Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions

Solution 1:
Income Statement
Particulars Amount (₹)
Sales 86,00,000
Less: Variable cost (65% of 86,00,000) 55,90,000
Contribution (35% of 86,00,000) 30,10,000
Less: Fixed costs 10,00,000
Earnings before interest and tax (EBIT) 20,10,000
Less: Interest on debt (@ 10% on ₹55 lakhs) 5,50,000
Earnings before tax (EBT) 14,60,000
Tax (40%) 5,84,000
PAT 8,76,000

𝐸𝐵𝐼𝑇 𝐸𝐵𝐼𝑇
(i) ROCE (Pre-tax) = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
× 100 = 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡
× 100
₹20,10,000
₹(75,00,000+55,00,000)
× 100 = 15.46%
EPS (PAT/ No. of equity shares) 1.168 or ₹1.17
(ii) ROCE is 15.46% and Interest on debt is 10%. Hence, it has a favourable financial leverage.
(iii) Calculation of Operating, Financial and Combined leverages:

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹30,10,000
Operating Leverage = 𝐸𝐵𝐼𝑇
= ₹20,10,000 = 1.497 (approx)
𝐸𝐵𝐼𝑇 ₹20,10,000
Financial Leverage = 𝐸𝐵𝑇 = ₹14,60,000 = 1.377 (approx.)
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹30,10,000
Combined Leverage = 𝐸𝐵𝑇
= ₹14,60,000 = 2.062 (approx.)
Or, = Operating Leverage × Financial Leverage = 1.497 × 1.377 = 2.06 (approx.)
(iv) Operating leverage is 1.497. So, if sales are increased by 10%.
EBIT will be increased by 1.497 × 10% i.e. 14.97% (approx.)
(v) Since the combined Leverage is 2.062, sales have to drop by 100/2.062 i.e. 48.50% to bring EBT
to Zero.
Accordingly, New Sales = ₹86,00,000 × (1 - 0.4850)
= ₹86,00,000 × 0.515
= ₹44,29,000 (approx.)
Hence, at ₹44,29,000 sales level, EBT of the firm will be equal to Zero.

Solution 2:
(1) Preparation of Profit – Loss Statement Working Notes:
Post tax interest 5.60%
Tax rate 30%
Pre tax interest rate = (5.6/70) x 100 8%
Loan amount ₹ 1,25,000
Interest amount = 1,25,000 x 8% ₹ 10,000
(
𝐸𝐵𝐼𝑇
)( 𝐸𝐵𝐼𝑇 𝐸𝐵𝐼𝑇
) (
Financial Leverage (FL) = 𝐸𝐵𝑇 = (𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡) = (𝐸𝐵𝐼𝑇 −10,000) )
𝐸𝐵𝐼𝑇
1.5 = (𝐸𝐵𝐼𝑇 −10,000)
1.5 EBIT -15000 = EBIT
1.5 EBIT – EBIT = 15,000

0.5 EBIT = 15,000

EBIT = ₹ 30,000
EBT = EBIT – Interest = 30,000 – 10,000 = ₹ 20,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
2. Operating Leverage (OL) = 𝐸𝐵𝐼𝑇
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
2 = 30,000
Contribution = ₹ 60,000

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
3. Fixed cost = Contribution – Profit
= 60,000 – 30,000 = ₹ 30,000

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
4. Sales = 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜
60,000
= 30%
= ₹ 2,00,000

[Link] PV ratio is 30%, then the variable cost is 70% on sales.

Variable cost = 2,00,000 x 70% = ₹ 1,40,000
Profit – Loss Statement
Particulars ₹
Sales 2,00,000
Less: Variable cost 1,40,000
Contribution 60000
Less: Fixed cost 30,000
EBIT 30,000
Less: Interest 10,000
EBT 20,000
Less: Tax @ 30% 6,000
EAT 14,000
(2) Calculation of no. of Equity shares Market Price per Share (MPS) = ₹140 Price Earnings Ratio (PER) = 10
WKT,
𝑀𝑃𝑆 140
EPS = 𝑃𝐸𝑅 = 10 = ₹ 14
Total earnings (EAT) = ₹ 14,000
No. of Equity Shares = 14,000 / 14 = 1000

Solution 3:
1. Income Statement
Particulars Company P (₹) Company Q (₹)
Sales 40,00,000 18,00,000
Less: Variable Cost 30,00,000 12,00,000
Contribution 10,00,000 6,00,000
Less: Fixed Cost 8,00,000 4,50,000
EBIT 2,00,000 1,50,000
Less: Interest 1,50,000 1,00,000
EBT 50,000 50,000
Tax (45%) 22,500 22,500
EAT 27,500 27,500
Workings:
(i) Margin of Safety
For Company P = 0.20
For Company Q = 0.20 x 1.25 = 0.25
(ii) Interest Expenses
For Company P = ₹ 1,50,000
For Company Q = ₹ 1,50,000 (1-1/3) = ₹ 1,00,000
(iii) Financial Leverage
For Company P = 4
For Company Q = 4 x 75% = 3
(iv) EBIT
For Company A
Financial Leverage = EBIT/(EBIT- Interest)
4 = EBIT/(EBIT- ₹ 1,50,000)
4EBIT – ₹ 6,00,000 = EBIT

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
3EBIT = ₹ 6,00,000

EBIT = ₹ 2,00,000
For Company B
Financial Leverage = EBIT/(EBIT - Interest)
3 = EBIT/(EBIT – ₹ 1,00,000)
3EBIT – ₹ 3,00,000 = EBIT
2EBIT = ₹ 3,00,000
EBIT = ₹ 1,50,000
(i) Contribution For Company A
Operating Leverage = 1/Margin of Safety
= 1/0.20 = 5
Operating Leverage = Contribution/EBIT
5 = Contribution/₹ 2,00,000 Contribution
= ₹ 10,00,000
For Company B
Operating Leverage = 1/Margin of Safety
= 1/0.25 = 4
Operating Leverage = Contribution/EBIT
4 = Contribution/ ₹1,50,000
Contribution = ₹ 6,00,000

(ii) Sales
For Company A
Profit Volume Ratio = 25%
Profit Volume Ratio = Contribution/Sales x 100
25% = ₹ 10,00,000/Sales
Sales = ₹ 10,00,000/25%
Sales = ₹ 40,00,000

For Company B
Profit Volume Ratio = 33.33%
Therefore, Sales = ₹ 6,00,000/33.33%

Sales = ₹ 18,00,000

Solution 4:

Sources of Capital Plan I Plan II Plan III Plan IV

Present Equity Shares 13,00,000 13,00,000 13,00,000 13,00,000
New Issue 7,80,000 5,20,000 3,90,000 3,90,000
Equity share capital (₹) 2,08,00,000 1,82,00,000 1,69,00,000 1,69,00,000
No. of Equity shares 20,80,000 18,20,000 16,90,000 16,90,000
12% Long term loan (₹) - 26,00,000 - -
9% Debentures (₹) - - 39,00,000 -
6% Preference Shares (₹) - - - 39,00,000

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
Computation of EPS and Financial Leverage
Sources of Capital Plan I Plan II Plan III Plan IV
EBIT (₹) 52,00,000 52,00,000 52,00,000 52,00,000
Less: Interest on 12% Loan (₹) - 3,12,000 - -
Less: Interest on 9% debentures
- - 3,51,000 -
(₹)
EBT (₹) 52,00,000 48,88,000 48,49,000 52,00,000
Less: Tax@ 40% 20,80,000 19,55,200 19,39,600 20,80,000
EAT (₹) 31,20,000 29,32,800 29,09,400 31,20,000
Less: Preference Dividends (₹) - - - 2,34,000
(a) Net Earnings available for
31,20,000 29,32,800 29,09,400 28,86,000
equity shares (₹)
(b) No. of equity shares 20,80,000 18,20,000 16,90,000 16,90,000
(c) EPS (a ¸ b) (₹) 1.50 1.61 1.72 1.71
Financial leverage EBIT)
1.00 1.06 1.07 1.08*
(EBT

*Financial Leverage in the case of Preference dividend = ( 𝐸𝐵𝐼𝑇

𝐷𝑜
(𝐸𝐵𝐼𝑇− 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡)−( (1−𝑡) ) )
= ( 52,00,000
(52,00,000−0)−(
2,34,000
(1−40)
) )
=( 52,00,000
48,10,000 )=1.08
Solution 5:
Income Statement of companies A, B and C
Particulars A B C
Sales ₹15,00,000 ₹30,00,000 ₹41,66,667
Less: Variable Expenses ₹9,00,000 ₹15,00,000 ₹16,66,667
Contribution ₹6,00,000 ₹15,00,000 ₹25,00,000
Less: Fixed Cost ₹4,50,000 ₹10,00,000 ₹15,00,000
EBIT ₹1,50,000 ₹5,00,000 ₹10,00,000
Less: Interest ₹1,00,000 ₹4,00,000 ₹6,00,000
PBT ₹50,000 ₹1,00,000 ₹4,00,000
Less: Tax @ 30% ₹15,000 ₹30,000 ₹1,20,000
PAT ₹35,000 ₹70,000 ₹2,80,000
Working Notes:
𝐸𝐵𝐼𝑇
(i) Degree of Financial Leverage= 𝐸𝐵𝐼𝑇− 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
DFL x (EBIT – Int) = EBIT
DFL x EBIT – Int x DFL= EBIT
DFL x EBIT – EBIT =Int x DFL
EBIT(DFL – 1) = Int x DFL
𝐼𝑛𝑡×𝐷𝐹𝐿
EBIT = 𝐷𝐹𝐿 − 1
For A,
₹1,00,000×3
EBITA = 3−1
EBITA = ₹150000
For B
₹4,00,000×5
EBITB = 5−1
EBITB = ₹500000
For C
₹6,00,000×2.5
EBITc = 2.5−1

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
EBITc =10,00,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
(ii) DOL= 𝐸𝐵𝐼𝑇
Contribution = DOL x EBIT
ContributionA = 4 x ₹1,50,000
ContributionA = ₹6,00,000
ContributionB = 3 x ₹5,00,000
ContributionB = ₹15,00,000
ContributionC = 2.5 x ₹10,00,000
ContributionC = ₹25,00,000
(ii) Fixed Cost = Contribution – EBIT
Fixed CostA= ₹6,00,000 – ₹1,50,000 = ₹4,50,000
Fixed CostB =₹15,00,000 – ₹5,00,000 = ₹10,00,000
Fixed CostC = ₹25,00,000 – ₹10,00,000 = ₹15,00,000
(iii) Contribution= Sales – VC
VC= Sales – Contribution
Sales x VC Ratio= Sales – Contribution
Contribution= Sales – Sales x VC Ratio
Contribution=Sales(1-VCR)
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
Sales = 1−𝑉𝐶𝑅
SalesA = ₹6,00,000/(1-0.6) = ₹15,00,000
SalesB = ₹15,00,000/(1-0.5) = ₹30,00,000
SalesC = ₹25,00,000/(1-0.4) = ₹41,66,667
Of all the companies, A has the highest degree of Operating Leverage, B has highest degree of Financial
Leverage and C is equally leveraged on both Operating and Financial fronts. If we consider combined leverage
companies will have the leverages of 12, 15 and 6.25 (by multiplying both operating and financial leverages).
This means A is undertaking a higher degree of operating risk while B is undertaking a higher degree of
financial risk.

Solution 6:
Break Even Sales = ₹ 6800000×0.75 = ₹ 51,00,000
Income Statement (Amount in ₹)
Original Calculation of Interest Now at present
at BEP (backward level
calculation)
Sales 68,00,000 51,00,000 68,00,000
Less: Variable Cost 40,80,000 30,60,000 40,80,000
Contribution 27,20,000 20,40,000 27,20,000
Less: Fixed Cost 16,32,000 16,32,000 16,32,000
EBIT 10,88,000 4,08,000 10,88,000
Less: Interest (EBIT-PBT) ? 3,93,714 3,93,714
PBT ? 14,286(10,000/70%) 6,94,286
Less: Tax @ 30%(or PBT-PAT) ? 4,286 2,08,286
PAT ? 10,000(Nil+10,000) 4,86,000
Less: Preference Dividend 10,000 10,000 10,000
Earnings for Equity share holders ? Nil (at BEP) 4,76,000
Number of Equity Shares 1,50,000 1,50,000 1,50,000
EPS ? - 3.1733
So Interest=₹3,93,714, EPS=₹3.1733, Amount of debt=3,93,714/12%=₹ 32,80,950

Solution 7:
Income Statement
Particulars Amount (₹)
Sales 1,11,00,000
Contribution (Sales × P/V ratio) 27,75,000
Less: Fixed cost (excluding Interest) (7,15,000)

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
EBIT (Earnings before interest and tax) 20,60,000
Less: Interest on debentures (12% ´ ₹ 60,91,400) (7,30,968)
EBT (Earnings before tax) 13,29,032
Less: Tax @ 30% 3,98,710
PAT (Profit after tax) 9,30,322
(i) Operating Leverage:
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹27,75,000
= 𝐸𝐵𝐼𝑇
= ₹20,60,000 = 1.35
(ii) Combined Leverage:
= Operating Leverage × Financial Leverage
= 1.35 ´ 1.55 = 2.09 (Approx)
Or,
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐸𝐵𝐼𝑇
Combined Leverage = 𝐸𝐵𝑇
× 𝐸𝐵𝑇
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹20,60,000
Combined Leverage = 𝐸𝐵𝑇
= ₹13,29,032 = 2.09 (Approx)
(iii) Earnings per share (EPS):
𝑃𝐴𝑇 ₹9,30,322
= 𝑁𝑜. 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = 6,55,000 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 = ₹1.42

Solution 8:
Firms
A(₹.) B(₹.) C(₹.) D(₹.)
Sales 5,000 5,000 5,000 5,000
Sales revenue (Units × price) (₹.) 1,00,000 1,60,000 2,50,000 3,50,000
Less: Variable cost (30,000) (80,000) (1,00,000) (2,50,000)
(Units × variable cost per unit) (₹.)
Less: Fixed operating costs (₹.) (60,000) (40,000) (1,00,000) Nil
EBIT 10,000 40,000 50,000 1,00,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑠𝑎𝑙𝑒𝑠 (𝑆)− 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑠 (𝑉𝐶)
DOL = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐸𝐵𝐼𝑇
₹.1,00,000 − ₹.30,000
DOL(A) = ₹.10,000
= 7
₹.1,60,000 − ₹. 80,000
DOL(B) = ₹. 40,000
= 2
₹.2,50,000 − ₹. 1,00,000
DOL(C) = ₹. 50,000
= 3
₹.3,50,000 − ₹. 2,50,000
DOL(D) = ₹. 1,00,000
= 1
The operating leverage exists only when there are fixed costs. In the case of firm D, there is no magnified
effect on the EBIT due to change in sales. A 20 per cent increase in sales has resulted in a 20 per cent increase
in EBIT. In the case of other firms, operating leverage exists. It is maximum in firm A, followed by firm C and
minimum in firm B. The interception of DOL of 7 is that1 per cent change in sales results in 7 per cent change
in EBIT level in the direction of the change of sales level of firm A.

Solution 9:
Contribution per unit = Sales Price Variable Cost = ₹. 30 – ₹. 20 = ₹. 10 p.u.
Total Contribution = (10,000 units × 60%) × ₹. 10p.u = ₹. 60,000
XY (In ₹.) XM (In ₹.)
Financial Plan
Situation A Situation B Situation A Situation B
Total Contribution 60,000 60,000 60,000 60,000
Less: Fixed cost (20,000) (25,000) (20,000) (25,000)
EBIT 40,000 35,000 40,000 35,000
40,000 × 12% 40,000 × 12% 10,000 × 12% 10,000 × 12%
Less: Interest (4,800) (4,800) (1,200) (1,200)
EBT 35,200 30,200 38,800 33,800
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
DOL = 𝐸𝐵𝐼𝑇 1.50 times 1.71 times 1.50 times 1.71 times
𝐸𝐵𝐼𝑇
DFL = 𝐸𝐵𝑇 1.14 times 1.16 times 1.03 times 1.04 times

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
Solution 10:
(i) Calculation of Operating Leverage (In ₹.)
Sales 50,000
Less: Variable cost (60% of sales) (30,000)
Contribution 20,000
Less: Fixed Costs (12,000)
Operating Profit (EBIT) 8,000
Operating Leverage = Contribution/ Operating Profit = ₹. 20,000/₹. 8,000 = 2.5 times

(ii) Calculation of Financial Leverage

Calculation of debt and Interest thereon:
(a) Debt = ₹. 25,00,000 × 3 = ₹. 75,00,000
(b) Interest on Debt = ₹. 75,00,000 × 12/100 = ₹. 9,00,000 (In ₹.)
Operating Profit 20,00,000
Less: Interest on debt (9,00,000)
Profit before tax 11,00,000
Financial Leverage = Operating Profit/Profit before tax = ₹. 20,00,000/₹. 11,00,000 = 1.82 times

Solution 13.
Statement for calculating of DOL
Particulars Original Proposed
Equity 5,00,000 5,00,000
Debt - 4,00,000
Sales 5,00,000 6,65,000
-VC 2,50,000 2,80,000
Contribution 4,50,000 3,85,000
- FC 4,00,000 4,00,000
50,000
Profit/EBIT 50,000 1,35,000
Int. 4,00,000 x 10% 40,000
EBT 95,000 new

VC pu = 2,50,000/5,000 = 50 – 10 = 40
Advices: Yes profit accept us included in profit
DOL = C/EBIT = 2,50,000/50,000 = 5 times 3,85,000/1,35,000 = 2.85 times

Solution 14:
(i) Degree of operating leverage is computed as % Change in operating Income / % Change in Revenue
Firm Degree of Operating Leverage Beta
PQR Ltd. 25/27 = 0.92 1.00
RST Ltd. 32/25 = 1.28 1.15
TUV Ltd. 36/23 = 1.56 1.30
WXY Ltd. 40/21 = 1.90 1.40

(ii) The degree of operating leverage and the beta have a clear relationship. The greater the degree of
operating leverage, the more responsive income will be to changes in revenue which are correlated with
changes in market movements.

Solution 16:
Percentage change in Earnings per share
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆
DCL = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆
2.475 = 5%
∴ % Change in EPS = 12.375%.

Working Notes:

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
(1) Degree of Operating Leverage (DOL)
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐸𝐵𝐼𝑇+𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
= 𝐸𝐵𝐼𝑇
= 𝐸𝐵𝐼𝑇
15,750+1,575
= 15,750
= 1.1 times

(2) Degree of Financial Leverage (DFL)

𝐸𝐵𝐼𝑇 15,750
= 𝐸𝐵𝑇 = 7,000 = 2.25 times

(3) Degree of combined Leverage (DCL)

= DOL × DFL
= 1.1 × 2.25 times = 2.475 times

Solution 17:
Calculation of Leverages:
Particulars ₹.
Sales 60,00,000
Less: Variable cost (sales × 100/150) (4,00,000)
Contribution 20,00,000
Less: Fixed Cost (5,00,000)
EBIT 15,00,000
Less: Interest on Debentures (3,30,000)
EBIT 11,70,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
Operating Leverage = 𝐸𝐵𝐼𝑇
₹.20,00,000
= ₹.15,00,000
= 1.3333 times

𝐸𝐵𝐼𝑇
Financial Leverage = 𝐸𝐵𝐼𝑇
₹.15,00,000
= ₹.11,70,000
= 1.2821 times
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
Combined Leverage = Operating Leverage × Financial Leverage or 𝐸𝐵𝑇
₹.20,00,000
= 1.3333 × 1.2821 or ₹.11,70,000
= 1.7094 times

Solution 18:
Computation of Degree of Operating leverage, Financial leverage & Combined leverage of two Companies
Particulars Company A Company B
Sales revenue 18,00,000 37,50,000
(60,000 units × ₹. 30) (15,000 units × ₹. 250)
Less: Variable costs (6,00,000) (11,25,000)
(60,000 units × ₹. 10) (15,000 units × ₹. 75)
Contribution 12,00,000 26,25,000
Less: Fixed Costs (7,00,000) (14,00,000)
EBIT 5,00,000 12,25,000
Less: Interest @ 12% on Debentures (48,000) (78,000)
EBT 4,52,000 11,47,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
DOL = 𝐸𝐵𝐼𝑇 (₹.12,00,000/₹. 5,00,000) (₹.26,25,000/₹. 12,25,000)
= 2.4 times = 2.14 times
𝐸𝐵𝐼𝑇
DFL = 𝐸𝐵𝑇 (₹.5,00,000/₹. 4,52,000) (₹.12,25,000/₹. 11,47,000)
= 1.11 times = 1.07 times
DCL = DOL × DFL (2.4 × 1.11) = 2.66 times (2.14 × 1.07) = 2.29 times

Solution 19:
𝐸𝐵𝐼𝑇 𝐸𝐵𝐼𝑇 ₹. 27,00,000
(i) ROI = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
= 𝐷𝑒𝑏𝑡+𝐸𝑞𝑢𝑖𝑡𝑦
= ₹. 1,00,00,000
= 0.27 = 27%

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
(ii) Since the return on investment (27%) is higher than the interest payable on debt at 9%, the firm has
a favorable financial leverage.

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
(iii) Asset Turnover = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠=𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
₹. 75,00,000
Firm’s assets turnover is = ₹. 1,00,00,000 = 0.75
The industry average is 3. Hence the firm has low asset leverage.
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹. 33,00,000
(iv) Operating leverage = 𝐸𝐵𝑇
= ₹. 27,00,000 = 1.2222 times
𝐸𝐵𝐼𝑇 ₹. 27,00,000
Financial leverage = 𝐸𝐵𝑇
= ₹. 22,95,000 = 1.1764 times
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹. 33,00,000
Combined leverage = 𝐸𝐵𝑇
= ₹. 22,95,000 = 1.438 times
Or
Combined leverage = Operating leverage × Financial leverage
= 1.2222 × 1.1764 = 1.438 times

(v) If the sales drop to ₹. 50,00,000 from ₹. 75,00,000, the fall is by 33.33%.
Hence EBIT will drop by 40.73% (% Fall in sales × operating leverage)
∴ The new EBIT will be ₹. 27,00,000 × (1 – 40.73%)
= ₹. 16,00,290 or rounded upto ₹. 16,00,000.

(vi) EBT to become zero means 100% reduction in EBT. Since the combined leverage is 1.438 times,
sales have to drop by 100/1.438 i.e. 69.54%.
Hence the new sales will be ₹. 75,00,000 × (1 – 69.54%) = ₹. 22,84,500 (approx.)

Working Notes:
Particulars ₹.
Sales 75,00,000
Less: Variable cost (42,00,000)
Contribution 33,00,000
Less: Fixed Costs (6,00,000)
EBIT 27,00,000
Less: 9% interest on ₹. 45,00,000 (4,05,000)
EBT 22,95,000

Solution 22.
Total Liability = Debt + Equity
= 60,000 + 20,000 = 80,000
80,000 = Total liability = Total Assets
Assets turnover = Sale/Total Assets
2 = Sales/80,000
Sales = ₹ 1,60,000
Statement for computing leverage
Particulars (a)A (a)B (a)C (b)A (b)B
Sales 1,60,000 1,60,000 1,60,000 1,60,000
(-)VC
Con. 40% 64,000 64,000 64,000 64,000
(-)FC 4,000 4,000 4,000 6,000 6,000
EBIT 60,000 60,000 60,000 58,000
(-) Int 2,000 4,000 6,000 2,000
EBT 58,000 56,000 54,000 56,000
C 64,000 64,000 64,000 64,000
DOL = C/EBIT 60,000 60,000 60,000 58,000
DOE = EBIT/EBT 60,000/58,000 60,000/56,000 60,000/54,000 58,000/56,000

Solution 23:
Ratios for the year 2020-21
(i)Inventory turnover ratio

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
𝐶𝑂𝐺𝑆 ₹7,38,500
= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = (87,500+70,000) = 9.4
2

(ii)Financial leverage
𝐸𝐵𝐼𝑇 ₹33,250
= 𝐸𝐵𝑇 = ₹22,750 = 1.46
𝐸𝐵𝐼𝑇(1−𝑡) ₹33,250(1−0.3) ₹23275
(iii)ROCE = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
= ₹2,10,000+₹1,92,500 = ₹2,01,250
× 100 = 11.56%
2

Solution 26:
₹.14.4 𝑐𝑟𝑜𝑟𝑒𝑠
(i) Earnings per share = 1 𝑐𝑟𝑜𝑟𝑒 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠
= ₹. 14.40
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹. 35
(ii) Operating Leverage = 𝐸𝐵𝐼𝑇
= ₹. 27 = 1.296 times
It indicates the choice of technology and fixed cost in cost structure. It is level specific. When firm operates
beyond operating break-even level, then operating leverage is low. It indicates sensitivity of earnings before
interest and tax (EBIT) to change in sales at a particular level.
𝐸𝐵𝐼𝑇 ₹. 27
(iii) Financial Leverage = 𝑃𝐵𝑇 = ₹. 24 = 1.125 times
The financial leverage is favourable since the debt service obligation is small vis-a-vis EBIT.
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐸𝐵𝐼𝑇
(iv) Combined Leverage = 𝐸𝐵𝐼𝑇
× 𝑃𝐵𝑇 = 1.296 × 1.125 = 1.458 times
The combined leverage studies the choice of fixed cost in cost structure and choice of debt in capital
structure. It studies how sensitive the change in EPS is vis-a-vis change in sales.
The leverages – operating, financial and combined are measures of risk.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 15
(v) Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 8 = 1.88

Working Notes:
Total Assets = ₹. 40 crores
Total Asset Turnover Ratio = 2.5 times
Hence, Total Sales = 40 × 2.5 = ₹. 100 crores

Computation of Profits after Tax (PAT) (₹. In crores)

Sales 100
Less: Variable operation cost @ 65% 65
Contribution 35
Less: Fixed cost (other than Interest) 8
EBIT 27
Less: Interest on debentures (15% × 20) 3
PBT 24
Less: Tax 40% 9.6
PAT 14.4

Solution 29:
(a) Calculation of Degree of Operating (DOL), Financial (DFL) and Combined leverages (DCL).
₹.3,40,000−₹.60,000
DOL = ₹.2,20,000
= 1.27 times.
₹.2,20,000
DFL = ₹.1,60,000
= 1.37 times.
DCL = DOL × DFL
= 1.27 × 1.37 = 1.75 times.

(b) Earnings per share at the new sales level.

Particulars Increase by 20% (₹.) Decrease by 20% (₹.)
Sales level 4,08,000 2,72,000
Less: Variable expenses (72,000) (48,000)
Less: Fixed cost (60,000) (60,000)
Earnings before interest and taxes 2,76,000 1,64,000
Less: Interest (60,000) (60,000)
Earnings before taxes 2,16,000 1,04,000
Less: Taxes (75,600) (36,400)
Earnings after taxes (EAT) 1,40,400 67,600

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Number of equity shares 80,000 80,000
EPS 1.75 0.84

Working Notes:
(i) Variable Costs = ₹. 60,000 (Total cost – depreciation)
(ii) Variable Costs at:
(a) Sales level, ₹. 4,08,000 = ₹. 72,000
(b) Sales level, ₹. 2,72,000 = ₹. 48,000

Solution 32:
Computation of Earnings after tax
Contribution = ₹. 60 × 1,000 units = ₹. 60,000
Operating Leverage (OL) × Financial Leverage (FL) = Combined Leverage (CL)
6 × Financial Leverage = 24
∴ Financial Leverage = 4 times
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹. 60,000
Operating Leverage = 𝐸𝐵𝐼𝑇
= 𝐸𝐵𝐼𝑇 = 6
₹. 60,000
∴ EBIT = 6
= ₹. 10,000
𝐸𝐵𝐼𝑇
Financial Leverage = 𝐸𝐵𝑇
=4
𝐸𝐵𝐼𝑇 ₹. 10,000
∴ EBT = 4
= 4
= ₹. 2,500
Since tax rate = 30%
Earnings after Tax (EAT) = EBT (1 – 0.30)
= 2,500 (0.70)
∴ Earnings after Tax (EAT) = ₹. 1,750

Solution 33:
ROE = [ROI + {(ROI – r) × D/E}] (1 – t)
= [20% + {(20% – 10%) × 0.60}] (1 – 0.40)
= [20% + 6%] × 0.60 = 15.60%

Solution 35:
(i) Financial leverage
Combined Leverage = Operating Leverage (OL) × Financial Leverage (FL)
2.8 = 1.4 × FL
Financial Leverage = 2

(ii) P/V Ratio and EPS

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
P/V ratio = 𝑆𝑎𝑙𝑒𝑠
× 100
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
Operating leverage = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 –𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
× 100
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
1.4 = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛−₹. 2,04,000
1.4 (Contribution – ₹. 2,04,000) = Contribution
1.4 Contribution – ₹. 2,85,600 = Contribution
₹. 2,85,600
Contribution = 0.4
Contribution = ₹. 7,14,000
7,14,000
P/V ratio = 30,00,000 × 100 = 23.8%
Therefore, P/V Ratio = 23.8%
𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥
EPS = 𝑁𝑜.𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠
EBT = Sales – VC – FC – Interest
= ₹. 30,00,000 – ₹. 22,86,000 – ₹. 2,04,000 – ₹. 2,55,000 = ₹. 2,55,000
PAT = EBT – Tax
= ₹. 2,55,000 – ₹. 76,500 = ₹. 1,78,500
₹. 1,78,500
EPS = ₹. 1,70,000 = ₹. 1.05

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(iii) Assets turnover
𝑆𝑎𝑙𝑒𝑠 ₹.30,00,000
Assets Turnover = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
= ₹. 38,25,000
= 0.784
0.784 < 1.5 means lower than Industry Turnover.

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 ₹. 2,04,000+₹. 2,55,000

(iv) 𝑃/𝑉 𝑅𝑎𝑡𝑖𝑜
= 23.8%
= ₹. 19,28,571
Therefore, at 19,28,571 level of sales, the Earnings before Tax of the company will be equal to zero.

Solution 37:
Income Statement (In ₹.)
Particulars Company A Company B
Sales 91,000 (Contribution + Variable cost) 1,05,000
Less: Variable Cost 56,000 63,000 (60% of 1,05,000)
Contribution 35,000 (EBIT + Fixed Cost) 42,000 (Sales – Variable Cost)
Less: Fixed cost 20,000 31,500 (Bal. Fig)= (Contribution – EBIT)
EBIT 15,000 (EBT + Interest) 10,500
Less: Interest 12,000 9,000
EBT 3,000 1,500 (EBIT – Interest)
Less: Tax 900 (30% on EBT) 450 (30% on EBT)
EAT 2,100 (EBT – Tax) 1,050 (EBT – Tax)
𝐸𝐵𝐼𝑇 𝐸𝐵𝑇+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹. 42,000
DFL = 𝐸𝐵𝑇
= 𝐸𝐵𝑇
= 5Times. DOL = 𝐸𝐵𝐼𝑇
= 𝐸𝐵𝐼𝑇
= 4Times
𝐸𝐵𝑇+₹. 12,000
So, 𝐸𝐵𝑇
= 5. EBT = ₹. 3,000 EBIT = ₹. 10,500

Solution 38.
I II III
TA 2,000 2,000 2,000
Debt : Equity 0:1 1:4 2:3
Debt 0 400 800
Equity 2000 1600 1200
ROI = EBIT/CE x 100 30% 30% 30%
EBIT = CE x ROI 600 600 600
(-) interest @ 15% - (60) (120)
EBT 600 540 480
(-) Tax @ 35%
EAT/EAES 390 351
ROE = EAES/Equity 390/2,000 351/1,600 312/1,200
19.5% 21.93% 26%
Here trading on equity is favourable because ROI > Interest Rate. Hence when we increase debt content in the
capital, then could earn more on equity funds. Hence ROE has increased with increase in leverage.

Solution 39:
₹. 12,00,000
(a) Operating Leverage = ₹. 2,00,000
= 6 times
₹. 2,00,000
(b) Financial Leverage = ₹. 1,00,000
= 2 times
(c) Combined Leverage = DOL × DFL = 6 × 2 = 12 times
50,000
(d) R.O.E. = 10,00,000 × 100 = 5%
(e) Operating Leverage = 6
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇
6 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠
6 × 25% = Percentage change in EBIT
Percentage change in EBIT = 150%
Increase in EBIT = ₹. 2,00,000 × 150% = ₹. 3,00,000
New EBIT = 5,00,000

Working Notes.
Sales ₹. 24,00,000

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Less: Variable cost (₹. 12,00,000)
Contribution ₹. 12,00,000
Less: Fixed cost (₹. 10,00,000)
EBIT ₹. 2,00,000
Less: Interest (₹. 1,00,000)
EBT ₹. 1,00,000
Less: Tax (50%) (₹. 50,000)
EAT ₹. 50,000
No. of equity shares ₹. 10,000
EPS 5

Solution 41.
Computation of Profits after Tax (PAT)
Particulars Amount (₹)
Sales 84,00,000
Contribution (Sales × P/V ratio) 23,14,200
Less: Fixed cost (excluding Interest) (6,96,000)
EBIT (Earnings before interest and tax) 16,18,200
Less: Interest on debentures (12% x ₹ 37 lakhs) (4,44,000)
Less: Other fixed Interest (balancing figure) (88,160)
EBT (Earnings before tax) 10,86,040*
Less: Tax @ 40% 4,34,416
PAT (Profit after tax) 6,51,624

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 23,14,200
(i) Operating Leverage : 𝐸𝐵𝐼𝑇
= ₹ 16,18,200
= 1.43
(ii) Combined Leverage: Operating Leverage × Financial Leverage = 1.43 x 1.49 = 2.13
Or,
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐸𝐵𝐼𝑇
Combined Leverage = 𝐸𝐵𝐼𝑇
x 𝐸𝐵𝑇

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 23,14,200
Combined Leverage = 𝐸𝐵𝑇
= ₹ 10,86,040
= 2.13

𝐸𝐵𝐼𝑇 ₹ 16,18,200
Financial Leverage = 𝐸𝐵𝑇
= 𝐸𝐵𝑇
= 1.49

₹ 16,18,200
So , EBT = 1.49
= ₹ 10,86,040

Accordingly, other fixed interest

= ₹ 16,18,200 – ₹ 10,86,040 – ₹ 4,44,000 = ₹ 88,160

𝑃𝐴𝑇 ₹ 6,51,624
(iii) Earnings per share (EPS) : = 𝑁𝑜. 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
= 5,00,000 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠
= ₹ 1.30

Solution 42.
Workings:
1. Contribution = Sales x P/V ratio= ₹ 15,00,000 x 70% = ₹ 10,50,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
2. Operating Leverage = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 & 𝑇𝑎𝑥 (𝐸𝐵𝐼𝑇)

₹ 10,50,000
Or, 1.4 = 𝐸𝐵𝐼𝑇

EBIT = ₹ 7,50,000
𝐸𝐵𝐼𝑇
3. Financial Leverage = 𝐸𝐵𝑇

₹ 7,50,000
Or , 1.25 = 𝐸𝐵𝑇

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EBT = ₹ 6,00,000
4. Fixed Cost = Contribution – EBIT = ₹ 10,50,000 – ₹ 7,50,000 = ₹ 3,00,000
5. Interest = EBIT – EBT = ₹ 7,50,000 – ₹ 6,00,000 = ₹ 1,50,000
6. Income Statement
Particulars Amount (₹)
Sales 15,00,000
Less: Variable cost (30% of ₹ 15,00,000) 4,50,000
Contribution (70% of ₹ 15,00,000) 10,50,000
Less: Fixed costs 3,00,000
Earnings before interest and tax (EBIT) 7,50,000
Less: Interest 1,50,000
Earnings before tax (EBT) 6,00,000

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 10,50,000
(i) Combined Leverage = 𝐸𝐵𝑇
= ₹ 6,00,000
= 1.75 times

Or, Combined Leverage = Operating Leverage x Financial Leverage

= 1.4 x 1.25 = 1.75 times
So, if sales is increased by 15% then taxable income (EBT) will be increased by 1.75 × 15% = 26.25%
Verification
Particulars Amount(₹)
New Sales after 15% increase (₹ 15,00,000 + 15% of ₹15,00,000) 17,25,000
Less: Variable cost (30% of ₹ 17,25,000) 5,17,500
Contribution (70% of ₹ 17,25,000) 12,07,500
Less: Fixed costs 3,00,000
Earnings before interest and tax (EBIT) 9,07,500
Less: Interest 1,50,000
Earnings before tax after change (EBT) 7,57,500
Increase in Earnings before tax (EBT) = ₹ 7,57,500 - ₹ 6,00,000 = ₹ 1,57,500
₹ 1,57,500
So, percentage change in Taxable Income (EBT) = ₹ 6,00,000 x 100 = 26.25%
hence verified

(ii) Degree of Operating Leverage (Given) = 1.4 times

So, if sales is decreased by 10% then EBIT will be decreased by 1.4 × 10% = 14%
Verification
Particulars Amount (₹)
New Sales after 10% decrease (₹ 15,00,000 - 10% of ₹ 15,00,000) 13,50,000
Less: Variable cost (30% of ₹ 13,50,000) 4,05,000
Contribution (70% of ₹ 13,50,000) 9,45,000
Less: Fixed costs 3,00,000
Earnings before interest and tax after change (EBIT) 6,45,000
Decrease in Earnings before interest and tax (EBIT) = ₹ 7,50,000 - ₹ 6,45,000 = ₹ 1,05,000
₹1,05,000
So, percentage change in EBIT = ₹ 7,50,000 x 100 = 14% , hence verified

(iii) Degree of Financial Leverage (Given) = 1.25 times

So, if EBIT increases by 15% then Taxable Income (EBT) will be increased by 1.25 × 15% = 18.75%
Verification
Particulars Amount (₹)
New EBIT after 15% increase (₹ 7,50,000 + 15% of ₹ 7,50,000) 8,62,500
Less: Interest 1,50,000
Earnings before Tax after change (EBT) 7,12,500
Increase in Earnings before Tax = ₹ 7,12,500 - ₹ 6,00,000 = ₹ 1,12,500
₹ 1,12,500
So, percentage change in Taxable Income (EBT) = ₹ 6,00,000 x 100 = 18.75%, hence verified

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
Solution 43.
Workings :
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
1. Profit volume ratio = 𝑆𝑎𝑙𝑒𝑠
x 100

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
So, 25 = ₹ 84,00,000
x 100

₹ 84,00,000
Contribution = 100
x 25 = ₹ 21,00,000

𝐸𝐵𝐼𝑇
2. Financial Leverage = 𝐸𝐵𝑇

₹ 13,50,000
Or , 1.39 = 𝐸𝐵𝑇
(as calculated above)
EBT = ₹ 9,71,223
3. Income Statement
Particulars (₹)
Sales 84,00,000
Less: Variable Cost (Sales - Contribution) (63,00,000)
Contribution 21,00,000
Less: Fixed Cost (7,50,000)
EBIT 13,50,000
Less: Interest (EBIT - EBT) (3,78,777)
EBT 9,71,223
Less: Tax @ 30% (2,91,367)
Profit after Tax (PAT) 6,79,856
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 21,00,000
(i) Operating leverage = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐵𝐼𝑇)
= ₹ 13,50,000
= 1.556 (approx.)

(ii) Combined Leverage = Operating Leverage x Financial Leverage

= 1.556 x 1.39 = 2.163 (approx.)
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 21,00,000
Or, 𝐸𝐵𝑇
= ₹ 9,71,223 = 2.162 (approx.)

𝑃𝐴𝑇 ₹ 6,79,856
(iii) Earnings per share (EPS) = 𝑁𝑜. 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 50,000
= ₹ 13.597

𝐸𝑃𝑆 ₹ 13.597
(iv) Earning Yield = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒
x 100 = ₹ 200
x 100 = ₹ 13.597

Market price ₹ 200

Note: The question has been solved considering Financial Leverage given in the question as the base for
calculating total interest expense including the interest of 12% Bonds of ₹ 30 Lakhs. The question can also be
solved in other alternative ways.

Solution 44:
(i) Calculation of P/V ratio ,EPS, Financial Leverage and Asset Turnover
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 (𝐶)
Operating leverage = 𝐶 – 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 (𝐹𝐶) x 100

𝐶
1.2 = 𝐶 − 2,25,000

Or, 1.2 (C – 2,25,000) = C

Or, 1.2 C – 2,70,000 = C
₹ 2,70,000
Or, C = 0.2
= ₹ 13,50,000

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 (𝐶) ₹ 13,50,000

Now, P/V Ratio = 𝑆𝑎𝑙𝑒𝑠 (𝑆)
x 100 = ₹ 45,00,000
x 100 = 30%

Therefore , PV Ratio = 30%

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥
EPS = 𝑁𝑜. 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠

EBT = Contribution – FC – Interest

= ₹ 13,50,000 - ₹ 2,25,000 - ₹ 2,40,000
= ₹ 8,85,000

PAT = EBT- Tax

= ₹ 8,85,000 - ₹ 2,65,500 = ₹ 6,19,500

₹ 6,19,500
EPS = ₹ 3,85,000
= ₹ 1.61

Combined Leverage = Operating Leverage (OL) x Financial Leverage (FL)

4.8 = 1.2 x FL
Or, FL =4
Financial Leverage = 4
𝑆𝑎𝑙𝑒𝑠 ₹ 45,00,000
Assets Turnover = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = ₹ 58,50,000 = 0.769

0.769 < 1.1. It means lower than industry turnover.

