FSM Marathon Mega Revision Notes

CS EXECUTIVE
mega -revision
FINANCIAL & STRATEGIC
MANAGEMENT
CA CS Harish A. Mathariya
FINANCIAL MANAGEMENT
1. Nature & Scope of Financial Management 1.1 – 1.16
2. Working Capital Management 2.1 – 2.11
3. Receivables Management 3.1 – 3.7
4. Inventory Management 4.1 – 4.9
5. Management of Cash & Marketable Securities 5.1 – 5.7
6. Leverages 6.1 – 6.9
7. Capital Structure 7.1 – 7.18
8. Cost of Capital 8.1 – 8.15
9. Capital Budgeting 9.1 – 9.15
10. Dividend Policy 10.1 – 10.12
11. Security Analysis & Portfolio 11.1 – 11.12
12. Project Finance 12.1 – 12.9
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

STRATEGIC MANAGEMENT
13. Introduction To Management 13.1 – 13.3
14. Introduction To Strategic Management 14.1 – 14.3
15. Business Policy & Formulation of Functional Strategy 15.1 – 15.2
16. Strategic Analysis & Planning 16.1 – 16.4
17. Strategic Implementation & Control 17.1 – 17.3
18. Analysing Strategic Edge 18.1 – 18.2

NATURE AND SCOPE OF BY CA CS HARISH A MATHARIYA
FINANCIAL MANAGEMENT 98220 93220

❑ To Compare cash flow arising at different point of time.
Time Value of Money Example:- Amt. invested in a project = ₹ 1,00,000
(Here we will cover) Year Income form project P.V @ 10%
30,000
1 30,000 27,273 = mt
1.10
Present Value Future Value 2 40,000 33,057.85
40,000
= mt
1.10
#Meaning:- “Value of ₹ 1 Today is more than value of ₹ 1 tomorrow 3 50,000 37,655
50,000
= mt
1.10
#Why money has time value?
❑ Opportunity cost (E.g. Interest income) 1,20,000 PV=97,896.32
∴ Do not invest
❑ Risk – Higher Risk Higher time value
∴
PV < Investment
E.g. Interest rate charged Interest rate charged ❑ In capital budgeting decision (Will see later)
by money lender by bank ❑ To value different types of securities (Like shares, debenture)
❑ Inflation – means loss in purchasing power of money #Methods of analysis:-

(Higher inflation rate Higher Time value of money)
To find future value (FV) from
#Why TVOM is Important ? present value (PV)
❑ To take financial decisions. Compounding
Example:- HDFC ICICI Here we will add interest in
Amt. investment 1,00,000 1,00,000 We will use two PV to find FV
techniques in this
Interest rate 10% p.a. 9.8% p.a. chapter to find PV
Compounding Annually Semi-Annually & FV To find PV from FV
Amt. to receive 1,00,000 1,00,000 Discounting
After 1 year (1 + 0.10) 1 + 0.098/2 Here to find PV we will
calculate Interest from FV
= ₹ 1,10,000 = ₹ 1,10,040.1
∴ Conclusion go for ICICI
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 1.1
#Methods to find Future Value (FV)
Simple Interest methods Compound Interest methods Annuity at the end of the year Annuity at the beginning of year
(cash flow at end) (cash flow at beginning)
Here, interest will calculated on
Here, Interest is calculated
original principle as well as interest Annuity:-
on original principle only
earned up to previous period ▪ Means periodic flow of equal cash flow amt.
▪ Amount is equal
#Formula for calculation of simple interest ▪ Time gap between two payments and receipts is equal
❑ Simple interest = P X R X T E.g.
P = Principle • Loan EMI • Insurance • Pension
R = Rate of interest p.a.% • Lease rent • Recurring deposit • Sealey etc.
T = Time period in years
❑ Future Value = Principle + interest #Future Value of single C.F. depends on:-
= P + (P X R X T)
= P (1+RT)
#Compounding (Using compound Interest) Frequency of
PV of Principle Rate of interest Time
compounding
Types of Situation
(for deciding formula)
साल में कितने बार Interest calculate होगा
Annual
Single cash flow Multiple cash flow Annuity Semi Annual Quarterly Monthly
Compounding
Every cash flow has ‘Constant ₹ & constant 4 times in a 12 times in a

separate calculation gap’ Once in a year Twice I a year
year year
Annual Compounding:- Quarterly Compounding
FV = PV (1 + r)n PV = Present Value 𝑟 nx4
FV = PV 1 +
= 1,00,000 (1+0.10)n r = rate of interest 4
= 1,21,000 n = no of years Monthly Compounding

nx12
𝑟
Year 0 Year 1 Year 2
FV = PV 1 +
12
E.g. 10% 10% IMP NOTE:- If question is silent assume annual compounding
1,00,000 1,10,000 1,21,000
Semi-annually nx2
Compounding Future Value of Annuity
𝑟
FV = PV 1 + Case -A: Annuity at the end of period
2
𝒏
E.g. PV = 1,00,000; r = 10%; n= 2years ∴ FV = A
𝟏+𝒓 −𝟏
𝒓
Compounding = semi – annually
0.10 nx2
∴ FV = 1,00,000 1 +
2 Source of above Geometric
2 years X 2
= 1,00,000 (1+0.5) formula = series
= 1,00,000 (1.05) 4
(Calci…(1.05 X 1.05 X 1.05 x 1.05) (Extra – no need (GP series)
= 1,00,000 x 1.215506 to stress)
= 1,21,550.6
Yr. 0 Yr. 1 Yr. 2
I1 I2 I3 I4 Case -B: Annuity at the Beginning of year

𝒏
If interest income asked in above question ∴ FV = A
1+𝑟 −1
(1 + r)
𝑟
Interest = FV – PV
= 1,21,550.6 – 1,00,000
Interest = ₹ 21,550.6
TVOM
Compounding for F.V Future से present Discounting for P.V
निकलिा है !
Simple interest (S.I.) Compounding (S.I.) Single cash flow Multiple cash flow Annuity
Single cash flow Multiple cash flow Annuity Finite annuity ( no. of Infinite annuity (No. of
years are known) years not known)
Annuity occurs @ Annuity occurs @
FV = PV(1+r) PV = A x PV Without growth
end beginning With growth rate
AF(n,r) rate
𝑛 𝑛
1+𝑟 −1 𝑎+𝑟 −1 𝐴 𝐴
FV = A FV = A (1 = 𝑟) Pv = Pv =
𝑟 𝑟 𝑟 𝑟−𝑔
As you already know FV = PV(1 + r)

∴ therefore;
Yrs. Amt. No. of years interest earned F.V = PV(1+r)n A. PV =
𝐹𝑉
(Annual comp.)
❑ S.I. =PXRXT (1+𝑟)𝑛 …………
𝐹𝑉
P = Principle B. PV = 𝑟 𝑛 x 2 ………… (Semi Annual comp.)
(1+ )
R = Rate 2
𝐹𝑉
T = Period C. PV = 𝑟 𝑛 x 4 ………… (Quarterly comp.)
(1+ )
4
❑ FV = P + S.I. 𝐹𝑉
= P + (P X R X T) D. PV = 𝑟 𝑛 x 12………… (Monthly comp.)
(1+ )
12
FV= P (1+RT) ANS Alternative Formula: PV = FV x PVF(n,r)
#Present value of single cash flow #Lets try to calculate PVF by tour own calculation:
n
∴ FV = PV( 1+r)
𝐹𝑉 Eg.1. 10%, 10 years Eg.2. 8%, 3 years
∴ PV = n
(1 + 𝑟) 𝟏 𝟏
OR ∴ = PVF = 0.3855 ∴ = PVF = 0.7938
𝟏.𝟏𝟎 𝟏.𝟎𝟖
PV = F.V. [PV factor (n,r)]
= 10 times ∴ 10 years = 3 times ∴ 3 years
PV factor means PV of ₹ 1 at given rate of interest ‘r’ and given

Eg.3. 2.5%, 4 years Eg.4. 0.8%, 3 years
number of years ‘n’
E.g. ∴
𝟏
= PVF = 0.9060 ∴
𝟏
= PVF = 0.9764
𝟏.𝟎𝟐𝟓 𝟏.𝟎𝟎𝟖
5 years
= 4 times ∴ 4 years = 3 times ∴ 3 years
PV= ? If r = 10% FV= ₹ 1
𝐹𝑉 ₹1 1
∴ PV = = = #PV of multiple cash flows:
(1 + 𝑟)n (1 + 0.10)5 1.6105
∴ PV = 0.6209
0 1 2 3 4 5 6 7 8 9 10
(ii) (i) This present value of ₹ 1

∴ PV = FV X PVF { or in can to be recd. After 5 yr. if 3 Through 10 (3 to 10 years)
say this is PVF of ₹ 1 after 5 disc. Rate is 10% ∴ USE table:- 5,000 each year
yr. if r is 10%}
year Cash Flows Calculation Present value #Present Value of Infinite Annuity
1 1,000 1000/1.12 = (1 Time) M+ 892.857 ❑ Constant Annuity (without growth)
2 2,500 2,500/1.12 = (2 Time) M+ 1992.985
Example:- Find the P.V. of a share of company who pays dividend of ₹
3 5,000 5,000/1.12 = (3 Time) M+ 3558.9 10 p.a. for every year for ever, & required rate of return is 10%
4 5,000 5,000/1.12 = (4 Time) M+ 3177.59
5 5,000 5,000/1.12 = (5 Time) M+ 2837.13
0 1 2 3 4 . . . . . ∞
6 5,000 5,000/1.12 = (6 Time) M+ 2533.155 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐴 ₹ 10
7 5,000 5,000/1.12 = (7 Time) M+ 2261.75 ∴ PV = = = = ₹ 100
𝑅𝑎𝑡𝑒 𝑜𝑓 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟 0.10 𝑦𝑒𝑎𝑟𝑠
8 5,000 5,000/1.12 = (8 Time) M+ 1803.05
9 5,000 5,000/1.12 = (9 Time) M+ 1603.87 Just for knowledge
10 5,000 5,000/1.12 = (10 Time) M+ 1609.87 Source of formula geometric progression series
MRC 22.686.7
❑ PV of Infinite annuity growing at constant growth rate (with Growth)
#PV of multiple cash flows:
Example:- A company pays dividend of ₹ 100 year 1, dividend growth
Logic @ 10% p.a. for of share if rate of return is 20%
1+𝑟 𝑛 −1 𝐴
PV =A ∴ PV = g = Growth rate
𝑟 1+𝑟 𝑛 𝑟 −𝑔
₹ 100 A = Annuity
1+𝑟 𝑛 −1 1 =
=A X 20% − 0.10 Cond: r > g
𝑟 1+𝑟 𝑛
100 (if r < g then Ans is indeterminate)
=
0.20 −0.10
This FV of This is PV
PV = ₹ 1000 Can not be determinate
Annuity factor
OR
[∴ PV = A x P.V. Annuity factor (n,r)]
#Effective rate of interest CALCULATOR STEPS FOR CALCULATIONCALCULATE
If rate of interest is compounded more than once in a year (e.g. semi
annually, quarterly, monthly, etc.)
E.g.
5
0.20 ➞ 𝑓𝑖𝑓𝑡ℎ 𝑟𝑜𝑜𝑡 𝑜𝑓 0.20
Then what is its equivalent annual rate of interest rate ?

Steps – 1 ➞ 0.20 on calculator
Steps – 2 ➞ 12 times
Yr. 0 r = 10% p.a.]
compound semi.
6 month Yr. 1 Steps – 3 ➞ -1
Steps – 4 ➞ ÷5
₹ 100
100 + 5%
₹105
105 + 5%
₹ 110.25
Steps – 5 ➞ +1
∴ Here, effective rate will be :-

Steps – 6 ➞ X = 12 times
Interest = 110.25 – 100 = 10.25
➞
10.25
∴ Rate (effective rate) = = 10.25% E.g. 40.2 (4 rest to power 0.2)
100
∴ 10% compound half yearly = 10.25% compound yearly
Formula:-
Steps – 1 ➞ 4 on calculator
E= 1
𝑚
𝑖 m – 1 Steps – 2 ➞ 12 times
m
E
= Frequency of compounding
= effective rate of interest
Steps – 3 ➞ -1
i = interest rate Steps – 4 ➞ ÷ 0.2
Steps – 5 ➞ +1
Steps – 6 ➞ X = 12 times
INTRODUCTION
Finance is the life blood of a business. The financial PROCUREMENT OF FUNDS
management is study about the process of procuring and
judicious use of financial resources
Procurement of funds inter alia
includes
FINANCIAL MANAGEMENT • Identification of sources of finance
• Determination of finance mix
According to S. C. Kuchhal “Financial Management deals
• Raising of funds
with procurement of funds and and their effective utilization • Division od profits
in the business
FINANCIAL DECISION A business organization can obtain

funds from following sources
Investment Finance Dividend
• Issue of preference or equity shares capital
Decisions Decision Decisions • Issue of debenture
• Careful • Is procurement • Decisions • Loan from banks and financial is institution
selection of of funds keep relating to the • Sale of assets etc.
viable & in view the distribution of
profitable cost of funds earnings
investment
proposals
ROLES OF MANAGER
Forecasting of Managing the

Raising Funds Flow of Urgency
Cash Flow internal funds
Internal
rate of Pay Back
return
To facilities To facilities pricing of product,
cost control product lines and services
DECISION
Present CRITERIA Rate of
Forecasting Measuring Managing value Return
profits required return assets method
Discount Undiscou
Managing ed nted
Funds benefit benefit
cost ratio cost ratio
PROFIT MAXIMIZATION PROFIT MAXIMIZATION & WEALTH MAXIMIZATION
It ensures that the firm utilizes its available resources most Points Profit Maximization Wealth Maximization
efficiently under profit maximization as corporate goal is
criticized by scholars mainly on the following grounds Meaning Profit maximization ensures Aim at increasing the
▪ It is vague conceptually that firm utilizes resources value of the stakeholders
▪ It ignores the timing of returns most efferently
▪ It ignores the risk factor Aim To earn a larger amount To improve the market
▪ May in the long run prove disastrous of profit value of its shares
▪ Emphasis is generally on short-run projects
▪ May cause decreasing shares prices Concept Narrow Boarder
▪ Profit is only one of the many objectives Risk Ignore the risk factor Consider risk
Period Emphasis is generally on On the long run picture
WEALTH MAXIMIZATION short run projects
To see that the shareholders get good return on the shares. Timing of Ignore timing Considers timing of return
Value of the share should increases in the share market. If returns
the company makes a risky investment, people may lose
confidence in the company and the share value will come
down. Thus, wealth or value maximization is the most FINANCIAL DISTRESS
important goal of financial management
▪ Maximizing owner’s economic welfare Is a condition where a company cannot meet, or has
▪ Focuses on the long run picture difficulty paying off, its financial obligation to its creditors
▪ Considers risk due to high fixed costs, illiquid assets or revenues sensitive
▪ Recognizes the value of regular dividend payments to economical downturns
▪ Takes into account time value of money
▪ Maintains market prices of its share
FINANCIAL INSOVENCY
This means the organization can no longer meet its financial
obligations
That is the difference between illness and death!
Permanent financial distress may lead an organization to
the chaotic financial insolvency state
FINANCIAL GEARING IS A DOUBLE EDGED SWORD

Using borrowed funds or fixed-cost funds. High financial
gearing will increases the EPS of the company if earnings
before interest and taxes are rising, as compared to the
EPS of the company with low or no financial gearing. It may
be understood that leverage and gearing are used
interchangeably
However, if the company is not doing well when its profits
before interest and taxes are falling, the EPS of a highly
geared company will fall faster than those of the low
geared company
1. ______ is the life blood of a business. (b) Maximize the value of the firm's common stock.
(a) Finance Manager (c) Maximize return on investment.
(b) Finance (d) Maximize market share.
(c) Financial Management
(d) Corporate Financial Management 6. Financial Management is concerned with –
(a) Investment Decisions
2. "Shareholder wealth" in a firm is represented by – (b) Finance Decisions
(a) The number of people employed in the firm. (c) Dividend Decisions
(b) The book value of the firm's assets less the book value of its liabilities. (d) All of the above
(c) The amount of salary paid to its employees.
(d) The market price per share of the firm's common stock. 7. Procurement of funds inter alia includes –
(a) Identification of sources of finance
3. Financial Management is study – (b) Determination of finance mix
(i) Of the process of procuring and judicious use of financial resources (c) Raising of funds
(ii) Undertaken to maximize the value of the firm /owners. (d) Division of profits between dividends and retention of profits of
Select the correct answer from the options given below. internal funds generation
(a) (I) only Select the correct answer from the options given below.
(b) (II) only (a) (a) & (b)
(c) Both (I) and (II) (b) (a), (c) & (d)
(d) Neither (I) nor (II) (c) (b) & (c)
(d) (c), (a), (d) & (b)
4. To increase a given present value, the discount rate should be adjusted –
(a) Upward 8. Statement (I):
(b) Downward Since funds can be obtained from different sources therefore their
(c) Keep it as it is procurement is always considered as complex a problem by business
(d) None of the above concerns.
Statement (II):
5. Long-run objective of financial management is to – Funds produced from different sources have a different characteristic in
(a) Maximize earnings per share. terms of risk, cost and control.
Select the correct answer from the options given below (b) Enable individuals and small businesses to invest indirectly in money-
(a) Statement I is correct but Statement II is incorrect. market instruments.
(b) Statement II is correct but Statement I is incorrect. (c) Are available only to high net-worth individuals.
(c) Statement I & Statement II both are correct and Statement II support (d) Are involved in acquiring and placing mortgages.
Statement I.
(d) Statement I & Statement II both are incorrect 13. Match the following:
LIST I LIST II
9. The funds raised by the issue of _____ are the best from the risk point of (p) Risk Management 1. Amounts to he retained by the
view for the company. company
(a) equity shares (q) Dividend Decisions 2. Financial planning, controlling &
(b) debentures decision making
(c) both (A) & (B)
(r) Financial manager's primary 3. Determining the proper amt. of funds
(d) none of the above to be employed
responsibility
(s) Financial Analysis & Planning 4. Collect data and present the data
10. A 30-year bond issued by Reliance Ltd. in 2007 would now trade in the
(a) Primary money market 5. Protecting assets
(b) Secondary money market Select the correct answer from the options given below.
(c) Primary capital market (p) (q) (r) (s)
(d) Secondary capital market (a) 5 1 2 3
(b) 5 1 4 3
11. Which of the following is not function of finance manager? (c) 5 1 3 2
(a) Investor relations (d) 3 2 1 4
(b) Credit & collections
(c) Investments 14. The purpose of financial markets is to:
(d) Appointment of financial personnel (a) Increase the price of common stocks
(b) Lower the yield on bonds
12. Money market mutual funds – (c) Allocate savings efficiently
(a) Are also known as finance companies (d) Control inflation
15. ______ ensures that firm utilizes its available resources most efficiently (b) 0.683
under conditions of competitive markets. (c) 0.621
(a) Wealth Maximization (d) 0.513
(b) Profit Maximization
(c) Value Maximization 19. What is the annuity factor for 13% at 5 years?
(d) Relation Maximization (a) 2.974
(b) 3.998
16. For which of the following reason(s) profit maximization concept is (c) 3.517
criticized – (d) 3.402
1. It is vague conceptually.
2. It ignores timing of returns. 20. Find out the present value of projects cash flow from the following data
3. It ignores the risk factor if the cost of capital of the firm is 12%:
4. Its emphasis is generally on short run projects. Year Cash flow PV Factor
Select the correct answer from the options given below 1 20,000 0.893
(a) 1 2 20,000 0.797
(b) 1 & 2 3 20,000 0.712
(c) 1, 2 & 3 4 20,000 0.636
(d) 1, 2, 3 & 4 5 20,000 0.567
(a) 71,200
17. _______ is a condition where a company cannot meet, or has difficulty (b) 72,001
paying off, its financial obligations to its creditors, typically due to high (c) 72,430
fixed costs, illiquid assets, or revenues sensitive to economic downturns (d) 72,100
(a) Financial risk
(b) Financial uncertainty 21. If you invest 10,000 (P0) in a bank at simple interest of 7% p.a., what
(c) Financial certainty will be the amount at the end of 3 (n) years? Note: Use simple interest
(d) Financial distress rate method.
(a) ₹ 12,100
18. What is the present value factor for 1096 at 6 years? (b) ₹ 15,400
(a) 0.564 (c) ₹ 17,500
(d) ₹ 20,600 (a) ₹ 1,425.76
(b) ₹ 425.76
22. 2,000 is deposited in a bank for 2 years at simple interest of 6%. How (c) ₹ 452.76
much will he the balance at the end of 2 years? Note: Use simple interest (d) ₹ 542.67
rate method
(a) ₹ 2,000 26. Ram has taken a 20-month car loan of? ₹ 6,00,000. The rate of interest
(b) ₹ 2,240 is 12% p.a. What will be the amount of monthly loan amortization?
(c) ₹ 2,420 (a) 33,294.1
(d) ₹ 2,640 (b) 33,249.1
(c) 33,924.1
23. Determine the compound interest for an investment of F 7,500 at 6% z (d) 32,349.1
compounded half yearly. Given that (1+i)" for i = 0.03 and n= 12 is
1.42576. 27. Find the amount of an annuity it payment of 500 is made annually for 7
(a) ₹ 3,193.20 years at an interest rate of 14% compounded annually.
(b) ₹ 3,913.20 (a) ₹ 5,356.25
(c) ₹ 3,319.20 (b) ₹ 5,563.52
(d) ₹ 3,139.20 (c) ₹ 5,365.25
(d) ₹ 5,635.52
24. ₹ 2,000 is invested at an annual rate of interest of 10%. What is the
amount after 2 years if the compounding is done semiannually? 28. If 18% is the best risk-free return available, then you would be indifferent
(a) ₹ 2,420.00 to receiving ₹ 100 now or ₹ 118 in one year's time –
(b) ₹ 2,431.00 (a) Expressed another way the present value of ₹ 100 receivable one
(c) ₹ 2,440.58 year hence is ₹ 118
(d) ₹ 2,442.70 (b) Expressed another way the present value of ₹ 118 receivable one
year hence is ₹ 100
25. Determine the compound interest on ₹ 1,000 at 6% compounded semi- (c) Both are correct
annually for 6 years. Given that (1+i)n = 1.42576 for i = 3% and n = (d) Data given is insufficient
12.
29. Y bought a TV costing ? 13,000 by making a down payment of 3,000 (a) ₹ 4,94,775
and agreeing to make equal annual payment for 4 years. How much (b) ₹ 4,49,775
would be each payment if the interest on unpaid amount be 14% (c) ₹ 4,49,577
compounded annually? (d) ₹ 4,47,975
(a) 3,431.71
(b) 3,413.17 32. Assuming that the discount rate is 7% per annum, how much would you
(c) 3,134.17 pay to receive 50, growing at 5%, annually, forever?
(d) 3,341.71 (a) 2,500
(b) 5,200
30. Determine the present value of 700 each paid at the end of each of the (c) 2,200
next 6 years. Assume an 8% interest. (d) 5,500
(a) 7 3,263.10
(b) 3,632.01 33. ABCL Company has issued debentures of ? 50 lakhs to be repaid after 7
(c) 3,326.01 years. How much should the company invest in a sinking fund earning 12%
(d) 3,236.10 in order to be able to repay debentures?
(a) 4.96 lakhs
31. Ramu wants to retire and receive₹ 3,000 a month. He wants to pass this (b) 4.92 lakhs
monthly payment to future generations after his death. He can earn an (c) 4.98 lakhs
interest of 8% compounded annually. How much will he need to set aside (d) 5.00 lakhs
to achieve his perpetuity goal?
Answers
1 B 2 D 3 C 4 B 5 B 6 D 7 D 8 C 9 A 10 D
11 D 12 B 13 C 14 C 15 B 16 D 17 D 18 A 19 C 20 D
21 A 22 B 23 A 24 B 25 B 26 B 27 C 28 B 29 A 30 D
31 B 32 A 33 A
WORKING CAPITAL BY CA CS HARISH A MATHARIYA
MANAGEMENT 98220 93220

CONCEPT OF WORKING CAPITAL For reducing and controlling working capital requirement, the
“The excess of current assets over current liabilities and provision” following 3 aspects are to considered
Working capital is also is known as operating capital
Positive working capital is able to pay off its short-term liabilities. Reduction of Increases of Reduction in
Negative working capital means that the company currently is manufacturing credit period credit period
unable to meet its short-term liabilities cycle allowed by given to
creditor customers
FORMAT OF COMPUTATION OF WORKING CAPITAL
Particulars ₹ ADEQUACY OF CURRENT ASSETS
Current Assets XXXX To ensure the survival of the business & to pay day-to-day
expenses /to creditors
(A) XXXX
Current Liabilities XXXX WORKING CAPITAL BASED ON CASH COST
This approach is based on the fact that in the case of current assets,
(B) XXXX like debtors and finished goods, etc. the exact amount of funds
Gross working Capital (A) – (B) XXXX blocked is less than the amount od such current assets
(+) Contingencies XXXX
OPERATING CYCLE
Net Working Capital XXXX A useful tool for managing working capital is the operating cycle
analyzes accounts receivable, inventory, and accounts payable cycle
WORKING CAPITAL MANAGEMENT IS IMPORTANT in terms of the number of days
Twin objectives are to maximize profit and maximize the The Working Capital cycle indicates the length of time between a
shareholder’s wealth. For maximizing the profits, sales value has to company’s paying for materials, entering into stock, and receiving
be improved and the cost is too reduced the cash from sales of finished goods
Computation of working capital with help of operating cycle TYPES OF WORKING CAPITAL
concept
Initial working • Required at the time of the commencement
1. Percentage od 2. Regression 3. Operating Cycle capital
sales Method Analyses Method Approach of business
Regular Working • Working Capital remains always in the

Capital enterprise for the successful operation
Operating Cycle = R + W + F + D – C
Where,
Fluctuating • Capital is needed to meet the seasonal requirement
R = Raw material conversion period Working Capital od the business also called variable working capital
W = Work in progress conversion period
F = Finished goods conversion period
D = Debtors collection period Reserve margin • It represent the amount utilized at the time
C = Creditors payment period working capital of contingencies
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘
Raw material conversion period = 𝑋 365 𝑑𝑎𝑦𝑠
𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑑 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 Permanent & • To carry on a business a certain minimum level of
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑊𝐼𝑃 Temporary working capital is necessary on a continuous and
WIP conversion period = 𝑋 365 𝑑𝑎𝑦𝑠 Working Capital uninterrupted basis
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠
Finished goods conversion period = 𝑋 365 𝑑𝑎𝑦𝑠
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
Gross Working • Refers to the firm’s investment in current
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 Capital
Debtors collection period = 𝑋 365 𝑑𝑎𝑦𝑠 assets
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑙𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒
Creditors payment period = 𝑋 365 𝑑𝑎𝑦𝑠
𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 Net working • Refers to the difference between current
Working Capital =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡
𝑋 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 𝑐𝑜𝑠𝑡
capital asset and current liabilities
365 𝑑𝑎𝑦𝑠
HARDCORE WORKING CAPITAL WORKING CAPITAL & DIVIDEND POLICY
Hard core working capital or core current assets as that part of the Payment of dividends may reduce cash in current assets
current assets which represent the very minimum level of raw considerably which in turn may reduce the available working for
materials, work in process, finished goods, stores, debtors, and cash the company
which is in circulated to ensure continuity of production are blocked Working Capital Leverage
for long term. In relation to inventory, the base stock is treated as Working capital leverage is measured as under
hard core. Vary from industry to industry
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑂𝐶𝐸
Working Capital Leverage =
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑡𝑠
POSITIVE WORKING CAPITAL AND NEGATIVE OR

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
WORKING CAPITAL Working Capital Leverage =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑡𝑠 − ∆ 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
Gross ∆ Current Assets = Change in current assets

Working • Firm’s investment in current assets 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 & 𝑇𝑎𝑥 (𝐸𝐵𝐼𝑇)
Capital Return on capital employed (ROCE) = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑡𝑠 𝑜𝑟 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
Net Working • Difference between current assets and

Capital current liabilities LIQUIDITY VS PROFITABILITY
A Positive • Means the company is able to pay off its Particulars Liquidity Risk
working short term liabilities
Capital Greater
Conservative current assets policy Greater Risk
Liquidity
A Negative • Company currently in unable to meet its
Working Moderate
short term liabilities Moderate current assets policy Moderate Risk
Capital Liquidity
Aggressive current assets policy Poor Liquidity Poor Risk
HARDCORE WORKING CAPITAL WORKING CAPITAL & DIVIDEND POLICY
Sources of permanent working capital First method of lending
• Owner's Funds • [75% of (Current assets – Current Liabilities)]
• Bonds Financing • This method of lending gives a current ratio of only 1:1
• Term Loan from banks
• Shot term borrowing Second method of lending
Source od variable working capital • [75% of Current assets – Current Liabilities]
• Trade Creditors • Gives a current ratio of only 1:33:1
• Bank Loan Third method of lending
• Commercial paper
• Depreciation as a source of working capital • [75% of (Current assets – Core current Assets)] – Current
• Tax liabilities Liabilities
• Other miscellaneous sources are dealer deposits., customer • Will provide the largest multiple of bank finance
advance etc.
TANDON COMMITTEE NORMS

ON WORKING CAPITAL
• Was constituted framing guidelines for commercial
banks for follow-up & supervision of bank credit
for ensuring proper end use of funds
1. Working capital is also known as – (b) increase the credit period allowed by creditors to the extent that does
(a) Operation capital not affect the production
(b) Operating capital (c) Increase in credit period given to customers
(c) Current assets capital (d) All Of the above
(d) Capital relating to the main projects of the company
5. Statement 1:
2. Which of the following will be considered while calculating working Maintaining adequate working capital is not just important in the short-
capital? term. Sufficient liquidity must be maintained in order to ensure the survival
(1) Short Term Advances of the business in the long-term as well.
(2) Stock of WIP Statement II
(3) Short-Term Investments Even a profitable business may fail if it does not have adequate cash flow
(4) Perpetual inventory policy to meet its liabilities as they fall due.
Select the correct answer from the options given below. Select the correct answer from the options given below.
(a) (2) & (3) (a) Statement I is correct while Statement II is incorrect.
(b) (1) & (3) (b) Statement II is correct while Statement I is incorrect.
(c) (1), (2) & (3) (c) Both Statement I and Statement 11 are correct.
(d) All of the above except (4) (d) Both Statement I and Statement II are incorrect.
3. Contingencies are – 6. Initial Working Capital –

