Q&A-Accounts & Finance (Optional Included)

Basics of Cash Flow Statement
Company A is a textile manufacturing industry. Which of the following activities will be recorded in the
cash flow statement of company A? (Note: More than one answer can be correct)
Company A acquired company B by paying $2.5 billion in cash and $0.5 billion in shares.
✓ Correct
Feedback:
The cash flow statement records the inflow and outflow of cash. Hence, paying cash to acquire another
company will result in a cash outflow
Company A sold a button-making textile machine at a loss of $25,000.
✓ Correct
Feedback:
The cash flow statement records the inflow and outflow of cash. The sale of a machine will result in a
cash inflow, which will be recorded in the cash flow statement.
Company A's brand recognition increased.
Company A took a loan from the bank at 6.5% interest rate.
✓ Correct
Feedback:
The cash flow statement records the inflow and outflow of cash. The payments on the loan amount
with a 6.5% interest rate will result in cash outflow from the company, and hence this will be recorded
in the cash flow statement.
Suppose, at the end of the year, Zeta Limited reported a cash balance of $5 million. However, the cash
flow statement reveals that the total cash generated by the company during that period was $6.8
million. What does this indicate?
The company had a negative cash balance at the beginning of the current year.
✓ Correct
Feedback:
While the total cash generated during the year was $6.8 million, the year-end balance was less than
$6.8 million. This indicates that the opening balance was a negative cash balance of -$1.8 million. This
also indicates that the company had a negative cash balance at the end of the preceding year.
The company has a cash outflow greater than the cash inflow in the current year.
The company had a positive total cash generated and cash balance at the beginning of the
previous year.
✕ Incorrect
Feedback:
Use this formula and think again:
Total cash generated = Cash at the beginning of the period - Cash at the end of the period.
The company had a negative cash flow from operations in the current year.
Balance Sheet
1. What information does a balance sheet provide?
A company’s financial performance over a period of time.
A company’s financial position at a particular point in time and performance over a period
of time.
A company’s financial position at a particular point in time.
✓ Correct
Feedback:
A balance sheet is a statement that provides information about the financial position of a company at
a particular point in time. For instance, a company’s balance sheet would be prepared as on 31 March
2021 and not from 01 April 2020 to 31 March 2021. This means the balance sheet would indicate the
company’s financial position at that particular point in time, rather than over a longer period of time.
2. If there is an increase in the value of an asset owing to a business transaction, which of the
following actions may balance this effect? Select all the appropriate options. (Note: More than one
option may be correct).
Increase in the value of liability
✓ Correct
Feedback:
The accounting equation states that for any company, Assets = Liability + Equity. If the value of assets
increases, then it can be compensated for by an equal increase in the value of liability in order to
balance out both sides of the equation.
Decrease in another asset
✓ Correct
Feedback:
The accounting equation states that for any company, Assets = Liability + Equity. If the value of assets
increases, then it can be compensated for by an equal decrease in another asset in order to nullify the
effect of increase in the asset value.
Decrease in equity
3. Which of the following statements about shareholders and bankers is true?
They are part of the core operations of a company.
They are interested in assessing a company’s return on investment.
✓ Correct
Feedback:
The shareholders and bankers, both are fundholders of the company. They have invested in the
company to earn some return, and hence they will be interested in assessing a company’s return on
investment.
The amount invested by the shareholders and bankers can be traced on a company’s income
statement.
The amount of money invested by the shareholders and bankers are classified as
shareholder’s equity.
Financial Statements
Suppose you want to invest in a company that has very little short-term liability. Which of the following
financial statements of a prospective company would you primarily look at in order to gather this
information?
Cash flow statement
Balance sheet
✓ Correct
Feedback:
The balance sheet shows the financial position of a company. It helps you understand what the
company owes to others. Hence, the amount of short-term liability outstanding with the company can
be easily seen on the company’s balance sheet.
Income statement
Overview of Financial Statement

1. During the discussion, Ajitabh was asked whether the company managed to generate wealth. Where
will Ajitabh find this information? Choose the correct option from those given below.
The information can be ascertained with the help of the income statement.
✓ Correct
Feedback:
Wealth generated means the profit earned by the company. Profit is earned when the sales revenue is
more than the cost incurred towards it during the year. Ajitabh can find the information in the income
statement of the company.
The information can be ascertained using the cash flow statement.
The information can be ascertained using the balance sheet.
No, the information provided above is insufficient to ascertain the wealth of the company.
2. The client had borrowed money from the bank for the tenure of five years. Choose the correct option
from those given below.
The loan payments are part of expenses and can be traced in the profit and loss
statement.
The loans borrowed are part of the assets under the balance sheet.
The loans borrowed are part of the liabilities under the balance sheet.
✓ Correct
Feedback:
The balance sheet is a snapshot of the financial position of a company. It shows the balances of amounts
owed and owned by the company as on one particular date. Bank loans are amounts that the company
owes to others and hence can be seen under the head of liabilities in the balance sheet.
3. When Ajitabh mentioned the total amount of wealth generated, the client was surprised. The actual
cash earned differed and was lower than the amount mentioned. Is this possible? Choose the correct
option from those given below.
No, it means that the financial statements prepared are incorrect. The amount of profit
earned and the actual cash in business should be the same.
Yes, the amount of profit and cash can differ. The actual cash earned in a period can be
traced in the cash account under the asset side of the balance sheet.
Yes, the amount of profits earned can differ from the actual cash receipts. The actual cash
inflows and outflows can be tracked in the cash flow statement.
✓ Correct
Feedback:
Yes, the profits earned during the year can differ from the actual cash earned. The actual cash inflows
and outflows can be tracked in the cash flow statement.
No, this gap cannot be identified, as there is a limitation in the financial accounting system.
Typical financial event Case
Elements
1. Suppose Ram purchased a truck in cash ₹2 Lakhs. Which of the following elements will be
impacted?
Asset and equity
✓ Correct
Feedback:
The purchase of a truck will lead to the ownership of it. Hence, it will be treated as an asset.
Moreover, it is funded by his own cash, hence it will be his own equity.
Asset and expense
Asset and liability
Income and expense
2. Virat runs a clothing business. To manufacture the goods, he took a piece of machinery on rent
worth ₹20 lakhs. How will this event be recorded?
Expense
✓ Correct
Feedback:
The asset is taken on rent. Hence, the business needs to pay rent on it. This rent is an expense for the
business.
Asset
Income
Liability
3. Suppose you want to buy a house in Mumbai. The cost of the house is ₹1 crore. You have ₹40 lakhs
with you, and you decide to take a housing loan of ₹60 lakh. What is the value of your asset, liability,
and equity in this case?
Asset: ₹60 lakh, Equity: ₹40 lakh, Liability: ₹1 crore
Asset: ₹1 crore, Equity: ₹40 lakh, Liability: ₹60 lakh
✓ Correct
Feedback:
Assets are resources that you own. Here, the house will be owned by you and, therefore, it will be
your asset. Since the worth of the house is ₹1 crore, you own assets worth ₹1 crore.
Liabilities are resources that you owe to others. Here, since you have taken a loan to buy the house, it
is a liability. Since the loan taken is worth ₹60 lakh, you have liabilities worth ₹60 lakh.
Equity refers to the amount that is invested by you or a shareholder to buy an asset; hence, the equity
here is worth ₹40 lakh.
Asset: ₹40 lakh, Equity: ₹1 crore, Liability: ₹60 lakh
✕ Incorrect
Feedback:
Refer to the meaning of assets, liability and equity
4. Match the financial events with relevant accounting terms.
Financial Event Accounting terms

(A) You have raised ₹50 crores from investors. 1. Equity
(B) You have taken a loan of ₹70 crores from the bank, which is to be
2. Income
repaid after 7 years.
(C) You have made a sale worth ₹20 crores 3. Expense
(D) The cost of the raw material used in your manufacturing processes
4. Liability
was ₹15 crores.
A1, B2, C3, D4
A1, B4, C2, D3
✓ Correct
Feedback:
Equity refers to the money that is invested by owners or raised through funding. Hence, raising ₹50
crore from investors falls under equity.
Liability refers to the money that a company owes to others. The ₹70 crore that is taken from the
bank is a loan that needs to be repaid after 7 years. Hence, it is categorised under ‘Liabilities’.
A sale results in cash generation from the business activity and, hence, it falls within the purview of
‘Income’.
The cost of the material used in manufacturing is an ‘Expense'.
A4, B1, C2, D3
A3, B1, C3, D4

PIZZA FOOD TRUCK QUESTIONAIRE
Renting the truck for $2,500 per month would directly impact which of the following financial
statements?
[Hint: Rent is an expense for the pizza food truck which is generally paid in cash]
Note: This question will help steer your thoughts in the right direction. Do not get discouraged if you fail
to identify the correct answer, as making mistakes is an integral part of learning. Some questions have
been purposefully placed to help you appreciate the need for new concepts which will appear in
subsequent videos.
Income statement
✓ Correct
Feedback:
Refer to the next video to check the explanation for the solution.
Cash flow statement
✓ CorrectYou missed this!

Feedback:
Refer to the next video to check the explanation for the solution.
Balance sheet
2. What is the total sales revenue for the month of January?
[Hint: Sales Revenue = Goods sold x Selling price per unit]
subsequent videos.
The sales revenue would be $5000 dollars for the month of January, taking into consideration that I
sold 500 pizza at $10 per pizza. If the Cost of making the pizza is $2 that means that means I made a
profit of $8 per pizza. That represents the sales revenue of $5000 is equal to the 500 pizzas sold at
$10 which means 500 times 10.
Suggested Answer
The total sales revenue for January is $5,000. Refer to the next video to understand the solution.
Financial Decision on Different Financial Statements
3. What is the total ‘production cost per pizza’?
[Hint: Production cost includes the raw material and utility cost of manufacturing the goods.]
subsequent videos.
The production cost per pizza is $2 taking into consideration, the material cost per pizza is
at $1.5 per pizza and the utilities like water and electricity cost of $0.50 per pizza.
Suggested Answer
The total ‘production cost per pizza’ is $2. Refer to the next video to understand the solution.
4. What is the opening cash balance for the month of January?
[Hint: The opening cash balance for a month(n) = Ending cash balance of the previous month(n-1).]
subsequent videos.
$5,000
$4,500
$4,250
✓ Correct
Feedback:
The cash balance at the beginning of a period is always equal to the cash balance at the end of the
previous period. The opening cash balance for January will be the closing cash balance for December,
which in this case is $4,250.
$6,500

5. Does the ‘share capital’ value change for the month of January as compared to December?
No
✓ Correct
Feedback:
Refer to the next video to understand the solution.
Yes
6. What will be the value of ‘Cash’ on the assets side of the balance sheet for the month of January?
[Hint: In the Cash flow statement, "Cash at the beginning + Total cash generated = Cash at the end".
The "Cash at the end" value is recorded on the balance sheet under "Cash".]
subsequent videos.
The cash value on the asset side would be $6500. The breakup is as follows:
Cash at the beginning is $4250, then add the sales revenue $5000 and then subtract the
utilities cost which is $250 and the truck rental cost $2500 and you'll get the total as
$6500.
Suggested Answer
For January, the cash balance on the assets side of the balance sheet will be $6,500. Refer to the next
video to check the correct explanation for the solution.
7. Does the pizza food truck business hold any inventory at the end of the month?
[Hint: Inventory includes stock of unused raw materials at the end of the month.]
subsequent videos.
Yes
No
✓ Correct
Feedback:
The inventory value is 0 for January. Hence, the pizza food truck business does not hold any inventory
at the end of the month. Refer to the next video to check the correct explanation for the solution.
Stakeholders
The monthly profit earned by the company belongs to which of the following stakeholders?
Supplier
Employees
Shareholder
✓ Correct
Feedback:
Shareholders are owners of a company. They do not get any payment until the company makes a
profit. Hence, the profit earned by the company solely belongs to the shareholders.
Banks
Break-even point
How many pizzas do you need to sell in order to cover your total costs if your selling price is $20 per
pizza?
313
139
✓ Correct
Feedback:
At the break-even point, your sales revenue equals your total cost (cost of goods sold and truck
rental cost). Here is the formula to determine how many pizzas to sell to cover your total cost:
Quantity sold = 2,500/(20−2) = 138.9 pizzas, or 139 pizzas.
191
114
Impact of Financial Decision on Different Financial Statements

The salary of a part-time employee would directly impact which of the following financial
statements? (Note: There may be more than one correct answer)
[Hint: Salary is an expense usually paid in cash for a business.]
subsequent videos.
Income statement
✓ Correct
Feedback:
The salary of a part-time employee would directly impact the income statement and cash flow
statement. The next video details out the explanation for the solution.
Cash flow statement
✓ Correct
Feedback:
The salary of a part-time employee would directly impact the income statement and cash flow
statement. The next video details out the explanation for the solution.
Balance sheet
✕ Incorrect
Feedback:
What will be the value of sales revenue for the month of February?
$10,000
$20,000
$30,000
✓ Correct
Feedback:
The total sales revenue for February is $30,000. The next video details out the explanation for the
solution.
$40,000
You sold 3,000 pizzas, out of which you sold 2,000 pizzas to the neighbouring company with a 30-day
credit period. How much cash inflow should you record in this month from your overall sales of 3000
pizzas?
[Hint: The cash inflow for the credit sales will take place within the 30-day credit period.]
subsequent videos.
$10,000
✓ Correct
Feedback:
You only received $10,000 in cash. The remaining is on credit. The next video will explain how to deal
with this in your financial statements.
$30,000
$20,000
You purchased raw materials worth $5,000, but materials worth only $4,500 were used in
manufacturing the pizzas sold in February. What would you do with the remaining $500 worth of raw
materials?
Note: This question will help steer your thoughts in the right direction. Do not get discouraged if you fail to
identify the correct answer, as making mistakes is an integral part of learning. Some questions have been
purposefully placed to help you appreciate the need for new concepts which will appear in subsequent videos.
Suggested Answer
It would be recorded as the inventory on the asset side of the balance sheet.
What is the value of the ‘Cash at the end’ in the cash flow statement?
[Hint: In the Cash flow statement, "Cash at the beginning + (cash inflow - cash outflow) = Cash at the
end".]
subsequent videos.
$6,000
✕ Incorrect
Feedback:
Refer to the next video for the solution.
$6,500
✓ Correct
Feedback:
The ‘Cash at the end’ of the cash flow statement will have $6,500. The next video explains the solution
further.
$7,000
$4,500
What would be the value for ‘Total liabilities and equity’ in the balance sheet at the end of the
month?
[Hint:Total equity = Share capital + Profit for the period + Retained earnings.]
subsequent videos.
$6,500
$800
$27,000
✓ Correct
Feedback:
‘Total liabilities and equity’ in the balance sheet would be $27,000 for February. The next video
explains the solution.
$16,500
Cash Flow Statement

How much is the cash generated for the month of February?
[Hint: Total cash generated = Cash at the beginning - Cash at the end.]
subsequent videos.
$6,500
$16,500
✓ Correct
Feedback:
Total cash generated = Cash at the beginning - Cash at the end. The cash generation for February
was 0. The next video details out the explanation for the solution.
$10,000
Impact of Financial Decisions on Financial Statements

What would be the value of inventory at the end of March?
[Hint: Inventory includes stock of unused raw materials at the end of the month.]
subsequent videos.
$1,000
✓ Correct
Feedback:
The value of inventory at the end of March would be $1,000. This can be calculated as follows:
Inventory from last month + New food supply purchases - Food supply used for pizzas
= $500 + $5000 - $1.5*3000 = $1000
$100
$500
$200
What is the ‘Net truck value’ at the end of March?
[Hint: Depreciation = Gross truck value / useful life of an asset in months. Net truck value = Gross
truck value - Accumulated depreciation.]
subsequent videos.
$35,000
✓ Correct
Feedback:
The net truck value is $35,000 at the end of March. This will be explained further in the next video.
$30,000
$18,000
$5,000
If you purchase a truck for $36,000 and pay half the value of the truck in March and half in April, how
will the three financial statements account for this in the month of March?
[Hint: Due to this purchase, the cash flow statement will record any cash outflow, the income
statement will record any expenses, the balance sheet will record the asset value, cash value, and
credit received.]
subsequent videos.
Cash flow statement: -$18,000; income statement: -$18,000; balance sheet asset: $36,000;
balance sheet liability: $18,000
Cash flow statement: -$18,000; balance sheet: +$36,000 fixed asset; -$18,000 cash ;
✓ Correct
Feedback:
The purchase of truck for $36,000 and payment of $18,000 in March and the rest in April would
impact the financial statement in the following way:
• Cash flow statement:-$18,000
• Balance sheet asset:Truck value: +$36,000 and cash value: -$18,000
• Balance sheet liability: $18,000
The next video details out the explanation for the solution.
Cash flow statement: -$18,000; balance sheet asset: $18,000; balance sheet liability:
$36,000
Cash flow statement: -$18,000; income statement: -$36,000; balance sheet asset: $36,000;
Would you record the entire value of truck insurance ($300) as an expense in the income statement,
given that you pay half the purchase amount in March and half in April?
[Hint: The insurance of 300 is due monthly on the truck]
subsequent videos.
Yes
✓ Correct
Feedback:
The truck insurance value of $300 is a recurring cost that the company needs to pay every month.
This value would be expensed in the income statement irrespective of cash or credit purchase.
No