(ii)
EBT zero means Contribution = Fixed cost + Interest
(iii)
Hence Contribution = ₹ 2,25,000 + ₹ 2,40,000 = ₹ 4,65,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 4,65,000
Sales = 𝑃/𝑉 𝑅𝑎𝑡𝑖𝑜 = 30% = ₹ 15,50,000

Therefore , at ₹ 15,50,000 level of sales , the Earnings before tax of the company will be equal to zero.
(Note: Question may also be solved in alternative ways.)

Solution 45:
(i) Working Notes
Earnings after tax (EAT)is 5% of sales
Income tax is 50%
So, EBT is 10% of Sales
Since Interest Expenses is ₹ 30,000
EBIT = 10% of Sales + ₹ 30,000……………………………………………………. (Equation i)
Now Degree of operating leverage = 4
So, Contribution / EBIT = 4
Or, Contribution = 4 EBIT
Or, Sales – Variable Cost = 4 EBIT
Or, Sales – ₹ 6,00,000 = 4 EBIT ………………………………………………………………………(Equation ii)
Replacing the value of EBIT of equation (i) in Equation (ii)
We get, Sales – ₹ 6,00,000 = 4 (10% of Sales + ₹ 30,000)
Or, Sales – ₹ 6,00,000 = 40% of Sales + ₹ 1,20,000
Or, 60% of Sales = ₹ 7,20,000
₹ 7,20,000
So, Sales = 60% = ₹ 12,00,000

Contribution = Sales – Variable Cost = ₹ 12,00,000 – ₹ 6,00,000 = ₹ 6,00,000

₹ 6,00,000
EBIT = 4
= ₹ 1,50,000

Fixed Cost = Contribution – EBIT = ₹ 6,00,000 – ₹ 1,50,000 = ₹ 4,50,000

EBT = EBIT – Interest = ₹ 1,50,000 – ₹ 30,000 = ₹ 1,20,000
EAT = 50% of ₹ 1,20,000 = ₹ 60,000
Income Statement
Particulars (₹)
Sales 12,00,000
Less: Variable cost 6,00,000
Contribution 6,00,000

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 Chapter 4: FINANCING DECISIONS- LEVERAGES Solutions
Less: Fixed cost 4,50,000
EBIT 1,50,000
Less: Interest 30,000
EBT 1,20,000
Less: Tax (50%) 60,000
EAT 60,000

𝐸𝐵𝐼𝑇 1,50,000
(ii) Financial leverage = 𝐸𝐵𝑇
= 1,20,000
= 1.25 times

Combined Leverage = Operating leverage x Financial leverage

= 4 x 1.25 = 5 times
Or,
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐸𝐵𝐼𝑇
Combined Leverage = 𝐸𝐵𝐼𝑇
x 𝐸𝐵𝑇

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 ₹ 6,00,000
Combined Leverage = 𝐸𝐵𝐼𝑇
= ₹ 1,20,000
= 5 times

(iii) Percentage Change in earnings per shares

% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆 % 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆
Combined Leverage = % 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠 = 5 = 5%
5%
% Change in EPS = 25%
Hence, if sales increased by 5%, EPS will be increased by 25%

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS

Solution 1:
(i) Determination of Sales and Cost of goods sold:
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
Gross Profit Ratio = 𝑆𝑎𝑙𝑒𝑠
x100
25 ₹ 12,00,000
Or, 100
= 𝑆𝑎𝑙𝑒𝑠

₹ 12,00,000
Or, Sales = 25
= ₹ 48,00,000

Cost of Goods Sold = Sales – Gross Profit

= ₹ 48,000 – ₹ 12,00,000 = ₹ 36,00,000

(ii) Determination of Sundry Debtors:

Debtors’ velocity is 3 months or Debtors’ collection period is 3 months,
12 𝑚𝑜𝑛𝑡ℎ𝑠
So, debtors’ turnover ratio = 3 𝑚𝑜𝑛𝑡ℎ𝑠 = 4

𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 ₹ 48,00,000

Debtors’ turnover ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
= 𝐵𝑖𝑙𝑙𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 + 𝑆𝑢𝑛𝑑𝑟𝑦 𝐷𝑒𝑏𝑡𝑜𝑟𝑠
= 4

Or, Sundry Debtors + Bills receivable = ₹ 12,00,000

Sundry Debtors = ₹ 12,00,000 – ₹ 75,000 = ₹ 11,25,000

(iii) Determination of Closing Stock

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
Stock Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 = ₹ 36,00,000 = 1.5

So, Average Stock = ₹ 24,00,000

𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘

Now Average Stock = 2

(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘 + ₹ 30,000)

Or, Opening Stock + 2
= ₹ 24,00,000

Or 2 Opening Stock + ₹ 30,000 = ₹ 48,00,000

Or 2 Opening Stock = ₹ 47,70,000
Or, Opening Stock = ₹ 23,85,000
So, Closing Stock = ₹ 23,85,000 + ₹ 30,000 = ₹ 24,15,000

(iv) Determination of Sundry Creditors:

Creditors’ velocity of 2 months or credit period is 2 months.
12 𝑚𝑜𝑛𝑡ℎ𝑠
So, Creditors’ turnover ratio = 2 𝑚𝑜𝑛𝑡ℎ𝑠 = 6

𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠*
Creditors turnover ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
= ₹ 36,30,000 =6
Sundry Creditors + Bills Payables
So Sundry Creditors + Bills Payable = ₹ 6,05,000
Or, Sundry Creditors + ₹ 30,000 = ₹ 6,05,000
Or, Sundry Creditors = ₹ 5,75,000

(v) Determination of Fixed Assets

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
Fixed Assets Turnover Ratio = 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
=4
Or, ₹ 36,00,000 = 4
Fixed Assets
Or, Fixed Asset = ₹ 9,00,000

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

Workings:
*Calculations of Credit Purchases:
Cost of goods sold = Opening Stock + Purchases – Closing Stock
₹ 36,00,000 = ₹ 23,85,000 + Purchases – ₹ 24,15,000
Purchases (credit) = ₹ 36,30,000

Calculation of credit purchase also can be done as below:

Or Credit Purchases = Cost of goods sold + Difference in Opening Stock
Or Credit Purchases = 36,00,000 + 30,000 = ₹ 36,30,000

Solution 2:
Working Notes:
(1) Total liability = Total Assets = ₹ 50,00,000
Debt to Total Assets Ratio = 0.40
𝐷𝑒𝑏𝑡
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
= 0.40

𝐷𝑒𝑏𝑡
Or, 50,00,000
= 0.40

So Debt = 20,00,000

(2) Total Liabilities = ₹ 50,00,000

Equity share Capital + Reserves + Debt = ₹ 50,00,000
So, Reserves = ₹ 50,00,000 – ₹ 20,00,000 = ₹ 20,00,000
So Reserves & Surplus = ₹ 10,00,000

𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡
(3) 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝐹𝑢𝑛𝑑
= 30%*

𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

(20,00,000 + 10,00,000)
= 30%

Long Term Debt = ₹ 9,00,000

(4) So, Accounts Payable = ₹ 20,00,000 – ₹ 9,00,000

Accounts Payable = ₹ 11,00,000

(5) Gross Profit to Sales = 20%

Cost of Goods sold = 80% of Sales = ₹ 64,00,000
100
Sales = 80 x 64,00,000 = 80,00,000

(6) Inventory Turnover = 360/55

COGS/Closing Inventory = 360/55
64,00,000/Closing Inventory = 360/55
Closing Inventory = 9,77,778
(7) Accounts Receivable Period = 36 days
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
x 360 = 36

36
Accounts Receivables = 360
x Credit Sales

36
= 360
x 80,00,000 (Assumed all sales are on credit)

Accounts Receivable = ₹ 8,00,000

(8) Quick Ratio = 0.9
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 0.9

Cash + debtors = 0.9

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

11,00,000
Cash + 8,00,000 = ₹ 9,90,000
Cash = ₹ 1,90,000

(9) Fixed Assets = Total Assets – Current Assets = 50,00,000 – (9,77,778 + 8,00,000 + 1,90,000) = 30,32,222
Balance Sheet of ABC Industries as on 31st March 2021
Liabilities ₹ Assets ₹
Share Capital 20,00,000 Fixed Assets 30,32,222
Reserved Surplus 10,00,000 Current Assets:
Long term debt 9,00,000 Inventory 9,77,778
Accounts payable 11,00,000 Accounts 8,00,000
Receivables
Cash 1,90,000
Total 50,00,000 Total 50,00,000
(* Note: Equity shareholders’ fund represents equity in “Long term debts to equity ratio”. The question can be
solved assuming only share capital as ‘equity’)

Solution 3:
Calculation of Fixed Assets and Proprietor’s Funds
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 0.75
' = 1
𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑜𝑟𝑟 𝑠 𝐹𝑢𝑛𝑑
Fixed Assets = 0.75 Proprietor’s Fund
Proprietor’s Fund = Total Assets – Current Liabilities
Proprietor’s Fund = Fixed Assets + Current Assets – Current Liabilities
Proprietor’s Fund = Fixed Assets + Net Working Capital
Proprietor’s Fund = 0.75 Proprietor’s fund + Net Working Capital
0.25 Proprietor’s Fund = ₹ 6,00,000
₹6,00,000
Proprietor’s Fund = 0.25 = ₹ 24,00,000
Therefore, Fixed Assets = 0.75 × ₹ 24,00,000
= ₹ 18,00,000

Solution 4:
Ratios for the year 2005-2006(₹ in Lakhs)
𝐶𝑂𝐺𝑆 ₹20,860
(i) (a) Inventory Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = ₹2,867+₹2,407 = 7.91 times
( 2
)
𝐸𝐵𝐼𝑇 ₹170
(b) Financial Leverage = 𝑃𝐵𝑇
=₹ 57
= 2.98 times

𝐸𝐵𝐼𝑇 ₹170
(c) Return on Investment= 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
= ₹5,947+₹4,555 = 3.24%
2
𝑃𝐴𝑇 ₹34 ₹ 34
(d) ROE= ' = ₹ 2,377+₹ 1,472 = ₹1,924.5
= 1.77%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠 2

(e) Average Collection Period

₹ 22,165
Average sales per day = 365 = ₹ 60.73 lakhs
₹ 1,495+₹ 1,168
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 ₹ 1,331.5
Average collection period = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑎𝑙𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
= 2
₹ 60.73
= ₹60.73
= 22 days.

(ii) Brief Comment on the financial position of JKL Ltd. = The Profitability of operations of the
company are showing sharp decline due to increase in Operating expenses. The financial and
operating leverages are becoming adverse. The liquidity of the company is under great stress.

Solution 6:
a. Calculation of Quick Ratio
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 ₹ 3,30,000
Quick Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = ₹ 3,00,000
= 1.1:1 times

b. Calculation of Fixed Assets Turnover Ratio

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

𝑆𝑎𝑙𝑒𝑠 ₹ 35,00,000
Fixed Asset Turnover Ratio = 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
= ₹ 10,00,000
= 3.5 times

c. Calculation of Proprietary Ratio

𝑁𝑒𝑡 𝑊𝑜𝑟𝑡ℎ ₹ 1050,000
Proprietary Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = ₹ 17,50,000 = 0.6 : 1

d. Calculation of Earnings per Equity shares (EPS)

𝑃𝐴𝑇−𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 ₹ 2,62,500−₹ 18,000
Earnings per Equity Share = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠
= ₹ 60,000
= ₹ 4.075 per Share = ₹ 4.08

e. Calculation of Price Earnings Ratio (P/E Ratio)

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒 ₹16
P/E Ratio = 𝐸𝑃𝑆
= ₹4.075 = 3.926
Price – Earnings Ratio (P/E Ratio) = 3.93 times

Working Notes:
1. Net Working Capital = Current Assets – Current Liabilities
2.5 – 1 = 1.5
𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 × 2.5 ₹ 4,50,000 × 2.5
Thus, Current Assets = 1.5
= 1.5
= ₹ 7,50,000
Current Liabilities = ₹ 7,50,000 – ₹ 4,50,000= ₹ 3,00,000

𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
2. Total Assets Turnover Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
=2
Sales = Total Assets Turnover × Total Assets
= 2 × (₹ 10,00,000 + ₹ 7,50,000) = ₹ 35,00,000

3. Cost of Goods Sold = 100 – 20 = 80% of Sales

= 80% of ₹ 35,00,000 = ₹ 28,00,000

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 ₹28,00,000

4. Average Stock = 𝑆𝑡𝑜𝑐𝑘 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
= 7
= ₹ 4,00,000
Closing Stock = (Average Stock × 2) – Opening Stock
= (₹ 4,00,000× 2 ) – ₹ 3,80,000 = ₹ 4,20,000

Quick Assets = Current Assets – Closing Stock

= ₹ 7,50,000 – ₹ 4,20,000 = ₹ 3,30,000

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐷𝑒𝑏𝑡 𝐸𝑞𝑢𝑖𝑡𝑦)1.5 ₹17,50,000 × 1.5

Net Worth = 1+1.5
= 2.5
= ₹ 10,50,000

5. Profit After Tax (PAT) = Total Assets × Return on Total Assets = ₹ 17,50,000× 15% = ₹ 2,62,500

Solution 7:
(In ‘000)
Ratio Formula 2018-19 2019-20 2020-21 Industry
Average
Current 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 1,320
= 2.54
6,200
= 1.80
8,912
= 1.60 2.30:1
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 520 3,456 5,560
ratio
Acid test 𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 680
= 1.31
3,200
= 0.93
4,412
= 0.79 1.20:1
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 520 3,456 5,560
ratio (quick
ratio)
Receivable 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 3,600
=
8,640 14,400 7 times
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 (600 +600)/2 (600 +3000)/2 (3000 + 4,200)/2
turnover
6 = 4.80 =4
ratio
Inventory 𝐶𝑂𝐺𝑆 2,480
=
5,664 9,600
= 4.85 times
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 (640 + 640)/2 (640 + 3,000)/2 (3,000 + 4,500)/2
turnover
3.88 = 3.11 2.56
ratios
Long-term 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡
x 100
1,472
x100 =
2,472
x 100
5,000
x 100 24%
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 1,992 5,928 10,560
debt to
73.90% = 41.70% = 47.35%
total debt

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Debt-to-eq 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡

x 100
1,472
x 100
2,472
x 100
5,000
x 100 = 35%
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝑒𝑞𝑢𝑖𝑡𝑦 3,128 5,272 7,752
uity ratio
= 47.06% = 46.89% 64.50%
Net profit 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
x 100
728
x 100
1,344
x 100
1,680
x 100 18%
𝑆𝑎𝑙𝑒𝑠 4,000 9,600 16,000
ratio
= 18.2% = 14% = 10.5%
Return on 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥𝑒𝑠
x
728
x 100
1,344
x 100
1,680
x 100 10%
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 5,120 11,200 18,312
total
100 = 14.22% = 12% = 9.17%
assets
Interest 𝐸𝐵𝐼𝑇 1,160
= 9.67
2,236
= 7.08
3,080
= 4.53 10
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 120 316 680
coverage
ratio
(times
interest
earned)

Conclusion:
In the last two years, the current ratio and quick ratio are less than the ideal ratio (2:1 and 1:1 respectively)
indicating that the company is not having enough resources to meet its current obligations. Receivables are
growing slower. Inventory turnover is slowing down as well, indicating a relative build-up in inventories or
increased investment in stock. High Long-term debt to total debt ratio and Debt to equity ratio compared to
that of industry average indicates high dependency on long term debt by the company. The net profit ratio is
declining substantially and is much lower than the industry norm. Additionally, though the Return on Total
Asset (ROTA) is near to industry average, it is declining as well. The interest coverage ratio measures how
many times a company can cover its current interest payment with its available earnings. A high interest
coverage ratio means that an enterprise can easily meet its interest obligations, however, it is declining in the
case of Jensen & Spencer and is also below the industry average indicating excessive use of debt or inefficient
operations.
On overall comparison of the industry average of key ratios than that of Jensen & Spencer, the company is in
deterioration position. The company’s profitability has declined steadily over the period. However, before
jumping to the conclusion relying only on the key ratios, it is pertinent to keep in mind the industry, the
company dealing in with i.e. manufacturing of pharmaceutical drugs. The pharmaceutical industry is one of
the major contributors to the economy and is expected to grow further. After the covid situation, people are
more cautious towards their health and are going to spend relatively more on health medicines. Thus, while
analyzing the loan proposal, both the factors, financial and non-financial, needs to be kept in mind.

Solution 8:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 ₹ 3,75,000
(1) Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= ₹1,65,000
= 2.27 : 1

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 ₹ 2,00,000

(2) Quick Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= ₹ 1,65,000
= 1.21 : 1

𝐷𝑒𝑏𝑡 ₹ 3,50,000
(3) Debt Equity Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦
= ₹ 7,50,000
= 0.467 : 1

𝐸𝐵𝐼𝑇 4.09−0.35−0.25−0.50
(4) Interest coverage Ratio = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
= 0.47
= 6.36 times

𝐸𝐵𝐼𝑇 ₹2.99
(5) Fixed Charge Coverage= 𝑃𝑟𝑒𝑓.𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = ₹0.2 = 3.44 times
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡+ (𝑖−𝑡)
₹0.47+ (𝑖−0.5)

𝐶𝑂𝐺𝑆 ₹ 11,00,000
(6) STR = 𝑆𝑡𝑜𝑐𝑘
= ₹ 1,50,000+ ₹ 1,75,000 = 6.77 times
2

𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 ₹ 12,00,000

(7) DTR = 𝐷𝑒𝑏𝑡𝑜𝑟𝑠
= ₹ 1,00,000
= 12 times

360 𝑑𝑎𝑦𝑠
(8) Average Collection Period = 12
= 30 days

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 ₹ 4,00,000

(9) Gross Profit Ratio = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
× 100 = ₹ 15,00,000
× 100 = 26.67%

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𝑃𝐴𝑇 ₹ 1,26,000
(10) Net Profit Ratio = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
× 100 = ₹ 15,00,000
× 100 = 8.4%

𝐶𝑂𝐺𝑆+𝐴𝑑𝑚.𝐸𝑥𝑝. +𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝐸𝑥𝑝. ₹ (11,00,000+50,000)+ 35,000+25,000

(11) Operating Ratio = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
× 100 = ₹ 15,00,000
× 100 = 80.67%
𝐸𝐵𝐼𝑇 ₹ 2,99,000
(12) Return on Capital Employed = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 × 100 = ₹ 11,00,000 × 100 = 27.18%

𝐸𝐴𝐸 ₹1,26,000−₹ 20,000

(13) Earnings per share = 𝑁𝑜. 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠
= 35,000
= ₹ 3.03

𝐸𝐴𝑇 ₹ 1,26,000
(14) Return on Shareholder’s fund = ' × 100 = ₹ 7,50,000
× 100 = 16.8%
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 𝑠𝑓𝑢𝑛𝑑

𝑀𝑃𝑆 ₹ 45
(15) P/E Ratio = 𝐸𝑃𝑆
= ₹ 3.03
= ₹ 14.85 times

𝐸𝑃𝑆 ₹ 3.03
(16) Earning Yield = 𝑀𝑃𝑆
× 100 = ₹ 45
× 100 = 6.73%

Solution 9:
𝐸𝐴𝑇+𝑇𝑎𝑥 +𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 480+125+162
(i) Interest Coverage Ratio= 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
= 162
= 4.73 times

𝐸𝐴𝑇+𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 +𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 480+155+162

(ii) Debt Service Coverage Ratio = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡+𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙
= 162+178
= 2.34 times

Solution 10:
Computation of Ratios
Particulars 2009 2010
1. Gross Profit Ratio
64,000 76,000
Gross Profit/Sales 3,00,000
x 100 3,74,000
x 100
= 21.3% = 20.3%
2. Operating Expense to Sales Ratio
49,000 57,000
Operating Expenses/Total Sales 3,00,000
x 100 3,74,000
x 100
= 16.3% = 15.2%
3. Operating Profit Ratio
15,000 19,000
Operating Profit/ Total Sales 3,00,000
x 100 3,74,000
x 100
= 5% = 5.08%
4. Capital Turnover Ratio
3,00,000 3,74,000
Sales/ Capital Employed 1,00,000
= 3 times 1,47,000
=2.54 times
5. Stock Turnover ratio
2,36,000 2,98,000
COGS/ Average Stock 50,000
= 4.7times 77,000
= 3.9 times
15,,000 17,,000
Net Profit/ Net Worth 1,00,000
x 100 =15% 1,00,000
x100=14.5%
7. Debtors Collection Period
50,000 82,000
Average Debtors/ Average Daily Sales [wn 1] 739.73 936.99
= 67.6 days = 87.5 days
Working note:
2,70,000 3,42,000
(1) Average Daily Sales = Credit Sales/ 365 365 365
= ₹ 739.73 = ₹ 936.99
Analysis: The decline in the Gross profit ratio could be either due to a reduction in the selling price or increase
in the direct expenses. Similarly there is a decline in the ratio of Operating expenses to sales. And in depth
analysis reveals that the decline in the warehousing and the administrative expenses has been partly set off by
an increase in the transport and the selling expenses. The operating profit ratio has remained the same in spite
of a decline in the Gross profit margin ratio.
The company has not been able to deploy its capital efficiently. This is indicated by a decline in the Capital
turnover from 3 to 2.5 times. In case the capital turnover would have remained at 3 the company would have
increased sales and profits by ₹ 67,000 and ₹ 3,350 respectively.

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The decline in the stock turnover ratio implies that the company has increased its investment in stock. Return
on Net worth has declined indicating that the additional capital employed has failed to increase the volume of
sales proportionately. The increase in the Average collection period indicates that the company has become
liberal in extending credit on sales. However, there is a corresponding increase in the current assets due to
such a policy.
It appears as if the decision to expand the business has not shown the desired results.

Solution 12:
(a)Inventory turnover = Cost of goods sold/Average inventory
Since gross profit margin is 15 per cent, the cost of goods sold should be 85 per cent of the sales.

Cost of goods sold = 0.85 × ₹ 6,40,000 = ₹ 5,44,000.

Thus, = ₹ 5, 44,000 /Average inventory =5

Average inventory = ₹ 5, 44,000/5 = ₹ 1,08,800

(b) Average collection period = {Average Receivables×360 days}/ Credit Sales

Average Receivables = (Opening Receivables+Closing Receivables)/2

Closing balance of receivables is found as follows:
₹ ₹
Current assets (2.5 of current liabilities) 2,40,000
Less: Inventories 48,000
Cash 16,000 64,000
\ Receivables 1,76,000
Average Receivables = (₹1,76,000 + ₹ 80,000)/2 = ₹ 1,28,000
So,
Average collection period = (₹ 1,28,000 × 360)/₹ 6, 40,000 = 72 days

Solution 14:
Working Notes:
(i) Cost of Goods Sold = Sales – Gross Profit (25% of sales)
= ₹ 30,00,000 – ₹ 7,50,000= ₹ 22,50,000

(ii) Closing Stock = Cost of Goods sold/ Stock turnover

= ₹ 22,50,000 / 6 = ₹ 3,75,000

(iii) Fixed Assets = Cost of Goods sold / Fixed Assets Turnover

= ₹ 22,50,000 / 1.5
= ₹ 15,00,000

(iv) Current Assets:

Current Ratio = 1.5 and Liquid ratio = 1
Stock = 1.5 – 1 = 0.5
Current Assets = Amount of Stock x 1.5/0.5
= ₹ 3,75,000 x 1.5/0.5 = ₹ 11,25,000

(v) Liquid Assets (Debtors and Cash)

= Current Assets – Stock
= ₹ 11,25,000 – ₹ 3,75,000 = ₹ 7,50,000

(vi) Debtors = Sales x Debtors collection period ½

= ₹ 30,00,000 x 2/12 = ₹ 5,00,000

(vii) Cash = Liquid Assets – Debtors

= ₹ 7,50,000 – ₹ 5,00,000 = ₹ 2,50,000

(viii) Net Worth = Fixed Assets / 1.2

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= ₹ 15,00,000 / 1.2 = ₹ 12,50,000

(ix) Reserves & Surplus

Reserves & Share Capital = 0.6 + 1 = 1.6
Reserves & Surplus = ₹ 12,50,000 x 0.6/1.6 = ₹ 4,68,750

(x) Share Capital = Net Worth – Reserves & Surplus

= ₹ 12,50,000 – ₹ 4,68,750 = ₹ 7,81,250

(xi) Current liabilities = Current Assets / Current Ratio

= ₹ 11,25,000/ 1.5 = ₹ 7,50,000

(xii) Long-term debts

Capital Gearing ratio = long-term debts/Equity Shareholders’ Fund
Long –term Debts = ₹ 12,50,000 x 0.5 = ₹ 6,25,000

(a) Preparation of Balance Sheet of a Company

Balance Sheet
Liabilities Amount (₹) Assets Amount (₹)
Equity Share Capital 7,81,250 Fixed Assets 15,00,000
Reserves & Surplus 4,68,750 Current Assets
Long – term debts 6,25,000 Stock 3,75,000
Current Liabilities 7,50,000 Debtors 5,00,000
Cash 2,50,000
26,25,000 26,25,000

(b) Statement showing working capital Requirements

(₹) (₹)
Current Assets
(i) Stocks 3,75,000
(ii) Receivables 5,00,000
(iii) cash in hand & at bank 2,50,000
A. Current Assets: Total 11,25,000
Current Liabilities
B. Current Liabilities : 7,50,000
Total
Net Working Capital (A – B) 3,75,000
Add: Provision for 41,667
contingencies
(1/9th of Net Working Capital)
Working Capital Requirement
4,16,667

Solution 15:
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 ₹2 (0.20 × ₹10)
(a) Dividend Yield on the Equity Shares = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
× 100 = ₹40
× 100 = 5%

(b) Dividend Coverage Ratio

𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠 ₹2,70,000
(i) Preference = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑡𝑜 𝑃𝑟𝑒𝑓𝑒𝑟𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = ₹27,000 (0.09 × ₹3,00,000)
= 10 times

𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠−𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

(ii) EquityCoverage Ratio = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑡𝑜 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝑎𝑡 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 𝑜𝑓 ₹2 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
=
₹2,70,000−₹27,000
₹1,60,000 (80,000 𝑠ℎ𝑎𝑟𝑒𝑠 × ₹2)
= 1.52 times

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑡𝑜 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ₹2,43,00

(c) Earnings per equity share= 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
= 80,000
= ₹ 3.04 per share

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𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 ₹40

(d) Price-earning (P/E) ratio= 𝐸𝑞𝑢𝑖𝑡𝑦 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
= ₹3.04
= 13.2 times

Solution 16(a):
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
(a) Sales Gross Profit Ratio = 𝑆𝑎𝑙𝑒𝑠
₹5,00,000
20% = 𝑆𝑎𝑙𝑒𝑠
Sales = ₹ 25,00,000

(b) Sundry Debtors

12
Debtors Velocity = 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

12
3= 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

Debtor Turnover Ratio = 4 times

𝑆𝑎𝑙𝑒𝑠
Debtor Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒

₹25,00,000
4= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒

Average Receivable = ₹ 6,25,000

Average Receivable = Bills Receivable + Debtors
₹ 6,25,000 = ₹ 60,000 + Debtors
Debtors = ₹ 5,65,000

(c) Sundry Creditors

𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
Creditors Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒

₹22,00,000
6= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
Average Payable = ₹ 3,36,667
Average Payable = Bill Payable + Creditors
₹ 3,36,667 = ₹ 36,667 + Creditors
Creditors = ₹ 3,30,000

Working Notes:
(i) Cost of Goods sold = Net Sales – Gross Profit = ₹ 25,00,000 – ₹ 5,00,000 = ₹ 20,00,000

(ii) Let Opening Stock = x

Therefore Closing Stock = x + ₹ 20,000
12
Stock Velocity = 𝑆𝑡𝑜𝑐𝑘 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
12
6= 𝑆𝑡𝑜𝑐𝑘 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
Stock Turnover Ratio = 2 times

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑

(iii) Stock Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘

₹20,00,000
2= 2𝑥+2,00,000
2

x = ₹ 9,00,000
Opening Stock = ₹ 9,00,000
Therefore, Closing Stock = ₹ 9,00,000 + ₹ 20,000 = ₹ 11,00,000

(iv) Cost of Goods sold = Opening Stock + Purchases – Closing Stock

₹ 20,00,000 = ₹ 9,00,000 + Purchases – ₹ 11,00,000
Purchases = ₹ 22,00,000

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(d) Stock = ₹ 11,00,000

Solution 17:
(i) Computation of Opening Stock
Gross Profit = 20 % of sales = 20% of ₹ 40,00,000 = ₹ 8,00,000
Cost of Goods Sold (COGS) = Sales - Gross Profit = ₹ 40,00,000 – ₹ 8,00,000 = ₹ 32,00,000

𝐶𝑂𝐺𝑆
Inventory Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

₹ 32,00,000
Or, 8 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Average Inventory = ₹ 4,00,000
Now, Closing Stock = Opening stock + ₹ 40,000
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘
2
= ₹ 4,00,000

Or, Opening Stock + Opening Stock + ₹ 40,000 = ₹ 8,00,000

Or, 2 opening stock = 7,60,000
Opening stock = ₹ 3,80,000

(ii) Computation of Bank Overdraft

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠(𝐶𝐴)
Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠(𝐶𝐿)
= 1.5

CA = 1.5 CL
𝐶𝐴
Or, CL = 1.5

Further, Working Capital = Current Assets – Current Liabilities

So, ₹ 2,85,000 = 1.5 CL – CL
Or, .5 CL = ₹ 2,85,000
CL = ₹ 5,70,000
Bank Overdraft + Other CL = ₹ 5,70,000
Other CL = ₹ 5,70,000 - Bank Overdraft

𝐵𝑎𝑛𝑘 𝑂𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡 2
Now, 𝑂𝑡ℎ𝑒𝑟 𝐶𝐿
= 1
𝐵𝑎𝑛𝑘 𝑂𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡 2
Or , ₹ 5,70,000 – 𝑏𝑎𝑛𝑘 𝑜𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡
= 1
Or , ₹ 11,40,000 – 2 bank overdraft = bank overdraft
Bank Overdraft = ₹ 3,80,000

Solution 18:
Balance Sheet
Liabilities Amount (₹) Assets Amount (₹)
Capital 8,00,000 Fixed Assets 7,20,000
Reserves & Surplus 1,60,000 Stock 1,60,000
Bank Overdraft 40,000 Current Assets 2,40,000
Sundry Creditors 1,20,000
11,20,000 11,20,000

Working Notes
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
(1) Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
2.5 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙+𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

2.5 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

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Current Liabilities = ₹ 1,60,000

(2) Working Capital = Current Assets – Current Liabilities

₹ 2,40,000 = Current Assets – ₹ 1,60,000
Current Assets = ₹ 4,00,000

(3) Quick Liabilities = Current Liabilities – Bank overdraft

= ₹ 1,60,000 – ₹ 40,000 = ₹ 1,20,000

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
(4) Quick Ratio = 𝑄𝑢𝑖𝑐𝑘 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
1.5 = ₹1,20,000
Quick Assets = ₹ 1,80,000

(5) Stock = Current Assets – Quick Assets

= ₹ 4,00,000 – ₹ 1,80,000 = ₹ 2,20,000

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
(6) 𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑎𝑟𝑦 𝐹𝑢𝑛𝑑
= 0.75
Fixed Assets = 0.75 Proprietary Fund
Working Capital = 0.25 Proprietary Fund
₹ 2,40,000
Proprietary Fund = 0.25
Proprietary Fund = ₹ 9,60,000

(7) Fixed Assets = 0.7 × ₹ 9,60,000 = ₹ 7,20,000.

Solution 19:
Balance Sheet(In ₹)
Equity Share Capital 4,87,500 Fixed Assets 6,00,000
Reserves 5,000 Current Assets
P&L A/c 7,500 Stock 18,750
Debt's 5,00,000 Debtors 18,750
Current Liabilities 18,750 Other Current Assets 7,62,500
Other Current Liabilities 3,81,250
14,00,000 14,00,000
Working Notes:
(1) Let CL be x
CA = 2x
Net WC = CA – CL
4,00,000 = 2x – x
x = 4,00,000
CL = 4,00,000
CA = 4,00,000 × 2 = ₹8,00,000

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
(2) 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
=4

6,00,000
= 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
=4
Turnover = ₹ 1,50,000

(3) GP = (25% of 1,50,000) = ₹ 37,500

(4) COGS = Sales – GP = 1,50,000 – 37,500 = ₹ 1,12,500
1.5
(5) Debtors = 1,50,000 × 12 = ₹ 18,750
2
(6) Stock = 1,12,500 × 12
= ₹ 18,750
2
(7) Creditors = 1,12,500 × 12
= ₹ 18,750
(8) Net Profit = 1,50,000 × 5% = ₹ 7,500

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2
(9) Reserve = 3
× 7,500 = ₹ 5,000
𝐷𝑒𝑏𝑡 1
(10) Capital Gearing ratio = ' = 1
𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑟 𝑠𝑓𝑢𝑛𝑑𝑠
Capital employed = FA + Net WC
= ₹ 6,00,000 + ₹ 4,00,000
= ₹ 10,00,000
1
Debt = 10,00,000 × 2 = ₹ 5,00,000
1
Equity Shareholder’s Fund = 10,00,000 × 2
= ₹ 5,00,000
(11) Equity Share Capital = Equity Shareholder’s funds – Reserve – P & L A/c = 5,00,000 – 5,000 – 7,500
= ₹ 4,87,500

Solution 21:
(a) Calculation of operating Expenses for the year ended 31st March, 2010.
(₹)
Net profit [@ 6.25% of sales] 3,75,000
Add: Income Tax (@ 50%) 3,75,000
Profit Before Tax (PBT) 7,50,000
Add: Debenture Interest 60,000
Profit before interest and tax (PBIT) 8,10,000
Sales 60,00,000
Less: Cost of goods sold 18,00,000
PBIT 8,10,000 26,10,000
Operating Expenses 33,90,000

(b) Balance Sheet as on 31st March, 2010

Liabilities ₹ Assets ₹
Share Capital 10,50,000 Fixed Assets 17,00,000
Reserve and Surplus 4,50,000 Current Assets:
15% Debentures 4,00,000 Stock 1,50,000
Sundry Creditors 2,00,000 Debtors 2,00,000
Cash 50,000
21,00,000 21,00,000

Working Notes:
(i) Share capital and Reserves
The return on net worth is 25%. Therefore, the profit after tax of ₹ 3,75,000 should be equivalent to 25%
of the net worth.
25
Net worth × 100 = ₹ 3,75,000
₹3,75,000×100
∴ New worth = 25
= ₹ 15,00,000
The ratio of share capital to reserves is 7:3
7
Share Capital = 15,00,000 × 10 = ₹ 10,50,000
3
Reserves = 15,00,000× 10 = ₹ 4,50,000

(ii) Debentures
Interest on Debentures @ 15% = ₹ 60,000
60,000×100
∴ Debentures = 15
= ₹ 4,00,000

(iii) Current Assets

Current Ratio = 2
Sundry Creditors = ₹ 2,00,000
∴ Current Assets = 2 Current Liabilities
= 2×2,00,000 = ₹ 4,00,000

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(iv) Fixed Assets

(In ₹)
Liabilities:
Share Capital 10,50,000
Reserves 4,50,000
Debentures 4,00,000
Sundry Creditors 2,00,000
21,00,000
Less: Current Assets 4,00,000
Fixed Assets 17,00,000

(v) Composition of Current Assets

Inventory Turnover = 12
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘
= 12
₹18,00,000
Closing Stock = 12
Closing Stock = ₹ 1,50,000

Composition: ₹
Stock 1,50,000
Sundry Debtors 2,00,000
Cash (Balancing
Figure) 50,000
Total Current Assets 4,00,000

Solution 22:
Balance Sheet
Liabilities ₹ Assets ₹
Creditors 60,000 Cash 42,000
Long term Debt 2,40,000 Debtors 12,000
Shareholders’ funds 6,00,000 Inventory 54,000
Fixed assets 7,92,000
9,00,000 9,00,000
Working Note:
1. Gross Profit:
GP Margin = 20%
GP = ₹ 54,000
∴ Sales = ₹ 2,70,000

2. Credit Sales
Credit sales = 80% of total sales
= 2,70,000× 80%
= ₹ 2,16,000.

3. Total Assets:
𝑆𝑎𝑙𝑒𝑠
Total Assets Turnover = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
= 0.3 times
2,70,000
∴ Total Assets = 0.3
= ₹ 9,00,000

4. Inventory Turnover :
𝐶𝑎𝑠ℎ
Inventory Turnover = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
× 100

₹ 2,70,000−₹ 54,000
∴ 4 = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Inventory = ₹ 54,000

5. Debtors:

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𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
Debtors = 360 𝑑𝑎𝑦𝑠
× 20 days

₹2,16,000
= 360 𝑑𝑎𝑦𝑠
× 2 = ₹ 12,000

𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

6. Creditors: 𝐸𝑞𝑢𝑖𝑡𝑦
= 40%
Long term debt = 40% of equity
= 6,00,000× 40%
= ₹ 2,40,000
Creditor + Long term debt + shareholders funds = ₹ 9,00,000
Creditor + ₹ 2,40,000 + ₹ 6,00,000 = ₹ 9,00,000
∴ Creditors = ₹ 60,000.

7. Current Ratio:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
Current ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐷𝑒𝑏𝑡𝑜𝑟𝑠+𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦+𝐶𝑎𝑠ℎ
1.8 = 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
12,000+54,000+𝐶𝑎𝑠ℎ
1.8 = 60,000
Cash = ₹ 42,000

8. Fixed Assets: It is the balancing figure on assets side.

Solution 25:
Balance Sheet
Liabilities ₹ Assets ₹
Equity Share Capital 1,00,000 Fixed assets 60,000
Current Debt 24,000 Inventory 40,000
Long Term Debt 36,000 Cash 60,000
1,60,000 1,60,000
Working Notes:
1. Total Debt = 0.60 × Owner equity = 0.60 × ₹ 1,00,000 = ₹ 60,000
Current debt to Total debt = 0.40, hence current debt = 0.40 × 60,000 = ₹ 24,000
2. Fixed assets = 0.60 × Owners Equity = 0.60 × ₹ 1,00,000 = ₹ 60,000
3. Total Equity = Total Debt + Owners equity = ₹ 60,000 + ₹ 1,00,000 = ₹ 1,60,000
4. Total assets consisting of fixed assets and current assets must be equal to ₹ 1,60,000 (Assets =
Liabilities + Owners equity). Since Fixed assets are ₹ 60,000, hence Current assets should be ₹ 1,00,000
5. Total assets turnover = 2 Times : Inventory turnover = 8 times
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 2 1
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
= 8 = 4
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 1
₹1,60,000
= 4
or 4 × Inventory = 1 × ₹ 1,60,000
= ₹ 1,60,000
₹ 1,60,000
Or Inventory = 4
= ₹ 40,000
Balance on Asset side
∴ Cash = ₹ 1,60,000 – ₹ 60,000 – ₹ 40,000
= ₹ 60,000

Solution 26:
Balance Sheet
Liabilities ₹ Assets ₹
Notes and payables 1,00,000 Cash 50,000
Long-term debt 1,00,000 Accounts receivable 50,000
Common stock 1,00,000 Inventory 1,00,000
Retained earnings 1,00,000 Plant and equipment 2,00,000
Total liabilities and equity 4,00,000 Total assets 4,00,000

Working Notes

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𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡 𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡

𝑁𝑒𝑡 𝑤𝑜𝑟𝑡ℎ
= 0.5 = 2,00,000
Long – term debt = ₹ 1,00,000
Total liabilities and net worth = ₹ 4,00,000
Total assets = ₹ 4,00,000

𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
= 2.5 = 4,00,000
Sales = ₹ 10,00,000
Cost of goods sold = (0.9) (₹ 10,00,000) = ₹ 9,00,000.
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 9,00,000
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
= 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = 9
Inventory = ₹ 1,00,000

𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 × 360
10,00,000
= 18 days
Receivables = ₹ 50,000

𝐶𝑎𝑠ℎ + 50,000
1,00,000
=1
Cash = ₹ 50,000
Plant and equipment = ₹ 2,00,000.