(a) Added to gross working capital (a) Supplies the funds necessary to meet the current working expenses.
(b) Deducted from gross working capital (b) Is used to raise the volume of production by improvement or extension
(c) Contingencies are not considered in financial management; it is of machinery.
considered in accounts only (c) Is required at the time of the commencement of business
(d) None of the above (d) Represents the amount utilized at the time of contingencies.
4. For reducing and controlling working capital requirement which of the 7. Which of the following is determinant of working capital?
following step is required to be taken – (1) Nature and size of business
(a) Increase in the manufacturing cycle (2) Manufacturing cycle
(3) Credit policy
(4) Production policy (c) Both (A) and (B)
Select the correct answer from the options given below. (d) Neither (A) nor (B)
(a) (1) only
(b) (1) and (2) only 12. A conservative policy implies –
(c) (1), (2) and (3) only (a) Greater liquidity and lower risk
(d) (1), (2), (3) and (4) (b) Greater risk and lower liquidity
(c) Negligible risk
8. Operating cycle is also called as – (d) No risk at all with low liquidity
(a) working cycle
(b) Business cycle 13. which of the following represents the amount utilized at the time of
(c) Current asset cycle contingencies?
(d) Working capital cycle (a) Reserve Working Capital
(b) Net working capital
9. Capital which is needed to meet the seasonal requirements of the business (c) Extra working capital
– (d) fixed working capital
(a) Gross Working Capital
(b) Reserve Margin Working Capital 14. Any amount over and above the permanent level of working capital is
(c) Net working capital known as _____ working capital.
(d) Fluctuating Working Capital (a) Temporary
(b) Fluctuating
10. A higher current assets/fixed assets ratio indicates – (c) Variable
(a) Hedging Approach (d) All of the above
(b) Conservative Approach
(c) Matching/hedging Approach 15. Current assets are usually financed through -
(d) Aggressive Approach (a) equity capital, preference capital, debentures, bonds and long term
bank loans.
11. Aggressive approach covers those policies – (b) (A) and (C)
(a) Where the firm relies heavily on short term bank finance (c) mode of overdraft, cash credit, public deposits etc.
(b) Seeks to increase dependence on long term financing. (d) money market instrument and long term securities.
20. It is understood that a current ratio of _____ for a manufacturing firm
16. Which of the following is/are method of maximum permissible bank implies that the firm has an optimum amount of working capital.
finance as recommended by the Tandon Committee? (a) 1 (one)
(a) 75% of (Current Assets - Current Liabilities) (b) 2 (two)
(b) 50% of (Current Assets - Current Liabilities) (c) 3 (three)
(c) 75% of (Core Current Assets -Current Liabilities) (d) 2.5 (two and half)
(d) 50% of (Core Current Assets -Current Liabilities) 21. If raw material consumed is 8,42,000; cost of production is ₹ 14,25,000;
Stock of raw material WIP is 1,24,000 and ₹ 72,000 respectively then
17. _____ varies inversely with profitability. Raw Material Conversion period will be –
(a) Liquidity Note: 1 Year = 365 days
(b) Risk (a) 54 days
(c) Gross profit (b) 18 days
(d) None of the above (c) 29 days
(d) 49 days
18. Financing a long-lived asset with short-term financing would be
(a) an example of "moderate risk -moderate (potential)profitability" asset 22. Calculate the working capital from the following data:
financing. Particulars ₹
(b) an example of "low risk - low (potential) profitability" asset financing. Raw material Stock 11,70,000
(c) an example of "high risk - high (potential) profitability" asset financing.
WIP Stock 9,58,750
(d) an example of the "hedging approach" to financing.
Finished Goods Stock 26,65,000
19. In deciding the appropriate level of current assets for the firm, Debtors 55,12,000
management is confronted with – Cash Bank 6,00,000
(a) Trade-off between profitability and risk. Creditors 17,55,000
(b) Trade-off between liquidity and marketability. Outstanding expenses 14,95,000
(c) Trade-off between equity and debt. (a) 76,75,550
(d) Trade-off between short-term versus long-term borrowing. (b) 76,55,750
(c) 75,65,750
(d) 77,55,650
23. Annual credit sales = ₹ 19,50000 26. A Ltd. financial statement shows the following data: Equity 5,67,500,
Cash sales = ₹ 1,50 000 Reserve & surplus 3,87,850, total debt ₹ 5,88,778 out of which ₹
Debtors = ₹ 1,60 000 2,88,778 are long term debt, fixed assets are 11,44,128.
Bills receivable = ₹ 1,00 000 Current Ratio = ?
Finished goods = ₹ 1,22,000 (a) 2.48
Collection Period = ? (b) 1.92
Note: 1 Year = 360 days (c) 3.68
(a) 29 days (d) 1.33
(b) 30 days
(c) 48 days 27. Raw material consumption = ₹ 6,48,000
(d) Data given in not sufficient Raw material purchase = ₹ 8,42,000
Annual cost of production = ₹ 14,42,000
24. Financial statement of A Ltd. shows the folk)wing data: Creditors = ₹ 75,000
Opening stock ₹ 1,75,000, Total purchase ₹ 10,75,000 including cash Bills payable = ₹ 25,000
purchase ₹ 1,75,000, Total sales 15,00,000 out of which 20% are on Creditors Payment Period = ?
cash basis. Closing stock is ₹ 1,50,000. Stock turnover ratio Note: 1 Year = 360 days
(a) 7.67 (a) 34 days
(b) 6.77 (b) 43 days
(c) 7.76 (c) 40 days
(d) 7.66 (d) 39 days
25. WIP Conversion Period = 18 days Raw Material Consumed = ₹ 8,42,000 28. The following information is available for your calculation.
Stock of WIP = 72,000 Cost of Production = ? Level of activity = 1,56,000 units
(a) 14,00,000 (₹ per unit)
(b) 22,67,000 Raw Materials 90
(c) 5,83,000 Direct Labour 40
(d) 14,60 000 Overheads 75
205
Profit 60 You are required to calculate working capital on cash cost basis.
Selling Price 265 (a) ₹ 4,20,000
Raw materials are in stock on average two month and Materials are in (b) ₹ 4,66,667
process, on average half month. (c) ₹ 7,35,000
Calculate value of Raw Material Stock for working capital purpose. (d) ₹ 8,16,667
(a) 26,65,000
(b) 23,40,000
31. KT Ltd. opening stock was ₹ 2,50,000 and closing stock was ₹ 3,75,000.
(c) 6,45,250
(d) 9,58,750
Sales during the year was ₹ 13,00,000 and gross profit ratio was 25%
on sales. Average accounts payable are ₹ 80,000. Creditors Turnover
Ratio = ?
29. Current assets of Z Ltd. are ₹ 3,70,000 which includes stock ₹ 1,00,000 (a) 13.75
and prepaid expense ₹ 70,000. Its current liability are ₹ 1,60,000 which (b) 14.33
includes provision for tax ₹ 60,000. (c) 13.33
Liquid Ratio = ? (d) 14.44
(a) 1.25
(b) 1.52
32. Opening and closing balance of creditors are ₹ 2,00,000 & ₹ 2,40,000
(c) 1.22
(d) 0.95
respectively. Raw material purchased on credit was ₹ 11,00,000.
Creditors payment period for the purpose of working capital statement
will be –
30. Following information is provided by the DPS Ltd. for the year ending [1 Year = 360 days]
31st March, 2019. (a) 72 days
Raw material storage period 55 days (b) 32 days
WIP conversion period 18 days (c) 65 days
Finished goods storage period 22 days (d) 78 days
Debt collection period 45 days
Creditor's payment period 60 days
33. Debtors as per working capital statement = 3,00,000
Annual operating cost including depreciation of ₹ 2,10,000 was ₹
Debtors collection period = 45 days
21,00,000.
Gross profit ratio 20%
[1 Year = 360 days]
Cash sales 5,00,000 36. If current assets are ₹ 1,09,05,750 and current liabilities are ₹ 32,50,000
Note: 1 Year = 365 days then maximum permissible bank finance as per second method of Tandon
Total sales =? Committee norms is –
(a) 24,00,000 (a) ₹ 57,41,813
(b) 19,00,000 (b) ₹ 49,29,313
(c) 29,00,000 (c) ₹ 52,29,813
(d) 25,00,000 (d) ₹ 49,41,813
34. Operating cost is ₹ 18,90,000. 37. Total wages for the year of Rakshit Ltd., a listed company are ₹
Current assets are ₹ 5,20,000 64,80,000 out of which ₹ 2,40,000 are paid in cash immediately after
Current liabilities are ₹ 1,00,000 they became due.
Operating cycle days =? Lag in payment of wages - 1 month. If you are appointed to prepare
(Assume a 360-day year.) working capital statement for the company, then how much outstanding
(a) 80 days wages you will take while preparing working capital statement?
(b) 99 days (a) ₹ 5,40,000
(c) 19 days
(b) ₹ 5,50,000
(d) 70 days
(c) Not enough data
(d) ₹ 5,20,000
35. If current assets are ₹ 1,09,05,750 and current liabilities are ₹ 32,50,000
then maximum permissible bank finance as per first method of Tandon 38. Outstanding overheads appearing in balance sheet are 9,75,000. Lag in
Committee norms is – payment of overheads is 30 days. Overheads accrue evenly throughout
(a) ₹ 57,41,813 the year. Total overheads incurred by the company are –
(b) ₹ 49,29,313 (a) ₹ 1,17,00,000
(c) ₹ 52,29,813 (b) ₹ 32,500
(d) ₹ 49,41,813 (c) ₹ 2,92,50,000
(d) ₹ 1,92,50,000
39. Following is the balance sheet of PBX Ltd. Calculate maximum permissible Fixed Assets 1,000
bank finance by Third Method of Tandon Committee norms. Assume the Current Assets:
level of Core Assets to be ₹ 60 lakhs. Raw Material 200
LIABILITIES ₹ Work-in-progress 300
Lakhs
Finished Goods 150
Equity Shares (₹ 10 400
Debtors 200
each)
Cash at Bank 110
Retained Earnings 1,000
1,960
Public Deposits 200
Trade Creditors 160 (a) ₹ 450 lakhs
(b) ₹ 360 lakhs
Bills Payable 200
(c) ₹ 315 lakhs
1,960
(d) ₹ 425 lakhs
ASSETS Lakhs
Answers
1 B 2 D 3 A 4 B 5 C 6 C 7 D 8 D 9 D 10 B
11 A 12 A 13 A 14 D 15 C 16 A 17 A 18 C 19 A 20 B
21 A 22 B 23 C 24 B 25 D 26 D 27 B 28 B 29 A 30 A
31 A 32 A 33 C 34 A 35 A 36 B 37 D 38 A 39 C
RECEIVABLES MANAGEMENT
BY CA CS HARISH A MATHARIYA
98220 93220

MANAGEMENT OF RECEIVABLES FACTORING
Receivables means the book debts or debtors these arise, if the Is an arrangement to have debts collected by a third entity for a
goods are sold on credit. Debtors involve an element of risk and fee. A large business house has two options, namely either to
bad debts also. Hence, it calls for careful analysis is and proper manage its own receivables or to entrust the task of such
management. For this purpose, a finance manager has management to a third party for a fee.
❑ Obtain the optimum (not maximum) value of sales; ❑ Parties in Factoring
❑ Control the cost of receivables ▪ Seller, who has produced the goods/services and raised the
❑ Maintain the debtors at minimum invoice
❑ Offer cash discount suitably
▪ Buyer, consumer of goods
CREDIT EVALUATION ▪ Factor financial institution that advances the portion of funds
Involves the following 5 stages to the seller and recovers the amount from the buyer
❑ Gathering credit information of the customer ❑ Factoring Arrangement
▪ Financial statement ▪ Factor enters into an agreement
▪ Bank Transfer ▪ Pays 80% or more of the amount of receivables
▪ Reports of credit rating ▪ Factor receives payments from the buyer on due date
❑ Credit Analysis
❑ Functions of a Factor
▪ The creditworthiness of the applicant is to be analyzed
❑ Credit Decision ▪ Administration of sellers’ sales ledger
▪ Is the decision to extend the credit facility ▪ Collection of receivables
❑ Credit Limit ▪ Provision of finance
❑ If the decision is to extend the credit facility, a limit may be ▪ Protection against risk of bad debts
prescribed by the financial manager ▪ Rendering advisory services
❑ Collection Procedure
▪ A suitable & clear cut collection procedure is to be established
ADVANTAGES OF FACTORING DEBT SECURITIZATION
❑ Provide specialized with regard to sales administration and Is a process by which a company clubs its different financial assets
credit control to form a consolidated financial instrument that is used by investors.
❑ Increase his liquid resources
❑ It provides flexibility to the company In return, the investors in such securities get interested.
❑ Enables the company to meet seasonal demands Securitization is a long-term finance arrangement
❑ Better purchases planning is possible Four parties are involved in securitization i.e. Obligor, Owner,
❑ Saves the management time Special purpose vehicle, investor
❑ It ensures better management of receivables
ADVANTAGES OF FACTORING FORFAITING
Financing used by exporters that enables them to receive cash
Non-Recourse /Fully factoring Recourse Factoring immediately by selling their medium-term receivables
• Bank takes all the risk and • Any loss arising out or bad
bear all the loss in case of debts will be borne by the
debts becoming bad debts company
Maturity Factoring Advance Factoring

• Does not given any advance • Factor provides an advance
to the company against the uncontrolled and
non due receivables to the
firm
Undisclosed Factoring Invoice Discounting

• The customer is mot informed • Bank provides an advance to the
of the factoring arrangement company against the account
receivable and in turn charges an
interest rate from the company for
the payment
1. Receivables means – 4. What do we call, when a firm extends credit terms that encourage the
(i) Book debts buyers of certain products to take delivery before the peak sales period
(ii) Debtors and to defer payment until after the peak sales period?
(iii) Account receivables (a) Trade account
Select correct answer from the options given below (b) Cash discount
(a) I&II (c) Peak trade account
(b) II&III (d) Seasonal dating
(c) I & Ill
(d) All of the above 5. The payment terms 2/10, Net 30 tell us that:
(a) 2% discount will be awarded if the payment is made within 10 days
2. Receivables arise – of invoice date; otherwise, the full amount is payable within next 10
1. If the goods are sold on credit. days of invoice date.
2. If the goods are sold on cash (b) 10% discount will be awarded if the payment is made within 20 days
3. If the services are rendered on credit of invoice date; otherwise, z the full amount is payable within 30 days
4. If the services are rendered on cash. of invoice date.
Select correct answer from the options given below: (c) 2% discount will be awarded if the payment is made within 30 days
(a) 1 only of invoice date; otherwise, the full amount is payable within next 10
(b) 1 & 2 days of the invoice date.
(c) 1 & 3 (d) 2% discount will be awarded if the payment is made within 10 days
(d) All 1 to 4 of invoice date; otherwise, the full amount is payable within 30 days
of invoice date.
3. The goal of receivables management is to maximize the value of the firm
by achieving a trade-off between 6. Which of the following sentence describes correct strategy for proper
(a) Risk & Profitability administration of receivables?
(b) Liquidity & Profitability (a) Most of the firms dissuade credit sales to first time customers.
(c) Return & Profitability (b) Promoting cash sales
(d) Return & Liquidity (c) Firms must have special staff earmarked for recovery efforts.
(d) (A) and (C)
7. Increasing the credit period from 30 to 60 days, in response to a similar 10. _____ is an arrangement to have debts collected by a third-party entity
action taken by all of our competitors, would likely result in: for a fee.
(a) An increase in the average collection period. (a) Factoring
(b) A decrease in bad debt losses. (b) Aging
(c) An increase in sales. (c) Forming
(d) Higher profits. (d) Crediting
8. An exercise of credit rating involves –

11. In_____ type of factoring the bank/factor takes all the risk and bear all
(a) Doing it internally by a team within the firm
the loss in case of debts becoming bad debts.
(b) Doing it through external special agencies.
(a) Non-Recourse Factoring
(c) (A) or (B)
(b) Invoice Discounting
(d) None of the above
(c) Maturity Factoring
(d) Recourse Factoring
9. Place the methods of collecting on delinquent accounts from the most likely
lowest to highest cost.
12. In factoring arrangement the debts as and when fall due are collected by
(a) Letters, phone calls, legal action, and personal visits.
the –
(b) Phone calls, letters, legal action, and personal visits.
(a) Debtor
(c) Letters, phone calls, personal visits, and legal action.
(b) Seller
(d) Personal visits, phone calls, letters, and legal action.
(c) Factor
(d) Agent
14. Romoji Ltd. has sales of ₹ 1,18,00,000 and its debtor turnover ratio is
13. If credit sales for the year is ₹ 5,40,000 and Debtors at the end of year 4:2. Cost of goods sold is ₹ 82,60,000. Debtors = ?
is ₹ 90,000 the Average Collection Period will be – (a) ₹ 19,66,725
(a) 30 days (b) ₹ 19,67,333
(b) 61days (c) ₹ 19,66,263
(c) 90 days (d) ₹ 19,66,667
(d) 120 days
15. X Ltd. cash sales and credit sales are ₹ 5,67,500 & ₹ 87,50,000 (b) ₹ 2,40,000
respectively. Cost of goods sold is ₹ 61,25,000. Debtors are ₹ 8,20,833 (c) ₹ 2,36,712
and bills receivable are ₹ 2,00,000. Debtors turnover ratio = ? (d) ₹ 2,40,721
(a) 6.00
(b) 7.46 19. F Ltd. is examining relaxation of its credit policy. It sells at present 20,000
(c) 10.66 units at a price of ₹ 100 per unit, the variable cost per unit is ₹ 88 and
(d) 5.38 average cost per unit at the current sales volume is ₹ 92. All the sales are
on credit, the average collection period being 36 days. A relaxed credit
16. Total sales of LMN Ltd. are ₹ 31,248 out of which 25% are cash sales. policy is expected to increase sales by 10% and the average age of
Closing balance of debtors are ₹ 9,468. Debtors velocity = ? receivables to 60 days. Assuming 15% return, should F Ltd. relax its credit
(a) 4.2 months policy?
(b) 157 days Note: 1 Year = 360 days
(c) 148 days (a) Yes, F Ltd. can change its policy as it leads to 15.79% increase in
(d) 4.43 months profit
(b) No, F Ltd. need not to change its policy as there is no incremental
17. Debtors velocity = 3 months return.
Sales = ₹ 25,00,000 (c) Yes, F Ltd. can change its policy 5 as it lead to the incremental return
Bills receivable & Bills payable were 60,000 and 36,667 respectively. of ₹ 2,400.
the sundry debtors = ? (d) None of the above option is correct. s
(a) ₹ 6,25.000
(b) ₹ 5,25,000 20. Average cost increases from ₹ 88 to ₹ 92. Incremental profit &
(c) ₹ 6,65,000 incremental debtors are ₹ 48,000 & ₹ 3,04,000 respectively. Cost of
(d) ₹ 5,65,000 capital is 15%. What is the rate of incremental return on change of credit
policy?
18. K Ltd. had sales last year of ₹ 26,50,000, including cash sales of ₹ (a) 15.79%
2,50,000. If its average collection Period was 36 days, its ending accounts (b) No incremental return
receivable balance is closest to _____ (Assume a 365 day year.) (c) 0.79%
(a) ₹ 2,63,127 (d) 1.58%
(d) Increased by 1,04,635
21. In order to increase sales from normal level of ₹ 2,40,000 per annum, the
marketing manager submits following two proposal for relaxing credit 23. A company has sales of ₹ 25,00,000. Average collection period is 50
policy: days, bad debts losses are 5% of sales and collection expenses are ₹
Proposal I: 25,000. The cost of funds is 15%. The company has two alternative
Increase credit period from 30 days to 45 days which will lead to increase collection programmes:
in sales by 12,000. Particulars I II
Proposal II:
Average collection 40 days 30
Increase credit period from 30 days to 60 days which will lead to increase
period days
in sales by 18,000.
P/V Ratio and excepted pre-tax rate of return are 33.33% and 20 Bad debt reduced to 4% of 3% of
respectively. Which of the following statement is correct? ` sales sales
Debtors are calculated on sales. Collection expenses ₹ ₹
(a) Data given in question is not sufficient because without data as to cost 50,000 80,000
no conclusion can be drawn. Debtors are calculated on sales.
(b) As compared to present policy, profit will increase by ₹ 1,800 for Advice the company by selecting the most correct option –
Proposal I and by ₹ 2,000 for Proposal II. (a) The company should shift toward Programme I as profit is increasing
(c) As compared to present policy, profit will increase by ₹ 1,700 for by ₹ 10,274.
Proposal I and by ₹ 2,000 for Proposal II. (b) The company should shift toward Programme II as profit is increasing
(d) As compared to present policy, 1,700 profit will increase by ₹ 1,700 by ₹ 15,548.
for proposal I by ₹ 1,400 for proposal II (c) The company should not change its policy as Programme I &
Programme II does not have any incremental profits.
(d) The company may shift to Programme I or Programme II as both have
22. A firm has current sales of ₹ 25,48,000. The firm has unutilized capacity.
In order to boost its sales, it is considering the relaxation in its credit policy. incremental profit of ₹ 10,274 & ₹ 15,548 respectively but
The proposed terms of credit will be 60 days credit against the present Programme II will be selected as it has more incremental profit as
policy of 45 days. As a result, debtors (calculated on sales) will be – compared to Programme I.
(a) Increased by 1,06,735
(b) Decreased by 1,04,712 24. H Ltd. has current sales of ₹ 20,00,000. It is planning to introduce a
(c) Increased by 1,06,167 discount policy of 2/10, Net 30. As a result, the Company expects the
average collection period to go down by 10 days and 80% of the sales (b) Profit will increase by ₹ 9,986
opt for cash discount facility. Required return on investment is 20%, should (c) Profit will increase by ₹ 8,986
it introduce the new discount policy? (d) Profit will decrease by ₹ 9,986
(a) Yes, as profit is increasing by ₹ 20,888.
(b) No, as profit is decreasing by ₹ 20,889. 26. G Ltd. presently gives credit terms of 'net 30 days'. It has ₹ 600 lakh in
(c) Make no policy change. credit sales and its average collection period is 45 days. To stimulate
(d) No, as profit is decreasing by ₹ 20,837. sales, the company may give credit terms of 'net 60 days' with sales
expected to increase by 15%. After the change, the average collection
25. Present credit terms of P Ltd. are 1/10 Net 30. Its annual sales are ₹ 80 period is expected to be 75 days. Variable cost to sales ratio is 80% and
lakhs, its average collection period is 20 days. Its variable and average before tax required rate of return on investment in receivables is 20%.
total costs to sales are 0.85 & 0.95 and its K. is 10%. Proportion of sales Assume 360 days in a year. Debtors are calculated on sales. Should the
on which customers currently take discount is 0.5. Company is relaxing its company extend its credit period?
discount terms to 2/10 Net 30 which will increase sales by ₹ 5 lakh, (a) Yes, as there is incremental return of 26.18%
reduce average collection period to 14 days and increase the proportion (b) Yes, as there is incremental return of 26.32%
of discount to sales to 0.8. What will be the effect of on company's profit? (c) Yes, as there is incremental return of 26.52%
Take year as 360 days. Debtors are calculated on cost. (d) Yes, as there is incremental return 4 of 26.81%
(a) Profit will increase by ₹ 9,900
Answers
1 D 2 C 3 A 4 D 5 D 6 D 7 A 8 C 9 C 10 A
11 A 12 C 13 B 14 D 15 A 16 C 17 D 18 C 19 A 20 A
21 D 22 C 23 D 24 B 25 D 26 A
INVENTORY MANAGEMENT
BY CA CS HARISH A MATHARIYA
98220 93220

MEANING ID ‘INVENTORY’ & NEED FOR PROPER MARTIALS INSPECTION NOTE
INVENTORY CONTROL When materials are unloaded, the warehouse staff checks the
Defined inventory as, tangible property held: material unloaded with the delivery note. Then the warehouse staff
▪ For sale in the ordinary course of business (Finished Goods) or prepares a Materials receipt note, a copy of which is given to the
▪ In the process of production for sale (WIP) or supplier. After receiving the inspection department thoroughly
▪ For consumption in the production of goods or service for sale, inspect whether the quality of the material is in accordance with the
including maintenance supplies and consumables other than purchase, and prepares a note called material inspection note
machinery spares (Raw Material)
MATERIAL TRANSFER NOTE
DORMANT STOCK AND SLOW MOVEING STOCK Transferred from one department or job to another within the
organization transfer note should be raised
Dormant/Non-Moving stock Slow Moving Stock BILL OF MATERIAL
• Which are not moving temporarily • Which are moving at a slow rate List of materials, with specifications, materials codes, and quantity
but their movement is expected of each martial required for a particular job, process, or
shortly
production unit
PURCHASE REQUISITION
REQUIREMENT FOR EFFICIENT SYSTEM OF Manager of purchase department obtains requisition from the store
MATERIAL CONTROL BIN CARD
Features of material cost control Indicates the level of each particular item of stock at any point of
▪ Quality and specification of material shall be commensurate with item. It is attached to the concerned bin, rack or place where the
the requirement raw material is stored
▪ Timely Procurement STORE LEDGER
▪ Overstocking should also be avoided
▪ Wastage and losses be avoided Records the quantity details, rates and values of stock movement.
▪ Materials should be properly classified and accounted
TECHNIQUE USED FOR INVENTORY VALUATION SPOILAGE
❑ First in First Out Method Are those materials or components which are so damaged in the
❑ Last in First Out Method manufacturing process that they cannot be repaired or
❑ Average Cost Method reconditioned. Some spoilage may be sold as seconds. IF they are
❑ Highest in First-Out Method
❑ Base Stock Method badly spoiled they can be sold as waste or scrap.
▪ Any inventory level up to the base stock would be valued at a
uniform figure and any surplus over the base stock is valued DEFECTIVE
in accordance with any other appropriate method like, FIFA, That portion of the process loss, can be converted into a finished
LIFO, etc. product by incurring more material and labor expenses
❑ Standard Cost Method
❑ Adjusted Selling Price Method VARIOUS TECHNIQUE USED FOR INVENTORY
❑ Specific Identification Method
❑ Market Price Method CONTROL
WASTE ❑ Min-Max Plan:
Comprises invisible loss, a visible loss that cannot be collected, and ▪ Lays down a Minimum and Maximum quantity for each stock
also the unsaleable portion. Waste is excluded from output ❑ Two Bin system
quantity ▪ For each item of stock, two poles or buns are maintained. The
Examples: Smoke, dust, gases, slag, etc. first bin stock the quantity
Normal Waste Unavoidable and uncontrollable ❑ Order cycling system
▪ Quantities in the hand of each item or class of stock is
Abnormal Waste Cost is transferred to the costing P & L a/c reviewed periodically and order is placed according
❑ ABC Plan
SCRAP ▪ Exercising selective control over inventory items classifies them
Represents the unusable loss, which can be sold. And has a minor into A, B & C
Value.
Example: Cut pieces in leather industry ❑ Fixation of various levels
▪ Stock levels are fixed for every item of stores
❑ Use of a perpetual inventory system and continuous verifications MINIMUM STOCK LEVEL
❑ Use of control ratios
▪ Help management avoid capital being locked up
Lowest figure of stock, which must be maintained at all time
❑ Review of slow and non-moving items
▪ Be identified and speedily disposed of • Minimum level = Re-order – (Average or normal usage X
Average re-order period)
ABC ANALYSIS
Type of analysis of material dividing in three groups called A-
Group items, B-Group items, and C- Group MAXIMUM STOCK LEVEL
Category % of items % of items
Maximum figure of stock held at any time
A 15% 80%
• Maximum level = (Re-order + Re-order qty.) - (Minimum
B 35% 15% consumption X Minimum re-order period)
C 50% 5%
100% 100%
ECONOMIC ORDER QUANTITY
RE-ORDER QUANTITY
Quantity of stock for which an order is to be placed at any one
point of time Is an optimum quantity of material to be ordered every time.
Was developed by F. Wilson Harris in 1913. EOQ is also know
RE-ORDER LEVEL as re-order quantity
It is level at which fresh order should be placed 2 𝑋 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑋 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡
• Formula =
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕 𝒑𝒆𝒓 𝒂𝒏𝒏𝒖𝒎
Re-order Level = (Maximum usage X Maximum re-order period)
OR
Re-order Level = Safety stock + Normal lead time consumption
Inventory Levels
Re-order Level = (Maximum usage X Minimum re-order period)
CONTINUO Or Safety stock + Normal usage
US STOCK PERIODIC JUST IN INVENTORY Minimum Level = Re-order level – (Average or normal usage X
VERIFICATI INVENTORY TIME TURNOVER Average re-order period)
ON SYSTEM PURCHASE RATIO Maximum Level = (re-order level + Re-order qty.) – (Minimum
consumption X Minimum re-order period)
Or
EOQ qty.
𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑙𝑒𝑣𝑒𝑙+𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑙𝑒𝑣𝑒𝑙
IMPORTANT FORMULA Average stock level =
2
Economic Order Quantity = Minimum level + ½ pf re-ordering qty.
Danger level = (Average consumption X Lead time for emergency
2 𝑋 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑋 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡
EOQ = Formula = purchase)
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕 𝒑𝒆𝒓 𝒂𝒏𝒏𝒖𝒎
Safety stock level = Ordering level – (average usage X Re-order period) OR
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛
No. of orders = = (Maximum usage – average usage) X Lead time
𝑅𝑒−𝑜𝑟𝑑𝑒𝑟𝑖𝑛𝑔 /𝐸𝑂𝑄 𝑞𝑡𝑦
Re-order point = (Delivery time X normal usage during lead time) +
How to calculate total cost at EOQ level? safety stock OR
= Safety stock + Lead time for consumption
Material cost (Annual consumption in units X price p.u.)) XXXX
(+) Ordering (no. of orders X ordering cost per order) XXXX Turnover Ratio
cost
Material consumed = Opening stock + Purchase – closing stock
(+) Carrying 𝑅𝑒 − 𝑜𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑜𝑟 𝐸𝑂𝑄 𝑞𝑡𝑦 XXXX 𝑀𝑎𝑡𝑟𝑖𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑
𝑋 𝑝𝑟𝑖𝑐𝑒 𝑝. 𝑢. 𝑋 . . % Materials Turnover ratio =
cost 2 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘
Stock Velocity = X 365 days or 12 months
XXXX 𝑀𝑎𝑡𝑟𝑖𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑
Ordering + Carrying cost = 2 𝑋 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑋 𝑂𝑟𝑑𝑖𝑛𝑔 𝑋 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝. 𝑢. 𝑎
1. Which type of material is classified as 'A' type in ABC analysis — (d) ABC analysis
(a) High price, more quantity
(b) High price, less quantity 6. A company manufactures 5,000 units of a product per month. The cost of
(c) Low price, more quantity placing an order is ₹ 100. Purchase price of the raw material is ₹ 10 per
(d) Low price, less quantity kg. Average consumption of material is 275 kg per week. The carrying cost
of inventory is 20% per annum. The economic order quantity is—
2. Which of the following formula cannot be used to calculate re-order level (a) 1,196 kg
(a) Minimum level + consumption during lead time (b) 707 kg
(b) Maximum consumption X maximum re-order period (c) 2,449 kg
(c) Maximum consumption X lead time + safety stock (d) 2,400 kg
(d) Minimum consumption X mini-mum re-order period
7. Under which of the following inventory control techniques, two piles or
3. Which of the following is recorded by bin card — bundles are maintained for each item of stock —
(a) Quantity (a) MM-max plan
(b) Quantity and value (b) Order cycling system
(c) Value (c) Two-bin system
(d) Quality (d) ABC analysis
4. The method of regular physical verification of material throughout the year 8. A company requires 1,500 units, of an item per month. The cost of each unit
is known as — is Rs. 30. The cost of placing an order is Rs. 200 and the material carrying
(a) Periodic stock taking charges work out to be 20% of the average material. The economic order
(b) Bin card system quantity (EOQ) is —
(c) Continuous stock taking (a) 1,095 units
(d) Stock ledger system (b) 316 units
(c) 490 units
5. Under which of the following inventory control technique, maximum and (d) 33 units
minimum level of each stock is laid down —
(a) Min-max plan 9. In a company, weekly minimum and maximum consumption of Material-A is
(b) Two bin system 25 and 75 units respectively. The re-order quantity as fixed by the
(c) Order cycle system
company is 300 units. The material is received within 4 to 6 weeks from 12. Which one of the following statement is true in ABC classification of
issue of supply order. Maximum level of Material-A is — materials-
(a) 640 Units (a) ‘C’ items of material have a moderate % of cost & high % of quantity
(b) 650 Units (b) ‘A’ item of material have high % of cost and low % of quantity
(c) 175 Units (c) ‘A’ items of material have high % of cost and low % of quantity
(d) 560 Units (d) ‘B’ items of material have a moderate % of cost and low % of the
quantity
10. XYZ Ltd. had 4,000 units of inventory in hand on 1st Mar, 2016 costing ₹
4 per unit. Purchases & issues of material during the month were as follows: 13. In a situation of rising prices, profit and tax liability would be lower under
Date Purchase Issue ______ method than under ______ method of material issue pricing.
Mar 8 500 units @ ₹ 5 per unit (a) FIFO; LIFO
(b) LIFO; FIFO
Mar 15 2,000 units
(c) LIFO; Average
Mar 20 6,000 units @ ₹ 6 per unit (d) FIFO; Average
Mar 28 4,000 units
The cost of inventory as on 31st March, 2016 under FIFO and weighted 14. Re-order quantity : 300 kg
average cost method will be — Minimum usage : 20 kg per day
(a) ₹ 27,000 and ₹ 24,498 Minimum lead time : 5 days
(b) ₹ 27,000 and ₹ 23,625 Maximum stock level : 400 kg
Re-order level will be -
(c) ₹ 22,000 and ₹ 23,625
(a) 350 kg
(d) ₹ 22,000 and ₹ 24,498 (b) 200 kg
11. EOQ is 200 units, ordering cost Rs. 20 per order and total purchases 4,000 (c) 375 kg
units. The carrying cost per unit will be - (d) 150 kg
(a) ₹ 2 15. Which of the following are advantages of perpetual inventory system:
(b) ₹ 6 (i) No interruption of production process
(c) ₹ 4 (ii) More wastage of material
(d) None of the above (iii) Detect loss of stock due to theft, shrinkage, fire, etc.
(iv) Ascertain stock without physical verification
Select the correct answer from the options given below — (b) Unit cost
(a) (1), (ii) and (iii) (c) Supplier's name
(b) (iii) and (iv) (d) Quantity requisitioned
(c) (i), (ii) and (iv)
(d) (1), (iii) and (iv) 20. This type of loss is connected with both input and output:
(a) Waste
16. A company produces a single product for which following data is available: (b) Scarp
Average production per week: 200 units (c) Defectives
Usage per unit: 10 kg 1 Re-order level: 8,000 kg (d) All of the above
Delivery time required: 2 weeks minimum level of stock required will be —
(a) 3,000 kg 21. Which of following is not a cost price method of pricing of material issues?
(b) 5,000 kg (a) First-in-first-out (FIFO) method
(c) 4,000 kg (b) Last-in-first-out (LIFO) method
(d) 2,500 kg (c) Standard price method
(d) Specified price method
17. Which of the following is considered as normal loss of material —
(a) Pilferage 22. For the financial year ended 31st March, 2017, the figures extracted from
(b) Loss due to flood the balance sheet of EXE Ltd. are as follow:
(c) Loss due to accident Opening stock ₹ 29,000
(d) Loss arising from careless handling of material Closing stock ₹ 31,000
Cost of goods sold ₹ 2,40,000
18. Two avoidable reasons for the difference between bin card and physical The stock turnover ratio will be:
quantity of material may be ______ and wrong posting in the bin card. (a) 12 times
(a) Pilferage (b) 10 times
(b) Normal (c) 8 times
(c) Abnormal (d) 9 times
(d) Reasonable
23. In ________ technique of inventory control, quantities in hand of each item
19. Which of following does not normally appear on material requisition form? or class of stock is reviewed periodically say 30, 45 or 60 days.
(a) Job number (a) ABC Analysis
(b) Two-bin System (d) 100 units
(c) Order Cycling System
(d) Perpetual Inventory System 27. V Ltd. is the manufacturer of picture tubes for TV, The following are details
of their operation. Minimum usages 50 tubes per week, Maximum usages
24. If annual total carrying cost, per unit carrying cost & cost per order are ₹ 200 tubes per week; Normal usages 100 tubes per week; lead time to
15,000, ₹ 10 & ₹ 150 respectively, then Economic Order Quantity will be: supply 4-6 weeks; and Re-order quantity 400 tubes. What would be the
(a) 1,500 units maximum and minimum level of stock?
(b) 3,000 units (a) 1,400 units and 700 units
(c) 100 units (b) 1,200 units and 700 units
(d) 200 units (c) 1,300 units and 600 units
(d) 1,100 units and 600 units
25. The monthly requirement of a component is 4,000 units. The cost per order
is ₹ 1,000 and the carrying cost per unit per annum is ₹ 24. The Economic 28. The following information is given for receipts and issues of a material in
Ordering Quantity is: the month of March, 2019.
(a) 2,000 units Date Description Quantity (kg) Rate
(b) 4,000 units 1 Mar Receipt 400 5.00
(c) 577.35 units 5 Mar Receipt 600 6.00
(d) 1,825.74 units 8 Mar Issue 700 -
26. The following information is given: 10,000 units of material are consumed 20 Mar Receipt 500 4.50
per year; per unit cost is ₹ 20; cost of processing an order is ₹ 50; Annual 30 Mar Issue 600 -
interest rate is 5%; Annual carrying cost of material per unit is 15% (other What is the value of closing stock under FIFO and LIED method?
than interest). What would be the Economic Order Quantity (EOQ)? (a) 800 and 900
(a) 200 units (b) 900 and 800
(b) 500 units (c) 1,000 and 900
(c) 400 units (d) 900 and 1,000
Answers
1 B 2 D 3 A 4 C 5 A 6 A 7 C 8 A 9 B 10 A
11 C 12 B 13 B 14 B 15 B 16 C 17 ** 18 A 19 C 20 A
21 D 22 C 23 C 24 D 25 A 26 B 27 A 28 D
MANAGEMENT OF CASH & BY CA CS HARISH A MATHARIYA
MARKETABLE SECURITIES 98220 93220