What would be the value of accounts receivable in the balance sheet?
$30,000
$40,000
✓ Correct
Feedback:
The value of accounts receivable will be $40,000. The next video shares the explanation for the
solution.
$10,000
$35,000
What is the total cash generated for the month of April?
$6,300
$13,300
-$13,300
-$6,300
✓ Correct
Feedback:
The total cash generated for the month of April is -$6,300. The next video explains the solution.
Which of the following activities from the cash flow statement would be classified as an ‘operating
activity’? (Note: There may be more than one correct answer)
Payment for the purchase of truck
✕ Incorrect
Feedback:
Water and electricity
✓ Correct
Feedback:
Water and electricity are used to cook pizza and, hence, are 'operating' in nature.
Truck insurance
✓ Correct
Feedback:
Truck insurance is a recurring expense incurred on the truck on which pizza is manufactured and sold.
Hence, it is 'operating' in nature.
Sales in cash

Feedback:
Sales in cash are due to the pizza sold and, hence, are 'operating' in nature.
Comment on the performance of the pizza food truck company for the month of April.
In the month of April, even though our B2B order increased but so did our payment timeline. Apart from this
our cash flow shows a negative closing balance which indicates that the financial health is not what we thought
it would be. To be able to operate for the next month we do not have any cash balance to either pay the Truck
insurance nor the part time employee for the month of May.
Suggested Answer
The company has generated a decent profit of $29,700. However, the cash at the end of the month is
less than the cash at the beginning of the month, implying a cash burnout during the month of April.
However, further analysis reveals that the cash flow from operations is positive. Overall, the company
is performing well.
GRADED QUESTION MODULE 1

A company pays advertising expenses of $50,000 every month. Which of the following financial
statements would be directly impacted due to this financial event?
Cash flow statement and balance sheet
Balance sheet
Cash flow statement and income statement
✓ Correct
Feedback:
Advertising expense is a recurring operating expense for the company and hence must be deducted
from the sales revenue in the income statement to determine the profit. Also, since the event will lead
to a cash outflow, it will impact the cash flow statement too.
Balance sheet and income statement
Credit Sales
A company sold $150k worth of products, out of which $50k was on credit. How should the following
be recorded on the assets side of the balance sheet?
+$50k cash
+$100k accounts receivable
+$100k cash
+$50k accounts receivable
✓ Correct
Feedback:
$100k sales were in cash, which increased the cash balance by $100k. $50k sales were on credit, which
increased the accounts receivable by $50k.
+$100k cash
+$50k inventory
+$200k cash
-$50k accounts receivable
Accounting Fundamentals
Which of the following statements is true?
Depreciation reduces the value of a fixed asset.
✓ Correct
Feedback:
Depreciation is a non-cash expense that reduces the value of the fixed asset on account of its usage.
Inventory value can be negative.
The cash balance in the balance sheet at the end of a period is the total cash generated for
the period.
Cost of goods sold (COGS) includes salary of employees and depreciation expenses.
Operating Expenses
An e-commerce company dealing in industrial equipments recently partnered with a logistics
company for the smooth delivery of their products. Which of the following items should be
classified as an operating activity for this company?
(Note: More than one option may be correct.)

Marketing expenses
✓ Correct
Feedback:
Marketing expenses are made to ensure that the company rightly prices, promotes and channels its
services. Such an expense is done in order to increase the profit from operations and, hence, will be
classified as an operating expense.
Website maintenance cost
✓ Correct
Feedback:
The core business of the e-commerce company is to provide an e-commerce platform to suppliers
and buyers. Hence, the cost of maintaining the platform, which is the website, will be included as an
operating expense.
Payment to logistics and delivery services company
✓ Correct
Feedback:
The core business of the e-commerce company is to provide a platform to suppliers and buyers
where they can purchase and sell their products. These products are delivered by the logistics
company to the respective buyers. Hence, the payment to the logistics company for their
services would be classified as an operating expense for the company.
Interest payments on loan taken from bank
Sales Revenue
Wellness Limited had sold goods having an invoice value of $1.5 million during the month of January.
Out of the total invoice value, it has received cash amounting to $0.55 million only. What must be the
value of sales revenue in the income statement for the month of January?
Sales revenue: $0.95 million
✓ Correct
Feedback:
Sales revenue records the sum of all the invoices of the goods sold by the company. Here, the
company is yet to receive $0.95 million from its customers. However, it has delivered goods worth
$1.5 million and drawn invoices of the same. Hence, the sales revenue would amount to $1.5 million.

Analyse the Performance of a Company
The following data is available for two companies A and B:
Company A
Metric Previous Year (Amount in $ million) Current Year (Amount in $ million)
Sales revenue 500 425
Cost of goods sold 260 320
Variable Margin 240 105
Fixed cost 25 25
Company B
Metric Previous Year (Amount in $ million) Current Year (Amount in $ million)

Sales revenue 300 195
Cost of goods sold 110 115
Fixed cost 15 15
Based on the given data, which of the following statements is true?
Company A has significantly performed better than company B because it has a higher
variable margin for the given two years.
The absolute variable margins of the two companies are not directly comparable.
✓ Correct
Feedback:
While looking at the two companies, it is clear that the variable margins are not comparable as the
two companies have different operating scales. Because of the difference in the operating scales, we
need to calculate the variable margin per unit of sales revenue, which is the variable margin as a
percentage of sales revenue.
Company A
Previous Year Current Year

Variable Margin (As a percentage of Sales Revenue) 48% 24.71%

Company B
Previous Year Current Year

Variable Margin (As a percentage of Sales Revenue) 63.33% 41.03%
It is clear from the table that company B has a better performance as it has a higher proportion of
variable margin (as a percentage of sales revenue) as compared to company A in both the years.
Company B has a much better operating performance as it has a lower fixed cost than
company A.
✕ Incorrect
Feedback:
The company’s operating performance cannot be judged solely on the basis of the amount of fixed
cost.
Suppose you have invested $50,000 each in two pharmaceutical companies – Luvin Limited and
Moon Limited – five years ago. Both the companies have the same operational scale. You want to
understand the operating performance of the two companies. While browsing the income statement
of the two companies, you find the following information:
Luvin Limited Moon Limited
Metric Amount (in $) Metric Amount (in $)
Sales revenue 76,000 Sales revenue 71,000
COGS 23,000 COGS 14,000
Variable Margin 53,000 Variable Margin 57,000
Fixed Cost 3,000 Fixed cost 4,000
EBITDA 50,000 EBITDA 53,000
Amortisation 10,000 Amortisation 50,000
EBIT 40,000 EBIT 3,000
Additionally, it is given that Luvin Limited had filed for a patent for ₹2,00,000, 20 years ago and
Moon Limited had filed for a patent for ₹10,00,000, 20 years ago. Determine which company’s cash
operating performance is better.
Note: The patent expense appears as amortisation in the income statement.
Luvin Limited
✕ Incorrect
Feedback:
In the given situation, Luvin Limited has a lower patent expense while Moon Limited has a higher
patent expense. Therefore, the EBIT of Luvin Limited is higher than the EBIT of Moon Limited.
However, EBITDA is a better metric than EBIT to compare the cash operating performance of
companies. It helps in getting rid of non-cash biases like depreciation and amortisation and reveals
the true cash operating performance of a company. The EBITDA value of Moon Limited is higher than
Luvin Limited. Hence, Moon Limited has better cash operating performance.
Moon Limited
✓ Correct
Feedback:
In the given situation, Luvin Limited has a lower patent expense while Moon Limited has a higher
patent expense. Therefore, the EBIT of Luvin Limited is higher than the EBIT of Moon Limited.
However, EBITDA is a better metric than EBIT to compare the cash operating performance of
companies. It helps in getting rid of non-cash biases like depreciation and amortisation and reveals
the true cash operating performance of a company. The EBITDA value of Moon Limited is higher than
Luvin Limited. Hence, Moon Limited has better cash operating performance.
Interest Income and Interest Expense

The following data is available about Luvin Limited and Moon Limited.
Luvin Limited Moon Limited

EBIT $40,000 EBIT $35,000
Net interest payment $3,700 Net interest payment -$3,700
Earnings Before Tax $36,300 Earnings Before Tax $38,700
Which of the two companies has interest income greater than interest expense?
Moon Limited
✓ Correct
Feedback:
Moon Limited had a net interest payment figure of -$3,700. This means instead of interest payment,
there is an interest income of $3,700. This means interest income is greater than the interest expense
for Moon Limited by $3,700. Hence, instead of subtracting the net interest payment, it is added to the
EBIT to determine the company’s profit. For Luvin Limited, the $3,700 shows a payment of $3,700 as
an interest expense. This indicates that the net effect of income and expense is an expense.
Luvin Limited
✕ Incorrect
Feedback:
Moon Limited had a net interest payment figure of -$3,700. This means instead of interest payment,
there is an interest income of $3,700. This means interest income is greater than the interest expense
for Moon Limited by $3,700. Hence, instead of subtracting the net interest payment, it is added to the
EBIT to determine the company’s profit. For Luvin Limited, the $3,700 shows a payment of $3,700 as
an interest expense. This indicates that the net effect of income and expense is an expense.
Income Statement Metric

The financial statements are very relevant to government and other regulatory bodies. Which of the
following income statement metrics is the most relevant for tax authorities?
Variable margin
EBITDA
EBT
✓ Correct
Feedback:
The government collects tax on the profit earned by the business and, hence, the most relevant
metric for them is the EBT. Higher the EBT, higher the taxes to be paid to the government. A negative
EBT shows loss and, hence, no tax payment.
Net income
Principles of Accounting
Delta Limited is an Indian soap manufacturing firm. Following are three financial events mentioned in
the auditor's report of the company for the current year.
Event Record of Event
Sold goods worth ₹18 crore (out of which ₹15 crore was on credit). As a
The company reports sales
part of the contract, an additional ₹2 crore worth of goods are to be
revenue of ₹20 crore.
manufactured and delivered next year.
Out of the credit sales, the company sold goods worth ₹3 crore to a The company reports accounts
company that has filed for bankruptcy. receivable of ₹15 crore.
The company records a short-term

The company received a loan of ₹4 crore at 4% interest to be repaid within
debt of ₹4 crore on its balance
six months.
sheet.
Which of the following are red flags for Delta Limited?
Hint: A violation of any of the accounting principles you have learnt can be seen as a red flag.
Record I and record II
✓ Correct
Feedback:
For Delta Limited, goods worth ₹2 crore are yet to be manufactured and delivered. Hence, the
recorded sales revenue should be ₹18 crore according to the ‘realisation of sales principle’, which
states that the sales should be recognised as the sales revenue when the goods/service becomes the
property of the company’s customer irrespective of the receipt of cash for them. However, the
recording of sales revenue worth ₹20 crore is an attempt to overstate sales and, hence, overstate
profit to show an improved financial position for the company.
When Delta Limited sold its goods on credit to a company that has declared bankruptcy, the amount
receivable is a probable bad debt. Hence, the accounts receivable must be recorded as ₹12 crore. By
recording the accounts receivable at ₹15 crore, the company is violating the prudence principle,
which states that assets should not be overvalued, and liabilities should not be undervalued. It is
trying to inflate its assets and show an improved financial position for the company.
Record II and record III
Record III and record I
Only record II
✕ Incorrect
Feedback:
Think about the accounting principles taught in this course. Apply them to these financial events and
try again.
Balance Sheet
Assets
Following is the extract of a company’s balance sheet for three months:
Item January (In Million) February (In Million) March (In Million)
Inventory $150 $300 $400
Work-in-Progress Inventory $100 $200 $400
Finished Goods Inventory $50 $100 $150
Fixed Assets $1200 $900 $600
Depreciation $300 $300 $300
Net Fixed Assets $900 $600 $300
Additionally, you know from further research that the market value of the finished goods for the
month of February was $50 million. Which of the following statements about the company is true?
(NOTE: More than one option may be correct.)

The production process of the company is very long.
✓ Correct
Feedback:
Since the company’s work in progress is higher than the finished goods inventory for the three months,
it can be inferred that its production process is very long.
The company is manipulating its depreciation amount.
The company has overstated the value of its assets.
✓ Correct
Feedback:
The market value of the finished goods inventory is $50 million but the company is recording it at $100
million. This is inflating the inventory value. It is a pure violation of the prudence principle and has
inflated the value of the assets.
Net Receivables
Zed Motors Limited is a two-wheeler manufacturing company. Given is an extract from the company’s
balance sheet.
In this table, you will notice a substantial increase in ‘net receivables'. Which of the following
scenarios could be one of the possible reasons for this increase?
Extract from the balance sheet as on 31 March: Zed Motors Limited.
Year 1 (in ₹) Year 0 (in ₹)

Particulars
Current Year Previous Year
Net Receivables 4,43,74,100 1,02,63,400
Accounts Payables 2,68,28,700 1,95,36,900
Long-Term Debt 2,36,09,300 50,12,300
An increase in the percentage of raw material procured on a credit basis
An increase in the percentage of automobiles sold on a credit basis
✓ Correct
Feedback:
When goods are sold on credit, the corresponding cash obtained is realised later. Hence, the cash
becomes a part of accounts receivables. An increase in Zed Motors Limited’s accounts receivables
indicates that the company has made credit sales.
A decrease in the percentage of loans procured from lenders
A decrease in the percentage of expenses on the goods manufactured

Dividend and Retained Earnings
Given is the information about the owner’s equity portion of the balance sheet of a company. All
figures are from the end of the respective years.
Particulars Year 0 (In Million) Year 1 (In Million) Year 2 (In Million)
Share Capital $4,000 $4,000 $4,000
Yearly Profit $2,800 $1,500 $1,800
Retained Earnings $2,600 $3,800

--
Owner’s Equity $6,800 $8,100 $9,600
In which year did the company declare a dividend?
Neither year 1 nor year 2
Year 1
Year 2
Both year 1 and year 2
✓ Correct
Feedback:
The company had earned profits amounting to $2,800 million in year 0. However, the retained earnings
of year 1 was less than $2,800. This indicates that $2,800-$2,600 = $200 million was distributed as
dividend. Similarly, for year 2, the retained earnings was $3800 (less than $4,100). The difference of
$300 was distributed as dividends.
Financial Triangle Link Between Financial Statements

The following information is available for a company.
Income Statement (In ₹ million)
Sales revenue 2
Operating expenses 0.45
Operating profit 1.55
Interest expenses 0.22
Taxes 0.28
Net profit ?
Cash Flow Statement (In ₹ million)
Cash in the beginning 0.75
Cash generated during the year ?
Cash at the end 1.52
Balance Sheet
Amount (in ₹ million) Liability and equity Amount (in ₹ million)

Asset
Fixed assets 6 Share capital 5
Cash Profit for the Year

? ?
Inventory 2.53 Owner’s equity ?
Long-term debt 4
Total assets ? Total liabilities and equity ?
What is the total assets and owner’s equity?
Total assets: ₹ 10.05 million; owner’s equity: ₹ 6.05 million
✓ Correct
Feedback:
In order to determine the total assets, the missing figure is cash. This cash balance can be extracted
from the cash flow statement. From the cash flow statement, we can find that: Cash at the end = ₹
1.52 million. Hence, total assets = ₹ 6 million + ₹ 1.52 million + ₹ 2.53 million = ₹ 10.05 million. On
the other hand, owner’s equity is a sum of share capital and profit for the month. Profit for the month
can be transposed from the income statement. From the given details, profit for the month = ₹ 1.55
million - ₹ 0.22 million - ₹0.28 million = ₹ 1.05 million. Thus, owner’s equity = ₹ 6.05 million.

Which of the following statements will be affected for the month of April?
Cash flow statement and income statement
✕ Incorrect
Feedback:
Think about the purpose of the three statements and try again.
Income statement and balance sheet
Balance sheet, cash flow statement and income statement
✓ Correct
Feedback:
The company has certain cash inflows during the month of April; hence, the cash flow statement will
be affected. Also, the company purchases inventory and infuses share capital. Hence, the balance sheet
will be affected. Since no sales are made during the month of April, the income statement will not be
affected.
Break-Even Point
Aryan wants to understand the minimum number of units he needed to sell in order to break-
even. What is the break-even level of output for the month of May?
102
217
✓ Correct
Feedback:
Aryan needs to sell 217 pieces of chocolate for the month of May to reach the break-even point. Break-
even point = Fixed cost / Variable margin per unit.
Fixed cost for the month of May = ₹13,000
Variable margin per unit = ₹60.
Hence, the break-even point = 217 units. Since Aryan has made sales of 400 pieces of chocolates for
the month, he is operating above the break-even level.
230
120
Performance Metric
What is the variable margin (as a % of sales) for Chococera?
40%
20%
60%
✓ Correct
Feedback:
Variable Margin = (Sales revenue - cost of goods sold)/ Sales revenue x 100. Hence, Variable margin
= (40-16)/40 = 60%.