Solution 28:
1. Balance Sheet
Liabilities ₹ Assets ₹
Share Capital (WN6) 7,81,250 Fixed Assets (WN 3) 15,00,000
Reserves (WN6) 4,68,750 Current Assets
Long-Term Loans (Balancing Figure) 6,25,000 Stock (WN4) 3,75,000
Current Liabilities (WN8) 7,50,000 Debtors (WN5) 5,00,000
Bank (WN9) 2,50,000 11,25,000
Total 26,25,000 Total 26,25,000

Working Notes
1. Gross Profit Ratio= 25%of sales. So, Gross Profit = 25% × ₹ 30,00,000= ₹ 7,50,000
2. Cost of Goods Sold (COGS)= Sales – Gross Profit = ₹ 30,00,000 – ₹7,50,000 = ₹ 22,50,000
𝐶𝑂𝐺𝑆 ₹ 22,50,000
3. Fixed Assets Turnover (based on COGS)= 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 = 1.5 times.
₹ 22,50,000
Hence, Fixed Assets= 1.5
= ₹ 15,00,000
𝐶𝑂𝐺𝑆 ₹ 22,50,000 22,50,000
4. Stock Turnover = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
= 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =6 times. So, Inventory = 6
=₹ 3,75,000
2 2
5. Debt Collection Period= 2 months. So, Debtors= Sales × 12 = ₹ 30,00,000 × 12
= ₹ 5,00,000
𝐹𝑖𝑥𝑒𝑑 ₹ 15,00,000 ₹ 15,00,000
6. 𝑁𝑒𝑡 𝑊𝑜𝑟𝑡ℎ
= 𝑁𝑒𝑡 𝑊𝑜𝑟𝑡ℎ
= 1.20. So, Net Worth = 1.2
= ₹ 12,50,000
Re𝐴𝑠𝑠𝑒𝑡𝑠serve & Surplus to Share Capital = 0.6:1
0.6
Reserve & Surplus = 12,50,000 × 1.6 = ₹ 4,68,750
1
Share Capital = 12,50,000 × 1.6
= ₹ 7,81,250
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
7. Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 1.5 times. So, Current Assets = 1.5 × Current Liabilities.
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝑆𝑡𝑜𝑐𝑘
8. Quick Ratio= 𝑄𝑢𝑖𝑐𝑘 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 1 time. So, 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 1.
1.5 × 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠−₹ 3,75,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=1
Current Liabilities = ₹ 7,50,000
9. Hence, Current assets= 1.5 × 7,50,000 = ₹ 11,25,000
Current Assets = Inventory + Debtors + Cash & Bank
₹ 11,25,000 = ₹ 3,75,000 + ₹ 5,00,000 + Cash & Bank
Cash & Bank = ₹ 2,50,000
𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙+𝐷𝑒𝑏𝑡 𝑁𝑖𝑙+₹ 6,25,000
10. Verification of Long Term Loans: Capital Gearing Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠
= ₹ 12,50,000
= 0.5
times.
Note: in the absence of information, Share Capital = Equity Share Capital only.

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

Net Worth = WN6 = ₹ 12,50,000. Debt is taken as balancing figure from the B/s above.

2. Statement of Working Capital Requirements

Particulars Computation ₹
A. Current Assets Stock (WN4) 3,75,000
Debtors (WN5) 5,00,000
Bank (WN9) 2,50,000 11,25,000
B. Current Liabilities (WN8) 7,50,000
C. Net Working Capital (A – B) 100% –10% =90% 3,75,000
D. 10% Provision for Contingencies 10%(on Item E)= 1/9thon Item C 41,667
E. Required Net Working Capital 100% 4,16,667

Solution 29:
Projected Profit and Loss Account for the year ended 31-3-2010
To Cost of Goods Sold 2,04,000 By Sales 2,40,000
To Gross Profit 36,000
2,40,000 2,40,000
To Debenture Interest 1,000 By Gross Profit 36,000
To Depreciation 5,000
To Administration and Other
Expenses 17,000
To Net Profit 13,000
36,000 36,000

Projected Balance Sheet as at 31st March, 2010

Liabilities ₹ Assets ₹
Share Capital 1,00,000 Fixed Assets
Profit and Loss A/c(17,000 + 13,000) 30,000 Land &Buildings 80,000
Plant &Machinery
5% Debentures 20,000 60,000
Less: Depreciation
Current Liabilities 20,000 40,000
Trade Creditors 50,000 Current Assets
Stock
30,000
Debtors
40,000
Bank
10,000 80,000
2,00,000 2,00,000
Working Notes:
1.
Particulars % ₹
Share Capital 50% 1,00,000
Other Shareholders Funds 15% 30,000
5% Debentures 10% 20,000
Trade Creditors 25% 50,000
Total 100% 2,00,000
2. Total liabilities = Total Assets
₹ 2,00,000 = Total Assets
Fixed Assets = 60% of total gross fixed assets and current assets
= ₹ 2,00,000 × 60/100 = ₹ 1,20,000

3. Net Plant & Machinery = ₹ 1,20,000 – ₹ 80,000 = ₹ 40,000

Depreciation increased by ₹ 5,000
∴Depreciation = ₹ 15,000 + ₹ 5,000 = ₹ 20,000
Gross Plant and Machinery = ₹ 40,000 + ₹ 20,000 = ₹ 60,000

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

4. Current Assets = Total Assets – Fixed Assets

= ₹ 2,00,000 – ₹ 1,20,000 = ₹ 80,000

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝑆𝑡𝑜𝑐𝑘
5. Quick Ratio= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=1
₹80,000−𝑆𝑡𝑜𝑐𝑘
= ₹50,000
=1
₹ 50,000 = ₹ 80,000 – Stock
Stock = ₹ 80,000 – ₹ 50,000 = ₹ 30,000

6. Debtors = 4/5th of Quick Assets

= (₹ 80,000 – 30,000) × 4/5 = ₹ 40,000
𝐷𝑒𝑏𝑡𝑜𝑟𝑠
Debtors Turnover Ratio= 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 × 365 = 60 days
40,000 × 12
= 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
× 365 = 2 months
2 credit sales = 4,80,000
Credit sales = 4,80,000/2 = 2,40,000

7. Gross Profit (15% of Sales) ₹ 2,40,000 × 15/100 = ₹ 36,000

8. Return on net worth (Profit after tax)
Net worth = ₹ 1,00,000 + ₹ 30,000
= ₹ 1,30,000
9. Net profit = ₹ 1,30,000 × 10/100 = ₹ 13,000
10. Debenture interest = ₹ 20,000 × 5/100 = ₹ 1,000
11. Quick Assets = ₹ 50,000
Debtors + Bank = ₹ 50,000
₹ 40,000 + Bank = ₹ 50,000
Bank = ₹ 10,000

Solution 30:
Profit and Loss Statement of Check& Co.
Particulars Amount (₹)
Sales 50,00,000
Less: Variable Cost(60% on Sales) 30,00,000
Contribution 20,00,000
Less : Fixed cost(Balancing Figure) 9,00,000
EBIT 11,00,000
Less: Interest (Balancing Figure) 6,00,000
EBT(10% of sales of ₹ 50,00,000) 5,00,000
Less: Tax NIL
EAT 5,00,000

Balance Sheet of M/s Check& Co.

Liabilities Amount (₹) Assets Amount (₹)
Share capital 5,00,000 Fixed Assets 41,66,667
Reserves & Surplus 15,00,000 Current Assets
12% Term loan 50,00,000 Stock 10,00,000
Current Liabilities 5,00,000 Debtors 4,16,667
Other Current Assets 83,333
Other Non Current assets 18,33,333
75,00,000 75,00,000
Working Notes:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
1. Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 3 times.
Current Assets = 3 × Current Liabilities.
Net Working Capital = Current Assets – Current Liabilities = ₹ 10,00,000.
3 × Current Liabilities – Current Liabilities = ₹ 10,00,000 = 2 × Current Liabilities = ₹ 10,00,000
𝑅𝑠, 10,00,000
Current Liabilities = 2
= ₹ 5,00,000
Current Assets = 3 × ₹ 5,00,000 = ₹ 15,00,000

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 ₹15,00,000 3

2. 𝑆𝑡𝑜𝑐𝑘
= 𝑆𝑡𝑜𝑐𝑘
= 2
2
Stock = ₹ 15,00,000 × 3
= ₹ 10,00,000

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
3. Quick Ratio = 𝑄𝑢𝑖𝑐𝑘 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 1 time.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝑆𝑡𝑜𝑐𝑘
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠−𝐵𝑎𝑛𝑘 𝑂𝐷
=1
₹15,00,000−₹10,00,000
₹5,00,000−𝐵𝑎𝑛𝑘 𝑂𝐷
=1
Bank OD = ₹ Nil.

𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠
4. Stock Turnover Ratio = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
= ₹10,00,000
= 5.
Sales = ₹ 10,00,000 × 5 = ₹ 50,00,000

𝑆𝑎𝑙𝑒𝑠 ₹50,00,000
5. Fixed Assets T/O = 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
= 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 = 1.2
₹50,00,000
Net Fixed Assets = 1.2
= ₹ 41,66,667

30
6. Average Collection Period = 30 days. Assuming 1 year = 360 days, Debtors = Sales × 360
= ₹ 50,00,000
30
× 360
= ₹ 4,16,667

𝐸𝐵𝐼𝑇 𝐸𝐵𝐼𝑇
7. Financial Leverage = 𝐸𝐵𝑇
= ₹5,00,000
= 2.20

EBIT = ₹ 5,00,000× 2.2 = ₹ 11,00,000

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐴𝑚𝑜𝑢𝑛𝑡 ₹6,00,000

8. Long Term Loan = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒
= 12%
= ₹ 50,00,000.

9. Total External Liabilities = Long Term Liabilities + Current Liabilities = ₹ 50,00,000 + ₹ 5,00,000 = ₹
55,00,000

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 ₹55,00,000

10. 𝑁𝑒𝑡 𝑊𝑜𝑟𝑡ℎ
= 2.75 𝑁𝑒𝑡 𝑊𝑜𝑟𝑡ℎ
= 2.75.
₹55,00,000
Net Worth = 2.75
= ₹ 20,00,000

𝑁𝑒𝑡 𝑤𝑜𝑟𝑡ℎ ₹20,00,000

11. Number of Equity Shares = 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
= ₹40
= 50,000 Shares.
Equity share Capital = 50,000 shares × ₹ 10 = ₹ 5,00,000

12. Retained Earnings = Net Worth – Share Capital = ₹ 20,00,000 – ₹ 5,00,000 = ₹ 15,00,000

13. Total Current Assets = Inventory + Debtors + Cash &Bank.

₹ 15,00,000= ₹ 10,00,000 + ₹ 4,16,667 + Cash & Bank.
Cash & Bank = ₹ 83,333

Solution 31:
Trading and Profit and Loss Account for the period ending 31st December, 2010
To Cost of Materials 3,60,000 By Sales 12,00,000
To Wages & Overheads 5,40,000
To Gross Profit c/d 3,00,000
12,00,000 12,00,000
To Expenses & Depreciation
(Balancing Figure) 2,46,800 By Gross Profit b/d 3,00,000
To Net Profit 53,200
3,00,000 3,00,000

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Projected Balance Sheet as on 31st December, 2010

Liabilities ₹ Assets ₹
Share Capital: Fixed Assets 7,60,000
Equity Share Capital 5,32,000 Current Assets
Preference Share Capital 1,90,000 Stock 1,80,000
Reserves & Surplus: Debtors 2,00,000 3,80,000
General Reserve 79,800
Profit & Loss A/c 53,200
Secured Loan:
Debentures 95,000
Current Liabilities:
Creditors 90,000
Bank Overdraft 1,00,000
11,40,000 11,40,000
Working Notes:
(1)
Sales: ₹
Gross Profit 3,00,000
Ratio of Gross Profit 25%
100
Sales (₹ 3,00,000 × 25 ) 12,00,000

(2)
₹
Cost of Sales: 12,00,000
Sales 3,00,000
Less: Gross Profit 9,00,000

(3) Assuming stock and debtors are the only Current Assets:
₹9,00,000
(a) Stock in Trade = 5
= ₹ 1,80,000
₹12,00,000
(b) Debtors = 6
= ₹ 2,00,000

1
(4) Current Liabilities = 2
of ₹ 3,80,000 = ₹ 1,90,000
1
(5) Trade Creditors = 4
of ₹ 3,60,000 = ₹ 90,000
(6) Bank Overdraft: Current Liabilities – Trade Creditors
= 1,90,000 – 90,000 = ₹ 1,00,000
(7) Material: 40% of ₹ 9,00,000 = ₹ 3,60,000

(8) Fixed Assets to Capital employed = 80%

Working Capital to Capital employed = 20%
The amount of Working Capital being ₹ 1,90,000, the amount of Fixed Assets will be ₹ 1,90,000 × 4 = ₹
7,60,000.

(9) Total Capital employed: Fixed Assets + Working Capital = ₹7,60,000 + ₹ 1,90,000 = ₹ 9,50,000

(10) Capital Gearing Ratio = 30%

Preference Shares + Debentures = 30% of ₹ 9,50,000 = ₹ 2,85,000

(11) Preference Shares = 2/3 of ₹ 2,85,000 = ₹ 1,90,000

Debentures = 1/3 of ₹ 2,85,000 = ₹ 95,000
(12) General Reserve & Profit & Loss A/c balance being 25% of Equity Capital
= 1/5 of ₹ 6,65,000 = ₹ 1,33,000
(13) Equity Capital = ₹ 5,32,000
(14) Profit (10% on Equity Capital) = ₹ 53,200
(15) General Reserve (₹ 1,33,000 – ₹ 53,200) = ₹ 79,800
(16) Wages and Overheads = 60% of ₹ 9,00,000 = ₹ 5,40,000

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

Solution 32:
Return on Equity = Net Profit Margin × Asset Turnover Ratio × Equity Multiplier
= 0.1439 × 1.0455 × 2.0621 = 0.3102 or 31.02%
Working Notes:
Net Profit Margin = Net Income (₹ 4,212) ÷ Revenue (₹ 29,261) = 0.1439, or 14.39%
Asset Turnover Ratio = Revenue (₹ 29,261) ÷ Assets (₹ 27,987) = 1.0455 times
Equity Multiplier = Assets (₹ 27,987) ÷ Shareholders’ Equity (₹ 13,572) = 2.0621 times

Solution 33:
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
(a) Capital Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

Net Sales ₹ 3,00,000

Capital Employed ₹ 2,25,000
Capital Turnover Ratio 1.33 Times

𝑃.𝐴.𝑇.
(b) Net Operating Profit Ratio = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
× 100
PAT ₹ 80,000
Net Sales ₹ 3,00,000
Net Operating Profit Ratio 26.67%

(c) ROI = Net Operating Ratio × Capital Turnover Ratio

Net Operating Profit 26.67%
Capital Turnover Ratio 1.33 Times
ROI 35.47%

Solution 34:
ROI = Net Operating Profit Ratio × Capital Turnover Ratio
Ram Ltd = 5% × 4 times = 20%
Shyam Ltd = 6% ×6 times = 36%

Working Notes:
Sales = ₹ 1,80,000/ 15% = ₹ 12,00,000
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Capital Turnover Ratio = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

12,00,000
= 2,00,000
= 6 times

Solution 38:
(i) Return on total assets
𝐸𝐵𝐼𝑇 (1−𝑇) ₹ 2.30 𝐶𝑟𝑜𝑟𝑒𝑠 (1−0.3)
Return on total assets= 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐹𝐴 + 𝐶𝐴)
= ₹ 5.20 𝑐𝑟𝑜𝑟𝑒𝑠 + ₹ 7.80 𝑐𝑟𝑜𝑟𝑒𝑠

₹ 1.61 𝑐𝑟𝑜𝑟𝑒𝑠
= ₹ 13 𝑐𝑟𝑜𝑟𝑒𝑠
= 0.1238 or 12.38%

(ii) Return on owner's equity (Amount in ₹ )

Financing policy (₹)
Conservative Moderate Aggressive
Expected EBIT 2,30,00,000 2,30,00,000 2,30,00,000
Less: Interest
Short term Debt @ 12% 12,96,000 24,00,000 36,00,000
Long term Debt @ 16% 35,84,000 21,12,000 5,12,000
Earnings before tax (EBT) 1,81,20,000 1,84,88,000 1,88,88,000
Less: Tax @ 30% 54,36,000 55,46,400 56,66,400
Earnings after Tax (EAT) 1,26,84,000 1,29,41,600 1,32,21,600

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Owner's Equity 5,00,00,000 5,00,00,000 5,00,00,000

Return on owner's equity =
1,26,84,000 1,29,41,600
= 5,00,00,000 =
1,32,21,600
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥𝑒𝑠 (𝐸𝐴𝑇) 5,00,00,000 5,00,00,000
= 𝑂𝑤𝑛𝑒𝑟𝑠' 𝑒𝑞𝑢𝑖𝑡𝑦 = 0.2537 or = 0.2588 or = 0.2644 or
25.37% 25.88% 26.44%

(iii) Net Working capital (₹ in crores)

Financing policy
Conservative Moderate Aggressive
Current Liabilities (Excluding 4.68 4.68 4.68
Short Term Debt)
Short term Debt 1.08 2.00 3.00
Total Current Liabilities 5.76 6.68 7.68
Current Assets 7.80 7.80 7.80
Net Working capital 7.80 - 5.76 7.80 - 6.68 7.80 - 7.68
= Current Assets - Current Liabilities = 2.04 = 1.12 = 0.12

(iv) Current ratio (₹ in crores)

Financing policy
Conservative Moderate Aggressive
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 7.80 7.80 7.80
Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 5.76
= 1.35 = 6.68
= 1.17 = 7.68
= 1.02
Advise: It is advisable to adopt aggressive financial policy, if the company wants high return as the return on
owner's equity is maximum in this policy i.e. 26.44%.

Solution 39:
Working Notes :
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 1
(i) Calculation of Sales = 𝑆𝑎𝑙𝑒𝑠
= 3
26,00,000 x 3 = 1 x sales = Sales = ₹ 78,00,000

(ii) Calculation of Current Assets

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 13
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
= 11

26,00,000 13
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
= 11
= Current Assets = ₹ 22,00,000

(iii) Calculation of Raw Material Consumption and Direct Wages

₹
Sales 78,00,000
Less : Gross Profit 11,70,000
Works Cost 66,30,000
Raw Material Consumption (20% of Work Cost) ₹ 13,26,000
Direct Wages (10% of Work Cost) ₹ 6,63,000

(iv) Calculation of Stock of Raw Materials (= 3 months usage)

3
= 13,26,000 x 12 = ₹ 3,31,500

(v) Calculation of Stock of Finished Goods (= 6% of Works Cost)

6
= 66,30,000 x 100 = ₹ 3,97,800

(vi) Calculation of Current liabilities

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 2
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 1

22,00,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=2

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Current Liabilities = ₹ 11,00,000

(vii) Calculation of Receivables

𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Average collection period = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 x 365

𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
78,00,000
x 365 = 60 = Receivables = ₹ 12,82,191.78 or ₹ 12,82,192

(viii) Calculation of Long Term Loan

𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑙𝑜𝑎𝑛 2
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 1 = Long Term Loan = ₹ 22,00,000

𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑙𝑜𝑎𝑛 2

11,00,000
= 1
= Long Term Loan = ₹ 22,00,000

(ix) Calculation of Cash balance

₹
Current Assets 22,00,000
Less : Receivables 12,82,192
Raw material stock 3,31,500
Finished goods stock 3,97,800 20,11,492
Cash balance 1,88,508

(x) Calculation of Net Worth

Fixed Assets 26,00,000
Current Assets 22,00,000
Total Assets 48,00,000
Less : Long term Loan 22,00,000
Current Liabilities 11,00,000 33,00,000
Net Worth 15,00,000

Net Worth = Share Capital + Reserves = 15,00,000

𝐶𝑎𝑝𝑖𝑡𝑎𝑙 1
= 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 & 𝑆𝑢𝑟𝑝𝑙𝑢𝑠 = 4 = Share Capital

1
= 15,00,000 x 5
= ₹ 3,00,000

4
Reserve and Surplus = 15,00,000 x 5
= ₹ 12,00,000

Profit and Loss Account of PQR Ltd , for the year ended 31st March , 2020
Particulars ₹ Particulars ₹
To Direct Materials 13,26,000 By Sales 78,00,000
To Direct Wages 6,63,000
To Works (Overhead) Balancing Figure 46,41,000
To Gross Profit c/d (15% of Sales) 11,70,000 -
78,00,000 78,00,000
To Selling and Distribution Expenses 5,46,000 By Gross Profit b/d 11,70,000
(balancing figures)
To Net Profit (8% of sales) 6,24,000 -
11,70,000 11,70,000

Balance Sheet of PQR Ltd. as at 31st March , 2020

Liabilities ₹ Assets ₹
Share Capital 3,00,000 Fixed Assets 26,00,000
Reserve & Surplus 12,00,000 Current Assets :

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Long term loans 22,00,000 Stock of Raw Material 3,31,500

Current liabilities 11,00,000 Stock of Finished goods 3,97,800
Receivables 12,82,192
Cash 1,88,508
48,00,000 48,00,000

Solution 40:
Ratios 2018 2019 2020
Current ratio 1.19 1.25 1.20
Acid test ratio 0.43 0.46 0.40
Average collection period 18 22 27
Inventory turnover NA* 8.2 6.1
Total debt to net worth 1.38 1.40 1.61
Long term debt to total 0.33 0.32 0.32
capitalization
Gross profit margin 0.200 0.163 0.132
Net profit margin 0.075 0.047 0.026
Assets turnover 2.80 2.76 2.24
Return on Assets 0.21 0.13 0.06
Analysis : The company’s profitability has declined steadily over the period . As only ₹ 50,000 is added to
retained earnings , the company must be paying substantial dividends . Receivables are growing slower ,
although the average collection period is still very reasonable relative to the terms given . Inventory turnover is
slowing as well , indicating a relative build-up in inventories . The increase in receivables and inventories ,
coupled with the fact that net worth has increased very little , has resulted in total debt – to – worth ratio
increasing to what would have to be regarded on an absolute basis as a high level.

The current and acid – test ratios have fluctuated , but the current ratio is not particularly inspiring . The lack of
deterioration in these ratio is clouded by the relative build up in both receivables and inventories , evidencing
deterioration in the liquidity of these two assets. Both the gross profit and net profit margins have declined
substantially. The relationship between the two suggests that the company has reduced the relative expenses
in 2019 in particular. The build up in inventories and receivables has resulted in a decline in asset turnover ratio
, and this, coupled with the decline in profitability , has resulted in a sharp decrease in the return on assets
ratio.

Solution 41:
Ratios Navya Ltd. Industry
Norms
1. Current Ratio =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 52,80,000
= 2.67 2.50
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 19,80,000

2. Receivable Turnover Ratio=

𝑆𝑎𝑙𝑒𝑠 1,10,00,000
= 10.0 8.00
𝐷𝑒𝑏𝑡𝑜𝑟𝑠 11,00,000

3. Inventory turnover ratio =

𝑆𝑎𝑙𝑒𝑠 1,10,00,000
= 3.33 9.00
𝑆𝑡𝑜𝑐𝑘 33,00,000

4. Total Asset Turnover Ratio =

𝑆𝑎𝑙𝑒𝑠 1,10,00,000
= 1.43 2.00
𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 77,00,000

5. Net Profit Ratio =

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 2,31,000
= 2.10% 3.50%
𝑆𝑎𝑙𝑒𝑠 1,10,000

6. Return on Total Asset =

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 2,31,000
= 3.00% 7%
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 77,00,000
7. Return on Net Worth (Based on Net profit 2,31,000
= 4.81% 10.5%
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 48,00,000
) = 𝑁𝑒𝑡 𝑊𝑜𝑟𝑡ℎ
8.
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 29,00,000
= 37.66% 60%
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 77,00,000
Comments :
1. The position of Navya Ltd. is better than the industry norm with respect to Current Ratios and the Sales to
Debtors Ratio.
2. However, the position of sales to stock and sales to total assets is poor comparing to industry norm .
3. The firm also has its net profit ratios , net profit to total assets and net profit to total worth ratio much
lower than the industry norm.

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4. Total debt to total assets ratio suggest that , the firm is geared at lower level and debt are used to Asset.

Solution 42:
(i) Calculation of Shareholders’ Fund:
𝑅𝑒𝑠𝑒𝑟𝑣𝑒 & 𝑆𝑢𝑟𝑝𝑙𝑢𝑠
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟'𝑠 𝐹𝑢𝑛𝑑𝑠
= 0.5

𝑅𝑒𝑠𝑒𝑟𝑣𝑒 & 𝑆𝑢𝑟𝑝𝑙𝑢𝑠

𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 & 𝑆𝑢𝑟𝑝𝑙𝑢𝑠
= 0.5

𝑅𝑒𝑠𝑒𝑟𝑣𝑒 & 𝑆𝑢𝑟𝑝𝑙𝑢𝑠

10,00,000+ 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 & 𝑆𝑢𝑟𝑝𝑙𝑢𝑠
= 0.5
Reserve & Surplus = 5,00,000 + 0.5 Reserve & Surplus
0.5 Reserve & Surplus = 5,00,000
Reserve & Surplus = 10,00,000
Shareholders’ funds = 10,00,000 +10,00,000
Shareholders’ funds = ₹20,00,000

(ii) Calculation of Value of Stock:

𝑆𝑎𝑙𝑒𝑠
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟'𝑠 𝐹𝑢𝑛𝑑𝑠
= 1.5
Sales = 1.5 × 20,00,000
Sales = 30,00,000
Gross Profit = 30,00,000 × 20% = 6,00,000
Cost of Goods Sold = 30,00,000 – 6,00,000
= ₹24,00,000
Stock velocity = 2 months
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
× 12 = 2
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘
24,00,000
× 12 = 2
Average stock = ₹4,00,000

(iii) Calculation of Debtors:

Debtors Turnover Ratio = 6
𝑆𝑎𝑙𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑒𝑏𝑡𝑜𝑟𝑠
=6
30,00,000
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑒𝑏𝑡𝑜𝑟𝑠
=6
Average Debtors = ₹5,00,000

(iv) Calculation of Current Liabilities:

Net Working Capital Turnover ratio = 2.5
𝑆𝑎𝑙𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 2.5
30,00,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 2.5
Current Assets – Current Liabilities = 12,00,000.................. (1)
Current Ratio = 2.5
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 2.5
Current Assets = 2.5 Current Liabilities.............................. (2)
From (1) & (2),
2.5 Current Liabilities – Current Liabilities = 12,00,000
1.5 Current Liabilities = 12,00,000
Current Liabilities = ₹8,00,000

(v) Calculation of Cash Balance:

Current Assets = 2.5 Current Liabilities
Current Assets = 2.5 (8,00,000) = 20,00,000
(-) Debtors (5,00,000)
(-) Stock (4,00,000)
Cash Balance ₹11,00,000

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Solution 43:
1. Working Notes:

(i) Calculation of Sales

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 1
𝑆𝑎𝑙𝑒𝑠
=3

1,30,00,000 1
𝑆𝑎𝑙𝑒𝑠
= 3
⇒ Sales = ₹ 3,90,00,000

(ii) Calculation of Current Assets

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 13
𝑆𝑎𝑙𝑒𝑠
= 11

1,30,00,000 13
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
= 11
⇒ Current Assets = ₹ 1,10,00,000

(iii) Calculation of Raw Material Consumption and Direct Wages

₹
Sales 3,90,00,000
Less: Gross Profit (15 % of Sales) 58,50,000
Cost of Goods sold 3,31,50,000
Raw Material Consumption (20% of Cost of Goods Sold) ₹ 66,30,000 Direct
Wages (10% of Cost of Goods Sold) ₹ 33,15,000
(iv) Calculation of Stock of Raw Materials (= 3 months usage)
3
= 66,30,000 × 12
= ₹ 16,57,500

(v) Calculation of Stock of Finished Goods (= 6% of Cost of Goods Sold)

6
= 3,31,50,000 × 100 = ₹ 19,89,000
(i) Calculation of Current Liabilities
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=2
1,10,00,000
=2 ⇒ Current Liabilities = ₹ 55,00,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
(ii) Calculation of Debtors
𝐷𝑒𝑏𝑡𝑜𝑟𝑠
Average collection period = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 × 12 months
𝐷𝑒𝑏𝑡𝑜𝑟𝑠
× 12 = 2 ⇒Debtors = ₹ 65,00,000
3,90,00,000
(iii) Calculation of Long-term Loan
𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐿𝑜𝑎𝑛 2
=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 1
𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐿𝑜𝑎𝑛 2
55,00,000
= 1 ⇒Long term loan = ₹ 1,10,00,000
(iv) Calculation of Cash Balance
₹
Current assets 1,10,00,000
Less: Debtors 65,00,000
Raw materials stock 16,57,500
Finished goods stock 19,89,000 1,01,46,500
Cash balance 8,53,500

(v) Calculation of Net worth

Fixed Assets 1,30,00,000
Current Assets 1,10,00,000
Total Assets 2,40,00,000

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Less: Long term Loan 1,10,00,000

Current Liabilities 55,00,000 1,65,00,000
Net worth 75,00,000
Net worth = Share capital + Reserves = ₹ 75,00,000
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 1 1
𝑅𝑒𝑠𝑒𝑟𝑣𝑒𝑠 𝑎𝑛𝑑 𝑆𝑢𝑟𝑝𝑙𝑢𝑠
= 4
⇒ 𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 =₹75,00,000 × 5 =₹ 15,00,000

4
Reserves and Surplus = ₹75,00,000 × 5
=₹ 60,00,000

Profit and Loss Statement of ASD Ltd. for the year ended31st March, 2022
Particulars (₹) Particulars (₹)
To Direct Materials consumed 66,30,000 By Sales
To Direct Wages 33,15,000
3,90,00,000
To Works (Overhead) (Bal. fig.) 2,32,05,000
To Gross Profit c/d (15% of Sales) 58,50,000
3,90,00,000 3,90,00,000
Selling and Distribution Expenses
To 27,30,000 By Gross Profit b/d
(Bal. fig.) 58,50,000
To Net Profit (8% of Sales) 31,20,000
58,50,000 58,50,000

Balance Sheet of ASD Ltd. as at 31st March, 2022

Liabilities (₹) Assets (₹)
Share Capital 15,00,000 Fixed Assets 1,30,00,000
Reserves and Surplus 60,00,000 Current Assets:
Long term loans 1,10,00,000 Stock of Raw Material 16,57,500
Current liabilities 55,00,000 Stock of Finished Goods 19,89,000
Debtors 65,00,000
Cash 8,53,500
2,40,00,000 2,40,00,000

Solution 44:
Liabilities (₹) Assets (₹)
Equity Share Capital 12,50,000 Fixed Assets (cost) 20,58,000
Reserves & Surplus 2,50,000 Less: Acc. Depreciation (3,43,000)
Long Term Loans 6,75,000 Fixed Assets (WDV) 17,15,000
Bank Overdraft 60,000 Stock 2,30,000
Payables 4,00,000 Receivables 2,62,500
Cash 4,27,500
Total 26,35,000 Total 26,35,000

Working Notes:
(i) Sales ₹ 21,00,000
Less: Gross Profit (20%) ₹ 4,20,000
Cost of Goods Sold (COGS) ₹ 16,80,000

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
(ii) Receivables Turnover Velocity = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
× 12
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
2= ₹21,00,000×75%
× 12

₹21,00,000×75%×2
Average Receivables = 12
Average Receivables = ₹ 2,62,500

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

Closing Receivables = ₹ 2,62,500

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘
(iii) Stock Turnover Velocity = 𝐶𝑂𝐺𝑆
× 12
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘
Or 1.5 = ₹16,80,000
× 12
₹16,80,000×1.5
Or Average Stock = 12
Or Average Stock = ₹ 2,10,000
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑆𝑡𝑜𝑐𝑘
2
=₹ 2,10, 000
Opening Stock + Closing Stock = ₹ 4,20,000 (1)
Also, Closing Stock-Opening Stock = ₹ 40,000 (2)
Solving (1) and (2), we get closing stock = ₹ 2,30,000

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 𝑆𝑡𝑜𝑐𝑘 +𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 + 𝐶𝑎𝑠ℎ

(iv) Current Ratio= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 𝐵𝑎𝑛𝑘 𝑂𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡 + 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
₹2,30,000+₹2,62,500+ 𝐶𝑎𝑠ℎ
Or 2 = ₹60,000+ 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
Or ₹ 1,20,000 + 2 Payables = ₹ 4,92,500 + Cash
Or 2 Payables – Cash.= ₹ 3,72,500
Or Cash = 2 Payables – ₹ 3,72,500 (3)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝑆𝑡𝑜𝑐𝑘 𝐷𝑒𝑏𝑡𝑜𝑟 + 𝐶𝑎𝑠ℎ
Acid Test Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
3 ₹2,62,500+ 𝐶𝑎𝑠ℎ
Or 2
= 60,000 + 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
Or ₹ 1,80,000 + 3 Payables = ₹ 5,25,000 + 2 Cash
Or 3 Payables – 2 Cash = ₹ 3,45,000........................... (4)
Substitute (3) in (4)
Or 3 Payables – 2(2 Payables – ₹ 3,72,500) = ₹ 3,45,000
Or 3 Payables – 4 Payables + ₹ 7,45,000= ₹ 3,45,000
(Payables) = ₹ 3,45,000 - ₹ 7,45,000
Payables = ₹ 4,00,000
So, Cash = 2 x ₹ 4,00,000 – ₹ 3,72,5000

Cash = ₹ 4,27,500

(v) Long term Debt = 45% of Net Worth

Or ₹ 6,75,000 = 45% of Net Worth
Net Worth = ₹ 15,00,000
(vi) Equity Share Capital (ESC) + Reserves = ₹ 15,00,000
Or ESC + 0.2ESC = ₹ 15,00,000
Or 1.2 ESC = ₹ 15,00,000
Equity Share Capital (ESC) = ₹ 12,50,000
(vii) Reserves = 0.2 x ₹ 12,50,000
Reserves = ₹ 2,50,000
(viii) Total of Liabilities=Total of Assets
Or ₹ 12,50,000 + ₹ 2,50,000 + ₹ 6,75,000 +₹ 60,000 + ₹ 4,00,000 + Fixed Assets(FA) (WDV) + ₹ 2,30,000 + ₹
2,62,000 +₹ 4,27,500
Or ₹ 26,35,000 = ₹ 9,20,000 + FA(WDV)
FA (WDV) =₹ 17,15,000
Now FA(Cost) – Depreciation = FA(WDV)
Or FA(Cost) – FA(Cost)/6 = ₹ 17,15,000
Or 5 FA(Cost)/6 = ₹ 17,15,000
Or FA(Cost) = ₹ 17,15,000x 6/5
So, FA(Cost) = ₹ 20,58,000
Depreciation = ₹ 20,58,000/6 = ₹ 3,43,000

Solution 45:
1. Current Ratio = 3:1
Current Assets (CA)/Current Liability (CL) = 3:1
CA = 3CL
WC = 10,00,000

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

CA – CL = 10,00,000
3CL – CL = 10,00,000
2CL = 10,00,000
10,00,000
CL = 2
CL = ₹5,00,000
CA = 3 x 5,00,000
CA = ₹15,00,000
2. Acid Test Ratio = CA – Stock / CL = 1:1
15,00,000− 𝑆𝑡𝑜𝑐𝑘
= 5,00,000
=1
15,00,000 – stock = 5,00,000
Stock = ₹10,00,000
3. Stock Turnover ratio (on sales) = 5
𝑆𝑎𝑙𝑒𝑠
𝐴𝑣𝑔 𝑠𝑡𝑜𝑐𝑘
=5
𝑆𝑎𝑙𝑒𝑠
10,00,000
=5
Sales = ₹50,00,000
4. Gross Profit = 50,00,000 x 40% = ₹20,00,000
Net profit (PBT) = 50,00,000 x 10% = ₹5,00,000
5. PBIT/PBT = 2.2
PBIT = 2.2 x 5,00,000
PBIT= 11,00,000
Interest = 11,00,000 – 5,00,000 = ₹6,00,000
6,00,000
Long term loan = 0.12 = ₹50,00,000
6. Average collection period = 30 days
30
Receivables = 360 x 50.00.000 = 4,16,667
7. Fixed Assets Turnover Ratio = 0.8
50,00,000/ Fixed Assets = 0.8
Fixed Assets = ₹62,50,000

Income Statement
Amount (₹)
Sales 50,00,000
Less: Cost of Goods Sold 30,00,000
Gross Profit 20,00,000
Less: Operating Expenses 9,00,000
Less: Interest. 6,00,000
Net Profit 5,00,000

Balance sheet
Liabilities Amount (₹) Assets Amount (₹)
Equity share capital 22,50,000Fixed asset 62,50,000
Long term debt 50,00,000Current assets:
Current liability 5,00,000Stock 10,00,000
Receivables 4,16,667
Other 83,333 15,00,000
77,50,000 77,50,000

Solution 46:
Ratios Comment

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

Liquidity Current ratio has improved from last year and matching the industry average.
Quick ratio also improved than last year and above the industry average.
The reduced inventory levels (evidenced by higher inventory turnover ratio) have led
to better quick ratio in FY 2022 compared to FY 2021.
Further the decrease in current liabilities is greater than the collective decrease in
inventory and debtors as the current ratio have increase from FY2021 to FY 2022.
Operating Operating Income-ROI reduced from last year, but Operating Profit Margin has been
Profits maintained. This may happen due to decrease in operating cost. However, both the
ratios are still higher than the industry average.
Financing The company has reduced its debt capital by 1% and saved earnings for equity
shareholders. It also signifies that dependency on debt compared to other industry
players (60%) is low.
Return to the Prabhu’s ROE is 26 per cent in 2021 and 28 per cent in 2022 compared to an industry
shareholders average of 18 per cent. The ROE is stable and improved over the last year.

Solution 47:
1. Balance Sheet of Rudra Ltd.
Liabilities (₹) Assets (₹)
Capital 10,00,000 Fixed Assets 30,00,000
Reserves 20,00,000 Current Assets:
Long Term Loan @ 10% 30,00,000 Stock in Trade 20,00,000
Current Liabilities: Debtors 20,00,000
Creditors 10,00,000 Cash 5,00,000
Other Short-term 2,00,000
Current Liability (Other
STCL)
Outstanding Interest 3,00,000
75,00,000 75,00,000

Working Notes:
Let sales be ₹ x
Balance Sheet of Rudra Ltd.

Liabilities (₹) Assets (₹)

Capital Reserves Fixed Assets Current x/4
Net Worth x/4 Assets:
Long Term Loan @ 10% x/4 Stock in Trade x/6
Debtors x/6
Cash 5,00,000
Current liabilities:
Creditors x/12
Other Short-term Current Liability
Outstanding Interest
Total Current Liabilities x/9+5,00,000/3
Total Total

1. Fixed Asset Turnover = 4 = x/Fixed Assets

Fixed Assets =x4

2. Stock Turnover = 6 = x /stock

Stock = x/ 6

3. Sales to net worth = 4 = x /net worth

Net worth =x/4

4. Debt: Equity =1:1

Long Term Loan /Net worth = 1/ 1

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 Chapter - FINANCIAL ANALYSIS & PLANNING - RATIO ANALYSIS- SOLUTION

Long term loan = Net worth = x/ 4

5. Gross Profit to Cost = 20%

GP / Sales – GP = 20%
G P/ x – G P = 20%
GP = 0.2 x – 0.2 GP
1.2 GP = 0.2 x
GP = 0.2x / 1.2
GP = x/6
Cost of Goods Sold = x – x/6 = 5/6 x

6. COGS to creditors = 10:1

COGS/ Creditors = 10 / 1
(5 x/6) / Creditors = 10/ 1
Creditors = 5x/60 = x/12

7. Stock /Debtor =1
Debtor = Stock = x/ 6

8. Current Ratio =3:1

(Stock +Debtors + Cash)/Current Liabilities = 3/1
(x/6 + x/6 +5,00,000)/ Current Liabilities = 3
{x/3 +5,00,000}/3 = CL
CL = x/9 + 5,00,000/3

9. CA = 3CL
= 3 {x/9 +₹ 5,00,000/3}
CA = x/3 +5,00,000

10. Net worth + Long Term Loan + Current Liability = Fixed Asset + Current Assets
{x/4 + x/4 + x/9 + ₹ 5,00,000/3} = {x/4 + x/3+ ₹ 5,00,000}
{x/4 + x/9 – x/3} = {₹ 5,00,000 – ₹ 5,00,000/ 3}
(9x+ 4x –12x)/36 = (₹15,00,000 – ₹ 5,00,000)/3
x /36 = ₹10,00,000/ 3
x = ₹ 1,20,00,000

11. Now, from above calculations, we get,

Fixed Asset =x/4 = ₹1,20,00,000/4 = ₹ 30,00,000
Stock =x/6 = ₹1,20,00,000/6 = ₹ 20,00,000
Debtor =x/6 = ₹1,20,00,000/6 = ₹ 20,00,000
Net Worth = x/4 = ₹ 30,00,000
Now, Capital to Reserve is 1 : 2
Capital = ₹ 10,00,000
and, Reserve = ₹ 20,00,000
Long Term Loan = x/4 = 30,00,000
Outstanding Interest = 30,00,000×10% = 3,00,000
Creditors = x/12 = ₹ 1,20,00,000 /12 = ₹ 10,00,000

Current Liabilities = Creditors + Other STCL + Outstanding Interest

{x/9 + ₹ 5,00,000/3} = ₹ 10,00,000+ Other STCL + ₹ 3,00,000
{₹1,20,00,000/9 + ₹ 5,00,000/3} = ₹ 13,00,000+ Other STCL
₹ 15,00,000 = Other STCL + ₹ 13,00,000
Other STCL = ₹ 2,00,000

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 Chapter 3 Cost Of Capital

Cost Of Capital
Solution 4:
Particulars Year 1 (₹) Year 2 (₹) Year 3 (₹) Year 4 (₹)
Principal Outstanding 20,000 15,000 10,000 5,000
Principal repaid 5,000 5,000 5,000 5,000
Add: Interest at 12.5% p.a. on Principal
Outstanding = Coupon Payment 2,500 1,875 1,250 625
Total Cash Flows p.a. (A) 7,500 6,875 6,250 5,625
𝑛
(1 + 0. 12) where n = nth year (B) 1.1200 1.2544 1.4049 1.5735
PV of Cash Flows (A)/(B) 6,696 54,811 4,448 3,575
Hence, Present value of Bond = Total of PV of Cash Flows = ₹ 20,200

Solution 5:
The amount of interest for five years will be:
First year ₹ 5,000 × 0.08 = ₹ 400;
Second year (₹ 5,000 – ₹ 1,000) × 0.08 = ₹ 320;
Third year (₹ 4,000 – ₹ 1,000) × 0.08 = ₹ 240;
Fourth year (₹ 3,000 – ₹ 1,000) × 0.08 = ₹ 160; and
Fifth year (₹ 2,000 – ₹ 1,000) × 0.08 = ₹ 80.
The outstanding amount of bond will be zero at the end of fifth year.
Since Reserve Bank of India will have to return ₹ 1,000 every year, the outflows every year will consist of
interest payment and repayment of principal:
First year ₹ 1,000 + ₹ 400 = ₹ 1,400;
Second year ₹ 1,000 + ₹ 320 = ₹ 1320;
Third year ₹ 1,000 + ₹ 240 = ₹ 1,240;
Fourth year ₹ 1000 + ₹ 160 = ₹ 1,160; and
Fifth year ₹ 1000 + ₹ 80 = ₹ 1080.