CASH MANAGEMENT CASH BUDGET
Important function of the finance manager. For the survival of the Is a financial budget prepared to calculate the budgeted cash
business there should be adequate cash, also to ensure that there inflows and outflows during a period and the budgeted cash
no funds blocked in idle cash balance at the end of the period. A cash budget helps managers to
determine any excessive idle cash
MOTIVES TO HOLD CASH
METHODS OF PREPARATION OF CASH BUDGET
Transactional Speculative Contingency
Motive Motive Motive
• Purchase of • To deploy • This motive of Receipt & Payment Adjusted Income Adjusted Balance
capital goods surplus cash in holding cash Method Method sheet method
• Purchase of raw short term takes into
material investments to account the
• Payment of rent get better element of
and wages returns uncertainly ACCELERATING CASH COLLECTION
associated with
any form of 1. Concentration Banking
business ❑ The company establishes a number of strategic collection
centers in different regions instead of a single collection
STRATEGY FOR EFFECTIVE CASH MANAGEMENT center
2. Lock Box System
❑ The purpose of the lack box system is to eliminate the time
between the receipt of remittances by the company and the
Realistic cash Speeding up Spreading deposit in the bank
forecasting Collection out Payments ❑ The company rents the local post office box and authorizes
its bank at each of the locations to pick up remittances in the
boxes
3. Playing the Float MILLER-ORR CASH MANAGEMENT MODEL
❑ Besides accelerating collections, an effective control over In this model, control limits are set for the cash balance. These limits
payments can also cause faster turnover of cash. This is may consist of h as an upper limit, Z as the return point; and zero
possible only by making payments on the due date. as the lower limit.
Different kinds of float The MO model is more realistic since it allows variations in cash
▪ Billing Float: An invoice is the formal document. The time balance within lower and upper limits. The Finance manager can set
between the sale and the mailing of the invoice the limits according to the firm’s liquidity requirements i.e.
▪ Mail Float: This is the time when a cheque is being maintaining minimum and maximum cash balance
processed by post office or other means of delivery
▪ Cheque Processing Float: Time required for sale seller to MANAGEMENT OF MARKETABLE SECURITIES
sort, record and deposit cheque Is an integral part of an investment of cash as it serves both the
▪ Banking Processing Float: Time from the deposit of the purpose of liquidity and, provided a choice of investment is made
cheque to the crediting of funds in the sellers account correctly
The selection of securities should be guided by three principles
namely safety, maturity and marketability
BAUMOL’S MODEL OF CASH MANAGEMENT
For optimum cash balance which is normally used in inventory
management. Is the trade-off between cost of holding cash and the
transaction cost
Optimum 𝟐 𝑿 𝑨𝒏𝒏𝒖𝒂𝒍 𝒄𝒂𝒔𝒉 𝒅𝒊𝒔𝒃𝒖𝒓𝒆𝒔𝒆𝒎𝒆𝒏𝒕𝒔 𝑿 𝑻𝒓𝒂𝒏𝒔𝒂𝒕𝒄𝒕𝒊𝒐𝒏 𝒄𝒐𝒔𝒕
=
Cash Balance 𝑶𝒑𝒑𝒐𝒓𝒕𝒖𝒏𝒊𝒕𝒚 𝒄𝒐𝒔𝒕 𝒐𝒏𝒆 𝒓𝒖𝒑𝒆𝒆 𝒑𝒆𝒓 𝒂𝒏𝒏𝒖𝒎
1. Which of the following will NOT appeal' ill a Cash Budget? 5. The optimal balance of marketable securities held to take care of
(a) Machinery bought on hire purchase probable deficiencies in the firm's cash account is referred to as the _____
(b) Depreciation of machinery segment in the firm's portfolio of short-term marketable securities.
(c) Sales revenue (a) Ready cash
(d) Wages (b) Controllable cash
(c) Free cash
2. A cash budget for the six months ended 30th September 2020 shows an (d) Cash and cash equivalent
anticipated overdraft of approximately ₹ 9,05,500. Which of the
following would reduce the expected overdraft? 6. Advantages of cash budgets would not include one of the following: ____
(a) Allowing customers 2 months credit, instead of 1 month, in which to pay. (a) Surplus cash can be put to more profitable uses if expected to occur
(b) Suppliers' purchases Being made for cash, instead of 1 month's credit. (b) Debtors can be paid more quickly
(c) Assets being leased, rather than purchased for cash, in 2020. (c) Time is available to investigate the possible future sources of finance
(d) Charging depreciation on fixed assets at 25% on the straight-line (d) Overdrafts can be negotiated in advance of when they are needed
basis, rather than 2096.
7. Which of the following would be found in a cash budget?
3. NSZ Ltd. cash budget forewarns of a short-term surplus. Which of the (a) Capital expenditure
following would be appropriate action to be taken in such a situation? (b) Provision for doubtful debts
(a) Increase debtors and stock to boost sales (c) Depreciation
(b) Purchase new fixed assets (d) Accrued expenditure
(c) Repay long term loans
(d) All of the above 8. Which of the following will not affect preparation of cash budget?
(a) Loan taken by firm
4. Which of the following would NOT lead to an increase in net cash flow? (b) Proceeds from asset disposal
(a) Larger sales volume (c) Reduction in provision for doubtful debts
(b) Reduced materials costs (d) Cash sales
(c) Lower depreciation charge
(d) Higher selling price 9. Which of following would have to be included for company preparing a
schedule of cash receipts & disbursements for calendar year 2019?
(a) The annual depreciation for the Year 2019.
(b) Purchase order issued in Dec 2014 for items to be delivered in Feb (a) Keeping a cash reserve for purchasing goods and services to balance
2019. out the cash inflows and outflow.
(c) Dividends declared in November 2019, to be paid in January 2020 (b) Keeping the cash for all the transactions made during a periodic term.
to shareholders of record as of December 2019 (c) keeping the cash for transactions mandatory for day to day activities
(d) Funds borrowed from a bank on a note payable taken out in June (d) Keeping the transactions for foreign trading.
2018 with an agreement to pay the principal and all of the interest
owed in December 2019. 14. The statement of cash flows tells us –
(a) The financial position of the business at a point in time.
10. Availability float is the _______ (b) The forecast cash movements over a period of time.
(a) Total time between the mailing of the cheque by the customer and the (c) How much cash received & paid during an accounting period.
availability of cash to the receiving firm. (d) How much profit the business has made during an accounting
(b) Time consumed in clearing the cheque through the banking system.
(c) Time the cheque is in the mail. 15. Cash flow is –
(d) Time during which the cheque received by firm remains uncollected. (a) Linked only to the balance sheet.
(b) Linked only to the income statement.
11. Cash management is a broad term used for collecting and managing cash. (c) Not linked to the balance sheet or income statement.
Speculative motive of holding cash refers to – (d) Linked to the balance sheet and income statement.
(a) Holding the cash to utilize it in internal projects.
(b) Holding the cash for any future loss the company is expecting. 16. Z Ltd. has an estimated cash payments of ₹ 8,00,000 for a one month
(c) Holding the cash to avail any future investment opportunity. period and the payments are expected to steady over the period. The
(d) Holding the cash to utilize it for international project. fixed cost per transaction is ₹ 250 and interest rate on marketable
securities is 12% p.a. Optimal cash balance = ? & No. of transaction = ?
12. Non-cash transactions _______ (a) 20,000; 4.8
(a) Form part of cash budget (b) 2,00,000; 48
(b) Do not form part of cash budget (c) 20,00,000; 480
(c) May or may not form part of cash budget (d) 2,00,00,000; 4,800
(d) I cannot say whether they are part of cash budget
17. The budgeted sales for the next four quarters are ₹ 1,92,000, ₹
13. Companies hold cash time-to-time. Transaction motive of holding cash 2,88,000, ₹ 2,88,000 & ₹ 3,36,000, respectively. It is estimated that
means sales will be paid as follows:
75% of the total will be paid in the quarter that the sales were made of cost of direct labour ₹ 4,68,000, what would be the surplus or deficit of
the balance 50% will be paid in the quarter after the sale was made. cash at the end of the period?
The remaining 50% will be paid in the quarter after this. (a) Deficit of ₹ 8,000
The amount of cash received in quarter 3 will be ______ (b) Surplus of ₹ 18,000
(a) ₹ 2,76,000 (c) Deficit of ₹ 18,000
(b) ₹ 1,44,000 (d) No surplus or deficit
(c) ₹ 3,24,000
(d) ₹ 2,40,000 20. The annual cash requirement of A Ltd. is ₹ 10,00,000. The company has
marketable securities in lot size of ₹ 1,00,000. Cost of conversion of
18. BDL Ltd. is currently preparing its cash budget for the year to 31 Mar. marketable securities per lot is ₹ 1,000. The company can earn 5% annual
2019. An extract from its sales budget for the same year shows the yield on its securities. Calculate total cost.
following sales values. (a) ₹ 10,500
March ₹ 60,000 (b) ₹ 10,450
April ₹ 70,000 (c) ₹ 12,500
May ₹ 55,000 (d) ₹ 14,500
June ₹ 65,000
40% of its sales are expected to be for cash of its credit sales, 70% are 21. The following information is available:
expected to pay in month after sale and take a 2% discount. 27% are Wages for January: ₹ 20,000
expected to pay in the second month after the sale, and the remaining Wages for February: ₹ 22,000
3% are expected to be bad debts. The value of sales budget to be shown Delay in payment of wages:1/2 month The amount of wages paid during
in the cash budget for May the month of February is —
(a) ₹ 60,532 (a) ₹ 11,000
(b) ₹ 61,120 (b) ₹ 22,000
(c) ₹ 66,532 (c) ₹ 20,000
(d) ₹ 86,620 (d) ₹ 21,000
19. If the beginning balance of cash is ₹ 5,000 and the desired closing cash 22. In Rise Ltd., cash sales is 25% and credit sales 75%. Sales for November,
balance is ₹ 10,000, with the only other cash-related items being 2014 is ₹ 15,00,000, December, 2014 ₹ 14,00,000, January, 2015 ₹
sales/revenue ₹ 15,00,000, direct materials purchases ₹ 10,45,000, and
16,00,000, February, 2015 ₹ 10,00,000 & Mardi, 2015 ₹ 9,00,000, (c) Cash is the lifeblood of a business and without it the business will die.
60% of the credit sales arc collected in the next month alter sales, 30% (d) A profitable company will never run out of cash.
in the second month & 10% in I he third month. No bad debts are
anticipated. The cash collected in the month of Mar, 2015 from debtors is 25. The following information extracted from the' records equity shares
(a) ₹ 14,60,000 appears in funds of P Ltd. flow statement.
(b) ₹ 14,20,000 Sales for Oct, Nov & Dec, 2018 are ₹ 90,000, ₹ 1,10,000 and ₹ 80,000
respectively. 40% of its sales are expected to be for cash. Of its credit
(c) ₹ 12,20,000
sales 70% are expected to pay in the month after sales and take 2%
(d) ₹ 9,15,000 discount on it. Balance is expected to pay in second month after sales and
23. Consider the following statements: 3% of it is expected to bad debts. What are the sales receipts to be
1. Depreciation reduces tax liability; hence it is a source of funds. shown in cash budget for the month of December?
2. Decrease in current liabilities during the year results in an increase in (a) ₹ 92,990
working capital. (b) ₹ 1,23,174
3. The term cash equivalents includes short-term marketable investments. (c) ₹ 95,609
4. Conversion of debentures into (d) ₹ 1,25,793
5. Only non-cash expenses are added to net profit to find out funds from
operation. 26. The following information is given:
Select the incorrect statements from the options given below — Depreciation provided during the year: Furniture ₹ 15,000, Building ₹
(a) (1), (3), (4) and (5) 14,000. The statement of P&L for the year: Opening balance ₹ 38,500
(b) (1), (2), (4) and (5) Add: Profit for the year ₹ 40,300, Less: Goodwill written off ₹ 15,000,
(c) (1), (4) and (5) Closing balance ₹ 63,800.
(d) (2), (3) and (4) What will be the amount of cash From operations?
(a) ₹ 69,300
24. Which one of the following is false? (b) ₹ 54,300
(a) If cash outflows exceed cash inflows on an ongoing basis, the business
(c) ₹ 78,800
will eventually run out of cash.
(b) Rapidly expanding companies can sometimes face a cash shortage. (d) ₹ 25,300
Answers
1 B 2 C 3 A 4 C 5 A 6 B 7 C 8 C 9 D 10 B
11 C 12 B 13 A 14 C 15 D 16 B 17 A 18 A 19 C 20 C
21 D 22 B 23 C 24 D 25 ** 26 A
LEVERAGES BY CA CS HARISH A MATHARIYA
98220 93220

LEVERAGE Operating leverage depends on three factors
In general, refers to a relationship between two interrelated Contribution
variables. In financial analysis is represent the influence of one Fixed cost and
financial variable over some other Volume of sales
• Operating Leverage Utility: High operating leverage shows a higher burden of fixed
• Financial Leverage cost and low EBIT. Directly proportion to business risk
• Combined Leverage
FINANCIAL LEVERAGE
E.g. I II
Measure the ability of the firm to use fixed financial charges to
Sales 10,000 11,000 ➔ (↑10%) magnify the effects of change in EBIT on EPS.
V. C. 5,000 5,500 𝐸𝐵𝐼𝑇
𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 =
Contribution 5,000 5,500 𝐸𝐵𝑇
F. C. 4,000 4,000 OR
Profit (IEBIT) 1,000 1,500 ➔ (↑50%) % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆
𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 =
OPERATING LEVERAGE % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇
Ability of firm to use fixed cost (Fixed operating cost)
To magnify effect of change in sale on EBIT Formula when capital structure consists of preference shares
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 and equity shares:
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 = 𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 =
OR Dp
EBT -
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇 (1−𝑇)
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
Where, BUSINESS RISK & FINANCIAL RISK
EBIT = Earning before tax Business risk refers to the risk associated with the firm’s
I = Interest operations. It is represented by the variability earnings before
Dp = Preference dividend interest and tax (EBIT). The operating leverage concept can be used
T = Tax to evaluate business risk
Risky Situation: High operating leverage with high financial
leverage will constitute risky situation Financial risk refers to the additional risk placed on firm’s
Normal Situation: One should be high and another should be low shareholders as a result debt use in financing. More debt would
Ideal Situation: Both should be low have higher financial risk
A higher financial leverage is better than higher operating
leverage
COMBINED LEVERAGE
Combines the effect of ‘operating leverage’ and ‘financial leverage.
If both are high it means a company has a high burden of fixed cost
as well as interest cost which is risky situation.
Combined Leverage = Operating Leverage X Financial Leverage
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐸𝐵𝐼𝑇
= 𝑋
𝐸𝐵𝐼𝑇 𝐸𝐵𝑇
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
=
𝐸𝐵𝐼𝑇
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆
=
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
It indicates the effect the sales change will have in EPS
1. The term Leverage in general refers to a – 5. In the context of operating leverage break-even analysis, if selling price
(a) Relationship between fixed cost and profit. per unit rises and all other variables remain constant, the operating
(b) Relationship between sales and fixed cost. break-even point in units will:
(c) Relationship between two interrelated variables. (a) Fall
(d) Relationship between two unrelated variables. (b) Rise
(c) Stay the same
2. In financial analysis Leverage represents the influence of one ______ over (d) Still be indeterminate until interest and preferred dividends paid are
some other related ______ known
(a) Non-financial variable; financial variable
(b) Financial variable; financial variable 6. A firm’s degree of leverage (DTL) is equal to its degree of operating
(c) Financial variable; non-financial variable leverage ______ it’s degree of financial leverage (DFL).
(d) Variable relating to revenue; financial variable (a) Plus
(b) Minus
3. Operating leverage indicates the tendency of operating profits (EBIT) to (c) Divided by
vary disproportionately with – (d) Multiplied by
(a) Profit
(b) Fixed cost 7. A high operating leverage indicates –
(c) Sales (a) Highly favourable situation as it consists of low fixed costs
(d) EPS (b) Highly risky situation as it consists of large interest costs.
(c) Highly favourable situation as it consists of higher EPS..
4. Degree of ____ is the ratio of the percentage increase in earnings per (d) Highly risky situation as it consists of large fixed costs.
share (EPS) to the percentage increase in earnings before interest and
taxes (EBIT). 8. Match List-I with List-II and select the correct answer using the codes given
(a) Operating Leverage below the lists:
(b) Combined Leverage List-I List-II
(c) Working Capital Leverage P. Factoring 1. Sales
(d) Financial Leverage Q. Operating leverage 2. Fixed interest cost
R. Debtors turnover ratio 3. Working capital
S. Financial – leverage 4. Break-even point (b) Not proportional
5. Fixed cost (c) Unrelated
Select the correct answer from the (d) Not related
options given below:
P Q R S 12. More operating leverage leads to –
(a) 4 5 1 2 (a) Less financial risk
(b) 3 5 2 1 (b) More financial risk
(c) 3 5 1 2 (c) More business risk
(d) 4 2 3 5 (d) Less business risk
9. Which of the following is correct formula to calculate Financial Leverage? 13. Higher operating leverage is related to the use of additional _______.
𝐸𝐵𝑇 (a) Fixed costs
(a) Financial Leverage = (b) Variable costs
𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 (c) Debt financing
(b) Financial Leverage = (d) Common equity financing
𝐸𝑃𝑆
𝐸𝑃𝑆
(c) Financial Leverage = 14. Lower financial leverage is related to the use of additional ______.
𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 (a) Fixed costs
(d) Financial Leverage = (b) Variable costs
𝐸𝐵𝑇
(c) Debt financing
(d) Common equity financing
10. A firm has a DOL of 4.5 at Q units. What does this tell us about the firm?
(a) If sales rise by 4.5%, then EBIT will rise by 1%.
15. If financial leverage is 2.5, this means that –
(b) If EBIT rises by 4.5%, then EPS will rise by 1%.
(a) 2.5% change in EBIT will cause 1% change in EBT
(c) If EBIT rises by 1%, then EPS will rise by 4.5%.
(b) 1% change in sales will cause 2.5% change in EBT
(d) If sales rise by 1%, then EBIT will rise by 4.5%
(c) 2.5% change in sales will cause 1% change in EBT
(d) 1% change in EBIT will cause 2.5% change in EBT
11. Operating leverage is directly _______ to business risk.
(a) Proportional
16. Where a company has large amount of fixed interest charges, the (c) 2.67
financial leverage will be ______ (d) 1.07
(a) High
(b) Low 19. If operating leverage is 2.1429 and financial leverage is 1.0699 then
(c) Negative combined leverage will be –
(d) Unreliable (a) 2.2927
(b) 2.0029
17. Output (units) = ₹ 3,00,000 (c) 0.4993
Fixed cost = ₹ 3,50,000 (d) Data given is not sufficient
Unit variable cost = ₹ 1.00
Interest expenses = ₹ 25,000 20. If combined leverage is 2.2926 and operating leverage is 2.1429 then
Unit selling price = ₹ 3.00 financial leverage will be –
Applicable tax rate is 35% (a) 1.0699
Calculate Operating Leverage. (b) 0.9347
(a) 1.11 (c) 4.9128
(b) 2.40 (d) Data given is not sufficient
(c) 2.67
(d) 1.07 21. Operating leverage is 4. This means 10% change in sales will cause –
(a) 4% change in variable cost
18. Output. (units) = ₹ 3,00,000 (b) 40% change in EPS
(c) 4% change in EBIT
Fixed cost = ₹ 3,50,000
(d) 40% change in EBIT
Unit variable cost = ₹ 1.00
Interest expenses = ₹ 25,000 22. If sales increase by 6% taxable income i.e. PAT and EPS will increase by
Unit selling price = ₹ 3.00 24%. Combined leverage must be –
Applicable tax rate is 35% (a) 3
Calculate Financial Leverage. (b) 4
(a) 1.11 (c) 5
(b) 2.40 (d) 6
Capital structure of the company consists of equity shares and preference
23. The capital structure of a company consists of the following securities. shares.
10% Preference Share Capital ₹ 1,00,000 Amount of Preference Dividend = ?
Equity Share Capital (₹ 10 Shares) ₹ 1,00,000 (a) ₹ 39,967
12% Debenture ₹ 75,000 (b) ₹ 39,970
The amount of operating profit is ₹ 69,000. (c) ₹ 39,000
The company is in 35% tax bracket. (d) ₹ 40,000
You are required to calculate the financial leverage of the company.
(a) 1.1500 26. EBIT = ₹ 4,00,000
(b) 1.5466 Fixed cost = ₹ 6,00,000
(c) 1.1566 Interest = ₹ 80,000
(d) 1.1554 Combined leverage = ?
(a) Sufficient data is not given
24. Total assets of Alpha Company are ₹ 3,00,000. The company's total (b) 3.12
assets turnover ratio is 3, its fixed operating cost is ₹ 1,50,000 and its (c) 3.215
variable operating cost ratio is 50%. The income-tax rate is 50%. It also (d) 3.125
has long term debts of ₹ 1,20,000 on which interest @ 10% is payable.
Operating, Financial & Combined Leverages of the company are – 27. EBIT of a firm is ₹ 3,000.
(a) 1.5; 1.042; 1.563 respectively Financial Plan Plan I Plan II Plan III
(b) 1.05; 1.42; 1.05625 respectively
Equity ₹ 5,000 ₹ 7,500 ₹ 2,500
(c) 1.50; 1.42; 2.13 respectively
(d) 1.55; 1.042; 1.6151 respectively Debt ₹ 5,000 ₹ 2,500 ₹ 7,500
Cost of Debt 12% 12% 12%
25. Operating leverage =2 Compute the financial leverage for the three plans respectively.
Combined leverage = 3.5 (a) 1.33; 1.11; 1.43
EBIT = ₹ 2,80,000 (b) 1.25; 1.18; 1.43
Interest = ₹ 40,000 (c) 1.66; 1.48; 1.90
Tax rate = 50%. (d) 1.25; 1.11; 1.43
(b) ₹ 20,000
28. From the following data of Abhishek Ltd., compute the operating (c) ₹ 60,000
leverage, financial leverage, combined leverage. (d) ₹ 15,000
EBIT Profit ₹ 10 Lakh
before tax (PBT) ₹ 4 Lakh 31. From the following information answer questions:
Fixed cost ₹ 6 lakh Sales 4,00,000
(a) 1.6; 2.5, 4.0 Less: Variable expenses 1,40,000
(b) 2.5; 1.6; 4.0 Contribution 2,60,000
(c) 4.0; 2.5; 1.6 EBIT 80,000
(d) 4.0; 1.5; 2.5
Less: Interest 10,000
Taxable income 70,000
29. From the following data of Tanishka Ltd., compute the percentage change
in earnings per share (EPS), if sales are expected to increase by 5%: What percentage will EBIT increase, if there is a 10% increase in sales?
EBIT 16.00 lakh (a) 32.0%
Profit before tax (PBT) 6.40 lakh (b) 31.14%
Fixed cost 9.60 lakh (c) 33.71%
(a) 5% (d) 32.5%
(b) 10%
(c) 4% 32. What is the Financial Leverage?
(d) 20% Situation 1 Situation 2
Plan A Plan B Plan A Plan B
30. Following data is available for X Ltd. (a) 1.33 1.43 1.09 1.11
Variable cost (% of sales) 70% (b) 1.33 1.43 1.11 1.09
Interest expense ₹ 20,000 (c) 1.33 1.09 1.43 1.11
DOL 5:1 (d) 1.09 1.33 1.43 1.11
DFL 3:1
Corporate tax rate 30%
EBIT =? 33. What is the Combined Leverage?
(a) ₹ 30,000
36. ABC Ltd. has an average selling price of ₹ 10 per unit. Its variable unit
Situation 1 Situation 2 costs are ₹ 7 and fixed costs amount to ₹ 1,70,000. It finances all its
Plan A Plan B Plan A Plan B assets by equity funds. It pays 30% tax on its income. PQR Ltd. is identical
(a) 2.22 1.81 2.22 2.86 to ABC Ltd. except in respect of the pattern of financing. The latter
(b) 2.22 2.86 1.81 2.22 finances its assets 50% by equity and 50% by debt, the interest on which
(c) 2.22 1.82 2.86 2.22 amounts to ₹ 20,000. Which of the following statement is correct?
(d) 1.81 2.22 2.86 2.22 (a) Both companies have similar business risk.
(b) PQR Ltd. has high financial risk as compared to ABC Ltd.
(c) PQR Ltd. has high business risk & financial risk as compared to ABC
34. Total assets of Honey Well Ltd. are ₹ 6,00,000. Total assets turnover ratio Ltd.
is 2.5 times. The fixed operating costs are ₹ 2,00,000 and variable (d) All of the above
operating cost ratio is 40%. Income tax rate is 30%. Calculate operating,
financial and combined leverage? 37. A firm has a DOL of 3.5 at Q units. What does this tell us about the firm?
(a) 1.2857; 1.0355; 1.3314 (a) If sales rise by 3.5% at the firm, then EBIT will rise by 1%.
(b) 1.0355; 1.2857; 1.3314 (b) If EBIT rises by 3.5% at the firm, then EPS will rise by 1%.
(c) 1.3314; 1.0355; 1.2857 (c) If EBIT rises by 1% at the firm, then EPS will rise by 3.5%.
(d) 1.2857; 1.3314; 1.2857 (d) If sales rise by I% at the firm, then EBIT will rise by 3.5%
35. Total assets of Q Ltd. are ₹ 6,00,000. Total assets turnover ratio is 2.5 38. Calculate the degree of financial leverage (DFL) for a firm when its EBIT
times. The fixed operating costs are ₹ 2,00,000 and variable operating is ₹ 20,00,000. The firm has ₹ 30,00,000 in debt that costs 10% annually.
cost ratio is 40%. Income tax rate is 30%. No. of equity shares are The firm also has a 9%, ₹ 10,00,000 preferred stock issue outstanding.
18,000. Determine the likely level of EBIT if EPS is ₹ 6. The firm pays 40% in taxes.
(a) ₹ 1,54,286 (a) 0.78
(b) ₹ 1,78,286 (b) 0.80
(c) ₹ 1,54,682 (c) 1.24
(d) ₹ 1,78,862 (d) 1.29
Answers
1 C 2 B 3 C 4 D 5 A 6 D 7 D 8 C 9 D 10 D
11 A 12 C 13 A 14 D 15 D 16 A 17 B 18 A 19 A 20 A
21 D 22 B 23 B 24 A 25 D 26 D 27 D 28 A 29 D 30 A
31 D 32 C 33 C 34 A 35 B 36 D 37 D 38 A
CAPITAL STRUCTURE BY CA CS HARISH A MATHARIYA
98220 93220

