10 shares of lphaEs stoc can +e acuiredN liewise for Rs.500, 10
shares of >etaEs stoc can +e acuired. )he pro+a+ility distri+ution of this option is:
Return Rs! Probability
410 3 55 / 410 3 $5 = 1,00 0.
410 3 50 / 410 3 !5 = 1,150 0.
410 3 !0 / 410 3 50 = 1,100 0.#
410 3 $0 / 410 3 0 = 1,100 0.#
3pected return = 41,00 3 0. / 41,150 3 0. / 41,100 3 0.# /

41,100 3 0.#
= Rs.1,1$5
2tandard deviation = @41,00 1,1$5# 3 0. / 41,150  1,1$5 # 3 0. /
41,100  1,1$5# 3 0.# / 41,100  1,1$5 # 3 0.# A1-#

= Rs.8.1
d. For Rs.$00, 1 shares of lphaEs stoc can +e acuiredN liewise for Rs.00, !
shares of >etaEs stoc can +e acuired. )he pro+a+ility distri+ution of this
option is:
18
Return Rs! Probability
41 3 55 / 4! 3 $5 = 1,##0 0.

41 3 50 / 4! 3 !5 = 1,0"0 0.
41 3 !0 / 4! 3 50 = 1,10 0.#
41 3 $0 / 4! 3 0 = 1,##0 0.#
3pected return = 41,##0 3 0. / 41,0"0 3 0. / 41,10 3 0.# / 41,##0 3 0.#
= Rs.1,1!5
2tandard deviation = @41,##0  1,1!5# 3 0. / 41,0"0  1,1!5 # 3 0. /

41,10  1,1!5# 3 0.# / 41,##0  1,1!5 # 3 0.#A1-#
= Rs.5$.!!
)he e3pected return to standard deviation of various options are as follows :

E#pected return Standard de$iation E#pected % Standard
"ption Rs! Rs return de$iation
a 1,150 1 8.0
+ 1,#00 #!5 .5
c 1,1$5 8 1.""
d 1,1!5 58 #0.0"
ption DdE is the (ost preferred option +ecause it has the hi'hest return to ris ratio.
. 3pected rates of returns on euity stoc , >, ? and B can +e co(puted as follows:
: 0.10 / 0.1# / 40.08 / 0.15 / 40.0# / 0.#0 = 0.0$8 = $.8%

!
>: 0.08 / 0.0 / 0.15 /.1# / 0.10 / 0.0! = 0.0"1$ = ".1$%

!
?: 0.0$ / 0.08 / 0.1# / 0.0" / 0.0! / 0.1# = 0.0"00 = ".00%

!
B: 0.0" / 0.0" / 0.11 / 0.0 / 0.08 / 0.1! = 0.0"5 = ".50%

!
4a Return on portfolio consistin' of stoc  = $.8%
4+ Return on portfolio consistin' of stoc  and > in eual

proportions = 0.5 40.0$8 / 0.5 40.0"1$
= 0.085 = 8.5%
1"
4c  Return on portfolio consistin' of stocs , > and ? in eual

proportions = 1-40.0$8  / 1-40.0"1$ / 1- 40.0"0
= 0.08!$ = 8.!$%
4d Return on portfolio consistin' of stocs , >, ? and B in eual

proportions = 0.#540.0$8 / 0.#540.0"1$ / 0.#540.0"00 /
0.#540.0"5
= 0.088$5 = 8.88%
. Befine R A and R & as the returns on the euity stoc of uto lectricals 6i(ited a and ;aret
portfolio respectively. )he calculations relevant for calculatin' the +eta of the stoc are
shown +elow:
Year R A R & R A-R A R & -R & R A-R A ! R & -R & ! R A-R A %R & -R &

1 15 1# 0.0" .18 0.01 10.11 0.#"
# ! 1 #1.0" 1.18 .$" #01.0$ #"".0!
 18 1 #."1 1.18 8.$ 1." .
 0 # 1."1 8.8# ###.1 $$.$" 11.51
5 1# 1! 0.0" 0.8# ".55 0.!$ #.5
! #5 0 "."1 1.8# "8.#1 #1".! 1!.8$
$ #  1.0" 18.18 1$1.5 0.51 #$."8
8 #0 # ."1 8.8# #.11 $$.$" .1
" 18 15 #."1 0.18 8.$ 0.0 0.5#
10 # ## 8."1 !.8# $"." !.51 !0.$$
11 8. 1# $.0" .18 50.#$ 10.11 ##.55
R A = 15.0" R & = 15.18
∑ 4 R A  R A# = 111!." ∑ 4 R &  R &  # = "$5.!1 ∑ 4 R A  R A 4 R &  R &  = "5.8!
>eta of the euity stoc of uto lectricals

∑ 4 R A  R A 4 R &  R & 
∑ 4 R &  R &  #
= "5.8! = 0."!
"$5.!1
lpha = R A  O R &
= 15.0"  40."! 3 15.18= 0.5#
#0
uation of the characteristic line is
R A = 0.5# / 0."! R &
5. )he reuired rate of return on stoc  is:
R A = R ' / O A 4 R &  R ' 

= 0.10 / 1.5 40.15  0.10
= 0.1$5
&ntrinsic value of share = D1 - 4r  g  = Do 41/ g  - 4 r  g 
Miven Do = Rs.#.00, g = 0.08, r = 0.1$5

#.00 41.08
&ntrinsic value per share of stoc  =
0.1$5  0.08
= Rs.##.$
!. )he 2;6 euation is R A = R ' / O A 4 R &  R ' 
Miven R A = 15%. R ' = 8%, R & = 1#%, we have
0.15 = .08 / O A 40.1#  0.08
0.0$
A
i.e.O = = 1.$5
0.0
>eta of stoc  = 1.$5
$. )he 2;6 euation is: R ( = R ' / O ( 4 R &  R ' 
Ie are 'iven 0.15 = 0.0" / 1.5 4R & 

0.0" i.e., 1.5 R & = 0.1"5
or R & = 0.1%
)herefore return on (aret portfolio = 1%
8. R & = 1#% O ( = #.0 R ( =18% g = 5% P o = Rs.0
P o = D1 - 4r  g 
Rs.0 = D1 - 40.18  .05

#1
2o D1 = Rs." and Do = D1 - 41/ g  = ." -41.05 = Rs..$1
R # = R ) / O # 4 R & 

R ) 
0.18 = R ) / #.0 40.1#  R ) 
2o R ) = 0.0! or !%.
"riginal Re$ised
R ) !% 8%
R &  R ) !% %
g 5% %
O # #.0 1.8
Revised R # = 8% / 1.8 4% = 15.#%
9rice per share of stoc P, 'iven the a+ove chan'es is
.$1 41.0
= Rs..5
0.15#  0.0
Chapter $%
O&TIONS AN T'EI# VALUATION
##
1. S = 100 u = 1.5 d = 0.8
E = 105 r = 0.1# R = 1.1#
)he values of ∆ 4hed'e ratio and B 4a(ount +orrowed can +e o+tained as follows:
C u  C d
Q =
4u  d  S
C u = ;a3 4150  105, 0 = 5
C d = ;a3 480  105, 0 = 0
5  0 5 "
Q = = = = 0.!#"
0.$ 3 100 $0 1
u.C d  d .C u
B =
4ud  R
41.5 3 0  40.8 3 5

=
0.$ 3 1.1#
!
= =  5."#
0.$8
C = Q S / B
= 0.!#" 3 100  5."#
= Rs.18.$
Value of the call option = Rs.18.$
#. S = 0 u = G d = 0.8

R = 1.10 E = 5 C = 8
Ie will assu(e that the current (aret price of the call is eual to the pair value of the call
as per the >ino(ial (odel.
Miven the a+ove data
#
C d = ;a3 4#  5, 0 = 0
Q Cu  Cd R
= 3
B u C d  d C u S
Q C u  0 1.10
= 3
B 0.8C u 0
= 4 0.0$5
Q =  0.$5 B 41
C = Q S / B
8 = Q 3 0 / B 4#
2u+stitutin' 41 in 4# we 'et
8 = 40.0!5 3 0 B / B
8 = 0.$5 B
or B =  #1.
Q =  0.0$5 4#1. = 0.$#
)he portfolio consists of 0.$# of a share plus a +orrowin' of Rs.#1. 4entailin' a

repay(ent of Rs.#1. 41.10 = Rs.#.! after one year. &t follows that when u occurs either u 3 0
3 0.$#  #.! = u 3 0  5
10.!$# u = #1.5
u = #.0#
or
u 3 0 3 0.$#  #.! = 0

u = 0.8
2ince u  d , it follows that u = #.0#.

9ut differently the stoc price is e3pected to rise +y 1.0# 3 100 = 10#%.
. 7sin' the standard notations of the >lac2choles (odel we 'et the followin' results:
l n 4S - E  / r t / L# t -#
d 1 =
#
σ √ t
#
= l n 41#0 - 110 / 0.1 / 0. -#
0.
= 0.08$01 / 0.1 / 0.08

0.
= 0.$!$5
d # = d 1  σ √ t

= 0.$!$5  0.
= 0.!$5
* 4d 1 = * 40.$!$5 S * 40.$$ = 0.80$85

* 4d # = * 40.!$5 S * 40.$ = 0.!1
C = 2o * 4d 1  E . ert . * 4d #

= 1#0 3 0.80$85  110 3 e0.1 3 0.!1
= 41#0 3 0.80$85  4110 3 0.8!"! 3 0.!1
= 5.
Value of the call as per the >lac and 2choles (odel is Rs.5..
. σ √t = 0.# 3 √ 1 = 0.#
Ratio of the stoc price to the present value of the e3ercise price
80
= 
8# 3 9V&F 415.0,1
80
= 
8# 3 0.8!"
= 1.1##
Fro( ta+le ! we find the percenta'e relationship +etween the value of the call option and
stoc price to +e 1.1 per cent. *ence the value of the call option is
0.11 3 80 = Rs.11,#8.
5. Value of put option

= Value of the call option
/ 9resent value of the e3ercise price
#5
 2toc price TTT 4
)he value of the call option 'ives an e3ercise price of Rs.85 can +e o+tained as follows:
σ √t = 0.# √ 1 = 0.#
Ratio of the stoc price to the present value of the e3ercise price
80
= 
85 3 9V&F 415.0,1
= 80 - $.8" = 1.08
Fro( )a+le .!, we find the percenta'e relationship +etween the value of the call option and
the stoc price to +e 11."%
*ence the value of the call option = 0.11" 3 80 = Rs.".5#
9lu''in' in this value and the other relevant values in 4, we 'et
Value of put option = ".5# / 85 3 41.1501  80
= Rs..1
!. S o = + o * 4d 1  B1 e  rt * 4d #
= !000 * 4d 1  5000 e  0.1 * 4d #
l n 4!000 - 5000 / 40.1 3 1 / 40.18-#

d 1 = 
√ 0.18 3 √ 1
l n 41.# / 0.1"
=
0.#
= 0.8$$5 = 0.88
* 4d 1 = * 40.88 = 0.8105$

d # = d 1  t
= 0.8$$5  0.18
#!
= 0.5# = 0.5
* 4d # = * 40.5 = 0.!$!

2o = !000 3 0.8105$  45000 3 0."08 3 0.!$!
= 181!
B0 = + 0  S 0

= !0000  181!
= 18
Chapter $$
TEC'NI(UES OF CA&ITAL BUETIN

1.4a J9V of the proHect at a discount rate of 1%.
=  1,000,000 / 100,000 / #00,000

 
41.1 41.1#
/ 00,000 / !00,000 / 00,000

#$
  

41.1 41.1 41.15
=  8$
4+ J9V of the proHect at ti(e varyin' discount rates
=  1,000,000
/ 100,000
41.1#
/ #00,000
41.1# 41.1
/ 00,000
41.1# 41.1 41.1
/ !00,000

41.1# 41.1 41.1 41.15
/ 00,000

41.1# 41.1 41.141.1541.1!
=  1,000,000 / 8"#8! / 1580#8 / #0$"1 / !1!#0 / 1558$1
=  #$#!
#. &nvest(ent 
a 9ay+ac period = 5 years

+ J9V = 0000 3 9V&F 41#,10  #00 000
= #!000
c &RR 4r  can +e o+tained +y solvin' the euation:
0000 3 9V&F 4r , 10 = #00000
i.e., 9V&F 4r , 10 = 5.000
Fro( the 9V&F ta+les we find that

#8
9V&F 415,10 = 5.01"

9V&F 41!,10 = .88
6inear interporation in this ran'e yields

r = 15 / 1 3 40.01" - 0.1!
= 15.1%
d >?R = >enefit ?ost Ratio

= 9V> - &
= ##!,000 - #00,000 = 1.1
&nvest(ent >
a 9ay+ac period = " years
+ J9 V = 0,000 3 9V&F 41#,5

/ 0,000 3 9V&F 41#,# 3 9V&F 41#,5
/ #0,000 3 9V&F 41#, 3 9V&F 41#,$
- 00,000
= 40,000 3 .!05 / 40,000 3 1.!"0 3 0.5!$

/ 4#0,000 3 #.0# 3 0.5#  00,000
=  105"
c &RR 4r  can +e o+tained +y solvin' the euation

0,000 3 9V&F 4r , 5 / 0,000 3 9V&F 4r , # 3 9V&F 4r ,5 /
#0,000 3 9V&F 4r ,  3 9V&F 4r , $ = 00,000
)hrou'h the process of trial and error we find that

r = 1.$%
d >?R = 9V> - &

= 1",!!1 - 00,000 = 0.!5
&nvest(ent ?
a 9ay+ac period lies +etween # years and  years. 6inear interpolation in this
ran'e provides an appro3i(ate pay+ac period of #.88 years.
+ J9V = 80.000 3 9V&F 41#,1 / !0,000 3 9V&F 41#,#

/ 80,000 3 9V&F 41#, / !0,000 3 9V&F 41#,
/ 80,000 3 9V&F 41#,5 / !0,000 3 9V&F 41#,!
/ 0,000 3 9V&F 41#, 3 9V&F 41#.!

#"
 #10,000
= 111,$1
c &RR 4r  is o+tained +y solvin' the euation
80,000 3 9V&F 4r ,1 / !0,000 3 9V&F 4r ,# / 80,000 3 9V&F 4r ,
/ !0,000 3 9V&F 4r , / 80,000 3 9V&F 4r ,5 / !0,000 3 9V&F 4r ,!
/ 0000 3 9V&F 4r , 3 9V&F 4r ,! = #10000
)hrou'h the process of trial and error we 'et

r = #".#"%
d >?R = 9V> - & = #1,$1 - #10,000 = 1.5
&nvest(ent B
a 9ay+ac period lies +etween 8 years and " years.  linear interpolation in this
ran'e provides an appro3i(ate pay+ac period of 8.5 years.
8 / 41 3 100,000 - #00,000
+ J9V = #00,000 3 9V&F 41#,1

/ #0,000 3 9V&F 41#,# / #00,000 3 9V&F 41#,"
/ 50,000 3 9V&F 41#,10
 #0,000
=  $,1!0
c &RR 4r  can +e o+tained +y solvin' the euation

#00,000 3 9V&F 4r ,1 / #00,000 3 9V&F 4r ,#
/ #00,000 3 9V&F 4r ," / 50,000 3 9V&F 4r ,10
= #0000
)hrou'h the process of trial and error we 'et r = 8.5%
d >?R = 9V> - & = #8#,80 - #0,000 = 0.88
?o(parative )a+le
In$estment A B C D
a 9ay+ac period
4in years 5 " #.88 8.5
+ J9V U 1#% pa #!000 105" 111$1 $1!0
c &RR 4% 15.1 1.$ #".#" 8.5
0
d >?R 1.1 0.!5 1.5 0.88
(on' the four alternative invest(ents, the invest(ent to +e chosen is ?E

+ecause it has the 6owest pay+ac period
*i'hest J9V
*i'hest &RR
*i'hest >?R
. &RR 4r  can +e calculated +y solvin' the followin' euations for the value of r .
!0000 3 9V&F 4r ,$ = 00,000
i.e., 9V&F 4r ,$ = 5.000
)hrou'h a process of trial and error it can +e verified that r = ".#0% pa.
. )he &RR 4r  for the 'iven cashflow strea( can +e o+tained +y solvin' the followin' euation
for the value of r .
000 / "000 - 41/ r   000 - 41/r  = 0
2i(plifyin' the a+ove euation we 'et
r = 1.!1, 0.!1N 4or 1!1%, 4!1%
*",E : Miven two chan'es in the si'ns of cashflow, we 'et two values for the
&RR of the cashflow strea(. &n such cases, the &RR rule +reas down.
5. Befine J?F as the (ini(u( constant annual net cashflow that Hustifies the purchase of the
'iven euip(ent. )he value of J?F can +e o+tained fro( the euation
J?F 3 9V&F 410,8 = 500000

J?F = 500000 - 5.5
= "#$1
!. Befine I as the initial invest(ent that is Hustified in relation to a net annual cash
inflow
of I canof+e#5000 for 10
o+tained years
fro( the at a discount
followin' rate of 1#% per annu(. )he value
euation
#5000 3 9V&F 41#,10 = I

i.e., I = 11#5!
$. 9V of +enefits 49V> = #5000 3 9V&F 415,1

/ 0000 3 9V&F 415,#
/ 50000 3 9V&F 415,
1
/ 0000 3 9V&F 415,

/ 0000 3 9V&F 415,5
= 1##!! 4
&nvest(ent = 100,000 4>
>enefit cost ratio = 1.# @= 4 - 4>A
8. )he J9VEs of the three proHects are as follows:
&ro*e+t
P  R
Discount rate
0% 00 500 !00

5% ## #51 1#
10% !" 0 $0
15%  !!  1#  15
#5%  #"1  5  !1

0%  8!  555  5"1
". J9V profiles for 9roHects 9 and W for selected discount rates are as follows:
4a
&ro*e+t
P 
Discount rate .!
0 #"50 500
5 18$! #08
10 10$5  #8
15 $1  ###
#0 11  8#
+ 4i )he &RR 4r  of proHect P can +e o+tained +y solvin' the followin'
euation for Dr E.

1000 1#00 3 9V&F 4r ,1  !00 3 9V&F 4 r ,#  #50 3 9V&F 4r ,
/ #000 3 9V&F 4r , / 000 3 9V&F 4r ,5 = 0
)hrou'h a process of trial and error we find that r = #0.1%
4ii )he &RR 4r ' of proHect  can +e o+tained +y solvin' the followin' euation for r '
#
1!00 / #00 3 9V&F 4 r ',1 / 00 3 9V&F 4r ',# / !00 3 9V&F 4r ',
/ 800 3 9V&F 4r ', / 100 3 9V&F 4r ',5 = 0
)hrou'h a process of trial and error we find that r ' = ".%.
c Fro( 4a we find that at a cost of capital of 10%
J9V 49 = 10$5

J9V 4W =  #8
Miven that J9V 49 . J9V 4WN and J9V 49  0, & would choose proHect 9.
Fro( 4a we find that at a cost of capital of #0%
J9V 49 = 11
J9V 4W =  8#
'ain J9V 49  J9V 4WN and J9V 49  0. & would choose proHect 9.
d 9roHect 9
9V of invest(entrelated costs
= 1000 3 9V&F 41#,0

/ 1#00 3 9V&F 41#,1 / !00 3 9V&F 41#,#
/ #50 3 9V&F 41#,
= #$#8
)V of cash inflows = #000 3 41.1# / 000 = !#0
)he ;&RR of the proHect 9 is 'iven +y the euation:
#$#8 = !#0 3 9V&F 4;&RR,5
41 / ;&RR5 = #.#8$
;&RR = 18%
4c 9roHect W
9V of invest(entrelated costs = 1!00
)V of cash inflows U 15% p.a. = #$$#
)he ;&RR of proHect W is 'iven +y the euation:
1!000 41 / ;&RR5 = #$$#

;&RR = 11.!#%
10
4a 9roHect 
J9V at a cost of capital of 1#%

=  100 / #5 3 9V&F 41#,!
= Rs.#.$" (illion
&RR 4r  can +e o+tained +y solvin' the followin' euation for r .
#5 3 9V&F 4r ,! = 100
i.e., r = 1#,"8%
9roHect >
J9V at a cost of capital of 1#%

, - 50 / 1 3 9V&F 41#,!
= Rs..5 (illion
&RR 4r ' can +e o+tained +y solvin' the euation
1 3 9V&F 4r ',! = 50
i.e., r ' = 1.0% @deter(ined throu'h a process of trial and errorA
4+ Bifference in capital outlays +etween proHects  and > is Rs.50 (illion
Bifference in net annual cash flow +etween proHects  and > is Rs.1# (illion.
J9V of the differential proHect at 1#%
= 50 / 1# 3 9V&F 41#,!
= Rs..15 (illion
&RR 4r '' of the differential proHect can +e o+tained fro( the euation
1# 3 9V&F 4r '', ! = 50
i.e., r '' = 11.5%
11
4a 9roHect ;
)he pay +ac period of the proHect lies +etween # and  years. &nterpolatin' in
this ran'e we 'et an appro3i(ate pay +ac period of #.! years-
9roHect J
)he pay +ac period lies +etween 1 and # years. &nterpolatin' in this ran'e we
'et an appro3i(ate pay +ac period of 1.55 years.