V8 = 1,400/(1.06)1 + 1,320/(1.06)2 + 1,240/(1.06)3 + 1,160/(1.06)4 + 1,080/(1.06)5

= 1,400 × 0.943 + 1,320 × 0.890 + 1,240 × 0.840 + 1,160 × 0.792 + 1,080 × 0.747
= 1,320.20 + 1,174.80 + 1,041.60 + 918.72 + 806.76
= ₹ 5,262.08

Solution 8.b.:
Here,
Redemption Value (RV)= ₹1,50,000
Net Proceeds (NP) = ₹ 3,750
Interest = 0
Life of bond = 25 years
There is huge difference between RV and NP therefore in place of approximation method we should use trial &
error method.
FV = PV x (1 + r)n
1,50,000 = 3,750 x (1 + r)25
40 = (1 + r)25
Trial 1: r = 15%, (1.15)25 = 32.919
Trial 2: r = 16%, (1.16)25 = 40.874
Here:
L = 15%; H = 16%
NPVL = 32.919 - 40 = - 7.081
NPVH = 40.874 - 40 = + 0.874
𝑁𝑃𝑉𝐿
IRR = L + 𝑁𝑃𝑉𝐿 − 𝑁𝑃𝑉𝐻
(H-L)

−7.081
= 15% + −7.081 – (0.874)
x (16% -15%) = 15.89%

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 Chapter 3 Cost Of Capital

Solution 8B:
Determination of Redemption value:
Higher of-
(i) The cash value of debentures = ₹ 100
(ii) Value of equity shares = 5 shares × ₹ 20 (1+0.04)5
= 5 shares × ₹ 24.333
= ₹ 121.665 rounded to ₹ 121.67
₹ 121.67 will be taken as redemption value as it is higher than the cash option and attractive to the investors.
Calculation of Cost of 10% Convertible debenture

(i) Using Approximation Method:

(𝑅𝑉 – 𝑁𝑃) (121.67 – 100)
𝐼 (1 – 𝑡) + 10 (1 – 0.25) + 7.5 + 4.334
Kd = (𝑅𝑉 + 𝑁𝑃)
𝑛
= (121.67 + 100)
5
= 110.835
= 10.676%
2 2

(ii) Using Internal Rate of Return Method

Year Cash flows Discount factor @ Present Value Discount factor @ Present Value
(₹) 10% 15% (₹)
0 100 1.000 (100.00) 1.000 (100.00)
1 to 5 7.5 3.790 28.425 3.353 25.148
5 121.67 0.621 75.557 0.497 60.470
NPV +3.982 -14.382
𝑁𝑃𝑉𝐿 3.982
IRR = L + 𝑁𝑃𝑉𝐿 − 𝑁𝑃𝑉𝐻
(H – L) = 10% + 3.982 – (− 14.382)
(15% - 10%) = 0.11084 or 11.084% (approx.)

Solution 31:
(i) Calculation of Cost of Convertible Debentures:
Given that,
RF = 10%
Rm – Rf = 18%
Β = 1.25
D0 = 12.76
D-5 = 10
Flotation Cost = 5%
Using CAPM,
Ke = Rf + β (Rm – Rf)
= 10%+1.25 (18%)
= 32.50%
Calculation of growth rate in dividend
12.76 = 10 (1+g)5
1.276 = (1+g)5
(1+5%)5 = 1.276................ from FV Table
g = 5%
7
𝐷7 12.76(1.05)
Price of share after 6 years = 𝑘𝑒−𝑔
= 0.325−0.05
12.76×1.407
P6 = 0.275
P6 = 65.28
Redemption Value of Debenture (RV) = 65.28 × 2 = 130.56 (RV)
NP = 95
n =6
(𝑅𝑉−𝑁𝑃)
𝐼𝑛𝑡(1−𝑡)+
Kd = (𝑅𝑉−𝑁𝑃)
𝑛
× 100
2
(130.56−95)
15(1−0.4)+
= (130.56+95)
6
× 100
2
9+5.93
= 112.78
× 100
Kd = 13.24%

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 Chapter 3 Cost Of Capital

(i) Calculation of Cost of Preference Shares:

Net Proceeds = 100 (1.1) - 6% of 100 (1.1)
= 110 - 6.60
= 103.40
Redemption Value = 100
Year Cash Flows (₹) PVF @ 3% PV (₹) PVF @ 5% PV (₹)
0 103.40 1 103.40 1 103.40
1-10 -5 8.530 -42.65 7.722 -38.61
10 -100 0.744 -74.40 0.614 -61.40
-13.65 3.39
5%−3%
Kp = 3% + {3.39−(−13.65)}
× 13. 65
2%
= 3% + 17.04 × 13. 65
Kp = 4.6021%

Solution 35:
𝐷1 ₹17.716
1. Cost of Equity (K ) = 𝑃𝑜−𝐹 + 𝑔 = ₹125−₹5
+ 0. 10 *

Ke = 0.2476
*Calculation of g:
₹ 10 (1+g)5 = ₹ 16.105
16.105
Or, (1+g)5 = 10
= 1.6105
Table (FVIF) suggests that ₹ 1 compounds to ₹ 1.6105 in 5 years at the compound rate of 10
percent. Therefore, g is 10 per cent.

𝐷1 ₹17.716
(ii) Cost of Retained Earnings (K ) = 𝑃𝑜
+g = 125
+ 0.10 = 0.2417

𝑃𝐷 ₹15
(iii) Cost of Preference Shares (Kp) = 𝑃𝑜
= ₹105 =0.1429

(iv) Cost of Debentures (Kd) =

𝐼(1−𝑡)+ ( 𝑅𝑉−𝑁𝑃
𝑛 )
( 𝑅𝑉 +𝑁𝑃
2 )

=
₹15(1−0.30)+ (₹100−₹91.75*
11 𝑦𝑒𝑎𝑟𝑠 )
₹100+₹91.75
2

₹15×0.70+ ₹0.75 ₹11.25

= ₹95.875
= ₹95.875
= 0.1173

*Since yield on similar type of debentures is 16 per cent, the company would be required to offer
debentures at discount.

Market price of debentures (approximation method)

= ₹ 15 ÷ 0.16 = ₹ 93.75
Sale proceeds from debentures = ₹ 93.75 – ₹ 2 (i.e., floatation cost) = ₹91.75
Market value (P0) of debentures can also be found out using the present value method:
P0 = Annual Interest × PVIFA (16%, 11 years) + Redemption value × PVIF (16%, 11 years)
P0 = ₹ 15 × 5.0287 + ₹ 100 × 0.1954

P0 = ₹ 75.4305 + ₹ 19.54 = ₹ 94.9705

Net Proceeds = ₹ 94.9705 – 2% of ₹ 100 = ₹ 92.9705

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 Chapter 3 Cost Of Capital

Accordingly, the cost of debt can be calculated

Total Cost of capital [BV weights and MV weights]

(Amount in (₹) lakh)
Weights Specific Total cost

Source of capital BV MV Cost (K) (BV × K) (MV × K)

Equity Shares 240 320** 0.2476 59.4240 79.2320
Retained Earnings 60 80** 0.2417 14.502 19.336
Preference Shares 72 67.50 0.1429 10.2888 9.6458
Debentures 18 20.80 0.1173 2.1114 2.4398
Total 390 488.30 86.3262 110.6536

**Market Value of equity has been apportioned in the ratio of Book Value of equity and retained earnings i.e.,
240:60 or 4:1.
Weighted Average Cost of Capital (WACC):

₹86.3262
Using Book Value = ₹390
= 0.2213 or 22.13%

₹110.6536
Using Market Value = ₹488.30
= 0.2266 or 22.66%

Solution 37:
Statement of WACC
Source Amount Weight Cost of Capital WACC
Equity (2,00,000 × 30) ₹ 60,00,000 0.6 17.00% 10.20%
Preference Capital ₹ 10,00,000 0.10 12.00% 1.20%
Debt ₹ 30,00,000 0.30 5.40% 1.62%
Total ₹ 1,00,00,000 1.00 WACC = K0 13.02%
Working Notes:
𝐷𝑃𝑆 ₹3
(1) Revised Ke = 𝑀𝑃𝑆 + g = ₹ 30
+ 7% = 17.00%
(2) Kd = 9% × (100% – 40%) = 5.40%

Solution 40:
Market Value of Equity, E = 5,00,000 × 1.50 = ₹ 7,50,000
Market value of Debt, D = Nil
Cost of Equity Capital, Ke = Dividend/Market value of Share = 27/150 = 0.18
Since there is no Debt Capital, WACC = Ke = 18%

Solution 45:
(a) Cost of Equity / Retained Earnings (using dividend growth model)
𝐷1
Ke = 𝑃𝑜
where D1 = Do (1 + g) = 2 (1 + .10) = 2.2
2.2
Ke = 44 + 0.10 = 0.15 or 15 %
(b) Cost of Debt (Post Tax)
Kd = I (1-t)
Upto 3,60,000 Kd = .08 (1-0.4) = 0.048
Beyond 3,60,000 = .12 (1-0.4) = 0.072
Thus, post-tax cost of additional debt = 0.048 x 3,60,000 / 6,00,000 + 0.072 x 2,40,000/ 6,00,000 = 0.0288 +
0.0288 = 0.0576 or 5.76%
(c) Pattern for Raising Additional Finance
Debt = 20,00,000 x 30% = 6,00,000
Equity = 20,00,000 x 70 % = 14,00,000

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 Chapter 3 Cost Of Capital

Out of this total equity amount of

₹ 14,00,000 - Equity Shares = 14,00,000 – 4,20,000
= 9,80,000
And Retained Earnings = 4,20,000
(d) Overall Weighted Average after tax cost of additional finance
WACC = Kd x Debt Mix + Ke x Equity Mix
= 0.0576 x 30% + 0.15 x 70% = 0.01728 + 0.105 = 0.1223 or 12.23% (approx.)

Solution 46.
Statement to find WACC
(i) Using Book value weights
Source Amount (in lakhs) Weight Rate WACC
Deb 8,00,000 0.4 3.619% 1.4476%
Preference 2,00,000 0.1 8.474% 0.8474%
Equity 10,00,000 0.5 15% 7.5%
20,00,000 Ko = 9.795%

(ii) Using market value weights

Source Amount (in lakhs) Weight Rate WACC
Deb 8,00,000/100 x 110 =8,80,000 0.265 3.619% 0.959%
Pref 2,00,000/100 x 120 = 2,40,000 0.072 8.474% 0.610%
Equity 10,00,000/10 x 22 = 22,00,000 0.663 15% 9.945
33,20,000 Ko = 11.514%

Working note 1
(𝑅𝑉 – 𝑁𝑃) (100 – 105.6)
𝐼(1 − 𝑡) + 8(1 − 50%) + 3.72
Kd = (𝑅𝑉 + 𝑁𝑃)
𝑛
= (100 + 105.6)
20
= 102.8
= 3.619%
2 2

Working Note 2
(𝑅𝑉 – 𝑁𝑃) (100 – 114)
𝐼(1 − 𝑡) + 10 + 10 − 0.933
Kp = (𝑅𝑉 + 𝑁𝑃)
𝑛
= 15
(100 + 114) = 107
= 8.474%
2 2

Working Note 3
Ke = D1/Po + g
= 2/(22 – 2) + 5%
= 15%

Solution 47:
(i) Weighted Average Cost of Capital of the Company is as follows:
Capital Structure Amount Cost of Capital Weights WACC
Equity Share Capital 40,00,000 15% 0.500 7.50%
11.5% Preference Shares 10,00,000 11.5% 0.125 1.4375%
10% Debentures 30,00,000 6.5% 0.375 2.4375%
80,00,000 1.000 11.375%
Working Notes:
1. Cost of Equity Capital:
𝐷1 ₹2
Ke = 𝑃0
+g= ₹20
+ 5% = 15%

2. Cost of Preference Share Capital:

𝐷 ₹1,15,000
Kp = 𝑃 = ₹ 10,00,000 = 0.115 = 11.5%
3. Cost of Debentures:
𝐼 (1−𝑡) ₹ 3,00,000 (1−0.35)
Kd = 𝑃 = ₹ 30,00,000
= 6.5%

(ii) New Weighted Average Cost of Capital of the company is as follows:

Capital Structure Amount Cost of Capital Weights WACC

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Equity share capital 40,00,000 20% 0.40 8.00%

11.5% preference shares 10,00,000 11.50% 0.10 1.15%
10% debentures 30,00,000 6.50% 0.30 1.95%
12% debentures 20,00,000 7.80% 0.20 1.56%
1,00,00,000 1.00 12.66%
Working Notes:
𝐷1 ₹2.40
Cost of Equity Capital (Ke) = 𝑃0
+g= ₹16
+ 5% = 20%
Comment: In the computation of weighted average cost of capital weights are preferred to book value. For
example, weights representing the capital structure under a corporate financing situation, its cash flows are
preferred to earnings and market. Balance sheet is preferred to book value balance sheet.

Solution 51:
Calculation of Cost of Equity
(i) D0 = ₹ 5x 60%
D0 = ₹ 3
g = b x r = (1-0.6) x 10% = 4%

D1 = D0 x (1 + g) = 3 x (1 + 4%) = 3 x 1.04 = 3.12

𝐷1
Ke= 𝑃𝑜 + 𝑔
3.12
Ke= 20.8
+ 0. 04
Ke= 19%

(ii) Calculation of Cost of Preference Shares

N =10 years
NP = ₹ 90
PD = ₹ 15
RV = ₹ 100
𝑃𝐷+(𝑅𝑉−𝑁𝑃)/𝑁
Kp= (𝑅𝑉+𝑁𝑃) ×100
15+(100−90)/10
Kp= (100+90)/2
× 100
Kp = 16/95 x 100
Kp= 16.84%

(iii) Calculation of Cost of Debentures

N = 6 years
NP = ₹ 75
Interest = ₹ 14 RV = ₹ 100
T = 40%
𝐼𝑛𝑡(1−𝑡)+(𝑅𝑉−𝑁𝑃)/𝑁
Kd = (𝑅𝑉+𝑁𝑃)/2
× 100
14×(1−0.04)+(100−75)/6
Kd = (100+75)/2
× 100
8.4−4.17
Kd= 87.5
× 100
Kd= 14.37%

(iv) Cost of Term Loan

Kd = Interest rate (1-t) Kd = 13% (1-40%)
Kd = 7.8%

Calculation of Weighted Average Cost of Capital (WACC) (using market weights)

Capital Cost of Market Value Market Value Product (Cost x
Capital Weights weights)
Equity 19.00% 20.8 x 50,00,000 ₹10,40,00,000 0.6218 11.81%
Preference Shares 16.84% 90 x 50,000 ₹ 45,00,000 0.0269 0.45%
Debentures 14.37% 75 x 2,50,000 ₹ 1,87,50,000 0.1121 1.61%
Term Loan 7.80% ₹ 4,00,00,000 0.2392 1.87%

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 Chapter 3 Cost Of Capital

Total ₹16,72,50,000 1 15.74%

WACC= 15.74%

(b)Calculation of Marginal Cost of Capital (MACC)

The required capital of ₹ 50,000,000 will be raised as follows:
Equity = 60% of ₹ 50,000,000 = ₹ 30,000,000
Deby = 20% of ₹ 50,000,000 = ₹10,000,000
Retained Earnings= 20% of ₹ 50,000,000 = ₹ 10,000,000
3.12
Marginal Cost of Equity= 1.4 + 0. 04
= 26.28%
Marginal Cost of Debt
13% 𝑜𝑓 ₹40,00,000 + 15% 𝑜𝑓 ₹60,00,000
Cost of Debt (before tax)= ₹1,00,00,000
₹5,20,000+₹9,00,000
= ₹1,00,00,000
= 14.2%
Cost of Debt (after tax)). = 14.2% (1-t)
= 14.2% (1-0.4)
= 8.52%
Calculation of marginal cost of capital
Capital Cost of Capital Value Weights Product (Cost x
weights)
Equity 26.28% ₹ 3,00,00,000 0.6 15.77%
Reserves 26.28% ₹ 1,00,00,000 0.2 5.26%
Debt 8.52% ₹ 1,00,00,000 0.2 1.70%
Total ₹ 5,00,00,000 1 22.73%
Marginal Cost of Capital (MACC) = 22.73%

Solution 55:
(a) (i) After tax cost of new Debt:

𝐼 (1−𝑡) (1−0.3)
Kd= 𝑃
= 15 96

= 0.1094 (or) 10.94%

(ii) After tax cost of New Preference share capital:

𝑃𝐷 12
𝐾𝑝= 𝑃𝑜
− ( 91.5 )=0.1311 (or) 13.11%

(iii) After tax cost of Equity shares:

𝐷 (2.50×50%)
K = 𝑃1 + 𝑔 = 25
+ 0. 10
𝑜

= 0.15 (or) 15%

(b) Marginal Cost of Capital

Type of capital Proportions Specific cost Product

Equity Shares 0.8 0.15 0.12

Preference Shares 0.05 0.1311 0.0066
Debentures 0.15 0.1094 0.0164
\Marginal cost of capital 0.143
(c) Amount that can be spend for capital investment
Retained earnings = 50% of EPS x No. of outstanding Equity shares

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 Chapter 3 Cost Of Capital

= 1.25 x 50,000
= ₹ 62,500
Proportion of equity (Retained earnings here) capital is 80% of total capital. Therefore, ₹ 62,500 is 80% of
total capital.
62,500
Amount of Capital Investment = 0.80
= ₹ 78,125

Solution 63:
(A) (i) Cost of new debt
𝐼(1− 𝑡) ₹ 16(1− 0.3)
Kd = 𝑃𝑜 = ₹ 96
= 0.11667

(ii) Cost of new preference shares

₹ 2.22
Kp = ₹ 18.5 = 0.12

(iii) Cost of new equity shares

𝐷1 + 𝑔 2.36 + 0.10
Ke = 𝑃𝑜
= 47.20 = 0.05 + 0.10 = 0.15

Calculation of g when there is a uniform trend (on the basis of EPS)

𝐸𝑃𝑆 (2012) – 𝐸𝑃𝑆 (2011) ₹ 2.20 − ₹ 2.00
= 𝐸𝑃𝑆 (2011)
= ₹ 2.00
= 0.10 or 10%

Calculation of D1
D1 = 50% of 2020 EPS = 50% of ₹ 4.72 = ₹ 2.36

(B) Calculation of marginal cost of capital

Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debentures 0.15 0.11667 0.0175
Preference Share 0.05 0.1200 0.0060
Equity Share 0.80 0.1500 0.1200
Marginal cost of capital 0.1435
(C) The company can spend the following amount without increasing marginal cost of capital and
without selling the new shares:
Retained earnings = 50% of EPS of 2020 × outstanding equity shares
= 50% of ₹ 4.72 × 10,000 shares = ₹ 23,600
The ordinary equity (Retained earnings in this case) is 80% of total capital.
So, ₹ 23,600 = 80% of Total Capital
₹ 23,600
∴ Capital investment before issuing equity shares = 0.80 = ₹ 29,500

(D) If the company spends in excess of ₹ 29,500, it will have to issue new equity shares at ₹ 40 per
share.
The cost of new issue of equity shares will be:
𝐷1 + 𝑔 ₹ 2.36 + 0.10
Ke = 𝑃𝑜 = ₹ 40
= 0.159

The marginal cost of capital will be:

Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debentures 0.15 0.11667 0.0175
Preference Shares 0.05 0.1200 0.0060
Equity Shares 0.80 0.1590 0.1272
(New)
Marginal cost of capital 0.1507

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 Chapter - Capital Structure

Capital Structure
Solution 1:
Computation of level of earnings before interest and tax (EBIT)
In case alternative (i) is accepted, then the EPS of the firm would be:
(𝐸𝐵𝐼𝑇 – 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡) (1 – 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒) (𝐸𝐵𝐼𝑇 – 0.14 𝑥 8,00,000) (1 – 0.3)
EPS Alternative (i) = 𝑁𝑜. 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠
= 1,20,000 𝑠ℎ𝑎𝑟𝑒𝑠

In case the alternative (ii) is accepted, then the EPS of the firm would be
(𝐸𝐵𝐼𝑇 – 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡) (1 – 𝑇𝑎𝑥 𝑅𝑎𝑡𝑒) – 𝑃𝐷
EPS Alternative (ii) = 𝑁𝑜. 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠
(𝐸𝐵𝐼𝑇 – 0.14 𝑥 8,00,000) (1 – 0.3)
= 80,000 𝑠ℎ𝑎𝑟𝑒𝑠
– 0.16 x 4,00,000

In order to determine the indifference level of EBIT, the EPS under the two alternative plans should be equated
as follows:
(𝐸𝐵𝐼𝑇 – 0.14 𝑥 8,00,000)(1− 0.3) (𝐸𝐵𝐼𝑇 – 0.14 𝑥 8,00,000)(1− 0.3)
1,20,000 𝑠ℎ𝑎𝑟𝑒𝑠
= 80,000 𝑠ℎ𝑎𝑟𝑒𝑠
– 0.16 x 4,00,000

0.7 𝐸𝐵𝐼𝑇 – 78,400 0.7 𝐸𝐵𝐼𝑇 − 1,42,400

Or, 1,20,000
= 80,000

Or 1.40 EBIT – ₹1,56,800 = 2.10 EBIT – ₹ 4,27,200

Or 0.70 EBIT = ₹ 2,70,400
2,70,400
Or, EBIT = 0.7

Or, EBIT = ₹ 3,86,285.71(approx.)

Solution 2:
(i) Computation of EPS under three-financial plans
Plan I: Equity Financing
(₹ ) (₹) (₹) (₹) (₹ )
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Interest 0 0 0 0 0
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% 10,000 20,000 40,000 60,000 1,00,000
PAT 10,000 20,000 40,000 60,000 1,00,000
No. of equity shares 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
EPS 0.10 0.20 0.40 0.60 1

Plan II: Debt – Equity Mix

(₹) (₹) (₹) (₹) (₹)
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 40,000 40,000 40,000 40,000 40,000
EBT (20,000) 0 40,000 80,000 1,60,000
Less: Tax @ 50% 10,000* 0 20,000 40,000 80,000
PAT (10,000) 0 20,000 40,000 80,000
No. of equity shares 50,000 50,000 50,000 50,000 50,000
EPS (₹ 0.20) 0 0.40 0.80 1.60
* The Company can set off losses against the overall business profit or may carry forward it to next financial
years.

Plan III: Preference Shares – Equity Mix

(₹ ) (₹ ) (₹ ) (₹ ) (₹ )
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 0 0 0 0 0
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% 10,000 20,000 40,000 60,000 1,00,000
PAT 10,000 20,000 40,000 60,000 1,00,000

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 Chapter - Capital Structure

Less: Pref. dividend 40,000* 40,000* 40,000 40,000 40,000

PAT after Pref. dividend. (30,000) (20,000) 0 20,000 60,000
No. of Equity shares 50,000 50,000 50,000 50,000 50,000
EPS (0.60) (0.40) 0 0.40 1.20
* In case of cumulative preference shares, the company has to pay cumulative dividend to preference
shareholders, when company earns sufficient profits.

(ii)From the above EPS computations tables under the three financial plans we can see that when EBIT
is ₹ 80,000 or more, Plan II: Debt-Equity mix is preferable over the Plan I and Plan III, as rate of EPS is
more under this plan. On the other hand an EBIT of less than ₹ 80,000, Plan I: Equity Financing has
higher EPS than Plan II and Plan III. Plan III Preference share Equity mix is not acceptable at any level
of EBIT, as EPS under this plan is lower.
The choice of the financing plan will depend on the performance of the company and other macro economic
conditions. If the company is expected to have higher operating profit Plan II: Debt – Equity Mix is preferable.
Moreover, debt financing gives more benefit due to availability of tax shield.

Solution 3:
Ascertainment of probable price of shares of Prakash limited
Plan-I Plan-II
If ₹ 5,00,000 is raised If ₹ 5,00,000
Particulars as debt is raised by
issuing equity
(₹) Shares (₹)
Earnings Before Interest and Tax (EBIT)
{20% of new capital i.e., 20% of (₹15,00,000 + 4,00,000 4,00,000
₹ 5,00,000)}
(Refer working note1)
Less: Interest on old debentures (10% of ₹5,00,000) (50,000) (50,000)
Less: Interest on new debt (12% of ₹5,00,000) (60,000) --
Earnings Before Tax (EBT) 2,90,000 3,50,000
Less: Tax @ 50% (1,45,000) (1,75,000)
Earnings for equity shareholders (EAT) 1,45,000 1,75,000
No. of Equity Shares (refer working note 2) 25,000 35,000
Earnings per Share (EPS) ₹ 5.80 ₹ 5.00
Price/ Earnings (P/E) Ratio (refer working note 3) 8 10
Probable Price Per Share (PE Ratio × EPS) ₹ 46.40 ₹ 50
Working Notes:
1. Calculation of existing Return of Capital Employed (ROCE):
(₹)
Equity Share capital (25,000 shares × ₹10) 2,50,000
(
10% Debentures ₹50, 000 × 10
100
) 5,00,000
Reserves and Surplus 7,50,000
Total Capital Employed 15,00,000
Earnings before interest and tax (EBIT) (given) 3,00,000
₹3,00,000
ROCE = ₹15,00,000 × 100 20%
2. Number of Equity Shares to be issued in Plan-II:
₹5,00,000
= ₹50 = 10,000 Shares
Thus, after the issue total number of shares = 25,000+ 10,000 = 35,000 shares
3. Debt/Equity Ratio if ₹ 5,00,000 is raised as debt:
₹10,00,000
= ₹20,00,000 ×100 = 50%
As the debt equity ratio is more than 40% the P/E ratio will be brought down to 8 in Plan-I

Solution 6:
Particulars Plan I (₹.) Plan II (₹.) Plan III (₹.) Plan IV (₹.)
Equity Share Capital 16,00,000 14,00,000 13,00,000 13,00,000

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 Chapter - Capital Structure

12% Long Term Loan (₹.) - 2,00,000 - -

9% Debentures - - 3,00,000 -
6% Preference Shares - - - 3,00,000
EBIT 4,00,000 4,00,000 4,00,000 4,00,000
Interest on Debentures/Term
Loan Nil (24,000) (27,000) Nil
(₹. 3,00,000
(₹. 2,00,000 ×12%) ×9%)
EBT 4,00,000 3,76,000 3,73,000 4,00,000
Tax at 40% (1,60,000) (1,50,400) (1,49,200) (1,60,000)
EAT 2,40,000 2,25,600 2,23,800 2,40,000
Preference Dividend Nil Nil Nil (18,000)
Residual Earnings 2,40,000 2,25,600 2,23,800 2,22,000
No. of Equity Shares 1,60,000 1,40,000 1,30,000 1,30,000
𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
EPS = 𝑁𝑜.𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 ₹. 1.50 ₹.1.61 ₹. 1.72 ₹. 1.71
𝐸𝐵𝐼𝑇
DFL(For Interest) = 𝐸𝐵𝑇 1.00 times 1.06 times 1.07 times 1.00 times
DFL (For Interest & Pref.
Dividend) 1.00 times 1.06 times 1.07 times 1.08 times
𝐸𝐵𝐼𝑇 ₹.4,00,000
DFL (With Interest and Preference Dividend) = 𝐸𝐵𝐼𝑇−𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡−𝑃𝑟𝑒 𝑇𝑎𝑥 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = ₹.4,00,000−𝑁𝑖𝑙−₹.30,000
= 1.08
𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 ₹.18,000
Pre tax preference Dividend = (100%−𝑇𝑎𝑥 𝑅𝑎𝑡𝑒) = 60% = ₹. 30,000

Solution 11:
(i) Computation of Earnings per Share (EPS)
Plans X (₹) Y (₹) Z (₹)
Earnings before interest & tax (EBIT) 1,00,000 1,00,000 1,00,000
Less: Interest charges (10% of ₹ 2,00,000) -- (20,000) --
Earnings before tax (EBT) 1,00,000 80,000 1,00,000
Less: Tax @ 50% (50,000) (40,000) (50,000)
Earnings after tax (EAT) 50,000 40,000 50,000
Less: Preference share dividend (10% of ₹ 2,00,000) -- -- (20,000)
Earnings available for equity shareholders (A) 50,000 40,000 30,000
No. of equity shares (B) 20,000 10,000 10,000
Plan X = ₹ 4,00,000/ ₹ 20
Plan Y = ₹ 2,00,000 / ₹ 20
Plan Z = ₹ 2,00,000 / ₹ 20
E.P.S (A ¸ B) 2.5 4 3

(ii) Computation of Financial Break-even Points

Financial Break-even point = Interest + Preference dividend/(1 - tax rate)
Proposal ‘X’ =0
Proposal ‘Y’ = ₹ 20,000 (Interest charges)
Proposal ‘Z’ = Earnings required for payment of preference share dividend
= ₹ 20,000 ÷ (1- 0.5 Tax Rate) = ₹ 40,000

(iii) Computation of Indifference Point between the plans

Combination of Proposals
a. Indifference point where EBIT of proposal “X” and proposal ‘Y’ is equal
(𝐸𝐵𝐼𝑇)(1 – 0.5) (𝐸𝐵𝐼𝑇 – ₹ 20,000)(1 – 0.5)
20,000 𝑠ℎ𝑎𝑟𝑒𝑠
= 10,000 𝑠ℎ𝑎𝑟𝑒𝑠
0.5 EBIT = EBIT – ₹ 20,000
EBIT = ₹ 40,000

b. Indifference point where EBIT of proposal ‘X’ and proposal ‘Z’ is equal:
(𝐸𝐵𝐼𝑇)(1 – 0.5) 𝐸𝐵𝐼𝑇 (1 – 0.5) – ₹ 20,000
20,000 𝑠ℎ𝑎𝑟𝑒𝑠
= 10,000 𝑠ℎ𝑎𝑟𝑒𝑠
0.5 EBIT = EBIT- ₹ 40,000

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 Chapter - Capital Structure

0.5 EBIT = ₹ 40,000

₹ 40,000
EBIT = 0.5 = ₹ 80,000

c. Indifference point where EBIT of proposal ‘Y’ and proposal ‘Z’ are equal
(𝐸𝐵𝐼𝑇 – ₹ 20,000)(1 – 0.5) 𝐸𝐵𝐼𝑇(1 – 0.5) – ₹ 20,000
10,000 𝑠ℎ𝑎𝑟𝑒𝑠
= 10,000 𝑠ℎ𝑎𝑟𝑒𝑠

0.5 EBIT – ₹ 10,000 = 0.5 EBIT – ₹ 20,000

There is no indifference point between proposal ‘Y’ and proposal ‘Z’
Analysis: It can be seen that financial proposal ‘Y’ dominates proposal ‘Z’, since the financial break-even-point
of the former is only ₹ 20,000 but in case of latter, it is ₹ 40,000. EPS of plan ‘Y’ is also higher.

Solution 12:
(i) Computation of Earnings per share (EPS)
Plans A B C
Earnings before interest and 10,00,000 10,00,000 10,00,000
tax (EBIT)
Less: Interest Charges --- (20,000) ---
(10% x 2 lakh)
Earnings before tax (EBIT) 10,00,000 9,80,000 10,00,000
Less: Tax (@30%) (3,00,000 ) (2,94,000) (3,00,000)
Earnings after tax (EAT) 7,00,000 6,86,000 7,00,000
Less: Preference Dividend --- --- (20,000)
(10% x ₹ 2 Lakh)
Earnings available for equity 7,00,000 6,86,000 6,80,000
shareholders (A)
No. of Equity Shares (B) 20,000 10,000 10,000
(₹ 4 lakh ÷ ₹ 20) (₹ 2 lakh ÷ ₹ 20) (₹ 2 lakh ÷ ₹ 20)
EPS ₹ [(A) ÷ (B)] 35 68.6 68

(ii) Calculation of Financial Break-even point

Financial break-even point is the earnings which are equal to the fixed finance charges and preference
dividend.
Plan A: Under this, plan there is no interest payment of ₹ 2,00,000 and no preference dividend. Hence, the
Financial Break-even point will be zero.

Plan B: Under this plan, there is an interest payment of ₹ 20,000 and no preference dividend. Hence, the
Financial Break-even point will be ₹ 20,000 (Interest charges)

Plan C: Under this plan, there is no interest payment but an after tax preference dividend of ₹ 20,000 is paid.
Hence, the Financial Break – even point will be before tax earnings of ₹ 28,571 (i.e. ₹ 20,000 ÷ 0.7)

(iii) Computation of indifference points between the plans.

The Indifference between two alternative methods of financing is calculated by applying the following formula.
(𝐸𝐵𝐼𝑇 – 𝐼1) (1 – 𝑇) (𝐸𝐵𝐼𝑇 – 𝐼2) (1 – 𝑇)
𝐸1
= 𝐸2

Where,
EBIT = Earnings before Interest and tax.
I1 = Fixed charges (interest or pref. dividend) under Alternative 1
I2 = Fixed charges (interest or pref. dividend) under Alternative 2
T = Tax rate
E1 = No. of equity shares in Alternative 1
E2 = No. of equity shares in Alternative 2

Now, we can calculate indifference points between different plans of financing.

(a) Indifference point where EBIT of Plan A and Plan B is equal.

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(𝐸𝐵𝐼𝑇 – 0) (1 – 0.3) (𝐸𝐵𝐼𝑇 – 20,000)(1−0.3)

20,000
= 10,000
0.7 EBIT (10,000) = (0.7 EBIT – 14,000) (20,000)
7,000 EBIT = 14,000 EBIT – 28 Crores
EBIT = 40,000

(b) Indifference point where EBIT of Plan A and Plan C is equal

(𝐸𝐵𝐼𝑇 – 0) (1 – 0.3)
(𝐸𝐵𝐼𝑇 – 0) (1−0.3)
20,000
= 10,000
– 20,000

0.7 EBIT (10,000) = (0.7 EBIT – 20,000) (20,000)

7,000 EBIT = 14,000 EBIT – 40 crores
EBIT = 57,142.86

(c) Indifference point where EBIT of Plan B and Plan C are equal
(𝐸𝐵𝐼𝑇 – 20,000) (1 – 0.3)
(𝐸𝐵𝐼𝑇 – 0) (1 – 0.3)
10,000
= 10,000
– 20,000

(0.7 EBIT – 14,000) (10,000) = (0.7 EBIT – 20,000) (10,000)

7,000 EBIT – 14 crore = 7,000 EBIT – 20 crore
There is no indifference point between the financial plans B and C.