VARIOUS TYPES OF CAPITAL STRUCTURE
1. Horizontal capital structure
• Has zero components is quite sable. Expansion of the firm takes in a lateral manner, i.e. through equity or
retained earnings only. Lack of financial leverage.
2. Vertical capital structure

• A small amount of equity share capital serves as the foundation on which the superstructure of
preference share capital and debt is built. Incremental addition in the capital structure is almost entirely in
the form of debt. Quantum of retained earnings is low and divided payout ratio is quite high. Cost of
equity capital is usually higher than the cost of debt. High component of debt in the capital structure
increases the financial risk. Vulnerable to hostile takeover
3. Pyramid-shaped capital structure

• Has a large proportion consisting of equity capital and retained earning. Cost of share capital and the
retained earnings of the firm are usually lower than the cost of debt is indicative of risk-averse
conservative firms
4. Inverted Pyramid shaped capital structure

• Has a large component of equity capital, a reasonable level of retained earning but ever-increasing
components pf debt. Highly vulnerable to collapse.
➯
CAPITAL STRUCTURE Proportion of long
This is capital structure decision term finance
Is a part of financing Decision
financing Decision
Existing Desired Payout
C.S D-E mix policy
Capital Structure Cost of capital Leverage
1st see this to reach @ desired C.S
As you know, financing decision
➢ Means to decide from when To reach at desired C.S consider
➢ Funds should be raise ? Like Eq/deb/pref./loan/etc.
➢ In what proportion ? Should raise Risk Return
➢ Difference source of finance have differ in terms of risk/cost/control
This will impact on cost of capital funds
Risk Cost Control
➯
Equity More expense Dilute Equity 30 50 90
Loan / debenture Cheaper No-Dilution Preference share 20 30 10
Deb 30 20 -
Financing Decision Loan 20 - -
➯
➯ ➯ ➯
Decision relating to
From Regd. For capital budgeting purchase of D.A Optimum CS Try to reach most
Internal • Expansion appropriation
• Funds (retained earning) • Diversification
Need to raise funds • modernization
External
• Debts/IPO/right share • Replacement of PSH
Now, we have to decide how much Minimize cost of Maximize value
money to raise from which source capital of firm
4. Treading on equity
Features of Appropriate C.S ROCE = 15%
Profitability Rate of interest = 10%
• Your return must cover cost of capital here must be some balance after that Return of equity share holder (ROE) will rise because company > than
• Flexibility what it pays to loan provider
• Should capable of being change rights Debt = 100
Rights
Equity <Buy back
Equity = 100
ROCE = EBIT =200 X 15% = 30
• Callable bond (flexibility) (-) interest = (100 X 10%) = 10
• Conservatism
• Risk should be very high ∴ ROE = 20
• Too much debt should be avoid When, ROCE > Rate of interest
• Control Then, will use debt to ↑ ROE
• Too much of dilution of control should be avoided <50%
5. Corporate Taxation
(impact on decision related to CS)
Risk Cost Control Deb 100
1. Equity Lowest Costliest Dilution and Rate 10% Pref share 100
= no dividend ∴ Company sharing profit control – V.R. Interest 10 10% 10
= no repay ∴ Expecting ensure highest transfer to Tax 30% +DDT 2
even retained outsider Net 7% 12 %
2.Preference Riskier than equity Cheaper than equity but, No Dilution ∴ Net 7%
less risk than loan costlier than loan
3. Loan Highest Cheapest:- No Dilution 6. Government policy by Various KGI
= Interest -Interest is fixed generally (except loan - SEBI Rules related IPO guidelines
= repayment/. - Tax deduction is allowed from F.I) can - RBI Interest rate ↑↓
(Tax saving) appr - Income Tax Act Tax Rate
Nominee
- Partnership Act
dividend
- FEMA
7. Legal Requirement: - While raising funds from equity you also have to 13. Period of Finance
complete various legal requirement Short term - O/D, C.C
Medium term - Commercial Property
IRDA, SEBI, Etc. Long term - Prefernce share
Very long term - Equity/ R.E.
𝑌𝐸𝑆
8. Marketability - Market for your share/debenture <
𝑁𝑂 14. Nature of Investor / Requirement of invester
9. Flexibility – can change CS
10. Timing – कब raise करना है Risk Taker Risk Avoider

If, Capital market ↑↑
Share price ↑↑ Equity Equity So, Company must use b=debt/
preference share
Capital Market No Equity, Only debt So, यहा इन्व्हे स्टर के किक्स ररटनन ररस्क नही होगा
So, Debt
11. Size of company –
Small Company Equity से raise करे भी 15. Purpose & Finance
Large Company Debt से raise करे भी Bank/FI/NBFC - Debt
Nature of Industry -
इसलिए startup
∴ इसमे ज्यादा होती है equity raise ककया
If software company - Equity
16. Gestation period – Time regd. For project to generate revenue If, gestation
12. Purpose & Finance o
period - long - use equity & V.V.
So Interest pay भी कर सकते In G period
Productive Non - Productive
17. Certaimity:
Life Machine Adv. CSR, Donation Income certain - Use Debt
Uncertainity - Use Equity
Debt best Equity best 18. Quantum of Return
If ROCE > rate of interest use DEBT
∴ यहा ररटनन हे ∴ यहा ररटनन नही हे ROCE > rate of interest use Equity
CS Theories
Component of financial risk
Divides in 2 parts
Risk & cash insolvency Risk and Variation in Risk in cost of capital
EPS CS influence CS does not
Value of firm i.e. cost influence value of
Firm does not have
liquidity to pay its ∴ Earning will fluctuate ∴ Financial risk ↑ of capital = (WACC) firm
➩
liability
∴ Lender नािायक हो A. Net Income Approach (N.I) A. Net Operating Income (NOI)
Cause excess use of
∴ Excessive use of debt B. Traditional Theory B. Modigliani & Milter (MM)
debt जायगा Approach
∴ Firm may be CS Theories Explain:- How change in debt influence the value of firm
Liquidated
Firm become uncertain ∴ Interest rate ↑ 1. Impact of leverage
2. Cost of capital
3. Notes मे
Capital Structure Theories 4. Notes मे
Purpose/why: - Whether C.S. matters → YES
Theory के Assumptions
Does C.S. influence value of firm → YES
Does C.S. influence cost of capital of firm → YES
General Specific
(Applicable to all theories) (Applicable to Specific theories)
If, Yes. Then
What is optimum C.S ? A. There are only 2 source of funds < Debts & Equity
B. Total capital firm will remains constant.
Equity 10L 15 5 0
Debt 10L 5 15 20
20L 20 20 20
C. ∴ EBIT – Constant
∴ Sales Constant 4. EBIT or NOI Sales
{EBIT = sales - } (-) V.C.
(=) Balance
D. Zero retention – 100% payout (-) Opt. Fixed cost
E. EBIT = opt pt = ‘tve’ (=) EBIT
F. Business risk – constant (-) Interest
G. No Taxation – to simplify theory (=) EBT
H. no. of difference in investors pectatim (-) TAX
A B C D EAT
EBIT 20 20 20 20 Now, Kd = cost of debt
From 2 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
above Kd =
𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡 𝑖.𝑒. 𝐷
हर investor के same उम्मीद हे from firm 𝐼
I. Capital structure can be altered without any transfer cost Kd =
𝐷
Same,
1. E = Market value of equity From 1 Ke =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑣𝑙.𝑓𝑜𝑟 𝐸𝑆𝐻
Desired rate of return
𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑆𝐻 above 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
E= Kd =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑣𝑙.𝑓𝑜𝑟 𝐸𝑆𝐻
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑖.𝑒. 𝑘𝑒 बडे बडे ज्ञानी 𝐸 (𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦)
1,00,00,000 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝐴𝑣𝑙. 𝑡𝑜 𝐸𝑆𝐻
E=
10%
∴ ke =
𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 (𝑒)
लोग इसे 5. Ko = overall cost of capital
E = ₹ 10,00,000 समज नही = wt. Avg. cost of capital
पाये = Overall expectation of the investor from a business
2. D = Market value of Debt 𝐸𝐵𝐼𝑇
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 10,00,000 6. Ko = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑓𝑖𝑡𝑚
D= = = ₹ 1,00,000
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑑𝑒𝑏𝑡 (𝑖.𝑒. 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒) 10%
7. Ko = WACC = (Kd X Wd) (+) (Ke X We)
𝐼 E.g. ₹ Weight Cost
∴ Cost of debt =
𝐷 (𝑖.𝑒.𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 E 100 50% 10%
D 100 50% 8%
3. V = Value of firm
Ko = (10 X 0.5) + (8 X 0.5)
V=E+D
= 5+ 4 = 9%
#Net Income Approach (NI)
C.S influence value of firm
Specific Assumption:- Cost of
1. No taxation Capital जेसे जेसे Debt
2. Kd < Ke वेसे Ko
3. Kd & Ke remain constant at all level of D/E mix Ke =
#Net Income Approach (NI) Ko Ke>Kd
C.S influence value of firm Kd =
Specific Assumption:- Kd<Ke
1. No taxation
2. Kd < Ke
3. Kd & Ke remain constant at all level of D/E mix
D – E Mix
Ko = (Wd x Kd) + (We X Ke) D E Kd Kp Interest Firm should take max use of debt it will reduce Ko if firm
= 0 X 8 + 1 X 10 5 : 1 8% 10% rate e%
= 10% 4 : 1 8% 10% रहेगा चाहे
ककतना भी
Calculation value of firm (NI)
3 : 1 8% 10%
Kd = 0.1 X 8 + 0.9 X 10 debt हो Step 1: Determine EBIT
1 : 1 8% 10%
= 9.8% same Ke का (-) Interest
0 : 1 8% 10%
Ko = 1 X 8 + 0 X 10 (=) EBT
= 8% (÷) Ke
4. Use of debt control does not change the risk percept of investor (=) market value of equity XX
अगर debt increases भी हुवा
Step 2: Market Value of debt XX
𝐼
Debt Debt Debt Debt 𝐾𝑑 XX

0% 20% 30% 90%
Step 3: Add market value of firm
𝐸𝐵𝐼𝑇
Step 4: If, Ko =
In all above case investors risk 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚
percept always same Ko = (We X Ke) + (Wd X Kd)
5. Ko Decrease with increase in debt in capital share (logic Kd < Ke)
NOI Approach CS have no influence on value of firm Comparison Between – NI & NOZ
Y
Assumption Ke 1. In both theories Kd<Ke
2. In both the theories Kd is Constant
1. Kd<Ke 3. In NI approach Ke is constant where as in NOI approach Ke increasing
Ko
2. Kd remain constant Constant with increase in D/E ratio
3. Ke ↑ (NI मे Ke was constant) Kd 4. In NI approach the risk perception of equity investor does not change even
if debt ↑ ∴ Ko ↓ Ko = constant if firm uses more debt how even, in NOI approach the risk perception of
∴Ke ↑ ∴Ke ↑ ∴Ke ↑ X equity investor change because he thinks that financial risk increases with
4. Ko = constant & Kd use of more debt
𝐸𝐵𝐼𝑇 (𝑐𝑜𝑛𝑠𝑡𝑎𝑛𝑡)
5. Value of firm = ∴ also constant 5. The optimum C.S. is one where the value of firm maximum & COC is
𝐾𝑜 (𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡)
6. ∴ conclusion:- there is no optimum capital share each minimum. In approach it is possible to reach optimum C.S by making
capital share is as goods other C.S maximum use of debt.
↓ 6. In NOI approach value of firm remain constant at all S?E mix so no
From point of view & Value of firm optimum C.S in NOE approach
Formula:- 7. In NI approach Ko decreases with use of more debt where as in NOI
A. EBIT approach Ko remain constant for all levels of D/E mix
B. (-) Interest Traditional theory
C. (-) EBT
There are 3 phases in C.S. of an entity
D. Overall cost of capital (Ko) constant
𝐸𝐵𝐼𝑇 Phase – I Phase - I Phase - I
E. Value of firm (Low amt. of debt) (Moderate debt) (Excessive use of debt)
𝐾𝑜
F. Value of Debt
G. Value of equity (Value of firm – value of debt) Kd Constant Constant Increases
𝐸𝐵𝑇
H. Cost of equity (Ke) Ke Constant Increases @ highest rate Increases
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝐾𝑑↑
Ko Decreases Constant Increases 𝐾𝑒↑
(like N.I. approach) (like NOI approach)
बहोत ज्यादा debt use करोगे तो Ko ↑ M.M. Approach – (Modigliani and miller approach)
Nothing is constant • It is like NOI approach
• Value of firm does not change due to ch. In CS
Ko ↑
Ko
↑ Ko
↑
• There is no optimum CS
Low Debt Moderate Debt Exercise Debt
• This more detailed than NOI approach
As per this theory C.S. influence value of firm and overall capital the firm Assumption
should choose that CS where value of firm is may i.e. firm should choose cs in
1
Phase II
Like 2
NOI 3
4
Chance of Best CS-in Value of firm 5. Perfect capital Market
improved Phase II So Ko a. Investors are free to buy & sell section (No. Govt/any
Y
restrictions)
Phase – I Phase – II Phase – III b. No transaction cost
Ke
Like NOI Like NI Worst c. Investor have full knowledge of risk & returns of all securities
d. Investor behave rationally
e. They can borrow without any restrictions
Ke 6. Risk classification – SBI, ICICI invest where RD Infosys TCS Maruti,
Ke Hyundai
Ko Ko
Kd
𝐸𝐵𝐼𝑇
Ko - constant Proposal I 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑀𝑀 =
𝐾𝑜
Kd Ke MM = 𝐾𝑜 + 𝐾𝑜 − 𝐾𝑑 𝑋
𝐷𝑒𝑏𝑡
𝐸𝑞𝑢𝑖𝑡𝑦
Risk Prem
X
Proposal II Ke = Ko + Risk prem of that firm which has zero debt
i.e. Ke of that firm which has zero debt EPS Plan II
Plan I
Ko = Ke
Proposal III Financing & Investment decision are in depended EPS
. .. (EPS in difference point)
आप कैसे करें गे इसका पे कोई फकक नहीं पड़ेगा
Proposal IV Value of firm remains same in same industry
.
Financial BEP
.
Financial BEP
.
EPS indifference
BIT
Means financial leverage has no impact on market value

of plan I of plan II point
of firm in same risk class
Financial Break Even Point Note - It above graph if
1. It is that level of EBIT at which EPS is ‘O’ 1. EBIT is expected to be below EPS indifference point will be
2. It is that level of EBIT which is just sufficient to cover interest and plan I – Highest EPS
preference dividend 2. If EBIT expected to be more than EPS indifference point
𝑃𝑟𝑒𝑓𝑒𝑟𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
3. Financial BEP = interest + Plan II – will be have higher EPS
1 −𝑡𝑎𝑥 𝑟𝑎𝑡𝑒
3. EPS indifference point will be founded by solving an equation (later)
EBIT
4. Horizontal intersect represent financial ESP for Each plan
(+) Interest
(=) EBT Which plan to be chosen?
(-) Tax 1. If EBIT is expected to be below indifference point – the option with lower
(=) EAT debt should be chosen reason being at lower EIT level more interest and
(-) Preference dividend debt not advisable
Earning avl. For ESH 2. If EBIT is expected to be above in indifference – option with higher debt
EPS Indifference Point be chosen reason it increases the EPS
ये EBIT Level पे 3. If EBIT is expected to be equal to indifference point any plan can be
1. Is that level of EBIT at which EPS under
दोनो plan का EPS chosen coz, EPS is same
two financing plans are equal
same होगा
2. It is also called EPS equivalency point
Formula
CASE 1
Plan A = All equity plan
Plan B = Equity + Debt plan
यहााँ EBIT ननकािना है
So Equation will be
Plan A Plan B
𝐸𝐵𝐼+(1 −𝑡) 𝐸𝐵𝐼𝑇 1−𝑡 −𝑃𝑟𝑒𝑓𝑒𝑟𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒
=
𝑁1 𝑁2
No. of equity No. of equity

share under plan A share under plan B
CASE 2
Plan A = All equity plan Preference
Plan B = Equity + preference share dividend tax
𝐸𝐵𝐼+(1 −𝑡) 𝐸𝐵𝐼𝑇 1−𝑡 −𝑃𝑟𝑒𝑓𝑒𝑟𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 (-) करने के
= बाद (-) होता
𝑁1 𝑁2
CASE 3 है
Plan A = Equity + Debt
Plan B = Equity + preference share
𝐸𝐵𝐼𝑇 −𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 (1 −𝑡) 𝐸𝐵𝐼𝑇 1−𝑡 −𝑃𝑟𝑒𝑓𝑒𝑟𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒
=
𝑁1 𝑁2
CASE 4
Plan A = Equity + Debt + Preference share
Plan B = Equity + Debt + Preference share
𝐸𝐵𝐼𝑇 −𝐼1 1 −𝑡 𝑃𝐷1 (𝐸𝐵𝐼𝑇 −𝐼2) 1−𝑡 −𝑃𝐷2
=
𝑁1 𝑁2
1. _____ refers to the mix of a firm's capitalization and includes long term (c) Both Statement I and Statement II are false.
sources of funds. (d) Both Statement I and Statement II are true.
(a) Leverage
(b) Capital structure 5. While designing a capital structure a finance manager should choose a
(c) Debt mix pattern of capital which –
(d) Owner's equity (a) Minimizes cost of capital
(b) Maximizes the owners return.
2. The term "capital structure" refers to: (c) Maximizes cost of capital and minimizes the owners return.
(a) Current assets & current liabilities' (d) Both (A) and (B)
(b) Long-term debt, preferred stock, and common stock 'equity
(c) Total assets minus liabilities 6. The manner in which an organization's assets are financed is referred to
(d) Shareholders' equity as its –
(a) Capital structure
3. The decisions regarding the forms of financing, their requirements and (b) Financial structure
their relative proportions in total capitalization are known as – (c) Asset structure
(a) Equity decisions (d) Owners structure
(b) Equilibrium decisions
(c) Outright decisions 7. Which of the following is included in capital structure?
(d) Capital structure decisions (a) Long term debt
(b) Preferred stock
4. Which of the following statement is false? (c) Current assets
I. In case the firm wants to grow at a faster pace, it would be required (d) Retained earnings
to incorporate debt in its capital structure to a greater extent.
II. If the firm has no long term debt in its capital structure, it means that 8. Financial structure involves creation of –
either it is risk averse or it has cost of equity capital or cost of retained (1) Long term assets
earnings less than the cost of debt. (2) Short term assets
Select the correct answer from the options given below. Select the correct answer from the options given below.
(a) Statement I is true while Statement H is false. (a) (2) only
(b) Statement I is false while Statement H is true. (b) Neither (1) nor (2)
(c) (1) only
(d) Both (1) and (2) 12. If the debt component in the capital structure is predominant –
(a) The fixed interest cost of the firm will be minimum thereby decreasing
9. Financial structure is _______ concept while capital structure is _____ its risk.
concept. (b) Earnings per share (EPS) will be very low.
(a) Inappropriate; appropriate (c) Dividend expectations of equity shareholders are also and P/E Ratio
(b) Appropriate; inappropriate may decrease.
(c) Narrow; boarder (d) The fixed interest cost of the firm increases thereby increasing its risk.
(d) Boarder; narrow
13. Capital structure relates to _____ capital deployment for creation of
10. Assertion (A): _____ assets.
The capital structure should be determined within the debt capacity of the (a) Long term: long term
company and this capacity should not be exceeded. (b) Long term: Short term
Reason (R): (c) Short term: long term
The debt capacity of a company depends on its ability to generate future (d) Short term: short term
cash flows. It should have enough cash to pay creditors' fixed charges and
principal sum. 14. Which of the following statement is correct?
Select the correct answer from the options given below Horizontal capital structure –
(a) A is true but R is false 1. is quite stable.
(b) A is false but R is true. 2. is formed by a small amount of equity share capital
(c) Both A and R are true but R is not correct explanation of A. 3. there is absence of debt
(d) Both A and R are true and R is correct explanation of A. 4. have increasing component of debt.
Select the correct answer from the options given below.
11. Which of the following capital structure consist of zero debt components (a) 1, 2 & 4
in the structure mix? (b) 2 & 3
(a) Pyramid Shaped Capital Structure (c) 1 only
(b) Inverted Pyramid Shaped Capital Structure (d) 1 & 4 only
(c) Horizontal Capital Structure
(d) Vertical Capital Structure
15. One can design capital structure with proper proportions of equity
preference and debt mix. The choice of the combination of these sources 19. A firm's optimal capital structure:
is called – (a) Is the debt-equity ratio that exists at the point where the firm's
(a) Structural mix weighted after tax cost of debt is minimized.
(b) Policy mix (b) Is generally a mix of 40% debt and 60% equity
(c) Capital structure mix (c) Is the debt-equity ratio that results in the lowest" possible weighted
(d) Finance mix average cost of capital.
(d) Is found by locating the mix of debt and equity which causes the
16. In horizontal capital structure – earnings per share to equal exactly ₹ 1.
(a) Expansion of the firm takes place by issuance of debt securities.
(b) Expansion of the firm takes place by issuance of debt securities and 20. M & M Proposition I, without taxes, states that:
preferred stocks. (a) Firms should borrow to the point where the tax benefit from, debt is
(c) Expansion of the firm takes in a lateral manner, i.e. through equity or equal to the cost of the increased probability of financial distress.
retained earning only. (b) Financial risk is determined by the debt-equity ratio.
(d) Expansion of the firm takes place by issuance of short term and (c) The cost of equity rises when financial leverage rises.
marketable securities. (d) It is completely irrelevant how d firm arranges its finances.
17. According to Cost Principle an ideal pattern or capital structure is one that 21. Two firms that are virtually identical except for their capital structure are
– selling in the market at different values, According to M & M:
(a) Minimizes cost of capital structure (a) One will be at greater risk of bankruptcy.
(b) Maximizes earnings per share (EPS). (b) The firm with greater financial leverage will have the higher value,
(c) Both (A) and (B) (c) This proves that markets cannot be efficient.
(d) None of the above (d) This will not continue because arbitrage will eventually cause the firms
to sell at the same value.
18. Internal sources of finance do not include:
(a) Retained earnings 22. EBIT of NS Ltd. is ₹ 4,50,000.
(b) Ordinary shares Debt in capital structure = ₹ 9,00,000
(c) Better management of working capital Cost of debt (Kd) = 12%
(d) Trade credit Cost of equity (Ke) = 15%
Ignore taxation. to ruling market price result in net proceeds of ₹ 40 for every new share
Total market value of NS Ltd. = ? issued. How many equity shares are required to be issued for availing
(a) ₹ 22,80,000 finance of ₹ 20 Crore?
(b) ₹ 31,80,000 (a) 0.5 Crore shares
(c) ₹ 21,80,000 (b) 0.05 Crore shares
(d) ₹ 30,80,000 (c) 5 Crore shares
(d) 5 Crore shares
23. Take the data of above question and calculate the overall cost of capital.
(a) 12.90% 26. A company needs ₹ 31,25,000 for the construction of new plant. The
(b) 11.90% following two plans are feasible:
(c) 10.90% (i) Company may issue 3,12,500 equity shares at ₹ 10 per share.
(d) 9.90% (ii) Company may issue 1,56,250 ordinary equity shares at ₹ 10 per
share and 15,625 debentures of ₹ 100 denomination bearing a 8%
24. EBIT of NS Ltd. is ₹ 4,50,000. rate of interest.
Debt in capital structure = ₹ 6,00,000 Corporate income-tax rate is 40%.
Cost of debt (Kd) = 10% Calculate indifference point.
Cost of equity (Ke) = 12.5% (a) ₹ 2,50,000
Ignore taxation. (b) ₹ 2,75,000
Total market value of NS Ltd. = ? (c) ₹ 2,25,000
(a) ₹ 37,20,000 (d) ₹ 3,00,000
(b) ₹ 34,72,222
(c) ₹ 32,70,000 27. M Ltd. requires ₹ 25,00,000 for a new plant. This plant is expected to
(d) ₹ 34,70,000 yield EBIT of ₹ 5,00,000. The company considers the objectives of
maximizing EPS. It has 3 options to finance the project - by raising debt
25. Financing alternatives for obtaining the requisite amount of ₹ 20 Crores of ₹ 2,50,000 or ₹ 10,00,000 or ₹ 15,00,000 and the balance, in each
are under consideration. case, by issuing equity shares. Company's shares is currently selling at ₹
It was decided to issue equity shares of ₹ 10 par at a premium of ₹ 40 150, but it is expected to decline to ₹ 125 in case the funds are borrowed
each. Share issue expenses as also under pricing of the issue in comparison in excess of ₹ 10,00,000. The funds can be borrowed at the rate of 10%
up to ₹ 2,50,000 and 15% up to ₹ 10,00,000 and at 20% over ₹ Loan upto ₹ 6,25,001 to ₹ 10,00,000 16%
10,00,000. The tax rate is 50%. Which form of financing should company Tax Rate 50%
choose?
The market price of a share of the company is ₹ 40 which is expected to
(a) Option III containing debt issue of ₹ 15,00,000
come down to ₹ 25 a share, if the market borrowing exceeds ₹ 7,50,000
(b) Option II containing debt issue of ₹ 10,00,000 Which proposal is most profitable proposal from shareholders point view?
(c) Option II containing debt issue of ₹ 2,50,000 (a) Proposal I
(d) None of the above (b) Proposal II
(c) Proposal III
28. There are two firms P and Q which are identical except P does not use (d) None of the above
any debt in its capital structure while Q has ₹ 8,00,000, 9% debentures
in its capital structure. Both the firms have EBIT of ₹ 2,60,000 p.a. and the 30. Skyline Software Ltd. wants to implement a project for which ₹ 30 lakhs
capitalization rate is 10%. Corporate tax is 30%. Calculate the total is required. Following financing options are at hand:
market value of these firms according to MM Hypothesis. Option 1:
(a) ₹ 20,60,000; ₹18,20,000
Equity Shares 30,000
(b) ₹18,20,000; ₹20,60,000
Option 2:
(c) ₹18,20,000; ₹12,60,000
Equity Shares 10,000
(d) ₹12,60,000; ₹20,60,000
12% Preference Shares 10,000
29. B Ltd. requires 12 lakh to finance its activities. Its earnings before interest 10% Debentures 10,000
and tax amount to ₹ 2 lakh. The Finance Manager has forwarded three Calculate the indifference point & EPS at that level of EBIT assuming
proposals: corporate tax to be 35%.
Proposal I II III (a) ₹ 4,26,923; ₹ 12.00
(b) ₹ 4,26,923; ₹ 9.25
Equity capital 10,00,000 6,00,000 2,00,000
(c) ₹ 5,53,846; ₹ 9.25
Debt 2,00,000 6,00,000 10,00,000
(d) ₹ 3,00,000; ₹ 6.25
Interest slab applicable to loan is as under:
Loan upto ₹ 2,50,000 10% 31. Alpha Ltd. is contemplating conversion of 500 14% convertible bonds of
Loan upto ₹ 2,50,001 to ₹ 6,25,000 14% ₹ 1,000 each. Market price of the bond is ₹ 1,080. Bond indenture
provided that 1 bond will be exchanged for 10 shares. P/E ratio before calculates total value under Net Operating Income (NOI) approach. Help
redemption is 20:1 and anticipating price earnings ratio after redemption him by selecting correct option.
is 25:1. Number of shares outstanding Prior to redemption are 10,000. (a) When tax rate is same for both the companies.
EBIT amounts to ₹ 2,00,000, The company is in the 35% tax bracket. (b) When one company is totally financed by debt and other is totally
Calculate market price – finance by equity.
(i) Pre-redemption and (c) When both companies are financed by equity only.
(ii)Post redemption. (d) When both companies adopt same selling price.
(a) ₹ 169 & ₹ 216.67 per share
(b) ₹ 159 & ₹ 206.67 per share 34. Trade International is an all-equity firm that has projected earnings
(c) ₹ 179 & ₹ 226.67 per share before interest and taxes of ₹ 4,97,000 forever, The current cost of
(d) ₹ 170 & ₹ 220 per share equity is 16% and the tax rate is 34%. The company is in the process of
issuing ₹ 1.5 million of bonds at par that carry a 6% annual coupon. What
32. Following data is available for Company Y: is the levered value of the firm?
Total Assets : 15,00,000 (a) ₹ 20,50,125
Debt : Nil (b) ₹ 24,48,009
EBIT : 20% of total assets (c) ₹ 21,13,609
Tax rate : 50% (d) ₹ 25,60,125
Capitalization rate = 15%
Calculate market value of equity using Net Income (NI) approach. 35. Bharat Cylinders has 15,000 shares of stock outstanding and no debt, as
(a) ₹ 10,00,000 the original founder of the firm did not approve of debt financing. The
(b) ₹ 16,00,000 new CEO is considering issuing ₹ 2,50,000 of debt and using the proceeds
(c) ₹ 12,00,000 to retire 5,000 shares of stock. The interest rate on debt is 7.5%. What is
(d) ₹ 15,00,000 the break-even level of EBIT between these two capital structure options?
(a) ₹ 59,250
33. A student studying Financial Management subject is not able to (b) ₹ 38,500
uunderstand when total market value 'will be the same for Company X (c) ₹ 56,250
and Company Y if both companies have same total assets. Company X (d) ₹ 47,750
calculates total value under Net Income (NI) approach and Company Y
36. One-third of the total market value of X Ltd. consists of loan stock, which
has a cost of 10%. Another company, Y Ltd. is identical in every respect 37. IPL Ltd. has EBIT of ₹ 1,00,000. The company makes use of debt and
to X Ltd., except that its capital structure is all equity, and its cost of equity equity capital. The firm has 10% debentures of ₹ 5,00,000 and the firm's
is 16%. According to Modigliani and Miller, if we ignored taxation and equity capitalization rate is 15%. You are required to compute: (i) Current
tax relief on debt capital, what would be the cost of equity of X Ltd.? value of the firm; (ii) Overall cost of capital.
(a) 14% (a) ₹ 3,33,333; 15%
(b) 17% (b) ₹ 8,33,333; 12%
(c) 19% (c) ₹ 5,33,333; 14%
(d) 13%
(d) ₹ 6,33,333; 18%
Answers
1 B 2 B 3 D 4 D 5 D 6 B 7 C 8 D 9 D 10 D
11 C 12 D 13 ** 14 C 15 C 16 C 17 C 18 B 19 C 20 D
21 D 22 B 23 A 24 A 25 A 26 ** 27 B 28 B 29 B 30 B
31 A 32 A 33 C 34 D 35 C 36 C 37 B
COST OF CAPITAL BY CA CS HARISH A MATHARIYA
98220 93220