Does Chococera hold any inventory at the end of the month May?
Yes
✓ Correct
Feedback:
The raw materials used up in the month of May were 25 X 400 units = ₹10,000. However, Aryan had
an inventory of ₹20,000 at the end of April. Hence, after using ₹10,000 worth of raw materials, the
balance was ₹10,000 at the end of May.
No

What is the cash balance in the balance sheet at the end of May? Choose the correct option from
those given below.
[Hint: The raw material cash outflow is already factored in during raw material purchase in April.]
₹1,00,000
₹2,01,000
✓ Correct
Feedback:
The cash balance in the balance sheet comes from the bottom line of the cash flow statement. The cash
flow statement’s bottom line is cash at end, which, for the month of May, was ₹2,01,000. This is given
as follows.
₹3,00,000
₹4,80,000
Which of the following statements for the month of May is true?
Cash at the beginning: ₹1,80,000, monthly profit: ₹11,000 and sales revenue: ₹40,000
✓ Correct
Feedback:
The cash at the end of a month becomes the cash at the beginning of the next month. Therefore, the
cash at the beginning of May is the cash at the end of April, which is ₹1,80,000. Also, sales revenue
is ₹40,000, and after accounting for all the expenses, the monthly profit is 40,000 - 16,000 - 5,000 -
8,000 = 11,000.
Cash at the beginning: ₹0, monthly profit: ₹18,000 and sales revenue: ₹50,000
Cash at the beginning: ₹40,000, monthly profit: ₹19,500 and sales revenue: ₹ 25,000
What is the value of "Total liabilities and equity" for Chococera at the end of May?
₹2,11,000
✓ Correct
Feedback:
Total liabilities and equity = Share capital + Profit for the month. This gives, Total liabilities and equity
as ₹200,000 + ₹11,000 = ₹2,11,000
₹1,51,000
₹98,000
Graded
Performance Metric
Two companies have the same operational prospect but have a significant difference in their
depreciation expense. Which of the following would be the most appropriate metric to compare the
cash-operating performance of the two companies?
EBIT
EBITDA
✓ Correct
Feedback:
Whenever a company has depreciation or amortisation expense in its income statement, it is
recommended to evaluate the EBITDA of the company as it shows the true operating income before
accounting for non-cash expenses, such as depreciation and amortisation.
Variable margin
Profit after tax
Analyse the Performance of a Company

The following data is available for two fast food joints A and B.
Fast-Food Joint A
Metric Current Year (in ₹) Previous Year (in ₹)
Sales (100 customers) 40,000 35,000
COGS 16,000 15,000
Variable Margin 24,000 20,000
Variable Margin (as a % of sales) 60.00% 57.14%
Fast-Food Joint B
Metric Current Year (in ₹) Previous Year (in ₹)
Sales (100 customers) 80,000 65,000
COGS 38,000 32,000
Variable Margin 42,000 33,000
Variable Margin (as a % of sales) 52.50% 50.77%
Based on the given data, which of the following statements is true? [Hint: The companies have
different scales of operations. A direct rupee-to-rupee comparison may not be useful.]
Fast-food joint B has performed better than fast-food joint A because it has a higher
Fast-food joint A has performed better than fast-food joint B because it has a higher
Fast-food joint B has performed better than fast-food joint A because it has a
lower variable margin as a % of sales for the given two years.
Fast-food joint A has performed better than fast-food joint B because it has a higher
variable margin as a % of sales for the given two years.
✓ Correct
Feedback:
While looking at the two companies, it is clear that the variable margins are not comparable as the
two companies have different operating scales. Because of the difference in the operating scales, we
need to compare the variable margin as a percentage of sales revenue. This comparison reveals that
the variable margin (as a % of sales) for Fast-food joint A is greater than Fast-food joint B.
Hence, Fast-food joint A has performed better than Fast-food joint B.
Long-term Debt
Vedshakti Limited is an FMCG company. An extract from the company’s balance sheet extract is as
shown below.
In the balance sheet extract, the ‘long-term debt’ increased substantially. Which of the following
scenarios could be one of the most plausible reasons for this increase?
Extract from Vedshakti Limited’s Balance Sheet as of 31 March.
Year 1 (in ₹) Year 0 (in ₹)

Particulars Current Year Previous Year
Net Receivables 4,43,74,100 1,02,63,400
Accounts Payable 2,68,28,700 1,95,36,900
Long-Term Debt 2,36,09,300 50,12,300
An increase in the credit sales of the company
The company acquired land to set up a new plant, funded by debts/borrowings
✓ Correct
Feedback:
Long term assets like land are usually funded using long-term debt. This explains why the long-term
debt has increased.
The overall raw material costs increased which led to the company taking on a 6-month
loan
An increase in the amount invested by the shareholders of the company.

Module 2
Operating Working Capital
Which of the following statements about operating working capital is true?
Operating working capital is required to fulfil the long-term cash needs of a business.
When the payment from customers arrives before the due date for payment to suppliers,
the operating working capital requirement increases.
Operating working capital is required to fund the fixed assets of a business.
Operating working capital is required to fund the cash-to-cash period of a business.
✓ Correct
Feedback:
The time period between the first payment made to suppliers and the first payment received from
customers is called the cash-to-cash period. There is a heavy cash outflow during this period. The cash
required to fund this cash-to-cash to period is called the operating working capital of a company.
Capital Employed
Aryan has started a new logistics company last week. He also raised $2 million from the shareholders
of the company. In which of the following activities should the company employ this capital? (Assume
that there are no other sources of capital as this is the initial stage for the company.)
Purchase trucks and two-wheelers for logistics: $1 million
✓ Correct
Feedback:
The money raised from the shareholders and bankers must be invested in funding the long-term
resources and operating working capital of a company. If any money is left after meeting these
requirements and in the absence of other suitable opportunities, it can be utilised for other purposes
in the company. Here, the $2 million would be first prioritised for purchasing vehicles and funding
inventory and accounts receivable.
Conduct employee empowerment programmes: $0.5 million
Fund inventory and accounts receivables: $1 million
✓ Correct
Feedback:
The money raised from the shareholders and bankers must be invested in funding the long-term
resources and operating working capital of a company. If any money is left after meeting these
requirements and in the absence of other suitable opportunities, it can be utilised for other purposes
in the company. Here, the $2 million would be first prioritised for purchasing vehicles and funding
inventory and accounts receivable.
Provide a loan to third parties: $1 million
Operating Working Capital

The balance sheet of Aze Limited is given below.
Balance Sheet: Current Year

Assets Amount Liabilities and Equity Amount
Machinery $50,000.00 Share capital $35,000.00
Inventory $25,000.00 Retained earnings $5,000.00
Accounts receivable $2,000.00 Long-term debt $25,000.00
Patent $10,000.00 Short-term debt $7,000.00
Cash $5,000.00 Accounts payable $20,000.00
Total assets $92,000.00 Total liabilities and equity $92,000.00

Calculate the operating working capital for Aze limited.
$47,000
$7,000
✓ Correct
Feedback:
For this, we can use the following formula:
Operating working capital = Inventory + Accounts receivable - Accounts payable
= $25,000 + $2,000 - $20,000
= $7,000
$3,000
$43,000
Economical Balance Sheet
The balance sheet of Aze Limited is given below.

Inventory $25,000.00 Retained earnings $5,000.00
Accounts receivable $2,000.00 Long-term debt $25,000.00
Patent $10,000.00 Short-term debt $7,000.00
Prepare the economic balance sheet for Aze Limited and calculate the capital employed by the
company.
$87,000
$67,000
✓ Correct
Feedback:
For Aze Limited, all the items on the Assets side, except cash, are operating items, and all the items on
the Liabilities and Equity side, except accounts payable, are financing items. By rearranging the items
in the balance sheet, we get the following economical balance sheet:
Thus, for Aze Limited, Capital employed = $67,000
$92,000
$60,000
Return on Capital Employed
The table given below shows P&G’s return on capital employed (RoCE) for Year 0 and Year 1.
Company RoCE (Year 0) RoCE (Year 1)
P&G India 27.9% 70%
Which of the following could be the reason for the increase in P&G's RoCE from the previous year (Year
0) to the current year (Year 1)?
Expansion in variable margins
✓ Correct
Feedback:
Return on capital employed is calculated as EBIT/Capital employed. Expansion in variable margins
would increase the EBIT, as the expansion would indicate an increase in revenue or a decrease in COGS.
Therefore, it would lead to an increase in the RoCE.
Increase in the employee benefit expenses of the company
Ability to get long-term loans at lower interest rates
Analyse the RoCE of Different Companies

The table given shows a comparison between P&G’s return on capital employed (RoCE) and that of
other diversified FMCG companies.
Company RoCE (FY 2016 End) RoCE (FY 2017 End)
P&G India 28.9% 70%
HUL 59.5% 61.5%
ITC 28.1% 21.5%
Nestle India 17.9% 20.8%
Emami 19.3% 19.3%
Which of the following statements is true based on the data provided above?
Nestle has been managing its capital deployment better than ITC.
ITC’s capital deployment has improved in 2017 from 2016.
✕ Incorrect
Feedback:
The RoCE of ITC has decreased from the year 2016 to 2017. Hence this is incorrect.
HUL has been the most consistently efficient at deploying its capital across these two
years.
✓ Correct
Feedback:
HUL has the highest RoCE amongst its peers in 2016 and has been consistent in 2017 as well.
Emami’s capital deployment is on par with its peers.
Difference Between RoCE and RoACE

In which of the following cases, the difference between RoCE and RoACE would be significant?
Infusion of capital at multiple intervals in a year
✓ Correct
Feedback:
Return on adjusted capital employed (RoACE) takes the operating profit net of taxes and the average
capital employed while determining the return on per unit of capital employed while Return on capital
employed takes the closing capital employed. The infusion of share capital at multiple intervals in the
company throughout the year would impact the average capital employed and not the closing capital
figure, which would create a difference between the calculated RoCE and RoACE figure
Increase in employee benefit expenses
Increase in marketing expenses
Increase in interest rates
Value Creation
The data available for ZQT Limited is given below.
Based on the information given above, which of the following statements is true?
ZQT Limited could not create value in any year.
ZQT Limited created value in all the years.

ZQT Limited could not create value in Year 2.
✓ Correct
Feedback:
Value is created when the return expected by the fundholders is less than the after-tax RoCE generated
by a company. For Year 2, the after-tax RoCE of the company is less than the weighted average cost of
capital (return expected by the fundholders). Hence, the company could not create value in Year 2.
ZQT Limited created value only in Year 2.
Financial Leverage
Arun is the CFO of a company. The company wants to increase its return on equity to attract investors. For this,
Arun has suggested that the company should take debt from the market, which will help the company in its
upcoming project and also in increasing the RoE. Analyze the effect of such a decision.
Hint: The effect of debt in businesses is quite similar to the effect of taking a personal loan. It has both pros and
cons.
Taking on debt can increase overall investment in a project, leading to higher returns if
successful, and interest payments are tax-deductible, increasing after-tax profits. However,
taking on debt increases financial risk and regular interest payments can cut into profits
and cash flow. It's important for Arun and the management team to weigh the benefits
and drawbacks before deciding and have a solid plan to generate returns and manage
risks.
Suggested Answer
Taking debt from the market will have both advantages and disadvantages in the long run. Some of
the possible advantages and disadvantages can be:
• Advantages:
• The debt can be used for investment in high-potential projects. This will help in boosting
the profits of the company.
• If the cost of debt is low then the return on equity may increase in the long run.
• Disadvantages:
• The debt will increase the interest expense, which will eat away at the company's profit.
• Future fundholders may perceive higher risk due to the presence of debt in the capital
employed of a company and demand higher returns on their investment.
Factors impacting RoE

• The industry average return on equity (RoE) is 42% for year 1, whereas the RoE of Dabur is 24.2%.
Is Dabur generating less profit than the market average? What could be the possible reason for
this decline in Dabur’s RoE?
Dabur FMCG
Year 0 Year 1 Industry Average

Return on equity 26.9% 24.2% 42%
-Dabur's RoE is lower than the industry average, indicating lower profitability.
-A decline in RoE could be due to lower profitability, lower asset turnover, or higher
leverage.
-Possible reasons for Dabur's decline in RoE could be increased expenses, lower sales or
revenue, higher competition, or a change in strategy.
Suggested Answer
Return on equity is basically the net profit divided by the owner’s equity. A decrease in the RoE is not
a favourable sign for Dabur. This can happen due to a decrease in the net profit or an increase in the
equity value.
Generally, for a business, during the year, equity is likely to increase significantly. This could possibly
happen if you raise fresh equity. A more plausible option for this is a decline in the net profit, which
can further be due to a decrease in revenue or an increase in expenses. There are multiple categories
of expenses.
Basically, if the business is not generating the same returns, then you need to diagnose what has
happened, which requires thorough structured analysis.
Stan Oil Limited is an oil company that has been running for more than 35 years.
Recently, the company infused huge funds for its operations in the middle of the year. The company’s
management wants to analyze whether the company is creating value for its stakeholders.
The summarised ratios are given below.
Year 0 Year 1
RoCE 19.29% 18.72%
RoACE 12.33% 13.98%
Operating margin 13.50% 15.32%
SalesAverage Capital employed 1.43 1.375

Profitability
1. Identify the correct statement from those given below.
RoCE isn't the best profitability metric here because it ignores changes in capital allocation
and the effect of taxes.
✓ Correct
Feedback:
As the company has infused funds in the current period, RoCE will not be the correct measure of
profitability for Stan oil Limited. This is because RoCE uses the closing capital while determining the
rate of return.
RoCE is more than RoACE because of the infusion of capital in the current year.
RoACE has increased due to an increase in the sales/ capital employed ratio.
2. The operating profit per unit of sales has increased from year 0 to year 1. Based on your
understanding, which of the following could be a reason for this?
Decrease in tax rates
Decrease in the price of the same quality raw materials.
✓ Correct
Feedback:
Operating profit margin can increase either due to an increase in operating profit or a decrease in
sales. A decrease in the price of raw materials must have decreased the cost of goods sold, and thereby
increased the operating profit.
Decrease in the interest rates on the borrowed loans.
3. Identify the correct conclusion for the company from the following.
(Assume a WACC of 12.06%)
The company has created value, as RoCE (18.72%) is more than WACC (12.06%).
The company has not created value for its stakeholders, as RoCE for the current year has decreased
in comparison to the previous year.
The company is creating value, as RoACE (13.98%) is more than WACC (12.06%).
✓ Correct
Feedback:
RoACE is the correct metric for a company like Stan Oil Limited. Since RoACE > WACC of the company, it is
certain that the company has created wealth in the current year for its stakeholders.
Graded
Capital Employed
The balance sheet of Blaze Limited is given below.

Inventory $2,000.00 Long-term debt $10,000.00
Accounts receivable $1,000.00 Short-term debt $3,000.00
Calculate the capital employed by the company.
$20,000
$21,000
✓ Correct
Feedback:
For Blaze Limited, all the items on the Assets side, except cash, are operating items, and all the items
on the Liabilities and Equity side, except accounts payable, are financing items. By rearranging the
items in the balance sheet, we get the following economical balance sheet:
$27,000
$33,000
Return on Equity
Arun is the CFO of the FMCG company Indian Snack Company (ISC). The company wants to increase its
return on equity to attract investors. What steps can ISC take to increase its RoE, given that ISC already
has a lot of debt on its books?
ISC can take more long-term debt with an interest higher than the market rate of interest
ISC negotiates better contract terms with its utility providers, thus reducing costs.
✓ Correct
Feedback:
Reducing costs will increase the company’s net income. As the RoE is directly related to the net income,
the RoE will also increase.
ISC can onboard new suppliers who have a great variety of raw ingredients but at a high
cost.
The company can shift its operations to new geographies where the tax rates are higher
than the current tax rates.
Return on Capital Employed

Which of the following actions can help in increasing the RoCE?
Note: (RoCE = EBIT / Capital employed). Think of immediate impacts only. Don't predict the long-term
business implications of the actions.
Procuring fresh long-term loans
Cutting down on marketing expenses
✓ Correct
Feedback:
The RoCE of a company is calculated as follows:
RoCE = EBIT/Capital employed
Anything that increases the EBIT or decreases the capital employed will directly cause an increase in
the RoCE. A reduction in the marketing expenditure will increase the EBIT and the RoCE.
Raising more funds from investors
Procuring materials from a new vendor charging 10% higher than the current vendor
Activity Ratios
The following tables provide information regarding two companies.
Company A (in $ Company B (in $

Metrics
million) million)
Sales revenue 4 25
Cost of goods sold 0.9 3.2
Operating working
0.25 4
capital
Company A (all figures in $ million)

Fixed assets 2.5 Owners equity 3
Cash 2.25 Short-term debt 0.5
Accounts receivable 0.5 Long-term debt 1.5
Inventory 0.75 Accounts payable 1
Company B (all figures in $ million)
Fixed assets 11 Owners equity 13
Cash 4 Short-term debt 2.5
Accounts receivable 2 Long-term debt 3.5
Inventory 3 Accounts payable 1
Assume 360 operating days in a year.

Working Capital Need
Which company has a higher operating working capital need?
Hint: You cannot directly compare absolute working capital for companies of different scales.
Company A
Company B
✓ Correct
Feedback:
The absolute amount of working capital of company A cannot be compared to that of company B.
This is because both the companies are operating at a different scale. Hence, in order to facilitate
comparison between the two companies, you need to calculate the operating working capital/sales
ratio. The working capital/sales ratio of company A is 6.25% and that of company B is 16%. Hence, the
working capital need of company B is higher than that of company A.
Interpreting Activity Ratios
Determine which of the following statement is true?