4+ 9roHect ;
?ost of capital = 1#% p.a
9V of cash flows up to the end of year # = #."$
9V of cash flows up to the end of year  = $.$5
9V of cash flows up to the end of year  = $1.#!
Biscounted pay +ac period 4B9> lies +etween  and  years. &nterpolatin' in this ran'e we
'et an appro3i(ate B9> of .1 years.
9roHect J
?ost of capital = 1#% per annu(
9V of cash flows up to the end of year 1 = ."
9V of cash flows up to the end of year # = 51.$
B9> lies +etween 1 and # years. &nterpolatin' in this ran'e we 'et an appro3i(ate
B9> of 1."# years.
4c  9roHect ;
J9V =  50 / 11 3 9V&F 41#,1
/ 1" 3 9V&F 41#,# / # 3 9V&F 41#,
/ $ 3 9V&F 41#,
= Rs.#1.#! (illion
9roHect J
J9V = Rs.#0.! (illion
2ince the two proHects are independent and the J9V of each proHect is 4/ ve,
+oth the proHects can +e accepted. )his assu(es that there is no capital constraint.
4d 9roHect ;
?ost of capital = 10% per annu(
J9V = Rs.#5.0# (illion
9roHect J
?ost of capital
J9V = Rs.#.08
= 10% per annu(
(illion
2ince the two proHects are (utually e3clusive, we need to choose the proHect with the hi'her
J9V i.e., choose proHect ;.
*",E : )he ;&RR can also +e used as a criterion of (erit for choosin' +etween the two
proHects +ecause their initial outlays are eual.
4e 9roHect ;
?ost of capital = 15% per annu(
5
J9V = 1!.1 (illion
9roHect J
?ost of capital: 15% per annu(
J9V = Rs.1$.# (illion
'ain the two proHects are (utually e3clusive. 2o we choose the proHect with the
hi'her J9V, i.e., choose proHect J.
4f 9roHect ;
)er(inal value of the cash inflows: 11.$
;&RR of the proHect is 'iven +y the euation
50 41 / ;&RR = 11.$
i.e., ;&RR = #.01%
9roHect J
)er(inal value of the cash inflows: 115.1
;&RR of the proHect is 'iven +y the euation
50 4 1/ ;&RR = 115.1
i.e., ;&RR = #.#!%
!
Chapter $.
ESTIMATION OF &#O/ECT CAS' FLO0S
1.
4a Pro/ect Cash 'lo0s Rs1 in million!
Year 2 3 4 5 6 7 8 9
1. 9lant X (achinery 4150
#. Iorin' capital 450
. Revenues #50 #50 #50 #50 #50 #50 #50
. ?osts 4e3cludin' de

preciation X interest 100 100 100 100 100 100 100
5. Bepreciation $.5 #8.1 #1.0" 15.8# 11.8$ 8."0 !.!$
!. 9rofit +efore ta3 11#.5 1#1.8$ 1#8."1 1.18 18.1 11.11.
$. )a3 .$5 !.5! 8.!$ 0.#5 1. #. .0
8. 9rofit after ta3 $8.$5 85.1 "0.# "." "!.!" "8.$$100.
". Jet salva'e value of

plant X (achinery 8
10. Recovery of worin' 50
capital
11. &nitial outlay 4=1/# 4#00
1#. peratin' ?F 4= 8 / 5 11!.#5 11. 111. 10".$5 108.5! 10$.! 10$.00
1. )er(inal ?F 4 = " /10 "8
1. J?F 4#00 11!.#5 11. 111. 10".$5 108.5! 10$.!$ #05
4c &RR 4r  of the proHect can +e o+tained +y solvin' the followin' euation for r
#00 / 11!.#5 3 9V&F 4 r ,1 / 11. 3 9V&F 4r ,#
/ 111. 3 9V&F 4r , / 10".$5 3 9V&F 4r , / 108.5! 3 9V&F 4r ,5
$
/10$.!$ 3 9V&F 4r ,! / #05 3 9V&F 4r ,$ = 0
)hrou'h a process of trial and error, we 'et r = 55.1$%. )he &RR of the proHect is 55.1$%.
#. Post-ta# Incremental Cash 'lo0s Rs1 in million!
Year 2 3 4 5 6 7 8 9
1. ?apital euip(ent 41#0

#. 6evel of worin' capital #0 0 0 50 0 0 #0
4endin'
. Revenues 80 1#0 1!0 #00 1!0 1#0 80
. Raw (aterial cost # ! 8 !0 8 ! #
5. Varia+le (f' cost. 8 1# 1! #0 1! 1# 8
!. Fi3ed operatin' X (aint. 10 10 10 10 10 10 10
cost
$. Varia+le sellin' e3penses 8 1# 1! #0 1! 1# 8
8. &ncre(ental overheads  ! 8 10 8 ! 
". 6oss of contri+ution 10 10 10 10 10 10 10
10.>ad de+t loss 
11. Bepreciation 0 ##.5 1!.88 1#.!! "." $.1# 5.
1#. 9rofit +efore ta3 1 11.5 5.1# 5$. #.51 #!.88 !.!!
1. )a3 .# .5 10.5 1$.#0 1#.$5 8.0! #.00
1. 9rofit after ta3 ".8 8.05 #.58 0.1 #".$! 18.8# .!!
15. Jet salva'e value of
capital euip(ents #5
1!. Recovery of worin' 1!
capital
1$. &nitial invest(ent 41#0
18. peratin' cash flow #0.# 0.55 1.! 5#.80 ".#5 #5." 1.00
41 / 10/ 11
1". ∆ Iorin' capital #0 10 10 10 410 410 410
#0. )er(inal cash flow 1
#1. Jet cash flow 410 10.#0 #0.55 1.! !#.80 ".#5 5." 55.00
41$/181"/#0
4+ J9V of the net cash flow strea( U 15% per discount rate
= 10 / 10.#0 3 9V&F415,1 / #0.55 3 9V&F 415,#

/ 1.! 3 9V&F 415, / !#.80 3 9V&F 415, / ".#5 3 9V&F 415,5
/ 5." 3 9V&F 415,! / 55 3 9V&F 415,$
= Rs.1.$0 (illion
8
.
4a . &nitial outlay 4)i(e 0
i. ?ost of new (achine Rs. ,000,000

ii. 2alva'e value of old (achine "00,000
iii &ncre(ental worin' capital reuire(ent 500,000
iv. )otal net invest(ent 4=i  ii / iii #,!00,000
>. peratin' cash flow 4years 1 throu'h 5
Year 3 4 5 6 7
i. 9ostta3 savin's in
(anufacturin' costs 55,000 55,000 55,000 55,000 55,000
ii. &ncre(ental
depreciation 550,000 1#,500 0",$5 ##,01 1$,0#
iii. )a3 shield on

incre(ental dep. 1!5,000 1#,$50 "#,81 !",!0" 5#,#0$
iv. peratin' cash
flow 4 i / iii !#0,000 5$8,$50 5$,81 5#,!0" 50$,#0$
?. )er(inal cash flow 4year 5
i. 2alva'e value of new (achine Rs. 1,500,000

ii. 2alva'e value of old (achine #00,000
iii.
iv. Recovery of incre(ental
)er(inal cash flow 4 i  iiworin'
/ iii capital 500,000
1,800,000
B. Jet cash flows associated with the replace(ent proHect 4in Rs
Year 2 3 4 5 6 7
J?F 4#,!00,000 !#0000 5$8$50 5$81 5#!0" #0$#0$
4+ J9V of the

= replace(ent
#!00000 proHect
/ !#0000 3 9V&F 41,1
/ 5$8$50 3 9V&F 41,#
/ 5$81 3 9V&F 41,
/ 5#!0" 3 9V&F 41,
/ #0$#0$ 3 9V&F 41,5
= Rs.#!$8"
"
. )a3 shield 4savin's on depreciation 4in Rs

Depreciation ,a# shield P+ o) ta# shield
Year charge DC! :216 # DC ; 37. p1a1
1 #5000 10000 8!"!
# 18$50 $500 5!$1
 10! 5!#5 !""
 105$ #1" #1#
5 $"10 1! 15$


##051

9resent value of the ta3 savin's on account of depreciation = Rs.##051
5. . &nitial outlay 4at ti(e 0

i. ?ost of new (achine Rs. 00,000
ii. 2alva'e value of the old (achine "0,000
iii. Jet invest(ent 10,000
>. peratin' cash flow 4years 1 throu'h 5
Year 3 4 5 6 7
i. Bepreciation
of old (achine 18000 100 115#0 "#1! $$
ii. Bepreciation
of new (achine 100000 $5000 5!#50 #188 1!1
iii. &ncre(ental
depreciation
4 ii  i 8#000 !0!00 $0 #"$# ##!8
iv. )a3 savin's on

incre(ental
depreciation
4 0.5 3 4iii #8$00 #1#10 15!5! 1150 8"
v. peratin' cash
0
flow #8$00 #1#10 15!5! 1150 8"
?. )er(inal cash flow 4year 5
i. 2alva'e value of new (achine Rs. #5000

ii. 2alva'e value of old (achine 10000
iii. &ncre(ental salva'e value of new
(achine = )er(inal cash flow 15000
B. Jet cash flows associated with the replace(ent proposal.
Year 2 3 4 5 6 7
J?F 410000 #8$00 #1#10 15!5! 1150 #"
MINICASE
Solution:
a. ?ash flows fro( the point of all investors 4which is also called the e3plicit cost funds point of
view
Rs1in million
Item 0 1 #   5
1. Fi3ed assets 415

#. Jet worin'
. capital
Revenues 48 0 0 0 0 0
. ?osts 4other than
depreciation and
interest #0 #0 #0 #0 #0
5. 6oss of rental 1 1 1 1 1
!. Bepreciation .$50 #.81 #.10" 1.58# 1.18$
$. 9rofit +efore ta3 5.#50 !.18$ !.8"1 $.18 $.81
8.
". )a3
9rofit after ta3 1.5$5
.!$5 1.85!
.1 #.0!$
.8# #.##5
5.1" #.
5.!"
10. 2alva'e value of
fi3ed assets 5.000
11. Jet recovery of
worin' capital 8.000

1#. &nitial outlay 4#
1. peratin' cash
1
inflow $.#5 $.1 !." !.$$5 !.!5!
1. )er(inal cash
flow 1.000
15. Jet cash flow 4# $.#5 $.1 !." !.$$5 1".!5!
+. ?ash flows for( the point of euity investors
Rs1in million
Item 0 1 #   5
1. uity funds 410

#. Revenues 0 0 0 0 0
. ?osts 4other than
depreciation and
interest #0 #0 #0 #0 #0
. 6oss of rental 1 1 1 1 1
5. Bepreciation .$5 #.81 #.10" 1.58# 1.18$
!. &nterest on worin'
capital advance 0.$0 0.$0 0.$0 0.$0 0.$0
$. &nterest on ter(
loans 1.#0 1.1#5 0.8#5 0.5#5 0.##5
8. 9rofit +efore ta3 .5 .!# 5.!! !.1" !.888
". )a3 1.005 1.0" 1.!10 1.858 #.0!!
10. 9rofit after ta3 #.5 .05 .$5! .5 .8##
11. Jet salva'e value
1#. of
Jetfi3ed assets
salva'e value 5.000
of current assets 10.000
1. Repay(ent of ter(
ter( loans #.000 #.000 #.000 #.000
1. Repay(ent of +an
advance 5.000
15. Retire(ent of trade
1!. &nitial
creditors
invest(ent 410 #.000
1$. peratin' cash
inflow !.0"5 5.8!! 5.8!5 5."1$ !.00"
18. 6iuidation and
retire(ent cash
flows 4#.0 4#.0 4#.0 !.00
1". Jet cash flow 410 !.0"5 .8!! .8!5 ."1$ 1#.00"
#
Chapter $1
#IS! ANALYSIS IN CA&ITAL BUETIN
1.
4a J9V of the proHect = #50 / 50 3 9V&F 41,10
= Rs.#1.1 (illion
4+ J9Vs under alternative scenarios:

Rs1 in million!
Pessimistic E#pected "ptimistic
&nvest(ent 00 #50 #00

2ales 150 #00 #$5
Varia+le costs "$.5 1#0 15
Fi3ed costs 0 #0 15
Bepreciation 0 #5 #0
9reta3 profit  $.5 5 8!
)a3 U #8.5$%  #.1 10 #.5$
9rofit after ta3  5.! #5 !1.
Jet cash flow #.! 50 81.
?ost of capital 1% 1% 1#%
J9V  1$1.$ #1.1 #!0.10

ssu(ptions: 41 )he useful life is assu(ed to +e 10 years under all three
scenarios. &t is also assu(ed that the salva'e value of the
invest(ent after ten years is Yero.
4# )he invest(ent is assu(ed to +e depreciated at 10% per annu(N and it

is also assu(ed that this (ethod and rate of depreciation are
accepta+le to the &) 4inco(e ta3 authorities.

4 )he ta3 rate has +een calculated fro( the 'iven ta+le i.e. 10 - 5 3 100
= #8.5$%.
4 &t is assu(ed that only loss on this proHect can +e offset a'ainst the
ta3a+le profit on other proHects of the co(panyN and thus the co(pany
can clai( a ta3 shield on the loss in the sa(e year.

4c Accounting brea< e$en point under =e#pected> scenario!
Fi3ed costs / depreciation = Rs. 5 (illion
?ontri+ution (ar'in ratio = !0 - #00 = 0.
>rea even level of sales = 5 - 0. = Rs.150 (illion
'inancial brea< e$en point under =#pected> scenario!
i. nnual net cash flow = 0.$1 @ 0. 3 sales  5 A / #5

= 0.#1 sales  $.1
ii. 9V 4net cash flows = @0.#1 sales  $.1 A 3 9V&F 41,10

= 1.1!#8 sales  8.$
iii. &nitial invest(ent = #00
iv. Financial +rea even level

of sales = #8.$ - 1.1!#8 = Rs.#05.1 (illion
#.
4a 2ensitivity of J9V with respect to uantity (anufactured and sold:
in Rs!
&nitial invest(ent 0000 0000 0000

2ale revenue #000 #000 5000
Varia+le costs 1!000 #8000 !000
Fi3ed costs 000 000 000
Bepreciation
9rofit +efore ta3 #000
000 #000
"000 #000
1000
)a3 1500 500 !500
9rofit after ta3 1500 500 !500
Jet cash flow 500 !500 8500
J9V at a cost of
capital of 10% p.a
and useful life of
5 years 1!$#  5!0 ####
4+ 2ensitivity of J9V with respect to variations in unit price.

2ale revenue #8000 #000 $0000

Varia+le costs #8000 #8000 #8000
Fi3ed costs 000 000 000
Bepreciation #000 #000 #000
9rofit +efore ta3 5000 "000 $000
)a3 #500 500 18500
9rofit after ta3 #500 500 18500
Jet cash flow  500 !500 #0500
J9V  18"5 4 5!0 $$11
4c 2ensitivity of J9V with respect to variations in unit varia+le cost.

2ale revenue #000 #000 #000
Varia+le costs 5!000 #8000 #1000
Fi3ed costs 000 000 000
Bepreciation #000 #000 #000
9rofit +efore ta3 11000 "000 1!000
)a3 5500 500 8000
9rofit after ta3 5500 500 8000
Jet cash flow 500 !500 10000
J9V #!8  5!0 $"08
d! Accounting brea<-e$en point
i. Fi3ed costs / depreciation = Rs.5000
ii.
iii. ?ontri+ution (ar'in
>reaeven level ratio
of sales =
= 10 - 0- 0.
5000 = 0.
= Rs.15000
'inancial brea<-e$en point
i. nnual cash flow = 0.5 3 40. 2ales  5000 = #000

ii. 9V of annual cash flow = 4i 3 9V&F 410,5
= 0.!18 sales  18"!
iii. &nitial invest(ent = 0000
iv. >reaeven level of sales = 18"! - 0.!18 = Rs.508
. Befine At as the rando( varia+le denotin' net cash flow in year t .
A1 =  3 0. / 5 3 0.5 / ! 3 0.1

= .$
A# = 5 3 0. / ! 3 0. / $ 3 0.#
5
= 5.8
A =  3 0. /  3 0.5 / 5 3 0.#

= ."
J9V = .$ - 1.1 /5.8 - 41.1 # / ." - 41.1  10

= Rs.#.00 (illion
σ1# = 0.1
σ## = 0.5!
σ# = 0."
σ1# σ## σ#

σ J9V =
#
/ /
41.1# 41.1 41.1!
= 1.00
σ
4J9V = Rs.1.00 (illion
. 3pected J9V
 At
=  #5,000
t =1 41.08t
= 1#,000-41.08 / 10,000 - 41.08# / ",000 - 41.08 


/ 8,000 - 41.08  #5,000

= @ 1#,000 3 ."#! / 10,000 3 .85$ / ",000 3 .$" / 8,000 3 .$5A
 #5,000
= $,$08
2tandard deviation of J9V

 σt
∑
t =1 41.08t
= 5,000 - 41.08 / !,000 - 41.08# / 5,000 - 41,08 / !,000 - 41.08 

= 5,000 3 ."#! / !,000 3 .85$ / 5000 3 .$" / !,000 3 .$5
= 18,15#
5. 3pected J9V
!
 At
=  10,000 T. 41
t =1 41.0!t
A1 = #,000 3 0.# / ,000 3 0.5 / ,000 3 0.
= ,100
A# = ,000 3 0. / ,000 3 0. / 5,000 3 0.

= ,"00
A = ,000 3 0. / 5,000 3 0.5 / !,000 3 0.#

= ,"00
A = #,000 3 0.# / ,000 3 0. / ,000 3 0.

= ,#00
2u+stitutin' these values in 41 we 'et
3pected J9V = J9V
= ,100 - 41.0!/ ,"00 - 1.0!# / ,"00 - 41.0! / ,#00 - 41,0!

- 10,000 = Rs.,0
)he variance of J9V is 'iven +y the e3pression

 σ#t
σ 4J9V = ∑
#
TT.. 4#
t =1 41.0!#t
σ1# = @4#,000  ,100# 3 0.# / 4,000  ,100 # 3 0.5

/ 4,000  ,100# 3 0.A
= "0,000
σ## = @4,000  ,"00# 3 0. / 4,000  ,"00 # 3 0.

/ 45,000  "00# 3 0.A
= !"0,000
σ# = @4,000  ,"00# 3 0. / 45,000  ,"00 # 3 0.5

/ 4!,000  ,"00# 3 0.#A
= "0,000
σ# = @4#,000  ,#00# 3 0.# / 4,000  ,#00 # 3 0.

/ 4,000  #00# 3 0.A
= 5!0,000
$
2u+stitutin' these values in 4# we 'et
"0,000 - 41.0!# / !"0,000 - 41.0! 
/ "0,000 - 41.0!! / 5!0,000 - 41.08 8
@ "0,000 3 0.8"0 / !"0,000 3 0.$"#
/ "0,000 3 0.$05 / 5!0,000 3 0.!#$ A
= 1,!$",150
σ J9V = 1,!$",150 = Rs.1,#"!
J9V  J9V 0  J9V

9ro+ 4J9V Z 0 = 9ro+. Z
σ J9V σ J9V
0  0
= 9ro+ [ Z
1#"!
= 9ro+ 4[ Z #.5
)he reuired pro+a+ility is 'iven +y the shaded area in the followin' nor(al curve.
P 4[ Z  #.5 = 0.5  P 4#.5 Z ? Z 0

= 0.5  P 40 Z ? Z #.5
= 0.5  0."0!
= 0.00"
2o the pro+a+ility of J9V +ein' ne'ative is 0.00"
9ro+ 4 P 1  1.# 9ro+ 49V - I  1.#

9ro+ 4J9V - I  0.#
9ro+. 4J9V  0.# 3 10,000
9ro+ 4J9V  #,000
9ro+ 4J9V #,000= 9ro+ 4 ?  #,000 ,0 - 1,#"!

9ro+ 4 ?   0.81
)he reuired pro+a+ility is 'iven +y the shaded area of the followin' nor(al
curve:
P 4 ?   0.81 = 0.5 / P 40.81 Z ? Z 0
= 0.5 / P 40 Z ? Z 0.81
= 0.5 / 0.#"10
= 0.$"10
2o the pro+a+ility of P 1  1.# as 0.$"10
8
!. Miven values of varia+les other than , P and + , the net present value (odel of >idhan
?orporation can +e e3pressed as:
@4 P  +   ,000  #,000A 40.5/ #,000 0

5
J9V ∑ /  0,000
t =1 41.1t 41.15

0.5  4 P  +   500
5
∑ =   0,000
t =1 41.1t
= @ 0.5 4 P  +   500A 3 9V&F 410,5  0,000

= @0.5 4 P  +   500A 3 .$"1  0,000
= 1.8"55 4 P  +   1,8"5.5
3hi+it 1 presents the correspondence +etween the values of e3o'enous varia+les and the two
di'it rando( nu(+er. 3hi+it # shows the results of the si(ulation.
3hi+it 1
Corre2pon3en+e 4et5een 6alue2 o eo9enou2 6aria4le2 an3
t5o 3i9it ran3o nu4er2
@A*,I,Y PRICE +ARIABLE C"S,

,0o digit ,0o digit ,0o digit
Cumulati random Cumulati random Cum random
+alu Pro $e Prob1 numbers +alu Pro $e Prob1 numbers +alue Pro u- numbers
e b e b b lati$e
Prob1
800 0.1 0.10 00 to 0" #0 0. 0.0 00 to " 15 0. 0.0 00 to #"
0 0 0
1,00 0.1 0.#0 10 to 1" 0 0. 0.80 0 to $" #0 0.5 0.80 0 to $"
0 0 0 0
1,#0 0.# 0.0 #0 to " 0 0.1 0."0 80 to 8" 0 0.# 1.00 80 to ""
0 0 0 0
1,0 0. 0.$0 0 to !" 50 0.1 1.00 "0 to ""
0 0 0
1,!0 0.# 0."0 $0 to 8"
0 0
1,80 0.1 1.00 "0 to ""
0 0
"
3hi+it #
Siulation #e2ult2
@A*,I,Y ! PRICE P! +ARIABLE C"S, +! *P+

Ru Rando Corres- Random Corres- Rando Corres- 1.8"55 P-+!
n m ponding *umber ponding m pondin 1,8"5.5
*umb +alue $alue *umbe g $alue
er r
1 0 800 8 #0 1$ 15 #,1
# # 1,#00 !" 0 # 15 #,##
 !1 1,00 0 #0 0 15 18,!#$
 8 1,00 !0 0 8 0 58,
5 # 1,#00 1" #0 11 15 #0,5#
! 1 1,#00 88 0 0 #0 1,5"$
$ ## 1,#00 $8 0 1 #0 ",150
8 ! 1,00 11 #0 5# #0 1,8"!
" 5$ 1,00 #0 #0 15 15 18,!#$
Ru Rando Corres- Random Corres- Rando Corres- 1.8"55 P-+ 
n m ponding *umber ponding m pondin 1,8"5.5
*umb +alue $alue *umbe g $alue
er r
10 "# 1,800 $$ 0 8 #0 #,##
11 #5 1,#00 !5 0 ! #0 ",150
1# ! 1,00 0 #0 8 0 8,"$0
1 1 1,000 51 0 $# #0 1#,"1
1 05 800 " #0 81 0 !#,##
15 0$ 800 "0 50 0 #0 1,5"$
1!  1,#00 ! 0 !$ #0 ",150
1$ $" 1,!00 "1 50 "" 0 1,5!8
18 55 1,00 5 0 ! #0 5,5"
1" 5$ 1,00 1# #0 1" 15 18,!#$
#0 5 1,00 $8 0 ## 15 $,"10
#1 ! 1,#00 $" 0 "! 0 5,!#
## # 1,#00 ## #0 $5 #0 1,8"!
# " 1,00 " 50 88 0 5,5"
# #1 1,#00 8 0 5 #0 1,5"$
#5 08 .800 $0 0 #$ 15 ",150
#! 85 1,!00 ! 0 !" #0 1,5!8
#$ !1 1,00 !8 0 1! 15 $,"10
#8 #5 1,#00 81 0 " #0 1,5"$
#" 51 1,00 $! 0 8 #0 5,5"
0 # 1,#00 $ 0 ! #0 ",150
50
1 5# 1,00 !1 0 58 #0 5,5"
# $! 1,!00 18 #0 1 #0 1,8"!
  1,00 0 #0 " #0 1,8"!
 $0 1,!00 11 #0 5" #0 1,8"!
5 !$ 1,00 5 #0 #! 15 18,!#$
! #! 1,#00 ! 0 ## 15 #,##

Ru Random Corre Random Corres- Rando Corres- 1.8"55 P-+ 
n *umber s- *umber ponding m pondin 1,8"5.5
pondi $alue *umbe g $alue
ng r
+alue
$ 8" 1,!00 8! 0 5" #0 #8,$!1
8 " 1,800 00 #0 #5 15 1,8!
" 0" .800 15 #0 #" 15 #,1
0  1,00 8 0 #1 15 ,$
1 "8 1,800 # #0 $" #0 1,8"!
# 10 1,000 5 0 $$ #0 1#,"1
 8 1,#00  0 1 #0 ",150
 8 1,!00 0 #0 10 15 1!,$#
5 5 1,00 $1 0 5# #0 5,5"
! 1! 1,000 $0 0 1" 15 ,!
$ #0 1,#00 !5 0 8$ 0 5,!#
8 !1 1,00 !1 0 $0 #0 5,5"
" 8# 1,!00 8 0 "$ 0 !#,##
50 "0 1,800 50 0  #0 #,##
3pected J9V = J9V

50
= 1- 50 ∑ J9Vi
i=1
= 1-50 4$,#0,"!1
= 1,1"
50
Variance of J9V = 1-50 ∑ ( J9Vi  J9V#
i=1
= 1-50 @#$,$.0$ 3 10!A

= 5".81 3 10!
51
2tandard deviation of J9V = 5".81 3 10!