1. Capital raise करने के लिए cost िगती है IMP Point: “जो भी Return earn कर रहा हु must levered our COC,”
If only this in
Specific cost Debt cost interest Investment Expectation Return expected
It combined will
capital share
Specific cost Loan cost Interest then COC= Ke R 70 12% ₹ 8.4
get Ko
Specific cost Risk cost Pref. dividend S 20 10% ₹ 2.0

Specific cost Equity cost Dividend + Related earning sharing M 10 9% ₹ 0.9
Specific cost Owned funds cost opportunity lost 100% ₹ 11.30
Min rate of Return ∴ Firm must earn 11.30L to satisfy R/S/M
➯ ➯
∴ Rate of return to be Earning
ये अपनी cost of capital होनी चाहहये earned to satisfy all R/S/M
=
Iinvestment
Otherwise loss होगा =
11.30L
100L
“It is minimum rate of return that firm must earn so that it will maintain market
value of shares” = 11.3%
EBIT इनकी भी कुछ expection

(-) Interest
EBT ➯
इनको Expectation के इतना
Also called as opportunity
cost of capital invested by
It is the min rate of
return that firm must
(-) Tax
Equity share मिलना चाहहये investor earn to satisfy investor
(-) P. Dividend holder
∴ Market price maximum & to maintain market
Earning avl. For ESH
value preference share
If Expectation fulfil ↑ Share price if issue ज्यादा then
opportunity cost share price ↑
If Expectation not fulfil ↓ Share price
Own Business Investment in

other business
#Importance of cost of capital
- Capital structure decision
- Capital budgeting decision – decision to buy capital assets
➯ ➯
कैसे होना चाहहये
Cost is incurred now Benefit in future
10 Lakh That’s Cost of capital should be Minimum
यह अच्छा लग 3 4 6 7
रहा हे ये future in flow है
∴ Cost of capital at - ननकालना आना चाहहये
∴ Cost of capital is IMP
To compare ∴ we have to find out COC of difference CS & then, we
➯ ➯ ➯ ➯
have to compare the same
ये दोनो को equal footing लाना हे
- Evaluation of find performance
Cost of capital use to evaluate performance top management
So we need discount rate
➯
E.g. Company चचल्हा रही हे
That discount rate is “cost of capital” sale of 5,000 core
EPS 20
So cost of capital का पेहला use हे
decision making in capital budgeting Investors like; wait हमे दो बाते बताये
E.g. COC? 12%
ROCE? 10.1%
- Other Financial Decision:-

Like dividend decision right share bonus share ित चचल्ला ओ Here co. doing bad
with share holder
#Cost of redeemable deb (Can solve by 2 methods)
#Computation of Cost of Capital Formula method IRR Method
This we will discuss

𝑅𝑉 −𝑁𝑃 in the capital
Individually source of Avg. Cost of Capital (If Kd = I (1-t) + 𝑁𝑜.𝑜𝑓 𝑌𝑒𝑎𝑟𝑠 budgeting topic
capital का Cost of Capital more than one source)
𝑅𝑉+𝑁𝑃
∴ जिस source का Amt. 2
(weight) ज्यादा है उसका Note:-
influence ज्यादा होगा COC If RV not given – assumed FV @ par
पर If, N.P not given – assumed current as NP Market price
A.- Cost of Debt capital (Kd)
➪➪
(Debenture, loan, Bond, Notes, etc.)
If this also not given
Irredeemable debt Redeemable debt Assumed F.V as

(No maturity date) (maturity date fixed) net proceeds
𝐼(1−𝑡)
Kd = E.g. When diff RV & N.P is amortizable for tax purpose
𝑁𝑒𝑡 𝑝𝑟𝑜𝑐𝑒𝑒𝑑𝑠 𝑜𝑓 𝑖𝑠𝑠𝑢𝑒
Face value =100
➪
Issue exp. Interest value = 10%
(-) करने Deb issue Tax = 30% (𝑅𝑣−𝑁𝑃)
के बाद
If not given in que assume
करके net Esse expence =₹3 Then, I(1-t) + (1-t)
current market price 𝑛
ककतना मिला
10 (1 −0.30)
=
97
(𝑅𝑣−𝑁𝑃)
2
B. #Cost of Preference Share C. #(Cost of term loan) Kt
Kt = (1-t) } If interest rate is given
∴ interest is tax deductible
Bi Bii Interest amt. (1-t)
Irredeemable Redeemable = If, interest amount is given
Pref. share Pref. share Loan amt.
➯
(Maturity date given)

Pref. Dividend
Kp =
Net Proceeds
Formula IRR
If, Dividend tax also given
then, cost थोडा बढे गा
∴ DDT company की liability है Will see in
capital budget
Like Redeemable debt
Pref divi. + DDT
Kp =
Net Proceeds (𝑅𝑉 −𝑁𝑃)
PD +
𝑛
Kp = (𝑅𝑉+𝑁𝑃)
2
D. #Cost of Equity Share Capital I (i) #Constant Dividend model
∴ D/Pref/Loan Rate of interest/Dividend Ke =
D - Price of share is PV of future dividend
Her dividend
Redemption value Fixed Po - PV of annuity =
𝐴
Constant annuity
𝑟
𝐷
Redemption date - Po =
𝐾𝑒
But,
In Equity capital None of the above variable is fixed 𝐷1
II (ii) #Dividend price (+) Growth Approach Ke = + 𝑔
∴ Difficult to calculation ‘Cost of Equity’ 𝑃0
Earning & dividend will grow @ constant rate
∴ Lots of Theory approaches given for cost of equity
Yr Dividend Last/current/just
1 10 pd. Dividend etc.
𝐷1
Ke = +𝑔 2 10 + 10% = 11
Approaches 𝑃𝑜
3 11 + 10% = 12.10 Do
I II III VI 4 12.10 + 10% = 13.31
Dividend Price Earning Price Realized Yield CAPM

Approach Approach Approach So, dividend
or PV of share = P.V. of all future dividend
is growing
𝐴
Dividend Discount model (DDM) Pv = … … … … . . 𝑤ℎ𝑒𝑛 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 𝑖𝑠 𝑔𝑟𝑜𝑤𝑖𝑛𝑔
or 𝑟−𝑔
Dividend Cash Flow Model (DCF) Pv (r-g) = A @ 𝑐𝑜𝑛𝑠𝑡𝑠𝑎𝑛𝑡 𝑟𝑎𝑡𝑒 Hence we
𝐴 annuity with
r-g =
Demerit:- This method can use only for these 𝑃𝑉 ‘g’ format of
Few Assumption 𝐴
company earning r= +𝑔 TVOM
𝑃𝑉
- Dividend influence share price
- Price of share today is P.V of expected future Dividend Po
- Divi. are paid at a constant ₹ or Rate for perpetuity
II Ke using – earning price approach IV CAPM Approach (Nobel price winner)
By willium sharpes has given this model
Ke = Rf+Rf 𝛽 (𝑅𝑚 − 𝑅𝑓)
Constant EPS EPS is growing Rf = Rate of return on risk free sec
at constant rate 𝛽 = It is a measure of risk
𝐸𝑃𝑆
Ke =
𝐸𝑃𝑆1
+g • Higher 𝛽 – Higher risk & V.V
Ke = 𝑃𝑜 • If 𝛽 is high = investors expects high risk premium
𝑃𝑜
Rm = Rate of return on market portfolio (or stock market)
Ke = R1 + Security Risk premium
III Realized Yield Approach
(ये theory केहती है if investor invest in risky sec, he will expect
more risk them Rf rate )
Here, ‘Ke’ is – the rate of return you realized in post year
𝐷1+(𝑃1 −𝑃𝑜)
Yield (return) = Ke = Amt. investor
𝑃𝑜
Draw back:- It has realisation assumption (so earning not stable –

you will get not correct ans)
(Past is not guarantee of future)
E Cost of Retained Earning
Company Point of view

➪ Investors point view
R.E. is that portion of earning

which is not distributed
➪
R.E. is represented as Share

holder funds
➪
Now Does R.E has a cost

Year it is the opportunity
cost od S.H
➪
Cost of R.E = cost pf equity

दोनो का िमलक S.H. ही हे
1. Cost of equity shares or debt is called- (b) Future Cost
(a) Related cost of capital (c) Implicit Cost
(b) Easy to calculate cost of capital (d) Specific Cost
(c) Specific cost of capital
(d) Burden on the shareholder 5. Cost of capital is equal to required return rate on equity in case if investors
are only—
2. In which of the following method cost of equity capital is computed by (a) Valuation Manager
dividing the dividend by market price per share or net proceeds per (b) Common Stockholders
share? (c) Asset Seller
(a) Price Earning Method (d) Equity Dealer
(b) Adjusted Price Method
(c) Adjusted Dividend Method 6. Which of the following model/ method makes use of beta (β) in calculation
(d) Dividend Yield Method of cost of equity?
(a) Risk Adjusted Discount Model
3. In weighted average cost of capital, a company can affect its capital cost (b) Capital Assets Pricing Method
through- (c) MM Model
1. Policy of capital structure (d) Price Earning Method
2. Policy of dividends
3. Policy of investment 7. Bond risk premium is added into bond yield to calculate-
Select the correct answer from the options given below: (a) Cost of option
(a) 1 only (b) Cost of common stock
(b) 2 & 3 (c) Cost of preferred stock
(c) 1 & 3 (d) Cost of working capital
(d) All 1, 2 & 3
8. The cost of equity share or debt is called specific cost of capital. When
4. ______ is the rate of return associated with the best investment specific costs are combined, then we arrive at-
opportunity for the firm and its shareholders that will be forgone if the (a) Maximum rate of return
projects presently under consideration by the firm were accepted. (b) Internal rate of return
(a) Explicit Cost (c) Overall cost of capital
(d) Accounting rate of return (a) Statement I is false but Statement II is true
(b) Both Statement I and Statement II are false
9. Interest rates, tax rates and market risk premium are factors which – (c) Statement II is false but Statement I is true
(a) Industry cannot control (d) Both Statement I and Statement II are true
(b) Industry can control
(c) Firm must control 13. How you will calculate expected dividend i.e. dividend at the end of year
(d) Firm cannot control one?
(a) D1= [Do (1 + g)]
10. ______ is the rate that the firm pays to procure financing. (b) D1= [Do(1 - t)]
(a) Average Cost of Capital (c) D1= [Do X ( 1 - g)]
(b) Combine Cost (d) D1 = [Do + (1 - g)] (1 - t)
(c) Economic Cost
(d) Explicit Cost 14. Premium which is considered as difference of expected return on common
stock and current yield on Treasury bonds is called –
11. Preferred dividend is divided by preferred stock price multiply by (1- (a) Past risk premium
floatation cost) is used to calculate (b) Expected premium
(a) Transaction cost of preferred stock (c) Current risk premium
(b) Financing of preferred stock (d) Beta premium
(c) Weighted cost of capital
(d) Component cost of preferred stock 15. Select which of the following statement is correct?
(a) Capital budget decision largely depends on the cost of capital of
12. Statement I: each source.
Cost of retained earnings is the opportunity cost of dividends forgone by (b) Capital structure is the mix or proportion of the different kinds of short
shareholders. term securities.
Statement II: (c) Cost of capital helps to evaluate the financial performance of the firm.
The opportunity cost of reserve & surplus may be considered as their cost, (d) As per MM approach, the cost of equity (Ke) is equal to capitalization
which is equivalent to the income that would otherwise earn by placing rate of pure equity stream minus a premium for business risk.
these funds in alternative investment. Select the correct answer from the Select the correct answer from the options given below:
options given below: (a) and (II)
(b) (I), (III) and (IV) (d) Market risk premium
(c) (II) and (III)
(d) (I) and (III) 20. Key sources of value (earning an excess return) for a company can be
attributed primarily to _______
16. Which of the following is controllable factor affecting the cost of capital (a) competitive advantage and access to capital
of the firm? (b) quality management and industry attractiveness
(a) Dividend policy (c) access to capital and quality management
(b) Level of interest rates (d) industry attractiveness and competitive advantage
(c) Tax rates
(d) All of the above
21. The weighted average cost of capital (Ko) results from a weighted
17. Which of the following factor affects the determination of cost of capital average of the firm's debt and equity capital costs. At a debt ratio of
of the firm? zero, the firm is 100% equity financed. As debt is substituted for equity
(a) General economic conditions and as the debt ratio increases, the –
(b) Market conditions (a) Ko declines because the after-tax debt cost is less than the equity cost
(c) Operating and financing decisions (Kd < Ke).
(d) All of the above (b) Ko increases because the after-tax debt cost is less than the equity
cost (Kd < Ke)
18. Cost of equity which is raised by reinvesting earnings internally must be (c) Ko do not show any change and tend to remain same.
higher than the – (d) None of the above
(a) Cost of initial offering
(b) Cost of new common equity 22. While calculating the WACC, cost of each component of the capital is
(c) Cost of preferred equity weighted –
(d) Cost of floatation (a) In the ratio of 1:2:3:4
(b) by the relative proportion of that type of funds in the capital structure.
19. Risk free rate is subtracted from expected market return is considered as: (c) by the relative proportion of that type of funds to total assets in the
(a) Country risk company
(b) Diversifiable risk (d) Both (A) and (C)
(c) Equity risk premium
23. For which of the following costs is it generally necessary to apply a tax 26. Sweet Treats common stock is currently priced at ₹ 19.06 a share. The
adjustment to a yield measure? company just paid ₹ 1.15 per share as its annual dividend. The dividends
(a) Cost of debt have been increasing by 2.5% annually and are expected to continue
(b) Cost of preferred stock doing the same. What is this firm's cost of equity?
(c) Cost of common equity (a) 8.68%
(d) Cost of retained earnings (b) 8.86%
(c) 6.18%
24. The cost of preference share capital is calculated – (d) 6.03%
(a) By dividing the fixed dividend per share by the price per preference
share and then adding risk premium. 27. Narendra Ltd. is planning for issue of 15% Preference Shares of ₹ 100
(b) By dividing the fixed dividend per share by the price per preference each, redeemable at par after 8 years. They are expected to be sold at
share and then adding growth rate. a premium of 5%. Flotation cost is 9% of face value. Corporate tax is
(c) By dividing the fixed dividend per share by the price per preference 35% and corporate dividend tax is 10%. The cost of preference shares
share. on the basis of present value of future cash flow shall be –
(d) By dividing the fixed dividend per share by the book value per Use following rates for your calculations:
preference share. 16% 18%
PV of ₹ 1 for 1 to 8 years 4.344 4.078
25. Statement I:
Cost of equity capital is the rate of return which equates the present value PV of ₹ 1 at 8th year 0.305 0.266
of expected dividends with the market share price. (a) 17.49%
Statement II: (b) 16.22%
Dividend Yield Method cannot be used to calculate cost of equity of units (c) 18.34%
suffering losses. (d) 19.20%
Select correct answer from the options given below.
(a) Both Statements are false. 28. Mr. Investor, purchases an equity share of growing company, ATT Ltd. for
(b) Statement I is true but Statement II is false. ₹ 210. He expects that the ATT Ltd. to pay dividend of ₹ 10.5, ₹ 11.025
(c) Statement II is true but Statement I is false. & ₹ 11.575 in year 1, 2 & 3 respectively. He expects to sell shares at the
(d) Both Statements are true. end of year 3 at ₹ 243.10. Determine the growth rate in dividend.
(a) 4%
(b) 5% (a) 8.7%
(c) 6% (b) 7.7%
(d) 7% (c) 5.7%
(d) 6.7%
29. Mr. Lucky, purchases an equity share of growing company, XYY Ltd. for ₹
525. He expects that the XYY Ltd. to pay dividend of ₹ 26.25, ₹ 27.83 32. Equity shares of Anuradha Ltd. are quoted in stock exchange at ₹ 325
& ₹ 29.50 in year 1, 2 & 3 respectively. He expects to sell shares at the per share. New issue priced at ₹ 312.5 and flotation cost will be ₹ 12.5
end of year 3 at ₹ 607.75. What is the required rate of return of Mr. per share. During 5 years dividend on equity shares have steadily grown
Lucky on his equity • investment? from ₹ 26.5 to ₹ 35.48. Dividend at the end of current year is expected
(a) 11.50% at ₹ 37.5 per share. It has retained earning of ₹ 30,00,000. Corporate
(b) 10.5096 tax is 35% and shareholders are in tax slab of 20%. Ignore dividend tax.
(c) 10.05% Calculate cost of equity and cost of retained earnings?
(d) 11.65% (a) Ke = 18.50%; Kr = 14.80%
(b) Ke = 18.00%; Kr = 14.40%
30. National Ltd. has 12,000 equity shares of ₹ 100 each. Sale price is equity (c) Ke = 17.54%; Kr = 14.03%
share ₹ 115 per share; flotation cost ₹ 5 per share. Expected dividend (d) Ke = 18.94%; Kr = 15.15%
growth rate is 5% and expected dividend at the end of the financial year
is ₹ 11 per share. What is the cost of equity shares of National Ltd.? 33. A Company has ₹ 180 Million of 10% Debentures having face value of
(a) 0.1133 100. The debentures are redeemable after3 years and interest is paid
(b) 0.1278 annually. The current ex-interest debenture market value is ₹ 103.
(c) 0.1475 Pre-tax cost of debentures on the basis of present value of future cash
(d) 0.15 flow shall be –
Use following rates for your calculations:
31. Raja Ltd. has 8% Debentures (Face value ₹ 2,500) of ₹ 9,00,000 which 8% 9%
are redeemable at 5% premium, sold at 98%, 3% flotation costs with PV of ₹ 1 for 1 to 3 years 2.577 2.531
maturity of 20 years. Corporate tax rate is 35%. The company paid PV of ₹ 1 at 3rd year 0.794 1.772
debenture interest of ₹ 60,000 out of total interest payable of ₹ 72,000. (a) 9.32%
After tax cost of debt is (b) 7.91%
(c) 8.02% Equity ₹ 15,00,000
(d) 8.82% Debt (10%) ₹ 7,00,000
Profit after tax ₹ 4,00,000
34. The following is the capital structure of a company: Risk-free rate of return is 7%. Beta (β) = 0.9, Market rate of return =
Source of Capital Book Value Market Value 1596. Applicable tax rate is 40%.
Equity Shares (₹ 100 each) 80 160 (a) ₹ 1,87,020
9% Pref. Shares (₹ 100) 20 24 (b) ₹ 1,78,020
11 Debentures 60 66 (c) ₹ 1,87,200
Retained Earnings 40 - (d) ₹ 1,85,200
200 250
Current market price of equity share is ₹ 200. For the last year the 37. The preferred stock of ISO Ltd. pays an annual dividend of ₹ 6.50 a
company had paid equity dividend at 25% and its dividend is likely to share and sells for ₹ 48 a share. What is ISO's cost of preferred stock?
grow 5% every year. Corporate tax rate is 3096. Compute WACC on (a) 9.19%
the basis of market value. (b) 7.38%
(a) 14.5 per cent (c) 13.54%
(b) 13.5 per cent (d) 9.46%
(c) 12.9 per cent
(d) 14.1 per cent 38. Nikon Enterprises just paid an annual dividend of ₹ 1.56 per share. This
dividend is expected to increase by 3 percent annually. Currently, the
35. Debt as percentage of total capital of the Kinara Ltd. is 20%. Its cost of firm has a beta of 1.13 and a stock price of ₹ 28 a share. The risk-free
equity is 16% and pre-tax cost of debt is 12%. Tax rate is 50%. What rate is 3 percent and the market rate of return is 10.5 percent. What is
is overall cost of capital of Kinara Ltd.? your best estimate of Nikon's cost of equity?
(a) 16% (a) 8.74 per cent
(b) 14% (b) 11.48 per cent
(c) 15% (c) 9.72 per cent
(d) 16.6% (d) 10.11 per cent
36. Compute the EVA with the help of following information:
39. Jakson Ltd. has 12,000 bonds outstanding at a quoted price of 98% of company is 1.7158. The applicable income tax rate for the company is
face value. The bonds mature in 11 years and carry a 9% annual coupon. 3596. Kp = ?
What is your best estimate of Jakson's after tax cost of debt if the (a) 10%
applicable tax rate is 35%? (b) 11%
(a) 6.03% (c) 12%
(b) 5.77% (d) 3%
(c) 8.33%
(d) 7.04% 43. Calculate the marginal cost of capital (MCC) for the firm if it raises ₹ 750
million for a new project. The firm plans to have a target debt to value
40. Baba Ltd. has a cost of equity of 12%, a pre-tax cost of debt of 7%, and ratio of 20%. The beta of new project is 1.4375. The debt capital will be
a tax rate of 3596. What is the firm's weighted average cost of capital raised through term loans. It will carry interest rate of 9.5% for the first ₹
if the debt-equity ratio is 0.60? 100 million and 10% for the next ₹ 50 million.
(a) 9.21% The current market price per equity share is ₹ 60. The prevailing default
(b) 10.01% risk free interest rate on 10-year GUI treasury bonds is 5.5%. The
(c) 10.13% average market risk premium is 8%.
(d) 11.11% (a) 14.86%
(b) 12.22%
41. PWA Ltd. has ₹ 1,000, 9.5% debentures amounting to ₹ 1,500 Million. (c) 13.04%
The debentures of PWA Ltd. are redeemable after 3 years and are (d) 15.95%
quoting at ₹ 981.05 per debenture. The beta of the company is 1.1785.
The applicable income tax rate for the company is 35% Kd = ? 44. Black & White Ltd. has a cost of equity of 11% and a pre-tax cost of
(a) 1.59% debt of 8.5%. The firm's target weighted average cost of capital is 9%
(b) 6.87% and its tax rate is 35%. What is the firm's target debt-equity ratio?
(c) 7.86% (a) 0.6203
(d) 8.67% (b) 0.5756
(c) 0.5572
42. PWA Ltd. has ₹ 100, 10.5% preference shares amounting to ₹ 100 (d) 0.5113
Million. The preferred stock of the company is redeemable after 5 years
is currently selling at ₹ 98.15 per preference share. The beta of the
45. R&G Company has equity share capital (2,00,000 shares) ₹ 20,00,000. (a) 14% & 14.28%
The company's share has current market price of ₹ 27.75 per share. The (b) 6% & 6.12%
expected dividend per share in next year is 50% of the 2019 EPS. The (c) 7% & 7.14%
EPS of the last 4 years is as follows. The past trends are expected to (d) 8% & 8.16%
continue.
Year 2016 2017 2018 2019 47. Ganesh Ltd. requires amount of ₹ 5,00,000 to finance a project. It was
EPS 1.974 2.211 2.476 2.773 decided to raise such finance by issue of debentures. Cost of debt is 10%
(a) 17% (before tax) up to ₹ 2,00,000 and 13% (before tax) beyond that. Tax
(b) 24% rate is 30%. What is the average marginal cost of capital of new finance
(c) 16% of ₹ 5,00,000?
(d) 21% (a) 7.37%
(b) 11.5%
46. The Company can issue 14% new debenture. The company's debenture is (c) 8.26%
currently selling at ₹ 98. Face value of debenture is ₹ 100. The company's (d) 9.12%
marginal tax rate is 50%. What is cost of debenture – (i) based on book
value; (ii) based on market value?
Answers
1 C 2 D 3 D 4 C 5 B 6 B 7 B 8 C 9 D 10 D
11 D 12 D 13 A 14 C 15 D 16 A 17 D 18 B 19 C 20 D
21 A 22 B 23 A 24 C 25 D 26 A 27 A 28 B 29 D 30 D
31 D 32 A 33 D 34 A 35 B 36 A 37 C 38 D 39 A 40 A
41 B 42 C 43 A 44 B 45 A 46 C 47 C
CAPITAL BUDGETING BY CA CS HARISH A MATHARIYA
98220 93220

CAPITAL BUDGETING Merits
The process by which the firm decides which long-term investment to
make. Depends on analysis of the cash flow generated by the • Simple to apply
project and its cost • Invest in projects having shortest payback
• Suitable when the future is very uncertain
• Not involve assumptions about future interest rates
CAPITAL BUDGETING
Demerits
PROJECTS • Does not indicate whether the investment be accepted or
rejected
Independent Projects • Ignores cash generation beyond the payback period
• Whose cash flow are not affected by the accept/ • Fails to take into account. The timing of returns and cost of
reject decision for other projects. Thus, all projects capital
meet criterion accepted • Not consider the savage value
• No attempt to measure a percentage return on the capital
Mutually Excusive Projects invested
• Set of projects from which at most one will be Project cost (-) CFAT
accepted the best project can be accepted (a) P.B Period @ prev. year
= Prev. Year + x 12 months
(if uneven c.f) Diff. in CFAT of prev.
year & next year
PAYBACK PERIOD (b) P.B Period Project cost

Represents the amount of time that it takes for a capital budgeting (if even c.f) =
CFAT p.a.
project to recover its initial cost
DISCOUNTED PAYBACK PERIOD NET PRESENT VALUE (NPV) METHOD
• Disadvantage of simple payback period is that it ignores the time Indicate the expected impact of the project on the value of the
value of money. firm. Specifies that all independent project with a positive NPV
• In discounted payback period calculate the present value of each should be accepted calculated as the present value of the project’s
cash inflow taking the start of the first period as zero point for the cash inflows minus the present value of the project’s cash outflows.
set a suitable discount rate NPV = P.V. of C.I. (-) PV of C.O.
Merits: It recognizes the time value of money
PAYBACK PERIOD RECIPROCAL

Alternative way of expressing the payback period PROFITABILITY INDEX/DESIRABILITY FACTOR/BENEFIT
1
Payback period reciprocal = X 100 COST RATIO MODIFICATION OF NPV
𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑝𝑒𝑟𝑖𝑜𝑑
Investment appraisal technique calculated by dividing the present
value of future cash flow of a project by the initial investment
ACCOUNTING RATE OF RETURN METHOD (ARR)
Also known as return on investment or return on capital employed. required for the project
Technique to measure the increase in profit expected to result by Formula:
𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒
expressing the net accounting profit as rising from the investment as profitability Index =
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
a percentages of that capital investment actually a modification of the net present value method.
𝐴𝑣𝑎𝑟𝑎𝑔𝑒 𝑃𝐴𝑇
Accounting rate of return (ARR) = X 100 Decision Rate: Accept a project if the profitability index is greater
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
than 1
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡+𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒
Average Investment = X 100 Sometimes called benefit-cost ratio useful in capital rationing since
2
it helps in ranking projects based on their per rupee return
DEMERIT: It does not take into accounting time of money.
INTERNAL RATE OF RETURN (IRR) MULTIPLE RATE OF RETURN
Is the discount rate at which the net present value (NPV) of a project In case where projects cash flows change signs or reverse e.g. initial
equals zero. All independent projects with an IRR greater than the cash outflow is followed by cash inflows and subsequently followed
cost of capital should be accepted. When choosing among mutually by a major cash outflow, there may be more than one internal rate
exclusive the project with the highest IRR should be selected (as long of return (IRR)
as IRR is greater than the cost of capital) NPV
Use of IRR involves comparison of IRR with the required rate of
return known as cut off rate
NPV at low rate