For company A, accounts receivable of $0.5 million represents 45 days of sales revenue
outstanding
✓ Correct
Feedback:
For company A, the days sales outstanding (DSO) can be calculated as: Accounts receivable/sales per
day. Therefore, DSO = 0.5 × 360/4 = 45. This number indicates that company A’s receivable of $0.5
million represents 45 days of sales revenue outstanding.
Both the company pay their supplier 300 days after delivery
Company B’s days inventory outstanding (DIO) is greater than company A’s DIO

Feedback:
Days inventory outstanding (DIO) can be calculated as: Inventory/cost of goods sold per day. For
company A, DIO = 0.75/0.0025 = 300 days. And for company B, DIO = 3/0.0088 = 337.5 days. Hence,
the DIO of company B is greater than the DIO of company A.
For company B, accounts receivable of $2 million represents 45 days of sales outstanding
Change in Activity Ratios: Illustration

The following information is available for a company:
• Accounts receivable = $2 million
• Inventory = $3 million
• Accounts payable = $1 million
• Operating Working Capital = 3 million + 2 million - 1 million = $4 million
• Sales Revenue = $25 million, Working capitalSales revenue= 425 X 100= 16% and COGS=
$3.2 million
Assume 360 operating days in a year. Answer the following questions for the 4 different scenarios
related to this company.
Change in Working Capital: Scenario 1
What would happen if the company employs better technology to improve the efficiency of the
production process?
The working capital requirement will increase
✕ Incorrect
Feedback:
A more efficient production process implies that fewer resources will be stuck in work-in-progress
inventory.
The working capital requirement will remain the same
The working capital requirement will decrease
✓ Correct
Feedback:
A more efficient production process implies that fewer resources will be stuck in work-in-progress
inventory. This will reduce the DIO, which will in turn reduce the working capital.
Thus, technology can be a driver for reducing working capital.

Which of the following statements will be true if the customers pay the company 12 days later than
expected?
The new working capital will increase to $4.8 million.
✓ Correct
Feedback:
When the customers pay 12 days late, the accounts receivables would increase.
The yearly sales revenue is $25 million. Therefore, daily sales revenue is $25 million /360 = $0.0694
million.
Therefore, 12 days worth of sales = $0.0694 million * 12 = $0.83 million.
Therefore, Accounts Receivables would increase by $0.83 million since 12 more days are being added
before payment.
This would increase working capital from $4 million to $4.8 million.
Thus the effectiveness with which you can collect timely payments and customer payment
habits drive working capital.
The new working capital will decrease to $3.2 million.
The new working capital will increase to $9.6 million.
✕ Incorrect
Feedback:
Working capital increases because of an increase in accounts receivables.

What would happen when the sales revenue increases as a result of more units sold? Answer based
on a normal scenario.
The working capital requirement will decrease
The working capital requirement will remain unchanged
The working capital requirement will increase
✓ Correct
Feedback:
When more products are sold, it means larger quantities of raw material need to be ordered to meet
the production needs. This means more inventory.
While ordering larger quantities of raw materials, the company would owe more to its suppliers. Thus
accounts payables would increase.
It also means more customers will be owing money to the company (assuming the proportion of
credit sales will remain constant). This means more accounts receivables.
Working Capital = Accounts Receivable + Inventory - Accounts Payable
Overall, working capital will increase in most companies, since the accounts payables increase won't
be enough to offset the effects of increasing inventory and accounts receivables.
Thus sales revenue is a driver for working capital.
Impact of Working Capital Drivers

Which of the following statement(s) is true?
Improvement of production processes will help pile a lot of inventory in the warehouse,
thus increasing the operating working capital requirement.
Timely reminders to customers who owe money to the company will help in better
receivables management, thus decreasing the operating working capital requirement.
✓ Correct
Feedback:
Accounts receivable is an important element of working capital. Timely reminder to customers who
owe money to the company will help in better receivables management. It will help in decreasing the
working capital required to accommodate for the money stuck in accounts receivable, thus
decreasing the overall operating working capital requirement.
If the payment habit of a company is to provide long payment terms to the customers, the
operating working capital requirement will decrease.
The operating working capital/sales revenue ratio of the company will always increase with
the growth of the company.
Inventory Management
Determining Optimum Batch Size
A distributor sells industrial tools. He has a sales estimate of ₹20 crores for the upcoming year. Each
tool sells for ₹10,000. Assume that the demand remains constant throughout the year.
The set-up cost per order is ₹10,000 and the inventory holding cost per tool is 10% of its selling price.
What is the optimum no.of batches requiredto meet the annual demand? (You should round up your
answer to avoid a shortfall.)
10
16
24
✕ Incorrect
Feedback:
Think about the formula to calculate the optimum no of batches and try again.
32
✓ Correct
Feedback:
The annual demand (in units) = 20 crores/10,000 = 20,000
Set-up cost per order = ₹10,000
Warehousing cost per unit = 10% × ₹10,000 = ₹1,000
The optimum no of batches can be calculated using the following formula:
√ Inventory holding cost per unit X Annual quantity produced / 2 X Setup cost per batch
This gives: 31.6 batches ≈ 32 batches
Economic Order Quantity

In continuation with the previous question, how many units should the distributor order in a batch?
(You should round up your answer to avoid any shortfall.)
64
80
625
✓ Correct
Feedback:
Since the optimum batch size is 32, EOQ = Annual demand/Optimum batch size.
Hence, the EOQ is 625 units.
431
Ungraded Practice Questions

1. Calculate the DSO, DIO and DPO for the business.
Days inventory outstanding: 2.60 days, days sales outstanding: 94.88 days and days
payable outstanding: 7.09 days
Days inventory outstanding: 94.88 days, days sales outstanding: 2.60 days and days
payable outstanding: 7.09 days
✓ Correct
Feedback:
We can calculate the DIO, DSO and DPO using the following formulas.
• Days inventory outstanding = Inventory/COGS per day = 329562/3473.31 = 94.88 days

• Days sales outstanding = Accounts receivable/Sales per day = 19173/7358.84 = 2.60
days
• Days payable outstanding = Accounts payable/COGS per day = 24646/3473.31 = 7.09
days
Days inventory outstanding: 9.88 days, days sales outstanding: 2.60 days and days payable
outstanding: 7.09 days
Days inventory outstanding: 94.88 days, days sales outstanding: 2.60 days and days payable
outstanding: 70.9 days
✕ Incorrect
Feedback:
Recollect how to calculate days inventory outstanding, days sales outstanding and days payable
outstanding.
2. After looking at the DIO, DSO and DPO, what is your understanding?
Ed-a-Mamma takes almost 95 days to sell the product on the shelf.
✓ Correct
Feedback:
The DIO is 94.88 days, which means that the inventory on the shelf is sold after 95 days after it is
produced.
On average, Ed-a-Mamma has a better inventory management system than the industry.
Ed-a-Mamma takes considerably more duration in comparison to the industry to collect
its receivables.
Ed-a-Mamma should negotiate the credit period with its supplier to manage its working
capital.
✓ Correct
Feedback:
Alia should negotiate a credit period with its supplier to manage its working capital keeping in mind
the industry standard of 10 days, while Alia's company is paying its suppliers after 7 days. So, it must
ask for more credit period and should not pay its supplier faster than the industry standard.
3. Economic Order Quantity

In order to improve the inventory management system, Alia decided to use the optimum batch size
and economic order quantity technique for the upcoming years. Expected annual quantity to be
produced is 45,000, warehousing cost per unit is 100 and setup cost for each batch is 10,000. What is
the optimum batch size for Ed-a-Mamma?
22
20
15
✓ Correct
Feedback:
The optimum batch size for the company can be calculated using the following formula.
√ Warehousing cost per unit X Annual quantity produced / 2XSet−up cost per batch
=√ 100∗45,000 / 2∗10000
=15
12
4. Working Capital Need

If the company starts producing in batch sizes of 15, which of the following changes would hold true?
The DIO would reduce, as batch production will distribute the production optimally, unlike
mass production.
✓ Correct
Feedback:
The number of days to convert inventory into sale would reduce, as batch production will distribute the
production optimally, unlike mass production. This will surely reduce the DIO of 95 days to a great
extent.
The working capital requirement will increase due to increase in the number of batches.
✕ Incorrect
Feedback:
Optimum batch size is a point where the total of warehousing cost and setup cost is minimum for
business. This will reduce the inventory cost. Hence, working capital required will decrease.
Batch optimisation would not have any impact, as the annual quantity produced is
ultimately the same.
Graded Assessments
Days Sales Outstanding

Zeemart sells inventory to customers on the basis of a contract, which states that these customers will
pay for the merchandise within 30 days. A few customers pay for their goods quickly, while others
delay the payment. Zeemart’s year-end account details are as follows:
• Accounts receivable: ₹20,000

• Sales revenue(annual): ₹180,000
What is the days sales outstanding (DSO) for Zeemart? Assume that 1 year has 360 operating days.
Select the closest possible figure
40 days
✓ Correct
Feedback:
You can calculate days sales outstanding (DSO) using the formula: Accounts receivable/sales revenue
per day. Hence, you get: (20,000 × 360)/180,000 = 40 days
30 days
50 days
35 days
Working Capital
Take a look at the following information about the company Qube Limited (all figures in $):
Sales revenue 180,000
COGS 54,000
Accounts receivable 20,000
Accounts payable 18,000

Inventory 12,000
Based on the given information, calculate the working capital/sales ratio.
15.23%
7.78%
✓ Correct
Feedback:
Working capital = Inventory + Accounts receivable - Accounts payable. This gives working capital as:
14,000. Therefore, working capital/sales = 14000/180000= 7.78%
12.90%
9.65%
Economic Order Quantity

A company has an annual demand of 2,55,000 tons of steel. Further, each order that the company
places involves a fixed set-up cost per batch of ₹450, while the inventory-holding cost is about ₹45 per
ton. What should be the optimum batch size?
Choose the closest possible figure. You should round up your answer to avoid a shortfall.
181
125
110
113
✓ Correct
Feedback:
The annual demand (in units) = 2,55,000
Set-up cost per batch = ₹450
Inventory holding cost per unit (ton) = ₹45
The optimum batch size can be calculated using the following formula:
√ Inventory − holding cost per unit * Annual quantity produced / 2×Set−up cost per batch
This gives: 113.

Cash Flow Statement
Financing Activities of a Business
Which of the following events would be classified as a part of the cash flow from financing activities
(CFF) in the cash flow statement of a manufacturing firm?
Cash proceeds from the issue of shares
✓ Correct
Feedback:
The cash proceeds from the issue of shares is a source of finance for a company. Hence, it would be
considered under the heading ‘Cash flow from financing activities’ in the cash flow statement.
Purchase of fixed assets
Payment of wages
Payment to the suppliers of raw material
Categories of Cash Flow Statement

Lamda Ltd reported the following data.
1. Cash flow from operating activity: ₹25 lakh
2. Cash from investing activities: -₹2 lakh
3. Cash flow from financing activity: -₹2 lakh
Based on the numbers reported by the company, which of the following statements about this company
must be true?
During the year, Lamba Ltd did not sell any investments in assets.
The company could not generate enough cash from operations to fund its growth.
The cash inflow from any sale of assets is lower than the cash outflow from the purchase
of assets.
✓ Correct
Feedback:
The cash flow from investing activities is the net of the cash outflow from the purchase of investments
and the cash inflow from the sale of investments. A negative value of ₹2 lakh indicates that the cash
inflow from the sale of assets is lower than the cash outflow from the purchase of assets.
During the year, the company procured new loans and did not make payments to any
fundholders of the company.
Cash Flow Profile
Take a look at the cash flow profile for Amaze Limited.
Based on this profile, which of the following statements is true?
Amaze Limited has self-financed its investments.
The company has no prospects for future growth.
The company’s fundholders did not inject any cash during the current year.
Amaze Limited’s investments are funded partially by its operations and partially by its
fundholders.
✓ Correct
Feedback:
The positive cash flow from operations is insufficient to fully fund the investments of the company.
Hence, we see a positive cash flow from financing activities. This indicates that Amaze Limited’s
investments are funded partially by its operations and partially by its fundholders.
Take a look at the cash flow profile of Amaze Limited.
Based on this profile, did the company generate a positive free cash flow?
Yes
No
✓ Correct
Feedback:
Free cash flow is the amount of cash generated from operations remaining after investment in the
company’s growth. Since the company's cash flow from operations is less than its cash flow from
investment, the cash flow remaining for the fundholders is negative, which means that instead of
rewarding the fundholders, the company has taken additional investment from them.
Depreciation
How is depreciation treated while preparing a cash flow statement?
Depreciation is a non-cash expense; therefore, it should be subtracted from the EBIT while
calculating the cash flow from operating activities.
Depreciation is a non-cash expense; therefore, it should be added to the EBIT while

✓ Correct
Feedback:
Depreciation is a non-cash expense. It was initially treated as an expense while calculating the
operating expenses in the income statement. However, since there is no actual cash outflow on
account of depreciation, it should be added back to the EBIT.
Depreciation is a non-operational expense; therefore, it should be subtracted from the

EBIT while calculating the cash flow from operating activities.
Depreciation is a non-operational expense; therefore, it should be added to the EBIT while

Cash Flow from Operating Activities

Considering that accounts receivable have increased by ₹20,000 and
accounts payable have decreased by ₹15,000 during the year, what will be the effect of these events
collectively on the changes in the current assets and the current liability portion of the cash flow from
operating activities?
Cash inflow of ₹35,000
Cash inflow of ₹5,000
Cash outflow of ₹35,000
✓ Correct
Feedback:
Accounts receivable are current assets. An increase in accounts receivable indicates that more goods
are being sold on credit, and cash will not be realised from these sales. Hence, these sales are treated
as a cash outflow. Also, accounts payable are current liabilities. A decrease in the
accounts payable means that the company has repaid this current liability. It is assumed that a company
will use cash to repay this liability. Thus, a decrease in the accounts payables results in a decrease in the
operating cash.
Cash outflow of ₹5,000
✕ Incorrect
Feedback:
Recall what happens to the cash flow when the current assets increase and the current liability
decreases.
Operating Margin
Based on the financial statements and the key profitability ratios table given in the excel file, which of
the following could be the reason for the operating margin’s decline despite an increase in the
operating revenue?
As IndiGo is a low-cost carrier, the increase in fuel cost impacted the operating margin
negatively.
✓ Correct
Feedback:
The increase in the operating and direct expenses from ₹13,556.37 crore to ₹21,907.24 crore reflects
the increase in expenses such as fuel cost, which reduced the operating profits of the company.
The fall of Jet Airways led to a decline in the demand for airlines.
A decrease in other expenses was the main reason for the reduction in operating margin.
Profitability Analysis
On the basis of the data available, what can be concluded about the profitability of IndiGo over the
years?
Lack of sales has reduced the profitability of IndiGo.
Dividend payments have resulted in a negative operating margin.
An increase in depreciation and finance costs is resulting in reduction of the profit margins
✓ Correct
Feedback:
Since year 0, sales from operations is growing steadily. But higher costs have resulted in poor profits.
Working Capital and Activity Ratios
The following table summarises the Activity Ratios for the company.
Year 0 Year 1 Year 2
DIO 4.86 3.44 4.70
DSO 3.53 4.57 2.61
DPO 26.56 23.73 25.72
Which of the following statements for IndiGo is true?
DPO of 25.7 days indicates that, on average, payment to suppliers is made after 25.7 days
after the sale of seats to passengers.
DIO of 4.7 days indicates that the company holds five days worth of sales revenue as
inventory.
DSO of 2.61 indicates that the company’s accounts receivable of Rs.259.61 crore represent
2.61 days of sales revenue outstanding.
✓ Correct
Feedback:
DSO of 2.61 indicates that the company’s accounts receivable of ₹259.61 crore represent 2.61 days of
sales revenue outstanding.
The company has a positive operating working capital requirement in the current year.
Cash Flow Statement

Based on the cash flow statement information given in the excel sheet, interpret the cash flow profile
of a company.
IndiGo is repaying the debt with the help of cash flows earned from operations.
✓ Correct
Feedback:
Negative cash flows from financing activities in Year 1 and Year 2 show that the company has been
paying off its liabilities. A positive cash flow from operating activities indicates that the company
might be using its cash from operations to repay debt obligations.
Due to obsolete technology, a lot of aircraft have been sold, and so, we see a negative
cash flow in investing activities.
IndiGo has managed to generate cash flows from operating activities.