= #,1
$. )o carry out a sensitivity analysis, we have to define the ran'e and the (ost liely values of
the varia+les in the J9V ;odel. )hese values are defined +elow
+ariable Range &ost li<ely $alue
I Rs.0,000  Rs.0,000 Rs.0,000

< 10%  10% 10%
' Rs.,000  Rs.,000 Rs.,000
D Rs.#,000  Rs.#,000 Rs.#,000
, 0.5  0.5 0.5
* 55 5
S 00 0
 ?an assu(e any one of the values  1,00
800, 1,000, 1,#00, 1,00, 1,!00 and 1,800
P ?an assu(e any of the values #0, 0, 0
0 and 50
+ ?an assu(e any one of the values #0
15,#0 and 0

 )he (ost liely values in the case of , P and + are the values that have the
hi'hest pro+a+ility associated with the(
 &n the case of price, #0 and 0 have the sa(e pro+a+ility of occurrence viY 0.. Ie
have chosenis0
distri+ution as theto(ost
closer 0 liely value +ecause the e3pected value of the
Sensiti$ity Analysis 0ith Re)erence to 
)he relationship +etween  and J9V 'iven the (ost liely values of other
varia+les is 'iven +y
5 @ 40#0  ,000  #,000A 3 0.5 / #,000 0

J9V = ∑ /  0,000

t = 1 41.1t 41.15
5 5  500
= ∑  0,000

t = 1 41.1t
)he net present values for various values of  are 'iven in the followin' ta+le:
5#
 800 1,000 1,#00 1,00 1,!00 1,800

*P+ 1!,$# 1#,"1 ",150 5,5" 1,5!8 #,##
Sensiti$ity analysis 0ith re)erence to P
)he relationship +etween P and *P+ , 'iven the (ost liely values of other varia+les is defined as
follows:
5 @1,00 4 P #0  ,000  #,000A 3 0.5 / #,000 0

*P+ = ∑ /  0,0
t:1 41.1t
41.15
5 $00 P  1,500
= ∑  0,000

t = 1 41.1t
)he net present values for various values of P are 'iven +elow :
P 4Rs #0 0  0 50
*P+ 4Rs 1,8"! 5,5" #1,1$" $,$1!
8. *P+  5 0 5 10 15 #0
4Rs.in lahs
PI 0." 1.00 1.10 1.#0 1.0 1.0
9ro+. 0.0# 0.0 0.10 0.0 0.0 0.15
!
3pected PI = PI = ∑ 4 PI  / P /
/=1
= 1.#
!
2tandard deviation of P 1 = ∑ 4 PI /  PI  # P /
/=1
= √ .0115!
= .10$5
)he standard deviation of P 1 is .10$5 for the 'iven invest(ent with an e3pected PI of 1.#.
)he (a3i(u( standard deviation of PI accepta+le to the co(pany for an invest(ent with an
e3pected PI of 1.#5 is 0.0.
5
2ince the ris associated with the invest(ent is (uch less than the (a3i(u( ris accepta+le
to the co(pany for the 'iven level of e3pected PI , the co(pany (ust should accept the
invest(ent.
". )he J9Vs of the two proHects calculated at their ris adHusted discount rates are as follows:
! ,000
9roHect A: J9V = ∑  10,000 = Rs.#,
t =1 41.1#t
5 11,000
9roHect B: J9V = ∑  0,000 = Rs.$,$!
t =1 41.1t
PI and IRR for the two proHects are as follows:
Pro/ect A B
PI 1.# 1.#!

IRR #0% #.%
B is superior to A in ter(s of *P+ , PI , and IRR. *ence the co(pany (ust choose B.
10. )he certainty euivalent coefficients for the five years are as follows
Year Certainty eui$alent coe))icient
αt = 1  0.0! t
1 α1 = 0."
# α# = 0.88
 α = 0.8#
4 α = 0.$!
5 α5 = 0.$0
)he present value of the proHect calculated at the risfree rate of return is :
5 41  0.0! t  At
∑
t =1 41.08t
$,000 3 0." 8,000 3 0.88 ",000 3 0.8# 10,000 3 0.$! 8,000 3 0.$0
/ / / /
41.08 41.08# 41.08 41.08 41.085
5
!,580 $,00 $,80 $,!00 5,!00
/ / / /
41.08 41.08# 41.08 41.08 41.085
= #$,8!
Jet present value of the 9roHect = 4#$,8!  0,000

= Rs. #,!1

MINICASE
Solution:
1. )he e3pected J9V of the tur+oprop aircraft
0.!5 45500 / 0.5 4500

J9V =  11000 /
41.1#

/ 0.!5 @0.8 41$500 / 0.# 4000A / 0.5 @0. 41$500 / 0.! 4000A
41.1##
= #!"
#. &f 2outhern irways +uys the piston en'ine aircraft and the de(and in year 1 turns out to +e
hi'h, aen'ine
piston furtheraircraft,
decision has to as
proceed +efollows:
(ade with respect to capacity e3pansion. )o evaluate the
First, calculate the J9V of the two options viY., e3pandE and do not e3pandE at decision
point B#:
0.8 415000 / 0.# 41!00

3pand : J9V =  00 /
1.1#
= !!00
0.8 4!500 / 0.# 4#00

Bo not e3pand : J9V =
1.1#
= 50$1
55
7/27/2019 prasanna
2econd, truncate the do not e3pandE chandra
option as itfinancial management
is inferior to the e3pandE option. )his
(eans that the J9V at decision point B# will +e !!00
)hird, calculate the J9V of the piston en'ine aircraft option.
0.!5 4#500/!!00 / 0.5 4800

J9V =  5500 /
1.1#
0.5 @0.# 4!500 / 0.8 4#00A

/
41.1##
=  5500 / 551 / 8"8 = "#"
. )he value of the option to e#pand in the case of piston en'ine aircraft
&f 2outhern
J9V irways
of the piston doesaircraft
en'ine not have the option
would +e: of e3pandin' capacity at the end of year 1, the
0.!5 4#500 / 0.5 4800

J9V =  5500 /
1.1#
0.!5 @0.8 4!500 / 0.# 4#00A / 0.5 @0.# 4!500 / 0.8 4#00A
/ 41.1##
=  5500 / 1$01 / 8# = 
)hus the option to e#pand has a value of "#"   = 88!
. Value of the option to abandon if the tur+oprop aircraft can +e sold for 8000 at the end of year
1
&f the de(and in year 1 turns out to +e low, the payoffs for the continuationE and
a+andon(entE options as of year 1 are as follows.
0. 41$500 / 0.! 4000

?ontinuation: = $85$
1.1#
5!
7/27/2019 +andon(ent : 8000 prasanna chandra financial management
)hus it (aes sense to sell off the aircraft after year 1, if the de(and in year 1 turns out to +e
low.
)he J9V of the tur+oprop aircraft with a+andon(ent possi+ility is
0.!5 @5500 /\0.8 41$500 / 0.# 4000]- 41.1#A / 0.5 4500 /8000
J9V =  11,000 /
41.1#
1#08 / #"$5
=  11,000 / = #1
1.1#
2ince the tur+oprop aircraft without the a+andon(ent option has a value of #!", the
value of the a+andon(ent option is : #1  #!" = 
5. )he value of the option to abandon if the piston en'ine aircraft can +e sold for 00 at the
end of year 1:
&f the de(and in year 1 turns out to +e low, the payoffs for the continuationE and
a+andon(entE options as of year 1 are as follows:
0.# 4!500 / 0.8 4#00

?ontinuation : = #8$5
1.1#
+andon(ent : 00
)hus, it (aes sense to sell off the aircraft after year 1, if the de(and in year 1 turns out to
+e low.
)he J9V of the piston en'ine aircraft with a+andon(ent possi+ility is:
0.!5 @#500 / !!00A / 0.5 @800 / 00A

J9V =  5500 /
1.1#
5"15 / 18#0
=  5500 / = 10!
1.1#
For the piston en'ine aircraft the possi+ility of a+andon(ent increases the J9V
5$
7/27/2019 prasanna
fro( "#" to 10!. *ence the value of the chandra financial
a+andon(ent management
option is $$.
58
7/27/2019 prasanna chandra
Chapter $; financial management
T'E COST OF CA&ITAL
14a Befine r D as the preta3 cost of de+t. 7sin' the appro3i(ate yield for(ula, r D can +e
calculated as follows:
1 / 4100  108-10
r D =  3 100 = 1#.!0%
0. 3 100 / 0.!3108
4+ fter ta3 cost = 1#.!0 3 41  0.5 = 8.1"%
#. Befine r p as the cost of preference capital. 7sin' the appro3i(ate yield for(ula r p can +e
calculated as follows:
" / 4100  "#-!

r p = 
0. 3100 / 0.!3"#
= 0.1085 4or 10.85%

. I?? = 0. 3 1% 3 41  0.5
/ 0.! 3 18%
= 1.18%
. ?ost of euity = 10% / 1.# 3 $% = 18.%

4usin' 2;6 euation
9reta3 cost of de+t = 1%
fterta3 cost of de+t = 1% 3 41  0.5 = ".1%
Be+t euity ratio = #:
I?? = #-5 3 ".1% / -5 3 18.%
= 1.!8%
5. Miven
0.5 3 1% 3 41  0.5 / 0.5 3 r E = 1#%
where r E is the cost of euity capital.
)herefore r E  1."%
5"
7sin' the 2;6 euation we 'et
11% / 8% 3 β = 1."%
where O denotes the +eta of YeeYEs euity.
2olvin' this euation we 'et O = 0.8$5.
!4a )he cost of de+t of 1#% represents the historical interest rate at the ti(e the de+t was
ori'inally issued. >ut we need to calculate the (ar'inal cost of de+t 4cost of raisin' new
de+tN and for this purpose we need to calculate the yield to (aturity of the de+t as on the
+alance sheet date. )he yield to (aturity will not +e eual to1#% unless the +oo value of
de+t is eual to the (aret value of de+t on the +alance sheet date.
4+ )he cost of euity has +een taen as D1- P 0 4 = !-100 whereas the cost of euity is 4 D1- P 0
/ g where g represents the e3pected constant 'rowth rate in dividend per share.
$. )he +oo value and (aret values of the different sources of finance are
provided in the
wei'hts are followin'
provided ta+le.
within )he +oo
parenthesis in value wei'hts and the (aret value
the ta+le.
Rs1 in million!
Source Boo< $alue &ar<et $alue
uity 800 40.5 #00 40.$8
Be+entures  first series 00 40.#0 #$0 40.0"
Be+entures  second series #00 40.1 #0 40.0!
>an loan #00 40.1 #00 40.0$
)otal 1500 41.00 0$ 41.00
8. Reuired return
based on S&L E#pected
Pro/ect Beta euation .! return .!
9 0.! 1.8 1
W 0." 1$.# 1
R 1.5 ##.0 1!
2 1.5 ##.0 #0
Miven a hurdle rate of 18% 4the fir(Es cost of capital, proHects 9, W and R would have +een
reHected +ecause the e3pected returns on these proHects are +elow 18%. 9roHect 2 would +e
accepted +ecause the e3pected return on this proHect e3ceeds 18%.n appropriate +asis for
!0
7/27/2019 prasanna
acceptin' or reHectin' the proHects wouldchandra financial
+e to co(pare themanagement
e3pected rate of return and the
reuired rate of return for each proHect. >ased on this co(parison, we find that all the four
proHects need to +e reHected.
".
4a Miven
r D 3 41  0. 3 -" / #0% 3 5-" = 15%
r D = 1#.5%,where r D represents the preta3 cost of de+t.
4+ Miven
1% 3 41  0. 3 -" / r E 3 5-" = 15%
r E = 1".$#%, where r E represents the cost of euity.
10. ?ost of euity = D1- P 0 / g

= .00 - 0.00 / 0.05
= 15%
4a )he first chun of financin' will co(prise of Rs.5 (illion of retained earnin's costin' 15
percent and Rs.#5 (illion of de+t costin' 1 41. = ".8 per cent
)he second chun of financin' will co(prise of Rs.5 (illion of additional euity costin'
15 per cent and Rs.#.5 (illion of de+t costin' 15 41. = 10.5 per cent
4+ )he (ar'inal cost of capital in the first chun will +e :

5-$.5 3 15% / #.5-$.5 3 ".8% = 1.#$%

)he (ar'inal cost of capital in the second chun will +e:
5-$.5 3 15% / #.5-$.5 3 10.5% = 1.50%
Jote : Ie have assu(ed that

4i )he net realisation per share will +e Rs.#5, after floatation costs, and
4ii )he planned invest(ent of Rs.15 (illion is inclusive of floatation costs
11. )he cost of euity and retained earnin's

r E = D1- P  / g
= 1.50 - #0.00 / 0.0$ = 1.5%
)he cost of preference capital, usin' the appro3i(ate for(ula, is :
11 / 4100$5-10
r E = = 15."%
0.! 3 $5 / 0. 3 100
!1
7/27/2019 )he preta3 cost of de+entures, usin' the appro3i(ate
prasanna for(ula,
chandra is : management
financial
1.5 / 410080-!
D
r = = 1".1%
0.!380 / 0.3100
)he postta3 cost of de+entures is

1".1 41ta3 rate = 1".1 41  0.5
= ".!%
)he postta3 cost of ter( loans is

1# 41ta3 rate = 1# 41  0.5
= !.0%
)he avera'e cost of capital usin' +oo value proportions is calculated +elow :
Source o) capital Component Boo< $alue Boo< $alue Product o)

Cost Rs1 in million proportion 41 X 4
41 4# 4
uity capital
9reference capital 1.5%
15."% 100
10 0.#8
0.0 .0!
0.8
Retained earnin's 1.5% 1#0 0. .$"
Be+entures ".!% 50 0.1 1.
)er( loans !.0% 80 0.## 1.#
!0 vera'e cost11.""%
capital
)he avera'e cost of capital usin' (aret value proportions is calculated +elow :
Source o) capital Component &ar<et $alue &ar<et $alue Product o)

cost Rs1 in million
41 4# 4 41 X 4
uity capital
and retained earnin's 1.5% #00 0.!# 8.""
9reference capital 15."% $.5 0.0# 0.#
Be+entures ".!% 0 0.1# 1.15
)er( loans !.0% 80 0.# 1.
#$.5 vera'e cost 11."0%

capital
1#
!#
7/27/2019 4a I?? = 1- 3 1%prasanna
3 41  0.
chandra financial management
/ #- 3 #0%
= 1!.$%
4+ Iei'hted avera'e floatation cost

= 1- 3 % / #- 3 1#%
= "%
4c J9V of the proposal after tain' into account the floatation costs
= 10 3 9V&F 41!.$, 8  500 - 41  0.0"
= Rs.8.51 (illion
MINICASE
Solution:
a. ll sources other than noninterest +earin' lia+ilities
+. 9reta3 cost of de+t X postta3 cost of de+t

10 / 4100  11# - 8 8.5
r d = = = $."
0.! 3 11# / 0. 3 100 10$.#
r d 41  0. = 5.55
c. 9ostta3 cost of preference

" / 4100  10! - 5 $.8
= = $.5%
0.! 3 10! / 0. 3 100 10.!
d. ?ost of euity usin' the BB;
#.80 41.10
/ 0.10 = 0.85 / 0.10
80
= 0.185 = 1.85%
e. ?ost of euity usin' the ?9;
$ / 1.14$ = 1.$0%
f. I??
0.50 3 1.$0 / 0.10 3 $.5 / 0.0 3 5.55
!
7/27/2019 = $.5 / 0.$5 / #.## prasanna chandra financial management
= 10.#%
'. ?ost of capital for the new +usiness

0.5 @$ / 1.5 4$A / 0.5 @ 11 41  0.A
8.$5 / .85
= 1#.!0%
!
Chapter $<
CA&ITAL BUETIN : E=TENSIONS
1. ?
49lastic (ulsion = 00000 - 9V&F 41#,$
= 00000 - .5!
= Rs.!5$#
?
4Biste(per 9aintin' = 180000 - 9V&F 41#,
= 180000 - #.0#
= Rs.$"8
2ince ? of plastic e(ulsion is less than that of diste(per paintin', it is the preferred
alternative.
#. 9V of the net costs associated with the internal transportation syste(
= 1
/ 500
00 000
000 / 00 000
3 9V&F 3 9V&F
41, 41,1
/ 50 000 3/ 9V&F
!0 000 3 9V&F 41,#
41,
/ 500 000 3 9V&F 41,5  00 000 3 9V&F 41,5
= #$0"185
? of the internal transportation syste(
= #$0"185 - 9V&F 41,5

= #$0"185 - .51$
= Rs.$$0 11
. ? @ 2tandard overhaulA
= 500 000 - 9V&F 41,!

= 500 000 - .88"
= Rs.1#85!8 TTT 4
? @6ess costly overhaulA
= #00 000 - 9V&F 41,#

= #00 000 - 1.!$
= Rs.1#1 TTT 4>
2ince 4> Z 4, the less costly overhaul is preferred alternative.
!5
.
4a >ase case J9V
= 1#,000,000 / ,000,000 3 9V&F 4#0,!

= 1#,000,000 / ""$,8000
= 4 Rs.#,0##,000
4+ &ssue costs = !,000,000 - 0.88  !,000,000
= Rs.818 18#
dHusted J9V after adHustin' for issue costs
=  #,0##,000  818,18#
=  Rs.#,80,18#
4c )he present value of interest ta3 shield is calculated +elow :
Year Debt outstanding at

the beginning Interest ,a# shield Present $alue
ta# shield o)
1 !,000,000 1,080,000 #,000 #$,5"0
# !,000,000 1,080,000 #,000 ##,!"$
 5,#50,000 "5,000 #8,000 1$#,58
 ,500,000 810,000 #,000 1#5,"
5 ,$50,000 !$5,000 #0#,000 88,51
! ,000,000 50,000 1!#,000 !0,005
$ #,##5,000 00,500 1#0,000 $,$15
8 1,500,000 #$0,000 81,000 #1,5!
" $50,000 15,000 0,500 ",1
9resent value of ta3 shield = Rs.1,0##,0$!
5.
4a >ase case >9V
=  8,000,000 / #,000,000 3 9V&F 418,!

=  Rs.1,00,000
4+ dHusted J9V after adHust(ent for issue cost of e3ternal euity
= >ase case J9V  &ssue cost

=  1,00,000  @ ,000,000 - 0."  ,000,000A
=  Rs.1,$,
!!
4c )he present value of interest ta3 shield is calculated +elow :
Year Debt outstanding at Interest ,a# shield Present $alue o)

the beginning ta# shield
1 5,000,000 $50,000 00,000 #!0,880
# 5,000,000 $50,000 00,000 ##!,80
 ,000,000 !00,000 #0,000 15$,800
 ,000,000 50,000 180,000 10#,"#
5 #,000,000 00,000 1#0,000 5",!!
! 1,000,000 150,000 !0,000 #5,"8
9resent value of ta3 shield = Rs.8,0!
!$
Chapter $8
#AISIN LON TE#M FINANCE
1 @nder0riting Shares E#cess% Credit *et

commitment procured short)all short)all
A $0,000 50,000 4#0,000 "1" 415081
B 50,000 0,000 4#0,000 51 41!8!
C 0,000 0,000 410,000 #811 4$18"

D #5,000 1#,000 41,000 1$5$ 411#
E 15,000 #8,000 1,000
#.
@nder0riting Shares E#cess% Credit *et
commitment procured Short)all short)all
A 50,000 #0,000 40,000 1#8! 415$1
B #0,000 10,000 410,000 5$1 4#8!
C 0,000 50,000 #0,000  
. P o = Rs.##0 S = Rs.150 * = 

a. )he theoretical value per share of the cu(ri'hts stoc would si(ply +e
Rs.##0
+. )he theoretical value per share of the e3ri'hts stoc is :
!8
*P oS  3 ##0 /150
= = Rs.#0!
* /1 /1
c. )he theoretical value of each ri'ht is :

P o  S ##0  150
= = Rs.1
* /1 /1
)he theoretical value of  ri'hts which are reuired to +uy 1 share is Rs.131=Rs.5!.
. P o = Rs.180 * = 5
a. )he theoretical value of a ri'ht if the su+scription price is Rs.150
P o  S 180  150
= = Rs.5
*3 5/1

+. )he e3ri'hts value

*P o  S per5share
3 180if/the
1!0su+scription price is Rs.1!0
= = Rs.1$!.$
* /1 5/1
c. )he theoretical value per share, e3ri'hts, if the su+scription price is

Rs.180G 100G
5 3 180 / 180
= Rs.180
5/1
5 3 180 / 100
= Rs.1!!.$
5/1
!"
Chapter $"
CA&ITAL ST#UCTU#E AN FI#M VALUE
1. Jet operatin' inco(e "! : Rs.0 (illion

&nterest on de+t 4 I! : Rs.10 (illion
uity
?ost ofearnin's
P!
euity 44r E ! :: Rs.#0
15% (illion
?ost of de+t 4r D : 10%

;aret value of euity 4 E  : Rs.#0 (illion-0.15 =Rs.1 (illion
;aret value of de+t 4 D! : Rs.10 (illion-0.10 =Rs.100 (illion
;aret value of the fir( +  : Rs.# (illion
#. Bo# Co#

;aret value of euity #,000,000-0.15 #,000,000-0.15
= Rs.1. (illion = Rs.1. (illion
;aret value of de+t 0 1,000,000-0.10
=Rs.10 (illion
;aret value of the fir( Rs.1.(illion =#. (illion
4a vera'e cost of capital for >o3 ?orporation

1.. 0
3 15% / 3 10% = 15%
1. 1.
vera'e cost of capital for ?o3 ?orporation

1. 10.00
3 15% / 3 10% = 1#.8!%
#. #.
4+ &f >o3 ?orporation e(ploys Rs.0 (illion of de+t to finance a proHect that yields
Rs. (illion net operatin' inco(e, its financials will +e as follows.
Jet operatin' inco(e Rs.!,000,000

&nterest on de+t Rs.,000,000
uity earnin's Rs.,000,000
?ost of euity 15%
$0
?ost of de+t 10%
7/27/2019 ;aret value of euity prasanna chandra financial management
Rs.#0 (illion
;aret value of de+t Rs.0 (illion
;aret value of the fir( Rs.50 (illion
vera'e cost of capital

#0 0
15% 3 / 10% = 1#%
50 50
4c Rs.10
&f ?o3(illion
?orporation
of de+tsells Rs.10
, it will (illionanofalleuity
+eco(e additionalco(pany.
euity to 2o
retire
its
avera'e cost of capital will si(ply +e eual to its cost of euity,
which is 15%.
. r E = r A / 4r A-r D !D%E