IRR = Low rate + X difference in rate
Difference in NPV
Merits
IIR1 IIR2
• Considers the time value of money
• Takes into account total cash inflows & outflows
• It is easier to understand
Discount Rate
Demerits CAPITAL RATIONING
• Does not use the concept of desired rate of return Is the technique of allotting scare capital among various projects in a
• Involves tedious calculation rational way
• Produces multiple rates Refers to situations where a company cannot undertake all positive
• Projects selected may not be profitable NPV projects, it has identified because of shortage capital
Advantages of practicing capital rationing CAPITAL RATIONING DOES NOT ALWAYS LEAD TO
OPTIMUM RESULTS
• Budgeting May foregoes the next most profitable investment following after the
• Introduces a sense of stick budgeting of corporate budget ceiling even through it is estimated to yield a rate od return
resources much higher than the required rate of return
• Less wastage
• Fewer Projects CAPITAL BUDGETING & CAPITAL RATIONING
• Higher returns on investments Points Capital Budgeting Capital Rationing
• Stability Meaning Process by which Situation where a
• Company is not investing in every project, the finances firm decides which company cannot
are not overextended. Helps in having adequate investments make undertake all positive
finances for tough times
NPV because of shortage
of capital
CAPITAL RATIONING AND THE STANDARD NET Acceptance Project having Compelled to reject some
PRESENT VALUE (NPV) DECISION RULE project positive is selected of the viable projects
Term capital rationing refers to the situation where the funds having positive net
available to a firm are limited. The implicit assumption within the present value because of
NPV decision rule does not hold true i.e. a firm cannot accept all shortage of funds
positive NP V projects because of shortage of capital. Capital
rationing is of two types - Hard and Soft, characterized by sources Emphasis Emphasis profitable Emphasis effective
of capital expenditure constraints. Hard constrains externally projects utilization of funds
imposed soft rationing occurs, constraints are imposed internally by
management.
SOCIAL COST BENEFIT ANLYSIS CERTAINTY EQUIVALENT APPROACH
Need for social cost-benefit analysis Certainty equivalent factor (CEF) is the ratio of assured cash flows to
▪ Market prices are used to measure costs and benefits they do not uncertain cash flows. Cash flows expected in a project are converted
represent social value into risk less equivalent amount. This varies between 0 and . 1
▪ The external effects can be positive like development or negative indicates that cash flows are certain. Greater the risk in cash flow,
like pollution the smaller will be CEF ‘for receipts’ and larger will be the CEF ‘ for
▪ Taxes and subside are transfer payments hence ignored in social payments’
benefit-cost analysis
Year CFAT CE Adj. CFAT PV Factor 7% PV
Long term 1 1,15,000 0.90 1,03,500 0.935 96,772
Implications
2 1,15,000 0.85 97,750 0.873 85,336
3 1,15,000 0.75 86,250 0.816 70,380
Involvement of
Difficult to make large amount of 4 1,15,000 0.70 80,500 0.763 61,422
funds 5 1,15,000 0.65 74,750 0.713 53,297
Total present value 3,67,207
IMPORTANCE OF
CAPITAL BUDGETING (-) Initial Investment (3,00,000)
Net present value 67,207
Risk and Irreversible Since NPV is positive, project can be accepted
Uncertainty decisions
Risk ADJUSTED DISCOUNT RATE
Is the rate used in the calculation of the present value of a risky If CFAT = ₹ 50,000 If CFAT = ₹ 60,000
investment ₹ probability ₹ probability
Formula
R f + β (R m - R f ) 24,000 0.2 40,000 0.4
STANDARD DEVIATION (I.E. RISK) & COEFFUCUENT 32,000 0.3 50,000 0.5
OF VARIANCE 44,000 0.5 60,000 0.1
Standard deviation is a statistical measure od dispersion. It measures
The firm uses 10% discount rate for this type of investments.
deviation from a central number
However, wherever returns are expressed in revenue terms the co- SENSITIVITY ANALYSIS IN CAPITAL BUDGETING
efficient of variation gives better measurement for risk evaluation.
Lesser the coefficient of variance better the project Is a technique used to determine how different values of an
independent variable impact a particular dependent variable
σ σ = ෍ (𝑃𝑟𝑜𝑏. 𝑋 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛2 )
Coefficient of variation = under a given set of assumptions.
𝑁𝑃𝑉 σ = ෍ (𝑃. 𝐷2 )
In capital budgeting, sensitivity analysis deals with the
consideration of sensitivity of the NPV to different variables
DECISION TREE TECHNIQUE IN CAPITAL BUDGETING contributing to the NPV
Is a method to evaluate risky proposals. A decision tree shows the
sequential outcome of a risky decision.
Illustration: Disadvantages
The company use decision tree analysis to get clear picture of
project's cash inflow. The project cost Rs. 80,000 and the expected • Not provide clear cut results
lite of the project is 2 years. The net cash inflows are: • Fails to focus on the interrelationship between
In year 1 there is 0.4 probability that CFAT will be Rs. 50,000 and underlying variables
0.6 probability that CFAT will be Rs. 60.000. the probabilities • Sensitivity analysis does not eliminate risk
assigned to CFAT for the Year 2 are as follows:
1. The values of the future net incomes discounted by the cost of capital are (c) Profitability index will be greater than unity
called – (d) Any of the above
(a) Average capital cost
(b) Discounted capital cost 6. A Profitability Index (PI) of 0.92 for a project means that ______
(c) Net capital cost (a) The project's costs (cash outlay) are (is) less than the present value of
(d) Net present values the project's benefits.
(b) The project's NPV is greater than zero.
2. _____ is a project whose cash flows are not affected by the accept/reject (c) The project's NPV is greater than 1.
decision for other projects. (d) The project returns 92 cents in present value for each rupee invested:
(a) Mutually exclusive project
(b) Independent project 7. which of the following statements is incorrect regarding a normal project?
(c) Low cost project (a) If the NPV of a project is greater than 0, then its PI will exceed 1.
(d) Risk free project (b) If the IRR of a project is 8%, its NPV, using a discount rate, Ko, greater
than 8%, will be less than 0.
3. _____ is the discount rate which should be used in capital budgeting. (c) If the PI of a project equals 0, then the project's initial cash outflow
(a) Cost of capital (Ko) equals the PV of its cash flows.
(b) Risk free rate (Rf (d) If the IRR of a project is greater than the discount rate, K o, then its PI
(c) Risk premium (Rm) will be greater than 1.
(d) Beta rate (β)
8. Ranking projects according to their ability to repay quickly may be useful
4. Incorporating flotation costs into the analysis of a project will: to firms:
(a) Have no effect on the present value of the project. (a) When experiencing liquidity constraints.
(b) Increase the NPV of the project. (b) When careful control over cash is required.
(c) Increase the project's rate of return. (c) To indicate the prospective investors specifying when their funds are
(d) Increase the initial cash outflow of the project. likely to be repaid.
5. A project is accepted when:
(a) Net present value is greater than zero 9. Which of the following is demerit of payback period?
(b) Internal Rate of Return will be greater than cost of capital
(a) It does not indicate whether an investment should be accepted or (a) Project A dominates project B.
rejected, unless the payback period is compared with an arbitrary (b) Project B dominates project A.
managerial target. (c) Project A is more risky and should offer greater expected value.
(b) The method ignores cash generation beyond the payback period and (d) Each project is high on one variable, so the two are basically equal.
this can be seen more a measure of liquidity than of profitability.
(c) This method makes no attempt to measure a percentage return on the 13. Assume that a firm has accurately calculated the net cash flows relating
capital invested and is often used in conjunction with other methods. to two mutually exclusive investment proposals. If the net present value of
(d) All of the above both proposals exceed zero and the firm is not under the constraint of
capital rationing, then the firm should _______
10. When operating under a single-period capital-rationing constraint, you (a) Calculate the IRRs of these investments to be certain that the IRRs are
may first want to try selecting projects by descending order of their greater than the cost of capital.
________ in order to give yourself the best chance to select the mix of (b) Compare the profitability index of these investments to those of other
projects that adds most to firm value. possible investments.
(a) Profitability Index (PI) (c) Calculate the payback periods to make certain that the initial cash
(b) Net Present Value (NPV) outlays can be recovered within a appropriate period of time
(c) Internal Rate of Return (IRR) (d) Accept the proposal that has the largest NPV since the goal of the
(d) Payback Period (PBP) firm is to maximize shareholder wealth and, since the projects are
mutually exclusive, we can only, take one.
11. Situation in which company replaces existing assets with new assets is
classified as 14. Which of the following statements is correct regarding the risk-adjusted
(a) Replacement projects discount rate (RADR) approach?
(b) New projects (a) Under the RADR approach, we should accept a project if its net
(c) Existing projects present value (NPV) calculated using a risk-adjusted discount rate is
(d) Internal projects positive.
(b) Adjusting the firm's overall cost of capital upward is required if the
12. You are considering two mutually exclusive investment proposals, project project or group are of higher than average risk.
A and project B. B's expected value of net present value is $1,000 less (c) Under the RADR approach, we would still compare a project's internal
than that for A and A has less dispersion. On the basis of risk and return, rate of return (IRR) to the firm's overall weighted-average cost of
you would say that: capital in order to decide acceptance/rejection.
(d) Adjusting the firm's overall cost of capital downward is required if the 17. When evaluating the risk and return of a project using the probability
project or group are of lower than average risk. tree approach, what is the appropriate rate to discount each sequence of
cash flows in the tree?
15. Vayu Ltd. uses the Net Present Value (NPV) method, the Internal Rate of (a) Zero
Return (IRR) method and Discounted Payback Period (DPP) to appraise its (b) Risk-free rate
new investment. An investment opportunity was recently I appraised using (c) Cost of capital
each of these methods and was estimated to provide a positive NPV of (d) Firm's historical return on its stock
1.5 million, an IRR of 15% and a DPP of 3 years. Later, it was discovered
that the cost of capital of the company was lower than had been 18. AB Ltd. is considering either leasing an asset or borrowing to buy it, and
previously estimated. What would be the effect on the figures provided is attempting to analyze the options by calculating the NPV of each. When
by each investment appraisal method of taking account of the lower cost comparing the two, AB Ltd. is uncertain whether they should include
of capital? interest payments in their option to 'borrow and buy' as it is a future,
NPV IRR DPV incremental cash flow associated with that option. They are also uncertain
(a) Increase Increase Decrease which discount rate to use in the NPV calculation for the lease option. How
(b) Increase No effect Decrease should AB Ltd. treat the interest payments and what discount rate should
(c) Decrease No effect Decrease they use?
(d) No effect Decrease No effect Include
Discount rate
interest
16. A _____ approach to examine project risk occurs when the manager (a) Yes After-tax cost of the loan if they borrow and buy
applies a probability distribution to factors such as market size, selling (b) Yes AB Ltd’s WACC
price, fixed and variable costs, and the useful life of the project. The (c) No After-tax cost of the loan if they borrow and buy
manager then runs a computer program to determine the project worth (d) No AB Ltd’s WACC
by randomly selecting values for each variable, within the limits assigned.
This is done numerous times to generate a complete risk-return analysis.
(a) Simulation 19. Y Ltd. is considering a project which requires initial investment of ₹
(b) Probability-tree 6,75,000. Cost of capital is 10%. Estimated cash flow after tax are as
(c) Firm-portfolio follows:
(d) Market risk Year 1 -
Year 2 1,50,00
Year 3 6,60,000 (a) ₹ 5,710
Year 4 4,20,000 (b) ₹ 6,690
Year 5 4,20,000 (c) ₹ 6,800
What is projects discounted payback (d) ₹ 7,216
(a) 3 years & 7.58 months
(b) 4 years & 4.12 months 22. Profitability index of Project X is 1.20167 when its cash flow is discounted
(c) 3 years & 2.32 months
at 12%. Initial investment on project was ₹ 1,50,000. This project
(d) 4 years & 8.11 months
generates equal cash flow over the five years’ time. How much cash flow
will be generated by the project each year?
20. Rakesh Ltd. is considering to invest in one of four projects for which an (a) ₹ 50,000
analyst has calculated 'payback period reciprocal' as 25%, 40%, 50%
(b) ₹ 40,000
& 75% respectively for Project P, 0, R & S. Which project will be selected
on 'payback period' method of capital budgeting? (c) ₹ 60,500
(a) Project R (d) ₹ 40,897
(b) Project P
(c) Project S 23. LMN Corporation is considering an investment that will cost ₹ 80,000 and
(d) Project Q have a useful life of 4 years. During the first 2 years, the net incremental
after-tax cash flows are ₹ 25,000 per year and for the last 2 years they
21. Following data is available for Project A whose initial investment is ₹ are ₹ 20,000 per year. What is the payback period for this investment?
50,000 and salvage value after 5 years is ₹ 3,750. (a) 3.2 year
(b) 3.5 year
Year CFAT (₹)
(c) 4.0 year
1 25,000
(d) Cannot be determined with this information.
2 20,000
3 10,000
24. A company is considering three methods of attracting customers to expand
4 10,000
its business by undertaking –
5 1,250 (A) advertising campaign; (B) display of neon signs; and (C) direct
What is the NPV of the Project A if the Ke of the company is 10%? Ignore delivery service. The initial outlay for each alternative is as under:
taxation. A ₹ 1,00,000
B ₹ 1,50,000 26. Agrani Ltd. is in the business of manufacturing bearings. Some more
C ₹ 1,50,000 product lines are being planned to be added to the existing system. The
If A is carried out, but not B, it has an NPV of ₹ 1,25,000. If B is done, but cost of machine is ₹ 40,00,000 having a useful life of 5 years with the
not A, B has an NPV of ₹ 45,000. However, if both are done, then NPV salvage value of ₹ 8,00,000. The full purchase value of machine can be
is ₹ 2,00,000. The NPV of the delivery system C is ₹ 90,000. Its NPV is financed by 20% loan repayable in 5 equal instalments falling due at the
not dependent on whether A or B is adopted and the NPV of A or B does end of each year. Calculate the figure of interest payable at the end of
not depend on whether Cis adopted. Which of the investments should be 5th year.
made by the company if the budgeted amount is only ₹ 2,50,000? (a) ₹ 4,08,831
(a) The firm should adopt mode A + B only. The outlay would be ₹ (b) ₹ 2,08,138
2,50,000 & total NPV would be ₹ 2,00,000 (c) ₹ 2,21,813
(b) The firm should adopt mode B + C only. The outlay would be ₹ (d) ₹ 3,12,318
3,00,000 & total NPV would be ₹ 1,35,000
(c) The firm should adopt mode A + C only. The outlay would be ₹ 27. Following data are furnished by Lalita Leasing Ltd.:
2,50,000 & total NPV would be ₹ 2,15,000. Investment cost ₹ 1,250 lakhs
(d) None of the above Primary lease term 5 Years
Residual value NIL
25. Z Ltd. can acquire a machine by takings, 15% loan or on lease basis from Pre-tax required rate of return 24%
leasing company. Cost of machine is ₹ 1,26,965. Tax rate is 40%. The Company wants to charge equated lease rentals i.e. equal amount of
leasing company desires a return of 10% on the gross value of the asset. lease rental per year. Lease rental payable at the end of each year = ?
The present value of cash flow under buying option is ₹ 87,528. What (a) ₹ 437.35 lakh
should be the annual lease rental to be charged by the leasing company (b) ₹ 457.53 lakh
to match the loan option? (c) ₹ 453.73 lakh
(a) ₹ 37,900 (d) ₹ 455.37 lakh
(b) ₹ 37,805
(c) ₹ 37,424 28. Apple Ltd. has decided to invest in earth-moving equipment which costs ₹
(d) ₹ 37,501 5,50,000. The company can take it on lease for 7 years at ₹ 90,000 p.a.
payable in advance. Alternatively, it can borrow at 20%. Asset can be
written-off over 6 years under straight line method of depreciation.
Asset's useful life is 7 years. ln the terminal year the asset will be sold for (b) ₹ 38,103
₹ 40,000. Tax rate is 30%. At 6th year principal amount contained in (c) ₹ 33,603
loan instalment amount will be – (d) ₹ 27,542
(a) ₹ 88,265
(b) ₹ 1,05,918 31. Present value at year 3 is ₹ 35,190 by using CE Approach. CE Factor is
(c) ₹ 1,27,323 0.75. Risk free rate is 7%. Cost of capital is 11%. What is the cash flow
(d) ₹ 1,08,426 of year 3?
(a) ₹ 57,500
29. A company buys a machine for ₹ 10,000 and sells it for ₹ 2,000 at the (b) ₹ 55,500
end of year 3 Running costs of the machine are: (c) ₹ 52,500
Year 1 = ₹ 3,000 (d) ₹ 56,500
Year 2 = ₹ 5,000
Year 3 = ₹ 7,000 32. A company has ₹ 5,00,000 available for investment and is considering
If a series of machines are brought, run and sold on an infinite cycle of the following four divisible, but not repeatable, projects to invest in:
replacements, what is the equivalent, annual cost of the machine if the Cost NPV PI
discount rate is 10%?
Project 1 ₹ 3,00,000 ₹ 60,000 1.20
(a) ₹ 22,114
Project 2 ₹ 1,00,000 ₹ 40,000 1.40
(b) ₹ 8,288
Project 3 ₹ 2,00,000 ₹ 50,000 1.25
(c) ₹ 246
Project 4 ₹ 1,50,000 ₹ 45,000 1.30
(d) ₹ 7,371
What is the maximum net present value the company can generate from
30. HM is considering to take a new project. Management use Certainty its investment?
Equivalent (CE) approach to evaluate the projects. The project is expected (a) ₹ 1,95,000
to generate cash flow of ₹ 57,500 for next 5 years. CE Factors are 0.90, (b) ₹ 1,45,000
0.85, 0.75, 0.70 & 0.65. Projects requires initial investment of ₹ 1,50,000. (c) ₹ 1,35,000
Company's cost of capital is 12% and risk free borrowing rate is 7%. (d) ₹ 1,10,000
What is the NPV of this project?
(a) ₹ 24,486
33. X Ltd. is considering to start a new project for which it has gathered 30 0.3
following data: 60 0.3
Cash Flow Probability 75 0.2
1,08,000 0.1
2,16,000 0.4
Project requires initial investment of ₹ 180 Crore. Calculate the
4,32,000 0.4
profitability index of the Project Q.
5,40,000 0.1
(a) 0.25
Calculate the expected cash flow.
(b) 1.25
(a) ₹ 3,42,000 (c) 1.35
(b) ₹ 3,18,000 (d) 1.45
(c) ₹ 3,24,000
(d) ₹ 3,32,000 36. Following data is available for Project P:
NPV (₹ in Crore) Probability
34. X Ltd. is considering to star, new project for which it has gathered:, 15 0.1
following data: 0.4
30
NPV (₹ in lakh ) Probability 0.4
60
32 0.4
75 0.1
44 0.4
57 0.2 Calculate co-efficient of variation for the Project P.
Compute the risk associated with the project. (a) 0.42
(a) 89.88 (b) 0.43
(b) 9.30 (c) 0.44
(c) 11.62 (d) 0.45
(d) 8.97
37. B Ltd. is considering the renovation of its one of department. The
35. Following data is available for Project Q: renovation will cost 10 lakh. Its CFAT sensitive to various events as shown
NPV (₹ in Crore) Probability below:
15 0.2 Event Probability Incremental CFAT
I 0.1 2,00,000
II 0.2 3,00,000 Initial outlay : ₹ 1,50,000
III 0.4 4,00,000 Life : 4 years
IV 0.2 5,00,000 CFAT : ₹ 56,250
V 0.1 8,00,000 PVAF(14%, 3) : 2.3216
PVAF(14%, 4) : 2.9137
Company estimates that the probability distribution of incremental CFAT Calculate the sensitivity of the annual cash flows.
will exists for 4 years. The company's cost of capital is 1096. What is the (a) 8.48%
project expected NPV? (b) 9.32%
(a) ₹ 3,41,300 (c) 7.77%
(b) ₹ 3,13,400 (d) 8.84%
(c) ₹ 3,31,400
(d) ₹ 3,00,340 40. X Ltd. is considering a project with following cash flow:
Cost of the plant: 70,000
38. A project is expected to generate CFAT of ₹ 3,56,000. Other data Year Running cost Savings
relating to project are as follows: 1 20,000 60,000
Useful life = 6 years.
2 25,000 70,000
Risk free rate = 8%
Certainty factor = 0.9 The cost of capital is 8%. Measure the sensitivity of the project to the
Tax rate = 35% change in level of plant cost.
Initial investment = ₹ 12,00,000. PVAF(8%, 1) : 0.926
Depreciation Method = SLM. PVAF(8%, 2): 0.857
Calculate risk adjusted 1RR of the project using rates of 8% & 16%. (a) 8.92%
(a) 14.62% (b) 7.50%
(b) 18.51% (c) 9.16%
(c) 16.47% (d) 8.00%
(d) 15.49%
41. Z Ltd. is considering a project with following cash flow:
39. Following forecasts are made about a proposal which is being evaluated Cost of the plant: 70,000
by a firm: Year Running cost Savings
1 20,000 60,000 (d) 6.78%
2 25,000 70,000
The cost of capital is 8%. Measure the sensitivity of the project to the 42. A project has expected NPV of 1,22,000. Its coefficient of variation is
change in level of savings. 0.7377. Risk free rate is 8% and cost of capital is 10%. What is the
PVAF(8%, 1): 0.926 standard deviation of project?
PVAF(8%, 2): 0.857 (a) 1,00,000
(a) 3.58%. (b) 80,000
(b) 4.85% (c) 90,000
(c) 8.54% (d) 88,889
Answers
1 D 2 B 3 A 4 D 5 D 6 D 7 C 8 D 9 D 10 A
11 A 12 A 13 D 14 A 15 C 16 A 17 B 18 C 19 C 20 C
21 B 22 A 23 B 24 C 25 D 26 C 27 D 28 B 29 B 30 C
31 A 32 C 33 C 34 B 35 B 36 A 37 C 38 D 39 A 40 D
41 B 42 C
DIVIDEND POLICY BY CA CS HARISH A MATHARIYA
98220 93220
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545

#Dividend can be paid
#What is Dividend ?
‘Dividend is the distribution of company’s profit to its Share holders’
Quarterly Half Yearly Annually
#Company have 2 choice regarding earning Interim dividend Final Dividend
#Dividend Policy:-
Retained Distribute Dividend policy determines what portion of earnings will be
paid to share holders and what portion retained in business
Reserve Dividend
#Few IMP Formulae
𝑫𝑷𝑺
1. Dividend Rate = 𝒙 𝟏𝟎𝟎
This problem does not arise in partnership/Sole prop. firm 𝑭𝒂𝒄𝒆 𝑽𝒂𝒍𝒖𝒆
(Expressed as % of face value )
But, In company management & owners are diff. person
So company have to consider dividend policy 2. Dividend per share (DPS) = Face Value X Dividend Rate
dividends policy differ from company to company 𝑫𝑷𝑺 Invertors interested in
3. Dividend yield = …………..
𝑴𝑷𝑺 this ratio
% of eraning
#Dividend can be out of 4. Dividend payout ratio =
𝑫𝑷𝑺
………….. distributed as
𝑬𝑷𝑺
dividend
𝑬𝑷𝑺
Out of previous 5. Earning yield = … … … . (Return earned by S. H
Current year profit year profit
𝑴𝑷𝑺
1 taking P/E ratio as abase )
Or = 𝑃/𝐸 𝑟𝑎𝑡𝑖𝑜
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.1
6. EPS = Earning available to equity S.H
Growth rate of dividend in yr. 2 = 12,100 – 11,000
No. of Equity shares = 10%
10,000
PAT XXX
(-) Pref. Dividend (XX) Growth rate of dividend in yr. 3 = 12,100 – 11,000
(-) Bal. XXX = 10%
11,000
(-) Tax on Pref. dividend (XX)
(=) Profit Available for ESH XXX By Formulas –
So Growth rate = Retention Ratio X ROI
𝑀𝑃𝑆 = 50% X 20% = 10%
7. P/E Ratio =
𝐸𝑃𝑆
# Imp term
8. Retention Ratio = 1 – Dividend payout ratio
• Declaration Date
• Date When dividend is declared by BOD.
9. Growth Rate = Retention Ratio X Return In Investment
(Rate @ which earning & • Last – Cumdividend
dividends are growing’s) • Date up to which shares can be bought & eligible to receive
dividend.
E.g. • Ex – dividend date:
Yr. 1 Yr. 2 Yr. 3 • Date notified by stock exchange from which shares can be
A. Op. Investment 1,00,000 1,10,000 1,21,00 bought without being eligible for dividend .
B. Profit earned 20% 20,000 22,000 24,200 • Recorded Date:
C. Dividend paid (20% of PE) 10,000 11,000 12,000 • Date on which register of member is closed & list of eligible
member to receive dividend is made up.
D. Retained earnings 10,000 11,000 12,100
• Payment date:
E. cl. Investments (A+D) 1,10,000 1,21,000 1,33,100 • Dividend Actually paid.
#Factors affecting dividend policy: - #Approaches to Dividend policy
▪ Based on whether dividend policy influence the value of firm/not
Internal External
(out of the organization, not YES NO
under control of organization 1. Walter’s Approach 1. Modigliani &
– Nature of Earning 2. Gordon’s model Miller Approach
(Stable/Fluctuating) 3. Radical
– Contractual obligation 4. Graham
– Need of expansion – Tax Policy Regular dividend policy :- Stable Dividend Policy
– Liquidity Position – General State of Economy • Investment get regular dividend • Certain sum of money is regular
– Cost of Financing • investment from Weaker section of paid
society • Constant dividend per share
• Can be maintained only if • Constant payout ratio
company have regular earning • Stable dividend + extra
#Dividend decision & Tax dividend
• Before introduction of dividend tax; dividend was Types of dividend

taxable in the hands of share holders (1961 to 1996) policy
• It the S.H are in high tax bracket – low dividend by
company
• If the S.H in k=low tax bracket Iregular Dividend:- No Dividend
• High dividend by company • Does not pay regular dividend
#Consideration in Dividend Policy #Walters Model
Legal financial - By Prof. James E Walter
Economic nature of business - Says:- Dividend policy can influence value of firm
Existence of company type of company - Says:- Use appropriate dividend policy to increase value of
Financial needs market condition firm, which is depends on type of firm
Financial arrangement change in government
Growth firm Normal firm Declining firm

(Stable)
Types of dividend
R>Ke R = Ke R<Ke
• Optimum • Payout ratio is • Optimum
Cash Stock Bond Property Payout ratio - irrelevant (any payout ratio is
zero ratio is 100%
optimum)
Co. promise
In form of to S.H to pay In form of
In cash out of stock (Bonus dividend on other asset #Formula
PAT issue to future date (Property not D+
𝑅(𝐸−𝐷) D = Dividend Per. Share
existing S.H ) (Promise in cash) Price of Share (P) =
𝐾𝑒
E = EPS
form a bond) Ke Ke = Cost of Equity
Base :- PV of infinite annuity R = ROI
#Assumptions of Walter’s Model :- #Gardon’s Model (1972)
• Says, Price of shares is the present value of future
• Firm is all equity dividend
• Firm will use only retained earning for financial • Based on assumptions that dividend grows at uniform
needs rate
• R is constant Po = Mkt price at year ‘o’
• Ke is constant 𝐸(1−𝑏) b = retention ratio
• All earnings are distributed / Immediately Po = G = growth rate
𝐾𝑒−𝑔
• Firm has infinite life ‘g = bxr’
• Earning and dividend not change
Applicability :- (same as walter’s)

#Criticisms:-
• Assumptions are not realistic (like, firms will Growth firm - Optimal pay-out ratio O
use only retained earnings)
• Constant ROI is not acceptable Stable firm - Any pay-out ratio is optimum
• Constant Ke also not realistic
Declining firm – Optimal payout ratio is 100%
Note:- E(I-b) = Dividend

#Assumptions – Gordon’s model Stable Dividend Policy VS Stable D/P ratio (%)
▪ Firm is all Equity
▪ From will use only retained earnings to finance investment
▪ ‘R’ = Constant Investors like Investor generally do not
▪ G = Constant this policy like this So, Amt. uncertain
▪ B = Constant
▪ Ke>g #Modigliani – Miller Hypothesis
▪ Firm has infinite life
▪ g=bXr • Dividend Irrelevance “(MM theory)
▪ No taxes • Says, Dividend has no impact on wealth of S.H
• Value of firm determined by earnings power of firm.
# Criticism of Gordon’s model
▪ Same as Walters Model • Manner in which earning dividend into – Retained Earning
dividend or Dividend
does not affect
#Dividend 𝐷1
Growth Model
Says, Po = 𝐾𝑒 −𝑔 Po = Mkt price now, P1=price @period end
D1 + P1 D1 = Dividend @ end of yr. 1
Po - Mkt Price of share @year O ∴Po =
1 + Ke Ke = Cost equity (Expected return by SH)
D1 - Dividend @ end of year 1
Ke - Cost of Equity / capitalization rate
g – Growth rate Assumptions:-
• Existence of perfect Market with rational Investors
#IMP Points:- • NO taxes
▪ Stable Dividend policy is preferable than fluctuating. • No floatation Cost
▪ Wealthy S.H. not interested on dividend (they are • Fixed Investment policy of firm
interested in capital appreciation) ∴ Price as per mm} [ P.V. of D1 & P1 @ Ke ]
1. Which of the following factor will affect the dividend policy of the firm? 5. Which of the following techniques does not reward shareholders for
1. Insufficiency of cash investing in a company?
2. Firms contractual obligation (a) Repurchasing company shares
3. Ratio of debt to equity (b) Offering non-pecuniary benefits
4. Business cycle considerations (c) Making a rights issue
Select the correct answer from the options given below. (d) Offering a scrip dividend
(a) 1 and 3 only
(b) 2 and 4 only 6. Forecast by analysts, retention growth model and historical growth rates
(c) 2, 3 and 4 are methods used for an –
(d) 1, 2, 3 and 4 (a) Estimate future growth
(b) Estimate option future value
2. Retained earnings are – (c) Estimate growth ratio
(a) An indication of a company's liquidity. (d) Estimate option present value
(b) The same as cash in the bank.
(c) Not important when determining dividends. 7. Historical growth rates, analysis forecasts and retention growth model are
(d) The cumulative earnings of the company after dividends. approaches to estimate:
(a) Net present value of gain
3. In retention growth model, percent of net income firms usually pay out as (b) Growth rate
shareholders dividends, is classified as - (c) Growth gain
(a) Payout ratio (d) Discounted gain
(b) Payback ratio
(c) Growth retention ratio 8. The primary goal of a publicly owned firm interested in serving its
(d) Present value of ratio stockholders should be to
(a) Maximize expected total corporate profit
4. Which of the following is an argument for the relevance of dividends? (b) Maximize expected EPS
(a) Informational content. (c) Maximize the stock price per share
(b) Reduction of uncertainty. (d) Maximize expected net income.
(c) Some investor's preference for current income.
(d) All of the above.
9. Which of the following would not have an influence on the optimal (a) Each investment's expected return should equal its realized return.
dividend policy? (b) Each investment's expected return should equal its required return.
(a) The possibility of accelerating or delaying investment projects. (c) Each investment should have the same realized return.
(b) A strong shareholders' preference for current income versus capital (d) All of the statements above are correct.
gains.
(c) The costs associated with selling new common stock. 13. Regular Dividend Policy means –
(d) All of the statements above can have an effect on dividend policy. (a) Investors get dividend at usual rate.
(b) Reserve fund is created to pay fixed amount of dividend.
10. A stock split will cause a change in the total amounts shown in which of the (c) Payment of low dividend per share constantly plus extra dividend in
following balance sheet accounts? the year when the company earns high profit.
(a) Cash (d) All of the above
(b) Common stock
(c) Paid-in capital 14. Modigliani and Miller argue that the dividend decision _______.
(d) None of the above (a) Is irrelevant as the value of the firm is based on the earning power of
its assets.
11. You currently own 100 shares of stock in Baba Ltd. The stock currently (b) Is relevant as the value of the firm is not based just on the earning
trades at ₹ 120 a share. The company is contemplating a 2:1 stock split. power of its assets.
Which of the following best describes your position after the proposed (c) Is irrelevant as dividends represent cash leaving the firm to
stock split takes place? shareholders, who own the firm anyway.
(a) You will have 200 shares of stock, & the stock will trade at or near ₹ (d) Is relevant as cash outflow always influences other firm decisions
120 a share.
(b) You will have 200 shares of stock, and the stock will trade at or near 15. Consider following two statements;
₹ 60 a share. I. A company with large portion of inside ownership, all of whom are
(c) You will have 100 shares of stock, and the stock will trade at or near high-income individuals.
₹ 60 a share. II. A growth company with abundance of good investment opportunities.
(d) You will have 50 shares of stock, and the stock will trade at or near ₹ For each of the company described above, would you expect it to have
60 a share. a high or low dividend payout ratio?
(a) Low dividend payout ratio for both companies
12. If markets are in equilibrium, which of the following will occur: (b) High dividend payout ratio for both companies
(c) Low dividend payout ratio for company mentioned in Statement (I) & (c) Stock dividend
high dividend payout ratio for, company mentioned in Statement (II) (d) Regular dividend
(d) High dividend payout ratio for company mentioned in State-ment (I)
& low dividend payout ratio for company mentioned in Statement (II) 20. The date by which a shareholder must be recorded as the share owner in
order to receive a declared dividend is called the:
16. If you are calculating market price by using Gordon's Model, increasing (a) Ex-rights date
payout ratio other things renaming the same will – (b) Ex-dividend date
(a) Increase the price per share (c) Date of record
(b) Decrease the price per share (d) Date of payment
(c) Will not have any effect on price of the share
(d) Price will remain constant. 21. The difference between the highest and lowest prices at which a stock has
sold is called the stock's:
17. As per Gordon's Model whether company adopts 5096, 8096 or any (a) Average price
other payout ratio, market price will remain same when – (b) Bid-ask spread
(a) Ke > r (c) Trading range
(b) Ke < r (d) Opening price
(c) Ke = r
(d) Ke > Rf 22. Which one following statements concerning cash dividends is correct?
A. The chief financial officer of a corporation determines whether or not
18. As per Walter's Model when Ra < Rc decrease in retention ratio lead to a dividend will be paid.
(a) Increase in market price B. A dividend is not a liability of a firm until it has been declared.
(b) Decrease in market price C. If a firm has paid regular quarterly dividends in the past it is legally
(c) No change in market price obligated to continue doing so.
(d) None of the above D. Cash dividends always reduce the paid-in capital account balance
19. Which one of the following is a non-cash payment made by a firm to its
shareholders that dilute the value of each share of stock outstanding?
(a) Reverse stock split
(b) Cash distribution
23. Required return X Retention Ratio = ? to the Gordon Growth Model, what would the rate of earnings growth be
(a) Ke (Cost of equity) in future) Ignore tax.
(b) WACC (a) 4.2%
(c) B (Beta) (b) 7%
(d) g (Growth Rate) (c) 9.8%
(d) 14%
24. A share of common stock has just paid a dividend of ₹ 2.00. If the
expected long-run growth rate for this stock is 15 per cent, and if investors 27. DHC Ltd. is looking to purchase WIC Ltd., which has the following
require a 19 per cent rate of return, what is the price of the stock? information: Revenue ₹ 40,00,000; EBITD ₹ 9,00,000; Basic EPS ₹1.40;
(a) ₹ 57.50 Net assets ₹ 50,00,000 Dividends paid 20.50. Research has shown that
(b) ₹ 62.25 the price-earnings ratio for companies like WIC Ltd. is 9.5. Based on that
(c) ₹ 71.86 ratio, what is the value of WIC Ltd.?
(d) ₹ 64.00 (a) ₹ 23,75,000
(b) ₹ 85,50,000
25. Ali Motors recently completed a 3 for 1 stock split. Prior to the split, the (c) ₹ 50,00,000
company had 10 Million shares outstanding and its stock price was ₹ 150 (d) ₹ 66,50,000
per share. After the split, the total market value of the company's stock
equaled ₹ 1.5 Billion. What was the price of the company's stock 28. Following information is available in respect of Sober Ltd.:
following the stock split? No. of shares outstanding :1 lakh
(a) ₹ 15 Earnings per share :₹4
(b) ₹ 45 Equity capitalization rate : 12%
(c) ₹ 50 Rate of return on investment : 15%
(d) ₹ 150 Calculate Dividend payout ratio to keep share price at ₹40.
(a) 50%
26. Company Q is all equity financed. For each ₹1 of earnings, it consistently (b) 40%
pays 30 paisa in dividends and retains 70 paisa for reinvestment. It (c) 60%
expects to earn a rate of return of 14% on capital employed. According (d) 20%
29. A Chemical company belongs to a risk class for which P/E Ratio is 10. It and assuming no taxes, ascertain the price of the company's shares as it
currently has 50,000 equity shares selling at ₹ 200 each. The firm is is likely to prevail at the end of the year - (i) when dividend is declared;
contemplating the declaration of dividend of ₹ 16 per share at the current and (ii) when no dividend is declared.
fiscal year which has just started. Given the assumption of Modigliani- (i) (ii)
Miller, what will be the price of share at the end of the year if dividend (a) ₹ 15.0 ₹ 12.5
is declared? (b) ₹ 10.5 ₹11.5
(a) ₹ 205 (c) ₹ 11.5 ₹ 12.5
(b) ₹ 208 (d) ₹ 9.5 ₹ 11.5
(c) ₹ 204
(d) ₹ 225 32. Abhishek Steel Ltd. has one lakh equity shares outstanding which are
selling at ₹ 100 each. Its capitalization rate is 14%. The company is
30. Damodhar Ltd. has 10 lakh equity shares outstanding. Current market expecting ₹ 65 lakh income for the current year and is planning to pay
price of the shares is ₹ 150 each. The board of directors of the company dividend amounting to ₹ 4 lakh. The company wants to invest in a new
has recommended dividend of ₹ 8 per share. Rate of capitalization is project which will cost ₹ 75 lakh. It is assumed that the MM Model on
125. How many shares are to be issued as per MM Model at the end of dividend policy is applicable. Compute the number of shares to be issued
accounting year on the assumption that the net income is ₹ 2 Crore and for financing when: A. Dividend is not paid. B. Dividend amounting to ₹ 4
the investment budget is ₹ 4 Crore and dividend is declared as lakh is paid.
recommended by the directors. (a) 8,500 12,500
(a) 1,19,047 shares (b) 8,772 12,727
(b) 1,75,000 shares (c) 8,692 12,853
(c) 1,57,000 shares (d) 8,346 12,777
(d) 1,68,419 shares
33. Current price of share of X Ltd. is ₹ 60 and just paid dividend per share
31. Rama Ltd. had 1,00,000 equity shares of ₹ 10 each outstanding. Shares is ₹ 4. If the capitalization rate is 12%, what is the dividend growth rate?
are currently being quoted at par in the market. In the wake of the (a) 3%
removal of the dividend restraint, the company now intends to pay a (b) 5%
dividend of ₹ 2 per share for the current financial year. It belongs to a (c) 4%
risk class whose appropriate capitalization rate is 15%. Using MM Model (d) 6
Answers
1 D 2 D 3 A 4 D 5 C 6 A 7 B 8 C 9 D 10 D
11 B 12 B 13 A 14 A 15 A 16 A 17 C 18 A 19 C 20 C
21 C 22 B 23 D 24 A 25 C 26 C 27 D 28 D 29 C 30 B
31 D 32 B 33 B
SECURITY ANALYSIS AND BY CA CS HARISH A MATHARIYA
PORTFOLIO MANAGEMENT 98220 93220

