2 Ue ‘0 © Problems for Practicein Cost of Capita Cast af Copuat 000 8%. Debentures of € 10 cach at a premium of 10%. The cests of loatation ‘ole te the company is 60%. Compute the cost of éebt capital. se 25 ‘The rate of ax applic inns. 295% . 2A company issyes 5,000 12% debentures of € 100 each at 2 discount of 5 ayatsie tw underwriters and brpkers is % 25,000. The debentures are redeemable after 3 aiteray cost of debit assuajind a wy rate af 50% ‘The commission . Compute the 82%) A company issies € 10,00,000, 12% debentures'e 100) each, The debentures are éedeemable of fixed period of 7 years. Tihe company is in 35% tax bracket. Required (2) Calculate the cost fof debt after tax if debentures are issued at é 4a Par 2 {) 10% Discount anf {9 08% Premium : e (Gi IF brokerage is pad at 2%, what will be the cost of debentves, if issue is at‘par 2 BOQ « Uns. (i) Ca) 7.8% (D1 9.719% Ce) 6.07% : (ii) 8.1724) os Ex: 4 LA compan isswes 1,000 10%, Preferonce Shares of €100.cach at a discount of 5%. Costs aC of raising. copied ere ® 2,060, Compute te cost af Preference Capital e (i) Assume that tie frm pays tex ak 80%, Compote the aftersax cost of capital ofa preferred share : Sat 100 with a 9% dividend and a redemption price of € 110, ifthe company redeems it in five years. dams. (7) 10.2596, Gi)}t0.47%) Your compiny|s shave is quoted in the market at ® 20 curently, The company pays a dividend a of Re. 1 per share and the’ inpestr's snarket expoets © yrow'h rate of $ per cent per year 2 (2) Commute the. say on x 3 C ch Whe » Calculate the indicated market price per share 1 the cornmany"y Gos: of yt is She and the Aamicipated growth rate “price if the dividend of Re. 1 perishare is to be maintained. ta) 10% 4 5% pa, calenlate the 355 3333] i & der in ABC Company Ltd. Although earnings for the ABC-Ltd, have v D. hai the long-run average dividends for the firm have been 2 per share. He é similar pattern to pre}al i the future Given the volatility of the ABC's dividends, X has dicided that ws a minimum rate of 20% should be earned on his sare. What price would X be willing to pay forte AGC s hd shares? | . | : cy [Ans. & 10 per share]] | 2 Ex. 7. A mining comppny's iron 7 fsérias are being depleted and its cost of teow ‘ ee djuantity of iron .ore are rising pach year: As'a sequel to; the compass earnings and divideads are dect:ing Q at a rate of 10% p.a. If the previous year’s dividend (D,) was €'20 and the required rate of + 5 2 would cufrent price of| ly share of the company ? 2% a [Ans, % 60} +f c 9/_ Ex 8. Excel Industrie 2 and 20,060 of eaui y a year ent a | @ 2 | : ° |. © o> | ' a = : os | B. - ae6 teas S00 egy shases oF @ 100 ech selling ata market prise oF€ 129 er sre. What ie he weighted average cost of capital ? a Jans. 9.7425} ‘ | Bx, 9 A company is considering raising of fund of about ® 100 lakhs by one of two alternative nvcthods, viz, 14% institutional term loan and 15% non-convertble debentures tt iract no major incidental cost. The debentures would have 10 be i fnvolve cost of issue of & 1 tak. Advise the cornpany as to the better option based on the effect ray rate of 50% [Ans, 7% and 6.7496} Ex, 10. Thé Xavier Corporation, « dynamic growth fiem wh run level of future earning of @ 7 per share, The current price of Xavie}" € 55.54, floatation costs for the sales of equity shares would average absut 10% ofthe price of the|shares. What is che cost of equity capital to Xavier ? | [Ans. 14%] | term foun option 'd at a discount of 2.59% and sou: ive Gost of capital in each case. Assur: EX. II, Cateulate the weighted average cost of capital (before tax nd after wx) from th information. Assume thet the tax rate is 55%, Type of Capltat Proportion inthe Before Fas New Copital Structure Cost of Capita cei Bauity Caphal 25% Preference Capital tos Debt Capital 50%: Retained Eaenings 15%, Tans (3) 15.58% + (i) 13.39%) Ex. 12.71 ms have been extracted fromthe *Liabill comp ‘ber, 2607: + = , a ——- 1000 Equity Shares of® IWeach 560.000 a Reserves and Supls : 00 080 : Loans: g' 17% Non-Convertible Debeniures : 2.00.00 Me 16% lasitutional Loans te © §.00.008 cal ‘Other information about the company as relevpat b given bola == 5 : sat 5 Wearended Dividend Farajngs ‘ivanigeMtarker ~ > 311 Dec. | pershare pershare Pricepershare gg a | @ ©. 