#0 = 1# / 41#8 D%E
2o D%E = #
. E D E D
r E r D r A = r E / r
D
DE DE 4% 4% D/ E D/ E
1.00 0.00 11.0 !.0 11.00

0."0 0.10 11.0 !.5 10.55
0.80 0.#0 11.5 $.0 10.!0
0.$0 0.0 1#.5 $.5 11.00
0.!0 0.0 1.0 8.5 11.#0
0.50 0.50 1.0 ".5 11.$5
0.0 0.!0 15.0 11.0 1#.!0
0.0 0.$0 1!.0 1#.0 1.#0
0.#0 0.80 18.0 1.0 1.00
0.10 0."0 #0.0 1.0 1.#0
)he opti(al de+t ratio is 0.10 as it (ini(ises the wei'hted avera'e

cost of capital.
5. 4a &f you own Rs.10,000 worth of >harat ?o(pany, the levered co(pany
which is valued (ore, you would sell shares of >harat ?o(pany, resort
to personal levera'e, and +uy the shares of ?harat ?o(pany.
4+ )he ar+itra'e will cease when ?harat ?o(pany and >harat ?o(pany
are valued alie
$1
!. )he value of shwini 6i(ited accordin' to ;odi'liani and ;iller
7/27/2019 hypothesis is prasanna chandra financial management
3pected operatin' inco(e 15
= = Rs.1#5 (illion
Biscount rate applica+le to the 0.1#
ris class to which swini +elon's
$. )he avera'e cost of capital4without considerin' a'ency and +anruptcy cost
at various levera'e ratios is 'iven +elow.
D E E D
r D r E r A = r E / r D
D / E D/ E % % D/ E

.! D/ E
0 1.00 .0 1#.0 1#.0

0.10 0."0 .0 1#.0 11.#
0.#0 0.80 .0 1#.5 10.8
0.0 0.$0 .0 1.5 10.!
0.0 0.!0 .0 1.5 ".8!
0.50
0.!0 0.50
0.0 .0
.0 1.0
1.5 ".0
8.!8
0.$0 0.0 .0 15.0 8.1
0.80 0.#0 .0 15.5 $."0
0."0 0.10 .0 1!.0 7>7. Optial
+. )he avera'e cost of capital considerin' a'ency and +anruptcy costs is
'iven +elow
.
D E E D
r D r E r A = r E / r D
D / E D/ E % % D/ E D/ E
.!
0 1.00 .0 1#.0 1#.0

0.10 0."0 .0 1#.0 11.#
0.#0 0.80 .0 1.0 11.#
0.0 0.$0 .# 1.0 11.0!
0.0 0.!0 . 15.0 10.$!
0.50 0.50 .! 1!.0 10.0
0.!0 0.0 .8 1$.0 ".!8
0.$0 0.0 5.# 18.0 ".0
0.80 0.#0 !.0 1".0 8.!0
0."0 0.10 !.8 #0.0 8>$. Optial
8. )he ta3 advanta'e of one rupee of de+t is :
$#
141t c 41t pe 410.55 410.05
7/27/2019 = 1  prasanna chandra financial management
41t pd  410.#5
= 0. rupee
Chapter .%
CA&ITAL ST#UCTU#E ECISION
1.4a ?urrently
Jo. of shares = 1,500,000
EBI,
&nterest == Rs
0 $.# (illion
9reference dividend = Rs.1# 3 50,000 = Rs.0.! (illion
EPS = Rs.#
EBI,  &nterest 41-t!  9reference dividend

EPS :
Jo. of shares
4$,#00,000  0  41 t!  !00,000

Rs.# =
1,500,000
*ence t = 0.5 or 50 per cent
)he EPS under the two financin' plans is :

Finan+in9 &lan A : &ssue of 1,000,000 shares
4 EBI,  0  4 1  0.5  !00,000

EPS A =
#,500,000
Finan+in9 &lan B : &ssue of Rs.10 (illion de+entures carryin' 15 per cent
interest
4 EBI,  1,500,000 410.5  !00,000

EPS B =
1,500,000
)he EPS  EBI, indifference point can +e o+tained +y euatin' EPS A and EPS B

4 EBI,  0  41  0.5  !00,000 4 EBI,  1,500,000 41  0.5  !00,000
$
=
7/27/2019 #,500,000 prasanna chandra financial management
1,500,000
2olvin' the a+ove we 'et EBI, = Rs.,"50,000 and at that EBI, EPS is Rs.0.$5

under +oth the plans
4+ s lon' as EBI, is less than Rs.,"50,000 euity financin' (a3i(i3es EPS1

Ihen EBI, e3ceeds Rs.,"50,000 de+t financin' (a3i(ises EPS .
#.
4a EPS  EBI, euation for alternative A
EPS A = EBI, 4 1  0.5

#,000,000
4+ EPS  EBI, euation for alternative B
EBI, 4 1  0.5   0,000
EPS B =
1,!00,000
4c EPS  EBI,

4>&)
euation for alternative
 1,#00,000 C
41 0.5
EPS C =
1,#00,000
4d )he three alternative plans of financin' raned in ter(s of EPS over varyin'
6evels of EBI, are 'iven the followin' ta+le
Ran<ing o) Alternati$es
EBI, EPS A EPS B EPS C

Rs1! Rs1! Rs1! Rs1!
#,000,000 0.504& 0.54&& 0.4&&&

#,1!0,000 0.54& 0.04&& 0.04&&
,000,000 0.$54& 0.!!4&& 0.$54&
,000,000 1.004&& 0."84&&& 1.1$4&
,00,000 1.104&& 1.104&& 1.4&
;ore than ,00,000 4&&& 4&& 4&
. 9lan  : &ssue 0.8 (illion euity shares at Rs. 1#.5 per share.
9lan > : &ssue Rs.10 (illion of de+t carryin' interest rate of 15 per cent.
4 EBI,  0  41  0.!
EPS A =
$
1,800,000
7/27/2019 prasanna
4>&)  1,500,000 41  0.!chandra financial management
EPS B =
1,000,000

uatin' EPS A and EPS B , we 'et
4 EBI,  0  41  0.! 4 EBI,  1,500,000 41  0.!
=
1,800,000 1,000,000
2olvin' this we 'et EBI, = ,$5,000 or .$5 (illion

)hus the de+t alternative is +etter than the euity alternative when
EBI,  .$5 (illion
EBI,  EBI, .$5  $.000

9ro+4 EBI, ,$5,000 = 9ro+ 
σ EBI, .000
= 9ro+ @    1.#1A

= 0.88!"
. R"E : F R"I   R"I  r ! D%E G 41  t 

15 = @ 1 / 4 1  8  D- E A 4 1 0.5 
D- E = #.!$
5. R"E = @1# / 41#  "  0.! A 41  0.!

= 5.5# per cent
!. 18 = F R"I   R"I  8  0.$ A 4 1  0.5

R"I = #.$ per cent
>&)
$. a. &nterest covera'e ratio =
&nterest on de+t
150
=
0
= .$5
EBI, / Bepreciation
+. ?ash flow covera'e ratio =
6oan repay(ent instal(ent
$5
&nt.on de+t /
7/27/2019 prasanna chandra financial
41  )a3 management
rate
= 150 / 0
0 / 50
= #
8. )he de+t service covera'e ratio for 9ioneer uto(o+iles 6i(ited is 'iven +y :
5
∑ ( PA, i  Depi  Int i
i=1
DSCR = 5
∑ ( Int i  LRI !i
i=1
= 1.00 / ".1 /"5.80

"5.80 / $#.00
= #$$."
1!$.80
= 1.!!
". 4a &f the entire outlay of Rs. 00 (illion is raised +y way of de+t carryin' 15 per cent
interest, the interest +urden will +e Rs. 5 (illion.
?onsiderin' the interest +urden the net cash flows of the fir( durin'
a recessionary year will have an e3pected value of Rs. 5 (illion 4Rs.80 (illion  Rs. 5
(illion
 and athe
2ince standard
net cashdeviation
flow 4 ( ofisRs. 0 (illion
distri+uted .
nor(ally
(  5
0
has a standard nor(al deviation
?ash flow inadeuacy (eans that ( is less than 0.
0.5
9ro+4 ( Z0 = 9ro+ 4  Z  = 9ro+ 4  Z 0.8$5
0
= 0.1"0"
4+ 2ince µ = Rs.80 (illion, σ= Rs.0 (illion , and the ? value correspondin' to the ris
tolerance li(it of 5 per cent is  1.!5, the cash availa+le fro( the operations to service the
de+t is eual to ( which is defined as :
(  80
$!
=  1.!5
7/27/2019 0 prasanna chandra financial management
( = Rs.1.# (illion
Miven 15 per cent interest rate, the de+t than +e serviced is
1.#
= Rs. ".!$ (illion
0.15
Chapter .$
IVIEN &OLICY AN FI#M VALUE
1. Payout ratio Price per share

40.5/40.5 0.15
0.5
0.1#
= Rs. #8.1
0.1#
40.$ 5/40.#5 0.15

0.1#
0.$5 = Rs. #!.5!
0.1#
41.00
1.00 = Rs. #5.00
0.1#
#. Payout ratio Price per share
840.#5
0.#5 = undefined
0.1#  0.1!40.$5
840.50
0.50 = Rs.100
0.1#  0.1!40.50
841.00
1.0 =Rs.!!.$
0.1#  0.1! 40
$$
.
9 W
• Je3t yearEs price 80 $
• Bividend 0 !
• ?urrent price 9 W
• ?apital appreciation 4809 4$W
• 9ostta3 capital appreciation 0."4809 0." 4$W
• 9ostta3 dividend inco(e 0 0.8 3 !
• )otal return 0." 4809 0." 4$W / .8
9 W
= 1% =1%
• ?urrent price 4o+tained +y solvin' 9 = Rs.!".# W = Rs.!8.!5
the precedin' euation
$8
Chapter ..
IVIEN ECISION
1. a. 7nder a pure residual dividend policy, the dividend per share over the  year
period will +e as follows:
&S Un3er &ure #e2i3ual i6i3en3 &oli+?

 in Rs1!
Year 3 4 5 6
arnin's 10,000 1#,000 ",000 15,000

?apital e3penditure 8,000 $,000 10,000 8,000
uity invest(ent ,000 ,500 5,000 ,000
9ure residual
dividends !,000 8,500 ,000 11,000
Bividends per share 1.#0 1.$0 0.80 #.#0
+. )he e3ternal financin' reuired over the  year period 4under the assu(ption that the
co(pany plans to raise dividends +y 10 percents every two years is 'iven +elow :
#e@uire3 Le6el o Eternal Finan+in9
in Rs1!
Year 3 4 5 6
. Jet inco(e 10,000 1#,000 ",000 15,000
>. )ar'eted DPS 1.00 1.10 1.10 1.#1
?. )otal dividends 5,000 5,500 5,500 !,050
B. Retained earnin's4 A-C  5,000 !,500 ,500 8,"50
. ?apital e3penditure 8,000 $,000 10,000 8,000
$"
7/27/2019 F. 3ternal financin' prasanna chandra financial management
reuire(ent ,000 500 !,500 Jil
4 E-Dif E H D or 0 otherwise
c. Miven that the co(pany follows a constant !0 per cent payout ratio, the dividend per share
and e3ternal financin' reuire(ent over the  year period are 'iven +elow
i6i3en3 &er Share an3 Eternal Finan+in9 #e@uireent

in Rs1!
Year 3 4 5 6
. Jet inco(e 10,000 1#,000 ",000 15,00
>. Bividends !,000 $,#00 5,00 ",000
?. Retained earnin's ,000 ,800 ,!00 !,000
B. ?apital e3penditure 8,000 $,000 10,000 8,000
. 3ternal financin'
4 D-C if DHC , or 0 ,000 #,#00 !,00 #,000
otherwise
F. Bividends per share 1.#0 1. 1.08 1.80
#. Miven the constraints i(posed +y the (ana'e(ent, the dividend per share has to
+e +etween Rs.1.00 4the dividend for the previous year and Rs.1.!0 480 per
cent of earnin's per share
2ince share holders have a preference for dividend, the dividend should +e
raised over the previous dividend of Rs.1.00 . *owever, the fir( has su+stantial
invest(ent reuire(ents and it would +e reluctant to issue additional euity
+ecause of hi'h issue costs 4 in the for( of underpricin' and floatation costs
?onsiderin' the conflictin' reuire(ents, it see(s to (ae sense to pay
Rs.1.#0 per share +y way of dividend. 9ut differently the pay out ratio (ay +e
set at !0 per cent.
. ccordin' to the 6intner (odel

Dt = cr EPS t / 43c Dt 1
EPS t :.00, c= 0.$, r =0.!  and Dt-3
80
*ence
Dt = 0.$ 3 0.! 3 .00 / 410.$1.#0
= Rs.1.!#
. )he +onus ratio 4b (ust satisfy the followin' constraints :

4 R-S b !216S 41/b 41
0. 9>) ^0.1 S 41/b 4#
R = Rs.100 (illion, S = Rs.!0 (illion, 9>) = Rs.!0 (illion

*ence the constraints are
4100!0 b ^ 0.
0. 3 !0^0.1 3 !0
3 !0 b b
41/41/ 41a
4#a
)hese si(plify to
b ≥ $!-8
b ≥ #
)he condition b ^ $!-8 is (ore restructive than b≥ #

2o the (a3i(u( +onus ratio is $!-8 or 1"-#1
81
Chapter .1
e4t Anal?2i2 an3 Mana9eent

1. 4i &nitial utlay
4a ?ost of callin' the old +onds
Face value of the old +onds #50,000,000
?all pre(iu( 15,000,000
#!5,000,000
4+ Jet proceeds of the new +onds
Mross proceeds #50,000,000
&ssue costs 10,000,000
#0,000,000
4c )a3 savin's on ta3deducti+le e3penses
)a3 rate@?all pre(iu(/7na(ortised issue cost on
the old +ondsA ",#00,000
0. @ 15,000,000 / 8,000,000A
&nitial outlay i4a  i4+  i4c 15,800,000
4ii nnual Jet ?ash 2avin's

4a nnual net cash outflow on old +onds
&nterest e3pense #,500,000
- )a3 savin's on interest e3pense and a(ortisation of
issue e3penses 1$,00,000
0. @#,500,000 / 8,000,000-10A
#5,100,000
4+ nnual net cash outflow on new +onds
&nterest e3pense $,500,000
issue cost 15,500,000
0. @ $,500,000  10,000,000-8A
##,000,000
nnual net cash savin's : ii4a  ii4+ ,100,000
8#
4iii 9resent Value of the nnual ?ash 2avin's
9resent value of an 8year annuity of ,100,000 at a
discount rate of " per cent which is the post ta3 cost
of new +onds ,100,000 3 5.55 1$,158,500

4iv Jet 9resent Value of Refundin' the >onds
4a 9resent value of annual cash savin's 1$,158,500
4+ Jet initial outlay 15,800,000
4c Jet present value of refundin' the +onds :
iv4a  iv4+. 1,58,500
#. 4i &nitial utlay
4a ?ost
Faceof callin'
value theold
of the old+onds
+onds 1#0,000,000
?all pre(iu( ,800,000
1#,800,000
4+ Jet proceeds of the new issue
Mross proceeds 1#0,000,000
&ssue costs #,00,000
11$,!00,000
4c )a3 savin's on ta3deducti+le e3penses ,1#0,000
)a3 rate@?all pre(iu(/7na(ortised issue costs on
the old +ond issueA
0. @ ,800,000 / ,000,000A
&nitial outlay i4a  i4+  i4c ,080,000
4ii nnual Jet ?ash 2avin's

4a nnual net cash out flow on old +onds
&nterest e3pense 1",#00,000
issue costs $,"#0,000
0.@1",#00,000 / ,000,000-5A
11,#80,000
4+ nnual net cash outflow on new +onds

&nterest e3pense 18,000,000
- )a3 savin's on interest e3pense and a(ortistion of issue
costs $,"#,000
0.@18,000,000 / #,00,000-5A
10,!08,000
nnual net cash savin's : ii4a  ii4+ !$#,000

4iii 9resent Value of the nnual Jet ?ash 2avin's
8
9resent value of a 5 year annuity of !$#,000 at
as discount rate of " per cent, which is the postta3 #,!1,080 cost of
new +onds
4iv Jet 9resent Value of Refundin' the >onds

4a 9resent value of annual net cash savin's #,!1,080
4+ &nitial outlay ,080,000
4c Jet present value of refundin' the +onds :  1,!!,000
iv4a  iv4+
. Kield to (aturity of +ond P
"18.50 =8∑ 1!0 / 1000

t =1 41/r!t 41/r 8
r or yield to (aturity is 18 percent
Kield to (aturity of +ond 

5 1#0 1000
t ∑
$!1 = =1 41/r!t / 41/r 5
r or yield to (aturity is #0 per cent
uration o 4on3 P i2 +al+ulate3 4elo5
Year Cash )lo0 Present +alue Proportion o) Proportion o) bond>s
at 3J. bond>s $alue +alue # ,ime

1 1!0 15.5 0.18 0.18
# 1!0 11." 0.1#5 0.#50
 1!0 "$. 0.10! 0.18
 1!0 8#.! 0.0"0 0.!0
5 1!0 !"." 0.0$! 0.80
! 1!0 5".# 0.0! 0.8
$ 1!0 50.# 0.055 0.85
8 1!0 08.! 0.! #.!88
."1
uration o 4on3 Q i2 +al+ulate3 4elo5
Year Cash )lo0 Present +alue Proportion o) Proportion o) bond>s

at 42. bond>s $alue +alue # ,ime
8
1 1#0 100.0 0.11 0.11
7/27/2019 # 1#0 8.# prasanna chandra
0.10" financial management
0.#18

 1#0
1#0 !".5
5$.8 0.0"1
0.0$! 0.#$
0.0
5 11#0 50.# 0.5"# #."!0
.88!
+olatility o) bond P
."1 +olatility
.88! o) bond 
= .1! = .#
1.18 1.#0
. )he Y,& for +onds of various (aturities is
;aturity Y,&.!
1 1#.!

# 1.10
 1.#1
 1.8
5 1.$#
Mraphin' these Y,& s a'ainst the (aturities will 'ive the yield curve
)he one year treasury +ill rate , r 1, is
1,00,000
 1 = 1#.! %
8",000
)o 'et the forward rate for year #, r #, the followin' euation (ay +e set up :
1#500 11#500
""000 = /
41.1#! 41.1#!41/r #
85
2olvin' this for r # we 'et r # = 1."%
7/27/2019 )o 'et the forward rate for yearprasanna chandra euation

, r , the followin' financial (ay
management
+e set up :
1,000 1,000 11,000

"",500 = / /
41.1#! 41.1#!41.1" 41.1#!41.1"41/ r 
2olvin' this for r  we 'et r  = 1."%
)o 'et the forward rate for year , r  , the followin' euation (ay +e set up :
1,500 1,500 1,500

100,050 = / /
41.1#! 41.1#!41.1" 41.1#!41.1"41.1"
11,500
/
41.1#!41.1"41.1"41/ r 
2olvin' this for r  we 'et r  = 1.5%
)o 'et the forward rate for year 5, r 5 , the followin' euation (ay +e set up :
1,$50 1,$50 1,$50

100,100 = / /
41.1#! 41.1#!41.1" 41.1#!41.1"41.1"
1,$50
/
41.1#!41.1"41.1"41.15
11,$50
/
41.1#!41.1"41.1"41.1541/r 5
2olvin' this for r 5 we 'et r 5 = 15.08%
8!
Chapter .<
'YB#I FINANCIN
1. )he product of the standard deviation and suare root of ti(e is :
σ t = 0.5 # = 0."5
)he ratio of the stoc price to the present value of the e3ercise price is :
2toc price 0
= = 1.85!
9V 43ercise price #5-41.1!

)he ratio of the value of call option to stoc price correspondin' to nu(+ers
0."5 and 1.85! can +e found out fro( )a+le .! +y interpolation. Jote the
ta+le 'ives values for the followin' co(+inations
1.$5 #.00
0.5 .! 50.8
0.50 5. 51.

2ince we are interested in the co(+ination 0."5 and 1.85! we first interpolate
+etween 0.50 and 0.500 and then interpolate +etween 1.$5 and #.00
&nterpolation +etween 0.50 and 0.500 'ives
1.$5 #.00
0.50 .! 50.8
0."5 5.# 51.#5
0.500 5. 51.
8$
7/27/2019 prasanna
)hen, interpolation +etween 1.$5 and #.00chandra
'ives financial management
1.$5 1.85! #.00
0."5 5.# $.$8 51.#5
Chapter .;
LEASIN 'I#E &U#C'ASE AN &#O/ECT FINANCE

1. NPV o the &ur+ha2e Option
Rs1in =222!
Year 2 3 4 5 6 7
1.&nvest(ent4 I  41,500
#.Revenues4 Rt  1,$00 1,$00 1,$00 1,$00 1,$00
.?osts4other than
4Bepreciation4C t "00 "00 "00 "00 "00
.Bepreciation4 D !t 500 . ###.# 18.1 "8.8
5.9rofit +efore ta3
Rt -C t- D !
t 00 !!.$ 5$$.8 !51." $01.#
!.9rofit after ta3: 541-t  #10 #!.$ 0.5 5!. "0.8
$.Jet salva'e value 00
8.Jet cash flow
41/!//$ 41,500 $10 !10 !#!.$ !0. 88".!
".Biscount factor
at 11 percent 1.000 0."01 0.81# 0.$1 0.!5" 0.5"
10.9resent value 483" 41,500 !".$ "5. 58.1 "8. 5#$.5

NPV 49urchases=  1500/!".$/"5./58.1/"8./5#$.5 = 1018."

NPV o the Lea2in9 Option
Rs1 in =222!
Year 2 3 4 5 6 7
1.Revenues4 R ! t  1,$00 1,$00 1,$00 1,$00 1,$00
#.?osts4other than
lease rentals4C t "00 "00 "00 "00 "00
.6ease rentals4 Lt  #0 #0 #0 #0 #0 0
.9rofit +efore ta3
Rt -C t- L !
t #0 80 80 80 80 800
5.9rofit after ta3 4which
88
also reflects the net
cash flow41t! #" #!! #!! #!! #!! 5!0
7/27/2019 !.Biscount factor at prasanna chandra financial management
1 per cent
$.9resent value453! 1.000
#" 0.885
#5. 0.$8
#08. 0.!"
18. 0.!1
1!.1 0.5
0.1
*P+ 46easin' = #"/#5./#08./18./1!.1/0.1 = 801.#

#. 7nder the hire purchase proposal the total interest pay(ent is
#,000,000 3 0.1# 3  = Rs. $#0,000

)he interest pay(ent of Rs. $#0,000 is allocated over the  years period usin'
the su( of the years di'its (ethod as follows:
Year Interest allocation
!!
1 3 Rs.$#0,000 = Rs."5,!$!
!!!