Solution 16:
1. Profitability statement under different Plans
Plan I: Issue of 3,12,500 Equity shares at ₹. 10
Situation A B C D E
EBIT ₹. 62,500 ₹. 1,25,000 ₹. 2,50,000 ₹. 3,75,000 ₹. 6,25,000
Less: Interest on debentures Nil Nil Nil Nil Nil
EBT ₹. 62,500 ₹. 1,25,000 ₹. 2,50,000 ₹. 3,75,000 ₹. 6,25,000
Less: Tax at 40% (₹. 25,000) (₹. 50,000) (₹.1,00,000) (₹.1,50,000) (₹. 2,50,000)
EAT ₹. 37,500 ₹. 75,000 ₹. 1,50,000 ₹. 2,25,000 ₹. 3,75,000
Less: Preference Dividend Nil Nil Nil Nil Nil
Residual Earnings ₹. 37,500 ₹. 75,000 ₹. 1,50,000 ₹. 2,25,000 ₹. 3,75,000
No. of Equity shares 3,12,500 3,12,500 3,12,500 3,12,500 3,12,500
𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
EPS = 𝑁𝑜.𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 ₹. 0.12 ₹. 0.24 ₹. 0.48 ₹. 0.72 ₹. 1.20

Plan II: Issue of 1,56,250 equity Shares at ₹. 10 and ₹. 15,625 8% Debentures of ₹. 100
Situation A B C D E
EBIT ₹. 62,500 ₹. 1,25,000 ₹. 2,50,000 ₹. 3,75,000 ₹. 6,25,000
Less: Interest on
debentures (₹. 1,25,000) (₹. 1,25,000) (₹. 1,25,000) (₹. 1,25,000) (₹. 1,25,000)
EBT (₹. 62,500) Nil ₹. 1,25,000 ₹. 2,50,000 ₹. 5,00,000
Add: Tax Savings ₹. 25,000 - - - -
Less: Tax at 40% - Nil (₹. 50,000) (₹. 1,00,000) (₹. 2,00,000)
EAT (₹. 37,500) Nil ₹. 75,000 ₹. 1,50,000 ₹. 3,00,000
Less: Preference
Dividend Nil Nil Nil Nil Nil
Residual
Earnings (₹. 37,500) Nil ₹. 75,000 ₹. 1,50,000 ₹. 3,00,000
No. of Equity
shares 1,56,250 1,56,250 1,56,250 1,56,250 1,56,250
EPS =
𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
𝑁𝑜.𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 (₹. 0.24) Nil ₹. 0.48 ₹. 0.96 ₹. 1.92

Plan III: Issue of 1,56,250 Equity Shares at ₹. 10 and 15,625 8% Preference shares of ₹. 100
Situation A B C D E
EBIT ₹. 62,500 ₹. 1,25,000 ₹. 2,50,000 ₹. 3,75,000 ₹. 6,25,000

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Less: Interest on
debentures (Nil) (Nil) (Nil) (Nil) (Nil)
EBT ₹. 62,500 ₹. 1,25,000 ₹. 2,50,000 ₹. 3,75,000 ₹. 6,25,000
Less: Tax at 40% (₹. 25,000) (₹. 50,000) (₹. 1,00,000) (₹. 1,50,000) (₹. 2,50,000)
EAT ₹. 37,500 ₹. 75,000 ₹. 1,50,000 ₹. 2,25,000 ₹. 3,75,000
Less: Preference
Dividend (₹. 1,25,000) (₹. 1,25,000) (₹. 1,25,000) (₹. 1,25,000) (₹. 1,25,000)
Residual
Earnings ₹. 87,500 ₹. 50,000 ₹. 25,000 ₹. 1,00,000 ₹. 2,50,000
No. of Equity
shares 1,56,250 1,56,250 1,56,250 1,56,250 1,56,250
EPS =
𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
𝑁𝑜.𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 (₹. 0.56) (₹. 0.32) ₹. 0.16 ₹. 0.64 ₹. 1.60

2. Recommendation: In order to maximise EPS, the optimal financing plan will be as under:
Situation A B C D E
EBIT ₹. 62,500 ₹. 1,25,000 ₹. 2,50,000 ₹. 3,75,000 ₹. 6,25,000
Financing plan to be selected I I I or II II II
Maximum EPS ₹. 0.12 ₹. 0.24 ₹. 0.48 ₹. 0.96 ₹. 1.92

3. Computation of EBIT – EPS Indifference Point (i.e. same EPS under two alternatives)
(a) Plan I and II
For equal EPS, Let the required EBIT be ₹. A
𝐴 × (1−0.40)
Plan I EPS = 3,12,500 𝑆ℎ𝑎𝑟𝑒𝑠
(𝐴−1,25,000)× (1−0.40)
Plan II EPS = 1,56,250 𝑆ℎ𝑎𝑟𝑒𝑠
0.6 𝐴 0.6 𝐴−75,000
3,12,500
= 1,56,250
0.6 A = 1.2 A – 1,50,000
A = ₹. 2,50,000
EBIT should be ₹. 2,50,000

(b) Plan I and II

For equal EPS, Let the required EBIT be ₹. B
𝐵 × (1 – 0.40)
Plan I EPS = 3,12,500 𝑆ℎ𝑎𝑟𝑒𝑠
𝐵 × (1−0.40)– 1,25,000
Plan II EPS = 1,56,250 𝑆ℎ𝑎𝑟𝑒𝑠
0.6 B = 1.2 B – 2,50,000
B = ₹. 4,16,667
EBIT should be ₹. 4,16,667

Solution 17.
Income statement
Particulars I(Deb) II(Equity)
Equity 50,00,000 50,00,000
New Equity - 25,00,000
New Debt @ 8% 25,00,000 -

At indifference point
(EBIT – I1)(1-t) – PD1/n1 = (EBIT – I2) (1-t) – PD2
(EBIT – 2,00,000) (1 – 50%)/5,00,000 = (EBIT – 0) (1 – 50%) – 0/7,50,000
0.5 EBIT – 1,00,000/ 50 = 0.5 EBIT/75
3.75 EBIT – 75,00,000 = 25 EBIT
12.5 EBIT = 75,00,000
EBIT = ₹ 6,00,000

Income Statement
I II

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EBIT 6,00,000 6,00,000

(-) Int (20,00,000) (-)
EBT 4,00,000 6,00,000
(-) Tax @ 50% (2,00,000) (3,00,000)
EAT/EAES 2,00,000 3,00,000
(÷) No. of shares 5,00,000 7,50,000
EPS ₹ 0.4 ₹ 0.4

Or you can verify this way

EPS1 = (6,00,000 – 2,00,000) (1 - 50%)/5,00,000 = 0.4
EPS2 = (6,00,000)(0.5)/7,50,000 = 0.4
Hence verified as EPS1 = EPS2

Uncommitted EPS means EPS which is obtained after keeping sinking fund amount of each year. Sinking fund
is applicable only in that option where debentures are present. (Not only in equity option)
Uncommitted EPS = (EBIT – I1)(1 – t) – PD – Sinking Fund/n1

At indifference point, uncommitted EPS

U EPS1 = U EPS2
(EBIT – I1) (1-t) – sinking fund/n1 = (EBIT – I2) (1-t)/n2
(EBIT – 2,00,000)(0.5) – 2,50,000/5,00,000 = (EBIT) (0.5)/7,50,000
0.5 EBIT – 1,00,000 – 2,50,000/50 = 0.5 EBIT/75
37.5 EBIT – 2,62,50,000 = 25 EBIT
12.5 EBIT = 2,62,50,000
EBIT = 21,00,000
EPS1 = (21,00,000 – 2,00,000) (0.5) – 2,50,000/5,00,000 = ₹ 1.4/share
EPS2 = (21,00,000) (0.5)/7,50,000 = ₹ 1.4/share
Hence verified as EPS1 = EPS2

Solution 21:
Let the EBIT at the Indifference Point level be ₹. E (Amounts In ₹.)
Particulars Alternative 1 Alternative 2
Description ₹. 50 ESC = ₹. 5,00,000 9% Debt = ₹. 5,00,000
EBIT E E
Less: Interest at 9% of ₹. 5,00,000 (Nil) (45,000)
EBT E E
Less: Tax at 40% (0.5 E) (0.5 E – 22,500)
EAT 0.5 E 0.5 E – 22,500
Less: Preference Dividend (Nil) (Nil)
EAT 0.5 E 0.5 E – 22,500
No. of ₹. 50 equity shares(Present 20,000 +
Additional 10,000) 30,000 Shares 20,000 shares
𝐸𝐴𝑇 0.5 𝐸 0.5 𝐸−22,500
EPS = 𝑁𝑜.𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 30,000 𝑆ℎ𝑎𝑟𝑒𝑠 20,000 𝑆ℎ𝑎𝑟𝑒𝑠
For indifference between the above alternatives, EPS should be equal.
0.5𝐸 0.5 𝐸−22,500
30,000
= 20,000
1E = 1.5 E – 67,500
0.5 E = 67,500
67,500
E = 0.5 = ₹. 1,35,000
Required EBIT = ₹ 1,35,000 and EPS = ₹ 2.25

Solution 23:
Firm A B C D
EBIT ₹. 2,00,000 ₹. 3,00,000 ₹. 5,00,000 ₹. 6,00,000
Less: Interest (₹. 20,000) (₹. 60,000) (₹. 2,00,000) (₹. 2,40,000)
EBT (Net Income) ₹. 1,80,000 ₹. 2,40,000 ₹. 3,00,000 ₹. 3,60,000
Ke 12.00% 16.00% 15.00% 18.00%

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Value of Equity (VE) = EBT/Ke ₹. 15,00,000 ₹. 15,00,000 ₹. 20,00,000 ₹.20,00,000

Value of Debt (VD)= Interest/kd [Kd =10%] ₹. 2,00,000 ₹. 6,00,000 ₹. 20,00,000 ₹. 24,00,000
Value of Firm VF + VE +VD ₹. 17,00,000 ₹. 21,00,000 ₹. 40,00,000 ₹. 44,00,000
𝐸𝐵𝐼𝑇
K0 = WACC = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚 11.76% 14.29% 12.50% 13.64%

When Firm A borrow ₹ 2 Lakhs at 10% interest rate, to repay equity capital, the effect on WACC will be as
under:
Firm A B
EBIT ₹. 2,00,000 ₹. 2,00,000
Less: Interest (₹. 20,000) (₹. 40,000)
EBT (Net Income) ₹. 1,80,000 ₹. 1,60,000
Ke 12.00% 12.00%
Value of Equity VE =EBT/Ke ₹. 15,00,000 ₹. 13,33,333
Value of Debt VD = Interest/kd ₹. 2,00,000 ₹. 4,00,000
Value of Firm VP = VE + VD ₹. 17,00,000 ₹. 17,33,333
𝐸𝐵𝐼𝑇
KO = WACC = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚 11.76% 11.54%
Under Net Income Approach, Increase in Debt leads to increase in value of firm and decrease in WACC.

Solution 27:
Particulars Amount (₹.)
EBIT 9,00,000
Less: Interest (10% × 30,00,000) (3,00,000)
EBT 6,00,000
𝐸𝐵𝐼𝑇
Value of Firm = 𝐾0
9,00,000
= 0.12
= 75,00,000

Value of Equity = Value of Firm – Value of Debt

= 75,00,000 – 30,00,000 = 45,00,000
𝐸𝐵𝑇
Ke = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦
6,00,000
= 45,00,000
= 13.33%

Solution 33:
𝑁𝑂𝐼 ₹ 4,50,000
(a) Value of A Ltd. = 𝐾𝑜
= 18%
= ₹ 25,00,000

(i) Return on Shares of X on A Ltd.

Particulars Amount (₹)
Value of the company 25,00,000
Market value of debt (60% x ₹ 25,00,000) 15,00,000
Market value of shares (40% x ₹ 25,00,000) 10,00,000
Particulars Amount (₹)
Net operating income 4,50,000
Interest on debt (8% × ₹ 15,00,000) 1,20,000
Earnings available to shareholders 3,30,000
Return on 3% shares (3% × ₹ 3,30,000) 9,900

₹ 3,30,000
(ii) Implied required rate of return on equity of A Ltd. = ₹ 10,00,000
= 33 %

(b) (i) Calculation of Implied rate of return of B Ltd.

Particulars Amount (₹)
Total value of company 25,00,000
Market value of debt (20% × ₹ 25,00,000) 5,00,000
Market value of equity (80% × ₹ 25,00,000) 20,00,000

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Particulars Amount (₹)

Net operating income 4,50,000
Interest on debt (8% × ₹ 5,00,000) 40,000
Earnings available to shareholders 4,10,000

₹ 4,10,000
Implied required rate of return on equity = ₹ 20,00,000
= 20.5%

(iii) Implied required rate of return on equity of B Ltd. is lower than that of A Ltd. because B Ltd. uses less
debt in its capital structure. As the equity capitalization is a linear function of the debt-to-equity ratio
when we use the net operating income approach, the decline in required equity return offsets exactly
the disadvantage of not employing so much in the way of “cheaper” debt funds.

Solution 34:
1. Valuation of firms:
Particulars Levered company (₹.) Unlevered company (₹.)
EBIT 30,000 30,000
Less: Interest 10,000 Nil
Earnings available to equity shareholders / Ke 20,000 30,000
12.5% 12.5%
Value of equity 1,60,000 2,40,000
Debt 1,00,000 Nil
Value of Firm 2,60,000 2,40,000

Value of Levered company is more than that of unlevered company therefore investor will sell his shares in
levered company and buy shares in unlevered company. To maintain the level of risk he will borrow
proportionate amount and invest that amount also in shares of unlevered company.

2. Investment and Borrowings

Particulars Amount (₹.)
Sell shares in levered company (1,60,000 x 15%) 24,000
Borrow money (1,00,000 x 15%) 15,000
Buy shares in unlevered company 39,000

3. Change in Return
Particulars Amount (₹.)
Income from shares in unlevered company (39,000 x 12.5%) 4,875
Less: Interest on loan (15,000 x 10%) (1,500)
Net income from unlevered firm 3,375
Income from levered firm (24,000 x 12.5%) (3,000)
Incremental income due to Arbitrage 375

Solution 35:
Here we are assuming that MM Approach 1958: Without tax, where capital structure has no relevance with the
value of company and accordingly overall cost of capital of both levered as well as unlevered company is
same. Therefore, the two companies should have similar WACCs. Because Samsui Limited is all-equity
financed, its WACC is the same as its cost of equity finance, i.e. 16 per cent. It follows that Sanghmani Limited
should have WACC equal to 16 per cent also.

Therefore, Cost of equity in Sanghmani Ltd. (levered company) will be calculated as follows:
2 1
K0 = 3 x Ke + 3 x Kd = 16% (i.e. equal to WACC of Samsui Ltd.)
2 1
Or, 16% = 3
x Ke + 3
x 10% Or, Ke = 19

Solution 36:
1. Valuation of firms:
Particulars Levered company (₹.) Unlevered company (₹.)

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EBIT 30,000 30,000

Less: Interest 10,000 Nil
Earnings available to equity shareholders / Ke 20,000 30,000
20% 12.5%
Value of equity 1,00,000 2,40,000
Debt 1,00,000 Nil
Value of Firm 2,00,000 2,40,000

Value of Unlevered company is more than that of Levered company therefore investor will sell his shares in
unlevered company and buy shares in levered company. Market value of Debt and Equity of Levered company
are in the ratio of ₹.1,00,000 : ₹.1,00,000, i.e., 1:1. To maintain the level of risk he will lend proportionate
amount (50%) and invest balance amount (50%) in shares of Levered company.

2. Investment and Borrowings

Particulars Amount (₹.)
Sell shares in levered company (2,40,000 x 15%) 36,000
Lend money (36,000 x 50%) 18,000
Buy shares in levered company (36,000 x 50%) 18,000
Total 36,000

3. Change in Return
Particulars Amount (₹.)
Income from shares in levered company (18,000 x 20%) 3,600
Add: Interest on money lent (18,000 x 10%) 1,800
Total income after switch over 5,400
Income from unlevered firm (36,000 x 12.5%) (4,500)
Incremental income due to Arbitrage 900

Solution 41:
Constant Ko means the use of NOI or M&M Approach, Ke = Ko + Risk Premium.
𝐷𝑒𝑏𝑡
From M & M Approach, Ke = Ko + 𝐸𝑞𝑢𝑖𝑡𝑦 (Ko – kd) = 12% + [80% × (12% – 9%) = 14.40%

Solution 42:
(a) Computation of Market Value, Cost of Equity and WACC of RES Ltd.

Market Value of Equity = 25,00,00,000

Ke = 21%
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 (𝑁𝐼) 𝑓𝑜𝑟 𝑒𝑞𝑢𝑖𝑡𝑦−ℎ𝑜𝑙𝑑𝑒𝑟𝑠
𝐾𝑒
= Market Value of Equity
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 (𝑁𝐼) 𝑓𝑜𝑟 𝑒𝑞𝑢𝑖𝑡𝑦−ℎ𝑜𝑙𝑑𝑒𝑟𝑠
𝐾𝑒
= 25,00,000
Net income for equity holders = 5,25,000
EBIT= 5,25,000/0.7 = 7,50,000

All Equity Debt and Equity

EBIT 7,50,000 7,50,000
Interest to debt-holders - 75,000
EBT 7,50,000 6,75,000
Taxes (30%) 2,25,000 2,02,500
Income available to equity shareholders 5,25,000 4,72,500
Income to debt holders plus income available to shareholders 5,25,000 5,47,500

Present value of tax-shield benefits = 5,00,000 × 0.30 = 1,50,000

(i) Value of Restructured firm

= 25,00, + 1,50,000 = 26,50,000
(ii) Cost of Equity (Ke)

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Total Value = 26,50,000

Less: Value of Debt = 5,00,000
Value of Equity = 21,50,000
4,72,500
Ke = 21,50,000 = 0.219 = 22%

(iii) WACC
Cost of Debt (after tax) = 15% (1-0.3) = 0.15 (0.70) = 0.105 = 10.5%
Components of Costs Amount Cost of Capital Weight Weighted COC
Equity 21,50,000 0.22 0.81 0.178
Debt 5,00,000 0.105 0.19 0.020
26,50,000 0.198
WACC = 19.8%
Comment: At present the company is all equity financed. So, Ke = Ko i.e. 21%. However after restructuring, the
Ko would be reduced to 19.81% and Ke would increase from 21% to 21.98%. Reduction in Ko and increase in
Ke is good for the health of the company.

Solution 43:
(a) Amount of debt to be employed by firm as per traditional approach
Calculation of Equity, Wd and We
Total Capital (₹) Debt (₹) Wd Equity value (₹) We
(a) (b) (b)/(a) (c) = (a) - (b) (c)/(a)
50,00,000 0 - 50,00,000 1.0
50,00,000 5,00,000 0.1 45,00,000 0.9
50,00,000 10,00,000 0.2 40,00,000 0.8
50,00,000 15,00,000 0.3 35,00,000 0.7
50,00,000 20,00,000 0.4 30,00,000 0.6
50,00,000 25,00,000 0.5 25,00,000 0.5
50,00,000 30,00,000 0.6 20,00,000 0.4

Statement of Weighted Average Cost of Capital (WACC)

Ke We Kd Wd Ke We KdWd Ko
(1) (2) (3) (4) (5) = (1) x (2) (6) = (3) x (4) (7) = (5) + (6)
0.100 1.0 - - 0.100 - 0.100
0.105 0.9 0.060 0.1 0.095 0.006 0.101
0.110 0.8 0.060 0.2 0.088 0.012 0.100
0.113 0.7 0.062 0.3 0.079 0.019 0.098
0.124 0.6 0.070 0.4 0.074 0.028 0.102
0.135 0.5 0.075 0.5 0.068 0.038 0.106
0.160 0.4 0.080 0.6 0.064 0.048 0.112
So, amount of Debt to be employed = ₹ 15,00,000 as WACC is minimum at this level of debt i.e. 9.8 %

(b) As per MM approach, cost of the capital (Ko) remains constant and cost of equity increases linearly with
debt.
𝑁𝑒𝑡 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 (𝑁𝑂𝐼)
Value of a firm = 𝐾𝑜

₹ 5,00,000
₹ 50,00,000 = 𝐾𝑜

₹ 5,00,000
Ko = ₹ 50,00,000
= 10%
Statement of Equity Capitalization rate (ke) under MM approach
Debt Equity (₹) Debt / Ko Kd Ko - Kd Ke = Ko +(Ko – Kd)
(₹) Equity *Debt/Equity

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(1) (2) (3) = (1)/(2) (4) (5) (6) = (4) (7) = (4) +
-(5) (6) x (3)
0 50,00,000 0 0.10 - 0.100 0.100
5,00,000 45,00,000 0.11 0.10 0.060 0.040 0.104
10,00,000 40,00,000 0.25 0.10 0.060 0.040 0.110
15,00,000 35,00,000 0.43 0.10 0.062 0.038 0.116
20,00,000 30,00,000 0.67 0.10 0.070 0.030 0.120
25,00,000 25,00,000 1.00 0.10 0.075 0.025 0.125
30,00,000 20,00,000 1.50 0.10 0.080 0.020 0.130

Solution 44:
Note that the ration given in this question is not debt to equity ratio. Rather than it is the debt to value ratio.
Therefore, if the ratio is 0.6, it means that capital employed comprises 60% debt and 40% equity.
𝐾𝑑 𝑥 𝐷𝑥+𝐾𝑒 𝑥 𝑆
Ko = 𝐷+𝑆
In this question total of weight is equal to 1 in all cases, hence we need not to divide by it.
1) K0 = 11% x 0 + 13% x 1 = 13%
2) K0 = 11% x 0.1 + 13% x 0.9 = 12.8%
3) K0 = 11.6% x 0.2 + 14% x 0.8 = 13.52%
4) K0 = 12% x 0.3 + 15% x 0.7 = 14.1%
5) K0 = 13% x 0.4 + 16% x 0.6 = 14.8%
6) K0 = 15% x 0.5 + 18% x 0.5 = 16.5%
7) K0 = 18% x 0.6 + 20% x 0.4 = 18.8%

Decision: 2nd option is the best because it has lowest WACC.

Solution 45:
Alternative 1 = Raising Debt of ₹5 lakh + Equity of ₹15 lakh
Alternative 2 = Raising Debt of ₹10 lakh + Equity of ₹10 lakh
Alternative 3 = Raising Debt of ₹14 lakh + Equity of ₹6 lakh
Calculation of Earnings per share (EPS)
FINANCIAL ALTERNATIVES
Particulars Alternative 1 Alternative 2 Alternative 3
(₹) (₹) (₹)
Expected EBIT [W. N. (a)] 19,50,000 19,50,000 19,50,000
Less: Interest [W. N. (b)] (50,000) (1,25,000) (2,05,000)
Earnings before taxes (EBT) 19,00,000 18,25,000 17,45,000
Less: Taxes @ 40% 7,60,000 7,30,000 6,98,000
Earnings after taxes (EAT) 11,40,000 10,95,000 10,47,000
Number of shares [W. N. (d)] 1,07,500 1,05,000 1,03,000
Earnings per share (EPS) 10.60 10.43 10.17
Conclusion: Alternative 1 (i.e. Raising Debt of ₹5 lakh and Equity of ₹15 lakh) is recommended which
maximises the earnings per share.

Working Notes (W.N.):

(a) Calculation of Earnings before Interest and Tax (EBIT)
Particulars
Output (1,00,000 + 50%) (A) 1,50,000
Selling price per unit ₹40
Less: Variable cost per unit (₹20 – 15%) ₹17
Contribution per unit (B) ₹23
Total contribution (A x B) ₹34,50,000
Less: Fixed Cost (₹10,00,000 + ₹5,00,000) ₹15,00,000
EBIT ₹19,50,000

(b) Calculation of interest on Debt

Alternative (₹) Total (₹)
1 (₹5,00,000 x 10%) 50,000

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 Chapter - Capital Structure

2 (₹5,00,000 x 10%) 50,000

(₹5,00,000 x 15%) 75,000 1,25,000
3 (₹5,00,000 x 10%) 50,000
(₹5,00,000 x 15%) 75,000
(₹4,00,000 x 20%) 80,000 2,05,000

(c) Number of equity shares to be issued

₹(20,00,000−5,00,000) ₹15,00,000
Alternative 1 = ₹200 (𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒) = ₹200
=7,500 shares
₹(20,00,000−10,00,000) ₹10,00,000
Alternative 2 = ₹200(𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒)
= ₹200 = 5,000 shares
₹(20,00,000−14,00,000) ₹6,00,000
Alternative 3 = ₹200 (𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒)
= ₹200 = 3,000 shares

(d) Calculation of total equity shares after expansion program

Alternative 1 Alternative 2 Alternative 3
Existing no. of shares 1,00,000 1,00,000 1,00,000
Add: issued under 7,500 5,000 3,000
expansion program
Total no. of equity shares 1,07,500 1,05,000 1,03,000

Solution 46:
The following are the costs and values for the firms A and B

(a) (i) Computation of Equilibrium value of Firms A & B under MM Approach:

As per MM approach KO is equal to Keu

KO = Keu (1 – t) = 9.09 (1 – 0) = 9.09
Particulars A B
EBIT (NOI) (₹) 5000 5000
KO (%) 9.09 9.09
Equilibrium value (₹) (NOI/Ko) x 100 55005.5 55005.5
5,000 5,000
9.09
× 100 9.09
× 100

(ii) Computation of value of equity and cost of equity of Firms A & B

Particulars A B
Equilibrium value (₹) 55,005.50 55,005.50
Less: Value of Debt - 30,000
Value of Equity 55,005.50 25,005.50

Cost of Equity of Firm A (unlevered) = 9.09

Cost of Debt of Firm B (Kd) (levered) = (1800/30000) x 100 = 6%

Cost of Equity of Firm B (Levered) = KO + (KO - Kd ) x (Debt / Equity)

= 9.09 + (9.09 – 6) x (30000/25005.5)

= 9.09 + 3.09 x 1.2 = 9.09 + 3.71 = 12.80%

(OR)

Cost of Equity of Firm B (Levered) = ( 𝑁𝐼

𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 )x 100
3,200
= 25,005.5 x 100 = 12.8%

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Solution 47:
1. Ascertainment of probable price of shares
Plan (ii) (If ₹ 4,00,000
Plan (i) (If ₹ 4,00,000 is
Particulars is raised by issuing
raised as debt) (₹)
equity shares) (₹)
Earnings Before Interest (EBIT) 20% on (14,00,000 +
3,60,000 3,60,000
4,00,000)
Less: Interest on old debentures @ 10% on 4,00,000 40,000 40,000
3,20,000 3,20,000
Less: Interest on New debt @ 12% on ₹ 4,00,000 48,000 -
Earnings Before Tax (After interest) 2,72,000 3,20,000
Less: Tax @ 50% 1,36,000 1,60,000
Earnings for equity shareholders (EAIT) 1,36,000 1,60,000
Number of Equity Shares (in numbers) 30,000 40,000
Earnings per Share (EPS) 4.53 4
Price/ Earnings Ratio 8 10
Probable Price Per Share 36.24 (8 x 4.53) 40 (10 x 4)
Working Notes:
(₹)
1. Calculation of Present Rate of Earnings
Equity Share capital (30,000 x ₹ 10) 3,00,000
(
10% Debentures 40, 000 × 10
100
) 4,00,000
Reserves (given) 7,00,000
14,00,000
Earnings before interest and tax (EBIT) given 2,80,000
Rate of Present Earnings = ( 2,80,000
14,00,000
× 100) 20%
2. Number of Equity Shares to be issued in Plan ( 4,00,000
40 ) 10,000
30,000 + 10,000
Thus, after the issue total number of shares
= 40,000
3. Debt/Equity Ratio if ₹ 4,00,000 is raised as debt: ( 8,00,000
18,00,000 )
× 100 = 44.44%

As the debt equity ratio is more than 32% the P/E ratio shall be 8 in plan (i)

Solution 48:
Current Capital Structure
Equity Share Capital ₹ 20 x 7 lakhs ₹ 1,40,00,000
Reserves ₹ 10,00,000
9% Bonds ₹ 3,00,00,000
11% Preference Share Capital ₹ 50 x 3 lakhs ₹ 1,50,00,000
Total Capital Employed ₹ 6,00,00,000

Proposed Capital Structure

Capital Working Proposal I Proposal II
Capital to be raised ₹5,00,00,000 ₹5,00,00,000
Equity 50000000 x 25% ₹ 1,25,00,000 -
50000000 x 50% - ₹ 2,50,00,000
Debt @ 10% 50000000 x 75% ₹ 3,75,00,000 -
Preference Shares @ 50000000 x 50% - ₹ 2,50,00,000
12%
Combined Capital Amount (proposal Amount (proposal
1) 2)
Equity ₹ 2,65,00,000 ₹ 3,90,00,000
Reserves ₹ 10,00,000 ₹ 10,00,000
9% Bond ₹ 3,00,00,000 ₹ 3,00,00,000
10% Debt ₹ 3,75,00,000 -

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11% Preference Shares ₹ 1,50,00,000 ₹ 1,50,00,000

12% Preference Shares - ₹ 2,50,00,000
₹ 11,00,00,000 ₹ 11,00,00,000
Interest for Proposal I = ₹ 3,00,00,000 x 9% + ₹ 3,75,00,000 x 10%
= ₹ 27,00,000 + ₹ 37,50,000
= ₹ 64,50,000
Preference Dividend for Proposal I = ₹ 1,50,00,000 x 11% = ₹ 16,50,000
Interest for Proposal II = ₹ 3,00,00,000 x 9% = ₹ 27,00,000
Preference Dividend for Proposal II = ₹ 1,50,00,000 x 11% + ₹ 2,50,00,000 x 12%
= ₹ 16,50,000 + ₹ 30,00,000 = ₹ 46,50,000
Let the indifference point be ₹ X
For Proposal I,
(𝑋− ₹64,50,000)×0.66−₹16,50,000 (𝑋−₹27,00,000)×0.66−₹46,50,000
EPS= 13,25,000
= 19,50,000
0.66 ×₹42,57,000−₹16,50,000 0.66𝑋−₹17,82,000−₹46,50,000
1,325
= 1,950
0.66𝑥− ₹59,07,000 0.66𝑋 −𝑛₹64,32,000
53
= 78
51.48 X - ₹46,07,46,000 = 37.98X-₹34,08,96,000
16.5X = ₹11,98,50,000
Indifference Point = X = ₹72,63,636.36

Solution 49:
Calculation of Equity Share capital and Reserves and surplus:
Alternative 1:
Equity Share capital = ₹20,00,000 + =₹21,50,000
Reserves= ₹10,00,000 +=₹10,50,000
Alternative 2:
Equity Share capital = ₹ 20,00,000 + =₹27,20,000
Reserves= ₹10,00,000 +=₹11,80,000
Capital Structure Plans
Amount in ₹
Capital Alternative 1 Alternative 2
Equity Share capital 21,50,000 27,20,000
Reserves and surplus 10,50,000 11,80,000
10% long term debt 15,00,000 15,00,000
14% Debentures 8,00,000 -
8% Irredeemable Debentures - 1,00,000
Total Capital Employed 55,00,000 55,00,000

Computation of Present Earnings before interest and tax (EBIT)

EPS (₹) 21
No. of equity shares 20,000
Earnings for equity shareholders (I x II) (₹) 4,20,000
Profit Before Tax (III/75%) (₹) 5,60,000
Interest on long term loan (1500000 x 10%) (₹) 1,50,000
EBIT (IV + V) (₹) 7,10,000
EBIT after expansion = ₹7,10,000 +₹ 2,00,000 = ₹9,10,000
Evaluation of Financial Plans on the basis of EPS, MPS and Financial Leverage
Amount in ₹
Particulars Alternative I Alternate II
EBIT 9,10,000 9,10,000
Less: Interest: 10% on long term loan (1,50,000) (1,50,000)
14% on Debentures (1,12,000) Nil
8% on Irredeemable Debentures Nil. (8000)
PBT 6,48,000 7,52,000
Less: Tax @25% (1,62,000) (1,88,000)

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PAT 4,86,000 5,64,000

No. of equity shares 21,500 27,200
EPS 22.60 20.74
Applicable P/E ratio (Working Note 1) 7 8.5
MPS (EPS X P/E ratio) 158.2 176.29
Financial Leverage EBIT/PBT 1.40 1.21

Working Note 1

Alternative I Alternative II
Debt:
₹15,00,000 +₹8,00,000 23,00,000 -
₹15,00,000 +₹1,00,000 - 16,00,000
Total capital Employed (₹) 55,00,000 55,00,000
Debt Ratio (Debt/Capital employed) =0.4182 =0.2909
=41.82% =29.09%
Change in Equity: ₹21,50,000-₹20,00,000 1,50,000
₹27,20,000-₹20,00,000 7,20,000
Percentage change in equity 7.5% 36%
Applicable P/E ratio 7 8.5

Calculation of Cost of equity and various type of debt

Alternative I Alternative II
A) Cost of equity
EPS 22.60 20.74
DPS (EPS X 60%) 13.56 12.44
Growth (g) 10% 10%
Po (MPS) 158.2 176.29
Ke= Do (1 + g)/ Po 13.56(1.1) 12.44(1.1)
158.2 176.29
=9.43% =7.76%
B) Cost of Debt:
10% long term debt 10% + (1-0.25) 10% +(1-0.25)
= 7.5% = 7.5%
14% redeemable debentures 14(1−0.25)+(110−100/10) nil
110+100/2
= 10.5 + 1 / 10.5
= 10.95%
8% irredeemable debenture NA 8000(1-0.25)/1,00,00 = 6%

Calculation of Weighted Average cost of capital (WACC)

Alternative 1 Alternative 2
Capital Weights Cost (%) WACC Weights Cost (%) WACC
Equity Share Capital 0.3909 9.43 3.69% 0.4945 7.76 3.84%
Reserves and Surplus 0.1909 9.43 1.80% 0.2145 7.76 1.66%
10% Long term Debt 0.2727 7.50 2.05% 0.2727 7.50 2.05%
14% Debenture 0.1455 10.95 1.59%
8% Irredeemable - 0.0182 6 0.11%
Debentures
9.12% 7.66%

Calculation Marginal Cost of Capital (MACC)

Alternative 1 Alternative 2
Amount(weight) Cost Amount Cost MACC
Capital (%) MACC (weight) (%)
Equity Share ₹ 1,50,000(0.15) 9.43 1.41% ₹7,20,000(0.72) 7.76 5.59%
Capital

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 Chapter - Capital Structure

Reserves and ₹ 50,000(0.05) 9.43 0.47% ₹1,80,000(0.18) 7.76 1.40%

Surplus
14% Debenture ₹ 8,00,000(0.80) 10.95 8.76% - 0.00%
8%
Irredeemable - ₹1,00,000(0.10) 6 0.60%
Debentures
Total Capital ₹10,00,000 10.65% ₹10,00,000 7.58%
Employed

Summary of solution:
Alternate I Alternate II
Earning per share (EPS) 22.60 20.74
Market price per share (MPS) 158.20 176.29
Financial leverage 1.4043 1.2101
Weighted Average cost of capital (WACC) 9.12% 7.66%
Marginal cost of capital (MACC) 10.65% 7.58%
Alternative 1 of financing will be preferred under the criteria of EPS, whereas Alternative II of financing will
be preferred under the criteria of MPS, Financial leverage, WACC and marginal cost of capital.

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 Chapter 5 - Investment Decisions

Solution 1:
Particulars Amount (₹)
Profit Before Tax 3,00,000
Less: Tax @ 50% 1,50,000
Profit after tax 1,50,000
Add: Depreciation written off 2,50,000
Total cash inflow 4,00,000
₹ 20,00,000
Payback period = ₹ 4,00,000
= 5 years

Solution 3:
₹4,000 ×100
Payback Reciprocal = ₹20,000
= 20%

Solution 4:
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡/𝑁𝑜.𝑜𝑓 𝑦𝑒𝑎𝑟𝑠
(a) If Initial Investment is considered then, 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡/𝐼𝑛𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
× 100
92,000
= 10,00,000 × 100 = 9.2%
92,000
(b) If Average Investment is considered, then, 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
× 100
92,000
= 5,40,000 × 100 = 17%
Working Notes:
Average Investment = Salvage value + ½ (Initial investment – Salvage value)
= ₹ 80,000 + ½ (₹ 10,00,000 – ₹ 80,000)
= ₹ 80,000 + ₹ 4,60,000 = ₹ 5,40,000

Solution 5:
The ARR can be computed by following methods as follows:
(a) Version 1: Annual Basis
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑓𝑡𝑒𝑟𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
ARR = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑒𝑔𝑖𝑛𝑖𝑛𝑔 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
Year
1 80,000
= 26.67%
3,00,000
2 80,000
= 34.78%
2,30,000
3 80,000
= 50%
1,60,000
26.67% + 34.78% + 50.00%
Average ARR = 3
= 37.15%

(b) Version 2: Total investment Basis

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 (80,000 + 80,000 + 80,000 )/ 3

ARR = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑒𝑔𝑖𝑛𝑖𝑛𝑔
= 3,00,000
𝑥 100 = 26.67%

(c) Version 3: Average Investment Basis

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡
ARR = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 x 100

Average Investment = (₹3,00,000 + ₹ 90,000)/2 = ₹1,95,000

Or, ½(Initial Investment – Salvage Value) + Salvage Value
= ½(₹3,00,000 –₹90,000) + ₹90,000 = ₹ 1,95,000
80,000
= 1,95,000 x 100 = 41.03%

Further, it is important to note that project may also require additional working capital during its life in addition
to initial working capital. In such situation formula for the calculation of average investment shall be modified
as follows:
½(Initial Investment – Salvage Value) + Salvage Value+ Additional Working Capital

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Continuing above example, suppose a sum of ₹45,000 is required as additional working capital during the
project life then average investment shall be:
= ½ (₹3,00,000 – ₹90,000) + ₹90,000 + ₹45,000 = ₹2,40,000 and
80,000
ARR = 2,40,000 x 100 = 33.33%

Some organizations prefer the initial investment because it is objectively determined and is not influenced by
either the choice of the depreciation method or the estimation of the salvage value. Either of these amounts is
used in practice but it is important that the same method be used for all investments under consideration.

Solution 7:
Calculation of Net Present Value(In ₹)
Period Present Value Factor Project A Project B Project C Project D
1 0.893 44,650 35,720 66,975 66,975
2 0.797 39,850 39,850 59,775 59,775
3 0.712 35,600 49,840 42,720 42,720
4 0.636 31,800 47,700 50,880 25,440
5 0.567 28,350 42,525 56,700 11,340
Present value of cash inflows 1,80,250 2,15,635 2,77,050 2,06,250
Less: Initial Investment 2,00,000 1,90,000 2,50,000 2,10,000
Net present value (19,750) 25,635 27,050 (3,750)

Solution 8:
Calculation of Net Present Value
Year Net Cash Flow (₹) P.V. Factor Present Value (₹)
0 (1,00,000) 1.000 (1,00,000)
1 6,500 0.909 5,909
2 26,500 0.826 21,889
3 41,500 0.751 31,167
4 41,500 0.683 28,345
5 71,500 0.621 44,402
Net Present Value = 31,712
Working Notes:
Calculation of Net Flows
Contribution = (3.00 – 1.75) × 50,000 = ₹ 62,500
Fixed costs = 40,000 – (1,25,000 – 30,000)/5 = ₹ 21,000
Year Capital (₹) Contribution (₹) Fixed costs (₹) Adverts (₹) Net cash flow (₹)
0 (1,00,000) (1,00,000)
1 (25,000) 62,500 (21,000) (10,000) 6,500
2 62,500 (21,000) (15,000) 26,500
3 62,500 (21,000) 41,500
4 62,500 (21,000) 41,500
5 30,000 62,500 (21,000) 71,500

Solution 9:
The desirability factors for the three projects would be as follows:
₹6,50,000
1. ₹5,50,000 = 1.18
₹95,000
2. ₹75,000
=1.27
₹1,00,30,000
3. ₹1,00,20,000
= 1.001

Solution 10:
Determination of Cash inflows
Elements (₹)
Sales Revenue 45,00,000

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Less: Operating Cost 14,00,000

31,00,000
Less: Depreciation (90,00,000 – 10,00,000)/5 16,00,000
Net Income 15,00,000
Tax @ 40% 6,00,000
Earnings after Tax (EAT) 9,00,000
Add: Depreciation 16,00,000
Cash inflow after tax per annum 25,00,000
Less: Loss of Commission Income 6,60,000
Net Cash inflow after tax per annum 18,40,000
In 5th Year:
New Cash inflow after tax 18,40,000
Add: Salvage Value of Machine 10,00,000
Net Cash inflow in year 5 28,40,000
Calculation of Net Present Value (NPV)
Present Value of Cash
Year CFAT PV Factor @10%
inflows
1 to 4 18,40,000 3.169 58,30,960
5 28,40,000 0.62 17,60,800
75,91,760
Less: Cash Outflows 90,00,000
NPV (14,08,240)
𝑆𝑢𝑚 𝑜𝑓 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠 75,91,760,
Profitability Index= 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤𝑠
= 90,00,000
=0.844
Advise: Since the net present value is negative and profitability index is also less than 1, therefore, the hospital
should not purchase the MRI machine.

Solution 11:
Calculation of IRR
The ‘Factor’ must be found out, ‘the factor reflects the same relationship of investment and cash inflows as in
case of payback calculations’:
𝐼
F= 𝐶
Where, F = Factor to be located
I = Original Investment
C = Average cash inflow per year
For the project,
₹ 1,36,000
Factor = ₹ 36,000 = 3.78
The factor thus calculated will be located in present value of Re. 1 received annually for N year’s table
corresponding to the estimated useful of the asset. This would give the expected rate of return to be applied
for discounting the cash inflows.
In case of the project, the rate comes to 10%.
Year Cash Inflows (₹) Discounting Factor at 10% Present Value (₹)
1 30,000 0.909 27,270
2 40,000 0.826 33,040
3 60,000 0.751 45,060
4 30,000 0.683 20,490
5 20,000 0.621 12,420
Total Present Value 1,38,280
The present value at 10% comes to ₹ 1,38,280, which is more than the initial investment. Therefore, a higher
discount rate is suggested, say, 12%.
Year Cash Inflows(₹) Discounting Factor at 12% Present Value (₹)
1 30,000 0.893 26,790

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2 40,000 0.797 31,880

3 60,000 0.712 42,720
4 30,000 0.636 19,080
5 20,000 0.567 11,340
Total Present Value 1,31,810
₹1,38,280−₹1,36,000
IRR = [10 + ( ₹1,38,280−₹1,31,810 )×2
₹ 2280
= 10 + ( ₹ 6470 )×2 = 10.7%

Solution 12:
Computation of cash inflow per annum
Particulars ₹
Net operating income per annum 68,000
Less: Tax @ 45% 30,600
Profit after tax 37,400
Add: Depreciation (₹ 3,60, 000/5 years) 72,000
Cash inflow 1,09,400
The IRR of the investment can be found as follows:
NPV = -₹ 3,60,000 + ₹ 1,09,400 (PVAF5,r) = 0
₹3,60,000
Or PVA F5r (Cumulative factor) = ₹1,09,400 = 3.29
Computation of internal Rate of Return
Discounting Rate 15% 16%
Cumulative factor 3.35 3.27
Total NPV (₹) 3,66,490 3,57,738
(₹ 109,400 × 3.35) (₹ 1,09,400 × 3.27)
Internal outlay (₹) 3,60,000 3,60,000
Surplus (Deficit)(₹) 6,490 (2,262)
6490
IRR = 15 + ( 6490+2262 ) = 15 + 0.74= 15.74%.

Solution 13:
1. Conversion of Cash Flows into Terminal Value
Year CFAT Reinvestment Factor at 8% Terminal Value at 8%
1 30,000 (1 + 0.08)4 = 1.3605 40,815
2 40,000 (1 + 0.08)3 = 1.2597 50,388
3 60,000 (1 + 0.08)2 = 1.1664 69,984
4 30,000 (1 + 0.08)1 = 1.0800 32,400
5 20,000 (1 + 0.08)0= 1.0000 20,000
Total 2,13,587

2. Computation of MIRR
P (1 + R)n = A,
Where P = Initial Investment = ₹ 1,36,000, A = Terminal Value of Inflows = ₹ 2,13,587
N = Number of years of Project Life = 5, R = MIRR (to be calculated)
∴1,36,000 (1 + R)5 = 2,13,587.
2,13,587
Hence, (1 + R)5 = 1,36,000 = 1.5705
From the FV Tables, (1 + R) = 1.57051/5 = 1.09448.
So, R = 0.09448. Hence, MIRR = 9.448%

Solution 16:
1. Computation of ARR
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝑎𝑓𝑡𝑒𝑟 𝑇𝑎𝑥
Average Rate of Return = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
(40,000+30,000 +20,000+10,000+10,000)/5
= (2,50,000+40,000)/2
22,000
= 1,45,000
× 100 = 15.17%

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2. Computation of payback period

₹2,50,000− ₹40,000
Depreciation p.a. = 5 𝑦𝑒𝑎𝑟𝑠
= ₹ 42,000 per annum.
Year PAT Depreciation CFAT = PAT + Depreciation Cumulative CFAT
1 ₹ 40,000 ₹ 42,000 ₹ 82,000 ₹ 82,000
2 ₹ 30,000 ₹ 42,000 ₹ 72,000 ₹ 1,54,000
3 ₹ 20,000 ₹ 42,000 ₹ 62,000 ₹ 2,16,000
4 ₹ 10,000 ₹ 42,000 ₹ 52,000 ₹ 2,68,000
5 ₹ 10,000 ₹ 42,000 ₹ 52,000 ₹ 3,20,000
₹34,000
Simple payback period = 3 + ₹52,000
= 3.65 Years.