2007 5.00 9.90 60.00) ay too. | 7 ; 00 2005 $00 7 | 60 0100 You arc required to calculate the welghdd average cost of capital using book values as ‘weights ane raingstPrice (R/P} ratio as the basis of ost of equity: Assume 50% ian. ra ‘Ans 12.25%) . Ex, 13. The following is an extract from ihe finan jal statements of XYZ Ltd. 7 ae eee Operating Prot nderest on Debentures Less: theome-tax 50%) Net Prot1638 & a Canal (Shares of eserves and Supls Lot Non: Convetnisle eben Phe market price per equity (9) What is the carmmg per (a) What is the percent Tans, (0) £220, (17) 20%, 84 Ka MUNYY Lid, is currently, ng ay ay has 10,009 shares ouistandin nd it hay a payout ratio of 100%. Wh nd ni al cams 15% rate of retwrn [atis. (012.5% 5 7) 13.5%) Fy, 1S, The capital structure! yy shares of © 100 each is in the The company is contemplati crm loan from financial institutions. J equity would get retuced by 1/1 In the light of above proposal ax rate, expected dividend of 9 per ¢ dividend. dividend growth rate [Ans. Weighted average cost Ex. 16. Mis. Albert & Co.'h 10% Debentures 9% Preference Shares quity=5,000 of 160 each Total The equity shares of the coh dividend of ® 9 per share for 2007. The c be maintained. i (Assuming the tax rate'a capital, State your assui Gia) Assuming, in the above assessment is that it will share, but the busi [Ans. (1) 10.21% ; (i) 9.34%) 17. ‘Three companies A, 5,00,000 to finance an expansion, calculate the, revis se % 102 10 % 96 per sharel Cost of Capnal 400 150 309 750 Vosach) Kivnve 1 and per debentme © 95 share ? leosi af capital to tie company for the equity and debenture funds ? J, at book values and 812% at market value weights} 2 1,00.000 dnd its share is selling at a market price of @ 80. The ings of the firm arc expected 10 remain stable, 7 If the firm's payout ratio is assumed to be 60% hat would be the firm’s cost of earn ke has no debt is the cost of eq n its investment opportunities, them wl The lof Swan & co. comprising of 12% debenture 9% preference shares and roportion of 3: 245, i f to introduce Further|capital 10 sheet the expansion needs by seeking 14% a result of this proposal, the proportion of debentures, preference shares WIS and 1/6 respéctively. : i calcylate the impac} on weighted average cost of capital assuming 505 hare at thé’erdMbF tHe Year and growth rate of dividends 5%. No change ‘and mairket price offsharc is expected afier availing the proposed term of capital declines from 10.6% to 9.40) 1as the following capital structure as on 31st December, 2007 : ©. 3,00,000 2'00,000 | ~5,00,000 | 10,00,000 shnpany-are quoied at © 102 and the company. is expected 10° declare, a ‘ompany has registered a dividedd growth rate. of 5% which.is expected: plicable to the company at 50%, calculate the weighted average cost of hptions, if any. : ‘exercise, that the company can raise additional term loah at 12% for & ed weighted cost of capital. ‘The company’s be in a position to increase the dividend from ® 9 per.share-to € 10 per {sk associated with new financing may bring down the market price from and'C are in the same type of business and hence have similar operating each of them is différent and the following are the detail tl gplisks. However. the capital structure " " no 5 5 te i z z wz Tiquity Share capnal (Face value ¢ 10 per shore) 700,000 350000 o000 Market Value per Shire - 4 : 288 Dividend per Shave : Bebemres (Fate val per debsie® 100) Nil ca — al— t i aw Market Vatite per Debentute ww | . Interest Rate ni | 2 at et i 0% es ‘Assume that the current level of dividends are generally expe income tax rate 18 50%, You are required 10 compitte the weighted average cost of cup| JAns. Company A 18% B 16.8%; and C 19.25%] Equity Capital : 100 lakhs equity shares of € 10 oach Reserves 14% Debentures of € 100 each For the year ended 3-5-2009 the company has paid equity divider leader with good future, dividend is likely to grow by 5% every year. T 80 per share in the stock excliange. Income-tax rate applicable to the « Required (©) The current weighted cost of capital, ninue indefinitely and the tied 0 c tal-of cach company, 18. The capital structure of Bombay Traders Lid. as on 31-83-2009 is as follows 0 2 3 id at 20%, As the company is 2 market 1¢ equity shares are how treated at % ympany is’ 50%! (6) The company has plans to raise a further & 5 crores by way af long-term loan at 16% interest. When this takes place the market value of the equity shares ‘What will be the new weighted average cost of capital [Ans. (i) 7.4%; (it) 8.45%] Ex. 19, You are required to determine the weighted averiige cost (@ book value weights ; and (ii) market value weights. The following inf The K.C. Ltd.'s present book value capital structure is,: t's expected to fall to. 50 per share. |the company. lof capital (K,) of the K.C. Ltd. using, Imation is available for your perusal. : @ Debentures % 100 per debenture) ,00,000 ~ Preference Shares (@ 100 per share) 200,000 Equity Shares (& 10 per share) ‘10.00.00 20.00,000 ‘All these securities are traded in the capital markets. Recent prices are : debentures @ ¥ 110, preference shares @ € 120 and equity shares @ X 22. Anticipated external financi (F100 per debenture redecmable at par : 20 year maturity, 8 price % 100. (i) %-100 preference share redeemable at par: 15 year maturity, sale price & 100. (iit) Equity shares € 2-per share Motation costs, sale price & 29. In addition, the dividend expected on equity shares at the end of | growth rate in dividends is 5% and the company has the practice of dividends. The corporate tax rate is 50%, {Ans. ()) 10.273% (if) 11.841%) Ex. 20. Nishce Ltd: is an all, equity financed company. The cured 1 had just paid a dividend of & 15 per share and expected finure growl evaluating a proposal requiring funds of ® 20,00,000 with arinual inflow: the NPV (Net Present Value) of the proposal if : (tis financed from retained carnings Gi) is financed by issuing fresh equity (Notation costs 5%)| fAns. ( € 64,337; (i) € 48,513] 1g Opportunities ar eh coupon rate, 44 Notation costs, sale: lov dividerid rate, 3% Motationcosts, the year & 2 per share ; the anticipated aying all its earning in the fori of int market price of the share is &. 