###
# 3 Rs.$#0,000 = Rs.#0,000
!!!
$8
 3 Rs.$#0,000 = Rs.8,#
!!!
)he annual hire purchase instal(ents will +e :
Rs.#,000,000 / Rs.$#0,000
= Rs."0!,!!$

)he annual hire purchase instal(ents would +e split as follows
Year Kire purchase instalment Interest Principal repayment

1 Rs."0!,!!$ Rs."5,!$! Rs. 510,""1
# Rs."0!,!!$ Rs.#0,000 Rs. !!!,!!$
 Rs."0!,!!$ Rs. 8,# Rs. 8##,
8"
)he lease rental will +e as follows :
Rs. 5!0,000 per year for the first 5 years
7/27/2019 Rs. #0,000 per year for the ne3tprasanna
5 years chandra financial management
)he cash flows of the leasin' and hire purchse options are shown +elow
Year Leasing Kigh Purchase  I t  1-t c !-PRt 

- LRt  1-t c ! -I t 1-t c ! -PRt Dt t c ! *S+ t Dt t c !*S+ t
1 5!0,00041.=!,000 "5,!$!41. 510,""1 500,00040. 58,"$

# 5!0,00041.=!,000 #0,00041. !!!,!!$ $5,00040. !!0,!!$
 5!0,00041.=!,000  8,#41. 8##, #81,#5040. $!0,$
 5!0,00041.=!,000 #10,"840. 8,$5
5 5!0,00041.=!,000 158,#040. !,#81
!  #0,00041.=  1#,000 118,!5#40. $,!1
$  #0,00041.=  1#,000 88,"8"40. 5,5"!
8  #0,00041.=  1#,000 !!,$#40. #!,!"$
"  #0,00041.=  1#,000 50,05!40. #0,0#
10  #0,00041.=  1#,000 $,5#40. #00,000 #15,01$
9resent value of the leasin' option
5 !,000 10 1#,000
= ∑ − ∑ =  1,0#,#0$
t:1 41.10t t =! 41.10t
9resent value of the hire purchase option
58,"$ !!0,!!$ $!0,$ 8,$5

=   
41.10 41.10# 41.10 41.10

!,#81 $,!1 5,5"! #!,!"$

/ / /
41.105 41.10! 41.10$ 41.108
"0
#0,0# #15,01$
/
7/27/2019 41.10." 41.1010 prasanna chandra financial management
=  1,!",8
2ince the leasin' option costs less than the hire purchase option , pe3 should choose the
leasin' option.
Chapter .
0O#!IN CA&ITAL &OLICY
vera'e inventory
1 &nventory period =
nnual cost of 'oods sold-!5
4!0/!-#
= = !#." days
!0-!5
vera'e accounts receiva+le

ccounts receiva+le =
period nnual sales-!5
480/88-#
= = !1. days
500-!5
vera'e accounts paya+le

ccounts paya+le =
period nnual cost of 'oods sold-!5
40/!-#
= = . days
!0-!5
peratin' cycle = !#." / !1. = 1#.# days

?ash cycle = 1#.#  . = 80.$$ days
4110/1#0-#
#. &nventory period = = 5!.0 days
$50-!5
"1
410/150-#
ccounts receiva+le = = 5#." days
7/27/2019 period 1000-!5
prasanna chandra financial management
4!0/!!-#
ccounts paya+le = = 0.$ days
period $50-!5
peratin' cycle = 5!.0 / 5#." = 108." days

?ash cycle = 108."  0.$ = $8.# days
Rs.
. 1. 2ales ,!00,000
6ess : Mross profit 4#5 per cent "00,000
)otal (anufacturin' cost #,$00,000
6ess : ;aterials "00,000
Ia'es $#0,000 1,!#0,000
;anufacturin' e3penses 1,080,000
#. ?ash (anufacturin' e3penses "!0,000

480,000 3 1#
. Bepreciation : 41  4# 1#0,000
. )otal cash cost
)otal (anufacturin' cost #,$00,000
6ess: Bepreciation 1#0,000
?ash (anufacturin' cost #,580,000
dd: d(inistration and sales
pro(otion e3penses !0,000
#,"0,000

A  Current Assets Rs1
)otal cash cost #,"0,000

Be+tors 3 # = 3 #= "0,000
1# 1#
;aterial cost "00,000

Raw (aterial 3 1 = 3 1= $5,000
stoc 1# 1#
?ash (anufacturin' cost #,580,000

Finished 'oods 31= 3 1= #15,000
stoc 1# 1#
"#
?ash +alance  predeter(ined a(ount = 100,000
9repaid sales 2ales pro(otion e3penses 3 1.5 = 1#0,000 3 1.5 = 15,000

pro(otion 1# 1#
e3penses
?ash +alance  predeter(ined a(ount = 100,000
 : ?urrent ssets = ""5,000
B  Current Liabilites Rs1
;aterial cost "00,000

2undry creditors 3 #= 3 # = 150,000
1# 1#
;anufacturin' ne (onthEs cash

e3penses outstandin' (anufacturin' e3penses = 80,000
Ia'es outstandin' ne (onthEs wa'es = !0,000
> : ?urrent lia+ilities #"0,000
Iorin' capital 4 A  B $05,000

dd #0 % safety (ar'in 11,000
Iorin' capital reuired 8!,000
"
Chapter .7
CAS' AN LI(UIITY MANAEMENT
1. )he forecast of cash receipts, cash pay(ents, and cash position is prepared in the
state(ents 'iven +elow
'orecast o) Cash Receipts 4 Rs1 in 222>s!
*o$ember December Manuary 'ebruary &arch April &ay Mune
1. 2ales 1#0 1#0 150 150 150 #00 #00 #00

#. ?redit sales 8 8 105 105 105 10 10 10
. ?ash sales ! ! 5 5 5 !0 !0 !0
. ?ollection of receiva+les
4a 9revious (onth .! .! #.0 #.0 #.0 5!.0 5!.0
4+ )wo (onths earlier 50. 50. !.0 !.0 !.0 8.0
5. 2ale of (achine $0.0
!. &nterest on securities .0
$. )otal receipts 1#".0 1$. 150.0 #5.0 1$".0 #0.0
4//5/!
'orecast o) Cash Payments 4 Rs1 in 222>s!
December Manuary 'ebruary &arch April &ay Mune
1. 9urchases !0 !0 !0 !0 80 80 80
#. 9ay(ent of accounts !0 !0 !0 !0 80 80
paya+le
. ?ash purchases      
. Ia'e pay(ents #5 #5 #5 #5 #5 #5
5. ;anufacturin'
e3penses # # # # # #
!. Meneral, ad(inistrative
"
X sellin' e3penses 15 15 15 15 15 15
$. Bividends 0
7/27/2019
8. )a3es prasanna chandra financial management
5
". cuisition
(achinery of 80
)otal pay(ents4#to" 15 15 #15 15 155 ##0

Summary o) Cash 'orecast Rs1in 222>s!
Manuary 'ebruary &arch April &ay Mune
1. penin' +alance #8
#. Receipts 1#".0 1$. 150.0 #5.0 1$".0 #0.0
. 9ay(ents 15.0 15.0 #15.0 15.0 155.0 ##0.0
. Jet cash flow4# 4!.0 #. 4!5.0 100.0 #.0 41$.0
5. ?u(ulative net cash flow 4!.0 4.! 4!8.! 1. 55. 48.
!. penin' +alance /
?u(ulative net cash flow ##.0 #. 40.! 5". 8. !!.
$. ;ini(u( cash +alance
reuired 0.0 0.0 0.0 0.0 0.0 0.0
8. 2urplus-4Beficit 48.0 45.! 4$0.! #". 5.0 !.
#. )he proHected cash inflows and outflows for the uarter, <anuary throu'h ;arch, is shown +elow
.
&onth December Manuary 'ebruary &arch

Rs1! Rs1! Rs1! Rs1!
&nflows :
2ales collection 50,000 55,000 !0,000
utflows :
9urchases ##,000 #0,000 ##,000 #5,000
9ay(ent to sundry creditors ##,000 #0,000 ##,000
Rent 5,000 5,000 5,000
Brawin's 5,000 5,000 5,000
2alaries X other e3penses 15,000 18,000 #0,000
9urchase of furniture  #5,000 
"5
)otal outflows4#to! $,000 $,000 5#,000
Miven an
surplus-deficit in openin' cash
relation to the+alance of Rs.5000
tar'et cash +alanceand a tar'etout
is wored cash +alance
+elow : of Rs.8000, the
Manuary 'ebruary &arch

Rs1! Rs1! Rs1!
1. penin' +alance 5,000

#. &nflows 50,000 55,000 !0,000
. utflows $,000 $,000 5#,000
. Jet cash flow 4#   ,000 418,000 8,000
5. ?u(ulative net cash flow ,000 415,000 4$,000
!. penin' +alance / ?u(ulative
net cash flow 8,000 410,000 4#,000
$. ;ini(u( cash +alance reuired 8,000 8,000 8,000
8. 2urplus-4Beficit  418,000 410,000
. )he +alances in the +oos of Batta co and the +oos of the +an are shown +elow:
Rs1!
3 4 5 6 7 8 9 J N 32
Boo2 o atta
Co:
penin' 0,00 !,00 !#,00 $8,000 1,10,00 1,#!,0 1,#,0 1,58,0 1,$,0
>alance 0 0 0 ",000 0 00 00 00 00
Add ?heue #0,00 #0,00 #0,00 #0,000
received 0 0 0 #0,000 #0,000 #0,000 #0,000 #0,000 #0,000
Less ?heue ,000
issued ,000 ,000 ,000 ,000 ,000 ,000 ,000 ,000 ,000
?losin' !,00 !#,00 $8,00 ",000 1,10,0 1,#!,00 1,#,0 1,58,0 1,$,0 1,"0,0
>alance 0 0 0 00 0 00 00 00 00
Boo2 o the
Ban:
"!
penin' 0,00 0,00 0,00 0,000 0,000 0,000 50,000 $0,000 1,0!,0
>alance 0 0 0 "0,000 00
Add ?heues      #0,000 #0,000 #0,000
realised
Less ?heues         #0,000 #0,000

de+ited ,000 ,000
?losin' 0,00 0,00 0,00 0,000 0,000 50,000 $0,000 "0,000 1,0!,0 1,##,0
>alance 0 0 0 00 00
Fro( day " we find that the +alance as per the +anEs +oos is less than the +alance as per Batta
?o(panyEs +oos +y a constant su( of Rs.!8,000. *ence in the steady situation Batta ?o(pany has
a ne'ative net float of Rs.!8,000.
. pti(al conversion siYe is

#b,
C =
I
b = Rs.1#00, , = Rs.#,500,000, I = 5% 410% dividend +y two
2o,
# 3 1#00 3 #,500,000
C = = Rs.!,10
0.05
5.
  bσ#
RP = / LL
 I
@L =  RP  # LL
I = 0.1#-!0 = .000, b = Rs.1,500, σ = Rs.!,000, LL = Rs.100,000

  3 1500 3 !,000 3 !,000
RP = / 100,000
 3 .000
= ",!"5 / 100,000 = Rs.1",!"5
"$
@L =  RP  # LL =  3 1",!"5  # 3 100,000
= Rs.#",085
Chapter .8
C#EIT MANAEMENT
1. _ RI = @_S 41+  _SbnA41t  < _ I

_ S
_ I = 3 ACP 3 +
!0
_ S = Rs.10 (illion, + =0.85, bn =0.08, ACP = !0 days, < =0.15, t = 0.0
*ence, _ RI = @ 10,000,000410.85 10,000,000 3 0.08 A 410.
0.15 3 10,000,000 3 !0 3 0.85
!0
= Rs. #0$,500
#. _ RI = @_S 41+  _SbnA 41t   < O I
S o _S
_ I = 4 ACP *  ACP o /+ 4 ACP * 
!0 !0
"8
_S =Rs.1.5 (illion, + =0.80, bn=0.05, t =0.5, < =0.15, ACP * =!0, ACP o=5, S o=Rs.15 (illion
*ence _ RI = @1,500,000410.8  1,500,000 3 0.05A 41.5
0.15 4!05 15,000,000 / 0.8 3 !0 3 1,500,000

!0 !0
= 1#$50  1#$50 = Rs. 0
. _ RI = @_S 41+  _ DIS A 41t  / < _ I

_ DIS = pn4S o/_S d n  poS od o
S o _S
_ I = 4 ACP o ACP *   3 ACP * 3 +
!0 !0
S o =Rs.1# (illion, ACP o=#, + =0.80, t = 0.50, r =0.15, po=0., pn=0.$,

ACP * =1!, _S =Rs.1.# (illion, d o=.01, d n= .0#
*ence
_ RI = @ 1,#00,000410.80\0.$41#,000,000/1,#00,000.0#
0.41#,000,000.01]A410.5
1#,000,000 1,#00,000
/ 0.15 4#1!  3 1! 3 0.80
!0 !0

= Rs.$",#00
. _ RI = @_S 41+  _ BDA41t   <_

I
_ BD=bn4S o/_S   boS o
S o _S
_ I = 4 ACP * 
ACP o / 3 ACP * 3 +
!0 !0
S o=Rs.50 (illion, ACP o=#5, + =0.$5, < =0.15, bo=0.0, _S =Rs.! (illion,

ACP * =0 , bn= 0.0! , t = 0.
_ RI = @ Rs.!,000,00041.$5 \.0!4Rs.5!,000,000.04Rs.50,000,000A410.
""
Rs.50,000,000 Rs.!,000,000
 0.15 40#5 / 3 0 3 0.$5
!0 !0
=  Rs.#8"."5
5. 0% of sales will +e collected on the 10th day

$0% of sales will +e collected on the 50th day
ACP = 0. 3 10 / 0.$ 3 50 = 8 days
Rs.0,000,000
Value of receiva+les = 3 8
!0
= Rs.,###,###
ssu(in' that + is the proportion of varia+le costs to sales, the invest(ent in
receiva+les is :
Rs.,###,### 3 +
!. 0% of sales are collected on the 5th day and $0% of sales are collected on the
#5th day. 2o,
ACP = 0. 3 5 / 0.$ 3 #5 = 1" days
Rs.10,000,000
Value of receiva+les = 3 1"
!0
= Rs.5#$,$$8
&nvest(ent in receiva+les = 0.$ 3 5#$,$$8
= Rs."5,8
$. 2ince the chan'e in credit ter(s increases the invest(ent in receiva+les,

_ RI = @_S 41+  _ DIS A41t   < _ I
S o=Rs.50 (illion, _S =Rs.10 (illion, d o=0.0#, po=0.$0, d n=0.0, pn=0.!0,
ACP o=#0 days, ACP * =# days, + =0.85, < =0.1# , and t = 0.0
ODIS = 0.!0 3 !0 3 0.0  0.$0 3 50 3 0.#
= Rs.0.8 (illion
50 10
_ I = 4##0 / 3 # 3 0.85
!0 !0
= Rs.1.#### (illion
_ RI = @ 10,000,000 41.85  80,000 A 41.  0.1# 3 1,###,###
100
= Rs.5#5,
8. )he decision tree for 'rantin' credit is as follows :

?usto(er pays40."5
Mrant credit 9rofit 1500
?usto(er pays40.85
Mrant credit ?usto(er defaults40.05
9rofit 1500 Refuse credit
6oss 8500
?usto(er defaults40.15
6oss 8500
Refuse credit
)he e3pected profit fro( 'rantin' credit, i'norin' the ti(e value of (oney, is :
3pected profit on / 9ro+a+ility of pay(ent 3 3pected profit on

&nitial order and repeat order repeat order
\ 0.85415000.1548500] / 0.85 \0."541500.0548500]

= 0 / 850 = Rs.850
". 9rofit when the custo(er pays = Rs.10,000  Rs.8,000 = Rs.#000

6oss when the custo(er does not pay = Rs.8000
3pected profit = p1 3 #000 41 p18000
2ettin' e3pected profit eual to Yero and solvin' for p1 'ives :
p1 3 #000  41 p18000 = 0 p1 = 0.80
*ence the (ini(u( pro+a+ility that the custo(er (ust pay is 0.80
MINICASE
Solution:
9resent Bata
• 2ales : Rs.800 (illion
• ?redit period : 0 days to those dee(ed eli'i+le
• ?ash discount : 1-10, net 0
• 9roportion of credit sales and cash sales are 0.$ and 0.. 50 percent of the credit custo(ers
avail of cash discount
• ?ontri+ution (ar'in ratio : 0.#0
• )a3 rate : 0 percent
101
• 9ostta3 cost of capital : 1# percent
• ?9 on credit sales : #0 days
ffect of Rela3in' the ?redit 2tandards on Residual &nco(e
&ncre(ental sales : Rs.50 (illion
>ad de+t losses on incre(ental sales: 1# percent
?9 re(ains unchan'ed at #0 days
QR& = @Q241  V  Q2+nA 41  t  R Q &
where Q & = Q2 3 ?9 3 V

!0
Q R& = @50,000,000 410.8  50,000,000 3 0.1#A 41  0.
50,000,000
 0.1# 3 3 #0 3 0.8
!0
= #,800,000  #!!,!!$ = #,5,
ffect of 3tendin' the ?redit 9eriod on Residual &nco(e
Q R& = @Q241  V  Q2+nA 41  t  R Q &
2o Q2
where Q& = 4?9n  ?9o / V 4?9n
!0 !0
QR& = @50,000,000 41  0.8  50,000,000 3 0A 41  0.
800,000,000 50,000,000
 0.1# 450  #0 3 / 0.8 3 50 3
!0 !0
= $,000,000  8,!!!,!!$
=  Rs.1,!!!,!!$
ffect of Rela3in' the ?ash Biscount 9olicy on Residual &nco(e
QR& = @Q2 41  V  Q B&2A 41  t / R Q &
10#
where Q & = savin's in receiva+les invest(ent
2o Q2
= 4?9o  ?9n  V 3 ?9n
!0 !0
800,000,000 #0,000,000
= 4#0  1!  0.8 3 3 1!
!0 !0
= 8,888,88"  $11,111 = 8,1$$,$$8
Q B&2 = increase in discount cost

= pn 42o / Q2 d n  po 2o do
= 0.$ 4800,000,000 / #0,000,000 3 0.0#  0.5 3 800,000,000 3 0.01
= 11,80,000  ,000,000 = $,80,000
2o, QR& = @#0,000,000 41  0.8  $,80,000A 41  0. / 0.1# 3 8,1$$,$$8

=  #,!,000 / "81,
=  1,5,!!$
Chapter ."
INVENTO#Y MANAEMENT
1.
a. *o1 o) "rder "rdering Cost Carrying Cost ,otal Cost
"rders Per uantity @% # '! %4#P#C o) "rdering
Year ! 0here and Carrying
@%! P#C:Rs152!
@nits Rs1 Rs1 Rs1
1 #50 #00 ,$50 ,"50

# 1#5 00 1,8$5 #,#$5
5 50 1,000 $50 1,$50
10 #5 #,000 $5 #,$5

# @' #3#503#00
10
+. cono(ic rder Wuantity 4 E" = =
PC 0
PC 0
4@' = 58 units 4appro3
#. a E" : PC
@ =10,000 , ' =Rs.00, PC = Rs.#5 3 0.#5 =Rs.!.#5
# 3 10,000 3 00
E" = = "80
!.#5
10000
+. Ju(+er of orders that will +e placed is = 10.#0
"80
Jote that thou'h fractional orders cannot +e placed, the nu(+er of orders
relevant for the year will +e 10.# . &n practice 11 orders will +e placed durin' the year. *owever,
the 11th order will serve partly4to the e3tent of #0 percent the present year and partly4to the
e3tent of 80 per cent the followin' year. 2o only #0 per cent of the orderin' cost of the 11th
order relates to the present year. *ence the orderin' cost for the present year will +e 10.# 3
Rs.00
c. )otal cost of carryin' and orderin' inventories

"80
= @ 10.# 3 00 / 3 !.#5 A = Rs.!1##.5
#
. @ =!,000, ' =Rs.00 , PC =Rs.100 3 0.# =Rs.#0
# 3 !,000 3 00
E" : = "0 units
#0
@ @ >P-D!C  PC

Δπ = @D + - F- -
* > # #
!,000 !,000
= !000 3 .5 /  3 00
"0 1,000
1,000 4"50.# "0 3 100 3 0.#

- 
# #

10
= 0,000 / #"8  !00 = Rs.#$8"8
. @ =5000 , ' = Rs.00 , PC = Rs.0 3 0.# = Rs.!
# 3 5000 3 00
E" = = $0$ units
!
&f 1000 units are ordered the discount is : .05 3 Rs.0 = Rs.1.5 ?han'e in
profit when 1,000 units are ordered is :
5,000 5,000
Δπ = 5000 3 1.5 /  3 00
$0$ 1,000
1000 3 #8.5 3 0.# $0$ 3 0 3 0.#

  = $500 / !##$#" =Rs.$"
# #
&f #000 units are ordered the discount is : .10 3 Rs.0 = Rs. ?han'e in profit
when #,000 units are ordered is :
5000 5000 #0003#$30.# $0$3030.#

Δπ = 5000 3 .0 /  3 00 
$0$ #000 # #
= 15,000 /1$#  #$" = Rs.1,0"
5. )he uantities reuired for different co(+inations of daily usa'e rate4B7R

and lead ti(es46) alon' with their pro+a+ilities are 'iven in the followin'
ta+le
6)
4Bays
B7R 540.! 1040.# 1540.#
47nits
40. #040.18 040.0! !040.0!

!40.5 0 40.0 !040.10 "040.10
840.# 0 40.1# 8040.0 1#040.0
105

Jote that if the B7R is  units with a pro+a+ility of 0. and the 6) is 5 days with
a pro+a+ility of 0.!, the reuire(ent for the co(+ination B7R =  units and 6) =
7/27/2019 5 days is #0 units with a pro+a+ility of 0.30.!
prasanna = 0.18.financial
chandra Ie havemanagement
assu(ed that the
pro+a+ility distri+utions of B7R and 6) are independent. ll other entries in the
ta+le are derived si(ilarly.
)he nor(al 4e3pected consu(ption durin' the lead ti(e is :
#030.18 / 030.0 / 030.1# / 030.0! / !030.10 / 8030.0 / !030.0! / "030.10 /
1#030.0 = !. tonnes
a. ?osts associated with various levels of safety stoc are 'iven +elow :
Sa)ety Stoc< Stoc< out Probability E#pected Carrying ,otal Cost

Stoc< outsin Cost Stoc< out Cost
tonnes!
3 4 5 6 7 8 9
@3A @4131,000A @5/!A
)onnes Rs. Rs. Rs.