Solution 18:
(a) & (b) Calculation of Computation of NPV (In ₹)
Particulars Years Amount PV Factor @ 15% PV PV Factor @ 10% PV
Outflows
Initial
Investment 0 7,00,000 1 7,00,000 1 7,00,000
Further
Investment 1 10,00,000 0.869 8,69,000 0.909 9,09,000
PVCO (A) 15,69,000 16,09,000
Inflows
CFAT 2 2,50,000 0.756 1,89,000 0.826 2,06,500
3 3,00,000 0.657 1,97,100 0.751 2,25,300
4 3,50,000 0.572 2,00,200 0.683 2,39,050
5 - 10 4,00,000 2.164 8,65,600 2.975 11,90,000
PVCI (B) 14,51,900 18,60,850
NPV (A) – (B) (1,17,100) 2,51,850
Advice: When PV factor is @ 15% than NPV is negative, Proposal cannot be accepted. When PV factor is @
10% then NPV is positive, Proposal should be accepted.

𝐿𝑜𝑤𝑒𝑟 𝑅𝑎𝑡𝑒 𝑁𝑃𝑉

(c) Internal Rate of Return (IRR) = Lower Rate + 𝑁𝑃𝑉 𝑎𝑡 𝑙𝑜𝑤𝑒𝑟 𝑟𝑎𝑡𝑒−𝑁𝑃𝑉 𝑎𝑡 ℎ𝑖𝑔ℎ𝑒𝑟 𝑟𝑎𝑡𝑒
× Difference in Rate of NPV
2,51,850
= 10 + 2,51,850+1,17,100
× 5 = 13.41%

(d) Simply Payback period = 6 years

-₹ 7,00,000 – ₹ 10,00,000 + ₹ 2,50,000 + ₹3,00,000 + ₹ 3,50,000 + ₹ 4,00,000 + ₹ 4,00,000 = 0

Solution 19:
(i) Calculation of Pay-back Period
Cash Outlay of the Project = ₹. 1,60,00,000
Total Cash Inflow for the first five years = ₹. 1,40,00,000 .
Balance of cash outlay left to be paid back in the 6th year ₹. 20,00,000 .
Cash inflow for 6th year = ₹. 32,00,000
So the payback period is between 5th and 6th years, i.e.,
₹. 20,00,000
5 years + ₹. 32,00,000 5.625 years or 5 years 7.5 months
(ii) Calculation of Net Present Value (NPV) @10% discount rate:
Year Net Cash Inflow Present Value Factor at 10% Present Value
(₹.) Discount Rate (₹.)
(a) (b) (c) = (a) x(b)
1 28,00,000 0.909 25,45,200
2 28,00,000 0.826 23,12,800
3 28,00,000 0.751 21,02,800
4 28,00,000 0.683 19,12,400
5 28,00,000 0.621 17,38,800
6 32,00,000 0.564 18,04,800
7 40,00,000 0.513 20,52,000

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8 60,00,000 0.467 28,02,000

9 40,00,000 0.424 16,96,000
10 16,00,000 0.386 6,17,600
1,95,84,400
Net Present Value (NPV) = Present Value of Cash Inflows - Cash Outflow
= ₹. 1,95,84,400 - ₹.1,60,00,000 = 35,84,400
(iii) Calculation of Profitability Index @ 10% discount rate:
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠
Profitability Index = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
₹. 1,95,84,400
= ₹. 1,60,00,000
= 1.224

(iv) Calculation of Internal Rate of Return:

Net present value @ 10% discount factor has already been calculated in (ii) above, we will calculate Net
present value @15% discount factor.
Year Net Cash Present Value Factor at 15% Present Value
Inflow (₹.) Discount Rate (₹.)
(a) (b) (c) = (a) x(b)
1 28,00,000 0.870 24,36,000
2 28,00,000 0.756 21,16,800
3 28,00,000 0.658 18,42,400
4 28,00,000 0.572 16,01,600
5 28,00,000 0.497 13,91,600
6 32,00,000 0.432 13,82,400
7 40,00,000 0.376 15,04,000
8 60,00,000 0.327 19,62,000
9 40,00,000 0.284 11,36,000
10 16,00,000 0.247 3,95,200
1,57,68,000
Net Present Value at 15% = ₹.1,57,68,000 – ₹.1,60,00,000 = ₹. -2,32,000
As the net present value @ 15% discount rate is negative, hence internal rate of return falls in between 10%
and 15%. The correct internal rate of return can be calculated as follows:
IRR = L + [(NPVL) / NPVL – NPVH ] (H – L)
₹. 35,84,400
= 10% + ₹. 35,84,400−(−₹. 2,32,000) (15% - 10%)
₹. 35,84,400
= 10% + ₹. 38,16,400
x 5% = 14.7%

Solution 20:
(a)
(i) Payback Period
Project Cumulative Cash Outflows (In ₹)
Years A B C D
1 10,000 7,500 2,000 10,000
2 - 15,000 6,000 13,000
3 - - 18,000 16,000

Payback Period (In ₹)

A B C D
Cash Outflows (10,000) (10,000) (10,000) (10,000)
2,500 4,000
Payback Period 1 yr 1 yr + 7,500 = 1.33 yrs 2 yrs + 12,000 = 2.33 yrs 1 yr

(𝐶𝐹𝐴𝑇−𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)×1/𝑁𝑜. 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠
(ii) ARR = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
(10,000−10,000)1/1
Project A: (10,000)1/2
=0
(15,000−10,000)1/2
Project B: (10,000)1/2
= 2,500/5,000 = 50%
(18,000−10,000)1/3
Project C: (10,000)1/2
= 2,667/5,000 = 53%
(16,000−10,000)1/3
Project D: (10,000)1/2
= 2,000/5,000 = 40%

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Note: This net cash proceed includes recovery of investment also. Therefore, net cash earnings are found by
deducting initial investment.
(iii) IRR
Project A: The net cash proceeds in year 1 are just equal to investment. Therefore, r = 0%
Project B: This project produces an annuity of ₹ 7,500 for two years.
Therefore, the required PVAF is: 10,000/7,500 = 1.33. This factor is found under 32% column. ∴ r = 32%.
Project C: Since cash flows are uneven, the trial and error method will be followed.
Using 20% rate of discount the NPV is + ₹ 1,389. At 30% rate of discount, the NPV is (₹ 633).The true rate of
return should be less than 30%. At 27% rate of discount it is found that the NPV is –₹ 86 and at 26% + ₹ 105.
Through interpolation, we find r = 6.5%
Project D: In this case also by using the trial and error method, it is found that at 37.6% rate of discount
NPV become almost zero. Therefore, r = 37.6%.
(iv) NPV
Project A:
At 10% - 10,000 + 10,000 × 0.909 = (910)
At 30% - 10,000 + 10,000 × 0.769 = (2,310)
Project B:
At 10% - 10,000 + 7,500(0.909 + 0.826) = +3,013
At 30% - 10,000 + 7,500(0.769 + 0.592) = +208
Project C:
At 10% - 10,000 + 2,000 × 0.909 + 4,000 × 0.826 + 12,000 × 0.751 = +4,134
At 30% - 10,000 + 2,000 × 0.769 + 4,000 × 0.592 + 12,000 × 0.455 = (633)
Project D:
At 10% - 10,000 + 10,000 × 0.909 + 3,000 × (0.826 + 0.751) = +3821
At 30% - 10,000 + 10,000 × 0.769 + 3,000 × (0.4555) = +831
The projects are ranked as follows according to the various methods:
Ranks
Projects PBP ARR IRR NPV (10%) NPV (30%)
A 1 4 4 4 4
B 2 2 2 3 2
C 3 1 3 1 3
D 1 3 1 2 1

(b) Payback and ARR theoretically unsound method for choosing between the investment projects. Between
the two time-adjusted (DCF) investment criteria, NPV and IRR, NPV gives consistent results. If the projects
are independent (and there is no capital rationing), either IRR or NPV can be used since the same set of
projects will be accepted by any of the methods. In the present case, except projects A all the three projects
should be accepted if the discount rate is 10%. Only projects B and D should be undertaken if the discount
rate is 30%.
If it is assumed that the projects are mutually exclusive, then under the assumption of 30% discount rate,
the choice is between B and D (A and C are unprofitable). Both criteria IRR and NPV give the same results, D
is the best. Under the assumption of 10% discount rate, ranking according to IRR and NPV conflict (except
for project A). If the IRR rule is followed, project D should be accepted. But the NPV rule tells that project C
is the best. The NPV rule generally gives consistent results in conformity with the wealth maximization
principle. Therefore, project C should be accepted following the NPV rule.

Solution 22:
Particulars ₹
Additional Income (Saving in Materials Waste) 50,000
₹2,00,000
Less: Additional Depreciation on new Machine = ( 10 𝑦𝑒𝑎𝑟𝑠 ) 20,000
Additional Profit before Tax 30,000
Less: Tax thereon at 50% 15,000
Profit After Tax 15,000
Add: Depreciation 20,000
Cash Flow After Taxes 35,000
Annuity Factor for 10 years at 10% 6.1446
Discounted Cash Inflows (PVCI) (₹ 35,000 × 6.1446) 2,15,061

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Less: Initial Investment (PVCO) 2,00,000

Net Present Value (PVCI – PVCO) 15,061
PI =
𝑃𝑉𝐶𝐼 ₹2,15,061
=( ₹2,00,000 ) 1.075
𝑃𝑉𝐶𝑂
Decision: Since NPV > 0 and PI > 1, the Company may purchase the New Machinery.

IMPORTANT NOTE: In case of uniform CFAT, use Annuity Factors. In case of differential CFAT, use PV Factors.
NPV and PI generally give the same accept reject decision.

Solution 23:
Project Outflow ₹ 2,00,000
Year 1 (₹) 2 (₹) 3(₹) 4 (₹) 5(₹)
Profit after depreciation but
before tax 85,000 1,00,000 80,000 80,000 40,000
Less: Tax (30%) (25,500) (30,000) (24,000) (24,000) (12,000)
PAT 59,500 70,000 56,000 56,000 28,000 Average=₹ 53,900
Add: Depreciation 40,000 40,000 40,000 40,000 40,000
Net Cash Inflow 99,500 1,10,000 96,000 96,000 68,000 Average=₹ 93,900
(i) Calculation of payback period 1.91 years

(ii) Calculation of ARR

2,00,000+0
Average Investment = 2
= ₹ 1,00,000
₹53,900
ARR= Average of profit after tax/average investment = ₹1,00,000 = 53.90%

(iii) Calculation of net present value 10%

Net Cash 99,500. 1,10,000.0
Inflow 00 0 96,000.00 96,000.00 68,000.00
0.909 0.826 0.751 0.683 0.621
90,445. 3,61,197
Present value 50 90,860.00 72,096.00 65,568.00 42,228.00 .50
Net present value = ₹ 3,61,197.50 – ₹ 2,00,000= ₹ 1,61,197.50
Net present value index= Rs 1,61,197.50/₹ 2,00,000 =0.81

𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑓𝑎𝑐𝑡𝑜𝑟−𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 2,00,000

(iv) Calculation of IRR = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤
= 93,900
= 2.13
It lies in between 38% and 40%
Net Cash inflows 99,500.00 1,10,000 96,000.00 96,000.00 68,000.00
Present value factor
@38% 0.725 0.525 0.381 0.276 0.200
Present value @ 38% Total =
(P1) 72,137.50 57,750.00 36,576.00 26,496.00 13,600.00 2,06,559.50
Net Cash inflows 99,500.00 1,10,000.00 96,000.00 96,000.00 68,000.00
Present value factor
@ 40% 0.714 0.51 0.364 0.260 0.186
Present value @ 40%
(P2) 71,043 56,100 34,944 24,960 12,648 Total = 1,99,695
IRR is calculated by Interpolation:
6,559.50
IRR= 38+ (2,06,559.50−1,99,695) × 2% = 39.91%

Solution 24:
(i) Projects Cumulative Cash Inflows
Years A B C D
1 6,000 2,500 1,500 0
2 8,000 5,000 4,000 0
3 10,000 10,000 4,500 3,000
4 22,000 17,500 9,500 9,000

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Initial Cash Outflows

A B C D
O (10,000) (10,000) (3,500) (3,000)
2,000
Pay Back Period 3 Years 3 Years 1 Yr + 2,500 = 1.8 Years 3 Years

(i) If standard payback is 2 years, Project C is the only acceptable project. But if standard payback
period is 3 years, all the four projects are acceptable. However, as the projects are mutually
exclusive, only one project is to be chosen which has the earliest payback period; hence, Project C
is acceptable.

(ii) & (iv) Computation of Discounted payback Period & NPV

Tim P.V.
e F A B C D
Amt Cumu. Amt Cumu Am Cum Am Cum.
. P.V P.V. . P.V . P.V. t. P.V. u P.V. t. P.V. P.V.
(10, (10, (10, (10, (3,5 (3,5 (3,0 (3,0
0 1 000) 000) - 000) 000) - 00) 00) - 00) 00) -
(10, (10, (3,5 (3,0
(A) 000) 000) 00) 00) -
0.90 6,00 5,45 2,50 2,27 1,5 1,3
1 91 0 5 5,455 0 3 2,273 00 64 1,364 0 0 0
0.82 2,00 1,65 2,50 2,06 2,5 2,0
2 62 0 2 7,107 0 6 4,339 00 66 3,430 0 0 0
0.75 2,00 1,50 5,00 3,75 3,0 2,2
3 13 0 3 8,610 0 7 8,096 500 376 3,806 00 54 2,254
0.68 12,0 8,19 16,80 7,50 5,12 13,21 5,0 3,4 6,0 4,0
4 3 00 6 6 0 3 9 00 15 7,221 00 98 6,352
16,8 13,2 7,2 6,3
(B) 06 19 21 52
NPV (B – 6,80 3,21 3,7 3,3
A) 6 9 21 52

Discounted
PBP A B C D
1,390 1,904 70 746
3 Years + 8,196
= 3 Years + 5,123
= 2 Years + 376
= 3 Years + 4,098
=
3.17 Years 3.37 Years 2.19 Years 3.18 Years
If standard discounted payback period is 2 years, no project is acceptable on discounted payback period
criterion.
If standard discounted payback is 3 years, Project ‘C’ is acceptable on discounted payback period criterion.
According to NPV Technique Project A is the best. Project A is acceptable under the NPV method. The NPV
method gives a better mutually exclusive choice than PI method. The NPV method guarantees the choice of
the best alternative.

Solution 25:
Statement showing the computation of present value of cash flows:
Net Cash Flows Present discounted value @
Year ₹ 11% 12% 13% 14% 15%
1 70,000 63,063 62,503 61,950 61,390 60,872
2 1,00,000 81,160 79,720 78,310 76,950 75,610
3 1,30,000 95,056 92,534 90,103 87,750 86,775
4 90,000 59,283 57,195 55,197 53,289 51,462
5 60,000 35,610 34,044 32,568 31,164 29,832
Total 3,34,172 3,25,996 3,18,128 3,10,543 3,04,551
Note: Cash Flows in years 1 to 4 is the cash profit before depreciation and after tax. In the fifth year, the
amount also includes ₹ 5,500 the expected scrap value and ₹ 40,000, the working capital to be released (₹

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14,500 + ₹ 5,500 + ₹ 40,000 = ₹ 60,000). At 14% the inflows are almost equal to the outflow. The project hence
yields 14%.

Solution 26:
Computation of NPV (at 12%)
Particulars 1 2 3 4 5
CFBT 160 160 180 180 150
Less: Depreciation (20%) (80) (64) (51.2) (40.96) (163.84)
EBT 80 96 128.8 139.04 (13.84)
Less: Tax (50%) (40) (48) (64.4) (69.52) 6.92
CFAT 120 112 115.60 110.48 156.92
P.V. Factor 0.89 0.80 0.71 0.64 0.57
PVCI 106.8 89.6 82.076 70.707 89.444
PVCI = 438.62
PVCO = 400
NPV = 38.62
Computation of NPV (at 15%)
NPV = [(120 × 0.862) + (112 × 0.74) + (115.60 × 0.64) + (110.48 × 0.55) + (156.92 × 0.48)] – 400
= 396.15 – 400 = ₹ (3.85)
38.62
IRR = 12% + 4% × 42.47 = 15.63%

Solution 27:
1. Cost of Project M
At 15% I.R.R., the sum total of cash inflows = Cost of the project i.e. Initial cash outlay given:
Annual cost saving ₹ 40,000
Useful life 4 years
I.R.R. 15%
Now, considering the discount factor table @ 15% cumulative present value of cash inflows for 4 years is
2.885
Therefore,
Total of cash inflows for 4 years for Project M is (₹ 40,000 × 2.855) ₹ 1,14,200
Hence, cost of the project is ₹ 1,14,200

2. Payback Period of the Project M

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑝𝑟𝑜𝑗𝑒𝑐𝑡
Payback Period = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑠𝑎𝑣𝑖𝑛𝑔
₹1,14,200
= 40,000
= 2.855 or 2 years 11 months approximately.

3. Cost of Capital
If the profitability index (PI) is 1, cash inflows and outflows would be equal. In this case, (PI) is 1.064.
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠
Profitability Index (PI) = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑝𝑟𝑜𝑗𝑒𝑐𝑡
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠
1.064 = ₹1,14,200
1.064 ×₹ 1,14,200 = ₹ 1,21,509
Hence, Discounted cash inflows = ₹ 1,21,509
Since, Annual cost saving is ₹ 40,000. Hence, cumulative discount factor for 4 years
₹1,21,509
= 40,000
= 3.037725 or 3.038
Considering the discount factor table at a discount rate of 12%, the cumulative discount factor for 4 years is
3.038.
Hence, the cost of capital is 12%.

4. Net present value of the project

N.P.V. = Total present values of cash inflows – Cost of the project
= ₹ 1,21,509 – ₹ 1,14,200 = ₹ 7,309

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Solution 28:
₹6,15,000
1. Present value of 6 instalments = Annual Instalment x Annuity Factor at 12% = 6 𝑦𝑒𝑎𝑟𝑠
× 4.111 = ₹
4,21,378
2. Present value of lump sum payment = Given = ₹ 5,00,000
3. Conclusion: Instalment Option preferable, since PV of Outflows is lower.

Solution 29:
Statement of Operating Profit from processing of waste (₹ in lakh)
Year 1 2 3 4
Sales :(A) 966 966 1,254 1,254
Material consumption 90 120 255 255
Wages 180 195 255 300
Other expenses 120 135 162 210
Factory overheads (insurance only) 90 90 90 90
Loss of rent on storage space (opportunity cost) 30 30 30 30
Interest @14% 84 63 42 21
Depreciation (as per income tax rules) 150 114 84 63
Total cost: (B) 744 747 918 969
Profit (C)=(A)-(B) 222 219 336 285
Tax (30%) 66.6 65.7 100.8 85.5
Profit after Tax (PAT) 155.4 153.3 235.2 199.5
Statement of Incremental Cash Flows (₹ in lakh)
Year 0 1 2 3 4
Material stock (60) (105) - - 165
Compensation for contract (90) - - - -
Contract payment saved - 150 150 150 150
Tax on contract payment - (45) (45) (45) (45)
Incremental profit - 222 219 336 285
Depreciation added back - 150 114 84 63
Tax on profits - (66.6) (65.7) (100.8) (85.5)
Loan repayment - (150) (150) (150) (150)
Profit on sale of machinery (net) - - - - 15
Total incremental cash flows (150) 155.4 222.3 274.2 397.5
Present value factor 1.00 0.877 0.769 0.674 0.592
Present value of cash flows (150) 136.28 170.95 184.81 235.32
Net present value 577.36
Advice: Since the net present value of cash flows is ₹ 577.36 lakh which is positive the management should
install the machine for processing the waste.

Solution 32:
Computation of Initial Cash Outflows: (0 Period)
Cost of Equipment ₹ 6,00,000
(+) Net Working Capital ₹ 80,000
Initial Cash Outflows ₹ 6,80,000

Computation of Present Value of Cash Inflows(In ₹)

Particulars 1 2 3 4 5
Cash Inflows Before Tax (C.F.B.T.) (A) 2,40,000 2,75,000 2,10,000 1,80,000 1,60,000
Less: Depreciation (₹ 6,00,000/5) (1,20,000) (1,20,000) (1,20,000) (1,20,000) (1,20,000)
Profits before Tax (PBT) (1,20,000) 1,55,000 90,000 60,000 40,000
Tax Liability (35%) (B) (42,000) (54,250) (31,500) (21,000) (14,000)
C.F.A.T. (A) – (B) 1,98,000 2,20,750 1,78,500 1,59,000 1,46,000
P.V. Factor (12%) 0.8929 0.7972 0.7118 0.6355 0.5674
Present Value Cash Inflows 1,76,794 1,75,982 1,27,056 1,01,045 82,840
Terminal Value (Year 5) (80,000×0.5674) = 45,392

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(1) Payback Period(In ₹)

Years Cash Inflows Cumulative Cash Inflows
1 1,98,000 1,98,000
2 2,20,750 4,18,750
3 1,78,500 5,97,250
4 1,59,000 7,56,250
₹82,750
Payback Period = 3 years + ₹1,59,000
× 1 year = 3.52 years

(2) Discounted Payback Period(In ₹)

Years Present Value of Cash Inflows Cumulative Present Value of Cash Inflows
1 1,76,794 1,76,794
2 1,75,982 3,52,776
3 1,27,056 4,79,832
4 1,01,045 5,80,877
5 82,840 + 45,392 = 1,28,232 7,09,109
₹99,123
Discounted Payback Period = 4 years + ₹1,28,232
= 4.773 years

(3) Net Present Value

N.P.V. = Present Value of Cash Inflows – Present Value of Cash Outflows
= ₹ 7,09,109–₹ 6,80,000= ₹ 29,109

(4) I.R.R.
Years P.V. Factor (15%) Cash Inflows Present Value of Cash Inflows
1 0.8696 1,98,000 1,72,181
2 0.7561 2,20,750 1,66,909
3 0.6575 1,78,500 1,17,364
4 0.5718 1,59,000 90,916
5 0.4972 2,26,000 1,12,367
Present Value of Cash Inflows 6,59,737
N.P.V. at 15% Cost of Capital = ₹ 6,59,737 – ₹ 6,80,000 = (₹ 20,263)
Discount Rate N.P.V.
12% ₹ 29,109
15% (₹ 20,263)
₹ 29,109
I.R.R. = 12% + ₹49,372 × 3%
= 13.77%

Solution 34:
A hospital is considering to purchase
Analysis of Investment Decisions
Situation-(i) Situation-(ii)
Commission Commission
Determination of Cash inflows
Income before Income after
taxes taxes
Cash flow up-to 7th year:
Sales Revenue 40,000 40,000
Less: Operating Cost (7,500) (7,500)
32,500 32,500
Less: Depreciation (80,000 – 6,000) ÷ 8 (9,250) (9,250)
Net Income 23,250 23,250
Tax @ 30% (6,975) (6,975)
Earnings after Tax (EAT) 16,275 16,275
Add: Depreciation 9,250 9,250
Cash inflow after tax per annum 25,525 25,525

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Less: Loss of Commission Income (8,400) (12,000)

Net Cash inflow after tax per annum 17,125 13,525
In 8th Year:
Net Cash inflow after tax 17,125 13,525
Add: Salvage Value of Machine 6,000 6,000
Net Cash inflow in year 8 23,125 19,525
Calculation of Net Present Value (NPV) and Profitability Index (PI)
Situation-(i) Situation-(ii)
PV
[Commission [Commission
Particulars factor
@10% Income before Income after
taxes] taxes]

Present value of cash inflows (1st 83,347.38 65,826.18

A 4.867
(17,125 × 4.867) (13,525 × 4.867)
to 7th year)

Present value of cash inflow at 8th 10,799.38 9,118.18

B 0.467
(23,125 × 0.467) (19,525 × 0.467)
year

C PV of cash inflows 94,146.76 74,944.36

D Less: Cash Outflow 1.00 (80,000) (80,000)

E Net Present Value (NPV) 14,146.76 (5,055.64)

F PI = (C÷D) 1.18 0.94

Recommendation: The hospital may consider purchasing of diagnostic machine in situation
(i) where commission income is 12,000 before tax as NPV is positive and PI is also greater than 1.
Contrary to situation (i), in situation (ii) where the commission income is net of tax, the
recommendation is reversed to not purchase the machine as NPV is negative and PI is also less
than 1.

Solution 37:
Calculation of Net Cash flows
Contribution = (400 – 375) ´ 80,000 = ₹ 20,00,000
Fixed costs = 10,40,000 – [(40,00,000 – 5,00,000)/5] = ₹ 3,40,000

Year Capital Contribution Fixed costs Promotion Net cash flow

(₹) (₹) (₹) (₹) (₹)
0 (32,00,000) (32,00,000)
1 (8,00,000) 20,00,000 (3,40,000) (1,25,000) 7,35,000
2 20,00,000 (3,40,000) (1,75,000) 14,85,000
3 20,00,000 (3,40,000) 16,60,000
4 20,00,000 (3,40,000) 16,60,000
5 5,00,000 20,00,000 (3,40,000) 21,60,000
Calculation of Net Present Value
Year Net cash flow (₹) 12% discount factor Present value (₹)
0 (32,00,000) 1.000 (32,00,000)
1 7,35,000 0.893 6,56,355
2 14,85,000 0.797 11,83,545
3 16,60,000 0.712 11,81,920
4 16,60,000 0.636 10,55,760
5 21,60,000 0.567 12,24,720

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21,02,300
The net present value of the project is ₹21,02,300.

Solution 38:
1. Computation of CFAT from the projects
Particulars Machine – I Machine – II
Annual Income before Tax and Depreciation ₹ 3,45,000 ₹ 4,55,000
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒 ₹10,00,000 ₹15,00,000
Less: Depreciation = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑌𝑒𝑎𝑟𝑠 5 𝑦𝑒𝑎𝑟𝑠
= ₹ 2,00,000 6 𝑦𝑒𝑎𝑟𝑠
= ₹ 2,50,000
PBT ₹ 1,45,000 ₹ 2,05,000
Less: Tax at 30% ₹ 43,500 ₹ 61,500
PAT ₹ 1,01,500 ₹ 1,43,500
CFAT = PAT + Depreciation ₹ 3,01,500 ₹ 3,93,500

2. Computation of NPV (at 12% Cost of Capital) and Cumulative DCFAT(In ₹)

Year PVF at 12% Machine – I Machine – II
CFAT PV CumulativePV CFAT PV CumulativePV
1 0.893 3,01,500 2,69,240 2,69,240 3,93,500 3,51,396 3,51,396
2 0.797 3,01,500 2,40,296 5,09,536 3,93,500 3,13,619 6,65,016
3 0.712 3,01,500 2,14,668 7,24,204 3,93,500 2,80,172 9,45,188
4 0.636 3,01,500 1,91,754 9,15,958 3,93,500 2,50,266 11,95,454
5 0.567 3,01,500 1,70,951 10,86,909 3,93,500 2,23,115 14,18,569
6 0.507 Nil Nil NA 3,93,500 1,99,505 16,18,074
Total PVCI 10,86,909 16,18,074
Less: Initial Investment (PVCO) 10,00,000 15,00,000
Net Present value 86,909 1,18,074
Note: Since discounted payback period is to be calculated, cumulative PV should be computed at the end of
the year.

3. Discounted Payback Period

Machine I
(₹10,00,000−₹9,15,958)
Discounted Payback Period = 4 + ₹1,70,951
= 4.49 years
Machine II
(₹15,00,000−₹14,18,569)
Discounted Payback Period = 5 + ₹1,,99,505
= 5.41 years

4. Internal Rate of Return

Machine I
₹86,909
Internal Rate of Return = 12% + [₹86,909—₹ 12,889]
× (16% – 12%) = 15.48%
Machine II
₹1,18,074
Internal Rate of Return = 12% + [₹1,18,074−(−₹50,346)]
× (16% – 12%) = 14.80%

5. Decision/Project Choice
Criterion Machine I Machine II Preference
NPV at 12% cost of capital ₹ 86,909 ₹ 1,18,074 Machine II
IRR 15.48% 14.80% Machine II
Discounted payback period 4 years 6 months 5 years 5 months Machine II
Equivalent Annual Flows ₹ 86,909
=₹ 24,108
₹ 1,18,074
= ₹ 28,714 Machine II
3.605 4.112
In this case, Machine I and II have differential lives and hence Equivalent Annual Flow Method will be a better
𝑁𝑃𝑉
method for project ranking. Equivalent Annual Flows from the project = 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐹𝑎𝑐𝑡𝑜𝑟 𝑎𝑡 12% 𝑓𝑜𝑟 𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝐿𝑖𝑓𝑒 𝑌𝑒𝑎𝑟𝑠

Solution 39:
Working Notes:

1,50,000
Depreciation on Machine X = 5
= ₹ 30,000

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2,40,000
Depreciation on Machine Y = 6
= ₹ 40,000
Particulars Machine X (₹) Machine Y (₹)
Annual Savings:
Wages 90,000 1,20,000
Scrap 10,000 15,000
Total Savings (A) 1,00,000 1,35,000
Annual Estimated Cash Cost:
Indirect Material 6,000 8,000
Supervision 12,000 16,000
Maintenance 7,000 11,000
Total Cash Cost (B) 25,000 35,000
Annual Cash Savings (A-B) 75,000 1,00,000
Less: Depreciation 30,000 40,000
Annual Savings Before Tax 45,000 60,000
Less: Tax @ 30% 13,500 18,000
Annual Savings/Profit (After Tax) 31,500 42,000
Add: Depreciation 30,000 40,000
Annual Cash Inflows

Evaluation of Alternatives

(i) Average Rate of Return Method (ARR)

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑁𝑒𝑡 𝑆𝑎𝑣𝑖𝑛𝑔𝑠

ARR = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

31,500
Machine X = 75,000
x 100 = 42%

42,000
Machine Y = 120,000
× 100 = 35%

Decision: Machine X is better.

[Note: ARR can be computed alternatively taking initial investment as the basis for computation (ARR =
Average Annual Net Income/Initial Investment). The value of ARR for Machines X and Y would then change
accordingly as 21% and 17.5% respectively]

(ii) Present Value Index Method

Present Value = Annual Cash Inflow x P.V. Factor @ 10%

Machine X = 61,500 × 3.79
= ₹ 2, 33,085
Machine Y = 82,000 × 4.354
= ₹ 3, 57,028

𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒
P.V. Index = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

2,33,085
Machine X = 1,50,000
= 1.5539

3,57,028
Machine Y = 2,40,000
= 1,487

Solution 40:
(i) Net Present Value at different discounting rates
Project 0% (₹) 10% (₹) 15% (₹) 30% (₹) 40% (₹)
C 8000 4139 2654 - 632 - 2158

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{2000 + 4000 {2000 x 0.909 {2000 x {2000 x {2000 x

+ 12000 - + 4000 x 0.8696 + 4000 0.7692 + 4000 0.7143 + 4000
10000} 0.8264 + x 0.7561 + x 0.5917 + x 0.5102 +
12000 x 12000 x 12000 x 12000 x
0.7513 - 0.6575 - 0.4552 - 0.3644 -
10000} 10,000} 10,000} 10,000}
Ranking I I II II II
D 6000 3823 2937 833 -233
{10000 + 3000 {10000 x {10000 x {10000 x {10000 x
+ 3000 - 0.909 + 3000 x 0.8696 + 3000 0.7692 + 3000 0.7143 + 3000
10000} 0.8264 + 3000 x 0.7561 + x 0.5917 + x 0.5102 +
x 0.7513 - 3000 x 0.6575 3000 x 0.4552 3000 x 0.3644
10000} - 10,000} - 10,000} - 10,000}

The conflict in ranking arises because of skewness in cash flows. In the case of Project C cash flows occur
later in the life and in the case of Project D, cash flows are skewed towards the beginning.
At lower discount rate, project C’s NPV will be higher than that of project D. As the discount rate increases,
Project C’s NPV will fall at a faster rate, due to compounding effect.
After break even discount rate, Project D has higher NPV as well as higher IRR.

(ii) If the opportunity cost of funds is 10%, project C should be accepted because the firm’s wealth will increase
by ₹ 316 (₹ 4,139 - ₹ 3,823).
The following statement of incremental analysis will substantiate the above point.
Project Cash Flows (₹) NPV @ 10% (₹) IRR 12.5%
C0 C1 C2 C3
C-D 0 - 8,000 1,000 9,000 316 0
{- 8000 x 0.909 + {- 8000 x 0.88884
1000 x 0.8264 + + 1000 x 0.7898 +
9000 x 0.7513} 9000 x 0.7019}
Hence, the project C should be accepted, when opportunity cost of funds is 10%.

Solution 41:
1. Computation of NPV(In ₹ 000s)
Yea
rs PVF PVF Project A Project B
PVF
PVCI PVCI PVCI PVCI at at PVCI at
10% 20% CFAT at 10% at 20% CFAT at 10% 20% 27% 27%
1 0.91 0.83 85 77.35 70.55 480.00 436.80 398.40 0.79 379.20
2 0.83 0.69 200 166.00 138.00 100.00 83.00 69.00 0.62 62.00
3 0.75 0.58 240 180.00 139.20 70.00 52.50 40.60 0.49 34.30
4 0.68 0.48 220 149.60 105.60 30.00 20.40 14.40 0.38 11.4
5 0.62 0.41 70 43.40 28.70 20.00 12.40 8.20 0.30 6.00
Total PVCI 616.35 482.05 605.10 530.60 492.90
Less: Initial Investment (PVCO) 500.00 500.00 500.00 500 500
NPV 116.35 (17.95) 105.10 30.60 (7.10)

2. Project A:
116.35
IRR = 10% + [116.35−(−17.95)]
× 10 = 18.66%

Project B:
105.10
IRR = 10% + [(105.10−(−7.10)]
× 17 = 25.92%

3. Decision:
Particulars Project A Project B Preference
NPV at K0 (i.e. 10%) 116.35 105.10 Project A

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IRR 18.66% 25.92% Project B

In case of inconsistency in ranking based on NPV and IRR, NPV-based decision-making is preferable. So, in
this case, project A is preferable due to higher NPV.

Solution 42:
Option I: Purchase Machinery and Service Part at the end of Year 1.
Net Present value of cash flow @ 10% per annum discount rate.
36,000 36,000 36,000 20,000 25,000
NVP (in ₹) = - 1,00,000 + (1.1) + (1.1)2 + (1.1)3 – (1.1) + (1.1)3
= - 1,00,000 + 36,000 (0.9091 + 0.8264 + 0.7513) – (20,000 x 0.9091) + (25,000 x 0.7513)
= - 1,00,000 + (36,000 x 2.4868) – 18,182 + 18,782.5
= - 1,00,000 + 89,524.8 – 18,182 + 18,782.5
NPV = - 9,874.7
Since, Net Present Value is negative; therefore, this option is not to be considered.
If Supplier gives a discount of ₹ 10,000 then,
NPV (in ₹ ) = + 10,000 – 9,874.7 = + 125.3
In this case, Net Present Value is positive but very small; therefore, this option may not be advisable.
Option II: Purchase Machinery and Replace Part at the end of Year 2.
36,000 36,000 36,000 30,800 54,000
NVP (in ₹) = - 1,00,000 + (1.1) + (1.1)2 + (1.1)3 – (1.1)2 + (1.1)4
= - 1,00,000+ 36,000 (0.9091 + 0.8264 + 0.7513) – (30,800 x 0.8264) + (54,000 x 0.6830)
= - 1,00,000 + 36,000 (2.4868) – 25,453.12 + 36,882
= - 1,00,000 + 89,524.8 – 25,453.12 + 36,882
NPV = + 953.68
Net Present Value is positive, but very low as compared to the investment.
If the Supplier gives a discount of ₹ 10,000, then
NPV (in ₹) = 10,000 + 953.68 = 10,953.68
Decision: Option II is worth investing as the net present value is positive and higher as compared to Option I.

Solution 43:
(i) Project Initial Net Cash Outflow
Particulars ₹
Purchase Price of system 2,00,000
(+) Installation Cost 50,000
2,50,000

(ii) (a) Project Terminal Cash Inflows ₹

Scrap Value of Computer 0

(b) Project operating cash Inflows

Particulars ₹
Saving in annual salaries of Clerical Staff (₹ 15,000 × 10) 1,50,000
Add: Saving from reduced production delays 8,000
Add: Saving from lost sales due to inventory stock out 12,000
Add: Saving due to timely billing procedures 3,000
Gross Saving 1,73,000
Less: Annual salaries of two computer specialists (80,000)
Less: Annual maintenance and operating (cash) expenses (12,000)
C.F.B.T. (1) 81,000
Less: Depreciation (₹ 2,50,000/5) (50,000)
P.B.T. 31,000
Tax liability (2) 12,400
C.F.A.T. (1) – (2) 68,600

Statement showing evaluation of proposal(In ₹)

Particulars Time Present value factor Amount Present value
Cash Outflows:
Cost of Machine 0 1 2,50,000 2,50,000

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2,50,000
Cash Inflows:
C.F.A.T. 1-5 3.605 68,600 2,47,303
2,47,303
Net Present Value (2,697)

₹ 2,47,303
(iv) Profitability Index = ₹ 2,50,000 = 0.989

₹ 2,50,000
(v) Pay Back Period = ₹ 68,600
= 3.64 years
(vi) (a) Cash outflows (0 Period) = ₹ 2,50,000

(b) Cash inflows = CFAT (1-5) = ₹ 68,600

(c) Terminal value

Particulars (5 Period) (In ₹)
S.P. (1) 25,000
W.D.V. 0
Capital gain 25,000
Tax rate 40%
Less: Tax Liability (2) 10,000
Terminal value (1) – (2) 15,000

(d) Statement showing Evaluation of Proposal(In ₹)

Present
Particulars Time Present value factor Amount value
Cash Outflows:
Cost of machine 0 1 2,50,000 2,50,000
Present Value of Cash
Outflows (A) 2,50,000
Cash Inflows:
CFAT 1-5 3.605 68,600 2,47,303
Terminal Value 5 0.567 15,000 8,505
Present Value of Cash
Inflows (B) 2,55,808
Net Present Value (B) –
(A) 5,808

(vii) (a) Cash Outflows = 0 period = ₹ 2,50,000

(b) Cash Inflows CFAT
Particulars (1-5) (In ₹)
C.F.B.T (1) 81,000
Less: Depreciation 46,000
P.B.T. 35,000
Tax rate 40%
Tax Liability (2) 14,000
CFAT (1) – (2) 67,000

(c) Terminal Value

Particulars (Yr 5) (In ₹)
S.P. (1) 0
(-) WDV 20,000
Capital Loss: (20,000)
Tax rate 40%
Tax Saving (2) 8,000
Terminal Value {(1) + (2)} 8,000

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(d) Statement showing evaluation of Proposal(In ₹)

Particulars Time Present value factor Amount Present value
Cash Outflows:
Cost of machine 0 1 2,50,000 2,50,000
Present Value of Cash
Outflows (A) 2,50,000
Cash Inflows:
CFAT 1-5 3.605 67,000 2,41,535
Terminal Value 5 0.567 8,000 4,536
Present Value of Cash
Inflows (B) 2,46,071
Net Present Value (B) –
(A) (3,929)

Solution 45:
Gross electricity gene = 25 lakhs unit p.a.
Free commitment (4%) = 1 lakh unit p.a.
Net chargeable electricity generate = 24 lakhs unit p.a.
Computation of Annual Cash Flow
Period Rate per unit Revenue Maintenanc Profit Before Tax @ Profit after
(₹) (₹) e cost (₹) Tax (₹) 50%(₹) Tax (₹)
(A) (B) (C)= (A)-(B) (D) (C)-(D)
1 2.25 54,00,000 4,00,000 50,00,000 25,00,000 25,00,000
2 2.50 60,00,000 6,00,000 54,00,000 27,00,000 27,00,000
3 2.75 66,00,000 8,00,000 58,00,000 29,00,000 29,00,000
4 3.00 72,00,000 10,00,000 62,00,000 31,00,000 31,00,000
5 3.25 78,00,000 12,00,000 66,00,000 33,00,000 33,00,000
6 3.50 84,00,000 14,00,000 70,00,000 35,00,000 35,00,000
7 3.75 90,00,000 16,00,000 74,00,000 37,00,000 37,00,000
8 4.25 102,00,000 18,00,000 84,00,000 42,00,000 42,00,000
9 4.75 114,00,000 20,00,000 94,00,000 47,00,000 47,00,000
10 5.25 126,00,000 22,00,000 104,00,000 52,00,000 52,00,000

Computation of Net Present Value

Period Annual Subsidy Tax Benefit Sale Total Cash PVF PV
Cash (₹) on Machine of Inflow @15%
Flow (₹) Depreciation Land (₹)
(₹) (₹) (₹)
1 25,00,000 25,00,000 140,00,000 - 1,90,00,000 0.87 165,30,000
2 27,00,000 - - - 27,00,000 0.756 20,41,200
3 29,00,000 - - - 29,00,000 0.658 19,08,200
4 31,00,000 - - - 31,00,000 0.572 17,73,200
5 33,00,000 - - - 33,00,000 0.497 16,40,100
6 35,00,000 - - - 35,00,000 0.432 15,12,000
7 37,00,000 - - - 37,00,000 0.376 13,91,200
8 42,00,000 - - - 42,00,000 0.327 13,73,400
9 47,00,000 - - - 47,00,000 0.284 13,34,800
10 52,00,000 - - 90,00, 142,00,000 0.247 35,07,400
000
Total Present Value of Cash Inflows 3,30,11,500
Less: Initial Outlay 3,10,00,000
Net Present Value 20,11,500
The proposed project has NPV of ₹ 20,11,500 and is viable to undertake.

