FINANCIAL MANAGEMENT Solutions to Numerical Problems

Rajiv Srivastava – Dr. Anil Misra Chapter 2

2-1: Profitability and Liquidity ratios

The summarised financial statements for Zoom Ltd are as follows:
Summarised Profit and Loss account for the year ended 31st March
(Figures in Rs. Lakhs)
2006 2007
Sales 64.00 79.00
Cost of Sales 49.25 59.85
Gross Margin 14.75 19.15
Operating expenses
Administration 4.46 5.32
Selling and Distribution 2.78 2.99
Profit before interest and tax (PBIT) 7.51 10.84
Interest 2.43 3.32
Profit before tax (PBT) 5.07 7.51
Provision for taxes 1.95 2.89
Profit after tax (PAT) 3.12 4.62
Note:
1. Credit sales have been 89.13% and 90.9% of the total sales in the years 2005-06
and 2006-07 respectively.
2. Total number of shares outstanding for the firm is 1.25 lakhs.
3. The company follows a policy of 40% payout as there are tremendous
expansion opportunities.
Balance Sheet of Zoom Ltd as on
31/03/06 31/03/07
Assets (Figures in Rs. Lakhs)
Fixed Assets (Net) 25.50 36.25
Current Assets 25.05 29.38
Inventory 12.60 14.45
Accounts receivable 11.20 13.43
Cash 1.25 1.50
Less: Current Liabilities 6.70 9.60
Net Current Assets 18.35 19.78
Total Assets 43.85 56.03
Liabilities and owners' equity
Share capital 25.00 25.00
Reserves and surplus 5.45 8.22
Debt (long-term) 13.40 22.81
Total 43.85 56.03
Using the tool of ratio analysis you are required to comment on the profitability
and liquidity performance of Zoom Ltd.

Solution:
2005-06 2006-07
Profitability Ratios
Gross Margin (%) [(Gross Margin/ sales) X100] 23.04 24.24
Net Margin (%) [(Net Margin/ Sales) X 100] 4.87 5.85
Expenses Ratio (%) [(Expenses/ Sales) X 100] 88.27 86.28
Return on Capital Employed (ROCE) % 12.67 14.18
Return on Equity (ROE) % 10.24 13.91
Earnings Per Share (in Rs.) 2.50 3.70
Dividend Per Share (in Rs.) 1.00 1.48
Liquidity Ratios
Current Ratio 3.74 3.06
Acid Test Ratio 1.86 1.56
Cash Ratio 0.19 0.16
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

Analysis:
Profitability of the firm as indicated by the profitability ratios shows improved
performance in the Year 2006-07. Both gross margin and net margin have
improved marginally during the year. Similarly ROCE, EPS and DPS have improved
during the Year 2006-07. This improvement in the profitability performance of the
firm has been mainly on account of better cost management by the firm. The firm
has been able to bring down its cost of sales from 76.96% of the sales in 2005-06 to
75.76% in 2006-07. Another noteworthy aspect of firm's profitability performance
has been an increase in ROE from 10.24% in 2005-06 to 13.91% in 2006-07. This has
been interalia, due to the benefit of financial leverage. The increased usage of
long-term debt by 9.41 lakhs in the financial year 2006-07 has magnified the
return to the equity shareholders.

The profitability performance of Zoom ltd., though satisfactory, should be

analyzed on a longer time scale and also compared with that of other
comparable firms in the industry to arrive at more meaningful conclusions.

Liquidity position of Zoom ltd. in the year 2006-07 has weakened compared to
what it was in 2005-06. This is evident from the current ratio, acid test ratio, and
cash ratio for the firm. All the three ratios have declined marginally in 2006-07.
Before commenting whether it is good or bad for the financial health of the firm
we need to find out the reasons for this decline.

As can be seen from the financial statements, the decline in liquidity position has
to do more with the financing side than the investment side of the balance sheet.
During the period (2006-07) aggregate current assets of the firm grew by 17.29%
as compared to total current liabilities that saw a growth of 43.28%. This
disproportionate change in the current liabilities has brought down the liquidity
ratios for the firm during the year 2006-07.

The liquidity ratios of the firm are still on the higher side if compared with the
benchmark (current ratio of 1.33 and the acid test ratio of 1). Reduction in
liquidity ratios is not always bad as the increase in the liquidity ratio is not always
good. Since liquidity has opportunity cost, too high liquidity may not be good for
firms as it may be on account of unwarranted tying up of funds and may
adversely affect the profits.

2-2: Capital Structure Ratios

From the summarised financial statements of Zoom Ltd calculate the capital
structure ratio and comment on the firm’s performance. Assume that the
repayment of debt amounted to Rs. 4 lakhs during 2005-06 and 7 lakhs during
2006-07. The depreciation provision amounted to Rs. 2.15 lakhs and Rs. 2.75 lakhs
respectively during 2005-06 and 2006-07.