✓ Correct
Feedback:
A positive cash flow from operating activities indicates that the company might be generating
positive cash from operations.
Negative financing cash flows indicate that the company is taking new debt to invest in
new assets.
Grade Questions
Categories of Cash Flow Statement
Recently, the following activities took place in Qube Limited. Classify these into operating, investing
and financing activities.
Transaction Classification
A. Repayment of bank loan i. Operating activity
B. Decrease in trade payables ii. Investing activity
C. Sale of machinery iii. Financing activity
A-i, B-iii, C-ii
A-ii, B-i, C-iii
A-iii, B-i, C-ii
✓ Correct
Feedback:
Repayment of a loan is classified as a financing activity. This is because loans are paid to the lenders
of the company’s capital. These lenders of capital act as a source of finance for the company.
Any increase or decrease in current liability affects the operating activities of an organisation. Hence,
a decrease in trade payables is classified as the 'cash flow from operating activity'.
The sale of fixed assets would be considered an investing activity. This is because any sale or purchase
of the non-current assets of a company would lead to either a cash inflow or a cash outflow for the
company. Any cash inflow or outflow related to assets is considered under the heading 'cash flow
from investing activity'.
A-ii, B-iii, C-i

Cash Flow Profile
Take a look at the cash flow profile for Happyhearts Limited.
Based on this profile, which of the following statements is true?
Note: Cash flow from operating activities include cash flow from operations and working capital
requirement for the company. (Please also ensure that you can correctly read the cash flow diagram.
Revise the relevant segment if needed.)
Happyhearts Limited has self-financed its investments.
The company has no prospects for future growth.
Happyhearts Limited’s fundholders did not inject any cash during the current year.
The company is experiencing either low sales or an increase in working capital.
✓ Correct
Feedback:
A negative cash flow from operations indicates that it is unable to generate sales revenue and cash or
that its sales are adequate, but the working capital requirements have increased. Both these factors will
impact the cash flow from operations leading to a negative CFO. However, forecasting a positive future,
it has made an investment in fixed assets, which is funded by the fundholders. Hence, we see a positive
cash flow from financing activities.
Cash Flow from Operating Activities

The following activities have taken place in an organization:
1. Activity 1: Decrease in the inventory
2. Activity 2: Decrease in the accounts payables
According to you, what would be the effect of these activities on the cash flow statement?
Activity 1 would result in a cash inflow, whereas Activity 2 would result in a cash outflow.
✓ Correct
Feedback:
A decrease in inventory means less cash is stuck in working capital. Hence it would lead to a cash inflow.
A decrease in the accounts payable means that the company has repaid its supplier and hence it would
result in cash outflow.
Activity 1 would result in a cash outflow, whereas Activity 2 would result in a cash inflow.
Activities 1 and 2 will result in a cash inflow.
Activities 1 and 2 will result in a cash outflow.
Time Value of Money

Assume that investing ₹500 in a fund today will give you a return of ₹530 a year later. On the other
hand, the rate of interest that your bank can give you is 7.5% compounded anually. Will you choose
to invest in the fund?
No
✓ Correct
Feedback:
Money is invested with the motive of earning some return. In this case, the return is fixed in advance
at ₹530. Therefore, the decision to invest money can be based on the present value of the future cash
inflow.
To calculate the present value of ₹530, use the equation PV= FV/ ((1+r)^t).
Here, FV=530, r=7.5%, and t=1. The present value of ₹530 comes out to be ₹493 using the formula,
which means that you receive less than the current amount that you possess. Therefore, you should
not invest in the fund.
Alternatively, you can also calculate the amount of money you will receive after 1 year if you deposit
the money in the bank, and compare that amount to ₹530.
Yes
Time Value of Money
Gaurav has decided to make an investment in a fund. So, he approached four fund managers, A, B, C
and D to know more about the returns that he can get on an investment of ₹50,000. The fund
managers made him the following offers:
Fund manager A: ₹60,000 after one year

Fund manager B: ₹70,000 after two years
Fund manager C: ₹80,000 after three years
Fund manager D: ₹90,000 after four years
Which fund manager should Gaurav pick? You can use the discounting rate of 15% compounded
annually,
Fund manager A
Fund manager B
✓ Correct
Feedback:
An investment is made in order to receive returns. Out of the four investment options, Gaurav should
choose the one that will give him the highest absolute returns. Since the time period of investment is
different for all the four options, you cannot compare the amounts in terms of their future value.
Hence, you need to convert the amounts that are to be received from the different investors into their
present values at an interest rate of 15%. Here, using the following formula: PV= FV/[(1+r)^t]
For the four fund managers, the value of 'r' is constant @15%. The values for FV & t are following
A: FV- 60,000; t=1
B: FV- 70,000; t=2
C: FV- 80,000; t=3
D: FV- 90,000; t=4
Using these will give you the following values:
Fund managers Present Values

A 52173.91
B 52930.06
C 52601.30
D 51457.79
Fund manager B is offering a return of ₹52,930, which is the highest and, hence, must be chosen for
the investment.
Fund manager C
Fund manager D
Compound Rate in the Case of Periodic Compounding
A bank offers you an interest rate of 10% compounded quarterly on your investment of ₹10,000.
What would be amount of money that the bank will owe you after 4 years?
₹14845.06
✓ Correct
Feedback:
The formula to calculate the future value in the case of periodic compounding is as follows:
FV=PV∗(1+(Rn))n∗T , where,
n: The number of compoundings per time period
T: The total time period
Here, since this case involves periodic compounding, the respective values in the formula will be as
follows:
10000∗(1+0.104)16
This will give you the value as 14845.06.
₹21843.60
₹10987.43
₹15532.21
Time Value of Money

Dwet Limited is an Indian FMCG firm. The company has earned huge profits in the current year and
wants to invest some money today with the objective of buying a new plant worth ₹5,00,000 for its
snack food division after five years. You are the manager of the company. How much money should
you invest in a fixed deposit today to have a corpus amount of ₹5,00,000 at the end of the fifth year?
The interest rate of the fixed deposit is 7.5% compounded annually.
₹2,82,791.21
₹3,48,279.32
✓ Correct
Feedback:
In order to find the amount that you should invest today, you need to discount the fixed future value
that you intend to earn after five years @7.5%. The future value is ₹5,00,000, which you want to
receive after five years. So, you need to discount this amount at an interest rate of 7.5% to arrive at
the present value as follows:
PV=FV/ ((1+r)^t) where t=5

Present value = ₹5,00,000/((1 + 7.5%) ^ 5)
This will give you the present value as ₹3,48,279.32. Hence, you should invest ₹3,48,279.32 today to in
order receive ₹5,00,000 at the end of the fifth year.
₹1,46,911.20
₹2,88,569.79
TVM: Annuity
Consider a situation where you want to make an investment of ₹500, and you have two funds to
choose from: Fund A and Fund B. From Fund A, you will get a return of ₹525 after one month. From
Fund B, you will get a return of ₹120 per month in five monthly installments. Consider the monthly
interest rate to be 2%. Based on the present value of the two future inflows, in which of the two funds
should you invest the money?
Fund A
Fund B
✓ Correct
Feedback:
You should invest in Fund B.
Fund A will give you a return of ₹525 after a month, of which the present value will be ₹514.70,
whereas Fund B will give you a return of ₹120 in each of the five installments. The present value for
this will be ₹565.61.
Since the present value of the cash flows from Fund B is more than that from Fund A, you should
choose to invest the money in Fund B.
Present Value of an Annuity

Manvi has won a lottery in a city fair and is given the following two options in which she can receive
the prize money:
• Option1: Six equal installments of ₹12,000 per annum for six years, or
• Option 2: Three equal installments of ₹20,000 per annum for three years.
She will receive all the installments at the end of each year. Manvi’s friend suggested she choose Type
1, as she will receive a total of ₹72,000 rather than Type 2, where she will receive ₹60,000.
Identify the option that will yield the maximum present value, given that the interest rate per annum
is 15%, and calculate the total amount.
Six-year plan: ₹45,413.79
Three-year plan: ₹52,216
Six-year plan: ₹52,216
Three-year plan: ₹45,664.50

✓ Correct
Feedback:
Calculating the PV of both the options will help you compare the two amounts. Considering the
discount rate of 15%, the present value of the total amount of installments for Type 1 and Type 2 are
₹45,413.79 and ₹45,664.50, respectively. The workings for the same is given below.
Cash Flows Type 1 (Amount in ₹) Type 2 (Amount in ₹)

Year 1 12,000 20,000
Year 2 12,000 20,000
Year 3 12,000 20,000
Year 4 12,000 -
Year 5 12,000 -
Year 6 12,000 -
Total PV of Cash 45,413.79 45,664.50
Since the type 2 plan has a higher present value of ₹45,664.50, Manvi should opt for option D to
maximise the value.
Application of PV in Annuities
Suppose you own a building. You can sell it today at ₹14,00,000 or rent it out for 10 years at a yearly
rent of ₹2,00,000. Assume that the rent is payable annually, starting from the end of Year 1.
Considering an interest rate of 10%, which of the following options will you choose?
Rent out the building
✕ Incorrect
Feedback:
Compare the present values of the amounts that are to be received in both the options to make a
decision.
Sell the building
✓ Correct
Feedback:
Calculate the PV of the yearly rent for 10 years using the PV function in Excel as follows:
=PV(10%,10,200000).
This will give you a value of -₹1,228,913.42.
This means renting out the building is equivalent to selling it for ₹12,28,913 today. Whereas by
actually selling the building you will get an amount of ₹14,00,000. Hence, you should sell the building
today instead of renting it out for 10 years.
Indifferent between the options

Present Value in the Case of Annuity
Aayan has opted for an insurance cover for his newly purchased car. He needs to pay an insurance
premium of ₹30,000 yearly for five years at the end of each year. Calculate the present value of this
annuity payment, given that the discount rate is 8%.
₹1,19,781.30
✓ Correct
Feedback:
In Excel, the present value of an annuity can be calculated using the PV function. Here, it can be
calculated as follows:
= PV(8%,5,-30000).
This will give you the present value as ₹1,19,781.30. Hence, according to the Excel convention, Aayan
must have borrowed an amount of ₹1,19,781.30 at an interest rate of 8% today, for which he had to
pay ₹30,000 yearly for five years.
₹1,21,781.30
₹1,44,781.30
₹1,15,781.30
Time Value of Money

You decide to put your money into an investment plan that offers an interest rate of 7.5%
compounded annually. The plan requires you to invest a fixed amount at the end of every year,
beginning with Year 1. At the end of 10 years, you want to receive ₹40 lakhs.
Calculate the amount of money you need to put in each year so that you have a corpus amount of
₹40 lakh at the end of the tenth year.
282743.71.
✓ Correct
Feedback:
In order to find the amount that needs to be invested each year for 10 years to get a future value of
₹40 lakh at the end of the tenth year, you need to use the annuity formula, which is as follows:
Future value[(1+R)T−1]/R
The amount is compounded yearly at an interest rate of 7.5% for 10 years. Substituting the values in
the equation given above will give you the following values:
4000000/ [{(1.075) ^ 10} - 1] /7.5% = 282743.71.
145987.79
252809.45
105432.98
Calculation of Future Value to Estimate Returns

Delta Limited is an indian IT services firm. Recently, the company received an offer for a new project.
The net cash flows expected to be realised from Year 1 to Year 4 are as follows:
Year 1 234
Cash flows (in ₹ lakh) 20 7 6 4
Calculate the future value of the cash flows at the end of Year 4. Please write the answer in lakhs, i.e.
if the answer is ₹1200000, enter '12'. Consider the compound rate to be 10%.
₹42.11 lakh
₹51.92 lakh
₹34.87 lakh
₹45.69 lakh
✓ Correct
Feedback:
FV = FV of the cash flow of Year 1 + FV of the cash flow of Year 2 + FV of the cash flow of Year 3 + FV
of the cash flow of Year 4
FV of the cash flow of Year 1 = FV∗(1+0.10)3
Cash Flow CVF FV

20 1.331 26.62
7 1.21 8.47
6 1.1 6.6
4 1 4
Total FV 45.69
Hence, the future value of cash flows at the end of Year 4 is ₹45.69 lakh.
Calculation of the Present Value of Expected Unequal Cash Inflows
Sunrise Limited is an Indian real estate firm operating majorly in South India. The firm had
constructed a residential building 25 years ago in Cochin, Kerala. It wants to sell the building in about
three years from today and, hence, wants to calculate the present value of this property.
For the next three years, the company will continue to receive the rent for the building but at a
depreciating rate, after which it will sell it for ₹20 lakh at the end of 3rd year. Assuming the discount
rate to be 15%, calculate the present value of the investment. The details of cash inflows are given
below. Assume that all rents are collected at the end of the year.
Year 1 Year 2 Year Year 3

(rent) (rent) 3 (rent) (sale)
Cash Inflows (Amount
1,20,000 1,00,000 80,000 20,00,000
in ₹)
₹1,217,925.61
₹2,008,511.23
₹1,547,595.96
✓ Correct
Feedback:
The present value of uneven cash flows can be calculated using the NPV formula.
Since the building is expected to be sold at the end of the third year, the cash inflow will be added to
the rental amount that is expected to be received for that particular year. The total amount would be
discounted for 3 years to arrive at their present value.
Use the NPV formula as follows:
=NPV(15%, 120000,100000,2080000)
This will give the value as ₹1,547,595.96.
The calculated values are arrived as follows:
Year Cash Flow (Amount in ₹)

1 1,20,000
2 1,00,000
3 2,080,000
Total PV 1,547,595.96
₹1,324,638.92
Calculation of the Present Value of Expected Unequal Cash Inflows
Pharmacity Limited is an Indian pharmaceutical company. It wants to purchase equipment with a
useful life of five years for manufacturing its highest selling drug ‘X’. Purchasing the equipment will
lead to significant cost savings for the company.
Now, the company wants to estimate the maximum amount that it can pay for the equipment today
based on the expected cost savings from the equipment. The discount rate is 12.5%.
Details of expected cost savings are given below.
Year 1 Year 2 Year 3 Year 4 Year 5

Cost Savings (Amount in ₹) 75,000 45,000 80,000 55,000 20,000
₹1,26,743.652
₹2,03,843.587
✓ Correct
Feedback:
The maximum amount that the company needs to pay for the equipment today depends upon the
present value of the cash flow expected from the equipment. You can arrive at the total present value
of uneven cash flows either by calculating the sum of the PV of cash flows for each year individually
or by applying the NPV function in Excel.
Use the NPV formula in Excel as follows:

=NPV(12.5%,75000,45000,80000,55000,20000).
This will give you the value as 2,03,843.587.
You can also use another method to calculate this.

For this, you need to calculate the present value of cash flows for each year at a discount rate of
12.5%. You can use the following formula:
1/ (1 + r) ^ time, where,
r: The rate of interest, and
t: The time period.
Next, by multiplying the cash flow with the PVF, you will arrive at the PV of the cash flows for each
year. Finally, by taking the sum of the individual PVs for each year, you will arrive at the total PV. For a
detailed calculation, refer to the table given below.
Cash Inflow (a) (Amount in PV (a * b) (Amount in

Years PVF (b)
₹) ₹)
1 75,000 0.8888888889 66,666.66667
2 45,000 0.790123456 35,555.55556
3 80,000 0.7023319616 56,186.55693
4 55,000 0.624295077 34,336.2292
5 20,000 0.5549289573 11,098.5791
Total
2,03,843.587
PV
₹2,18,965.65
₹2,09,059.31
Application of PV in Annuities
Suppose you are given an option to invest money in two annuity schemes: Scheme A and Scheme B.
In Scheme A, you would need to make an initial investment of ₹1.2 lakh, and you would receive an
annual cash inflow of ₹35,000 for the next four years. In Scheme B, you would need to make the same
initial investment but would receive an annual cash inflow of ₹30,000 for the next five years.
Which of the following options would you choose, given that the discount rate is 10%?
Scheme A
✕ Incorrect
Feedback:
Compare the present values of cash inflows for both the schemes with their initial investment.
Scheme B
Neither
✓ Correct
Feedback:
The PV of cash inflow in Scheme A is ₹1,10,945.29, whereas in Scheme B, it is ₹1,13,723.60.
This means that in order to earn ₹35,000 yearly for the next four years, you should invest an amount
equal to or less than ₹1,10,945.29 today. Similarly, in order to earn ₹30,000 yearly for the next five
years, you should invest an amount equal to or less than ₹1,13,723.60 today.
Since the amount of investment ₹1,20,000 > the present value of both Scheme A and Scheme B,
neither schemes are worth investing in.
Both
Time Value of Money
Manvi has invested ₹3,48,279 in a fixed deposit at an interest rate of 7.5% per annum in order to
receive ₹5,00,000 after 5 years. Now, the bank has increased the interest rate to 9% per annum after
two years, which would be applicable to the current fixed deposits as well. At the end of the fifth year,
Manvi will receive an amount X. How much additional money will she receive over and above
₹5,00,000?
₹21,223.17
✓ Correct
Feedback:
The amount ₹3,48,279 increases at an interest of 7.5% for two years . Hence, the value of the amount
at the end of the second year will be (using the future value equation):
348279 * (1.075) ^ 2= ₹4,02,480.
Hence the value of initial amount at the end of year two is ₹4,02,480.
When the interest rate changes to 9% after two years, ₹4,02,480 will be further compounded at 9%
for the next three years. Hence, the amount at the end of fifth year will be (using the future value
equation) :
402480 * (1.09) ^ 3= ₹5,21,223.17
So, Manvi will now receive ₹5,21,224 at the end of fifth year as opposed to the expected ₹5,00,000,
i.e., she will receive (₹5,21,224- ₹5,00,000)= ₹21,223.17 additional money over the expected amount
of ₹5,00,000
₹26,879.09
₹19,876.32
₹29,541.88
Calculating the Present Value of Expected Unequal Cash Inflows
An FMCG company wants to launch a new product in the potato chips category in India. The
management of the company can set up a manufacturing plant and distribution centres in a new
zone, which can be run efficiently for seven years.
However, this would require a huge investment. So, the company wants to calculate the present value
of the expected cash flows from the new plant in order to decide the maximum amount that they can
spend on setting up the plant. The expected cash inflows for the plant are given below.
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

2,16,250 2,71,925 3,37,855 4,15,731 5,07,510 6,15,453 7,42,179
Calculate the present value of these cash inflows, given that the discount rate is 7.5%.
₹22,76,987
₹26,87,981
₹22,19,380
✓ Correct
Feedback:
You can arrive at the total present value of uneven cash flows either by calculating the sum of the PV
of cash flow for each year individually or by applying the NPV function in Excel.
Use the NPV function as follows:

NPV(7.5%, 216,250, 271,925, 337,855, 415,731, 507,510, 615,453, 742,179).
This will give you the amount as ₹2,219,380.27.
You can also use another method to calculate this.
For this, you need to calculate the present value factor for each year at a discount rate of 7.5%. You
can calculate this using the following formula:
1(1+r)time, where,
r: The rate of interest, and

t: The time period.
Next, by multiplying the cash flow with the PVF, you will arrive at the PV for each year. Finally, by
taking the sum of the individual PVs for each year, you will arrive at the total PV. For a detailed
calculation, refer to the table given below.
Years Cash inflow (Amount in ₹) PVF PV(Amount in ₹)