Solution 46:
Statement showing evaluation of replacement proposal (₹ in Lakhs)
Particulars Time PV Factor Amount Present value

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Cash Outflows:
Cost of new computer 35
Less: Scrap of old drawing office &
equipment furniture (9)
Net Cost of replacement 0 1 26 26
P.V. of C.O. 26
Cash Inflows:
Incremental CFAT 1-6 4.018 2.5 10.27
Tax Saving on depreciation 1 0.892 17.5 15.6
Terminal Value 6 0.506 1.0 0.506
26.386
26.386 – 26 =
Net Present Value 0.386

Computation of Incremental CFAT (₹ in Lakhs)

Particulars 1-6 Years
Savings in operating cost 12
Less: Operating maintenance cost of computer (7)
Incremental CFBT 5
Less: Tax 50% 2.5
Incremental CFAT Excluding tax savings on depreciation 2.5
Depreciation 35
Tax rate 50%
Tax savings on Depreciation 17.5

Solution 48:
Workings:
Calculation of Depreciation:
₨ 1,40,000 – ₨ 30,000
On Modernized Equipment = 5 𝑦𝑒𝑎𝑟𝑠
= ₨ 22,000 p.a.
₨ 3,50,000 – ₨ 60,000
On New Machine = 5 𝑦𝑒𝑎𝑟𝑠
= ₨ 58,000 p.a.
(i) Calculation of Incremental annual cash inflows/ savings:
Particulars Existing Modernization New Machine
Equipment Amount (₨) Savings Amount (₨) Savings (₨)
(₨) (₨)
(1) (2) (3)=(1)-(2) (4) (5)=(1)-(4)
Wages & Salaries 45,000 35,500 9,500 15,000 30,000
Supervision 20,000 10,000 10,000 7,000 13,000
Maintenance 25,000 5,000 20,000 2,500 22,500
Power 30,000 20,000 10,000 15,000 15,000
Total 1,20,000 70,500 49,500 39,500 80,500
Less: Depreciation 22,000 58,000
(Refer Workings)
Total Savings 27,500 22,500
Less: Tax @ 50% 13,750 11,250
After Tax Savings 13,750 11,250
Add: Depreciation 22,000 58,000
Incremental Annual 35,750 69,250
Cash Inflows

(ii) Calculation of Net Present Value (NPV)

Particulars Year Modernization (₨) New Machine (₨)
Initial Cash outflow (A) 0 1,40,000.00 3,50,000.00
Incremental Cash Inflows 1-5 1,35,492.50 2,62,457.50
(₨ 35,750 x 3.790) (₨ 69,250 x 3.790)
Salvage value 5 18,630.00 37,260.00
(₨ 30,000 x 0.621) (₨ 60,000 x 0.621)

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PV of Cash inflows (B) 1,54,122.50 2,99,717.50

Net Present Value (B - A) 14,122.50 (50,282.50)
Advise: The company should modernize its existing equipment and not buy a new machine because NPV is
positive in modernization of equipment.

Solution 49:
1. Initial Investment = Machine Purchase price + Modification charges + Installation Charges +
Testing Charges
= ₹ 9,00,000 + ₹ 30,000 + ₹ 60,000 + ₹ 90,000 = ₹ 10,80,000.
2. Salvage Value = ₹ 1,80,000
3. Life = 3 years
₹10,80,000−₹1,80,000
4. Depreciation p.a. = 3 𝑦𝑒𝑎𝑟𝑠
= ₹ 3,00,000 (same as charged in P&L Account given in
Question).
5. Computation of CFAT p.a. and NPV:(In ₹)
Particulars Year I Year II Year III
Sales 10,00,000 20,00,000 8,00,000
Less: Relevant Costs:
Materials and Labour (4,00,000) (7,50,000) (3,50,000)
Rent Expense (50,000) (50,000) (50,000)
Depreciation (3,00,000) (3,00,000) (3,00,000)
Rent Income foregone (37,500) (37,500) (37,500)
Total Costs 7,87,500 11,37,500 7,37,500
Profit After Tax 2,12,500 8,62,500 62,500
Less: Tax at 50% (1,06,250) (4,31,250) (31,250)
Profit After Tax 1,06,250 4,31,250 31,250
Add: Depreciation 3,00,000 3,00,000 3,00,000
CFAT 4,06,250 7,31,250 3,31,250
Add: Salvage value of Machine - - 1,80,000
PVF at 20% 0.8333 0.6944 0.5787
Present Value 3,38,528 (a) 5,07,780 (b) 2,95,860 (c)
Total Present Value (a) + (b) + (c) 11,42,168
Less: Initial Investment 10,80,000
NPV 62,168

Solution 50:
Statement showing computation of Annual CFAT(In ₹)
Particulars 1 2 3 4 5
Savings in Accommodation Expenses 8,00,000 10,00,000 12,00,000 14,00,000 16,00,000
Less: Annual Maintenance Cost (1,50,000) (1,50,000) (1,50,000) (1,50,000) (1,50,000)
Add: Saving in Boarding Charges 50,000 50,000 50,000 50,000 50,000
Add: Saving in Executive Training
Programmes 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
CFBT (1) 9,00,000 11,00,000 13,00,000 15,00,000 17,00,000
Less: Depreciation 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000
PBT 6,00,000 8,00,000 10,00,000 12,00,000 14,00,000
Less: Tax (2) 3,00,000 4,00,000 5,00,000 6,00,000 7,00,000
CFAT 6,00,000 7,00,000 8,00,000 9,00,000 10,00,000
PVF 0.87 0.76 0.66 0.57 0.50
PVCI 5,22,000 5,32,000 5,28,000 5,13,000 5,00,000
PVCI = ₹ 25,95,000
NPV = ₹ 25,95,000 – ₹ 15,00,000 = ₹ 10,95,000
Notes: 1. No other alternative use of land has been given hence it will not be considered for evaluation of
Proposal.
2. Consultants Remuneration, Travel and Conveyance & special allowances will continue to be incurred, hence
is ignored.

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Solution 51:

Computation of Annual Cash Flow after Tax

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Savings in Salaries 15,00,000 15,00,000 15,00,000 15,00,000 15,00,000
Reduction in 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000
Production Delays
Reduction in Lost Sales 2,50,000 2,50,000 2,50,000 2,50,000 2,50,000
Gain due to Timely Billing 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Salary to Computer (10,00,000 (10,00,000) (10,00,000) (10,00,000) (10,00,000)
Specialist )
Maintenance and (2,00,000) (1,80,000) (1,60,000) (1,40,000) (1,20,000)
Operating Cost
(payable in advance)
Depreciation (21 lakhs/5) (4,20,000) (4,20,000) (4,20,000) (4,20,000) (4,20,000)
Gain Before Tax 6,30,000 6,50,000 6,70,000 6,90,000 7,10,000
Less: Tax (30%) 1,89,000 1,95,000 2,01,000 2,07,000 2,13,000
Gain After Tax 4,41,000 4,55,000 4,69,000 4,83,000 4,97,000
Add: Depreciation 4,20,000 4,20,000 4,20,000 4,20,000 4,20,000
Add: Maintenance and 2,00,000 1,80,000 1,60,000 1,40,000 1,20,000
Operating Cost (payable
in advance)
Less: Maintenance and (2,00,000) (1,80,000) (1,60,000) (1,40,000) (1,20,000) -
Operating Cost (payable
in advance)
Net CFAT (2,00,000) 8,81,000 8,95,000 9,09,000 9,23,000 10,37,000
Note: Annual cash flows can also be calculated Considering tax shield on depreciation & maintenance and
operating cost. There will be no change in the final cash flows after tax.

Computation of NPV
Particulars Year Cash Flows (₹) PVF PV (₹)
Initial Investment (80% of 20 Lacs) 0 16,00,000 1 16,00,000
Installation Expenses 0 1,00,000 1 1,00,000
Instalment of Purchase Price 1 4,00,000 0.870 3,48,000
PV of Outflows (A) 20,48,000
CFAT 0 (2,00,000) 1 (2,00,000)
CFAT 1 8,81,000 0.870 7,66,470
CFAT 2 8,95,000 0.756 6,76,620
CFAT 3 9,09,000 0.658 5,98,122
CFAT 4 9,23,000 0.572 5,27,956
CFAT 5 10,37,000 0.497 5,15,389
PV of Inflows (B) 28,84,557
NPV (B-A) 8,36,557
Profitability Index (B/A) 1.408 or 1.41
Evaluation: Since the NPV is positive (i.e. ₹8,36,557) and Profitability Index is also greater than 1 (i.e. 1.41),
Alpha Ltd. may introduce artificial intelligence (AI) while making computers.

Solution 52:
Let the total value of machine necessary for replacement be x.
(a) Statement showing determination of cost of New Machine
Cash Outflows:
Cost of new Machine X
Less: Scrap value of old
machine (5,00,000)
Net cost of replacement 0 1 x – 5,00,000 x – 5,00,000
PVCO (A) x – 5,00,000

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Cash Inflows: 1 0.87 60,000 52,200

CFAT
2 0.76 1,20,000 91,250
3 0.66 1,80,000 1,18,800
4 0.57 2,40,000 1,36,800
5 0.49 3,00,000 1,47,000
0.08 x – 0.268x –
Tax Savings on Depreciation 1-5 3.35 40,000 1,34,000
0.268× +
PVCI (B) 4,12,000
NPV (B – A) 4,53,000

Working Notes:
(i) Computation of Incremental C.F.A.T.
Year 1 2 3 4 5
Incremental capacity 10% 20% 30% 40% 50%
Incremental Production and
sales (kgs.) 10,000 20,000 30,000 40,000 50,000
₹ ₹ ₹ ₹ ₹
Incremental Contribution 1,50,000 3,00,000 4,50,000 6,00,000 7,50,000
Less: Incremental Fixed Cost (50,000) (1,00,000) (1,50,000) (2,00,000) (2,50,000)
Incremental PBT 1,00,000 2,00,000 3,00,000 4,00,000 5,00,000
Tax @ 40% (40,000) (80,000) (1,20,000) (1,60,000) (2,00,000)
Incremental PAT 60,000 1,20,000 1,80,000 2,40,000 3,00,000

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑛𝑒𝑤 𝑎𝑠𝑠𝑒𝑡 − 𝑆𝑐𝑟𝑎𝑝 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑙𝑑 𝐴𝑠𝑠𝑒𝑡

(ii) Tax savings on Incremental Depreciation= 𝑁𝑜.𝑜𝑓 𝑦𝑒𝑎𝑟
× Tax Rates
𝑥 −5,00,000
= 5
× 40%
= (0.2x – 1,00,000) × 40%
= 0.08x – 40,000
NPV = PVCI – PVCO
4,53,000 = (0.268x + 4,12,000) – (x – 5,00,000)
x = ₹ 6,27,049

(b) Statement showing computation of N.P.V.

Particulars Time PVF Amount P.V.
Cash Outflows:
Cost of new Machine 6,27,049
Less: Scrap value of old
machine (5,00,000)
Net Cost of replacement 0 1 1,27,049 1,27,049
PVCO (A) 1,27,049
Cash Inflows:
CFAT 1 0.87 70,164 61,043
2 0.76 1,90,164 1,44,525
3 0.66 3,10,164 2,04,706
PVCI (B) 4,10,274
NPV 2,83,225
Comment: The filling of Managing Director is correct.

Working Notes:
1. Computation of Annual CFAT
Particulars 1 2 3
Incremental Production (unit) 10,000 30,000 50,000
Contribution (₹ 15 p.u.) 1,50,000 4,50,000 7,50,000
Less: Incremental F.C. (Example:
Depreciation) (50,000) (1,50,000) (2,50,000)

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Incremental CFBT 1,00,000 3,00,000 5,00,000

Less: Incremental Depreciation
627049 – 5,00,000 (25,410) (25,410) (25,410)
Incremental PBT 74,590 2,74,590 4,74,590
Less: Tax 40% (29,836) (1,09,836) (1,89,836)
44,754 1,64,754 2,84,754
Add: Depreciation 25,410 25,410 25,410
70,164 1,90,164 3,10,164

Solution 53:
Evaluation of proposal to repair existing machine or buy a new machine for
M/s S. Engineering Company
(i) To repair Existing Machine:
Particulars ₹
Present value of after-tax cash outflows
Cost of repairs immediately net of tax ₹9,500 (50% of ₹ 19,000)
₹9,500
Equivalent annual cost for 5 years( 3.791 ) 2,506
Running and maintenance cost per annum net of tax (50% of ₹
20,000) 10,000
Total net equivalent cash outflows p.a. 12,506

(ii) To buy a New Machine:

Particulars ₹
Present value of after-tax cash outflows
Purchase cost of new machine 49,000
Less: Sale Proceeds of old machine 5,000
44,000
₹44,000
Equivalent annual cost for 10 years( 6.145
) 7,160
Tax saving of depreciation (₹ 49,000/10) × 50% (2,450)
Running and maintenance cost p.a. net of tax (50% of ₹ 14,000) 7,000
Total net equivalent cash outflows per annum 11,710
Advise: The Company should go for buying a new machine.

Solution 54:
ABC & Co.
Equivalent Annual Cost (EAC) of new machine
₹
(i) Cost of new machine now 18,00,000
Add: PV of annual repairs @ ₹ 2,00,000 per annum for 8 years
(₹ 2,00,000 x 4.4873) 8,97,460
26,97,460
Less: PV of Salvage value at the end of 8 years
(₹ 4,00,000 x 0.3269) 1,30,760
25,66,700
Equivalent annual cost (EAC) (₹ 25,66,700/4.4873) 5,71,992

PV of cost of replacing the old machine in each of 4 years with new machine
Scenario Year Cash Flow (₹) PV @ 15% PV (₹)
Replace Immediately 0 (5,71,992) 1.00 (5,71,992)
0 8,00,000 1.00 8,00,000
2,28,008
Replace in one year 1 (5,71,992) 0.8696 (4,97,404)
1 (2,00,000) 0.8696 (1,73,920)
1 5,00,000 0.8696 4,34,800
(2,36,524)
Replace in two years 1 (2,00,000) 0.8696 (1,73,920)

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2 (5,71,992) 0.7561 (4,32,483)

2 (4,00,000) 0.7561 (3,02,440)
2 3,00,000 0.7561 2,26,830
(6,82,013)
Replace in three years 1 (2,00,000) 0.8696 (1,73,920)
2 (4,00,000) 0.7561 (3,02,440)
3 (5,71,992) 0.6575 (3,76,085)
3 (6,00,000) 0.6575 (3,94,500)
3 2,00,000 0.6575 1,31,500
(11,15,445)
Replace in four years 1 (2,00,000) 0.8696 (1,73,920)
2 (4,00,000) 0.7561 (3,02,440)
3 (6,00,000) 0.6575 (3,94,500)
4 (5,71,992) 0.5718 (3,27,065)
4 (8,00,000) 0.5718 (4,57,440)
(16,55,365)

Advice: The company should replace the old machine immediately because the PV of cost of replacing the old
machine with new machine is least.

Solution 56:
(i) Calculation of Net Initial Cash Outflow:
Particulars (₹.) (₹.)
Cost of new machine 5,25,000
Less: Sale proceeds of existing machine 90,000
Savings of tax on loss on sale of existing machine {₹.
1,87,500 - ₹. 90,000) x 0.3} 29,250 1,19,250
Net initial cash outflow 4,05,750

(ii) Calculation of annual depreciation:

₹. 3,75,000
On existing machine = 10 𝑌𝑒𝑎𝑟𝑠 = ₹. 37,500 p.a.
₹. 5,25,000−₹. 60,000
On new machine = 5 𝑌𝑒𝑎𝑟𝑠
= ₹. 93,000 p.a.
(iii) Calculation of annual cash inflows from operations
Particulars Years
1-4 (₹.) 5 (₹.)
Savings in Variable Cost 2,40,000 2,40,000
Less: Savings in Depreciation (₹. 93,000 - ₹. 37,500) 55,500 0*
Savings before tax 1,84,500 2,40,000
Less: Tax @ 30% 55,350 72,000
Savings after Tax 1,29,150 1,68,000
Add: Savings in Depreciation 55,500 0
Incremental Cash Inflows 1,84,650 1,68,000
* No depreciation to be charged in the year of sale of machine.
(iv) Calculation of Net Present Value
Particulars Period Cash Flow P/V Factor Present
(Year) (₹.) @ 11% Value (₹.)
Net Initial Cash Outflow 0 (4,05,750) 1.00 (4,05,750)
Incremental Cash Inflow 1–4 1,84,650 3.103 5,72,969
Incremental Cash Inflow 5 1,68,000 0.593 99,624
Salvage value of new 5 60,000 0.593 35,580
machine 5 27,900 0.593 16,545
Tax saving on Loss on sale {(₹.1,53,000**
of new machine - ₹.60,000) x
0.3} 3,18,968
Net Present Value (NPV)
** WDV of new machine at the end of Year 5

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Cost of New Machine ₹ 5,25,000

Less: Depreciation charged for 4 years
(₹. 93,000 x 4) ₹ 3,72,000
₹ 1,53,000
Comment: It is advisable to replace the existing machine since NPV is positive.

Solution 57:
Statement showing the evaluation of two machines
Machines A B
Purchase cost (₹) (i) 1,50,000 1,00,000
Life of machines (years) 3 2
Running cost of machine per year (₹) (ii) 40,000 60,000
Cumulative present value factor for 1-3 years @
10% (iii) 2.486 -
Cumulative present value factor for 1-2 years @
10% (iv) - 1.735
Present value of running cost of machines (₹)
(v) 99,440 [(ii) × (iii)] 1,04,100 [(ii) × (iv)]
Cash outflow of machines (₹) (vi) = (i) + (v) 2,49,440 2,04,100
Equivalent present value of annual cash 1,17,637 [(vi) ÷
outflow 1,00,338[(vi ÷ iii)] (iv)]
Decision: Company X should buy machine A since its equivalent cash outflow is less than machine B.

Solution 58:
Since project Lives are different, the Equivalent Annual Flows method is adopted.
Machine A B
1. Cost of Machine (Initial Investment) ₹ 6,00,000 ₹ 4,00,000
2. Useful Life 2 Years 2 years
3. Depreciation per annum = (1) ÷ (2) ₹ 2,00,000 ₹ 2,00,000
4. Cash Operating Expenses p.a. = Cash
Outflow p.a. ₹ 1,20,000 ₹ 1,80,000
5. Annuity Factor at 10% for 3 year and 2
years 0.9091 + 0.8264 + 0.9091 + 0.8264 =
6. Equivalent Annual Investment = (1) ÷ (5) 0.7513 = 2.4868 1.7355
7. Equivalent Annual Outflow/Cost (4) + (6) ₹ 2,41,274 ₹ 2,30,481
Outflow = ₹ 3,61,274 ₹ 4,10,481
Decision: Since Machine A has the least EAC (Equivalent Annual Costs), it may be selected.

Solution 59:
A firm is in need of a small vehicle
Selection of Investment Decision
Tax shield on Purchase of New vehicle
Year WDV Dep. @ 25% Tax shield @ 30%
1 1,50,000 37,500 11,250
2 1,12,500 28,125 8,437
3 84,375 21,094 6,328
4 63,281 15,820 4,746
5 47,461 11,865 3,560
6 35,596 8,899 2,670
7 26,697 6,674 2,002
8 20,023 5,006 1,502
9 15,017 3,754 1,126
10 11,263 2,816 845
11 8,447 Scrap value

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Tax shield on Purchase of Second hand vehicles

Year WDV Dep. @ 25% Tax shield @ 30%
1 80,000 20,000 6,000
2 60,000 15,000 4,500
3 45,000 11,250 3,375
4 33,750 8,437 2,531
5 25,313 6,328 1,898
6 60,000 15,000 4,500
7 45,000 11,250 3,375
8 33,750 8,437 2,531
9 25,313 6,328 1,898
10 18,985 4,746 1,424
Calculation of PV of Net outflow of New Vehicle
Year Cash OF/IF PV Factor PV of OF/IF
0 1,50,000 1 1,50,000
1 -11,250 0.892 -10,035
2 -8,437 0.797 -6,724
3 -6,328 0.711 -4,499
4 -4,746 0.635 -3,014
5 -3,560 0.567 -2,018
6 -2,670 0.506 -1,351
7 -2,002 0.452 -905
8 -1,502 0.403 -605
9 -1,126 0.36 -405
10 (845 + 8447) 0.322 -2,992
PVNOF 1,17,452

Calculation of PV of Net outflow of Second hand Vehicles

Year Cash OF/IF PV Factor PV of OF/IF
0 80,000 1 80,000
1 -6,000 0.892 -5,352
2 -4,500 0.797 -3,587
3 -3,375 0.711 -2,400
4 -2,531 0.635 -1,607
(60000 – 18985 –
5 0.567 22,179
1898) = 39,117
6 -4,500 0.506 -2,277
7 -3,375 0.452 -1,525
8 -2,531 0.403 -1,020
9 -1,898 0.36 -683
(1424 + 14239) =
10 0.322 -5,043
(15,663)
PVNOF 78,686
Advise: The PV of net outflow is low in case of buying second hand vehicles. Therefore, it is advisable to
buy second hand vehicles.

Solution 60:
(i) Statement showing Evaluation of Mutually Exclusive Proposals (In ₹)

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P.V.
Particulars Time Factor Service Part Replace Part
Amount P.V. Amount P.V
Cash Outflows:
Cost of machinery 0 1 50,000 50,000 50,000 50,000
Service Cost 1 0.9091 10,000 9,091 .... ....
Add: Replace part 2 0.8264 .... .... 15,400 12,727
P.V. of cash outflows
(A) 59,091 62,727
Cash Inflows:
Cash inflows from
operation 2.4869
1-3 18,000 44,764
1-4 3.1699 18,000 57,058
Scrap value of
machine 3 0.7513 12,500 9,391
4 0.6830 9,000 6,147
P.V. of cash inflows (A) 54,155 63,205
N.P.V. (B) – (A) (4,936) 478
Advise: Purchase machine & Replace the part at end of second year.

(ii) If the supplier gives a discount of ₹ 5,000 on purchase of machine (In ₹)

Proposals Service Part Replace Part
N.P.V. 64 5,478
Cumulative 2.4869 3.1699
Equivalent Annual N.P.V. 25.73 1,728
Advise: Purchase machine & Replace the part at end of second year.

Solution 61:

(a) Option I: Purchase Machinery and Service Part at the end of Year 2 and 4 .
Net Present value of cash flow @ 12% per annum discount rate.
NPV (in ₹) = - 10,00,000 + 2,56,000 x (0.8928+0.7972+0.7118+0.6355+0.5674) – (1,00,000 x
0.7972+1,00,000 x 0.6355) + (76,000 x 0.5674)
= - 10,00,000 + (2,56,000 x 3.6047) – 1,43,270+43,122.4
= - 10,00,000 + 9,22,803.2 – 1,43,270+ 43,122.4
NPV = - 1,77,344.4
Since Net Present Value is negative; therefore, this option is not to be considered.
If Supplier gives a discount of ₹ 90,000, then:
NPV (in ₹) = + 90,000 - 1,77,344.4 = -87,344.4
In this case, Net Present Value is still negative; therefore, this option may not be advisable
Option II: Purchase Machinery and Replace Part at the end of Year 2.
NPV (in ₹)= - 10,00,000 + 2,56,000 x (0.8928+0.7972+0.7118+0.6355+0.5674) – (3,00,000 x
0.7118) + (1,86,000 x 0.5066+1,36,000 x 0.5066)
= - 10,00,000 + (2,56,000 x 3.6047) – 2,13,540+1,63,125.2
= - 10,00,000 + 9,22,803.2 – 2,13,540+1,63,125.2
NPV = - 1,27,611.6
Net Present Value is negative, the machinery should not be purchased.
If the Supplier gives a discount of ₹ 90,000, then:

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NPV (in ₹) = 90,000 - 1,27,611.6 = - 37,611.6

In this case, Net Present Value is still negative; therefore, this option may not be advisable.
Decision: The Machinery should not be purchased as it will earn a negative NPV in both options of repair and
replacement.

Solution 62:
Let the minimum labour savings required per annum be x.
Statement showing determination of minimum labour saving required per annum(In ₹)
Particulars Time PV Factor Amount PV
Cash Outflows:
Cost of machine 0 1 80,000 80,000
80,000
Cash Inflows:
Saving in Raw Material
Cost 1-7 4.564 8,000 36,512
Minimum labour 1-7 4.564 x 4.564x
36,512 + 4.564x
80,000 = 36,512 + 4.564x
43,488
x = 4.564 = ₹ 9,528
Maximum Bonus per annum = 4,472
4,472
Maximum percentage change in estimated labour savings that will render project unviable = 14,000
× 100 =
31.94%

Solution 63:
Evaluation of Alternatives:
Savings in disposing off the waste
Particulars (₹)
Outflow (50,000 × ₹ 1) 50,000
Less: tax savings @ 50% 25,000
Net Outflow per year 25,000

Calculation of Annual Cash inflows in Processing of waste Material

Particulars Amount (₹) Amount (₹)
Sale value of waste 5,00,000
(₹ 10 × 50,000 gallon)
Less: Variable processing cost 2,50,000
(₹ 5 × 50,000 gallon)
Less: Fixed processing cost 30,000
Less: Advertisement cost 20,000
Less: Depreciation 60,000 (3,60,000)
Earnings before tax (EBT) 1,40,000
Less: Tax @ 50% (70,000)
Earnings after tax (EAT) 70,000
Add: Depreciation 60,000
Annual Cash inflows 1,30,000
Total Annual Benefits = Annual Cash inflows + Net savings (adjusting tax) in disposal cost
= ₹ 1,30,000 + ₹ 25,000 = ₹ 1,55,000

Calculation of Net Present Value

Year Particulars Amount (₹)
0 Investment in new equipment (6,00,000)
1 to 10 Total Annual benefits × PVAF (10 years, 15%)
₹ 1,55,000 × 5.019 7,77,945
Net Present Value 1,77,945
Recommendation: Processing of waste is a better option as it gives a positive Net Present Value.

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Note- Research cost of ₹ 60,000 is not relevant for decision making as it is sunk cost.

Solution 64:
Computation of initial cash outlay (COF)
(₹ In Lakhs)
Project Cost 240
Working Capital 30
270

Calculation of Cash Inflows (CIF):

Years 1 2 3-5 6-8
Sales in units 60,000 80,000 1,40,000 1,20,000
Contribution (₹200 x 60% x 72,00,000 96,00,000 1,68,00,000 1,44,00,000
No. of Units)
Less: Fixed Cost (30,00,000) (30,00,000) (30,00,000) (30,00,000)
Less: Advertisement (50,00,000) (25,00,000) (10,00,000) (5,00,000)
Less: Depreciation (30,00,000) (30,00,000) (30,00,000) (30,00,000)
(2,40,00,000/8) = 3,00,000
Profit/Loss (38,00,000) 11,00,000 98,00,000 79,00,000
Less: Tax @ 25% Nil (2,75,000) (24,50,000) (19,75,000)
Profit/loss after Tax (38,00,000) 8,25,000 73,50,000 59,25,000
Add: Depreciation 30,00,000 30,00,000 30,00,000 30,00,000
Cash Inflow (8,00,000) 38,25,000 1,03,50,000 89,25,000

(Note: Since variable cost is 40%, Contribution shall be 60% of sales)

Computation of PV of CIF
Year CIF PV Factor (₹)
(₹) @ 10%
1 (8,00,000) 0.909 (7,27,200)
2 38,25,000 0.826 31,59,450
3 1,03,50,000 0.751 77,72,850
4 1,03,50,000 0.683 70,69,050
5 1,03,50,000 0.621 64,27,350
6 89,25,000 0.564 50,33,700
7 89,25,000 0.513 45,78,525
8 89,25,000 0.467 55,68,975
Working Capital 30,00,000
3,88,82,700
PV of COF 2,70,00,000
NPV 1,18,82,700

Recommendation: Accept the project in view of positive NPV.

Solution 65:
Computation of initial cash outlay
Particulars Amount (₹ in lakhs)
Equipment Cost (0) 120
Working Capital (0) 15
135

Calculation of Cash Inflows

Years 1 2 3-5 6-8
Sales in units 80,000 1,20,000 3,00,000 2,00,000
₹ ₹ ₹ ₹
Contribution @ ₹ 60 p.u. 48,00,000 72,00,000 1,80,00,000 1,20,00,000
Fixed Cost (16,00,000) (16,00,000) (16,00,000) (16,00,000)

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Advertisement (30,00,000) (15,00,000) (10,00,000) (4,00,000)

Depreciation (15,00,000) (15,00,000) (16,50,000) (16,50,000)
Profit/(Loss) (13,00,000) 26,00,000 1,37,50,000 83,50,000
Tax @ 50% (Nil) (13,00,000) (68,75,000) (41,75,000)
Profit/(Loss) after tax (13,00,000) 13,00,000 68,75,000 41,75,000
Add: Depreciation 15,00,000 15,00,000 16,50,000 16,50,000
Cash Inflow 2,00,000 28,00,000 85,25,000 58,25,000

Computation of PV of CIF
Year CF (₹) PV Factor @ 12% ₹
1 2,00,000 0.893 1,78,600
2 28,00,000 0.797 22,31,600
3 85,25,000 0.712 60,69,800
4 85,25,000 0.636 54,21,900
5 85,25,000 0.567 48,33,675
6 58,25,000 0.507 29,53,275
7 58,25,000 0.452 26,32,900
8 58,25,000 0.404 29,99,700
WC 15,00,000
SV 1,00,000
2,73,21,450
PV of Cash Outflow 1,35,00,000
Additional Investment = ₹ 10,00,000 × 0.797 7,97,000 (1,42,97,000)
NPV 1,30,24,450
Recommendation: Accept the project in view of positive NPV.

Solution 66:
Workings:
(a) Calculation of annual cash flow (₹ in lakh)
Year Sales VC FC Dep. Profit Tax PAT Dep. Cash inflow
1 172.80 103.68 36 43.75 (10.63) - - 43.75 33.12
2 259.20 155.52 36 43.75 23.93 3.99* 19.94 43.75 63.69
3 624.00 374.40 36 43.75 169.85 50.955 118.895 43.75 162.645
4-5 648.00 388.80 36 48.25 174.95 52.485 122.465 48.25 170.715
6-8 432.00 259.20 36 48.25 88.55 26.565 61.985 48.25 110.235

(b) Calculation of Depreciation:

₹ 350 𝑙𝑎𝑘ℎ
● On initial equipment = 8 𝑦𝑒𝑎𝑟𝑠 = 43.75 lakh
(₹ 25 – 2.5 )𝑙𝑎𝑘ℎ
● On additional equipment = 5 𝑦𝑒𝑎𝑟𝑠
= 4.5 lakh

(c) *Calculation of tax in 2nd Year:

₹ in lakh
Profit for the year 23.93
Less: Set off of unabsorbed depreciation in 1st year (10.63)

Taxable profit 13.30

Tax @30% 3.99

(d) Calculation of Initial cash outflow

₹ in lakh
Cost of New Equipment 350
Add: Working Capital 40
Outflow 390

Calculation of NPV (₹ in lakh)

Year Cash flows PV factor @12% PV of cash- flows Remark

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0 (390) 1.000 (390.00) Initial equipment cost

1 33.12 0.893 29.57
2 63.69 0.797 50.76
3 162.645 0.712 115.80
3 (25.00) 0.712 (17.80) Additional equipment cost
4 170.715 0.636 108.57
5 170.715 0.567 96.79
6 110.235 0.507 55.89
7 110.235 0.452 49.83
8 110.235 0.404 44.53
8 40.00 0.404 16.16 Release of working capital
Net Present Value 160.10

Advise: Since the project has a positive NPV, therefore, it should be accepted.

Solution 67:
Project Investment Present value of Future Net Present value
Required Cash Flows
₹ ₹ ₹
1 2,00,000 2,90,000 90,000
2 1,15,000 1,85,000 70,000
3 2,70,000 4,00,000 1,30,000
1 and 2 3,15,000 4,75,000 1,60,000
1 and 3 4,40,000 6,90,000 2,50,000
2 and 3 3,85,000 6,20,000 2,35,000
1, 2 and 3 (Refer Working note) 6,80,000* 9,10,000 2,30,000

Working Note:
(i) Total Investment required if all the three projects are undertaken simultaneously:
(₹)
Project 1& 3 4,40,000
Project 2 1,15,000
Plant extension cost 1,25,000
Total 6,80,000
(ii) Total of Present value of Cash flows if all the three projects are undertaken simultaneously:
(₹)
Project 2& 3 6,20,000
Project 1 2,90,000
Total 9,10,000
Projects 1 and 3 should be chosen, as they provide the highest net present value.

Solution 68:
Since the life span of each machine is different and time span exceeds the useful lives of each modeI, we shall
use Equivalent Annual Cost method to decide which brand should be chosen.
(i) If machine is used for 20 years
(a) Residual value of machine of brand X
= [₹. 15,00,000 – (1 - 0.10)] - (₹. 15,00,000 × 0.06 × 14) = ₹. 90,000
(b) Residual value of machine of brand Y
= [₹. 10,00,000 – (1 - 0.40)] - (₹. 10,00,000 × 0.06 × 9) = ₹. 60,000

Present Value (PV) of cost if machine of brand X is purchased

Period Cash Outflow (₹.) PVF @ 12% PV (₹.)
0 15,00,000 1.000 15,00,000
1-5 50,000 3.605 1,80,250
6-10 70,000 2.046 1,43,220

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11-15 98,000 1.161 1,13,778

15 (90,000) 0.183 (16,470)
19,20,778
PVAF for 1-15 years = 6.812
₹. 19,20,778
Equivalent Annual Cost = 6.812 = ₹. 2,81,969.76
Present Value (PV) of cost if machine of brand Y is purchased
Period Cash Outflow (₹.) PVF @ 12% PV (₹.)
0 10,00,000 1.000 10,00,000
1-5 70,000 3.605 2,52,350
6-10 1,15,000 2.046 2,35,290
10 (60,000) 0.322 (19,320)
14,68,320
PVAF for 1-10 years = 5.651
₹. 14,68,320
Equivalent Annual Cost = 5.651
= ₹. 2,59,833.66
Present Value (PV) of cost if machine of brand Y is taken on rent
Period Cash Outflow (₹.) PVF @ 12% PV (₹.)
0 2,24,000 1.000 2,24,000
1-4 2,25,000 3.038 6,83,550
5-9 2,70,000 2.291 6,18,570
15,26,120
PVAF for 1-10 years = 5.651
₹. 15,26,120
Equivalent Annual Cost = 5.651 = ₹. 2,70,061.94
Decision: Since Equivalent Annual Cash Outflow is least in case of purchase of Machine of brand Y the same
should be purchased.
(ii) If machine is used for 5 years
a) Scrap value of machine of brand X
= [₹. 15,00,000 – (1 - 0.10)] - (₹. 15,00,000 × 0.06 × 4) = ₹. 9,90,000
b) Scrap value of machine of brand Y
= [₹. 10,00,000 – (1 - 0.40)] - (₹. 10,00,000 × 0.06 × 4) = ₹. 3,60,000
Present Value (PV) of cost if machine of brand X is purchased
Period Cash Outflow (₹.) PVF @ 12% PV (₹.)
0 15,00,000 1.000 15,00,000
1-5 50,000 3.605 1,80,250
5 (9,90,000) 0.567 (5,61,330)
11,18,920
Present Value (PV) of cost if machine of brand Y is purchased
Period Cash Outflow (₹.) PVF @ 12% PV (₹.)
0 10,00,000 1.000 10,00,000
1-5 70,000 3.605 2,52,350
5 (3,60,000) 0.567 (2,04,120)
10,48,230
Present Value (PV) of cost if machine of brand Y is taken on rent
Period Cash Outflow (₹.) PVF @ 12% PV (₹.)
0 2,24,000 1.000 2,24,000
1-4 2,25,000 3.038 6,83,550
5 1,10,000* 0.567 62,370
9,69,920
* [₹. 2,20,000 - (₹. 22,000 × 5) = ₹. 1,10,000]
Decision: Since Cash Outflow is least in case of rent of Machine of brand Y the same should be taken on rent.

Solution 69:
Calculation of Net Cash flows
Contribution = (₹ 6 – ₹ 3) x 1,00,000 units = ₹ 3,00,000
Fixed costs (excluding depreciation) = ₹ 1,00,000

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Year Capital (₹) Contribution (₹) Fixed costs (₹) Advertisement/ Net cash flow
Maintenance expenses (₹) (₹)
0 (2,50,000) (2,50,000)
1 3,00,000 (1,00,000) (20,000) 1,80,000
2 3,00,000 (1,00,000) 2,00,000
3 3,00,000 (1,00,000) 2,00,000
4 3,00,000 (1,00,000) 2,00,000
5 3,00,000 (1,00,000) (30,000) 1,70,000
6 3,00,000 (1,00,000) 2,00,000
7 3,00,000 (1,00,000) 2,00,000
8 3,00,000 (1,00,000) 2,00,000

Calculation of Net Present Value

Year Net cash flow (₹) 12% discount factor Present value (₹)
0 (2,50,000) 1.000 (2,50,000)
1 1,80,000 0.893 1,60,740
2 2,00,000 0.797 1,59,400
3 2,00,000 0.712 1,42,400
4 2,00,000 0.636 1,27,200
5 1,70,000 0.567 96,390
6 2,00,000 0.507 1,01,400
7 2,00,000 0.452 90,400
8 2,00,000 0.404 80,800
7,08,730
Advise: CK Ltd. should buy the new machine, as the net present value of the proposal is positive i.e ₹ 7,08,730.

Solution 71:
Statement showing ranking of projects on the basis of Profitability Index
Project Amount (₹) P.I. Rank
1 3,00,000 1.22 1
2 1,50,000 0.95 5
3 3,50,000 1.20 2
4 4,50,000 1.18 3
5 2,00,000 1.20 2
6 4,00,000 1.05 4
Assuming that projects are indivisible and there is no alternative use of the money allocated for capital
budgeting on the basis of P.I the S Ltd. is advised to undertake investment in projects 1, 3 and 5.
However, among the alternative projects the allocation should be made to the projects which add the most to
the shareholders wealth. The NPV method, by its definition, will always select such projects.

Statement showing NPV of the projects

Cash inflows of NPV of project
Project Amount (₹) P.I. Project (₹) (₹)
(i) (ii) (iii) (iv) = [(ii)× (iii)] (v) = [(iv) – (ii)]
1 3,00,000 1.22 3,66,000 66,000
2 1,50,000 0.95 1,42,500 (-) 7,500
3 3,50,000 1.20 4,20,000 70,000
4 4,50,000 1.18 5,31,000 81,000
5 2,00,000 1.20 2,40,000 40,000
6 4,00,000 1.05 4,20,000 20,000
The allocation of funds to the projects 1, 3 and 5 (as selected above on the basis of P.I.) will give N.P.V. of ₹
1,76,000 and ₹ 1,50,000 will remain unspent.
However, the N.P.V. of the projects 3, 4 and 5 is ₹1,91,000 which is more than the N.P.V. of projects 1, 3 and 5.
Further, by undertaking projects 3, 4 and 5 no money will remain unspent. Therefore, S Ltd. is advised to
undertake investments in projects 3, 4 and 5.