180, in dividends is 12%. Currently, it is of & 10,00,000 for 3 years. Find outrescore ese epee reeerenree see teee ese eacccce ———————— a y _ ae fully paiel up at pan) } 7 TiFetaence © ih 2 Tg el fully pai up 3 Pa” » 5 BSTRERE ce tnean ae S 15% Term Loans oe yetpeciel 57 TYRE NENT expected dividend on quity’ shares per “per share is 5 e at the rate of 7%. The market price per share is 40. ' & Prelerence stock, redeemable afigr ten years. is currently selling a Debentures, redeemable afier six| years, are selling at %°80 pe? a The income tax rate for company is 40%. ~ Required : lost of capital using : Z Caleulate the wei (a) book value propértions yan (b) market value proportions. S (Ans. (9 13.929%; (if) 14.593%] | Ex. 22. 1.K. Lid. has the following book value capital structure as on March 31, aw { Se Equity: share,capital 11.5% preference shares 10% Debentures 2011 will pay next year The equity share of the company sells for © 20. 4t js expected ‘that the ¢ tax rate. & dividend of € 2 per equity share, which is expected to grow at 5% forever. As: ‘ Required : e {i Compute weighted average tost of capital (WAC) of the company based on the existing capital structure, a (it) Compute the new WACC, if the company raises an additional % 20 lakhs debt by issuing 12%, aaaane osciie would regutt in inereasing the expected equity’ dividend 16 & 2.40 aiid leave’ the’ * C growth rate unchanged, but) the price of equity share shall fall to 16 per share. fans. (3) 11.375% ; Gi) 12.66%] eases5 RE ® vag : | 1d be mixed with equity when n tw fin) deb, equity: he rate of earnings is ~ ing securities SHO (eat of the €O0 it; (a) 108" ined cost be = than the Lan. 9 Long teh del 1) more, interest} B, Short Answer i 1. Define capital struc Write a note on th What optimal capital sructare ? Hes of capital structure. mprtance of ep structure 4 Name various theos ‘tal mis? What ane di seals of a sound capita 6 What is capital gesting ? ee & 2 Differentiate berwedn “Financial Structure” and “Capit Structure a S. What is wading on|equity ? 9 What is meant by nancial risk ? : XO. What are the assuption ef MM hypothe > 11. Differentiate “capitalisation” and ‘capital structure 2, Write a note on.*Arbitrage Process’. | gQ 15. Discuss any five factors relevant in determining, capital structure 14. Write a note on trading on equity 15. Explain the term point of indifference 16. What do you understand! by bankruptey eosts an 17. Write a shor note hn Pecking Order Theory of capital structure wd agency costs ? c. yy Type Questions & 1. What is meant by capital structure ? What are the major determinants of capital structure: 2 What do you understand by capital structure? What are the major determinants of capital strveture ? 2 3. Define capital stfucture. What should generally be the features of an appropriate capital structure’ 4 What basic prineipfes will you advocate. in the matter of deciding on a proper pattern of capital structure for a combany ? Explain and @lustrate the impact of financial leverage 5. Explain the meanigg of the term capital structure and mention the factors affecting capital He “structure. I oO 6 Give a critical appraisal of the traditional approach and the Modigliani~Millers approach to the problem of capital structire. & 7. .What do you underdtand by capital gearing ?What ig itssignificance ? Diseuss the effects of high and low gearing on the financial position of a compari’ during various phases of trade cycle. 8, Changes in capitalisation may be sought as a means of easing tension and giving corporation a betier opportunity 10 pursue’ its purpose.” In the light of this statement, discuss. various reasons for chiangts in capitalisation. 9. Using Imaginary’ figures show how to determine the value of firm under (a) The Net-Income (NI) Approach, and (b) The Net Operating Ihcome (NOI) Approach. i —— a | Exercises : saree Ex. 1. X Ud, 2 widely field company isconsiering a ajo ‘expansion of its production facilities and the following alternatives ae avilable: | i ‘Alternatives (Tin Lakhs) A B c hare Capial 1 ¢ 145 Dees | 7 @ ® : Loon @ 18% pa = D 2al on us ad tian 20% ‘The company at present has ano debt. of 7100 each ‘The management is planning totaise another €20 lakhs 10 fir throu! Whicl of the alternatives would you choose ? Inas fed ate of retuen before interest and tax is 25%. The rate OF dividend of the company is not less Rate of corporate tnk is 50%, [Ans, Rate of retum on share capital under alternatives A, 8 and C : 12.5%, 19.75% and 29.5% resp. "eC should be chesen} Ty, h