Solution:
Capital Structure Ratios 2005-06 2006-07
Debt-Equity Ratio [LT Debt/ (Share Capital + Reserves & Surplus) 0.44 0.69
Debt to Asset Ratio [Long-term debt/Total Assets] 0.31 0.41
Total Outstanding Liabilities to Net Worth [(Long-term debt+
Current liab.) / (Share Capital + Reserves & Surplus)] 0.66 0.98
Total Outstanding Liabilities to Assets
[(Long-term debt+ Current liab.)/ Total Assets] 0.46 0.58
Interest Coverage Ratio (ICR) [PBIT/ Interest] 3.08 3.26
Debt Service Coverage ratio (DSCR)
[(PAT + Interest + Depreciation)/(Interest + Debt repayable)] 1.20 1.04
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

Analysis:
Zoom Ltd’s dependence on debt as a source of financing has gone up. In 2006-
07, 41% of the assets of the firm have been debt financed as compared to 31%
in 2005-06. The total outstanding liabilities to assets ratio has also gone up in
2006-07 to 58% from 46% in the preceding year. Debt financing has increased
during the year, but whether it is a cause of alarm or not, depends on the
industry characteristics. Capital intensive firms can afford to have a higher debt
financing. In fact usage of debt within manageable proportion is good for the
financial health as it gives the shareholders the benefit of leverage.

Despite of increased debt component, the Interest coverage ratio (ICR) of the
firm has increased from 3.08 times to 3.26 times. This improves the cushion
available for lenders. The Debt Service Coverage ratio (DSCR) has declined
marginally.

2-3: Working Capital Ratios

Evaluate the working capital performance of Zoom Ltd. for the years 2005-06
and 2006-07 using the information given in Problem 1. Apply the tool of ratio
analysis for the purpose. The following additional information may be used:
1. Creditors account for 92% of the current liabilities in both the years
2. Purchases constitute 56% of sales in the year 2005-06 and 58% in 2006-07.
3. The current assets and liabilities position on 1st April 2005 stood as follows:

Current Assets (Rs. In lakhs)

Inventory 10.50
Accounts Receivable 9.45
Cash 0.89
20.84
Current Liabilities 5.40
Net current Assets (NCA) 15.44

Solution:
Working Capital Ratios 2005-06 2006-07
Sales
Current Assets Turnover Ratio (CATR) =
Average Current Assets 2.79 2.90
Average Current Assets
Current Asset Holding Period = X 365 days
Sales 130.86 125.74
Sales
Current Asset Turnover =
Average Net Current Assets 0.95 1.04
Cost of Goods Sold (COGS)
Inventory Turnover =
Average Inventory 1.07 1.11
Average Inventory
Inventory Holding Period = x 365 Days
COGS 65.87 62.49
Sales
Debtor Turnover =
Average Debtors 1.55 1.46
Average Debtors
Av Collection Period = x 365 Days
Sales 58.88 56.90
Purchases
Creditors Turnover Ratio =
Average Creditors 5.81 5.01
Average Creditors
Average Credit Availed = x 365 Days
Purchases 62.78 72.87
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

2-4: Valuation Ratios

Using the summarized financial statements of Zoom ltd. given in problem 1
comment on the firm's performance using the following ratios:
a. Earnings yield
b. Dividends yield
c. Price Earnings (P/E) Ratio
d. Market Price to Book Value (P/B) Ratio
Assume the current market price of Zoom Ltd's shares is Rs. 135 and the price in
2005-06 was Rs.105

Solution:
Valuation Ratios 2005-06 2006-07
Earning Per Share (EPS)
Earnings Yield = x100%
Market Price 2.38 2.74
Dividend Per Share (DPS)
Dividend Yield = x100%
Market Price 0.95 1.10
Market Price
Price Earnings Ratio =
Earning Per Share (EPS) 42.08 36.52
Market Price
Price to Book Value Ratio =
Book Value 4.31 5.08
Net Worth
Book Value Per Share (Rs./Share ) =
Number of shares 24.36 26.58

Analysis:
The returns of the firm as indicated by its earnings yield and dividend yield has
improved during the year 2006-07. This improvement has been primarily on
account of increase in the firm’s earnings. The book value per share has also
improved during the year. Due to the market value increasing more than
proportionately the book value ratio has also improved. The PE ratio has gone
down for the firm. Although the PE ratio of 36.52 is satisfactory, the reduction in
the PE ratio denotes lesser responsiveness of the market to the firm’s
performance. This may be a cause of concern for the firm’s management.