$.! 0 0 0 0 $,!00 $,!00
.! 0 1#0,000 0.0 ,800 ,!00 8,00
.! 10 0,000 0.10

0 1!0,000 0.0 10,00 ,!00 ,000
1.! #0 80,000 0.0

0 1#0,000 0.10 #,800 1,!00 8,00
!0 #0,000 0.0
10!
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0 1.! 5,00 0.1! 106/164
.! 1,00 0.0 ,#"! 0 ,#"!
.! 1$,00 0.10
7/27/2019 $.! #",00 prasanna chandra financial management

2afety stoc = ;a3i(u( consu(ption durin' lead ti(e  Jor(al
consu(ption durin' lead ti(e
2o the opti(al safety stoc= 1.! tonnes
Reorder level = Jor(al consu(ption durin' lead ti(e / safety stoc
`= !. / 1.! = !0 tonnes
+. 9ro+a+ility of stoc out at the opti(al level of safety stoc = 9ro+a+ility
4consu(ption +ein' 80 or "0 or 1#0 tonnes
9ro+a+ility 4consu(ption = 80 tonnes / 9ro+a+ility 4consu(ption = "0 tonnes /

9ro+a+ility 4consu(ption = 1#0 tonnes
= 0.0 /0.10/0.0 = 0.18
!. Reorder point is 'iven +y the for(ula : S 4 L / ' SR 4 L
= 0 3 0 / #.00 0 3 1,000 3 0 = ,"1 units
$.
Item Annual @sage Price per Annual Ran<ing
in @nits! @nit @sage +alue
Rs1 Rs1

1 00 #0.00 8,000 !
# 15 150.00 #,#50 10
 !,000 #.00 1#,000 5
 $50 18.00 1,500 
5 1,#00 #5.00 0,000 1
! #5 1!0.00 ,000 "
$ 00 #.00 !00 1
8 50 1.00 50 15
" 1,500 .00 !,000 $
10 1,00 #0.00 #!,000 #
11 "00 #.00 1,800 11
1# 1,!00 15.00 #,000 
1 !00 $.50 ,500 8
1 0 0.00 1,#00 1#
15 5 #0.00 "00 1
10$
1,5,#00
Cumulati$e +alue o) Items Q @sage
Item Ran< Annual Cumulati$e Cumulati$e Cumulati$e

*o1 @sage+alue Annual @sage . o) @sage . o) Items
Rs1! +alue Rs1! +alue
5 1 0,000 0,000 ##.# !.$

10 # #!,000 5!,000 1. 1.
1#  #,000 80,000 5".# #0.0
  1,500 ",500 !".# #!.$
 5 1#,000 105,500 $8.0 .
1 ! 8,000 11,500 8." 0.0
" $ !,000 11",500 88. !.$
1 8 ,500 1#,000 "1.$ 5.
! " ,000 1#8,000 ".$ !0.0
# 10 #,#50 10,#50 "!. !!.$
11 11 1,800 1#,050 "$.$ $.
108
1 1# 1,#00 1,#50 "8.! 80.0 108/164
15 1 "00 1,150 "".# 8!.$
$ 1 !00 1,$50 "".$ ".
7/27/2019 8 15 50 15,#00 100.0 100.0
Class *o1 o) Items . to the ,otal Annual @sage . to ,otal +alue

+alue Rs1
  #!.$ ",500 !".#

>  #0.0 #!,000 1".#
? 18 5. 15,$00 11.!

15 15,#00
Chapter 1%
0O#!IN CA&ITAL FINANCIN
1. nnual interest cost is 'iven +y ,

Biscount % !0
3
1 Biscount % ?redit period  Biscount period
)herefore, the annual per cent interest cost for the 'iven credit ter(s will +e as
follows:
a. 0.01 !0
3 = 0.18# = 18.#%
0."" #0
+. 0.0# !0
3 = 0.!$ = !.$%
0."8 #0
c. 0.0 !0
3 = 0.18 = 1.8%
10"
0."$ 5 109/164
d. 0.01 !0
3 = 0.! = !.%
0."" 10
#.
a.
0.01 !0
3 = 0.10 = 10.%
0."" 5
+. 0.0# !0

3 = 0.#1 = #1%
0."8 5
c. 0.0 !0
3 = 0.## = ##.%
0."$ 50
d. 0.01 !0
3 = 0.15 = 1.5%
0."" #5
. )he (a3i(u( per(issi+le +an finance under the three (ethods su''ested +y
)he )andon ?o((ittee are :
;ethod 1 : 0.$54CA-CL = 0.$54!1# = Rs.18 (illion

;ethod # : 0.$54CA-CL = 0.$54!1# = Rs.15 (illion
;ethod  : 0.$54CA-CCA-CL = 0.$54!181# = Rs.1.5 (illion
110
Chapter 1$
0O#!IN CA&ITAL MANAEMENT :E=TENSIONS
1.4a )he discri(inant function is :
? i : a( i  bY i

where ? i = discri(inant score for the ith account
( i = uic ratio for the ith account
Y i : EBDI, -2ales ratio for the ith account
)he esti(ates of a and b are :

4
σ y 1 d# - σ #y 1 dy
a =
σ # 41 σ y 4 - σ #y 1σ #y
σ # 41 dy − σ #y 1 d#
b =
σ # 4 . σ y 4 − σ #y . σ #y
111
)he +asic calculations for derivin' the esti(ates of a and b are 'iven
the acco(panyin' ta+le.
Brawin' on the infor(ation in the acco(panyin' ta+le we find that
∑ ( i : 1".81 ∑Y i: "1 ∑( i-(!4 ∑( Y i-Y!4 ∑( ( i-(!Y i-Y!
( = 0.$"# Y = 15.! = 0.811 =1!!1.$! = 10.00$
Account (i Y i ( i-(! Y i-Y! ( i-( !4 Y i-Y !4 ( i-(!Y i-Y!
*umber
1 0."0 15 0.10$! 0.! 0.011! 0.0"! 0.0!8"
# 0.$5 #0 0.0# .! 0.0018 1".00"! 0.18"
 1.05 10 0.#5$! 5.! 0.0!! 1.80"! 1.5#"
 0.85 1 0.05$! 1.! 0.00 #.!8"! 0.0"5
M 5 0.!5 1! 0.1# 0.! 0.0#0 0.1#"! 0.51
R ! 1.#0 #0 0.0$! .! 0.1!!1 1".00"! 1.$$$1
 $ 0."0 # 0.10$! 8.! 0.011! !".88"! 0.8""5
7 8 0.8 #! 0.0$! 10.! 0.00# 10$.#"! 0."1
9 " 0." 11 0.1$! .! 0.018" #1.5#"! 0.!85
10 0.$8 18 0.01# #.! 0.000# 5.5!"! 0.0#"
& 11 0."! 1# 0.1!$! .! 0.0#81 1.#"! 0.!101
1# 1.0# #5 0.##$! ".! 0.0518 8$.!0"! #.10
1 0.81 #! 0.01$! 10.! 0.000 10$.#"! 0.18#
1 0.$! 0 0.0# 1.! 0.0010 #0!.#0"! 0.!5
15 1.0# #8 0.##$! 1#.! 0.0518 15#.$!"! #.811
1! 0.$! 10 0.0# 5.! 0.0010 1.80!" 0.18#$

1$ 0.!8 1# 0.11# .! 0.01#! 1.#"! 0.0"1
M 18 0.5!  0.## 11.! 0.050 15.8"! #.$051
R 1" 0.!# 18 0.1$# #.! 0.0#"$ 5.5!"! 0.0!"
 #0 0."#  0.1#$! 1".! 0.01! 85.$#"! #.50!1
7 #1 0.58 #0 0.#1# .! 0.051 1".00"! 0."#!1
9 ## 0.$0 8 0.0"#  $.! 0.0085 58.!"! 0.$05"
# 0.5# 15 0.#$# 0.! 0.0$# 0.0"! 0.1$
&& # 0.5 ! 0.# ".! 0.11$# "#."#"! .00$
#5 0.!0 $ 0.1"# 8.! 0.0$0 $.!"! 1.!!#
1".81 "1 0.811 1!!1.$! ".5"
2u( of ( i for 'roup 1 1.#
11#
( 3 =
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15 15
2u( of ( i for 'roup # !."
7/27/2019 ( 4 = = prasanna
= chandra
0.!"0 financial management
10 10
2u( of Y i for 'roup 1 #"5

Y 3 : = = 1".!$
15 15
2u( of Y i for 'roup # "!

Y 4 = = = ".!0
10 10
1 0.811
σ # 4 = ∑( ( i (!4 = = 0.0!
n1 #51
1 1!!1.$!
σ y 4 = ∑( Y i  Y!4 = = !".#
n1 #51
1 10.000$
σ #y : ∑( ( i-(!Y i-Y! = = 0.1!$
n-1 #51
d# : ( 3 - ( 4 = 0.8"$  0.!"0 = 0.#55$
dy : Y 3  Y 4 = 1".!$  ".!0 = 10.0$
2u+stitutin' these values in the euations for a and b we 'et :
!".# 3 0.#55$  0.1!$ 3 10.0$

a = = !.0$"
0.0! 3 !".#  0.1!$ 3 0.1!$
0.0! 3 10.0$  0.1!$ 3 0.#55$

b = = 0.108"
0.0! 3 !".#  0.1!$ 3 0.1!$
*ence , the discri(inant function is :
11
? i = !.0$" ( i / 0.108" Y i

4+ ?hoice of the cutoff point
)he ? i score for various accounts are shown +elow
[i scores for various accounts
Account *o1 ?i Score

1 $.10!
# !.$$
 $.$#0
 !.!"18
5 5.!"8
! ".$#8
$ 8.08$
8 $."$8
" !.851
10 !.$018
11 $.1#!
1# 8."#1
1 $.$55
1 $.88$0
15 ".#"8
1! 5.$0"0
1$ 5.05
18 .8"8
1" 5.$#"#
#0 5.15$1
#1 5.$08
## 5.1#!5
# .$"!
# .8"0
#5 .0"$
)he ? i scores arran'ed in an ascendin' order are shown +elow
ood!
Account *umber ? i Score or
Bad B!
# .8"0 >
18 .8"8 >
#5 .0"$ >
11
#
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## 5.1#!5 >
#0 5.15$1 >
1$ 5.05 >
7/27/2019 5 prasanna chandra financial
5.!"8 M management
#1 5.$08 >
1! 5.$0"0 >
1" 5.$#"# >
 !.!"18 M
10 !.$018 M
# !.$$ M
" !.851 M
1 $.10! M
11 $.1#! M
 $.$#0 M
1 $.$55 M
1 $.88$0 M
8 $."$8 M
$ 8.08$ M
1# 8."#1 M
15 ".#"8 M
! ".$#8 M
Fro( the a+ove ta+le, it is evident that a ? i score which represents the (idpoint +etween the
? i scores of account nu(+ers 1" and  results in the (ini(u( nu(+er of (isclassifications . )his ? i
score is :
5.$#"# / !.!"18
= !.#105
#
Miven this cutoff ? i score, there is Hust one (isclassification 4ccount nu(+er 5

115
Chapter ;
ANALYSIN FINANCIAL &E#FO#MANCE
Jet profit
1. Return on euity =
uity
= Jet profit Jet sales )otal assets
3 3
Jet sales )otal assets uity
1
= 0.05 3 1.5 3 = 0.#5 or #5 per cent
0.
Be+t uity
Jote : = 0.$ 2o = 10.$ = 0.
)otal assets )otal assets
*ence )otal assets-uity = 1-0.
11!
#. 9>) = Rs.0 (illion

PBI,
)i(es interest covered !
&nterest
2o PBI, = ! 3 &nterest
PBI,  &nterest = PB, = Rs.0 (illion
! 3 &nterest = Rs.0 (illion
*ence &nterest = Rs.8 (illion
. 2ales = Rs.$,000,000
Jet profit (ar'in = ! per cent
Jet profit = Rs.$000000 3 0.0! = #0,000
)a3 rate = !0 per cent
#0,000
2o, 9rofit +efore ta3 = = Rs.1,050,000
41.!
&nterest char'e = Rs.150,000
2o 9rofit +efore interest and ta3es = Rs.1,#00,000

*ence
1,#00,000
)i(es interest covered ratio = = 8
150,000
. CA = 1500 CL = !00

6et BB stand for +an +orrowin'
CABB
= 1.5
CLBB
1500/ BB
= 1.5
!00/ BB
BB = 1#0
1,000,000
5. vera'e daily credit sales = = #$0
!5
1!0000
?9 = = 58.
11$
#$0
&f the accounts receiva+le has to +e reduced to 1#0,000 the ?9 (ust +e:
&f the accounts receiva+le has to +e reduced to 1#0,000 the ?9 (ust +e:
1#0,000
3 58. = .8days
1!0,000
?urrent assets
!. ?urrent ratio = = 1.5
?urrent lia+ilities
?urrent assets  &nventories

cidtest ratio = = 1.#
?urrent lia+ilities
?urrent lia+ilities = 800,000

2ales
&nventory turnover ratio = = 5
&nventories
?urrent assets  &nventories
cidtest ratio = = 1.#
?urrent lia+ilities
?urrent assets &nventories

)his (eans  = 1.#
?urrent lia+ilities ?urrent lia+ilities
&nventories
1.5  = 1.#
800,000
&nventories
= 0.
800,000
&nventories = #0,000
2ales
=5 2o 2ales = 1,#00,000
#,0,000
$. Be+t-euity = 0.!0
118
uity = 50,000 / !0,000 = 110,000

2o Be+t = 0.! 3 110,000 = !!,000
*ence )otal assets = 110,000/!!,000 = 1$!,000
)otal assets turnover ratio = 1.5
2o 2ales = 1.5 3 1$!,000 = #!,000
Mross profit (ar'in = #0 per cent
2o ?ost of 'oods sold = 0.8 3 #!,000 = #11,#00
BayEs sales outstandin' in accounts receiva+le = 0 days
2ales
2o ccounts receiva+le = 3 0
!0
#!,000
= 3 0 = #",
!0
?ost of 'oods sold #11,#00

&nventory turnover ratio = = = 5
&nventory &nventory
2o &nventory = #,#0
ssu(in' that the de+t of !!,000 represent current lia+ilities

?ash / ccounts receiva+le
cidtest ratio =
?urrent lia+ilities
?ash / #",
= = 1.#
!!,000
2o ?ash = "8!$
9lant and euip(ent = )otal assets  &nventories  ccounts receiva+le  ?ash

= 1$!,000  ##0  #"  "8!$
= 55!0
9ricin' to'ether everythin' we 'et

Balan+e Sheet
uity capital 50,000 9lant X euip(ent 5,5!0
Retained earnin's !0,000 &nventories #,#0
Be+t4?urrent lia+ilities !!,000 ccounts receiva+le #",
?ash ",8!$
11"

1$!,000 1$!,000

2ales #!,000
7/27/2019 ?ost of 'oods sold #11,#00 prasanna chandra financial management
?ash X +an +alances / Receiva+les / &nventories / 9repaid e3penses

8. 4i ?urrent ratio =
2hortter( +an +orrowin's / )rade creditors / 9rovisions
5,000,000/15,000,000/#0,000,000/#,500,000
=
15,000,000/10,000,000/5,000,000
#,500,000
= = 1.#
0,000,000
?urrent assets  &nventories ##,500,000

4ii cidtest ratio = = = 0.$5
?urrent lia+ilities 0,000,000
6on'ter( de+t / ?urrent lia+ilities

4iii Be+teuity ratio =
uity capital / Reserves X surplus
1#,500,000 / 0,000,000
= = 1.1
10,000,000 / ##,500,000
9rofit +efore interest and ta3

4iv )i(es interest covera'e ratio =
&nterest
15,100,000
= = .0#
5,000,000
?ost of 'oods sold $#,000,000

4v &nventory turnover period = = = .!
&nventory #0,000,000
!5
1#0
4vi vera'e collection period =

http://slidepdf.com/reader/full/prasanna-chandra-financial-management Jet sales-ccounts receiva+le 120/164
!5
= = 5$.! days
7/27/2019 "5,000,000-15,000,000
Jet sales "5,000,000

4vii )otal assets turnover ratio = = = 1.#$
)otal assets $5,000,000
9rofit after ta3 5,100,000

4i3 Jet profit (ar'in = = = 5.%
Jet sales "5,000,000
PBI, 15,100,000
43 arnin' power = = = #0.1%
)otal assets $5,000,000
uity earnin' 5,100,000

43i Return on euity = = = 15.$%
Jet worth #,500,000
)he co(parison of the (e3Es ratios with the standard is 'iven +elow
"me# Standard
?urrent ratio 1.# 1.5
cidtest ratio 0.$5 0.80
Be+teuity ratio 1.1 1.5
)i(es interest covered ratio .0# .5
&nventory turnover ratio .! .0
vera'e collection period 5$.! days !0 days
)otal assets turnover ratio 1.#$ 1.0
Jet profit (ar'in ratio 5.% !%
arnin' power #0.1% 18%
Return on euity 15.$% 15%
Jote that solutions to pro+le(s 10 X 11 are not 'iven
MINICASE
Solution:
1#1
4a èy ratios for #0 P 5

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?urrent ratio = = 0."
1.
8.8 / !.$
Be+teuity ratio = = 0."8
!.5 / ".
5$.
)otal assets turnover ratio = = 1."!
@4  !.! / 48  !.$A - #
.0
Jet profit (ar'in = = 5.# percent
5$.
5
arnin' power = = 1$.0 percent
@4  !.! / 48  !.$A - #
.0
Return on euity = = #0.# percent
41." / 15.8 - #
4+ Bupont ?hart for #0 3 5
Jet sales /-

Jonop. surplus
deficit 5$.8
Jet profit
.0 
Jet profit
(ar'in )otal costs
5.8
D
5.#%
Jet sales
5$.
Return on
total assets
10.#%
1##
http://slidepdf.com/reader/full/prasanna-chandra-financial-management Jet sales 122/164

5$.
7/27/2019 )otal asset prasanna chandra financial management
vera'e
turnover fi3ed assets
1."! D #1.

vera'e total
assets vera'e
#".5 net current
assets 5.0
/
vera'e
other assets
#.55
4c ?o((on siYe and co((on +ase financial state(ents
?o((on 2iYe Financial 2tate(ents

9rofit and 6oss ccount
Re'ular 4in (illion ?o((on 2iYe 4%
#0 P  #0 P 5 #0 P  #0 P 5
• Jet sales ".0 5$. 100 100
• ?ost of 'oods sold 0.5 5.8 $8 80
• Mross profit 8.5 11.! ## #0
• peratin' e3penses ." $.0 1 1#
• peratin' profit .! .! " 8
• Jonoperatin' surplus - 0.5 0. 1 1
deficit
• 9>&) .1 5.0 11 "
• &nterest 1.5 #.0  
• 9>) #.! .0 $ 5
1#
• )a3    
• 9rofit after ta3 #.! .0 $ 5 123/164
7/27/2019 prasanna chandra
>alance 2heet financial management
Re'ular 4in (illion ?o((on 2iYe 4%

#0 P  #0 P 5 #0 P  #0 P 5
• 2hareholdersE funds 1." 15.8 51 50
• 6oan funds 1.5 15.5 " 50
)otal #$. 1. 100 100
• Jet fi3ed assets 1".! #.# $# $
• Jet current assets 5.1 5.$ 1" 18
• ther assets #.$ #. 10 8
)otal #$. 1. 100 100
?o((on >ase Kear Financial 2tate(ents

9rofit and 6oss ccount
Re'ular 4in (illion ?o((on >ase Kear4%

#0 P  #0 P 5 #0 P  #0 P 5
• Jet sales ".0 5$. 100 1$
• ?ost of 'oods sold 0.5 5.8 100 150
• Mross profit 8.5 11.! 100 1!
• peratin' e3penses ." $.0 100 
•• peratin' profit

Jonoperatin' surplus -
.!
0.5
.!
0.
100
100
1#8
80
deficit
• 9>&) .1 5.0 100 1##
• &nterest 1.5 #.0 100 1
• 9>) #.! .0 100 115
• )a3   100 100
1#
• 9rofit after ta3 #.! .0 100 115

>alance 2heet
7/27/2019 prasanna
Re'ular chandra
4in (illion ?o((on
financial >ase Kear4%
management
#0 P  #0 P 5 #0 P  #0 P 5
• 2hareholdersE funds 1." 15.8 100 11
• 6oan funds 1.5 15.5 100 115
)otal #$. 1. 100 11
• Jet fi3ed assets 1".! #.# 100 118
• Jet current assets 5.1 5.$ 100 11#
• ther assets #.$ #. 100 8"
)otal #$. 1. 100 11
4d )he financial stren'ths of the co(pany are:
• sset productivity appears to +e 'ood.

• arnin' power and return on euity are uite satisfactory
• Revenues have 'rown i(pressively over #0 3   #0 3 5

)he financial weanesses of the co(pany are:
• ?urrent ratio is unusually low

• Ihile revenues 'rew i(pressively, costs rose even faster: s a result profit (ar'ins
declined
• )he co(pany did not have any ta3 lia+ility in the last two years. &f the co(pany has to
+ear the +urden of re'ular ta3es, its return on euity will +e adversely i(pacted
4e )he followin' are the pro+le(s in financial state(ent analysis
• )here is no underlyin' theory

• &t is difficult to find suita+le +ench(ars for con'lo(erate fir(s
• Fir(s (ay resort to window dressin'
• Financial state(ents do not reflect price level chan'es
• Biversity of accountin' policies (ay vitiate financial state(ent analysis
• &t is so(ewhat difficult to Hud'e whether a certain ratio is 'oodE or +adE
4f )he ualitative factors relevant for evaluatin' the perfor(ance and prospects of a
co(pany are as follows:
• re the co(panyEs revenues tied to one ey custo(erG
1#5
• )o what e3tent are the co(panyEs revenues tied to one ey productG
• )o what e3tent does the co(pany rely on a sin'le supplierG 125/164
• Ihat percenta'e of the co(panyEs +usiness is 'enerated overseasG
7/27/2019 •• *ow will co(petition i(pact the co(panyG
prasanna
Ihat are the future prospects chandra financial management
of the fir(G
• Ihat could +e the effect of the chan'es in the le'al and re'ulatory environ(entG
Chapter <AN LEVE#AES

B#EA!-EVEN ANALYSIS
1. a. EBI, : P-+!-'
= #0,000410!50,000 = Rs.0,000
+. EBI, = 1#,0004500#00,000 = Rs.0,000
#. EBI, : P-+!-'
EBI, =Rs.0,000 , =5,000 , P =Rs.0 , + =Rs.#0
2o, 0,000 = 5,00040#0 '
2o, ' = Rs.#0,000.
P-+!
. D"L =
1#!
P-+!-'
P =Rs.1,000 ,+ =Rs.!00, ' =Rs.100,000
0041,000!00
D"L=00 = = #.!$
0041,000!00100,000
!0041,000!00
D"L=!00 = = 1.$1
!0041,000!001,00,000
. D"L=15000 = #.5
EBI,=15000 = Rs.,00,000
9ercenta'e chan'e in EBI, : D"L 3 9ercenta'e chan'e in 

&f the percenta'e chan'e in  is 10%
9ercenta'e chan'e in EBI, = #.5 3 10% =  #5%
&f the percenta'e chan'e in W is / 5%
9ercenta'e chan'e in EBI, = #.5 3 5% = 1#.5%
*ence the possi+le forecast errors of EBI, in percenta'e ter(s is #5% to

1#.5%
)he correspondin' value ran'e of EBI, is Rs.##5,000 to Rs.$,500
5. >rea even point in units

' 50,000
 = = =10,000 units
P-+ 1#$
>rea even point in rupees:

 3 P = 10,000 3 Rs.1# = Rs,1#0,000
)o earn a preta3 inco(e of Rs.!0,000 the nu(+er of units to +e sold is
' / )ar'et preta3 inco(e

 =
P-+
= 50,000 / !0,000
= ##,000 units
1#$
)o earn an afterta3 inco(e of Rs.!0,000 if the ta3 rate is 0 per cent, the
1#$
9reta3 inco(e (ust +e Rs.!0,000

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1.
*ence the nu(+er of units to +e sold to earn an afterta3 inco(e of Rs.!0,000
is :
7/27/2019 50,000 / 100,000prasanna chandra financial management
 = = 0,000 units
1#$
!. P-+
= 0.0 P-+ = Rs.! ' =#0,000
P
#0000 !
 = = , P = = Rs.#0
! 0.0
>rea even point in rupees = Rs.!!,!!!
Ihen net inco(e is Rs.!0,000

#0,000 /!0,000
 = = 1,
!
2ales in rupees = 1, 3 Rs.#0 = Rs.#!!,!!!
10,000
$. 4a P = Rs.0 ,+ =Rs.1!, ' =Rs.10,000  = = $1. +a's
01!
4+ 9rofit when the uantity is 000 +a's

9rofit =,000401!10000 = Rs.#000
10 per cent increase in production (eans that the uantity is 00 +a's
t that production
9rofit
2o, the=percenta'e
,00401!10,000 = Rs.!#00
chan'e in profit is :
!#00#000
= 1.1%
#000
4c  10 per cent increase in sellin' price (eans that P = Rs.