one of four possible financial plans. The options are (i) Emirely through ordinary shares (1) © 0 lakhs through ordinary shares agd 10 lakhs throu per annum, Git) TS lakhs through ordinary shares and €15 I aynum, ABC company has currently an ordihary share capital 25 jakhs, consisting of 25,000 sha lance a major programme of expansion long-term borrowings at 8% interest khs through long-term borrowing at 9% interest per (iv) © 10 lakhs through ordinary shares and €10 lakhs roa prerenee shares with 5% dividend. ‘The company's expected caring before interest and taxes (EBIT) will be % 8 lakhs, Assuming corporate tax rate of 30%, determine the earnings per share in each alternative and comment which alternative is the best and why. [Ans. (i) 88.88; (i)%10.29 : (iii) €11.07; (iv)®10.00; Plan 111 i$.the best) Ex. 3. XY Ltd, needs & 50,00,000 for the installation of a new ae the new factory is expected 10 yield ennual Earnings Before Interest and Tax (EBI1) of €10,00,000. In. fn objective of maximising eamings por shar, iis considering the pass !noosing a financial plan, XY Lid. has cilities of issuing ordinary shares and raising debt of €5,00,000 or ¥ 20,00,000 or €30,00,000. ‘The current inarket price per share is 2300 and is expected to drop to £250 if the funds are borrowed in excess of €20,00,000. Funds can be raised at the following rates, is ad Upto £5,00,000 at 10% Over €5,00,000 to ¥ 20,00,000 at 15% Over € 20,00,000 at 20% Assuming a tax rate of 50%, advise the company, {Ans.1.231.675 11, £36.25; I € 32.81) ‘The second alternative which gives the highest earnings per expansion programme. Its current position is as follows vised 10 raise €20,00,00 through debt and £3,00,000 by oti shares. share’ isthe best Hence, the company Ex. 4. "The Hardware Company Ltd, has tolmake a'choiet katween debt issue and equity issue for its t t — Debts 5% | i 20,000 Pet Sit (10 pe shore Bom Staecs Soto Fa Capasaton vino. Sales | 300.000 Fe cos | : 290 re ete inert ns | Stoo ieee i 00 : soon ai Income tx $0% i debt will be 7% and the price-carning ratio will be 6 times. Ifthe expansion, new “The expansion programme is estimated to eGst %50,000. 1f this ‘hares: ean be sold nemting © 25 per shar, and the price i eT is[financed through debt, the rate on new programme is financed throu) equity ratio will be 7 times. ‘The expansion willa 3 eek generate adlalinonal sates of © 13M 50 follow a potiey oF mnayinnsi FAms. Debi torn ot EX. 8. company’ ean p profit of & 150,008 p on 12%. debentures. The tos nate fs 50% The number ot smmmings amount fo & 6,00,000, "fe company prope: 260.000 8 vequmed His anticipated tat oo investments at present. The OF 1286 oF by issu 4 i Rea (Compote the tari {e) the adeltional (i\ ' b . ” 2 > . be » » . > » . . ION & ‘esusvveve 2.08 Bd apital, is evaluating, a rojcet whieh yl cost & 100,000 © and recewatnes of $50,000 over its ff, The projeet will generate add ap SASH egpenses OF £ 50,0080 in each yoa is the net presemt vale and inten [ns. 851685 21.27%) Uy, 27, One of th ‘avilig to replace a large stamping mich superior siamping machine eosts 850, costs 875,000 but running ex Usetil life with no salvage va} (a) Whe company pays a should it purchase? Gb) Woutd your answer be [Ans, (a) Superior Stampi Ex. 28. A computers availa bbe 815,400 per month for minimum b saomth, the rentals fall due for piym ‘A company planning 16 economical to purchase the machite 0} as on outitow) ig to be taken at 10% ‘Sthe end of 6 years both at 10% are 4 largest antl most profit Capa Danke br cont ns ste and 10 pe een air tas ost ot sha wil require an nctense nthe level of inventories sa sles of €100,000 andl il require a basis The Phattys Covporaion, shied 9s 50 Yotite lave year life; i¢ ll be depreciated an a stra ate of return for the project table companies in the country is faced with the prospect of ne. Tavo machines curently being marketed will do the job satisfatorly.The 10 and will require edsh running expenses of 820,000 per year. Tie Pearless henses are only expected to be & 15,000 per year. Both machines have a fue nnd would be -depreeinted on straight fine method, [0% tax and bas 0 10% after-tax required rate of return, which machine hifferent if the required rate of return was $% ? Machine (lb) Pearless Machine] : lc ava cash purchase price of @4,40;000. Itaken on hire, the charges would eof 36 months, and thereafter the rate would be reduced to %7,500 per nt at the* end of each month, -quire the above computer wants advise whether it would be more {ake it on hice, What would be your advice ifthe cost of capital (aki per annum ? The prpsent values of Re.l and Re, 1/12 paid monthly, at follows “ier Fear (ay Present vale af Re Present value 172 patd monthly Rel T 0950 O57 ° 2 o.864 . 