SECURITY ANALYASIS
Is a process of estimating return and risk for individual securities. R = Return
Investment generally involve real assets or financial assets P1 = Market price at the end of the period
Real Assets are tangible, material things such as building P0 = Market price at the end beginning of the period
Financial Assets are pieces of paper representing an indirect D = Dividend
claim to real assets inform of debt or equity
PROBABILITY OF OCCURRENCE & RETURN
PORTFOLIO MANAGEMENT If probability of occurrence is assigned, then the expected return
Portfolio: Mean a basket or combination of securities would be weighted average return with probabilities assigned to
Portfolio Management: Means Pursuant to contract or arrangement return with probabilities assigned to return of security for the
with the client, advises or directing the administration of a portfolio various scenarios
Portfolio Management Manager: Person who pursuant to contract, Return in %
advises or direct or undertakes on behalf of the client the Scenario Probability
Security X Security Y
management or administration of a portfolio
Two Types of Portfolio Managers: I 0.05 35% 44%
1. Discretionary _
2. Non - Discretionary ∴ R = Σ(P X R)
RETURN OF LISTED SECURITY STANDARD DEVIATION (σ)

Return from listed security is in two: one is divided and Is a deviation from arithmetic mean and is a measure of
second is capital appreciation total risk is expressed in same units in respect of which the
(P1 – P0) + (D) deviation is computed lower standard deviation carries less
R= 𝑋 100 risk
P0
_
Step 1:- R = Σ(P X R) CORRELATION COEFFICIENT
Step 2 :- Calculation of standard deviation (σ) Is closeness of relationship between two random variables is
R D D2 P P. D2 bounded by +1 and -1. Supplements and upgrades the covariance
value in order to help comparison
Portfolio risk will be maximum when two components of a portfolio
2 stand perfectly positively
σ=
𝐶𝑜𝑣XY
∴σ= CorrXY =
σ 𝑋σ
X Y
COVARIANCE RISK OF PORTFOLIO

Is a measurement of the co-movement between two variable. Link Total risk in portfolio is the standard deviation of portfolio.
between _the variability of returns
Step 1:- R = Σ(P X R) 2 2 2 2
Step 2 :- (σA) 𝑥 𝑊A + (σB ) 𝑥 𝑊B + [2 𝑥 σA X WA X σ B X WB X CorrAB ]
P Dx Dy P x Dx X Dy
Where,
Covariance xy = σA = standard deviation of security A
WA = Weight of security A in portfolio
▪ Positive Covariance:
σB = standard deviation of security B
Returns on two assets tend to go together WB = Weight of security B in portfolio
▪ Negative Covariance: CorrAB = Correlation coefficient
Return on two assets bear a tendency to off set each other
▪ Zero Covariance:
No distinct relationship
How the box is constructed
Expected return
Tangency Efficient Frontier
A B C D portfolio
0.4 0.3 0.2 0.1
A 0.4 (σA)2 CovAB CovAC CovAD Individual assets
risk free Best free rate
B 0.3 CovAB (σB)2 CovBC CovBD rate
C 0.2 CovAC CovBC (σC)2 CovCD Helps to decide whether a new security can be selected or rejected
▪ If the security falls below the frontier, the security is dominated
D 0.1 CovAD CovBD CovCD (σD)2
by some security and will be rejected
▪ If the security falls on frontier, the security is efficient and hence
will be selected
CALCULATION OF WEIGHT OF SECURITIES SO THAT ▪ If the security falls above the frontier hence the frontier itself
PROTFOLIO RISK IS LOWEST
(σX )2 − 𝐶𝑜𝑣XY
CAPITAL MARKET LINE
WXY =
(σ )2 +(σ )2 − 2 x Cov
X Y XY To depict the rates of return for efficient portfolios subject to the
risk level (σ) for a market portfolio and the risk-free rate of return
(R) thus, capital market fine measures the relationship between
EFFICIENT FRONTIER return and risk
Is the set of optimal portfolios that offers the highest expected created by sketching a tangent line from the intercept point on the
return for a defined level of risk or the lowest risk for given level of efficient frontier CML is better than the efficient frontier because it
expected return considers the infusion of a risk-free asset in the market portfolio
Where,
CovSM = Covariance between security & market
(σM)2 = Variance of market
σS = Standard deviation of security
σM = Standard deviation of market
CorrSM = Correlation of security with market
CAPITAL ASSET PRICING MODEL (CAPM)

Provides the link between return and non diversifiable risk. To
assess the extent of additional return over risk free return, for a
BETA (β) given level of systematic risk
ER = RF + β (R m - Rf )
Is measure of non- diversifiable risk
▪ A beta of 1.15 for a security would indicate that security is 15% Where,
than index riskier/ market. Rf = Risk free rate
▪ A beta of 0.8 for a security would indicate that security is 20% β = Beta
less risky than index /market Rm = Market rate of return
▪ A beta of 1 for a security would indicate that security as risky as (Rf - Rm) = Risk premium
the index/market
__ a) CAPM Return < Expected return: Buy

ΣXY −X_Y β=
𝐶ovSM σS
β= 2 (σ ) β= X CorrSM b) CAPM Return < Expected return: Sell
ΣY −n Y2 M
2
σM
c) CAPM Return < Expected return: Hold
SECURITY MARKET LINE ALPHA (α)
Is a line drawn on a chart that serves as a graphic representation Indictor of the extent to which the actual return of a security
of the capital asset pricing model, which shows different levels of deviates from those predicated by its beta value.
systematic risk of various marketable securities plotted against the ▪ Positive Alpha Value: Expected return is more than required
expected return return as per CAPM undervalued should be bought.
▪ Negative Alpha Value: That expected return is less that
required return as per CAPM overvalued should be sold
▪ Zero Alpha Value: Expected return is equal to required return
correctly valued should be hold
RISKS INVOLVED IN SECURITY ANALYSIS
Is generally associated with possibility that the realized returns will
be less than the returns that were expected
▪ Systematic Risk: Those forces that are uncontrollable, external
and broad I their effect are called sources of systematic risk,
economic, political and sociologic changes
CAPITAL MARKET LINE & SECURITY MARKET LINE ▪ Unsystematic Risk: Controllable, internal factors which are
Points Capital Market Line Security Market Line peculiar to a particular industry know as unsystematic risk.
Unsystematic risk is the portion of the total risk
Meaning Used to show the rates of Also called a
return, which depends on characteristic line is a Points Systematic Risk Unsystematic Risk
risk free rates of return and graphical representation
levels of risk of the market’s risk and Nature Systematic risk is Unsystematic risk is
return at a given time uncontrollable controllable
Measurement Standard deviation is the Beta coefficient Factors Systematic risk arises due to Unsystematic risk arises due
of risk measure of risk determines the risk factor external factors to internal factors
Portfolio Define efficient portfolios Defines both efficient & Formula Systematic risk = Beta X SD Unsystematic risk = total
non efficient portfolio of market risk – systematic risk
TECHNICAL ANALYSIS RANDOM WALK THEORY
Assumes that market prices of securities are determined by the Suggests that stock price changes have the same distribution and
demand-supply equilibrium. are independent of each other, so the past movement or trend of a
The shifts in this equilibrium give rise to certain patterns of price stock price or market cannot be used to predict its future
and volume of trading which have a tendency to repeat themselves movement. In short, this is the idea that stock stake a random and
with these patterns can predict the future behavior of stock prices unpredictable path
it is a science of predicting the share price movements from the According to the theory, share prices will rise and fall on the whims
past data about share price movements. and fancies of manipulative individuals. No sure prediction can be
made random walk theory is inconsistent with technical analysis
DOW JONES THEORY
One of the earliest theories of technical analysis. Formulated by
Charles H. Dow of Dow Jones & Co. according to this theory, share RANDOM WALK THEORY
prices demonstrate a pattern over 4 to 5 years A market is treated as efficient when all know information is
These patterns can be divided into three distinct cyclical trends- immediately discounted by all investors and reflected in share
primary, secondary, and minor trends primary trends lasts from one prices
to three years.
MARKOWITZ MODEL
If the primary trend is upward it is called a bullish phase of the
Developing the first model portfolio analysis model. Concept of
market. If the primary trends is downwards, it is called a bearish
efficient portfolios has been enunciated in this model. A portfolio is
phase
efficient when it yield highest return for a particular level of risk or
TOOLS OF TECHNICAL ANALYASIS minimizes risk
Simple Markowitz portfolio optimization: It is possible to develop a
fairly simply decision rule for selecting an optimal portfolio for an
investor that can take both risk and return into account. This is
Technical Charts Technical Indicators called a risk adjusted return
SHARPE INDEX MODEL Basis of Fundamental factors, i.e. Technical charts and
Measures the risk to reward of a portfolio here we also compute decision performance of company market psychology
unsystematic risk
The major assumption of sharp’s single index model is that all the Risk Involved Moderate risk High risk
co-variation of security returns be explained by a single factor. This
factor is called the index Income Stable Uncertain and Erratic
According to the Sharpe single index model the return for each Behavior of Conservative and cautious Daring and careless
security
R = αI + βI + E participant
Where,
R = Expected return on a security
Α = Alpha Coefficient EFFICIENT PORTFOLIO & OPTIMUM PORTFOLIO
Β = Beta Coefficient
I = Expected return an index
E = Error term with a mean of zero & a constant standards
deviation Efficient Portfolio: Optimal Portfolio:
INVESTMENT & SPECULATION
The efficient portfolio
Points Investment Speculations which is best suited to
Meaning Define as a conscious act Also involves Efficient portfolio is the risk return
on the part of a person deployment funds but it that which lies along characteristics of
the capital market line particular individual
that involves deployment is not backed by a investor is an optimal
of money in securities conscious analysis of portfolio for the
issued by companies with a pros and cons investor
view to obtain a target
rate of return over a
specified period of time
1. Security Analysis is a process of estimating _______ for individual (c) In terms of rupee risk
securities. (d) In terms of amount
(a) Return and risk
(b) Risk and correlation 6. The market price of a bond depend on –
(c) Correlation and co-efficient (a) The coupon rate and terms of the indenture
(d) Return and co-efficient (b) The coupon rate and maturity date
(c) The terms of the indenture, and maturity date
2. Standard deviation determines – (d) The coupon rate, terms of the indenture, and maturity date
(a) Systematic risk of a security
(b) Unsystematic risk of security 7. Covariance is a measurement of.
(c) Total risk of security (a) The co-movement between two variables
(d) Premium of security (b) The link between the variability of returns in two independent
securities
3. Financial Assets are – (c) Both (a) and (b)
(a) Pieces of paper representing an indirect claim to real assets in form (d) None of the above
of debt or equity commitments.
(b) Tangible, material things such as buildings, furniture, automobiles etc. 8. Expected worth is the –
(c) Both (a) and (b) (a) Inverse of standard deviation
(d) Neither (a) nor (b) (b) Correlation between a security
(c) Same as discrete probability distribution
4. Return from listed security is in two forms – (d) Weighted average of all possible outcomes
(a) One is interest and second is capital appreciation in price.
(b) One is stock split and second is dividend. 9. Correlation Coefficient supplements and upgrades the –
(c) One is interest and second is dividend. (a) Expected return
(d) One is dividend and second is capital appreciation in price. (b) WACC
(c) Covariance
5. Standard deviation is expressed – (d) Mean deviation
(a) Always in percentage
(b) In same units in respect of which the deviation is computed.
10. A risk associated with project and way considered by well diversified
stockholder is classified as – 14. According to the Sharpe single index model the return for each security
(a) Expected risk can be given by the –
(b) Beta risk (a) αI + βI + E
(c) Industry risk (b) αI + βI X E
(d) Returning risk (c) αI + βI ÷ E
(d) αI + βI - E
11. A corporate bond is a corporation's write undertaking that it will refund
a specific amount of money plus
(a) Premium 15. Following details are available for two securities:
(b) Interest Return in %
(c) Nothing Probability Security
Security Y
(d) Security X
0.05 30% 39%
12. The advocates of Efficient market hypothesis (EMH) theory contend that 0.20 25% 29%
securities markets are – 0.50 20% 21%
(a) Perfect 0.20 15% 13%
(b) Imperfect 0.05 10% 3%
(c) Monopolistic
Calculate the expected return
(d) Perfect or at least not too imperfect.
Security X Security Y
(a) 21% 20%
13. According' to Dow Jones theory share prices demonstrate a pattern over (b) 19% 21%
4 to 5 years. These patterns can be divided into three distinct cyclical (c) 20% 21%
trends – (d) 22% 24%
(a) Preliminary, primary and secondary trends
(b) Preliminary, bullish and bearish trends 16. You have been given the following date for security X:
(c) Primary, secondary and minor trends
Probability Return
(d) Primary, secondary and major trends.
0.05 7%
0.20 10% (c) Returns on Security X & Security Y bear a tendency to off-set each
0.50 13.5% other.
0.20 17% (d) Covariance of these to two securities is positive that means standard
deviation of both securities must be negative.
0.05 20%
Calculate standard deviation of security
(a) 3.02% 19. Covariance between Security P & Q is 48.91. Standard deviation of
(b) 3.36% Security P is 5.36 while that of Security Q is 9.13. Compute value of
(c) 4.57% correlation coefficient.
(d) 4.12% (a) 0
(b) 1
(c) -1
17. Following details are available for EX Ltd. & FX Ltd. Securities (d) 0.899
Return in %
Probability
Security X Security Y 20. An investor has invested in Security A & B in the ratio of 70:30. Standard
0.5 20% 16% deviation of Security A & B is 4.47 & 7.62 respectively. Covariance AB is
0.3 30% 40% 34. Correlation Coefficient of Security A & B is 1. Risk of portfolio is –
0.2 40% 30% (a) 5.41%
Covariance between security EX and Security FX is (b) 6.48%
(a) 85 (c) 3,13%
(b) 58 (d) 7.26%
(c) -58
(d) -54 21. Actual return of GK Ltd. for last four year is 2096, 1496, 17% and 18%.
GK Ltd. has beta of 1.15. Return on market portfolio is 1596. Risk free
18. Covariance between Security X and Security Y is + 45.8. This indicate rate of return is 6%. Compute Alpha value and decide whether to hold,
that – buy or to sell the security?
(a) If return on Security X is below par, return on Security Y is likely to be (a) Alpha value is +0.8 and hence it is advised to sell the security.
above par. (b) Alpha value is -0.9 and hence it is advised to buy the security.
(b) Returns on Security X & Security Y tend to go together, i.e. if return on (c) Alpha value is -0.8 and hence it is advised to short sell the security
X is above par, return on Y is also likely to be above par. (d) Alpha value is +0.9 and hence it is advised to buy the security.
Market rate of return : 13.2%
If the alpha value is zero what investment action would you suggest?
22. following data is available for the security P & Q (a) Buy as Security is undervalued.
Return in % (b) Sell as Security is undervalued.
Probability (c) Hold as Security is correctly valued.
security P security Q
(d) Sell as Security is overvalued.
0.15 15% 5%
0.70 10% 10% 25. Stocks A & B have the following historical returns:
0.15 5% 15% Year Stock A's Return (KA) Stock B's Return (KB)
Correlation coefficient for the above two securities is
(a) -0.9899 2015 -12.24% 12.24%
(b) -0.9989 2016 23.67% 12.24%
(c) +0.8999 2017 35.45% 12.24%
(d) +0.9989 2018 5.82% 12.24%
2019 28.30% 12.24%
23. Following details are made available to you for a security. Assume that someone held a portfolio consisting of 7096 of Stock A and
Beta (β) : 1.4 3096 Stock B. What would have been the realized rate of return on the
Risk free rate of return : 6.3% portfolio in each year from 2015 to 2019?
Market rate of return : 13.2% (a) 16.20%
If the alpha value is + 1.8 what investment action would you suggest? (b) 15.40%
(a) Buy (c) 18.60%
(b) Hold (d) 13.70%
(c) Sell
(d) Short
26. Following details are gathered by the investor:
Standard deviation 2.8%
24. Following details are made available to you for a security. Market standard deviation 2.3%
Beta (β) : 1.4 Risk free rate of return 8%
Risk free rate of return : 6.3% Expected rate of return on market portfolio 18%
Correlation coefficient of portfolio with market 0.8 Beta of Security : 0.5
Required return on security is – Expected return on portfolio : 15%
(a) 14.77% Risk free rate of return : 0.06
(b) 17.74% In another security has an expected rate of return of 18% what would be
(c) 15.84 its beta
(d) 20.65% (a) 1.222
(b) 1.111
27. Following details are made available to you for particular security: (c) 1.333
(d) 1.444
Answers
1 A 2 C 3 A 4 D 5 B 6 D 7 C 8 D 9 C 10 B
11 B 12 D 13 C 14 A 15 C 16 A 17 B 18 B 19 B 20 A
21 D 22 B 23 A 24 C 25 A 26 B 27 C
PROJECT FINANCE & BY CA CS HARISH A MATHARIYA
TYPES OF FINANCING 98220 93220

WHAT IS PROJECT FINANCE PROJECT PLANNING
Is the financing of long term infrastructure, industrial project
Choosing the minimum quantum of investment which may yield the
Features
highest return
▪ Done through debt or equity or mix
Planning defines the project activities and end products. Purpose is
▪ Risk in project determines the amount of loan or equity
to define each major task estimate the time and resources required
▪ Cash flow from the project primarily used for repayment of loan.
Project planning activities include
▪ May be with or without recourse
▪ Specific work to be perform and goals
▪ Estimate to be document
Steps In Project Finance ▪ Commitments that are planned
• Feasibility Study ▪ Project alternative, assumption and constraints
• Project Planning
• Project report STEPS IN THE PROJECT PLANNING PROCESS
• Project appraisal The project plan form the basis for all management efforts
• Definitive agreement i.e. loan agreement ▪ Define the technical approach
• Disbursal ▪ Define the sequence the task
• Utilisation reports to the bank/ investor ▪ Define the dependency relations between tasks
▪ Estimate the resources
FEASIBILITY STUDY ▪ Schedule all tasks
❑ Market feasibility: whether demand and supply of the proposed ▪ Define a budget
product/ service are there ▪ Define the organization used to execute the project
❑ Technical Feasibility: Study of technical aspects availability of ▪ Identify the know risks in executing the project
raw materials other resources ▪ Define the process used for ensuring quality
❑ Financial Feasibility: Detailed analysis and projections of price of ▪ Define the process used for specifying and controlling
inputs and output, financing mix, repayment schedule requirements
▪ Implementation programme: in from of CPM/PERT
PROJECT REPORT
▪ Cost of project
Is an extremely important aspect of the project.
▪ Margin of financing
Encompasses a thorough investing process covering economic,
▪ Cost of financing
technical, social managerial aspect. Project report is a working plan
▪ Profitability
for implementation. Preparation of project report has become
▪ Cash flow statement and pay back period
essential exercise in the light of the following background
▪ Technical Feasibility
1. Planning the project in advance to accomplish desired objectives.
▪ Financial viability
2. To evaluate constraints
3. To avail of the financial facilities
4. Implementation depend upon course of action suggested in the STEPS TAKEN BY FINANCIAL INSTITUTIONS WHILE
project report APPRAISING THE PROJECT
FORMAT OF PROJECT REPORT
▪ Project profile its reliability and project report
No prescribed format contain mainly the following information ▪ Promoters capacity and competence
• About industry and its status
▪ Viability Tests
• Board market trend of the product • Technical aspects
• Raw market survey • Financial aspects
• Process: • Economic aspects
• Availability of technical know-how • Social aspects
• Location of plant, its advantages • Environment, Energy management
• Water • Commercial aspect
• Power
• Fule
• Marketing aspects
• Effluents
FINANCIAL ASPECTS OF PROJECT SOCIAL APPRAISAL OF PROJECT
Is most important for a banker. To determine whether the project Social analysis consists of two parts
satisfies the investment criteria Project should be able to service the ▪ Measurement of the distribution of the income
debt and ensure expected return ▪ Identification of the impact on the basic needs objectives of the
Cash flow statement is the basis for financial analysis society
MEASURES OF FINANCIAL VIABILITY ENVIRONMENTAL ASPECTS OF PROJECT APPRAISAL

a) NPV:
b) Benefit cost ratio (BCR)/ Profitability Index: Discounted value of • Is a predications of the consequences to the natural
benefit and discount value of cost environment from development projects
c) Internal Rates of return (IRR): Returns internally generated by
the project
d) Sensitivity Analysis: Projects are sensitive to fluctuation in values LENDING DEPOSITE RATIO
of variables like costs of inputs and prices of outputs
e) Scenario Analysis: Sensitivity analysis takes care of only one or • Bank can lend out only a certain proportion of its deposits
two variables which is at times inadequate since some part of deposits have to be statutorily maintained
f) Risk Analysis: Identification of key risk variables, finding out as cash reserve ratio deposits, and an additional part has to
values of each risk variable, & assigning probabilities for each. be used for making investment in prescribed securities
What is the probability that the NPV of the project will be
negative SOCIAL COST BENEFIT ANALYSIS
ECONOMIC APPRAISAL OF PROJECT • In social cost benefit analysis, a project is analyzed from the
Whether the project will improve the economic welfare of the point of view benefit it will generate for the society as a
whole.
country. Economic appraisal is traditionally not conducted by
• The social cost benefit analysis calculate the direct (primary),
agencies like the world bank and development agencies of the indirect (secondary) and external effects:
government
Direct effects: Indirect effects: External effects: VENTURE CAPITAL
Is money provided by professionals who invest alongside
• are the costs • Are the costs • Are the costs investment, in young, rapidly growing companies
and benefit that and benefits and benefits Venture capital is also referred to as Risk Capital
can be directly that are passed that cannot be Venture capitalists:
linked to the on to the passed on to ▪ Finance new companies
owners/user’s producers and any existing ▪ Purchases equity shares
project e.g. consumers markets because
owner of a outside the they relate to ▪ Assist in the development
building or market with issues like the ▪ Add value to
highway which the project environment Venture Capitalists invest in:
is involved (e.g. (noise, emission ▪ First-generation business
owner company of CO2, etc.) ▪ Untried products and untested products
located near the ▪ High-risk projects
newly planned
highway) VARIOUS TYPES OF FINANCE
1. Bills discounting
UNIDO APPROACH FOR SOCIAL COST-BENEFIT The drawer sends a bill to the buyer or his bank. Latter in turn
ANALYSIS (SCBE) discount the bill and sends the proceeds to seller.
A comprehensive framework for appraisal of projects and examine Bill discounting is the oldest and simplest form
their desirability and merit by using different yardstick 2. Commercial Papers
▪ Financial profitability Is an unsecured money market instrument issued in form of a
▪ Saving and consumption pattern promissory note. It was introduced in India in 1990.
▪ Income distribution 3. Certificate of deposits
▪ Production of merit and demerit goods Is a promissory note issued by a bank or other financial
These different aspects are examined in five stages, each stage institution. CDs are money market instruments of a relatively
leading towards a social benefit cost of the project short duration that pay a fixed rate of interest
4. Deep Discount Bonds PROJECT REVIEW AND CONTROL
A bonds that sells at a significant discount from par value is Project review is a very important aspects of entire project life
known as deep discount bond. Deep discount bonds are sold at Three principle categories of activities taking place during the
a discounted value and on maturity face value is paid to the monitoring. Evaluation and control phase are
investors. It was introduced by the Industrial Development Bank
of India (IDBI) in January 1992 with a maturity of 25 years. Project Project Project
5. Zero Coupon Bond
Is a bond bought at a price lower than its face value, with the Monitoring Evaluation Control
face value repaid at the time of maturity. When the bond
reaches maturity, its investor receives its par (or face) value
Main difference between deep discount bond and zero coupon PROGRESS MONITORING
bond is that in case of zero coupon bond no interest is payable Tracks the operational work of the project. Project progress
periodically while in case of deep discount bond interest is monitoring are perhaps best identified via the following table
payable periodically at very lower rate say 2% per annum. The what, why, when and how of monitoring
6. Commodity Bonds
7. Floating Rate Bonds PROJECT EVALUATION
8. Bill re-discounting Tends to focus on tracking progress at the higher levels of the
9. Bridge Finance logical framework. I.e. project outcomes. Tend to explore questions
10. Venture Capital Financing like, “Is the project successful at achieving its outcomes?” “Is the
11. Depository Receipts (DR) project contributing to its ultimate goal?”
12. Global Depository Receipts (GDR)
13. American Depository Receipts (ADR)
PROJECT CONTROL
Involves establishing the system and decision making process to
14. Euro Convertible Bonds manage variances between the project plans (in term of scope,
15. Indian Depository Receipts cost, schedule, etc.) and the realities of project implementation.
LEASE FINANCE HIRE-PURCHASE
Contractual arrangement whereby the lessor grants the lessee the Is a loan or contact that involves an initial deposit, linked to a
right to use assets for periodic lease rental payments. specific purchase, which is a way of obtaining the use of an asset
Two types od lease before payment is completed. The payments of the HP are in
monthly instalments plus interest
Finance Lease
• Intermediate term to along term non cancellable