>reaeven point when P = Rs.
1#8
10,000
 = = 588.# +a's
1!
7/27/2019 4d  50 per cent increase in fi3ed prasanna chandra

costs (eans financial management
that ' =Rs.15,000
>reaeven point when ' = Rs.15,000
15,000
 = = 88#. +a's
1!
4e &f + = Rs.#0, the +reaeven point is :
10,000
 = = 1000 +a's
0#0
8. A B C D
2ellin' price per unit Rs110 Rs.1!.!! Rs.#0 Rs.10
Varia+le cost per unit Rs.! Rs.8. Rs.1# Rs.5
?ontri+ution (ar'in per unit Rs. Rs.8. Rs.8 Rs.5
?ontri+ution (ar'in ratio 0. 0.5 0. 0.5
)otal fi3ed costs Rs.1!000 Rs.100000 Rs.1!0000 Rs.!0000
>reaeven point in units 000 1#000 #0000 1#000
>reaeven sales4Rs. Rs.0000 Rs.#00000 Rs.00000 Rs.1#0000
Jet inco(e4loss+efore ta3 Rs.0000 Rs.80000 Rs.40000 Rs.0000
Jo.of units sold 11500 #1!00 15000 #0000
". 4a >reaeven point for product P

0,000
= ,000 units
0#0
>reaeven point for product 

100,000
500 = 5,000 units

>reaeven point for product R
#00,000
= 5,000 units
800
4+ )he wei'hted contri+ution (ar'in is :
1#"
5000 8,000 !,000

3 Rs.10
http://slidepdf.com/reader/full/prasanna-chandra-financial-management / 3 Rs.#0 / 3 Rs.0 = Rs.#.!8 129/164
1"000 1"000 1"000
7/27/2019 10. EBI, prasanna chandra financial management
D'L :
D p
EBI,  I -
,
at  = #0000
EBI, = #00004Rs.0Rs.#=Rs.#0,000
Rs.#0,000
D'L=#0,000 =
Rs.10,000
Rs.#0,000Rs.0,000 
41.5
= 1.185
11. 4a EBI, : P-+!  '
Fir(  : #0,0004Rs.#0Rs.15  Rs.0,000 = Rs.!0,000

Fir( > : 10,0004Rs.50Rs.0  Rs.$0,000 = Rs.10,000
Fir( ? : ,0004Rs.100Rs.0 Rs.100,000 = Rs.80,000
4 EBI,-I!  1-,! - D p
b! EPS :
n
4Rs.!0,000Rs.10,00041.Rs.5,000
Fir(  : = Rs.1."
10,000
4Rs.10,000Rs.#0,00041.5Rs.5,000
Fir( >  = Rs..1$
1#,000
4Rs.80,000Rs.0,00041.!Rs.10,000
Fir( ? : = Rs.0.0
15,000
'  I
4c BEP :
P  +
10
Rs.0,000 / Rs.10,000
Fir(  :
= 10,000 units 130/164
Rs.#0  Rs.15
Rs.$0,000 / Rs.#0,000
Fir( > : = ,500 units
Rs.50  Rs.0
Rs.100,000 / Rs.0,000
Fir( ? : = #, units
Rs.100  Rs.0
P-+!
4d ! D"L :
P-+  '
#0,0004Rs.#0Rs.15
Fir(  : = 1.!$
#0,0004Rs.#0Rs.15 Rs.0,000
10,0004Rs.50Rs.0
Fir( > : = 1.5
10,0004Rs.50Rs.0Rs.$0,000
,0004Rs.100Rs.0
Fir( ? : = #.#5
,0004Rs.100Rs.0Rs.100,000
EBI,
4e D'L :
D p
EBI,  I -
3-,!
Rs.!0,000
Fir(  
Rs.5000 = 1.
Rs.!0,000Rs.10,000 
41.
Rs.10,000
Fir( >  = 1.0
11
Rs.5,000
Rs.10,000Rs.#0,000 
41.5
Rs.80,000
7/27/2019 Fir( ?  prasanna chandra financial
= 5. management
Rs.10,000
Rs.80,000Rs.0,000
41.!
4f D,L : D"L 3 D'L
Fir(  : 1.!$ 3 1. = #.0

Fir( > : 1.5 3 1.0 = #.00
Fir( ? : #.#5 3 5. = 1#.00
Chapter 
FINANCIAL &LANNIN AN BUETIN
1. )he profor(a inco(e state(ent of ;odern lectronics 6td for year  +ased on the per cent
of sales (ethod is 'iven +elow
A$erage per cent Pro)orma income statement

o) sales )or year 5 assuming sales o)
3242

Jet sales 100.0 10#0.0
?ost of 'oods sold $!. $$8.5$
Mross profit #.!$ #1.
2ellin' e3penses $.0 $5.8
Meneral X ad(inistration e3penses !.! !$.!
1#
Bepreciation !.$5 !8.85

peratin' profit #."0 #".58
Jonoperatin' surplus-deficit 1.0$ 10."1
arnin's +efore interest and ta3es ."! 0."
arnin's +efore interest and ta3es ."! 0."
&nterest 1.# 1#.!5
7/27/2019 arnin's +efore ta3 prasanna
#.$# chandra financial management
#$.$
)a3 1.00 10.#0
arnin's after ta3 1.$# 1$.5
Bividends 4'iven 8.00
Retained earnin's ".5
#. )he profor(a inco(e state(ent of ;odern lectronics for year  usin' the
the co(+ination (ethod is 'iven +elow :
A$erage per cent Pro)orma income statement
o) sales )or year 5
Jet sales 100.0 10#0.0

?ost of 'oods sold $!. $$8.5$
Mross
2ellin'profit
e3penses #.!$
$.0 #1.
$5.8
Meneral X ad(inistration e3penses >ud'eted 55.00
Bepreciation >ud'eted !0.00
peratin' profit 50."5
Jonoperatin' surplus-deficit 1.0$ 10."1
arnin's +efore interest and ta3es !1.8!
&nterest >ud'eted 1#.0
1
arnin's +efore ta3 ".8!

)a3 1.00 10.#0
arnin's after ta3 ".!!
Bividends 4'iven >ud'eted 8.00
Retained earnin's 1.!!
. )he profor(a +alance sheet of ;odern lectronics 6td for year  is 'iven +elow
A$erage o) percent Pro/ections )or year 5

o) sales or some based on a )orecast
other basis sales o) 3622
Jet sales 100.0 10#0.0
ASSETS
Fi3ed assets 4net 0.# 10.5
&nvest(ents Jo chan'e #0.00

?urrent assets, loans X advances :
?ash and +an 1.5 15.$1
Receiva+les ##." ##".0
&nventories #1.!0 ##0.#
9repaid e3penses 5.0" 51."#
1
;iscellaneous e3penditure X losses Jo chan'e 1.00
http://slidepdf.com/reader/full/prasanna-chandra-financial-management "!1.$0 134/164

LIABILITIES :
2hare capital :
uity Jo chan'e 150.00
Reserves X surplus 9rofor(a inco(e 1!0.!!
state(ent
2ecured loans:
)er( loans Jo chan'e 1$5.00
>an +orrowin's Jo chan'e 1"".00
?urrent lia+ilities :
)rade creditors 1$. 1$!.$$
9rovisions 5.0 51.1
3ternal funds reuire(ent >alancin' fi'ure 8."!
"!1.$
A L
. E'R : - ∆S  m S 3  1-d!
S S
800 1"0
=  00  0.0! 3 1,00 410.5
1000 1000
= 40.!1 3 00  40.0! 3 1,00 3 40.5
= 18  " = Rs.1.
Pro/ected Income Statement )or Year Ending 53 st December  4223
2ales 1,00
9rofits +efore ta3 1"5
)a3es 11$
15
9rofit after ta3 4!% on sales $8

Bividends "
Retained earnin's " 135/164
7/27/2019 Pro/ected Balance Sheetprasanna
as at 53134 4223 financial management
chandra
Liabilities Assets
2hare capital 150 Fi3ed assets 5#0

Retained earnin's #1" &nventories #!0
)er( loans 480/$# 15# Receiva+les 1"5
2hortter( +an +orrowin's #$# ?ash !5
4#00 / $#
ccounts paya+le 18#
9rovisions !5
1,00 1,00
A L
5. 4a E'R : - ∆S  m S 3  1 d!
S S
150 0
=  3 80  40.!#5 3 #0 3 40.5
1!0 1!0
= 4!0  $.5 = 5#.5
b! Pro/ected Balance Sheet as on 53134142(3
Liabilities Assets
2hare capital
Retained earnin's 5!.#5
$.50 Jet fi3ed assets
&nventories "0
$5
40 / $.5
)er( loans !.#5 Be+tors 5
2hortter( +an 0.00 ?ash 15
+orrowin's
)rade creditors $.50
9rovisions $.50
1!
##5.00 ##5.00
4c 42(2 42(3
7/27/2019 i ?urrent ratio 1.50
prasanna chandra financial 1.80
management
ii Be+t to total assets ratio 0.5 0.5
iii Return on euity 1.% 1.5%
4d
A L
E'R #0P1: - ∆S  mS 3  1  d!
2 2
150 0
=  #0  0.0!#5 3 180 3 0.5
1!0 1!0
= ".8
150 3 41.1#5 0 3 1.1#5

E'R #0P# =  3 #0  0.0!#5 3 #00 3 0.5
180 180
1!8.$5 .$5
=  3 #0 0.0!#5 3 ##0 3 0.5
180 180
= 8.$5
1!8.$5 3 41.11 .$5 3 41.11

E'R #0P =  #0  0.0!#5 3 ##0 3 0.5
#00 #00
18$.1 $.!
=  3 #0  !.88
#00 #00
= 8.11
18$.1 3 41.1 $.! 3 41.1
1$
E'R #0P =  3 #0  0.0!#5 3 #0 3 0.5

##0 ##0
= $."
7/27/2019 on 53 st December
Balance Sheet asprasanna chandra 42(6
financial management
Liabilities Rs1 Assets Rs1
2hare capital !.8$ Jet fi3ed assets "0.00

40/1!.8$ 4!0 3 #0-1!0
Retained earnin's &nventories
40.00/5.!/!.#5/!.88/$.50 !!.#! 4503#0-1!0 $5.00
)er( loans4#0/1!.8$ !.8$ Be+tors 403#0-1!0 5.00
2hortter( +an +orrowin's 0.00 ?ash 4103#0-1!0 15.00
)rade creditors $.50
9rovisions $.50
##5.00 ##5.00
!. E'R A L m  1/ g! 41d!
=  
∆S S S g
Miven A%S = 0.8 , L%S = 0.5  m= 0.05 , d = 0.! and E'R = 0 we have,
40.0541/ g 40.
40.80.5  =0
g
40.0541/ g 40.
i.e. 0.  =0
g
2olvin' the a+ove euation we 'et g = $.1%
A L
$. 4a ! E'R =  ∆S  mS 1 41d 
S S
#0 $0
=  3 100  40.05 4500 40.5
00 00
18
= Rs.50
4+ 6et CA = denote ?urrent assets
CL = ?urrent lia+ilities
SCL = 2pontaneous current lia+ilities
S,L = 2hortter( +an +orrowin's
'A = Fi3ed assets
and L,L = 6on'ter( loans
i. ?urrent ratio ≥ 1.25

CA
i.e 'reater than or eual to 1.#5 or
CL
CA
≥ 1.25
S,L SCL
s at the end of #0P1, CA = #030 3 1.#5 = #$.50

SCL = $0 3 1.#5 = 8$.50
2u+stitutin' these values, we 'et
1.#5 4S,L / 8$.5 ≤ #$.50
or 1.#5 S,L ≤ 237.50 − (8.50 3 1.25)
1285.125
or S,L =
1.#5
i.e S,L ≤ Rs.10#.50
ii. Ratio of fi3ed assets to lon' ter( loans ≥ 1.#5

'A
≥ 1.25
L,L
t the end of #0P1 'A = 10 3 1.#5 = 1!#.5
1!#.5
∴ L,L ≤ or L,L = Rs.10
1.#5
&f ∆ S,L and ∆ L,L denote the (a3i(u( increase in S, +orrowin's X L,
+orrowin's , we have :
∆ S,L : S,L 4#0P1  S,L 4#0P1 = 10#.50  !0.00 = #.50
1"
∆ L,L : L,L 4#0P1 L,L 4#0P1 = 10.00  80.00 = 50.00

*ence, the su''ested (i3 for raisin' e3ternal funds will +e :
2hortter( +orrowin's #.50 139/164
6on'ter( loans $.50
dditional euity issue 
50.00
A L
8. E'R =  ∆ S  m S 1 41d 
S S
A S
)herefore, mS 141-d   ∆S represents surplus funds
S S
Miven m= 0.0!, S 1 =11,000, d = 0.! , L= ,000 S = 10,000 and
surplus funds = 150 we have
A ,000
40.0! 11,000 410.!   1,000 = 150
10,000 10,000
A  ,000
= 40.0! 40. 411,000  150 = 11
10
or A = 41,10 / ,000 = ,10
∴ )he total assets of Videosonics (ust +e ,10
". m= .05 , d = 0.! , A- E = #.5 , A-S = 1.
m 41d  A%E .05 410.! #.5

4a g = = = .$0 per cent
A%S m41d  A%E 1. .05 410.! #.5
.05 410.! 3 A%E

4+ 0.5 = - = .
#.  .05 410.! A%E
d = 0.!!
)he dividend payout ratio (ust +e reduced fro( !0 per cent to !.! per cent
.05 410.! 3 A%E
10
4c .05 = A%E = .

1. .05 410.! A%E
)he A%E ratio (ust increase fro( #.5 to .
m 410.! #.5
4d .0! = m = $."# per cent
1.  m 410.! 3 #.5
)he net profit (ar'in (ust increase fro( 5 per cent to $."# per cent
.05 410.! #.5

4e .0! = A%S = .88
A%S  .05 410.! #.5
)he asset to sales ratio (ust decrease fro( 1. to 0.88

Chapter 1.
CO#&O#ATE VALUATION
1. 4a )he calculations for *itech 6i(ited are shown +elow :

Year 4 Year5
>&)
9>) 8! 10#
/ &nterest e3pense # #8
 &nterest inco(einco(e
Jonoperatin' 410
45 415
410
>&) "5 105
)a3 on >&)
)a3 provision on inco(e state(ent #! #
/ )a3 shield on interest e3pense ".! 11.#
 )a3 on interest inco(e 4 4!
11
 )a3 on nonoperatin' inco(e 4# 4

)a3 on >&) #".! .#
J96) !5. $1.8
Jet invest(ent 450 450
Jonoperatin' cash flow 4postta3  !
7/27/2019 F?FF prasanna chandra
18. financial#$.8
management
4+ )he financin' flow for years # and  is as follows :

Year 4 Year 5
fterta3 interest e3pense 1. 1!.8
?ash dividend 0 0
 Jet +orrowin's 40 40
/ ∆ 3cess (areta+le securities 0 10
 fterta3 inco(e on e3cess 4! 4"
(areta+le securities
 2hare issue 4#0 
18. #$.8
4c Year 4 Year 5

&nvested capital 4>e'innin' 10 !0
&nvested capital 4ndin' !0 10
J96) !5. $1.8
)urnover 00 !0
Jet invest(ent 50 50
9ostta3 operatin' (ar'in 1!.5% 15.!1%

?apital turnover 1.#" 1.#8
R&? #1.1% 1"."%
Mrowth rate 1!.1% 1."%
F?F 15. #1.8
#. Tele6i2ta Corporation
Base year
2 3 4 5 6 7
1. Revenues 1!00 1"#0 #0 #$!5 18 !50

#. >&) #0 #88 ! 15 "8 5$
. >&) 41t  15! 18$ ##5 #$0 # 5!
. ?ap. e3p. #00 #0 #88 ! 15 
 Bepreciation 1#0 1 1$ #0$ #"
1#
5. Iorin' capital 00 80 5$! !"1 8#" "1#

!. ∆Iorin' capital 80 "! 115 18 8
$. F?FF
http://slidepdf.com/reader/full/prasanna-chandra-financial-management 11 1 1! 1" #$ 142/164
4!
Biscount factor 0.8$! 0.$!$ 0.!$# .58"
9resent value ".! "."$ 10.$! 11.1"
?ost of capital for the hi'h 'rowth period
0. @1#% / 1.#5 3 $%A / 0.! @15% 41  .5A

8.% / 5.85%
= 1.15%
?ost of capital for the sta+le 'rowth period

0.5 @1#% / 1.00 3 !%A / 0.5 @1% 41  .5A
"% / .55%
= 1.55%
9resent value of F?FF durin' the e3plicit forecast period

= ".! / "."$ / 10.$! / 11.1" = 1.5!
#$ #$
*oriYon value = = = $!"0
0.155  0.10 0.055
9resent value of horiYon value = 5#".5
Value of the fir( = 1.5! / 5#".50 = Rs.5$1.0! (illion
. )he I?? for different periods (ay +e calculated :
I?? in the hi'h 'rowth period
Year <d 3-t! : 37. 3-t! <e : R )  β # &ar<et ris< premium < a : 0d < d 3-t! 0e < e
1 15 40." = 1.1% 1# / 1. 3 $ = #1.1% 0.5 3 1.1 / 0.5 3 #1.1 = 1$.!%

# 15 40.88 = 1.#% #1.1% 0.5 3 1.# / 0.5 3 #1.1 = 1$.#%
 15 40.8# = 1#.% #1.1% 0.5 3 1#. / 0.5 3 #1.1 = 1!.$%
 15 40.$! = 11.% #1.1% 0.5 3 11. / 0.5 3 #1.1 = 1!.%
5 15 40.$0 = 10.5% #1.1% 0.5 3 10.5 / 0.5 3 #1.1 = 15.8%
ACC in the transition period

< d 41t  = 1 41  0. = ".8%
1
< e = 11 / 1.1 3 ! = 1$.!%

< a = 0. 3 ".8 / 0.5! 3 1$.! = 1.#%
ACC )or the stable gro0th period
< d 41t  = 1 41  0. = ".1%
< e = 11 / 1.0 3 5 = 1!%
7/27/2019 < a prasanna
= 1- 3 ".1 / #- 3 1! = chandra
1.$% financial management
)he F?FF for years 1 to 11 is calculated +elow. )he present value of the
F?FF for the years 1 to 10 is also calculated +elow.
Multi2ot Liite3
Period Mrowth EBI, ,a# EBI, Cap1 Dep1 ∆C 'C'' D%E Beta ACC P+ Present
rate 4% rate  1-t! e#p1 . 'actor $alue
.!
0 "0 100 !0
1 0 1#! ! 118 10 8 #! ! 1:1 1. 1$.! .850 0.!
# 0 1$! 1# 155 1"! 118 " 8 1:1 1. 1$.# .$#! #$.!
 0 #$ 18 #0 #$ 1!5 50  1:1 1. 1!.$ .!## #$.
 0 ! # #! 8 #0 $0 " 1:1 1. 1!. .55 #0.8
5 0 8 0 " 58 # "8 #! 1:1 1. 15.8 .!# 1#.0
!  !" 0 5 $#1 # 1#  0.8:1 1.1 1.# .05 1.
$ #8 80 0 581 "## 55 1!"  0.8:1 1.1 1.# .5 15.
8 ## 101 0 $0" 11#5 !$5 #0! 5 0.8:1 1.1 1.# .10 1!.$
" 1! 11$5 0 8## 105 $8 #" !1 0.8:1 1.1 1.# .#$# 1!."
10 10 1#"# 0 "05 1! 8!# #! !8 0.8:1 1.1 1.# .#8 1!.!
11 10 1#1 0 ""5 1580 "8 #8" $ 0.5: 1.1 1.$ $!
1.0
!$.
)he present value of continuin' value is :
F?F11 $
3 9V factor 10 years = 3 0.#8 = $!
<  g 0.1$  0.100
)his is shown in the present value cell a'ainst year 11.
)he value of the fir( is eual to :

9resent value of F?FF durin' / 9resent value of continuin'
)he e3plicit forecast period of 10 years value
)his adds up to Rs.!85. (illion as shown +elow
1
http://slidepdf.com/reader/full/prasanna-chandra-financial-management MINI CASE 144/164

Solution:
Solution: 1 #   5 !
1. Revenues "50 1,000 1,#00 1,50 1,!!0 1,$$0
#. 9>&) 10 115 10 ### #5 #8$
. J9) = 9>&) "1 $.8 8.5 1. 15". 18!.!
41  .5
. Bepreciation 55 85 80 8 85 8$
5. Mross cash flow 1! 15".8 1!.5 ##$. #. #$.$
!. Mross invest(ent 100 #50 85 100 105 1#0
in fi3ed assets
$. &nvest(ent in net 10 15 $0 $0 $0 5
current assets
8. )otal invest(ent 110 #!5 155 1$0 1$5 1$
". F?FF 45  48 ! 4105.# ".5 5$. !". "".!
0. 1.0
I?? = 3 1# 3 41  0.5 / \8 / 1.0! 48]
1. 1.
= 1%
"".! 41.10
?ontinuin' Value = = #$".00
0.1  0.10

#$"
9resent value of continuin' value = = 1#"
41.1!
9V of the F?FF durin' the e3plicit forecast period

.! 105.# ".5 5$. !". "".!
=  / / / /
41.1 41.1# 41.1 41.1 41.15 41.1!
= $#.
Fir( value = $#. / 1#" = 1#1.
Value of euity = 1#1.  #00 = 11#1. (illion
15
Chapter 11
VALUE BASE MANAEMENT
1. )he value created +y the new strate'y is calculated +elow :
Current Income Statement Pro/ection
+alues
Year 2! 3 4 5 6 7
• 2ales #000 ##0 #50" #810 1$ 1$

• Mross (ar'in 4#0% 00 8 50# 5!# !#" !#"
• 2ellin' and 'eneral 1!0 1$" #01 ##5 #5# #5#
ad(inistration 48%
• 9rofit +efore ta3 #0 #!" 01 $ $8 $8
• )a3 $# 81 "0 101 11 11
• 9rofit after ta3 1!8 188 #11 #! #! #!
• Fi3ed assets !00 Balance

!$# Sheet
$5 Pro/ections
8 " "
• ?urrent assets !00 !$# $5 8 " "
• )otal assets 1#00 1 1505 1!"! 1888 1888
• uity 1#00 1 1505 1!8! 1888 1888
Cash 'lo0 Pro/ections

• 9rofit after ta3 188 #11 #! #! #!
• Bepreciation !0 !$ $5 8 "
• ?apital e3penditure 1# 18 1!! 185 "
• &ncrease in current assets $# 81 "0 101 
• peratin' cash flow  " 55 !# #!
• 9resent value of the operatin' cash flow = 1$

• Residual value = #! - 0.15 = 1$!0

•• 9resent value of residual value

)otal shareholder value
=
=
1$!0 - 41.15 = 100$
1$ / 100$ = 115
• 9restrate'y value = 1!8-0.15 = 11#0
• Value of the strate'y = 115  11#0 = 
#. ccordin' to the ;araon approach

& r  g
1!
=
B <  g
r  .10
# =
<  .10
7/27/2019 r  .10 = #<  .#0 prasanna chandra financial management
r = #<  .10
r -< = #  4.10-< 
)hus r -< is a function of < . 7nless < is specified r -< cannot +e deter(ined.
. 4a J9) for #0P1

9>&) 41  ) : # 40.!5 = 15.!
4+ Return on capital for #0P1

*"PA, 15.!
= = 15.!%
?apital e(ployed 1#0  #0 4Joninterest +earin' lia+ilities
4c ?ost of euity

!% / 0." 4!% = 1.%
4d vera'e cost of capital

0.5 3 8% 41  .5 / 0.5 3 11.% = 8.%
4e V for #0P1

J9)  vera'e cost of capital 3 ?apital e(ployed
15.!  .08 3 100 = $.