0.826 3 0.785 0751 4 ona 0.683 3 * 0649 062 6 0,591 0.56 Ans, As present valaes of a it is advised to purchase the computch ui ‘of computer. Ex. 29. An oil company prby javestments and Operating costs of the| ve been collectet terest of € 44000 pa flows for hiring are more than that of purchase from 6th ye it thé-life-of computer is inore than S years] has been'taken as an outflow at the end of each year in case of purchase loses to insalla pipeline for transport of erude oil from wells to refinery. pipeline vary for different sizes of pipes (diameter). The following details Pipelinediameter ¥ z + = Investven required (lakhs) | 16 % 6 150 Gross annual savings in Opera : oss bsfore depreciation andi @iakhs) ag ry S ' fimated life of the installa} he net savings after tox and thé cas installed if the company desires 18 pe shortest payback, {Ans. Surplus over 15% ret fn investment Pay-back period tenes, 6° diamete eeconinnended]| jon i510 years. Tax fate is'50%. Ignore invesunient allowance, Caleulate flow generations, from these reccinmiend the largest pipeline to be cent aller tx returd on investment, Also indigate the proposal that has x at 3, 6, r t- pr. 0.80, 030, 2.20, ~5.00, | Ne 4a, mm an 460 |a @ + « om 0633 0507 | 0506 of cash lows, please advise the company of the financial viability of the ‘Aller appropriate anhlva proposal | Liss, NPV = 258,600 positive, ‘The proposal is financially viable) Fs. 38, A cosietie cbmpany i considering @ introduce a nee lotion which i sefat borin winter and summers, The manufacturing equipment will cot % 5,60,000, The expected life of equipiment is $ years. ‘The company is thinking of selling the lotion ina single standard pack of 50 grams at& 12 each pack. It is estimated Ut varie cost per pack-wguld be @5 and annual fised cost, @4,50,000. Fixed cost includes (straight tine) depreciation of € 70,000 and allocated overheads of © 30,000. The company expects to sell 1,00,000 packs of lotion each year. Assume tax rate is 35% and straight line depreciation is allowed for tax purpose. The required rate of retuen 1 15%, Caleulale the time adjusted break-even point for project appraisal. The PY factor of an anauity of Re. 1 for 8 years at 15% rate of discount is 4.487. Ans. 22,045 packs) i : Ex, 36, Following art the data on a capitel project M being evaluated by the management of X Ltd. “Annual os ied Uset tite yeas IRR j 15% Proftabliy index (P.1) ij 1.064 NPV | ° Cost of cai | 4 Gost of project 2 Poyeback period 2 Salvage value o Find the missing fighres considering the following tablé of discount factor only: Discount Féeior | ___ 15% i Ti 73% TH ist Year [7088 OST a 0895 2nd Year i arse "1 ara 0783 0797 3rd Year | 065s} oss 0.693 0712 ath Year 1__asn 0572" 0613 0.636 2835 208 2974 3.038 [Ans. Cost eal = & 1,14,200; Pay-back period = 2.855 oF 2 years and I} months fappx); Cost of capital = 12%, ; NPY = © 7,309) Ex. 37. A Company |s considering a proposal of installing a drying equipment. the equipment would involve a cash outlay of 6,00,000 and net working capital of Rs 80,000. the expected life of the project is 5 years without any salvage vale. Assume that the company is allowed to charge depreciation on steight line basis for income-tax purpose. [The estimated before-tax cash inflows (earings before-depreciation and tax) are given below: Befortax cash inflows (© O00) Yer T_T z 3 : 7 ; 0 | ms 210 ie 60 The applicable inconte-tax rate to the company is 35%. If the company’s opportunity cost of capital rate of return. The PY factors at 12%, 14% and 15% ares, Year 7 z T = PV factor at 12% | 0.8929 07972 5 i omnis 0.6355 0.5674i ! S601 2 AAN SEVes —. 2 ial Wor Capita Managem ENT 4 __ Morking Conical Managemen and nance a ree 22.59 4 6 approaches to determine an appropriate financing mix of working capital, 2 2 1S iss te wis aprons Sr working capital troughout the yes, which ofthe tree % al ta, ERRNO capita’. AS a management consultant, you are required to = | Espn at cant by Waring COP mt in require woskng epi Suegest eS sways and means to meet the need for working capital in the ease of a newly” started business e ! 19. Discuss the now trends in financing of working capital by banks. 20. Write notes on fi) ‘Tandon Committee. (ii) Chore Committee. (iii) Marathe Commitee. (iv) Chakravarty Committee (vy) Kannan Com : AS 21. White vdesitea fot en analysis and control of working capital. What are the various methods of working eapitgl analysis ? : 22. Whar do you uijdersind by working eapital ? How will you measure working capital in a going concem : Exercises Ex. 1. Calculate the operating cycle of @ company from the following information a aw mateal connumplfon pa sanum 1 3 Annual coi of production 3 ® ‘Annual cot of goods shld sl Annual sles | - ‘Average value of cuir) asstsminsined ¢ « 3 Raw motels 4 Woriarprogess 3 Finished goods beors The company gets 30 may take one year as equal t [Ans. Gross Operatin Ex. 2, The following jays eredit from its suppliers. All sales made by the firm are gn credit only. You 365 days. “ i if Cycle Period : 150 days; Net Operating Cycle : 120 days} information is available for Shaguti Lid 1 (© 00)” ‘Average stock of raw ajaterials ond stores F 400 ‘Average worksin-procest inventory 600 ‘Average finished goods finventory = 360) “Average accounts receivgble 600 ‘Average accounts payable 360 ‘Average raw materials dnd stores purchased on eredi 20 ‘Average work-in-proces} value of raw materials committed per day 25 ‘Average cost of goods fold per day 36 ‘Average sales per day 40 (©) Duration of finished gods stage (f) Duration of the oper [Ans. (a) 20 days; (6 Ex. 3. From the following data, comput ‘You are required to calculate : (0) Duration of raw materials stage (8) Duration of work-in-progress lage tage (d) Duration of:accounts receivable stage (e) Duration of accounts payable Oe ; ise (€) Duration of accounts payabl 24 days; (2) 10 days (a) 15 day: 5 (@) 18 days; (51 days net) aay the duration of the operating cycle for cach of the evo = companies tomaya ‘Stocks 1 = = 3 Raw materials | = : 20,000 27000 > ne ~ | 9eB e 2 g a oa 2 easy og ay saunas es Daron 3 Ge TOAKAL CO BMAE a Seg \ con nou st ug «feedand . permititd to be made out of... value and the jos issve iv) Bonuslissue is made to make the .. the | company comparable. (Ans. (9 Redhetion; fi) 40 increase (i) Fres Reserves, ps 1ér Type Qhestions 1, Name the twp iin theories, of gividend. : : 2. Enlist the fagtors that influence fhe dividend policy of a firm. 3. What is the kignificance of stable dividends ? 4 What is ‘serfp dividend” ? 5.. What is dividend pay-out ratio ? 6" What, do yoh mean by’ bonus issue ? 7. Give Souiced of Bonus issue. 8. Bonus issue|Vs. stock split. 9. Write a note on dividend pol 10. What do you mean by rights 11. Write a note|on buy back of shares. . Rssay Type Questions J. How far do your agree that dividends are irrelevant ? : 2. “There is strohg view prevalent among financial experts that the irrelevant hypothesis underlying i the MM thedry of dividend distribution is out~dated aud unsuited to present conditions, Do you agree with this view? Discuss. : 3. In Walter's japproach, the dividend ‘policy of a firm depends on availability of investment ‘opportunity gnd the relationship between the firm's intemal rate of return and its cost of capital Discuss whal are'the shértcomings of this view. 4. Explain the Yarious factors which influence the dividend decision of a firm. “A frm sho follow a policy of very high dividend pay-ou.” Do you agree? Why or wy not? 6. What do yo} understand by a stable dividend policy ? Why should it be followed ? 7. Discuss the parious forms of dividends. 8. Define:*bonus shares” and enumerate the guidelines laid down by the Government of Indi the issue of [bonus shares. 9. What do you) vinderstand by bonus jgsue ? Mention the circumstancés that warrant the issue of bonus shares. Mtge i. 10, What are the sources of bonus issue ? Write detailed note on the issue of bonus shares. 11. “An investor gains nothing fiom ‘bonus shares”, Examine the statement critically. 12. Enumerate guidelines issued by SEBI for the issue of bonus shares. i = cand Raghs Iae es ; 2 Dividend Policy and Decision| Banus Issue nes IVIDEND Po icy 4 Flin i se : 7 ce (Bee 2 a on old bead pe eon O° t "TE dp efotal of the company. ee value of, the shares of” market meatlected in cash (iv) Nomi ® for 13. “Theoreticall y, retained ‘eamings should be treated as the active decision variable and dividends as the passive residual but the practice does not conform to this in most cases.” Examine this statement. 14, Discuss the legal and procedural aspects of the payment of dividend. : 15, What do you! understand by us issue ? Discuss the factors which determine: the success of A rights iss . Exercises TEx. 1. The Asbesfors Company belongs to a risk class of which the appropri i is b ich the appropriate capitalisation rate is 1036, 1 cureently has 1,00000 shares selling at @ 100 each. The firm is contemplating the declaration of ¢ &6 dividend at the end of thi curreit fiscal year, which has just begun, Answer the following questions based ‘on the MM model and tht assumption of no taxes:29366 4 as Om) 2 JO SYS a8 uno ed pr ea 20 sve pred Ave’ pe ‘dn peg 315201230 a 22LIG eo “Tea ee cl 2 @ set 2 ("oraz cl 2 at ice SS rents on 20 sue6 46. sea asso ap ex sont nnCase Studies 19 Ge O99 O98 OaMaRaRARea Paints nhs) Limited has paid @ dividend of 30 per cent on its shares of £10 year. in fhe opinion’ of Chokyf finance director, te clvidend is expe cent annum, Thg.requiced «ate of rewuen of the} company is 13 per can Malaysian Painss is faclng cough competioy} in the marker because panies have started theie bperations in tig company is seriously thinHng of di 3 special executive com formed. THE*special com ‘The special executive following alternative cov © To increase ach inthe onl tes prow 5 gu ¢ umber of muitinational con: infthe same line of business. ‘Therefore, thy qnanagerent of the ying th activites of the company. In a quarterly mectings of the Bo: -¢ consisting of finknee director, sharketing cli twee was chaired bylthe CMP of the company. ‘ouster had a bavnestoaning session and a series of meetings. I suggested the res of actioit (Gettn: donaideration of the Board: clone) growth rate 