2-5: Ratio Analysis-Comprehensive problem

Profit and Loss Account for Trinetra Ltd. for the year ended 31st March
Rs lakhs 2006 2007
Sales and Other Income 8015.00 9013.50
Cost of goods sold 3767.05 4134.55
Administrative Expenses 2244.20 2312.14
Profit Before Taxes (PBT) 2003.75 2566.81
Taxes 771.45 988.22
Profit After Tax (PAT) 1232.31 1578.59

Balance Sheet of Trinetra Ltd. As on

Rs lakhs 31/03/06 31/03/07
Liabilities and Share Capital
Share Capital 237.61 237.61
Reserves and Surplus 1157.15 1267.39
Secured Loans 115.02 78.49
Unsecured Loans 195.23 144.10
Current Liabilities and Provisions 1729.64 2480.74
Total 3434.66 4208.34
Assets
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

Fixed Assets (Net) 861.02 947.38

Investments 392.24 634.17
Inventories 1078.64 1246.60
Sundry debtors 171.24 173.53
Cash and Bank Balances 242.61 685.40
Other Current Assets 12.51 17.34
Loans and Advances 676.41 503.92
Total 3434.66 4208.34

Based on the above financial information calculate the following ratios:

a. Profitability ratios
b. Liquidity ratios
c. Turnover ratios
d. Capital structure ratios
e. Valuation ratios
f. DU PONT ratios
Comment on the financial performance of Trinetra Ltd. based on the above
ratios.

Solution:
2006 2007
a. Profitability ratios
Sales - Cost of Goods Sold (COGS) 47.78 49.03
Gross Margin = x100
Sales
PAT 17.08 19.46
Net Margin = x100%
Sales
Expenses 0.83 0.79
Expenses Ratio = x100%
Sales
EBIT(1- T) 37.01 38.17
Return on Capital Employed (ROCE) = x100%
Net Assets
Profit After Tax (PAT) 88.35 104.89
Return on Equity (ROE) % = x100%
Net Worth
PAT 51.86 66.44
Earnings Per Share (Rs.) =
Number of shares outstanding
Dividend 23.34 29.90
Dividend Per Share (Rs.) =
Number of shares outstanding
b. Liquidity ratios
Current Assets 1.09 1.07
Current ratio =
Current Liabilitie s
Current Assets - Inventory 0.31 0.44
Acid Test Ratio =
Current Liabilitie s
Cash + Marketable Securities 0.18 0.35
Cash Ratio =
Current Liabilitie s
c. Turnover Ratios
Sales 3.80 2.94
Current Assets Turnover =
Average Current Assets
Cost of Goods Sold (COGS) 3.49 3.32
Inventory Turnover =
Average Inventory
Sales 42.13 46.75
Debtors Turnover =
Average Debtors
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

d. Capital Structure Ratios

Long Term Debt 0.22 0.15
Debt equity Ratio =
Net Worth
Long Term Debt 0.090 0.053
Debt to Assets Ratio =
Net Assets
Total Outside Liabilitie s 1.21 1.47
Total Outside Liabilities to Net Worth =
Net Worth
Total Outside Liabilitie s 0.49 0.52
Total Outside Liabilities to Net Assets =
Net Assets
e. Valuation Ratios
Earning Per Share (EPS) 49.39% 48.85%
Earnings yield = x100%
Market Price
Dividend Per Share (DPS) 22.23% 21.98%
Dividend yield = x100%
Market Price
Market Price 2.02 2.05
Price Earnings ratio =
Earning Per Share (EPS)
Market Price 1.79 2.32
Price to Book Ratio =
Book Value
f. DU PONT ANALYSIS
ROE = Net Profit Margin x Assets Turnover x Financial leverage 88.35 104.89
Net Profit 17.08 19.46
Net Profit Margin =
Sales
Sales 2.10 1.93
Assets Turnover =
Assets
Assets 2.46 2.80
Financial Leverage =
Equity

Following assumptions have been made in solving the problem:

• Interest obligation for the two years has been 12.5% of secured and
unsecured loans
• Par value of equity share is Rs. 10 per share
• Since the data available is only for two years the year ending balances
of inventory/ current assets/ debtors etc have been taken instead of
average value
• Sales contribute to 90% of the Sales and other income
• All secured and unsecured loans are long-term
• Current liabilities are 80% of current liabilities and provision
• Average Market Price per share of Trinetra Ltd. was Rs. 105 in 2006 and
Rs. 136 in 2007
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