.
I : Rs.#00 (illion
r = 0.0
c = 0.#0
, = 5 years
#00 40.0  0.#0 5
Value of forward plan =
0.#0 41.#0
= Rs.8. (illion
5. ?ost of capital = 0.5 3 0.10 / 0.5 3 0.18 = 0.1 or 1 per cent
1. Revenues #,000 #,000 #,000 #,000 #,000
1$
#. ?osts 1,00 1,00 1,00 1,00 1,00

. 9>B&) !00 !00 !00 !00 !00
. Bepreciation #00 #00 #00 #00 #00
5. 9>&) 00 00 00 00 00
!. J9) #0 #0 #0 #0 #0
$. ?ash flow 4/! 0 0 0 0 0
7/27/2019 8. ?apital at char'e 1,000 prasanna
800 !00chandra
00 financial
#00 management
". ?apital char'e 4830.1 10 11# 8 5! #8
10. V 4!" 100 1#8 15! 18 #1#
5 0
J9V = ∑  1000 = 0 3 .  1000 = 510.5
t =1 41.1t
Vt
J9V = ∑ = 100 3 0.8$$ / 1#8 3 0.$!" / 15! 3 0.!$5 / 18 3 0.5"# /
41.1t #1# 3 0.51"
= 510.
!. uip(ent cost = 1,000,000

cono(ic life =  years
2alva'e value = Rs.#00,000
?ost of capital = 1 per cent
9resent value of salva'e value = #00,000 3 0.5"#

= 118,00
9resent value of the annuity = 1,000,000  118,00

= 881,!00
881,!00 881,!00
nnuity a(ount = =
9V&F1%, yrs #."1
= Rs.0#,50
Depreciation charge under sin<ing )und method

3 4 5 6
?apital 1,000,000 8$,!0 !5#,1! 0,"#$
Bepreciation 1!#,50 185,#"! #1#,#$ #0,810
?apital char'e 10,000 11$,# "1,0 !1,$0
2u( 0#,50 0#,50 0#,50 0#,50
$. &nvest(ent : Rs.#,000,000
6ife : 10 years
18
?ost of capital : 15 per cent

2alva'e value : 0
#,000,000
cono(ic depreciation
FV&F410yrs, 15%
#,000,000
= = "8,50
#0.0
8. &nvest(ent : Rs.5,000,000
6ife : 5 years
?ost of capital : 1# per cent
2alva'e value : Jil
9V&F45yrs,1#% = .!05 N nnuity a(ount = 5,000,000 - .!05 = 1,8!,"!
Depreciation charge under sin<ing )und method

3 4 5 6 7
?apital 5,000,000 ,#1,0$ ,1,!8 #,,$# 1,#8,8!
Bepreciation $8!,"! 881,"" "8$,1!! 1,105,!#! 1,#8,01
?apital char'e !00,000 505,5! "",$"$ #81,! 18,!!#
2u( 1,8!,"! 1,8!,"! 1,8!,"! 1,8!,"! 1,8!,"!
5,000,000
cono(ic depreciation =
FV&F45yrs, 1#%
5,000,000
= = Rs.$8$,00
!.5
". &nvest(ent = Rs.100 (illion

Jet worin' capital = Rs.#0 (illion
6ife = 8 yrs
2alva'e value = Rs.#0 (illion 4Jet worin' capital
nnual cash flow = Rs.#1.!18 (illion
?ost of capital = 15%
2trai'ht line depreciation = Rs.10 (illion per year
80 80
cono(ic depreciation = = = Rs.5.8#8 (illion
1"
FV&F48, 15% 1.$#$
http://slidepdf.com/reader/full/prasanna-chandra-financial-management Year 3 Year 6 149/164

• 9rofit after ta3 11.!18 11.!18
• Bepreciation 10.000 10.000
7/27/2019 • ?ash flow #1.!18 prasanna chandra financial management
#1.!18
• >oo capital100 $0
4>e'innin'
• R? 11.!#% 1!.5"%
• RM& #1.!#% #1.!#%
• ?FR& 15.$"% 15.$"%
150
Chapter 1;
ME#E#S AC(UISITIONS AN #EST#UCTU#IN
1. )he prea(al'a(ation +alance sheets of ?o3 ?o(pany and >o3 ?o(pany and the post
a(al'a(ation +alance sheet of the co(+ined entity, ?o3 and >o3 ?o(pany, under the poolin'E
(ethod as well as the purchaseE (ethod are shown +elow :
Be)ore Amalgamation A)ter Amalgamation

Co# Q Bo# Company
Co# Bo# Pooling method Purchase
method
Fi3ed assets
?urrent assets #5
#0 10
$.5 5
#$.5 5
0
Moodwill #.5
)otal assets 5 1$.5 !#.5 $$.5
2hare capital #0 5 #5 #0
4face value U Rs.10
Reserves X surplus 10 10 #0 10
2hare pre(iu(
Be+t 15
5 #.5
1$.5 1$.5
#.5 1$.5
$$.5
#. 9ost(er'er 92 of &nternational ?orporation will +e
# 3 100,000 / # 3100,000
100,000 / ER 3 100,000
2ettin' this eual to Rs.#.5 and solvin' for ER 'ives

ER = 0.!
. 9V A = Rs.#5 (illion, 9V B = Rs.10 (illion

>enefit = Rs. (illion, ?ash co(pensation = Rs.11 (illion
?ost = ?ash co(pensation  9V B = Rs.1 (illion
J9V to lpha = >enefit  ?ost = Rs. (illion
151
J9V to >eta = ?ash ?o(pensation  9V B = Rs.1 (illion
. 6et A stand for Heet and M for <eet 151/164
9V = Rs.!0 3 00,000 = Rs.18 (illion
A
9V M = Rs.#5 3 #00,000 = Rs.5 (illion
7/27/2019 >enefit = Rs. (illion prasanna chandra financial management
9V AM = 18 / 5 /  = Rs.# (illion
3chan'e ratio = 0.5
)he share of <eet in the co(+ined entity will +e :
100,000
α = = 0.#5
00,000 / 100,000
a )rue cost to Heet ?o(pany for acuirin' <eet ?o(pany

?ost = α 9V AB  9V B
= 0.#5 3 #$  5 = Rs.1.$5 (illion
+ J9V to Heet

= >enefit  ?ost
=   1.$5 = Rs.#.#5 (illion
c J9V to <eet = ?ost = Rs.1.$5 (illion
5. a 9V B = Rs.1# 3 #,000,000 = Rs.# (illion

)he reuired return on the euity of 7ni+e3 ?o(pany is the value of < in the
euation.
Rs.1.#0 41.05
Rs.1# =
<  .05
< = 0.155 or 15.5 per cent.
&f the 'rowth rate of 7ni+e3 rises to $ per cent as a seuel to (er'er, the intrinsic value
per share would +eco(e :
1.#0 41.0$
= Rs.15.11
0.155  .0$
)hus the value per share increases +y Rs..11 *ence the +enefit of the
acuisition is
# (illion 3 Rs..11 = Rs.!.## (illion
15#
4+ 4i &f ;ulti+e3 pays Rs.15 per share cash co(pensation, the cost of the
(er'er is # (illion 3 4Rs.15  Rs.1# = Rs.! (illion.
4ii &f ;ulti+e3 offers 1 share for every  shares it has to issue #- (illion
shares to shareholders of 7ni+e3.
2o shareholders of 7ni+e3 will end up with
0.!!$
α = = 0.11$$ or 11.$$ per cent
5/0.!!$
shareholdin' of the co(+ined entity,

)he present value of the co(+ined entity will +e
9V AB = 9V A / 9V B / >enefit
= Rs.##5 (illion / Rs.# (illion / Rs.!.# (illion
= Rs.#55.# (illion
2o the cost of the (er'er is :

?ost = α 9V AB  9V B
= .11$$ 3 #55.#  # = Rs.!.0 (illion
!. )he e3pected profile of the co(+ined entity AX B after the (er'er is shown in the last colu(n
+elow.
A B AQB
Ju(+er of shares 5000 #000 !
''re'ate earnin's Rs.5000 Rs.000 Rs."000
;aret value Rs."0000 Rs.#000 Rs.11000
9- # ! #.
$. 4a )he (a3i(u( e3chan'e ratio accepta+le to shareholders of ViHay 6i(ited is :
S 1 4 E 1/ E # PE 1#
ER1 =  /
S # P 1S #
1# 4!/1# 8
=  / = 0.1
8 0 3 8
4+ )he (ini(u( e3chan'e ratio accepta+le to shareholders of Hay 6i(ited is :

P # S 1
15
ER# =
4 PE 1# 4 E 1/ E #  P # S #
http://slidepdf.com/reader/full/prasanna-chandra-financial-management " 3 1# 153/164

= = 0.
" 4!/1#  " 3 8
4c 1# 48 PE 1#

ER1 =  /
8 #0
" 3 1#
ER# =
PE 1# 48  $#
uatin' ER1 and ER# and solvin' for PE 1# 'ives, PE 1# = "

Ihen PE 1# = "
ER1 = ER# = 0.
)hus ER1 and ER# intersect at 0.
8. )he present value of F?F for first seven years is

1!.00 1.0 ".$ 0
9V4F?F =    /
41.15 41.15# 41.15 41.15
/ 0 / 10.# / 1!.$
41.155 41.15! 41.15$
=  Rs.#0. (illion
)he horiYon value at the end of seven years, applyin' the constant 'rowth (odel is
F?F8 18
+  = = = Rs.#5$.1 (illion
0.150.08 0.15  0.08
1
9V 4+ K  = #5$.1 3 = Rs."!.$ (illion
41.15$
)he value of the division is :
15
 #0. / "!.$ = Rs.$!. (illion
MINICASE
Solution:
4a
;odern 9har(a ;a'nu( Bru's 3chan'e
Ratio
>oo value per share #00 !50 !5
= Rs.115 = Rs.!5
#0 10 115
arnin's per share 50 "5 ".5
= Rs.##.5 = Rs.".5
#0 10 ##.5
;aret price per share Rs.#0 Rs.10# 10#
#0
3chan'e ratio that 'ives eual wei'hta'e to +oo value per share, earnin's per share, and (aret
price per share
!5 / ".5 / 10#
115 ##.5 #0 0.5$ / 0.# / 0.#
= = 0.
 
4+ n e3chan'e ratio +ased on earnin's per share fails to tae into account the
followin':
4i )he difference in the 'rowth rate of earnin's of the two co(panies.
4ii )he 'ains in earnin's arisin' out of (er'er.
4iii )he differential ris associated with the earnin's of the two co(panies.
4c ?urrent 92 of ;odern 9har(a

50
155
= = Rs.##.5
#0
&f there is a syner'y 'ain of 5 percent, the post(er'er 92 of ;odern 9har(a is
450 / "5 41.05
#0 / R P 10
uatin' this with Rs.##.5, we 'et
450 / "5 41.05

= ##.5
#0 / 10R
)his 'ives R = 0.5
)hus the (a3i(u( e3chan'e ratio ;odern 9har(a should accept to avoid initial dilution of 92 is
0.5
4d 9ost(er'er 92 of ;odern 9har(a if the e3chan'e ratio is 1:, assu(in' no
syner'y 'ain:
50 / "5
= Rs.#.#
#0 / 0.#5 3 10
4e )he (a3i(u( e3chan'e ratio accepta+le to the shareholders of ;odern 9har(a if
the 9- ratio of the co(+ined entity is 1 and there is no syner'y 'ain
21 41 / # 9-1#
R 1 = /
2# 91 2#
 #0 450 / "5 1
= / = 0.#1
10 #0 3 10
4f )he (ini(u( e3chan'e ratio accepta+le to the shareholders of ;a'nu( Bru's if
the 9- ratio of the co(+ined entity is 1# and the syner'y +enefit is # percent
9#21
R # =
49-1# 41 / # 41 / 2  9#2#
15!
10# 3 #0
=
1# 450 / "5 41.0#  10# P 10
= 0.!
4' )he level of 9- ratio where the lines R 1 and R # intersect.
7/27/2019 prasanna
)o 'et this, solve the followin' for 9-1# chandra financial management
 21 41 / # 9-1# 9#21

/ =
2# 912# 9-1# 41 / #  9#2#
 #0 450 /"5 9-1# 10# 3 #0

/ =
10 #0 3 10 9-1# 450 /"5  10#0
 !00 / 55 9- 1# #00

=
#00 55 9-1#  10#0
455 9-1#  10#0 455 9- 1#  !00 = #00 3 #00
#"$0#5 9-#1#  88000 9- 1#  555"00 9- 1#

/!5#8000 = !5#8000
#"$0#5 9-#1# = 0"00 9-
#"$0#5 9-1# = 0"00
9-1# = 1.!1
15$
Chapter 17
INTE#NATIONAL FINANCIAL MANAEMENT
1. )he annualised pre(iu( is :
Forward rate  2pot rate 3 1#

2pot rate Forward contract len'th in (onths
!.50  !.00 1#
= 3 = .%
!.00 
#. 100
100 41.0! = 3 1.0$ 3 '
1.55
10! 3 1.55
' = = 1.58
10$
 forward e3chan'e rate of 1.58 dollars per sterlin' pound will (ean indifference +etween
investin' in the 7.2 and in the 7.`.
. 4a )he annual percenta'e pre(iu( of the dollar on the yen (ay +e calculated with
reference to 0days futures
105.5  105 1#
3 = 5.$%
105 1
158
4+ )he (ost liely spot rate ! (onths hence will +e : 10$ yen - dollar
4c Futures rate 1 / do(estic interest rate

http://slidepdf.com/reader/full/prasanna-chandra-financial-management = 158/164
2pot rate 1 / forei'n interest rate
10$ 1 / do(estic interest rate in <apan
7/27/2019 = prasanna chandra financial management
10! 1.0
Bo(estic interest rate in <apan = .0"$ = ."$ per cent
. S 0 = Rs.! , r h = 11 per cent , r ) = ! per cent

*ence the forecasted spot rates are :
Year 'orecasted spot e#change rate
1 Rs.! 41.11 - 1.0!1 = Rs.8.1$
# Rs.! 41.11 - 1.0!# = Rs.50.
 Rs.! 41.11 - 1.0! = Rs.5#.8#
 Rs.! 41.11 - 1.0! = Rs.55.1
5 Rs.! 41.11 - 1.0!5 = Rs.5$."#
)he e3pected rupee cash flows for the proHect
Year Cash )lo0 in dollars E#pected e#change Cash )lo0 in rupees

million! rate million!
0 #00 ! "#00
1 50 8.1$ #08.5
# $0 50. 50.8
 "0 5#.8# $5.8
 105 55.1 580$.!
5 80 5$."# !.!
Miven a rupee discount rate of #0 per cent, the J9V in rupees is :
#08.5 50.8 $5.8

J9V = "#00 / / /
41.18# 41.18 41.18
580$.! !.!
/ /
41.185 41.18!
= Rs.0!.# (illion
15"
)he dollar J9V is :

0!.# - ! = $.05 (illion dollars
5. Forward rate
1 / do(estic interest rate 159/164
=
2pot rate 1 / forei'n interest rate
7/27/2019 F 1 / .015 prasanna chandra financial management

=
1.!0 1 / .0#0
F =  1.5"# - £
!. 3pected spot rate a year fro( now 1 / e3pected inflation in ho(e country
=
?urrent spot rate 1 / e3pected inflation in forei'n country
3pected spot rate a year fro( now 1.0!

=
Rs.$0 1.0
2o, the e3pected spot rate a year fro( now is : $# 3 41.0! - 1.0 = Rs.$#.0
$. 4a )he spot e3chan'e rate of one 72 dollar should +e :

1#000
= Rs.8
#50
4+ ne year forward rate of one 72 dollar should +e :

1000
= Rs.50
#!0
8. 41 / e3pected inflation in <apan#

3pected spot rate = ?urrent spot rate 3
# years fro( now 41 / e3pected inflation in 7`#
41.01#
= 1$0 3 = 1!.! yen - £
41.0#
". 4i Beter(ine the present value of the forei'n currency lia+ility 4£100,000 +y usin'
"0day (oney (aret lendin' rate applica+le to the forei'n country. )his wors
out to :
1!0
£100,000
= £ "85##
41.015
4ii +tain £"85## on todayEs spot (aret
4iii &nvest £"85## in the 7` (oney (aret. )his invest(ent will 'row to
£100,000 after "0 days
7/27/2019
10. 4i Beter(ine the present value of prasanna
the forei'nchandra
currencyfinancial management
asset 4£100,000 +y usin'
the "0day (oney (aret +orrowin' rate of # per cent.
100,000
= £"80"
41.0#
4ii >orrow £"80" in the 7` (oney (aret and convert the( to dollars in the spot
(aret.
4iii Repay the +orrowin' of £"80" which will co(pound to £100000 after "0 days
with the collection of the receiva+le
11.  lower interest rate in the 2wiss (aret will +e offset +y the depreciation of the 72
dollar visbvis the 2wiss franc. 2o ;r.2eh'alEs ar'u(ent is not tena+le.
1!1
Chapter ;%
CO#&O#ATE #IS! MANAEMENT
1. 4a )he investor (ust short sell Rs.1. (illion 4Rs.1 (illion - 0.$0 of B
4+ *is hed'e ratio is 0.$0
4c )o create a Yero value hed'e he (ust deposit Rs.0. (illion

#. Futures price 2pot price 3 Bividend yield
= 2pot price 
41/Risfree rate0.5 41/Risfree rate0.5
#00 000 3 Bividend yield

= 000 
41.15 0.5 41.15 0.5
)he dividend yield on a si3 (onths +asis is # per cent. n an annual +asis it is
appro3i(ately  per cent.
. Futures price
= 2pot price / 9resent value of  9resent value
41/Risfree rate1 stora'ecosts of convenience yield
500
= 5000 / #50  9resent value of convenience yield
41.151
*ence the present value of convenience yield is Rs.55. per ton.
1!#
1!

Dokumen - Tips - Prasanna Chandra Financial Management

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7/27/2019 prasanna chandra ﬁnancial management

r = 10% FV5 = Rs.1!11

r = 1#% FV5 = Rs.1$!#

r = 15% FV5 = Rs.#011

ccordin' to the Rule of !", the dou+lin' period is:

0.5 / !" - &nterest rate

uatin' this to  and solvin' for interest rate, we 'et

&nterest rate = 18."%.

5. 6et  +e the annual savin's.

 3 FV&F 41#%, 10 years = 1,000,000

2o,  = 1,000,000 - 1$.5" = Rs.5!,"8.

!. 1,000 3 FV&F 4r , ! years = 10,000

FV&F 4r , ! years = 10,000 - 1000 = 10

Fro( the ta+les we find that

7sin' linear interpolation in the interval, we 'et:

#0% / 410.000  "."0

$. 1,000 3 FV&F 4r , 10 years = 5,000

Fro( the ta+les we find that

FV&F 41!%, 10 years = .11

7sin' linear interpolation in the interval, we 'et:

r = 1#% 9V = 10,000 3 9V&F 4r = 1#%, 8 years

r = 15% 9V = 10,000 3 9V&F 4r = 15%, 8 years

". ssu(in' that it is an ordinary annuity, the present value is:

)he alternative is to receive a lu(psu( of Rs.50,000.

1#. )he present value of the inco(e strea( is:

= 1,000 3 0.8" / #,500 3 0.$"$ / 5,000 3 ."!8 3 0.$"$ = Rs.##,!8.

1. )he present value of the inco(e strea( is:

15. Rs.#0,000 = Rs.,000 3 9V&F 4r , 10 years

Fro( the ta+les we find that:

7sin' linear interpolation we 'et:

1!. 9V 42trea(  = Rs.100 3 9V&F 41#%, 1 year / Rs.#00 3

9V&F 41#%,  years / Rs.500 3 9V&F 41#%, 5 years /

= Rs.100 3 0.8" / Rs.#00 3 0.$"$ / Rs.00 3 0.$1#

1$. FV5 = Rs.10,000 @1 / 40.1! - A53

18. FV5 = Rs.5,000 @1/4 0.1#-A 53

2tated rate 4% 1# # #

Freuency of co(poundin' ! ti(es  ti(es 1# ti(es

ffective rate 4% 41 / 0.1#-!! 1 41/0.#- 1 41 / 0.#-1#1#1

= 1#.! = #!.# = #!.8

Bifference +etween the

= Rs.1#,000 - 0.1# = Rs.100,000

)o have a su( of Rs.100,000

Fro( the ta+les we find that

)his (eans that the i(plied interest rate is nearly 15%.

##. FV10 = Rs.10,000 @1 / 40.10 - #A 103#

)he discounted value of Rs.$#,100 evaluated at the end of #000 is

P 3 41.01!0 = Rs.1,""8

#$. Rs.00 3 9V&F4r , # (onths = Rs.!,000

Fro( the ta+les we find that:

9V&F 4#%, # = 18."1

7sin' a linear interpolation

)hus, the +an char'es an interest rate of 1.5% per (onth.

= Rs.10 (illion 40.$" / 0.$5 / 0.!81

Rs.#0,000 3 9V&F 410%, n = Rs.100,000

Fro( the ta+les we find that

)hus n is +etween $ and 8. 7sin' a linear interpolation we 'et

0. uated annual install(ent = 500000 - 9V&F41%,

Loan Amortisation Schedule

Beginning Annual Principal Remaining

4 roundin' off error

#00,000 3 9V&F41%, n = 1,500,000

Fro( the ta+les or otherwise it can +e verified that 9V&F41,0 = $.500

= Rs.00 (illion 3 1  41.0! 15 - 41.1! 15