Hire of lessor Hire pays regular
arrangement. purchases the asset hire purchases
• Lease is more or less fully amortized during the and gives it on hire instalment
primary lease period. This means lessor recovers, to the hirer lessee
through the lease rentals
• Lessee is responsible for maintenance, insurance,
taxes
• Lessee usually enjoys the option for renewing the
The main
lease features
Operating Lease Higher charges Total interest

interest on a flat collected by the
basis. hire is a allocated
• Can be defined as any lease other than a finance
lease over various years
1. Project appraisal by financial institution takes into consideration (b) Income or earnings - where the firm is valued on some multiple of
(a) Promoter's capacity and competence accounting income or earnings.
(b) Project (c) Balance sheet - where the firm is valued in terms of its assets.
(c) Economic Aspects (d) Market Share
(d) All of above
5. The promoter's capacity and competence should be examined with
2. A project would normally be under-taken if its net present value is: reference to –
(a) Negative (a) Their management background, traits as entrepreneurs, business
(b) Exactly the same as the NPV of existing projects (b) Industrial experience, and past performance in other concerns,
(c) Positive (c) Their integrity and reputation, market standing and legal competence.
(d) Zero (d) All of the above
3. The project planning activities and goals include defining: 6. External sources of finance do not include:
1. The specific work to be performed & goals that define & bind the (a) Leasing
project. (b) Debentures
2. Estimates to be documented for planning, tracking, & controlling the (c) Retained earnings
project. (d) Overdrafts
3. Commitments that are planned, documented, & agreed to by affected
groups. 7. Which of the following is a drawback to a business that issues debentures?
4. Project alternatives, assumptions, and constraints. (a) Lenders do not have any voting rights.
Select the correct answer from the options given below. (b) There is dilution of control.
(a) 1, 2, 3 and 4 (c) There is a dilution of ownership.
(b) 2, 3 and 4 (d) The value of liabilities increases.
(c) 1 and 3 only
(d) 1 and 4 only 4. 8. Internal sources of finance do not include
(a) Better management of working capital
4. Which of the following is not one of the three fundamental methods of (b) Ordinary shares
firm valuation? (c) Trade credit
(a) Discounted Cash flow (d) Retained earnings
(b) Determine whether the project will improve the economic welfare of
9. Technical feasibility implies to mean – the country
(a) Appraisal of project by a team of expert drawn from different (c) Both (a) and (b)
disciplines. (d) Neither (a) nor (b)
(b) The adequacy of the proposed plant and equipment to produce the
product within the prescribed norms. 13. The social analysis consists of –
(c) Working plan for implementation of project proposal after investment (a) Measurement of the distribution of the income due to the project.
decision by a company has been taken. (b) Identification of the impact on the basic needs objectives of the
(d) To ensure before taking in hand a project whether or not the proposed society.
project is viable. (c) Both (a) and (b)
(d) Neither (a) nor (b)
10. The project is viable when BCR is –
(a) One 14. The UNIDO guidelines provide a comprehensive framework for –
(b) One or more than one (a) Appraisal of projects and examine their desirability and merit by
(c) Two using different yardsticks in a step-wise manner
(d) Two or more than two (b) Appraisal of project regarding chance of getting government subsidy.
(c) Adequacy of the proposed plant and equipment to produce the
11. Financial aspects of the project is judged with reference to – product within the prescribed norms.
(a) Availability of land and site. (d) All of the above
(b) Availability of servicing facilities like machine shops, electric repair
shop, etc. 15. _______ 1are those which are created by combining the features of
(c) NPV, Benefit Cost Ratio, Internal Rate of Return, Sensitivity & Risk equity with bond, preference and equity.
Analysis (a) Mixed instruments
(d) Availability of workforce as per required skill and arrangements (b) Baby bond
proposed for training-in-plant and outside. (c) Hybrid instruments
(d) Hypothetical instruments
12. The objective of economic appraisal is to –
(a) Examine the project from the entire economy's point of view 16. Zero Coupon bonds are bonds issued at ______ and redeemed at par.
(a) Face value to discount
(b) Discount to face value plus premium (b) (2) & (3)
(c) Par to discounted value (c) (2), (4) & (1)
(d) Discount to face value (d) (3), (1), (4) & (2)
17. A ______ lowers the interest rate risk by neutralizing the inflation risk. 19. _____ means any instrument in the form of a depository receipt created
(a) Carrot and stick bond by Domestic Depository in India against the underlying equity shares of a
(b) Capital indexed bonds company incorporated outside India.
(c) Commodity bonds (a) Global Depository Receipt (GDR)
(d) Dual convertible bond (b) American Depository Receipt (ADR)
(c) Indian Depository Receipt (IDR)
18. Derivatives include a variety of financial contracts, including _______ (d) Any of the above
1. Futures
2. Forwards 20. IDR is an instrument denominated in –
3. Swaps (a) Foreign currency
4. Options (b) Indian Rupees
Select the correct answer form the options given below. (c) Partly in (a) and partly in (b)
(a) (1) & (4) (d) Either (a) or (b)
Answers
1 D 2 C 3 A 4 D 5 D 6 B 7 A 8 B 9 B 10 B
11 C 12 C 13 C 14 A 15 C 16 D 17 B 18 D 19 C 20 B
1. "Management is the function of getting things done through people and 5. ______ is concerned with both the "orderly" assemblage of human and
directing the efforts of individuals towards a common objective". It is material resources as well as the process of development of a structure of
observed by – formally identified and distinguished tasks, roles and relationships that
(a) Haimann may be attributable to the various members so that they may effectively
(b) Koontz and O'Donnell work as a group.
(c) Hick (a) Planning
(d) Henry Fayol (b) Directing
(c) Organizing
2. Koontz & O'Donnell state that management means, "Getting things (d) Staffing
done_______”
(a) Through people 6. Control –
(b) With people (a) Is closely related to the planning job of the manager.
(c) Through or with people (b) Should not be viewed merely as a postmortem of past achievements
(d) Through and with people and performance.
(c) Should suggest corrective measures so that negative deviations may
3. Haimann observes that, "management is the function of ______”. not re-occur in future.
(a) Getting things done through people and directing the efforts of (d) All of the above
individuals towards a common objective.
(b) Forecast, and to plan, to organize to command. 7. Who is popularly known as the father of 'modern management theory?
(c) The process of getting things done by the people and through the (a) Luther Gulick
people. (b) Newmann
(d) Thinking and utilizing human, material & financial resources in such a (c) Henry Fayol
manner that would result in best combination. (d) Frederick Taylor
4. Management qualifies all tests of a profession except ______ 8. Administration is concerned with –
(a) Dominance of service motive (a) Policy implementation
(b) Restricted entry (b) Policy making
(c) Systematic body of knowledge (c) Both (a) and (b)
(d) Use of knowhow and skills (d) Neither (a) nor (b)
9. Broadly speaking, administration is concerned wit h – (c) The ability to apply specific knowledge, methods and skills to discrete
(a) Planning tasks
(b) Organizing; (d) None of the above
(c) Motivating and controlling
(d) Planning and organizing 14. What type of approach is most frequently identified with Human Capital
Management (HCM)?
10. Board of directors of any company is normally concerned with – (a) Controlling
(a) Management (b) Interpersonal and technical
(b) Administration (c) Formalized, technical and manipulative
(c) Health of managers (d) Influencing and manipulative
(d) None of above
15. Which of the following is NOT a measure of a manager's effectiveness?
11. Administration is a process of – (a) Absenteeism and sickness
(a) Laying down broad policies (b) Level of staff turnover
(b) Objectives of the organization (c) Accidents at work
(c) Either (A) or (B) (d) Speed of promotion through the organization
(d) Both (A) & (B)
16. How VOU will describe the planning as function of management?
12. Decision-making skills are required at – 1. An all-pervasive function 2. Fundamental function
(a) Top level management Select the correct answer from the options given below –
(b) Middle level of management (a) 2 only
(c) All levels of management (b) Neither 1 nor 2
(d) None of above (c) Both 1 and 2
(d) 1 only
13. Managers require a combination of technical competence, social & human
skills and conceptual ability. Technical competence may be defined as: 17. Planning is deciding in advance –
(a) The ability to view the complexities of the operations of the I. What is to be done?
organization as a whole, including environmental influences II. How is to be done?
(b) The ability to secure the effective use of human resources of the III. When it is to be done?
organization IV. Who has to do it?
Select the correct answer from the options given below – (b) Mission
(a) (I) (c) Forecasting
(b) (I), (II), (d) Policy
(c) (II), (III)
(d) (I), (II), (III), (IV) 21. Which of the following can be treated as external planning premise?
(a) Politico-technological conditions
18. Identify the best definition of planning. (b) Marketing plans
(a) An integrated process, in which plans are formulated, carried out and (c) Sales forecast
controlled. (d) Strategic Plans
(b) Devising ways of achieving the objectives of an organization.
(c) The core activity of planners and planning departments. 22. Identify the correct steps in planning.
(d) Setting an organization's objectives and the means of reaching them. I. Selecting a course of action
II. Determining alternative courses
19. Planning – III. Establishing objectives
(a) Involves identification and classification of activities of the enterprise IV. Formulating derivative plans
(b) Involves choosing the proper course of action from among alternatives V. Evaluation of alternatives
(c) Is based upon individual incentives rather than group incentives VI. Establishment of planning premises
(d) Give employees fresh insights into their own personalities and it can Select the correct answer from the options given below –
also help them understand why others sometimes respond as they do. (a) III, VI, II, IV, I, V
(b) VI, III, II, V, I, IV
20. A _______ statement define the company's business, its objectives and its (c) III, IV, II, V, I, VI
approach to reach those objectives. (d) III, VI, II, V, I, IV
(a) Planning
Answers
1 A 2 D 3 A 4 D 5 C 6 D 7 C 8 B 9 D 10 B
11 D 12 C 13 C 14 C 15 C 16 C 17 D 18 D 19 B 20 B
21 A 22 D
1. There are mainly two types of business environment – (a) Four
(a) Internal and external (b) Five
(b) Internal and operational (c) Six
(c) Operational and external (d) Ten
(d) Matrix and diagonal
6. Micro environment has _______ influence on the business.
2. Environment is complex. Which of the following supports this? (a) Indirect
(a) Customers are the people who pay money to acquire an (b) Direct
organization's products. (c) Negative
(b) The environment consists of a number of factors, events, conditions and (d) Minor
influences arising from different sources and it is somewhat easier to
understand in parts but difficult to grasp in totality. 7. The Porter's Five Forces tool is a simple but powerful tool to evaluate I the
(c) A study of the competitive scenario is essential for the marketer, power of business. Which of the following is not one of the five?
particularly threats from com-petition. (a) Bargaining power of suppliers
(d) If a supplier provides a poor service, this could increase timescales or (b) Bargaining power of customer
lower product quality. (c) Rivalry among current players
3. Operational strategy focuses on 2 issues of ______
(a) Resources 8. Assertion (A):
(b) Processes Porter's five forces model considers new entrants as a significant source
(c) People of competition.
(d) All of above Reason (R):
New capacity and product range that the new entrants bring in throw up
4. Micro environment is also known as – new competitive pressure. Bigger new entrant, the more severe the
(a) General Environment competitive effect. New entrant also places a limit on prices and affect
(b) Global Environment the profitability of existing players.
(c) Task environment Select the correct answer from the options given below
(d) Matrix environment (a) A is false and R is true explaining how A is false
5. The Porter's ______ Forces tool is a simple but powerful tool to evaluate (b) both A and R are true and R is correct explanation of A.
the power of business. (c) A is true and R is false
(d) Both A and R are true 13. If a firm takes over a competitor then, according to Porter's 5 forces
model:
9. Business strategy focuses on: (a) Buyer power is higher
(a) Strategies related to functional areas such as Marketing, Production (b) Supplier power is higher
and HRM. (c) Substitute threat is higher
(b) Where a firm is going and the scope of its activities. (d) Rivalry is lower
(c) How a firm competes within a particular market or industry.
(d) How to allocate resources between different parts of the business 14. Which of the following is not a force in the Porter Five Forces model?
(a) Buyers
10. Porter's notion of a differentiation strategy is best described as one in (b) Suppliers
which firms seek a competitive advantage: (c) Complementary products
(a) Through having a lower cost than their competitors. (d) Industry rivalry
(b) Through establishing their uniqueness.
(c) Through concentrating on a narrow market segment. 15. According.to Porter, suppliers are more able to exercise bargaining
(d) Through achieving a match be-tween their internal and external power over buyers when:
environments (a) The supply industry is dominated by a few large firms.
(b) The supply industry is populated by a large number of small firms.
11. Which of the following is not an element of Porter's 5 Forces Model? (c) When buyers have the ability to take over suppliers.
(a) The bargaining power of suppliers. (d) There are few buyers in the market
(b) The firm's existing competition.
(c) The firm's macro-economic environment. 16. which core competencies are required for a Company Secretary to
(d) The potential competition from new entrants. become effective player of strategic management?
A. Communication and professional skills, legal skills, management skills
12. Porter's Value Chain is essentially a tool for: and IT skills.
(a) Identifying the competitive forces within an industry. B. Updated knowledge of legal environment, financial environment &
(b) Advising firms on how to price their products. business environment.
(c) Diagnosing and enhancing sources of competitive advantage within C. Ability to work and achieve a consensus within multidisciplinary settings.
an organization. D. Remaining calm under pressure and not losing sight of perspective.
(d) Calculating what a firm is worth. Select the correct answer from the options given below.
(a) (A) & (B)
(b) (B) & (C) 19. Identify which of the following forces does not form part of Porter's
(c) (A) & (C) Competitive Position Analysis?
(d) All (A) to (D) (a) Buyer power
(b) Risk of losses
17. Potential rivals will not find it difficult to enter a market where:10 (c) Threat of new entry
(a) Existing firms have long-term contracts with the biggest customers. (d) Supplier power
(b) Product differentiation is very strong.
(c) Existing firms have the ability to retaliate strongly. 20. What is likely to happen if many new businesses enter a market?
(d) Economies of scale are insignificant (a) Barriers to entry will rise.
(b) Industry capacity will fall.
18. According to Porter, which of the following is most important to achieving (c) Competitive rivalry will intensify.
a competitive advantage? (d) Industry profits will increase.
(a) Serving all customers equally, rather than targeting the most
profitable. 21. In Porter's five forces model, what is meant by the term 'substitute'?
(b) Operating at lower cost, commanding a premium price, or both. (a) A substitute refers to an alternative manufacturing process.
(c) Focusing on becoming the most competitive business within the (b) A substitute is an alternative product or service that performs the same
sector/market. function for the consumer.
(d) Outsourcing activities which enhance/refine your competitive (c) A substitute is a rival firm offering the same products.
advantage (d) A substitute is something else consumers would rather spend their
money on.
Answers
1 A 2 B 3 D 4 C 5 B 6 B 7 D 8 B 9 C 10 B
11 C 12 C 13 D 14 C 15 A 16 D 17 D 18 B 19 B 20 C
21 B
1. Human Resource strategy is that part of management which is (d) Neither (1) nor (2)
(a) Concerned with how people at work use the various resources
available in organization. 5. In relation Human Resource management, Empowerment' means.
(b) Concerned with people at work & their relationship with an enterprise. (a) Accomplishments rather than active
(c) Concerned with how manger effectively use the various resources (b) Management or diverse work-force
available in organization. (c) Authorizing every member of an organization to take up his own
(d) Concerned with how manger effectively control the people in destiny realizing his full potential.
organization. (d) All of the above
2. Human resource strategy is concerned with the employed in an org. 6. Restructuring Strategies relating to Human Resource includes –
(a) Resources (a) Providing the current staff with training and development
(b) People opportunities to encompass new roles in the organization
(c) Assets (b) Reducing staff, regrouping tasks to create well-designed jobs, and
(d) All of the above reorganizing work groups to perform more efficiently.
(c) Outreaching to external individuals or organizations to complete
3. Which of the following activity is not included in human resource certain tasks.
management? (d) Area of the employer-employee relationship in your organization
(a) Training and development deserves your attention.
(b) Appraisal of performance employees
(c) Resistance management 7. Which of the following cannot be classified as Business Strategies;
(d) Motivation of workforce (a) Differentiation Strategy
(b) Delivery Strategy
4. Which of the following statement is true? (c) Cost Leadership Strategy
1. Human resource management aids in strategic management. (d) Market Segmentation Strategy
2. The human resource management helps the organization to effectively
deal with the external environmental challenges. 8. Under a _____ company tries to be different & unique from competitors.
Select the correct answer from the options given below. (a) Low Cost Strategy
(a) (1) only (b) Product Mix Strategy
(b) (2) only (c) Differentiation Strategy
(c) Both (1) and (2) (d) Quality Strategy
9. Under a cost leadership strategy – (a) 2 only
(a) The company divides the market according cost associated with (b) 1 only
marketing. (c) Both 1 and 2
(b) The company tries to reduce its cost of production. (d) Neither 1 nor 2
(c) The company sells A product below cost.
(d) The company reduces cost by scarifying quality. 13. An advertisement says, 'Have Roohafza with milk and lassi too'. Which
strategy is the company trying to use:
10. In ______ importance is given to speed and reliability. (a) Market Development
(a) Flexible response strategy (b) Product Development
(b) Service Strategy (c) Market Penetration
(c) Response strategy (d) All of the above
(d) Low Cost Strategy
14. A tool by which management identifies and evaluates the various
11. The term supply chain refers to the linkages between – businesses that make up a company is termed as:
(a) Seller, debtor and creditor (a) Value Chain Analysis
(b) Issuer, investor and broker (b) Portfolio Analysis
(c) Suppliers, manufacturers and customers. (c) Competition Analysis
(d) Purchaser and supplier (d) Strategic Analysis
12. Which of the following statement is true? 15. A campaign advocating the message of 'SAVE WATER' is:
Logistic Management is an extension of Supply Chain Management. (a) Services Marketing
Supply chain management is a tool of business transformation and (b) Holistic marketing
involves delivering the right product at the right time to the right place (c) Social Marketing
and at the right price. Select the correct answer from the options given (d) Direct Marketing
below.
Answers
1 B 2 B 3 C 4 C 5 C 6 B 7 B 8 C 9 B 10 A
11 C 12 A 13 C 14 B 15 C
1. Active scanning involves the ______ of continuous resources and, from time 5. As per ADL Matrix, the company's competitive position is determined by
to time, supplementing them with existing resources as needed. (a) Cash CQWS & Growth Stage
(a) Conscious selection (b) Market Improvement & Strategic Actions
(b) Subconscious selection (c) Strategic Actions & Competitor's Strategies
(c) Analysis of threats to the business (d) Strong & Stable Strategies
6. The ADL Matrix or Arthur D Little Strategic Condition Matrix is a Portfolio
2. Which of the following executes strategy into everyday executions Management technique that is based on the –
tactics? (a) Market Growth Strategy (MGS)
(a) Goal setting (b) Corporate Portfolio Investment (CPI)
(b) Technical planning (c) Product Life Cycle (PLC)
(c) Operational planning (d) Strategic Business Units (SBU)
7. One of India's premier utility vehicles manufacturing company ventures to
3. Which of the following refers to a sit nation where a product generates foray into foreign markets.
high profits which can then be invested in developing new products? In the context of Ansoff's Product-Market Growth Matrix, identify, the
(a) Dogs type of growth strategies followed for the given case.
(b) Cash cows (a) Market Development
(c) Question marks (b) Product Development
(d) Growth stage (c) Market Penetration
(d) Market improvement
4. A business giant in hotel industry decides to enter into dairy business.
In the context of Ansoff's Product-! Market Growth Matrix, identify, the; 8. What is shown in the Arthur D. Little- (ADL) Matrix?
type of growth strategies followed for the given case. (a) It classifies strategy options according to market coverage and
(a) Market Development competitive advantage dimensions.
(b) Product Development (b) This 5 X 4 model offers strategy prescriptions according to the
(c) Diversification competitive position of an organization and stage of maturity of its
(d) Market Penetration market.
(c) It relates an organization's competitive position and industry (a) Turnaround Strategy
attractiveness to determine appropriate strategies. (D) It shows the (b) Liquidation Strategy
relative market share and market growth rates of the organization's (c) Divestment Strategy
portfolio of SBUs (d) Differentiation Strategy
9. There are four categories of industry maturity as per ADL Matrix: 13. ______ is implemented by redefining the business by adding the scope
(a) Strong, favourable, mature and decline of business substantially increasing the efforts of the current business.
(b) Strong, favourable, tenable and weak (a) Expansion Strategy
(c) Embryonic, growth, mature and aging (b) Differentiation Strategy
(d) Embryonic, growth, tenable and weak (c) Retrenchment Strategy
(d) Cost Leadership Strategy
10. If Industry Attractiveness is ‘high’ and Business Unit Strength is ‘medium’
then which of the following strength, should be followed as per GE Matrix- 14. Dell Computer has decided to rely exclusively on direct marketing. This is
(a) Invest/grow example of –
(b) Hold/selective (a) Differentiation Strategy
(c) Divest/harvest (b) Focus Strategy
(d) Invest/selective (c) Cost Leadership Strategy
(d) Diversification Strategy
11. A renowned auto manufacturing company launches ungeared scooters in
the market. 15. NDTV a TV Channel has identified a profitable audience niche in the
In the context of Ansoff's Product-Market Growth Matrix, identify, the electronic media. It has further exploited that niche through the addition
type of growth strategies followed for the given case. of new channels like ‘NDTV' Profit and 'Image'. According to Porter, this is
(a) Market Development example of –
(b) Product Development (a) Differentiation Strategy
(c) Diversification (b) Focus Strategy
(d) Market Penetration (c) Cost Leadership Strategy
(d) Strategy
12. If the organization chooses to transform itself into a leaner structure and
focuses on ways and means to reverse the process of decline, it adopts a 16. In BCG matrix, what is the label of the horizontal axis?
(a) Relative Market share (a) Retrenchment Strategy
(b) Business Strength (b) Combination Strategy
(c) Industry Growth Rate (c) Growth Strategy
(d) Market Growth Rate (d) Incline Strategy
17. If Industry Attractiveness is 'Low' and Business Unit Strength is 'High', then 21. Statement I
which of the following strategy should be followed as per GE Matrix – Stability strategy is not a 'do-nothing' strategy.
(a) Hold/selective Statement II
(b) Divest/harvest Third step in BCG Matrix is to calculate relative market share.
(c) Invest/selective Select the correct answer from options given below.
(d) Invest/grow (a) Statement I is true and II is false
(b) Statement II is true and I is false
18. Car manufacturers Maruti' and Tata Motors work on reducing their costs (c) Both Statements are true
to sell their cars in popular segments at attractive prices. This is an (d) Both Statements are false
example of –
(a) Growth Strategy 22. In BCG Matrix, what is the label of segment at attractive prices. This is the
(b) Turnaround Strategy Vertical axis? example of –
(c) Cost Leadership Strategy (a) Relative Market share
(d) Unique Strategy (b) Business Strength
(c) National Growth Rate
19. Another name for GE/McKinsey Matrix is – (d) Market Growth Rate
(a) Business Making Matrix
(b) Business Planning Matrix 23. TOWS Matrix is an analytical tool that helps build over your ______ and
(c) Business Portfolio Matrix make the best use of available while also minimizing the ______.
(d) Business Grow Matrix (a) Threats; Opportunities; Strengths
(b) Strengths; Opportunities; Threats
20. A business organization can redefine its business by divesting a major (c) Opportunities; Strength; Threats
product line or market. This is supported by – (d) Strengths; Threats; Opportunities
Answers
1 A 2 C 3 B 4 C 5 C 6 C 7 A 8 B 9 C 10 A
11 B 12 A 13 A 14 A 15 B 16 A 17 A 18 C 19 B 20 A
21 B 22 D 23 B
1. _______ refers to the process of conducting research on a company and (c) Staff
its operating environment. to formulate a strategy. (d) Shared plan
(a) SWOT analysis 6. ______ means crafting a combination of strategies and picking out the
(b) Strategic implementation best one to achieve the organizational goals and objectives and thereby
(c) Strategic analysis reaching the vision of the organization.
(d) Strategic turnaround (a) Strategy implementation
(b) Strategic analysis
2. ______ is a process through which a strategy is put into action. (c) Strategy formulation
(a) Strategic analysis (d) Strategic management
(b) Strategy implementation
(c) SWOT analysis 7. The plan devised to maintain and build competitive advantage over the
(d) Strategic turnaround competition –
(a) Strategy
3. Strategic implementation is – (b) Style
(a) Concerned with translating a strategic decision into action. (c) Skills
(b) Crafting a combination of strategies and picking out the best one. (d) Systems
(c) Primarily an intellectual process.
(d) Considered easier and less time consuming. 8. Which of the following is NOT included in McKinsey 7 S framework?
(a) Strategy
4. The critical 7 S model was developed and created by reputed consulting (b) Structure
firm: (c) System
(a) Mckinsey (d) Safety
(b) Bain & Co
(c) A. T. Kearney 9. McKinsey's 7-S framework helps analyze organizations and improve their
(d) Accenture effectiveness. The seven elements to be coordinated are: shared values,
structure, systems, style and what?
5. Which of the following is NOT one `S' as per McKinsey 7-S framework? (a) Strategy, service levels and specialization
(a) Structure (b) Strategy, staff and skills
(b) Shared values (c) Service levels, stock and staff
(d) Specialization, skills and standards
14. ________ are at the core of McKinsey 7-S model.
10. What does SBU stand for? (a) Skills
(a) Significant business undertaking (b) Staff
(b) Special bureaucratic use (c) Shared Values
(c) Standard business usage (d) System
(d) Strategic business unit
15. Which of the following is benefit of McKinsey's 7-S Framework Model?
11. Strategy formulation requires – (a) It is a diagnostic tool for understanding the organizations which are
(a) Conceptual intuitive and analytical skills. non-effective.
(b) Motivation and leadership skills. (b) It also enhances employees' morale because they enjoy full freedom
(c) An operational process. to work hard which leads to their empowerment and development.
(d) None of the above (c) It becomes proposition to manage as a result of more divisions and
departments.
12. Maria is the Marketing Manager for Wholefoods Ltd. She is working on (d) It is useful in those organizations where activities are geographically
the firm's marketing plan. Her forecasts show that, if they carry on as they spread such as transport, insurance, banking, etc.
have been doing, they are likely to miss their sales revenue targets by
25,00,000. She needs some new ideas. What kind of analysis has Maria 16. Change in culture, attitude, and mindset calls for:
undertaken? (a) Engagement, involvement and motivation of employees
(a) PRESTCOM analysis (b) Rigorous performance appraisal
(b) SWOT analysis (c) Performance benchmarking
(c) Strategic gap analysis (d) Organization design change
(d) Ratio analysis
17. Vertical integration may be beneficial when:
13. An important activity in _______ is taking corrective action. (a) Lower transaction costs and improved coordination are vital and
(a) Strategy evaluation achievable through vertical integration.
(b) Strategy implementation (b) Flexibility is reduced, providing a more stationary position in the
(c) Strategy formulation competitive environment.
(d) Strategy leadership (c) Various segregated specializations will be combined.
(d) The minimum efficient scales of two corporations are different.
Answers
1 C 2 B 3 A 4 A 5 D 6 C 7 A 8 C 9 B 10 D
11 A 12 C 13 A 14 C 15 A 16 D 17 A
1. What is the term for the act of recreating a core business process with the (c) Object marking
goal of improving product output, quality or reducing costs? (d) Quality marking
(a) Business Process Improvement.
(b) Business Process Reengineering 5. Consider following two statements.
(c) Business Process Change 1. It refers to the analysis and re-design of workflows both within and
(d) Business Process Advance between the organization and the external entities.
2. Benchmarking is a process of finding the best practices within and
2. Which of the following is objective of Business Process Reengineering outside the industry to which an organization belongs.
(BPR)? Select true statement.
(a) Boost effectiveness and produce higher quality products for end (a) 1 only
customer. (b) 2 only
(b) Improve efficiency in the production processes. (c) Both 1 and 2
(c) Providing more meaningful work to employees. (d) Neither 1 nor 2
6. Consider following two statements.
3. Which of the following is NOT a principle underlying business process 1. Benchmarking and Business Process Reengineering are one and the
reengineering (BPR)? same.
(a) Business process must be managed end to end 2. Benchmarking is a remedy for all problems faced by organizations.
(b) Business processes should be agile. Select true statement.
(c) Business processes should use prototype technology (a) 1 only
(d) Business processes must be aligned with organizational strategy and (b) 2 only
needs (c) Both 1 and 2
(e) None of the above (d) neither 1 nor 2
4. _______ is an approach of setting goals and measuring productivity of 7. Managers use this type of bench marking to identify the best way to
firms based on be industry practices or against the products, services and compete in the market –
practices of its competitors or other acknowledged leaders in the industry. (a) Performance Benchmarking
(a) Benchmarking (b) Process Benchmarking
(b) Bench parking (c) Strategic Benchmarking
(d) Internal Bench marking (b) Risk management
(c) Crises of organizational misdeeds
8. _______ refers to a process when a company compares itself with the (d) None of above
competitors inside its industry.
(a) Functional Benchmarking 11. _________ is a defined and disciplined business methodology to increase
(b) Competitive benchmarking customer satisfaction and profitability by streamlining operations,
(c) Generic Benchmarking improving quality and eliminating defects in every organization-wide
(d) Strategic Bench marking process.
(a) Six Sigma
9. ________ collectively established a common set of quality standards (b) TQM
known as ISO 9000. (c) Five Alpha
(a) European Economic Community (d) Six Beta
(b) American Economic Community
(c) Italian Economic Community 12. The reasons for acquisition are –
(d) Indian Economic Community (a) Increased market power
(b) Increased diversification
10. ________ is also considered as a structured approach in managing (c) Increased speed to market
uncertainty related to a threat. (d) All of the these
(a) Crises management
Answers
1 B 2 D 3 C 4 A 5 C 6 D 7 C 8 C 9 A 10 B
11 D 12 D
CA CS Harish Mathariya
Founder - Onlylectures
Co-Founder - Yes Academy
Harish Mathariya is a Chartered Accountant as well as a Company
Secretary by profession. He specializes in extending services in the areas
of Finance & Auditing. He is also a visiting faculty to the most reputed
Management Institutes in & around Pune. His core lies in routing accounts
through the very basics, for which, he has been the most loved face for
Accounts. Having taught students for over 10 years, he is well known for
taking Accounts in a very conceptual way. To his credit, he as 100+ All India
Rankers, which also includes AIR 1 twice. His students acknowledge his
simplification in Accounts as "Don't worry Bol Hari". He is a Founder of
onlylectures.com and is also a Co-Founder of YES Academy, most loved
academy for CS.
Address: Office 27, 1st Floor, Gate No. 1, Kumar Prestige Point, Shukrawar Peth, Pune - 411 002
Mob.: +91 8888 235 235, 8888 545 545
Email: yesacademypune@gmail.com | Website: www.yesacademy.co.in
8888 078 078 csvikasvohra@gmail.com www.vikasvohra.com youtube/Vikas Vohra, Corporate Baba /csvikasvohra /vikasvohra

FSM Marathon Mega Revision Notes

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

FSM Marathon Mega Revision Notes

Uploaded by

Copyright:

Available Formats

CS EXECUTIVE

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

14. Introduction To Strategic Management 14.1 – 14.3

15. Business Policy & Formulation of Functional Strategy 15.1 – 15.2

16. Strategic Analysis & Planning 16.1 – 16.4

17. Strategic Implementation & Control 17.1 – 17.3

18. Analysing Strategic Edge 18.1 – 18.2

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

FINANCIAL MANAGEMENT 98220 93220

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

❑ Inflation – means loss in purchasing power of money #Methods of analysis:-

Every cash flow has ‘Constant ₹ & constant 4 times in a 12 times in a

= 1,21,000 n = no of years Monthly Compounding

I1 I2 I3 I4 Case -B: Annuity at the Beginning of year

As you already know FV = PV(1 + r)

PV factor means PV of ₹ 1 at given rate of interest ‘r’ and given

(ii) (i) This present value of ₹ 1

Then what is its equivalent annual rate of interest rate ?

∴ Here, effective rate will be :-

FINANCIAL DECISION A business organization can obtain

Forecasting of Managing the

FINANCIAL GEARING IS A DOUBLE EDGED SWORD

MANAGEMENT 98220 93220

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

Regular Working • Working Capital remains always in the

POSITIVE WORKING CAPITAL AND NEGATIVE OR

Gross ∆ Current Assets = Change in current assets

Net Working • Difference between current assets and

TANDON COMMITTEE NORMS

3. Contingencies are – 6. Initial Working Capital –

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

Maturity Factoring Advance Factoring

Undisclosed Factoring Invoice Discounting

8. An exercise of credit rating involves –

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

Ordering + Carrying cost = 2 𝑋 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑋 𝑂𝑟𝑑𝑖𝑛𝑔 𝑋 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝. 𝑢. 𝑎

MARKETABLE SECURITIES 98220 93220

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

2. Vertical capital structure

3. Pyramid-shaped capital structure

4. Inverted Pyramid shaped capital structure

10. Timing – कब raise करना है Risk Taker Risk Avoider

Debt Debt Debt Debt 𝐾𝑑 XX

Means financial leverage has no impact on market value

No. of equity No. of equity

CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545

Specific cost Risk cost Pref. dividend S 20 10% ₹ 2.0

EBIT इनकी भी कुछ expection

Own Business Investment in

- Other Financial Decision:-

#Computation of Cost of Capital Formula method IRR Method

This we will discuss

Irredeemable debt Redeemable debt Assumed F.V as

(Maturity date given)

Dividend Price Earning Price Realized Yield CAPM

Draw back:- It has realisation assumption (so earning not stable –

Company Point of view

R.E. is that portion of earning

R.E. is represented as Share

Now Does R.E has a cost

Cost of R.E = cost pf equity