Year 1 2,16,250 0.930 2,01,163
Year 2 2,71,925 0.865 2,35,306
Year 3 3,37,855 0.805 2,71,960
Year 4 4,15,731 0.749 3,11,300
Year 5 5,07,510 0.697 3,53,510
Year 6 6,15,453 0.648 3,98,790
Year 7 7,42,179 0.603 4,47,352
Total PV 22,19,380
Therefore, the company must not spend more than ₹22,19,380 on setting up the new plant;
Otherwise, it will run into losses.
₹19,82,810
Graded Questions
Future Value in Case of a Withdrawal
Rahul deposits ₹10,000 in a bank, which offers him an interest of 10% compounded annually. He
decides to withdraw ₹5,000 after a year. What would be his account balance at the end of the second
year?
₹4,400
₹6,600
✓ Correct
Feedback:
At the end of first year, the amount of ₹10,000 deposited by Rahul would increase to ₹11,000 as per
the 10% interest rate offered by the bank on the deposited amount. Since he wants to withdraw
₹5,000 after one year, he will have ₹6,000 as the balance amount in his account. This amount of
₹6,000 would earn him interest at a rate of 10% for one year and increase to ₹6,600 at the end of
second year.
₹6,400
₹4,600
Future Value of Uneven Cash Flow
Frez Limited is a Indian soft beverage-manufacturing start-up.
Recently, the government increased the interest rate on fixed deposits offered by banks. So, the
company wants to invest a certain portion of its profits at the end of each year for five years in a fixed
deposit with the State Bank of India.
The bank offers an interest rate of 10% compunded annually. The firm wants to invest the money as
shown in the table given below.
Year 1 Year 2 Year 3 Year 4 Year 5

Investment in fixed deposit (Amount in ₹) 2,00,000 2,10,000 2,20,000 2,30,000 2,40,000
Calculate the future value of the investment at the end of the fifth year.
₹14,31,530
₹12,31,530
₹15,31,530
₹13,31,530
✓ Correct
Feedback:
In order to calculate the future value of uneven cash flows, you need to find the compound value
factor for each year at a discount rate of 10%. The formula to calculate the compound value factor is
as follows:
(1 + r) ^ time, where
r = The rate of interest
t = Time period
Next, by multiplying the cash flow with the CVF, you will arrive at the FV for each year. Finally, by
taking the sum of the individual FVs for each year, you will arrive at the total FV. For a detailed
calculation, refer to the table given below.
Cash Flow (Amount FV (Amount in

Year CVF
in ₹) ₹)
1 2,00,000 1.4641 2,92,820
2 2,10,000 1.331 2,79,510
3 2,20,000 1.21 2,66,200
4 2,30,000 1.1 2,53,000
5 2,40,000 1 2,40,000
Total Future Value (Amount
13,31,530
in ₹)
Hence, the investment amount would be equal to ₹13,31,530 at the end of the fifth year.
Time Value of Money
Suppose you want to buy machinery for your new factory in Assam. So, you decide to put your
money into an investment plan that offers an interest rate of 5% compounded annually. The plan
requires you to invest a fixed amount yearly. After 10 years, you want to receive ₹60 lakh. How much
money should you invest yearly to receive ₹60 lakh at the end of the tenth year? Assume that the first
investment is at the end of year 1.
₹4,77,027.45
✓ Correct
Feedback:
In order to calculate the amount that you would need to invest each year for 10 years to get a future
value of ₹60 lakh at the end of the tenth year, you need to use the annuity formula, which is as
follows:
Future value/(1+rate)time−1rate
The amount is compounded yearly at an interest rate of 5% for 10 years. By substituting these values
in the equation given above, you will get the following values:
6000000/[{(1.05 ^ 10) - 1}/0.05]
This will give you the amount as ₹4,77,027.45.
₹4,57,627.45
₹4,27,627.45
₹4,87,757.45
WACC Calculation
Real estate firms launch projects. To fund their projects, they either take loans or raise money from
customers in the form of advances. Willing buyers pay 20-40% of the cost of flats in advance to
confirm their bookings. Apart from this, developers also invest their own money, which forms a part
of equity capital.
Suppose a real estate firm, Sun Realty, launches two projects, one in Mumbai and one in Pune.
• Mumbai project details: The total estimated project cost is ₹100 crore. Of this, ₹20 crore is
invested by the developer, ₹20 crore is raised through customer advances which is a short-
term liability, and the remaining ₹60 crore is raised through debt.
• Pune project details: The total estimated cost is ₹50 crore. Of this, the developer’s share is ₹25
crore, money raised through customer advances is ₹10 crore and debt is ₹15 crore.
• Cost of debt is 7% and cost of equity is 17%. Ignore tax.
Calculate the cost of capital for the Mumbai project.
8.75%
9.50%
✓ Correct
Feedback:
To answer this question, you need to prepare the balance sheet for the Mumbai project, along with
the company balance sheet. This will give you a sense of the capital structure, using which you can
calculate their respective cost of capital.
Mumbai project:
Asset Amount (cr) Liability and Equity Amount (cr)

Cash raised 100 Current liability 20
Long-term loan @7% 60
Equity capital @17% 20
Total 100 Total 100
WACC = (Weight of debt x cost of debt) + (Weight of equity x cost of equity), we get,
= 0.75*7+0.25*17
= 9.50%.
Here, 0.75 = 60/80 and 0.25 = 20/80.

Notably, here you do not take into account customer’s advances as long-term loans. They are current
liabilities and, therefore, part of the working capital. Hence, the total capital is only ₹80 crore.
12%
6.50%
WACC Calculation
of equity capital.
Calculate the cost of capital for the Pune project.
12.3%
11.55%
13.25%
✓ Correct
Feedback:
To answer this question, you need to prepare the balance sheet for the Pune project, along with the
company balance sheet. This will give you a sense of the capital structure, using which you can
calculate their respective cost of capital.
Pune project:

Total 50 Total 50
WACC = (Weight of debt x cost of debt) + (Weight of equity x cost of equity)
= 0.375*7+0.625*17
= 13.25%.
9.75%
✕ Incorrect
Feedback:
Refer to the formula for calculating WACC, weight of debt and weight of equity.Current liability is not
a part of WACC.
WACC Calculation
of equity capital.
Calculate the WACC for Sun Realty
10.75%
✓ Correct
Feedback:
Weighted average of both the projects will give you the cost of capital of Sun Realty Limited.

Total 150 Total 150
Hence, =7*0.625+17*0.375 = 10.75%
Here, the cost of debt is 7%, cost of equity is 17%, weight of debt is 75/120 = 0.625, and weight of
equity is 45/120=0.375.
12%
8.55%
13.96%
Difference Between Cost of Capital, Cost of Debt and Cost of Equity
Suppose you are the manager of an FMCG company AP Limited. You need to evaluate the feasibility
of project A. The details necessary for carrying out the evaluation are provided below:
Cash flow to be generated by the project each year for 15 years: ₹12 lakh
Equity raised for the project: ₹1 crore
Debt taken: ₹30 lakh
Cost of debt: 8%
Cost of equity: 14.7%
Cash flow after repaying the debt available for equity: ₹10 lakh
Calculate the WACC for AP limited.
8%
13.15%
✓ Correct
Feedback:
WACC can be calculated using the formula: Wd∗kd+We∗ke.
Putting the values, WACC =0.231*8+0.77*14.7
= 13.15%.
WACC of the firm is 13.15%.
14.7%
Difference Between Cost of Debt and Cost of Equity

Which of the following statements regarding the debt and equity holders are true? (Note: There may
be multiple correct answers)
Debt providers get a fixed rate of return in the form of interest and, hence, assume less
risk as compared to equity capital providers.
✓ Correct
Feedback:
Debt providers get a fixed rate of return in the form of interest payments, so irrespective of the level
of profit/loss of the company, the company has to make the fixed interest payments to the debt
providers. Hence, they assume less risk as compared to equity capital providers.
Equity shareholders get the residual amount left after the debt providers are paid and,
hence, assume a higher risk.
✓ Correct
Feedback:
Equity holders get their share of returns from the company’s profit, after the interest is paid to the
debt-providers and all external obligations are met. If the company runs into losses, then there is no
return for the equity shareholders. Hence, they assume a higher risk than debt providers.
Debt and equity capital providers always assume equal risk.

Equity shareholders are the owners of equity, i.e., the owners of the company; hence, the
cost of equity must be less than the cost of debt.
WACC Calculation
Suppose you are the finance manager of a mobile phone manufacturing company Quest Limited. For
an upcoming project, the details available indicate that the project cost and the company’s cost of
capital will be the same. Equity investors want a return of 11.10% and the cost of debt is 5.5%. The
debt:equity ratio is 3:5. Calculate the company’s cost of capital.
9%
✓ Correct
Feedback:
Calculate WACC using the formula: Wd∗kd+We∗ke
Here, Wd = debt/total capital, i.e., 3/8 = 0.375.
We = equity/total capital, i.e., 5/8 = 0.625.
The cost of equity (ke) is given as 11.10 and after-tax cost of debt (kd) is given as 5.5%.
Hence, applying the formula of WACC, we get 0.625*11.10+0.375*5.5 = 9%
6.7%
9.87%
✕ Incorrect
Feedback:
Refer to the formula for calculating WACC, weight of debt and weight of equity
11.25%
WACC Calculation
Wellness Limited is a chain of diagnostic centres based out of North India. They want to expand their
operations in South India and want to open their diagnostic centres at five locations. For this purpose,
they are looking to buy five plots worth a total of ₹25 crore. This entire amount is taken in the form of
debt from outsiders. The breakup of the amount is as follows:
• Bank loan of ₹10 crore @ 12% interest

• ₹5 crore as debt from Zeta Financial Company @ 8% interest rate
• ₹2 crore from an ex-partner in the company @ 10% interest rate
• ₹8 crore by issuing bonds @ 5% interest rate
Calculate the cost of debt for the company.
7.54%
9.76%
8.80%
✓ Correct
Feedback:
Total interest is ₹1.2 crore (12% of ₹10 crore) + 40 lakh (8% of ₹5 crore) +₹20 lakh (10% of ₹2 crore)
+ ₹40 lakh (5% of ₹8 crore) = ₹2.2 crore.
Total loan = ₹25 crore.
Hence, effective interest rate = 2.2/25 = 8.80%.
12.75%
NPV Technique of Project Evaluation

company’s management has identified two options:
• Project 1: They can set up a manufacturing plant which can be run effectively for seven years.
• Project 2: The management has identified several small local vendors who can be used for
production as well as distribution. The company can sign a seven-year contract with them.
The cost of capital for both the projects is 7.5%. The cash flows for both the projects are given below
(in ₹):
Project 1:
Year 0 (initial investment) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Cash flows -2,000,000 2,16,250 2,71,925 3,37,855 4,15,731 5,07,510 6,15,453 7,42,179
Project 2:
Cash flows -2,000,000 1,70,000 2,14,625 2,67,856 3,31,176 4,06,308 3,37,314 5,60,811
Calculate the NPV of Project 1.
₹2,03,261.98
₹2,16,908.54
₹2,19,380.27
✓ Correct
Feedback:
The NPV of the project can be calculated using the formula:
Initial investment - Present value of cash inflows.
By using the NPV function in excel:
=NPV(7.5%, 216250, 271925, 337855, 415731, 507510, 615453, 742179) - 2000000
you will get ₹219,380.27.
₹1,98,743.42
NPV
company’s management has identified two options:
• Project 1: They can set up a manufacturing plant which can be run effectively for seven years.
• Project 2: The management has identified several small local vendors who can be used for
production as well as distribution. The company can sign a seven-year contract with them.
The cost of capital for both the projects is 7.5%. The cash flows for both the projects are given below
(in ₹):
Project 1:
Cash flows -2,000,000 2,16,250 2,71,925 3,37,855 4,15,731 5,07,510 6,15,453 7,42,179
Project 2:
Cash flows -2,000,000 1,70,000 2,14,625 2,67,856 3,31,176 4,06,308 3,37,314 5,60,811
Which of the following is the NPV of Project 2.
-₹3,52,924.76
✓ Correct
Feedback:
The NPV of the project can be calculated using the formula:
Initial investment- Present value of cash inflows.
By using the NPV function in excel : =NPV(7.5% , 170000, 214625, 267856, 331176, 406308, 337314,
560811) -2,000,000,
we will get -₹352,924.76
-₹5,42,915.13
-₹7,89,542.11
₹2,89,765.55
Choice Between the Projects based on NPV Technique of Project Evaluation

Considering the NPV, suggest which project the company should choose?
Project 1
✓ Correct
Feedback:
A company should choose a project only when the NPV for that project is positive. After converting
all the cash flows to present value, the NPV of Project 1 is ₹219,380.27 and that of Project 2 is -
₹352,924.76. Therefore, the company should choose Project 1, as its NPV is positive.
Project 2
The smartphone-manufacturing company ZEA Mobile Limited wants to increase their sales. The
company has hired a consultant for conducting market research and identifying ways to increase the
sales. The consultant suggested the following options:
• Option 1: Launch a brand awareness campaign in all the zones, including ads in television /
newspaper / social media, tie-ups with social media influencers, etc. to recreate the brand
image through brand ambassadors.
• Option 2: Launch a sales campaign in the top four metro cities by aggressively targeting
customers through discounts and newspaper ads.
ZEA has to select a campaign by considering the impact on sales and the initial cost associated with
the campaigns.
Both campaigns will have different impacts on the sales. The monthly cash flows are shared below.
Monthly interest rate is 2.5%.
Month 0 Month 1 Month 2 Month 3 Month 4 Month 5

Option 1: Brand Campaign -2,00,00,000 42,50,000 48,02,500 54,16,625 60,98,856 68,56,339
Option 2: Sales Campaign -20,00,000 8,50,000 9,45,200 10,50,736 - -
Calculate the NPV of option 1.
₹53,90,987.87
₹53,32,572.03
✓ Correct
Feedback:
Since the cash flows occur at the end of each month, NPV of the project can be calculated using the
formula: =NPV(RATE, Range of values)- initial investment.
By using the NPV function in excel: =NPV(2.5%, 4250000, 4802500, 5416625, 6098856, 6856339)-
20,000,000, you will get ₹5,332,572.03.
₹49,87,541.77
₹48,92,731.65

The smartphone-manufacturing company ZEA Mobile Limited wants to increase their sales. The
company has hired a consultant for conducting market research and identifying ways to increase the
sales. The consultant suggested the following options:
• Option 1: Launch a brand awareness campaign in all the zones, including ads in television /
newspaper / social media, tie-ups with social media influencers, etc. to recreate the brand
image through brand ambassadors.
• Option 2: Launch a sales campaign in the top four metro cities by aggressively targeting
customers through discounts and newspaper ads.
ZEA has to select a campaign by considering the impact on sales and the initial cost associated with
the campaigns.
Both campaigns will have different impacts on the sales. The monthly cash flows are shared below.
Monthly interest rate is 2.5%.
Month 0 Month 1 Month 2 Month 3 Month 4 Month 5

Option 1: Brand Campaign -2,00,00,000 42,50,000 48,02,500 54,16,625 60,98,856 68,56,339
Option 2: Sales Campaign -20,00,000 8,50,000 9,45,200 10,50,736 - -
Calculate the NPV of option 2.
₹5,98,345.76
₹7,04,636.09
✓ Correct
Feedback:
The NPV of the project can be calculated using the formula: =NPV(RATE, Range of values)-initial
investment.
By using the NPV function in excel: =NPV(2.5% , 850000, 945200, 1050736)-2000000, you will get
₹7,04,636.09
₹8,91,567.13
₹8,12,678.25
Choice Between Projects based on NPV Technique of Project Evaluation

As a marketing manager, based on the NPV of the two options, which of the two options will you
choose?
Option 1
✓ Correct
Feedback:
A company should choose a project with a positive NPV. After converting all the cash flows to present
value, the NPV of Option 1 is ₹53,32,572.32 and that of Option 2 is ₹7,04,636.09. The company should
choose Option 1, as its NPV is positive and higher.
Option 2
✕ Incorrect
Feedback:
Compare the NPV of both the projects to make a decision.
Profitability Index
A company is looking for an opportunity to invest ₹1,500 crore, for which it has identified five
independent projects. The cash flows and the initial investment requirement of these five projects are
as follows (in ₹ crore):
Project 1 Project 2 Project 3 Project 4 Project 5

Year 0 (Initial investment) -1,200 -1,500 -700 -700 -300
Year 1 500 400 200 300 100
Year 2 500 500 250 300 100
Year 3 500 600 300 300 100
Year 4 500 700 350 300 100
Consider the rate of interest as 7.5%.Calculate the profitability index for Project 1.
1.21
1.40
✓ Correct
Feedback:
Profitability index of a project can be calculated using the formula
PV of future cash inflows/ Initial investment.
Here, PV of future inflows can be calculated using the NPV function. Therefore, @7.5%, entering the
inputs of NPV function as:
=NPV(7.5%, 500, 500, 500, 500), you will get ₹1,674.66.
Then, Profitability Index is = 1,674.66/1200 = 1.40.
1.35
1.98
Profitability Index

Year 1 500 400 200 300 100
Year 2 500 500 250 300 100
Year 3 500 600 300 300 100
Year 4 500 700 350 300 100
Consider the rate of interest as 7.5%.
Of the five projects mentioned above, which project has the highest Profitability Index value?
Project 1
Project 3
Project 4
✓ Correct
Feedback:
Profitability index of a project can be calculated using the formula
PV of future cash inflows/ Initial investment.
Here, PV of future inflows can be calculated using the NPV function. Therefore, @7.5%, entering the
inputs of NPV function as: NPV(7.5%, 300, 300, 300, 300), you will get ₹1,004.80.
Then, the Profitability Index is 1,004.80/700 = 1.44.
Similarly, applying the same formula for the other projects, the Profitability index for other projects
can be derived as follows:

Profitability Index 1.40 1.21 1.29 1.44 1.12
Therefore, you can clearly see that Project 4 has the highest profitability index of 1.44.
Project 2
Project 5
Application of NPV
Project A has an initial investment of ₹10 lakh, while Project B has an initial investment of ₹20 lakh.
Projects A and B are expected to be completed in four years. The cash flows expected for Projects A
and B are as follows:
Year 1 2 3 4
Cash Flow of Project A (in ₹ lakh) 1 4 6 5
Cash Flow of Project B (in ₹ lakh) 2 8 12 6
Assuming WACC at 10%, calculate the profitability indexes for both the projects.
Project A: 1.21; Project B: 1.4
✓ Correct
Feedback:
Profitability Index = PV of future cash inflows / initial investment.
Here, PV of future cash inflows can be calculated using the NPV function. Therefore, @10%, for
Project A, entering the inputs of NPV function as =NPV(10%,1, 4,6,5), you will get 12.14. Then, PI will
be 12.14/10 = 1.21.
Similarly, for Project B, PI will be 21.54/20 = 1.08.
Application of NPV
If a business decides to take up two projects of the same duration but with different NPVs and
profitability indexes, which of the following statements would be correct?
Statement 1: The overall PI is the sum of the PIs of the two projects.
Statement 2: The overall NPV is the sum of the NPVs of the two projects
Only statement 1 is true.
Only statement 2 is true.
✓ Correct
Feedback:
NPV signifies the value a project adds to your company. The NPVs of the two projects can be added
to get the overall NPV of the two projects combined. However, PI is a ratio so it cannot be added up!
Both the statements are true.
✕ Incorrect
Feedback:
Check the addition property for ratios and general numbers.
None of the statements is true.
NPV of a Project
Edubuzz, a professional upskilling company, provides customised professional courses for
organisations.
The development of these customised courses requires an investment of ₹20 lakh. One of its projects
is a soft skills development programme designed for a B2B client. Edubuzz would receive a payment
of ₹20,000 for every employee who enrols for the course. It is a 5-year-contract.
Given that the B2B client has mandated every new hire to enrol for the programme, what is the NPV
for Edubuzz in this project? Assume the number of new hires for the B2B client would be 30 per year
for the next 5 years. Edubuzz has a WACC of 8%. All the cash inflows occur at the end of the period.
₹3,32,850.54
₹3,95,626.02
✓ Correct
Feedback:
NPV of this project can be calculated using the NPV function of excel. Putting the inputs, 8% as
discount rate and cash flow for five years at ₹6,00,000 each year in the NPV function,
the function would be = NPV(8%,600000,600000,600000,600000,600000).
NPV can be then calculated by subtracting the initial investment of ₹20 lakh from this as ₹3,95,626.02.
₹3,09,481.67
₹3,51,890.41

An FMCG company wants to introduce a variety of fizzy drinks, but to produce these drinks, the
company will have to expand its current production capacity. It has identified three types of machines
available in the market, whose costs vary according to their production capacity and maintenance. For
these three machines, the finance team has evaluated the following cash flows (in ₹):
Small Machine Mid-sized Machine Large Machine

Year 0 -1,00,000 -7,50,000 -15,00,000
Year 1 40,000 2,50,000 4,00,000
Year 2 40,000 2,50,000 4,00,000
Year 3 40,000 2,50,000 4,00,000
Year 4 40,000 2,50,000 4,00,000
Year 5 40,000 2,50,000 4,00,000
The company can choose only one of the three available machines. According to you, based on the
NPV technique of project evaluation, which machine should the company purchase? Consider an
interest rate of 7.5%
Large machine
✕ Incorrect
Feedback:
Calculate the NPV of the three machines and compare the values to get the result.
Mid-sized machine
✓ Correct
Feedback:
You need to apply the formulas for NPV : =NPV(rate, range of values)+initial investment. You will get
the following values:

NPV ₹ 61,835 ₹ 2,61,471 ₹ 1,18,354
The NPV of the mid-sized machine is the highest. Hence, the company must select the mid-sized
machine.
Small machine
IRR Technique of Project Evaluation

An FMCG company wants to introduce a variety of fizzy drinks, but to produce these drinks, the
company will have to expand its current production capacity. It has identified three types of machines
available in the market, whose costs vary according to their production capacity and maintenance. For
these three machines, the finance team has evaluated the following cash flows (in ₹):

Year 0 -1,00,000 -7,50,000 -15,00,000
Year 1 40,000 2,50,000 4,00,000
Year 2 40,000 2,50,000 4,00,000
Year 3 40,000 2,50,000 4,00,000
Year 4 40,000 2,50,000 4,00,000
Year 5 40,000 2,50,000 4,00,000
The company can choose only one of the three available machines. According to you, based on the
IRR technique of project evaluation, which machine should the company purchase? Consider an
interest rate of 7.5%
Mid-sized machine
Small machine
✓ Correct
Feedback:
You need to apply the formula for calculating the IRR: =IRR(Range of values). You will get the
following values:

NPV ₹ 61,835 ₹ 2,61,471 ₹ 1,18,354
IRR 29% 20% 10%
Since the IRR of the small machine is higher than the IRR of the mid-sized and the large machine, the
small size machine should be selected.
Large machine
✕ Incorrect
Feedback:
Calculate the IRR of the three machines and compare the values to get the result.
Payback
Consider two projects: Project A and Project B. Project A requires an initial investment of ₹50 lakh and
Project B requires an initial investment of ₹30 lakh. The expected cash flows for the two projects are
as below (in ₹):
Year 1 2 3 4
Cash flow for Project A 10 40 15 15
Cash flow for Project B 10 10 15 20
Using the payback period method here, which project would you select?
Project A
✓ Correct
Feedback:
Payback period calculates the time taken by the project to cover up the initial investment made in the
project. In case of Project A, the initial investment of ₹50 lakh will get covered in two years as the cash
flows for the first two years are ₹10 lakh and ₹40 lakh, respectively. In case of Project B, the initial
investment of ₹30 lakh will get covered in 2.67 years: 2+{10/15}, as the cash flows for the first two
years are ₹10 lakh and ₹10 lakh, respectively, and for the third year, the cash flow is ₹15 lakh, of which
only ₹10 lakh is required. Hence, you choose the payback period in which you get the fastest returns
and since 2<2.67 years, you should choose Project A.
Project B
IRR

Year 1 500 400 200 300 100
Year 2 500 500 250 300 100
Year 3 500 600 300 300 100
Year 4 500 700 350 300 100
Consider the rate of interest as 7.5%.
Which of the following projects has the highest IRR ?
Project 2
Project 1
Project 4
✓ Correct
Feedback:
In excel, IRR can be calculated using the formula: IRR(Range of values including initial investment).
This will give the IRR for the projects:

IRR 24% 16% 19% 26% 13%
You can clearly see that Project 4 has the highest IRR value of 26%.
Project 3
✕ Incorrect
Feedback:
Recall the IRR function of excel and calculate the IRR for the project. Comparison of the IRR will help
you choose the correct answer.
Project 5
IRR
The smartphone manufacturing company, ZEA Mobile Limited, wants to increase their sales. For this,
the company hires a consultant for conducting market research and identifying the ways to increase
sales. The consultant suggests the following ways:
1. Launching a brand awareness campaign in all the zones, including ads on

television/newspaper/social media, tie-ups with social media influencers, recreation of the
brand image through brand ambassadors, etc.
2. Launching a sales campaign in the top four metro cities by aggressively targeting consumers
through discounts and newspaper ads.
ZEA has to select the appropriate campaign, considering its impact on the sales and its initial costs.
These campaigns will have different impacts on the company’s sales. The yearly cash flows are given
below (in ₹). Calculate the IRR of both the projects.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Brand Campaign -2,00,00,000 42,50,000 48,02,500 54,16,625 60,98,856 68,56,339
Sales Campaign -20,00,000 8,50,000 9,45,200 10,50,736 - -
Brand campaign: 13%
Sales campaign: 19%
Brand campaign: 11%
Sales campaign: 19%
✓ Correct
Feedback:
Applying the IRR formula in excel: IRR(Range of cells including initial investment), the IRR will be 11%
for the brand campaigns and 19% for the sales campaigns.
Brand campaign: 13%

Sales campaign: 17%
✕ Incorrect
Feedback:
The IRR is the rate of return at which NPV is zero. You can use the excel function to calculate the IRR.
Brand campaign: 11%

Sales campaign: 17%
IRR
An FMCG business plans to onboard a new distributor.
The outward cash flows of the business towards onboarding the distributor would be as follows:
Year 0 1 2 3 4 5 6
Outflow (₹ lakh) 30 20 10 10 10 10 10
The cash inflow in the form of additional contribution through the sale of goods by the distributor is
as follows:
Year 0 1 2 3 4 5 6
Inflow (₹ lakh) 05 30 15 20 20 25 25
Where relevant, assume the WACC of the business at 14%.
Calculate the IRR attributable to the addition of the new distributor.
31%
✓ Correct
Feedback:
To be able to use the IRR function in excel, you need to calculate the net cash flow for each. This will
come as:
Year 0 1 2 3 4 5 6
Net cash flow (₹ lakh) -25 10 05 10 10 15 15
By using the IRR function in excel: =IRR(range of cells of net cash flow from year 1 to year 7), you will
get 31%.
25%
28%
35%
Currency Risk
Larsen & Toubro, the Indian construction giant, has agreed to work on a project by a client based in
the Philippines. The project is fraught with multiple risks. Various risk scenarios and mitigation
techniques are provided in the table given below. Match the risk scenario with the most appropriate
mitigation technique.
Risk Scenario Mitigation Technique

A. The number of terrorist incidents in the I) Build a clause linking the contract value to
Philippines has been increasing constantly. the input costs.
B. The value of Philippines’ currency, the

Peso, had been fluctuating wildly in the last II) Insure against any contingency.
few years
C. There is a looming threat of a change in

the government, which may lead to III) Sign the contract in US Dollars.
regulatory headaches.
D. The price of Tungsten, an important input

IV) Procure a local advisory partner.
material, may rise in the coming months.
Select the correct option from those given below.
A-IV, B-III, C-II, D-I
A-II, B-I, C-IV, D-III
A-IV, B-I, C-II, D-III
A-II, B-III, C-IV, D-I
✓ Correct
Feedback:
Remember that risks can be averted using mitigation techniques. To avoid incurring losses in case of
fluctuations in the local currency, for example, the company should prefer to conduct transactions on
a stable currency, such as the USD. Similarly, to deal with the terrorist incidents in the Philippines, it is
better to insure against any contingency. Insurance helps a company protect itself against any
unexpected events, which may alter its project costs. To deal with the threat of a change in the
government that might land the organisation in legal troubles, it can procure a local advisory partner.
To deal with the contingency of a rise in price of Tungsten, an important input material, it is better to
build a clause linking the contract value to the input costs. This will ensure that the company does not
face any losses due to a rise in input prices.
Sensitivity Analysis
Which of the following risks poses a bigger threat to Suzuki’s project (in terms of impact on the
NPV)?
A change in the government
Sales of electric cars not keeping up with the projections
✓ Correct
Feedback:
The NPV in the case of a change in the government is ₹443.47 crore, whereas that in the case of the
electric car industry not taking off as expected is ₹404.98 crore. The NPV under normal circumstances
is 1,441.05. The fall in the NPV is higher in the case of decreasing sales, and hence, it is a bigger threat
to Suzuki’s project.
Equal risk in both
✕ Incorrect
Feedback:
To be equally risky, the fall in the NPV must be equal in both the situations. Try to find the changed
NPV and then compare them to get the answer.
Scenario Analysis
Maruti considered that the case of the electric car industry not taking off is its worst-case scenario, a
change in the government as its base case, and normal circumstances as the ideal case (best case).
Calculate the risk-adjusted NPV for the project. Take note of the following probabilities:
• Ideal case: 10%

• Base case with the estimations of the net cash flows made by the project manager: 60%
• E-cars facing a decline in sales: 30%
456.98
512.78
531.68
✓ Correct
Feedback:
The risk-adjusted NPV is calculated by multiplying the NPVs of different scenarios with their
respective probabilities. The following table summarises the risk-adjusted NPV.
Base Case 443.47 60%

Worst Case 404.98 30%
Best case 1,441.05 10%
Risk-adjusted NPV 531.68
564.09
Uses of Sensitivity Analysis
Which of the following statements regarding sensitivity analysis is true? (Note: More than one option
may be correct.)
Sensitivity analysis helps in understanding how your outcomes can change when your
input variables change in different situations.
✓ Correct
Feedback:
NPV is calculated on the basis of certain assumptions. Hence, it becomes important to understand
how the NPV behaves when the values change. Sensitivity analysis shows how your outcomes can
change when your input variables change in different situations; this way, you know which variables
are more risky and which ones are not.
Sensitivity analysis does not take into account the probabilities of different scenarios and
the associated changes in cash flows.
✓ Correct
Feedback:
Sensitivity analysis is conducted in order to deal with uncertainties with respect to one variable at a
time. The method of accounting for probability in different scenarios is a type of scenario analysis.
Sensitivity analysis is conducted after an input variable changes in the market to

understand whether a project should be continued.
Comprehension Question 1
Suppose you are the manager of an Indian herbal tea company. The demand of your herbal tea and
organic bean products have picked up in certain markets of Kerala and Tamil Nadu. Your logistics
partner has advised that a packaging unit should be set up at a place called Tiruvottiyur, which is
near Chennai.
You need a capital of ?8 crore to set up this unit. Your company’s last round of funding has raised
your debt/equity ratio to 0.6, and you decide to go for the same mix of debt and equity capital for
setting up the new unit.
Your bank has agreed to provide a partial loan at an interest rate of 9%. Assume the tax to be 0.
Meanwhile, to raise the balance amount, you decide to sell some stake in your growing business to
a willing investor. You go through an industry report and estimate that the cost of equity would be
about 14% for an FMCG business.
Cost of Capital
Based on the information provided, calculate the weighted average cost of capital (WACC) for the
business.
10.9%
11.2%
12.1%
✓ Correct
Feedback:
WACC=(Weightage of debt∗Cost of debt)+(Weightage of equity∗Cost of equity)
Here, weightages of debt and equity are 6/16 and 10/16, respectively, as (debt/equity = 6/10). The
cost of debt and equity are at 9% and 14%, respectively. Hence, 12.1% is the correct answer.
13.4%
Cost of Capital
The industry report that you went through to arrive at the cost of equity revealed some interesting
data, which is provided in the table given below.
Industry Cost of Equity (India) Cost of Equity (USA)

Packaged food 13.6% 5.84%
Pharmaceutical 15.5% 9.72%
What can you deduce from the information given above? (Note: Multiple options may be correct.)
Investments in Indian businesses are less risky as compared with investments made in
similar businesses in the US.
Investments in US businesses are less risky as compared with investments made in similar
businesses in India.
✓ Correct
Feedback:
Investments/Projects and businesses that come with a higher risk (higher probability of non-
repayment of loans or of value depreciation) will be able to raise capital only at a higher cost. Hence,
the risk profile order from the data set given above is: Indian pharma > Indian packaged food > US
pharma > US packaged food.
The pharmaceutical sector offers riskier investment options as compared with the
packaged foods sector.
✓ Correct
Feedback:
Investments/projects and businesses that come with a higher risk (higher probability of non-
repayment of loans or of value depreciation) will be able to raise capital only at a higher cost. Hence,
the risk profile order from the data set given above is: Indian pharma > Indian packaged food > US
pharma > US packaged food.
The packaged foods sector offers riskier investment options as compared with the
pharmaceutical sector.
Comprehension Question 2
The Western United Football Club plans to lease a stadium in the heart of Mumbai with a seating
capacity of 2,000 spectators.
They plan to organise 50 matches every year for the next five years in the stadium and expect an
average occupancy of 80% during their matches. Tickets will be priced at INR 200 for the first two
years and INR 500 for the third, fourth and fifth years.
The club would need to make an initial one-time investment of INR 4 crore at the end of Year 0 and
expenses amounting to INR 2 crore at the end of every subsequent year.
NPV of the Project

Which of the following is the NPV for this stadium? Assume the discount rate is 10%.
-5,837,157.17
✓ Correct
Feedback:
The NPV can be calculated using the Excel function: =NPV(10%, range of values from year 1 to year 5)
+ initial investment at year 0.
Using the net cash flow for each year, the NPV comes out to be -5,837,157.17.
Refer to the following table for further details.
Years Cash Inflow (in ₹) Cash Outflow (in ₹) Net Cash Flow (in ₹)
0 0 4,00,00,000 -4,00,00,000
1 1,60,00,000 2,00,00,000 -40,00,000
2 1,60,00,000 2,00,00,000 -40,00,000
3 4,00,00,000 2,00,00,000 2,00,00,000
4 4,00,00,000 2,00,00,000 2,00,00,000
5 4,00,00,000 2,00,00,000 2,00,00,000
NPV -58,37,157.17
-5,537,157.17
-5,737,157.17
-5,867,157.17
Criteria for IRR

Suppose you own a small real estate business and want to expand your business profile. You discuss
this idea with your financial advisor, and he suggests the following projects/businesses:
1. A logistics business requiring an investment of ₹20,00,000, with an internal rate of return of