2-6: Common-Size Income Statement

Summary of Income Statement of Zeta Ltd for two consecutive years is given
below. Prepare a common-size income statement and interpret the changes.
Income Statements for the year ended
(Figures in Rs. Lakh) 2005-06 2006-07
Sales 79.50 84.60
Less: Sales returns 2.15 1.76
Net Sales 77.35 82.84
Cost of sales 61.12 63.37
Gross Profit 16.22 19.46
Administrative Overheads 1.85 1.94
Selling and distribution overheads 2.63 2.90
Interest and other non operating expenses 0.17 0.20
Operating income 11.75 14.63
Other incomes 0.19 0.94
Profit Before Tax (PBT) 11.77 15.37
Tax 4.53 5.92
Profit After Tax (PAT) 7.24 9.46

Solution:
Common-Size Income Statement
2005-06 2006-07
Net Sales 100.00 100.00
Cost of sales [(Cost of Sales/ Net sales) x 100] 79.02 76.50
Gross Profit [(Gross Profit/ net sales) x100] 20.98 23.50
Administrative Overheads [(Admn. Ovd./ Net Sales) x100] 2.39 2.34
Selling and distribution overheads
[(S&D Overheads/ Net Sales) x100] 3.40 3.50
Interest and other non operating expenses
[(Int. and other non-operating expenses/ Net Sales) x100] 0.22 0.24
Operating income [(Operating income/ Net Sales) x100] 15.19 17.67
Other incomes [(Other income / Net Sales) x100] 0.24 1.14
Profit Before Tax (PBT) [(PBT/ Net Sales) x 100] 15.22 18.57
Tax [(Tax/ Net Sales) x 100] 5.86 7.15
Profit After Tax (PAT) [(PAT/ Net Sales) x 100] 9.36 11.42

Analysis and Interpretation:

1. The firm has been successful in containing its cost of sales as it is evident
from the COS coming down from approx. 79% of the sales to 76.5% of the
sales. This gets reflected further in the gross profit that has gone up from
20.98% of sales in 2005-06 to 23.50% in 2006-07.

2. Although the operating expenses have increased in the year 2006-07

compared to the previous year except the administrative overheads that
have declined marginally, yet the firm’s operating margin as a % of sales
has gone up from 15.19% in 2005-06 to 17.67% in 2006-07. This increase has
primarily on account of the increased gross margin for the firm.

3. Operating profit, PBT and PAT have shown an improvement on account of

two factors - the sales have gone up by 6.42% while cost of sales has
come down from 79% to 76.5% of sales during the year 2006-07.
FINANCIAL MANAGEMENT Solutions to Numerical Problems
Rajiv Srivastava – Dr. Anil Misra Chapter 2

2-7: Common-Size Balance Sheet

Given below are the Balance Sheets of the two firms-Gloria Ltd and Victoria Ltd
As on 31st March 2007
(Figures in Rs. Lakhs) Gloria Ltd. Victoria Ltd.
Cash and bank balance 12.70 38.60
Marketable securities 10.00 21.00
Sundry Debtors 22.00 23.70
Stock 93.50 162.45
Prepaid expenses 1.12 2.15
Current Assets 139.32 247.90
Fixed Assets (Net) 589.00 642.00
Total Assets 728.32 889.90
Sundry Creditors 6.75 26.45
Notes payable 6.56 6.45
Long term debt 130.01 345.00
Equity 585.00 512.00
Total Liabilities & Owners’ Equity 728.32 889.90
a. Can the financial position of the two firms be compared assuming that the
two firms fall in the same industry?
b. Prepare a common size Balance Sheet for the two firms and compare their
financial positions in terms of size and mix of their assets and liabilities

Solution:
a. Though the two firms belong to the same industry, their financial positions
are incomparable on an absolute basis due to their sizes. A sensible and
relevant comparison that is consequential for decision making should be
made on a relative basis.

b. Common-Size Balance Sheet

(Figures in Percentage) Gloria Ltd. Victoria Ltd.
Cash and bank balance 1.744 4.338
Marketable securities 1.373 2.360
Sundry Debtors 3.021 2.663
Stock 12.838 18.255
Prepaid expenses 0.154 0.241
Current Assets 19.129 27.857
Fixed Assets 80.871 72.143
Total Assets 100.00 100.00
Sundry Creditors 0.927 2.972
Notes payable 0.901 0.725
Long term debt 17.851 38.769
Equity 80.322 57.534
Total 100.000 100.000

Analysis and Interpretation:

• Capital intensity of Gloria is higher than that of Victoria ltd.
• The higher proportion of inventory and cash held by Victoria has been
primarily responsible for the high level of current assets of Victoria.
• On the financing side, Victoria is although less capital intensive yet it has
gone for high dosage of debt financing as compared to Gloria. The
management of Victoria has to be watchful as the combination of
lesser fixed assets and higher debt financing may be a risky strategy.
• Victoria is availing credit better provided by its suppliers.