10] 6 per cent, dl, ‘clot and production director was nd lower the required rate of eetuen to 14 per wo dene growth rate to 7. per cent and the required rate of retuen tw 17 per To raise the ‘equirga rate of return to 16 per cent and reduce the growth rate of dividend 10 4 per G9) To increase the ay idendl grown rie-to 8 per cent cent. You are the finance sh because, in the past, za {© suggest, wth calculatic ‘objective of maximising if and inereuse the required rate of return to 17 per angger of the conipany, The Board of (directors haw confidenee in your abil have helped the Boved in making such clecisions. The Hoard has requested you fs, the most suitable course of action for the conipany (assuming the Tir bu shareholders wealh). State your asskimpitions if any. SsP.10.15 Owing to the ongo “0 (0 have just 665 The company is fot willing business scenario, The finan dels like NPV, DVI, ete) help the company make thd sicong conipariy’s bottom line suffered yet it ying off the dividends to the shareholdess. the present state of the workd market 4 investment after pa a mal funds ether ¢hrough debt or equity, given the Or 2 a aitant tats the folowing. proiable prolects along with oxhes necessary een be invested. You are required to evatunte:these projects (0 nee the fone Cecio possible under the éverent scenario, Assume all giver Ig, recession 39 fos investment proposas ave inqependent.and evs Project __lavestmant oullay a Gross prosont valu8 | Present vatue index pL 221,85,000 £10,92,500 %32,77,500 1.50 Pe 20,80,000 10.19.20 20,99.200 1.49 fs 2,25,000 92,250 3,17,250 441 Pa -2,40,000 1,00,800 3,40,800, 442 Ps 11,80,000 18,41,000 26,81,000 2.94 6 9,40,000. 4,25,000 13,65,000 1.45 a 7 | 8,55,000 795,i50* 16,50,150 1.93 Pa '4,95,000 | 3,41,550, 8,36,550 1.69 Po 6.05,250 7,38,405 13,43,655 2.22 O ¢ Pro 3.90.00 4.48.50 8.38,500 25 Pt 2,08,000, 6,08,000 Ps 1.82 2 ‘ oa 2,83,500 5.98,500 1.20 mS ip 73,600 2,20,800 148 . 292.695 863,195 179 nd ie 968 7,61,468 . 271 ; Torat 79,33,318 1,86,19,568wo o ~~ & 8 Crmcon industnes id ie desinous of assessing is working capital raquiraenants tor ihe Nel anager has goliectet! she tovowing «formation for the Purnase. Lod “est per unit of finished product Scenona! infonnaron | () Soageres level of sctwiy is 1,20,000 units of output lor the next year (©) Saw maternal cost consists of the following: Big won 85S ger unit, Ferto alloys 15.per unit, and Cast iton borings 10 per unit (o) Raw matenals are purchased trom dillerent suppliers, exiending different credit perio: Sig ron. 2 monins, Ferto alloys, 1/2 month, and Cast iron borings, 1 month. (0s) Procust im process lor a cers of 1/2 monn, Production process requires full unit (100 per cent) Co! pig won and lero alloys in the Beginning ol prodéction: cest iron boring is required only (0 the ‘extent of 50 per cent in the beginning and ine remaining is needed at unilorm rate during ine | process. Direct labour and other overneads secrve simiafly ala uniform rate throughout production | process. : | (e) ast trengs indicate ingu ne pig iron is req 1 nonin Finisheo goods are in stock lor a period of month. ‘14s estimated that one-ourth o! otal sales arb on cash basis and the remaining sales are on credil. The past experience of tne liem has been lo Zollect the Credit sales in 2 morihs. 1d 10 be slored lor 2 months and other materials for | (vii Average time-tag in payment of all vemnedds is 1 mionth and1 months’ in the case ol Girect 1 about E in) Dested cash balance i$ 10 6¢ maintained at/810 lak. | PeertSaaite to detemjne tne amount of nel workig capital of the frm. Stale your assumpiions, | | | | | Iremeit—An Overview 13-31 Working, Capital taanagy eet Mini Cases 49.6.1 S1féng Comont por annum; its prasont is limostono which is ‘company produces con) ceaplial (NWC) roquiron} Gypsum) Limosto Coal Packing Direct Factory Administ Soling otal cost Proll me *soling a} Additional information: () Desired holding and Packing mat (i) The product Is In limestone and c (iv) Debtors are exter (v} Average time lag] (vi) Average time lag (vil) The credit period Gypsum, 2 mont (uli) Minimism desired You may state your i f cement i ally of producing 1.25 lakh tonnes of inal eapncly Tor raw material lo manufacture cement aj ravy 1 80 por cont The veated near the plant. The schanised mine 10% ‘ion given below, determine the not working Icompany Lid has an pacity ullisation Io tained from tho company’s ov mo Jat In 200 kg bags. From the Informa font of tho company for the curtont yoo". Coir atrcture per bag of cement (estimated) 325 l. 15 30 fraterial 10 ur 50 vatheads (including dopraciation of 210) 30 lative ovorhéade 20 orhoads 5 25 205 on : 45 co 7250 alo lax (107por cant of 2 25, 275 co 10 consuriors riod of rave materials: Gypsum,’3 months, Limestone, 1 month, Coal,2.6 months, rial, 1.5 months : . rocass for a period of 0.5 month (assume full units of materials, namely gypsum | are required in the beginning; other conversion costs’ are to be taken at 50 per fe in stock for & period of 1 month before they are sold: \ded credit for a period 3 months, in payment of wages is approximately 0.5 month and of overheads, 1 month: lin payment of Sales tax is 1.5 months, : : lextended by:various suppliers are: js. Coal, 1 month, apd Packing. material, 0.5 month: |cash batance is-¥25 lakh. a " ssumptions, any.2 MD Gi Present Value ad Future Value Tal lesBUECEOEEEE CEE sada es B Bo , NATURE AND SCOPE OF : FINANCIAL MANAGEMENT mama . + Meaning. evolution and importznce. + Finance JaRCTION = OpPTOUCHES Ord OPE. + Relationship of finance with other business functiors. . + Qryectves of financial managenent + Econonic value added and market value added eopvoach, «+ Financial decisions ~ investmem, fuancing ond dividend deczions. + Risk-retrn trade off + Functions of a finance manager + Financial engineering + Organisation of the finance fuvetion. INTRODUCTION 7 S . In our present day economy, finance is defined as the provision of money at the time when i is required. Every enterprise, whether big. medium or small, needs finznce to carry on is operations andy achieve its targets. {n fact, finance is so indispensable today that itis rightly said to be the lifebloud of an emerprise. its objectives. 1o io classes : (i) Public F the requirements, receipts arid disburseme Without adequate finance, no enterprise can possibly accompli ‘The subject of fiaance has heen traditionally cla Peivaie Finance. Public. fina wstee : and i) leals wi es, foeat 2 ‘and disbursements of funds in case of an individua, a profit organisation. Thus, private finance can be classified into : (i) Persor PUBLIC FINA? “coveenenr msteruTions “rensos, “Siane covennnienrs ousiness emnnce ‘LOCAL SELF-GOVERNMENTS, ~ FINANCE OF NON-Pi G. =CENTRALGOVERNMENT ee Personal finance deals with the analysis of principles and practices involved in managing one’s own The] study of principles, practices, proceduees, and problems concemiag financial routes naka anisations engaged in the field of indusuy, trade, and connerce is undertak: der the discipfin Sees ics) The finance of non-profit organisation is concerned with the practice1P 6 plow aoyauy wren NVI IVIONVNIS / 3ONVNIY NOLLVUOIUOD JO NOLLATOAA ye 15 Woueve sue eGo rode mo. 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Reasons for time preference of money. Learn-the techniques for édjisting the time value of money. - Compounding technique and discounting or present value technique. Practical applications of time value Techniques. INTRODUCTION ‘We have observed in the previous chapter.that profit maximisation objective ignores the ‘of money,and docs not-consider the magnitude and timing of earnings. I treats “all earnings as equal though they occur in different periods: Thus, maximisation of shareholder's wealth is considered to be en appropriate objective ofa firm. Given the objective of wealth maximisation, the firm should, white making financial decisions, consider those things which are important to investors. Financial theory asserts that as the shareholders make a current’sacrifice by investing their funds into the firm, they expect to get some furure benefit, as dividend. ‘or increased share price when the shares are sold or both. However, the expected beneiit is @ future one white the sacrifice is a current one, Hence, te investors expect a rate of return on their investment that compensates them the duration of the sacrifice deferral. This leads us to the study of the ratio of return of waiting o: the time value of money. Most of the financial decisions, such as acquisition of assets or procurement of furds affect firm's cash flows in different time periods. If a firm acquires an asset today, it will require an immediate cash outlay, bout the benefit of this asset will be received in future. Thus, it will have an effect-on future cash flows over the life of the asset will be received in future. Thus, it will have an affect on future cash flow over the life of the asset, Similarly, if funds are raised through borrowings for present needs, these will have. t0 be reluened in future as principal and-interest. A firm may also caise additional funds through issue of share capital, but will have to pay dividend on the share capital in future. While-taking such financial decision, the firm witl have to compare the total of cash inflows with the total cash outflows. The logical way is to recognise the tinie value of moniey and make appropriate adjustment for time otherwise it may take fauity decisions. The owner"s tility will be inaximised when net present worth is created froin the financial decisions CONCEPT OF TIME VALUE OF MONEY ‘The simple concept of time value of money is that the value of the money the velue of same amount of money received after a certain period. tn other words, mon: is not as valuable as money received today. the sooner one receives mone ‘of 2 rational human bei ived today is more than wey received in the future Y, the better it is . 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