18%
2. A bottling plant requiring an investment of ₹5,00,000, with an internal rate of return of 10%
3. A construction project requiring an investment of ₹75,00,000, with an internal rate of return of
22%
To invest in any of the projects/businesses mentioned above, you would need to borrow money on
credit, for which you have the following options:
1. From the bank at an interest rate of 12%, if the loan amount is less than ₹10,00,000
2. From an NBFC at an interest rate of 15%, if the loan amount is greater than ₹11,00,000 less
than ₹50,00,000
3. From institutional investors at an interest rate of 24%, if the loan amount is greater than
51,00,000 and up to ₹1,00,00,000
You can choose to borrow from only one of the options given above. Also, you can invest in only one
of the projects/businesses.
Which investment option will you choose based on the IRR technique of project evaluation?
Logistics business
✓ Correct
Feedback:
A simple and quick method for evaluating an investment opportunity is to assess the internal rate of
return (IRR), which should be greater than the cost of capital for any investment. The cost of capital
for a logistic plant is 15%, as you will be able to borrow from the NBFC at an interest rate of 15%. The
IRR is 18%. Since IRR > Kc.
Logistics Business Bottling Plant Construction Project

IRR 18% 10% 22%
Cost of capital 15% 12% 24%
Bottling plant
✕ Incorrect
Feedback:
You will favour an investment if the IRR is greater than the cost of capital. You are most likely to reject
a project if the IRR is lower than the cost of capital. In such a case, you will end up paying more
interest on the amount borrowed than the gains received from the investment.
Construction project
Change in Cost of Capital

Imagine a company whose capital structure has ₹50 crore equity and ₹50 crore debt in Year 1. The
company earned a profit of ₹30 crore at the start of Year 2 and decided to repay the debt.
The company’s capital structure in Year 2 became ₹80 crore equity and ₹20 crore debt.
What will be the WACC for Year 1 and Year 2 if the cost of debt is 7.5% and the cost of equity is 14%?
10.75%, 10.75%
10.75%, 12.70%
✓ Correct
Feedback:
WACC is calculated using the formula: Wd∗kd+We∗ke.
Applying this formula for year 1, we get: 0.5 * 14 + 0.5 * 7.5 = 10.75. After the company repaid the
debt to the extent of ₹30 crore from the profit earned in year 1, its capital structure changed from an
equity:debt ratio of 50:50 to 80:20. This change in the capital structure affected the cost of capital, as
it took into account the weights of debt and equity in the capital. Hence, there is a need to recalculate
the WACC for year 2. Using the formula, the WACC for year 2 is: 0.8 * 14 + 0.2 * 7.5 = 12.70%.
Hence, when the capital structure changes, the WACC changes.
Conclusively, you would use a different WACC for the cash flow of year 2.
12.70%, 12.70%
Graded
Comprehension
Mondelez, a manufacturer of confectionery products under the Cadbury trademark, plans to launch
a range of premium chocolate boxes under the brand name ‘Gazelle’. These boxes will be sold only
in special chocolate boutiques set up in malls and hotels. Manufacturing and packaging the product
would require special units, and thus, this would be an expensive investment. Also, Mondelez plans
to support the launch of Gazelle with a high decibel marketing campaign.
The brand manager of Gazelle projects the following cash flows for the first five years (all figures in
? lakh):
Year 1 2 3 4 5
Cash Outflow 100 80 50 20 20
Cash Inflow 30 50 100 120 150
Assume that there are no expenses in Year 0.
For questions 1–3 related to this comprehension, assume a WACC of 8%. It is strongly advised you
use a spreadsheet to solve the questions.
NPV
Calculate the NPV of the project. Assume that the cash flows occur at the end of each year.
₹340.45 lakhs
₹89.20 lakhs
₹111.14 lakhs
✓ Correct
Feedback:
Since the cash flows occur from year 1, all the cash flows need to be discounted. The NPV of the
project can be calculated using the formula: =NPV(RATE, Range of values). Using the NPV function in
Excel, you will get: ₹111.1 lakh, i.e., ₹1.111 crore.
₹243.56 lakhs
Sensitivity Analysis
The brand manager has been given a target of achieving a cash inflow of ₹30 lakh in Year 2. If he fails
to do so, the project will be discontinued. This is the worst-case scenario for the manager.
The manager estimates the worst-case analysis with the help of the cash inflows provided in the
following table.
Year 1 2 3 4 5
Cash Outflow (₹ lakh) 100 80 0 0 0
Cash Inflow (₹ lakh) 20 20 0 0 0
What would be the NPV of the project in case the brand is discontinued after two years, i.e., the cash
inflow and outflow is 0 for the rest of the three years?
₹-32.21 lakhs
₹-125.51 lakhs
✓ Correct
Feedback:
Since the cash flow for the 2nd year is ₹20 lakhs, which is less than ₹30 lakhs, the company will stop
the project after 2 years. Therefore, the NPV is calculated considering the cash flows of the period of
two years.
The NPV of the project can be calculated using the formula: =NPV(RATE, Range of values). Using the
NPV function in Excel, you will get: ₹-125.51 lakhs.
₹-220 lakhs
₹-193 lakhs
Risk-Adjusted NPV
The brand manager also presents a third scenario, where due to a new entrant in the market, the
company has to spend more on marketing activities. Hence, it would require a larger marketing
budget. Here, the brand manager assumes that the cash inflows remain the same as per the regular
scenario; however, the cash outflows would be revised as given in the following table.
Year 1 2 3 4 5
Cash Outflow (₹ lakh) 100 100 80 50 50
Cash Inflow (₹ lakh) 30 50 100 120 150
The following probabilities are assigned to each scenario:
• Regular launch and success (best case): 60%

• Failure in year 2 (worst case): 20%
• Success following a larger expenditure on marketing due to a new entrant (base case): 20%
Calculate the risk-adjusted NPV for the project. (You can use the NPVs of the first two scenarios as
calculated in the previous questions.) Choose the closest option.
₹10.20 lakhs
₹47.12 lakhs
✓ Correct
Feedback:
The risk-adjusted NPV is calculated by multiplying the NPVs of different scenarios by their respective
probabilities.
The NPV for the three scenarios and their probability are provided in the table given below.
NPV (₹ lakh) Probability

Best case 111.14 60%
Worst case -125.51 20%
Base case 27.71 20%
Using the formula for calculating the risk-adjusted NPV, we get: (111.14 * 0.60) -(125.51 * 0.20) +
(27.71 * 0.20) = ₹47.12 lakhs
₹-54.66 lakhs
₹33.59 lakhs
Cost of Capital
The details of a project are:
Equity raised for the project: ₹60 lakhs

Debt taken: ₹30 lakh
Cost of debt (kd): 8%
Cost of equity (ke): 18%
Calculate the cost of capital for the project.
12.88%
14.67%
✓ Correct
Feedback:
Calculate WACC using the formula: Wd∗kd+We∗ke
Here, Wd=debtdebt+ equity, i.e., 30/90= 0.33,
We=equitydebt+ equity, i.e., 60/90 = 0.67
The cost of equity (ke) is given as 18% and cost of debt (kd) is given as 8%.
Hence, applying the formula of WACC, we get 0.67*18%+0.33*8%= 14.67%
11.57%
15.25%
IRR
The expected cash flows from the project are as follows :
Year 0 1 2 3 4 5 6
Cash flow (₹ lakh) -120 27 43 15 24 25 25
Calculate the IRR of the project.
15%
11%
9%
✓ Correct
Feedback:
In excel, IRR can be calculated using the formula: IRR(Range of values including initial investment).
This will give the IRR for the project A as 9%,
12%
Optional Practise questions:

Mr Kartik started a garment business online, Clotrend, in the month of April. Following are the
transactions that took place for the months of April, May and June in his company.
April:
• He invested ₹10,00,000 to start the business.

• He bought dress material and other raw materials from a supplier for ₹6,00,000. As he is new
in the business, the supplier did not provide any credit period to him.
May:
• He started designing the garments.

• Sold 500 dresses. The selling price per dress was ₹1,000.
• To increase the social media reach, Kartik paid ₹50,000 for sponsor ads on the social media
platforms.
• He took a sewing machine on rent for ₹20,000 per month.
• Delivery and logistics expenses: ₹2,500 per month, fixed fee irrespective of the number of
items delivered. He had to pay this fee in May.
• Raw material cost: ₹400/dress.
• Water and electricity: ₹150/per dress.
June:
• Sales: 2000 units (out of which 500 were on credit)

• Raw materials purchased: ₹5,00,000
• Paid ₹50,000 for sponsor ads
• Due to increasing demand, in the month of June, Clotrendz employed 1 worker who would
help Kartik in designing and packaging. Salary to the worker was ₹10,000 per month paid
on the last day of every month.
• Kartik purchased the sewing machine for ₹3,00,000. For this machine, he paid ₹1,00,000 in
cash and borrowed the balance from a friend for a period of two years. The machine will be
used for a period of 4 years.
• Insurance on the machine: ₹10,000 monthly.
After working for a quarter, Kartik wants to understand the financial health and performance of his
online business.
Which of the following statements will be affected for the month of April?
Cash flow statement and P/L statement
P/L statement and balance sheet
Balance sheet, cash flow statement and income statement
✓ Correct
Feedback:
The company has certain cash inflows during the month of April; hence, the cash flow statement will
be affected. Also, the company purchases inventory and infuses share capital. Hence, the balance sheet
will be affected. Since no sales are made during the month of April, the income statement will not be
affected.
Break-Even Point
Kartik wants to understand the minimum number of units he needs to sell in order to break-
even. What is the break-even level of output for the month of May?
62
162
✓ Correct
Feedback:
Kartik needs to sell 162 dresses for the month of May to reach the break-even point. Break-even point
= Fixed cost / Variable margin per unit. Fixed cost for the month of May= ₹72,500 and variable margin
per unit = ₹450. Hence, the break-even point = 162 units. Since Kartik has made sales of 500 dresses
for the month, he is operating above the break-even level.
57
112
Which of the following statements for the month of May is true?
Cash at the beginning: ₹4,00,000, monthly profit: ₹1,52,500 and sales revenue: ₹5,00,000
✓ Correct
Feedback:
is ₹5,00,000, and after accounting for all the expenses, the monthly profit is 5,00,000 - 2,75,000 - 20,000
- 2500 - 50,000 = ₹1,52,500.
Cash at the beginning: ₹0, monthly profit: ₹2,50,500 and sales revenue: ₹5,00,000
Cash at the beginning: ₹4,00,000, monthly profit: ₹2,25,000 and sales revenue: ₹ 5,00,000
✕ Incorrect
Feedback:
is ₹5,00,000, and after accounting for all the expenses, the monthly profit is 5,00,000 - 2,75,000 - 20,000
- 2500 - 50,000 = ₹1,52,500.
Kartik has an urgent requirement of cash payment. What is the cash balance in the balance sheet at
the end of May? Choose the correct option from those given below.
4,00,000
7,52,500
✓ Correct
Feedback:
The cash balance in the balance sheet comes from the bottom line of the cash flow statement. The cash
flow statement’s bottom line is cash at end, which, for the month of May, was ₹7,52,500. This is given
as follows.
9,00,000
12,80,000
Accounting Through Practice

In respect of the month of June, identify the correct statement from those given below.
Sales of ₹15,00,000 identified by Kartik are correct, as only those transactions that are
completed are to be recorded in the financial statements
Sales of ₹20,00,000 are to be recorded, as the goods have become the property of the
company’s customer, irrespective of the receipt of cash for them.
✓ Correct
Feedback:
Sales revenue is recorded on the basis of the ‘realisation of sales’ principle. This principle states that
sales should be recognised as sales revenue when the goods/services become the property of the
company’s customer, irrespective of the receipt of cash for them. Hence, even though ₹5,00,000 was
credit sales, since the delivery had taken place, the total sales revenue to be recorded in the income
statement was ₹20,00,000.
Sales of ₹5,00,000 are to be recorded, as only cash sales are to be recorded in the
financial statements
Accounting Through Practice

Following actions are taken by Kartik for the month of June. Identify which of the following actions
taken by him is correct (for the month of June).
Gross value of the sewing machinery should be recorded at ₹3,00,000 and loan from a
friend taken for the sewing machine should be recorded as long-term liability.
✓ Correct
Feedback:
Assets should not be overvalued or undervalued. Hence, the sewing machine would be recorded at
cost. The long taken from the friend, having re-payment after 2 years is a long-term loan for the
business.
By the end of June, the book value of the sewing machine should be ₹2,93,750 after
accounting for its usage.
✓ Correct
Feedback:
Machinery must be recorded after accounting for depreciation to reflect its true value. Hence, the value
of machinery will be ₹2,93,750 after accounting for ₹6,250 as depreciation.
Credit sales of ₹5,00,000 shall translate into accounts receivable on the asset side of the
balance sheet.
✓ Correct
Feedback:
‘Sales on credit’ translates into ‘accounts receivable’ on the asset side of the balance sheet, as the
economic benefit shall be endured in future.
Total profit-earning will remain the same as calculated for the previous month.
Identify which of the following statements is correct after assessing the profits earned during the
month of June.
The net profit earned for the month of June is ₹7,55,000. Depreciation of ₹1,00,000 shall be
expensed in P/L and unused material of ₹4,00,000 shall translate to inventory balance in
books of accounts.
The net profit earned for the month is ₹8,21,250. Net machine value will be ₹ 2,93,750 and
unused material of ₹1,00,000 shall translate to inventory balance in books of accounts.
✓ Correct
Feedback:
The net profit earned for the current year is ₹8,21,250. Look at the information given below.
Net machine value = Gross machine value - Depreciation. Since the machine has a useful life of 4 years,
the depreciation per month will be 300000 / 48 = 6,250. Hence, the net machine value = 3,00,000 -
6,250 = 2,93,750. And, the inventory value was ₹4,00,000, but Kartik has purchased ₹ 5,00,000 worth
raw material during the month. However, the raw material used material of ₹8,00,000 only. Hence, the
balance of ₹1,00,000 worth of inventory will be the inventory balance at the end of June.
The net profit earned for the month is ₹15,80,000, cash sales of ₹5,00,000 is to be recorded
and depreciation being a non-cash expenditure shall not be accounted for in the income
statement.
After ascertaining the profits, which of the following statements related to the financial position of
Kartik’s business as on June end is correct?
Owner’s equity of Kartik’s business is ₹19,73,750.
✓ Correct
Feedback:
Owner’s equity is the sum of share capital, retained earnings and profit for the current period. Hence,
owner’s equity = Investment of ₹10,00,000 + Profit earned during the period of ₹8,21,250 + Retained
earnings of ₹1,52,500= ₹19,73,750.
Balance of total assets is ₹21,73,750 and the cash balance at the end of june is ₹12,80,000.
✓ Correct
Feedback:
Balance of total assets is ₹21,73,750 and the cash balance at the end of the june is ₹12,80,000.
Net value of machinery is ₹3,00,000 and the cash balance is ₹10,70,000.

Kartik wants to understand the increase/decrease in the cash position of the company as compared
to the previous month. How much is the cash generated for the month of June?
₹12,80,000
₹7,52,500
₹5,27,500
✓ Correct
Feedback:
Total cash generated = Cash at the beginning - Cash at the end. The cash generation for the month of
February was ₹5,27,500, as the cash at the beginning was ₹7,52,500 and the cash at end was ₹12,80,000.

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Basics of Cash Flow Statement

Company A sold a button-making textile machine at a loss of $25,000.

Company A's brand recognition increased.

Company A took a loan from the bank at 6.5% interest rate.

A company’s financial performance over a period of time.

A company’s financial position at a particular point in time.

Increase in the value of liability

Decrease in another asset

They are part of the core operations of a company.

They are interested in assessing a company’s return on investment.

Cash flow statement

Overview of Financial Statement

The information can be ascertained using the balance sheet.

Asset and equity

Asset and expense

Asset and liability

Income and expense

Asset: ₹60 lakh, Equity: ₹40 lakh, Liability: ₹1 crore

Asset: ₹1 crore, Equity: ₹40 lakh, Liability: ₹60 lakh

Asset: ₹40 lakh, Equity: ₹1 crore, Liability: ₹60 lakh

4. Match the financial events with relevant accounting terms.

Financial Event Accounting terms

(C) You have made a sale worth ₹20 crores 3. Expense

A1, B2, C3, D4

A1, B4, C2, D3

The cost of the material used in manufacturing is an ‘Expense'.

A4, B1, C2, D3

A3, B1, C3, D4

Cash flow statement

✓ CorrectYou missed this!

2. What is the total sales revenue for the month of January?

[Hint: Sales Revenue = Goods sold x Selling price per unit]

4. What is the opening cash balance for the month of January?

Financial Decision on Different Financial Statements

Quantity sold = 2,500/(20−2) = 138.9 pizzas, or 139 pizzas.

Impact of Financial Decision on Different Financial Statements

[Hint: Salary is an expense usually paid in cash for a business.]

Cash flow statement

Cash Flow Statement

Impact of Financial Decisions on Financial Statements

What is the ‘Net truck value’ at the end of March?

• Cash flow statement:-$18,000

• Balance sheet asset:Truck value: +$36,000 and cash value: -$18,000

• Balance sheet liability: $18,000

[Hint: The insurance of 300 is due monthly on the truck]

Impact of Financial Decisions on Financial Statements

What is the total cash generated for the month of April?

Payment for the purchase of truck

Water and electricity

✓ CorrectYou missed this!

GRADED QUESTION MODULE 1

Cash flow statement and income statement

Balance sheet and income statement

Inventory value can be negative.

(Note: More than one option may be correct.)

Website maintenance cost

Payment to logistics and delivery services company

Interest payments on loan taken from bank

Sales revenue: $0.95 million

Sales revenue: $0.55 million

Sales revenue: $1.5 million

Sales revenue: $0.45 million

Cost of goods sold 260 320