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Solution 72:
Computation of NPV of optimum project mix (In ₹)
Projects Initial Investment NPV
4 13,00,000 7,00,000
3 7,00,000 4,40,000
1 8,00,000 2,00,000
Uninvested 2,00,000 (17,313)
30,00,000 13,22,687
Working Notes:
Computation of NPV in various projects (In ₹)
Projects NPV
1 10,00,000 – 8,00,000 = 2,00,000
2 19,00,000 – 15,00,000 = 4,00,000
3 11,40,000 – 7,00,000 = 4,40,000
4 20,00,000 – 13,00,000 = 7,00,000

Computation of NPV ofUninvested Amount(In ₹)

Particulars Time P.V. Factor Amount P.V.
Cash Outflows: 0 1 2,00,000 2,00,000
P.V. of Cash Outflows 2,00,000
(2,00,000 ×
Cash Inflows: 5 0.567 1.611) 3,22,200 1,82,687
P.V.C.I 1,82,687
NPV (17,313)

Solution 73:
Computation of NPVs per Re. 1 of Investment and Ranking of the Projects
Investment (₹ NPV @ 15% (₹ NPV per ₹
Project '000) '000) 1invested Ranking
A (50) 15.4 0.31 5
B (40) 18.7 0.47 2
C (25) 10.1 0.40 3
D (30) 11.2 0.37 4
E (35) 19.3 0.55 1

Building up of a Programme of Projects based on their Rankings

Project Investment (₹ '000) NPV @ 15% (₹ '000)
E (35) 19.3
B (40) 18.7
C (25) 10.1
(2/3 of project
D (20) 7.5 total)
120 55.6
Thus project A should be rejected and only two-third of Project D is undertaken.
If the projects are not divisible then other combinations can be examined as:
Investment(₹'000) NPV @ 15%(₹ '000)
E+B+C 100 48.1
E+B+D 105 49.2
In this case E + B + D would be preferable as it provides a higher NPV despite D ranking lower than C.

Solution 74:
Option I: Cost of travel, in case Video Conferencing facility is not provided
Total Trip = No. of Locations × No. of Persons × No. of Trips per Person = 7×2×2 = 28 Trips
Total Travel Cost (including air fare, hotel accommodation and meals) (28 trips × ₹ 27,000 per trip)
= ₹ 7,56,000

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Option II: Video Conferencing Facility is provided by Installation of Own Equipment at Different Locations
Cost of Equipment at each location (₹ 8,25,000 × 8 locations) = ₹ 66,00,000
Economic life of Machines (5 years). Annual depreciation (66,00,000/5) = ₹ 13,20,000
Annual transmission cost (48 hrs. transmission × 8 locations × ₹ 300 per hour) = ₹ 1,15,200
Annual cost of operation (13,20,000 + 1,15,200) = ₹ 14,35,200

Option III: Engaging Video Conferencing Facility on Rental Basis

Rental cost (48 hrs. × 8 location × ₹ 1,500 per hr) = ₹ 5,76,000 Telephone cost (48 hrs.× 8 locations × ₹ 400 per
hr.) = ₹ 1,53,600
Total rental cost of equipment (5,76,000 + 1,53,600) = ₹ 7,29,600

Analysis: The annual cash outflow is minimum, if video conferencing facility is engaged on rental basis.
Therefore, Option III is suggested.

Solution 75:
Net Present Value (NPV) of Projects:
Year Cash Inflows Cash Inflows Present Value PV of Project PV of Project
Project A (₹) Project B (₹) Factor @ 10% A (₹) B (₹)
0 (1,00,000) (3,00,000) 1.000 (1,00,000) (3,00,000)
1 50,000 1,40,000 0.909 45,450 1,27,260
2 60,000 1,90,000 0.826 49,560 1,56,940
3 40,000 1,00,000 0.751 30,040 75,100
25,050 59,300
Internal Rate of Returns (IRR) of projects:
Since by discounting cash flows at 10% we are getting values very far from zero. Therefore, let us discount
cash flows using 20% discounting rate.
Year Cash Inflows Cash Inflows Present Value PV of Project A PV of Project B
Project A (₹) Project B (₹) Factor @ 20% (₹) (₹)
0 (1,00,000) (3,00,000) 1.000 (1,00,000) (3,00,000)
1 50,000 1,40,000 0.833 41,650 1,16,620
2 60,000 1,90,000 0.694 41,640 1,31,860
3 40,000 1,00,000 0.579 23,160 57,900
6,450 6,380
Since by discounting cash flows at 20% we are getting values far from zero. Therefore, let us discount cash
flows using 25% discounting rate.
Year Cash Inflows Cash Inflows Present Value PV of Project A PV of Project B
Project A (₹) Project B (₹) Factor @25% (₹) (₹)
0 (1,00,000) (3,00,000) 1.000 (1,00,000) (3,00,000)
1 50,000 1,40,000 0.800 40,000 1,12,000
2 60,000 1,90,000 0.640 38,400 1,21,600
3 40,000 1,00,000 0.512 20,480 51,200
(1,120) (15,200)
The internal rate of return is, thus, more than 20% but less than 25%. The exact rate can be obtained by
interpolation:
6,450 6,450
IRRA = 20% + 6,450 – (1,120) x (25% - 20%) = 20% + 7,570 x 5% = 24.26%
6,380 6,380
IRRB = 20% + 6,380 6,380 – (15,200)
x (25% - 20%) = 20% + 21,580
x 5% = 21.48%
Overall Position
Project A Project B
NPV @ 10% 25,050 59,300
IRR 24.26% 21.48%
Thus there is contradiction in ranking by two methods.

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Solution 2:
Since r > Ke , the optimum dividend pay-out ratio would ‘Zero’ (i.e. D = 0),
Accordingly, value of a share:
𝑟
𝐷+ 𝐾𝑒
(𝐸 − 𝐷)
P = 𝐾𝑒

0.12
0+ (10 − 0)
P = 0.10
0.10
= ₹ 120

The optimality of the above payout ratio can be proved by using 25%, 50%, 75% and 100% as pay- out
ratio:
At 25% pay-out ratio
0.12
2.5 + (10 − 2.5)
P = 0.10
0.10
= ₹ 115

At 50% pay-out ratio

0.12
5+ (10 − 5)
P = 0.10
0.10
= ₹ 110

At 75% pay-out ratio

0.12
7.5 + (10 − 7.5)
P = 0.10
0.10
= ₹ 105

At 100% pay-out ratio

0.12
10 + (10 − 10)
P = 0.10
0.10
= ₹ 100

Solution 3:
₹ in lakhs
Net Profit 30
Less: Preference dividend 12
Earning for equity shareholders 18
Therefore earning per share 18/3 = ₹ 6

Let, the dividend per share be D to get share price of ₹42

𝑟
𝐷+ 𝐾𝑒
(𝐸 − 𝐷)
P = 𝐾𝑒

0.20
𝐷+ (6 − 𝐷)
₹ 42 = 0.16
0.16

0.16𝐷 +1.2−0.20𝐷
6.72 = 0.16

0.04D = 1.2 – 1.0752

D = 3.12

𝐷𝑃𝑆 3.12
D/P ratio = 𝐸𝑃𝑆
x 100 = 6
x 100 = 52%

So, the required dividend payout ratio will be = 52%

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Solution 4:
₹ in lakhs
Net Profit 30
Less: Preference dividend 12
Earning for equity shareholders 18
Therefore earning per share 18/3 = ₹ 6.00

Price per share according to Gordon’s Model is calculated as follows:

𝐸1(1−𝑏)
P0 = 𝐾𝑒 −𝑏𝑟

Here, E1 = 6, Ke =

(i) When dividend pay-out is 25%

6×0.25 1.5
P0 = 0.16−(0.75×0.2)
= 0.16 − 0.15
= 150

(ii) When dividend pay-out is 50%

6×0.5 3
P0 = 0.16−(0.5×0.2)
= 0.16 − 0.10
= 50

(iii) When dividend pay-out is 100%

6×1 6
P0 = 0.16−(0 × 0.2)
= 0.16
= 37.50

Solution 5:
𝐷 5
P0 = 𝐾𝑒
= 0.10
= ₹ 50

Solution 6:
𝐷0 (1+𝑔)
P0 = 𝐾𝑒 −𝑔

D0 = 10 × 20% = ₹2
g = 2% or 0.02
Ke = 15% or 0.15
2(1+0.02)
P = 0.15−0.02 = ₹ 15.69

Solution 7:
In the present situation, the current MPS is as follows:
𝐷0 (1+𝑔)
P0 = 𝐾𝑒 −𝑔

2(1+0.05)
P = 0.15−0.05
= ₹ 21

(i) The impact of changes in growth rate to 8% on MPS will be as follows:

2(1+0.08)
P = 0.15−0.08 = ₹ 30.86

(ii) The impact of changes in growth rate to 3% on MPS will be as follows:

2(1+0.03)
P = 0.15−0.03 = ₹ 17.17

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

So, the market price of the share is expected to vary in response to change in expected growth rate is
dividends.

Solution 8:
𝐸
Price per share (P) = m (D + 3
)

30
P = 2 (30 x 0.6 + 3
)

P = 2(18 + 10) = ₹ 56

Solution 9:
𝐸
Price per share (P) = m (D + 3
)
𝐸
₹ 58.33 = 7 (5 + 3
)
105 + 7E = 175
Or, 7E = 175 -105 = ₹10
Therefore, EPS = ₹10

Solution 10:
D₁ = Dₒ + [(EPS ×Target payout) - Dₒ] × Af
D₁ = 9.80 + [(20 × 60%) – 9.80] × 0.45
D₁ = 9.80 + 0.99 = ₹10.79

Solution 11:
Given,
Cost of Equity (Ke) 12%
Number of shares in the beginning (n) 10,000
Current Market Price (P0) ₹ 100
Net Profit (E) ₹ 5,00,000
Expected Dividend ₹ 10 per share
Investment (I) ₹ 10,00,000

Computation of market price per share, when:

(i) No dividend is declared:

𝑃1 + 𝐷1
P0 = 1 + 𝐾𝑒

𝑃1+0
100 = 1+ 0.12

P1 = 112 – 0 = ₹112

(ii) Dividend is declared:

𝑃1+ 10
100 = 1+ 0.12

P1 = 112 – 10 = ₹102

(iii) Calculation of funds required for investment

Earning 5,00,000
Dividend distributed 1,00,000
Fund available for investment 4,00,000
Total Investment 10,00,000
Balance Funds required 10,00,000 - 4,00,000 = ₹ 6,00,000

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

𝐹𝑢𝑛𝑑𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑
No. of shares = 𝑃𝑟𝑖𝑐𝑒 𝑎𝑡 𝑒𝑛𝑑(𝑃1)

6,00,000
∆n = 102
= 5882.35 or 5883 shares

Solution 12:
(i) Walter’s model is given by
𝑟
𝐷+ 𝐾𝑒
(𝐸 − 𝐷)
P = 𝐾𝑒

Where
P = Market price per share.
E = Earnings per share = ₹ 5
D = Dividend per share = ₹ 3
R = Return earned on investment = 15%
Ke = Cost of equity capital = 12%
0.15
3+ (5 − 3)
P = 0.12
0.12
= ₹ 45.83

(ii) According to Walter’s model when the return on investment is more than the cost of equity capital, the price
per share increases as the dividend pay-out ratio decreases. Hence, the optimum dividend pay-out ratio in this
case is nil. So, at a pay-out ratio of zero, the market value of the company’s share will be:
0.15
0+ (5 − 0)
P = 0.12
0.12
= ₹ 52.08

Solution 13:
𝐸1 (1−𝑏)
P0 = 𝐾𝑒 −𝑏𝑟

(i) Situation-1: Growth Firm r > Ke

10(1−0.06) 4
P0 = 0.10−0.15 𝑥 0.6 = 0.10−0.09 = ₹ 400

(ii) Situation-2: Normal Firm r = Ke

10(1−0.06) 4
P0 = 0.10−0.10 𝑥 0.6 = 0.10−0.06 = ₹ 100

(iii) Situation-3: Normal Firm r < Ke

10(1−0.06) 4
P0 = 0.10−0.08 𝑥 0.6 = 0.10−0.048 = ₹ 76.92

If the retention ratio (b) is changed from 0.6 to 0.4, the new share price will be as follows:
Growth Firm
10(1−0.4) 6
P0 = 0.10−0.15 𝑥 0.4 = 0.10−0.06 = ₹ 150

Normal Firm
10(1−0.4) 6
P0 = 0.10−0.10 𝑥 0.4 = 0.10−0.04
= ₹ 100

Declining Firm
10(1−0.4) 6
P0 = 0.10−0.08 𝑥 0.4 = 0.10−0.032
= ₹ 88.24

From the above analysis it can be concluded that.

When r > k, the market value increases with retention ratio.
When r < k, the market value of share stands to decrease.
When r = k, the market value is not affected by dividend policy.
The conclusion of the Gordon’s model is similar to that of Walter’s model.

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Solution 14:
Given,
Cost of Equity (Ke) 10%
Number of shares in the beginning (n) 25,000
Current Market Price (P0) ₹ 100
Net Profit (E) ₹ 2,50,000
Expected Dividend ₹ 5 per share
Investment (I) ₹ 5,00,000

Case 1 - When dividends are paid Case 2 - When dividends are not paid
Step 1 Step 1
𝑃1 + 𝐷1 𝑃1 + 𝐷1
P0 = 1 + 𝐾𝑒
P0 = 1 + 𝐾𝑒

𝑃1 + 5 𝑃1 + 0
100 = 1 + 0.10
100 = 1 + 0.10

P1 = 110 - 5 = 105 P1 = 110 - 0 = 110

Step 2 Step 2
No. of shares required to be issued for No. of shares required to be issued for balance
balance fund fund

𝐹𝑢𝑛𝑑𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝐹𝑢𝑛𝑑𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑

No. of shares = 𝑃𝑟𝑖𝑐𝑒 𝑎𝑡 𝑒𝑛𝑑(𝑃1)
No. of shares = 𝑃𝑟𝑖𝑐𝑒 𝑎𝑡 𝑒𝑛𝑑(𝑃1)

3,75,000 2,50,000
∆n = 105
= 3,571.4285 ∆n = 110
= 2,272.73
Step 3: Step 3:

Calculation of value of firm Calculation of value of firm

(𝑛 + ∆𝑛)𝑃1− 𝐼+𝐸 (𝑛 + ∆𝑛)𝑃1− 𝐼+𝐸

Vf = (1 + 𝐾𝑒)
Vf = (1 + 𝐾𝑒)

Vf =
(25,000 + 3,75,000
105 )105 −5,00,000 + 2,50,000 Vf =
(25,000 + 2,50,000
110 )110 −5,00,000 + 2,50,000
(1 + 0.10) (1 + 0.10)

= ₹ 25,00,000 = ₹ 25,00,000

Solution 15:
(i) The EPS of the firm is ₹ 10 (i.e., ₹ 2,00,000/ 20,000). r = 2,00,000/ (20,000 shares × ₹100) = 10%. The P/E
Ratio is given at 12.5 and the cost of capital, Ke, may be taken at the inverse of P/E ratio. Therefore, Ke is 8
(i.e., 1/12.5). The firm is distributing total dividends of ₹ 1,50,000 among 20,000 shares, giving a dividend per
share of ₹ 7.50. the value of the share as per Walter’s model may be found as follows:
𝑟 0.1
𝐷+ 𝐾𝑒
(𝐸 − 𝐷) 7.5 + (10 − 7.5)
P = 𝐾𝑒
= 0.08
0.08
= ₹ 132.81

The firm has a dividend payout of 75% (i.e., ₹ 1,50,000) out of total earnings of ₹ 2,00,000. since, the rate of
return of the firm, r, is 10% and it is more than the Ke of 8%, therefore, by distributing 75% of earnings, the firm
is not following an optimal dividend policy. The optimal dividend policy for the firm would be to pay zero
dividend and in such a situation, the market price would be:
0.1
0+ (10 − 0)
0.08
0.08
= ₹ 156.25

So, theoretically the market price of the share can be increased by adopting a zero payout.

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

(ii) The P/E ratio at which the dividend policy will have no effect on the value of the share is such at which the
Ke would be equal to the rate of return, r, of the firm. The Ke would be 10% (= r) at the P/E ratio of 10.
Therefore, at the P/E ratio of 10, the dividend policy would have no effect on the value of the share.

(iii) If the P/E is 8 instead of 12.5, then the Ke which is the inverse of P/E ratio, would be 12.5 and in such a
situation ke > r and the market price, as per Walter’s model would be:
𝑟 0.1
𝐷+ 𝐾𝑒
(𝐸 − 𝐷) 7.5 + (10 − 7.5)
P = 𝐾𝑒
= 0.125
0.125
= ₹ 76

Solution 16:
Market price per share by
(i) Walter’s model:
𝑟 0.25
𝐷+ 𝐾𝑒
(𝐸 − 𝐷) 6+ (10 − 6)
P = 𝐾𝑒
= 0.20
0.20
= ₹ 55

(ii) Gordon’s model (Dividend Growth model): When the growth is incorporated in earnings and dividend, the
present value of market price per share (Po) is determined as follows:
Gordon’s theory:
𝐸 (1−𝑏)
Present market price per share (Po ) = P0 = 𝐾 −𝑏𝑟
Where,
Po = Present market price per share.
E = Earnings per share
b = Retention ratio (i.e. % of earnings retained)
r = Internal rate of return (IRR)

Growth rate (g) = br

10(1−0.4) 6
P0 = 0.20−(0.4 𝑥 0.25) = ₹ 0.1
= ₹ 60

Solution 17:
The P/E ratio i.e. price earnings ratio can be computed with the help of the following formula:

𝑀𝑃𝑆
P/E ratio = 𝐸𝑃𝑆

Since the D/P ratio is 40%,

D = 40% of E i.e. 0.4E
Hence,
Market price per share (P) using Graham & Dodd’s model =

𝐸
P0 = m (D + 3
)

Where,
P0 = Market price per share
D = Dividend per share
E = Earnings per share
m = a multiplier

𝐸
P0 = 9 (0.4E + 3
)

1.2 𝐸 + 𝐸
P0 = 9 ( 3
) = 3(2.2E)

P0 = 6.6E
𝑃
𝐸
= 6.6 i.e. P/E ratio is 6.6 times

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Solution 18:
Market Price (P) per share as per Walter’s Model is:
𝑟
𝐷+ 𝐾𝑒
(𝐸 − 𝐷)
P = 𝐾𝑒

Where,
P = Price of Share
r = Return on investment or rate of earning
Ke = Rate of Capitalization or Cost of Equity
Calculation of Market Price (P) under the following dividend payout ratio and earning rates:
(i) (ii) (iii)
Rate of Earning DP ratio 50% DP ratio 75% DP ratio 100%
(r)
(a) 15% 0.15
5 + 0.10 (10 − 5)
0.15
7.5 + 0.10 (10 − 7.5)
0.15
10 + 0.10 (10 − 10)
0.10 0.10 0.10

12.5 11.25 10
= 0.10
= ₹ 125 = 0.10
= ₹ 112.5 = 0.10
= ₹ 100
(b) 10% 5+
0.10
0.10
(10 − 5) 7.5 +
0.10
0.10
(10 − 7.5) 10 +
0.10
0.10
(10 − 10)
0.10 0.10 0.10

10 10 10
= 0.10
= ₹ 100 = 0.10
= ₹ 100 = 0.10
= ₹ 100
(c) 5% 5+
0.05
0.10
(10 − 5) 7.5 +
0.05
0.10
(10 − 7.5) 10 +
0.05
0.10
(10 − 10)
0.10 0.10 0.10

7.5 8.75 10
= 0.10
= ₹ 75 = 0.10
= ₹ 87.5 = 0.10
= ₹ 100

Solution 19:
₹ 40 𝑙𝑎𝑘ℎ𝑠
Earnings Per share(E) = 4,00,000
= ₹ 10

Calculation of Market price per share by

𝑟
𝐷+ 𝐾𝑒
(𝐸 − 𝐷)
(i) Walter’s formula: Market Price (P) = 𝐾𝑒

Where,
P = Market Price of the share.
E = Earnings per share.
D = Dividend per share.
Ke = Cost of equity/ rate of capitalization/ discount rate.
R = Internal rate of return/ return on investment
0.20
4+ (10 − 4)
P = 0.16
0.16

4 + 7.5
= 0.16
= ₹ 71.88

(ii) Gordon’s formula: When the growth is incorporated in earnings and dividend, the present value of market
price per share (Po) is determined as follows
𝐸 (1−𝑏)
Gordon’s theory = P0 = 𝑘 −𝑏𝑟
Where,
P0 = Present market price per share.
E = Earnings per share
b = Retention ratio (i.e. % of earnings retained)
r = Internal rate of return (IRR)
Growth rate (g) = br

10 (1−0.60) 4
Now, P0 = 16 −(0.60 𝑥 0.20)
= ₹ 0.04
= ₹ 100

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Solution 22:
Do= ₹ 4
D1= ₹4 (1.20)1 = ₹ 4.80
D2= ₹4 (1.20)2 = ₹ 5.76
D3= ₹4 (1.20)2 (1.10) 1 = ₹ 6.336

𝐷1 𝐷2 𝑃2
P0 = 1 + 2 + 2
(1+𝐾𝑒) (1+𝐾𝑒) (1+𝐾𝑒)

𝐷3 ₹ 6.336
P2 = 𝐾𝑒−𝑔
= 0.15−0.10
= ₹ 126.72

₹ 4.80 ₹ 5.76 ₹ 126.72

P0 = 1 + 2 + 2
(1+0.15) (1+0.15) (1+0.15)

= (₹ 4.80 x 0.8696) + (₹ 5.76 x 0.7561) + (₹ 126.72 x 0.7561) = ₹ 104.34

Solution 23:
Computation of Present value of Equity Shares
Particulars Time PVF Amount in PV in ₹
₹
Amount of dividends receivable during 1 0.917 2.30 2.11
abnormal growth period 2 0.842 2.65 2.23
3 0.772 3.04 2.35
4 0.708 3.35 2.37
5 0.650 3.68 2.39
6 0.596 4.05 2.41
Amount of Market Price at the end of 6 0.596 106.25 63.33
abnormal growth period
= ₹ 4.04 (1.05) / 0.09 – 0.05 = ₹ 106.25
Present Value of Share 77.19

Solution 24:
Stage 1:
Explicit Forecast Period (first 4 years)
Time PVF @ 16% Dividend PV
1 0.862 1.68 1.45
2 0.743 1.88 1.40
3 0.641 2.07 1.33
4 0.552 2.28 1.26
5.44

Stage 2:
Horizon Period (Beyond 4 years)
Expected dividend for the fifth year
D5 = 2.28 x 1.08 = 2.46

Horizon Price i.e.

P4 = D5 / (Re – g) = 2.46 / (0.16 – 0.08) = 30.75

PV of P4 = 30.75 x 0.552 = 16.97

Intrinsic Value of share today = Stage I + Stage II

= 5.44 + 16.97
= ₹ 22.41

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Solution 25.
Po = Rs 120
E = Rs 12
D = Rs 6
Compute P/E Ratio. Also compute multiplier as per traditional theory.
P = M (D + E/3)
120 = M (6 + 12/3)
120 = M (30/3)
12 = M

Solution 26:
P/E Ratio = 10
Ke = 1 / P/E Ratio = 1/10 = 10%
Equity Shares = 50,000
Dividend = ₹ 8

(i) Value of shares:

a) If Dividend is not declared:
P1 = P0 (1 + Ke) – D = ₹ 100 (1 + 0.10) – 0 = ₹ 100 (1.10) = ₹ 110

b) If Dividend is declared:
P1 = P0 (1 + Ke) – D = ₹ 100 (1 + 0.10) – ₹8 = ₹ 110 – ₹8 = ₹ 102

(ii) Computation of No. of Shares:

Particulars Amount (₹)
Net Income 5,00,000
Less: Dividend (50,000 x 8) (4,00,000)
1,00,000
Add: issue of Share 9,00,000
Fresh Investment 10,00,000

No. of shares = ₹ 9,00,000 / ₹ 102 = 8,823.5294

Solution 27:
(a)
₹ in lakhs
Net Profit 75
Less: Preference dividend 30
Earning for equity shareholders 45
Earning per share = 45/7.5 = ₹ 6.00
Let, the dividend per share be D to get share price of ₹ 42
𝑟
𝐷+ (𝐸−𝐷)
P= 𝐾𝑒
𝐾𝑒
0.20
𝐷+ 0.16 (6−𝐷)
₹42= 0.16

0.16 𝐷+ 1.2 − 0.20𝐷

6.72 = 0.16

0.04D = 1.2 – 1.0752

D = 3.12
𝐷𝑃𝑆 3.12
D/P ratio = 𝐸𝑃𝑆 ×100 = 6
×100 = 52%

So, the required dividend payout ratio will be = 52%

(b) Since r > Ke, the optimum dividend pay-out ratio would ‘Zero’ (i.e. D = 0),

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Accordingly, value of a share:

𝑟
𝐷+ 𝐾𝑒 (𝐸−𝐷)
P= 𝐾𝑒
0.20
0+ 0.16 (6−0)
P = 0.16
= ₹ 46.875

(c) The optimality of the above pay-out ratio can be proved by using 25%, 50%, 75% and
100% as pay- out ratio:
At 25% pay-out ratio
0.20
1.5+ (6−1.5)
P= 0.16
0.16
= ₹44. 531
At 50% pay-out ratio
0.20
3+ (6−3)
P= 0.16
0.16
= ₹42. 188
At 75% pay-out ratio
0.20
4.5+ (6−4.5)
P= 0.16
0.16
= ₹39. 844
At 100% pay-out ratio
0.20
6+ (6−6)
P= 0.16
0.16
= ₹ 37.50
From the above it can be seen that price of share is maximum when dividend pay-out
ratio is ‘zero’ as determined in (b) above.

Solution 28:
P0 = ₹ 10 n = 2,00,000, E = ₹ 5,00,000 Ke = 15%, ∆n = 26,089, I = ?
𝑃1
Po= 1+𝐾𝑒
𝑃1
10= 1.15
P1= 11.5
𝐼−𝐸 + 𝑛𝐷1
∆𝑛=𝑃1
1−5,00,000
26.089= 11.5
I = 8,00,024
Now,
P0 = ₹ 10, n = ₹ 2,00,000,
E = ₹ 5,00,000, I = 8,00,024,
Ke = 15%, ∆n 47,619, D1 = ?
𝑃1+𝐷1
Po= 1+𝐾𝑒
𝑃1+𝐷1
10= 1.15
P1= 11.5-D1
𝐼−𝐸 + 𝑛𝐷1
∆𝑛 = 𝑃1
8,00,024−5,00,000+2,00,000𝐷1
47.619= 𝑃1
47,619 P1 = 2,00,000 D1+ 3,00,024
From 1,

47619 (11.5 – D1) = 2,00,000 D1 + 3,00,024

5,47,618.5 – 47,619D1 = 2,00,000D1 + 3,00,024

2,47,594.5 = 2,00,000D1 + 47,619 D1

2,47,594.5 = 2,47,619 D1
2,47,594.5
D1 = 2,47,619 = 0.99 =1

P1 = 11.5 – D1

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

P1 = 11.5 – 1
P1 = 10.5
(2,00,000+47,619)(10.5)−8,00,024 +5,00,000
[Link] = 1.15
n.P0 = ₹19,99,979 » ₹20,00,000
Using direct calculation,
n.P0 = 2,00,000 ×10 = ₹ 20,00,000

Solution 29:
CASE 1: Value of the firm when dividends are not paid.
Step 1: Calculate price at the end of the period
Ke = 15%, P₀ = ₹100, D₁ = 0
𝑃1+𝐷1
Pₒ = 1+𝐾𝑒
𝑃1+0
₹100 = 1+0.15
P₁ = ₹115
Step 2: Calculation of funds required for investment
Earning ₹ 40,00,000
Dividend distributed Nil
Fund available for investment ₹ 40,00,000
Total Investment ₹ 50,00,000
Balance Funds required ₹ 50,00,000 - ₹ 40,00,000 = ₹
10,00,000
Step 3: Calculation of No. of shares required to be issued for balance funds
No. of shares = Funds required/P1
∆n = ₹10,00,000/₹115
Step 4: Calculation of value of firm
nPₒ = [(n+∆n)P1-I+E]/(1+Ke)
nP₀ = [(100000+1000000/₹115) ₹115 - ₹5000000 + ₹4000000]/(1.15)
= ₹1,00,00,000
CASE 2: Value of the firm when dividends are paid.
Step 1: Calculate price at the end of the period
Ke= 15%, P₀= ₹100, D₁= ₹10

𝑃1+𝐷1
Pₒ = 1+𝐾𝑒
𝑃1+10
₹100 = 1+0.15
P₁ = ₹105
Step 2: Calculation of funds required for investment
Earning ₹ 40,00,000
Dividend distributed 10,00,000
Fund available for investment ₹ 30,00,000
Total Investment ₹ 50,00,000
Balance Funds required ₹ 50,00,000 - ₹ 30,00,000 = ₹ 20,00,000
Step 3: Calculation of No. of shares required to be issued for balance fund
No. of shares = Funds Required/P1
∆n = ₹2000000/₹105
Step 4: Calculation of value of firm
nPₒ = [(n+∆n)P1 – I+E]/(1+Ke)
nP₀ = [(100000 + 2000000/₹105) ₹105 – ₹5000000 + ₹4000000]/(1.15)= ₹1,00,00,000
Thus, it can be seen from the above calculations that the value of the firm remains the same in either case.

Solution 30:
Price per share according to Gordon’s Model is calculated as follows:
Particulars Amount in ₹
Net Profit 78 lakhs
Less:Preference dividend(120 lakhs@15%) 18 lakhs
Earnings for equity shareholders 60 lakhs

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Earnings Per Share 60 lakhs/6 lakhs = ₹

10.00
Price per share according to Gordon’s Model is calculated as follows:
𝐸1(1−𝑏)
P0 = 𝐾𝑒 − 𝑏𝑟
Here, E1 = 10, Ke = 16%
(i) When dividend pay-out is 30%
10×0.30 3
Po = 0.16−(0.70×0.2) = 0.16−0.14 = ₹150
(ii) When dividend pay-out is 50%
10×0.5 5
P0 = 0.16−(0.5×0.2) = 0.16−0.10 = ₹83.33
(iii) When dividend pay-out is 100%
10×1 10
P0 = 0.16−(0×0.2) = 0.16 =₹ 62.5

Solution 31:
(i) As per Gordon’s Model, Price per share is computed using the formula:
𝐸1(1−𝑏)
P0 = 𝐾𝑒−𝑏𝑟
Where,
P0 = Price per share
E1 = Earnings per share
b = Retention ratio; (1 - b = Pay-out ratio)
Ke = Cost of capital r = IRR
br = Growth rate (g)
Applying the above formula, price per share
30×0.3* 9
P0 = 0.15−0.70×0.2 = 0.01 = ₹ 900
9
*Dividend pay-out ratio = ₹30 = 0.3 or 30%

(ii) As per Walter’s Model, Price per share is computed using the formula:
𝑟
𝐷+ 𝐾𝑒 (𝐸−𝐷)
Price (P) = 𝐾𝑒
Where,
P = Market Price of the share
E = Earnings per share
D = Dividend per share
Ke = Cost of equity/ rate of capitalization/ discount rate
r = Internal rate of return/ return on investment
Applying the above formula, price per share
0.20
𝑔+ 0.15 (30−9) 37
P= 0.15
= 0.15
= ₹246.67

Solution 32:
The Present Value of the Cash Flows for all the years by discounting the cash flow at 7% is calculated as
below:
Year Cash flows Discounting Present value of Cash
₹In lakhs Factor@7% Flows ₹ In Lakhs
1 50 0.935 46.75
2 120 0.873 104.76
3 150 0.816 122.40
4 160 0.763 122.08
5 130 0.713 92.69
Total of present value of Cash flow 488.68
Less: Initial investment (200.00)
Net Present Value (NPV) 288.68
Now, the risk-free rate is 7 % and the risk premium expected by the Management is 7 %. So, the risk adjusted
discount rate is 7 % + 7 % =14%.
Discounting the above cash flows using the Risk Adjusted Discount Rate would be as below:

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

Year Cash flows Discounting Present Value of Cash Flows

₹ in Lakhs Factor@14% ₹ in lakhs
1 50 0.877 43.85
2 120 0.769 92.28
3 150 0.675 101.25
4 160 0.592 94.72
5 130 0.519 67.47
Total of present value of Cash flow 399.57
Initial investment (200.00)
Net present value (NPV) 199.79

Solution 33:
(i) Current Market price of shares (applying Walter’s Model)
● The EPS of the firm is ₹ 5 (i.e., ₹ 10,00,000 / 2,00,000).
● Rate of return on Investment (r) = 20%.
● The Price Earnings (P/E) Ratio is given as 10, so capitalization rate (Ke), may be taken at
the inverse of P/E Ratio. Therefore, Ke is 10% or .10 (i.e., 1/10).
● The firm is distributing total dividends of ₹ 6,00,000 among 2,00,000 shares, giving a
dividend per share of ₹ 3.
The value of the share as per Walter’s model may be found as follows: Walter’s model is given by-
𝑟
𝐷+ 𝐾𝑒 (𝐸−𝐷)
P= 𝐾𝑒
Where,
P = Market price per share.
E = Earnings per share = ₹ 5
D = Dividend per share = ₹ 3
R = Return earned on investment = 20 %
Ke = Cost of equity capital = 10% or .10
0.20
3+ 0.10 (5−3)
P= 0.10
= ₹ 70
Current Market Price of shares can also be calculated as follows:
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒
Price Earnings (P/E) Ratio = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒𝑠
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
Or, 10 = ₹ 10,00,000 / 2,00,000
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
Or , 10 = ₹5
Market Price of Share = ₹ 50
(ii) Capitalization rate (Ke) of its risk class is 10% or .10 (i.e., 1/10).
(iii) Optimum dividend pay-out ratio
According to Walter’s model when the return on investment is more than the cost of equity capital (10%), the
price per share increases as the dividend pay-out ratio decreases. Hence, the optimum dividend pay-out ratio
in this case is nil or 0 (zero).
(iv) Market price per share at optimum dividend pay-out ratio
At a pay-out ratio of zero, the market value of the company’s share will be:
0 + 0.20 (5 – 0)
0.20
0+ 0.10 (5−0)
P= 0.10
= ₹ 100

Solution 34:
(i) Calculation of market price per share
According to Miller – Modigliani (MM) Approach:
𝑃1 + 𝐷1
Po = 1 + 𝐾𝑒
Where,
Existing market price (Po) = ₹ 150
Expected dividend per share (D1) = ₹ 8
Capitalization rate (ke) = 0.10
Market price at year end (P1) = to be determined
(a) If expected dividends are declared, then

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

𝑃1 + ₹ 8
₹ 150 = 1 + 0.10
P1 = ₹ 157
(b) If expected dividends are not declared, then
𝑃1 + 0
₹ 150 = 1 + 0.10
P1 = ₹ 165
(ii) Calculation of number of shares to be issued
(a) (b)
Dividends are declared Dividends are not
(₹ lakh) Declared (₹ lakh)
Net income 300 300
Total dividends (80) -
Retained earnings 220 300
Investment budget 600 600
Amount to be raised by new issues 380 300
Relevant market price (₹ per share) 157 165
No. of new shares to be issued (in 2.42 1.82
lakh) (₹ 380 ÷ 157; ₹ 300 ÷ 165)
(iii) Calculation of market value of the shares
(a) (b)
Dividends are declared Dividends are not Declared
Existing shares (in lakhs) 10.00 10.00
New shares (in lakhs) 2.42 1.82
Total shares (in lakhs) 12.42 11.82
Market price per share (₹) 157 165
Total market value of shares at the 12.42 × 157 11.82 × 165
end of the year (₹ in lakh) = 1,950 (approx.) = 1,950 (approx.)
Hence, it is proved that the total market value of shares remains unchanged irrespective of whether dividends
are declared, or not declared.

Solution 35:
Given,
Cost of Equity 12%
Number of shares in the beginning (n) 40,000
Current Market Price (Po) ₹ 200
Net profit (E) ₹ 5,00,000
Expected dividend (D1) ₹ 10 per share
Investment (I) ₹ 10,00,000

Situation 1 Situation 2
𝑃1 + 𝐷1 𝑃1 + 𝐷1
(i) Po = 1 + 𝐾𝑒 (i) Po = 1 + 𝐾𝑒
𝑃1 + 10 𝑃1 + 0
200 = 1 + 0.12 200 = 1 + 0.12
P1 + 10 = 200 x 1.12 P1 + 0 = 200 x 1.12
P1 = 224 – 10 = 214 P1 = 224 – 0 = 224
(ii) Calculation of funds required (ii) Calculation of funds required
= Total Investment – (Net profit – = Total Investment – (Net profit –
Dividend) Dividend)
= 10,00,000 – (5,00,000 – 4,00,000) = 10,00,000 – (5,00,000 – 0)
= 9,00,000 = 5,00,000
(iii) No. of shares required to be issued (iii) No. of shares required to be issued
for balance fund for balance fund
𝐹𝑢𝑛𝑑𝑠 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝐹𝑢𝑛𝑑𝑠 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑
No. of shares = 𝑃𝑟𝑖𝑐𝑒 𝑎𝑡 𝑒𝑛𝑑 (𝑃1) No. of shares = 𝑃𝑟𝑖𝑐𝑒 𝑎𝑡 𝑒𝑛𝑑 (𝑃1)
9,00,000 9,00,000
Δn = 214
= 4205.61 Δn = 214
= 2232.14
(iv) Calculation of value of firm (iv) Calculation of value of firm

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

(𝑛 + 𝑛)𝑃1 – 𝐼 + 𝐸 (𝑛 + 𝑛)𝑃1 – 𝐼 + 𝐸
Vf = 1 + 𝐾𝑒
Vf = 1 + 𝐾𝑒
9,00,000 5,00,000
{40,000+ 214 }214−10,00,000+5,00,000 {40,000+ 224 }224−10,00,000+5,00,000
= 1+0.12
= 1+0.12
94,60,000 – 5,00,000 94,60,000 – 5,00,000
= 1.12
= 80,00,000 = 1.12
= 80,00,000

Solution 36:
(a)
₹ In lakhs
Net Profit 75
Less: Preference Dividend 30
Earning for equity shareholders 45
Earnings per share = 45/7.5 = ₹ 6.00
Let, the dividend per share be D to get share price of ₹ 42
𝑟
𝐷+ 𝐾𝑒 (𝐸−𝐷)
P= 𝐾𝑒
0.20
𝐷+ 016 (6−𝐷)
₹ 42 = 0.16
0.16𝐷 + 1.2 – 0.20𝐷
6.72 = 0.16
0.04D = 1.2 – 1.0752
D = 3.12
𝐷𝑃𝑆 3.12
D/P ratio = 𝐸𝑃𝑆 x 100 = 6
x 100 = 52%
So, the required dividend payout ratio will be = 52%

(b) Since r > Ke, the optimum dividend pay-out ratio would ‘Zero’ (i.e. D = 0),
Accordingly, Value of a share:
𝑟
𝐷+ 𝐾𝑒 (𝐸−𝐷)
P= 𝐾𝑒
0.20
0+ 0.16 (6−0)
P= 0.16
= ₹ 46.875

(c) The optimality of the above pay-out ratio can be proved by using 25%, 50%, 75% and 100% as pay-out ratio:
At 25% pay-out ratio
0.20
1.5+ 0.16 (6−1.5)
P= 0.16
= ₹ 44.531

At 50% pay-out ratio

0.20
3+ 0.16 (6−3)
P= 0.16
= ₹ 42.188

At 75% pay-out ratio

0.20
4.5+ 0.16 (6−4.5)
P= 0.16
= ₹ 39.844

At 100% pay-out ratio

0.20
6+ 0.16 (6−6)
P= 0.16
= ₹ 37.50
From the above it can be seen that price of share is maximum when dividend pay-out ratio is ‘zero’ as
determined in (b) above.

Solution 37:
As per Dividend discount model, the price of share is calculated as follows:

𝐷1 𝐷2 𝐷3 𝐷4 𝐷4 (1+𝑔) 1
P= (1 + 𝐾𝑒)1
+ (1 + 𝐾𝑒)2
+ (1 + 𝐾𝑒)3
+ (1 + 𝐾𝑒)4
+ (𝐾𝑒 – 𝑔)
x (1 + 𝐾𝑒)4

Where,
P = Price per share
Ke = required rate of return on equity

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 Chapter 6 DIVIDEND DECISIONS SOLUTIONS

g = Growth rate
₹ 140 𝑥 1.12 ₹ 156.80 𝑥 1.12 ₹ 175.62 𝑥 1.12 ₹ 196.69 𝑥 1.12 ₹ 220.29(1 + 0.05) 1
P = (1 + 0.18)1 + (1 + 0.18)2
+ (1 + 0.18)3
+ (1 + 0.18)4
+ (0.18 – 0.05)
x (1 + 0.18)4
P= 132.81 + 126.10 + 119.59 + 113.45 + 916.34 = ₹ 1,408.29
Intrinsic value of share is ₹ 1,408.29 as compared to latest market price of ₹ 2,185. Market price of share is
over-priced by ₹ 776.71.

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 Chapter 7- WCM Part A

WCM - Introduction to Working Capital

Solution 5:
Computation of Operating Cycle
(1) Raw Material Storage Period (R)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙
Raw Material Storage Period (R) = 𝐷𝑎𝑖𝑙𝑦 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙
(14,40,000+16,00,000)/2
= 86,40,000/365
= 64.21 Days
Raw Material Consumed = Opening Stock + Purchases – Closing Stock
= ₹ 14,40,000+₹ 88,00,000–₹ 16,00,000 = ₹ 86,40,000
(2) Conversion/Work-in-Process Period (W)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝐼𝑃
Conversion/Processing Period = 𝐷𝑎𝑖𝑙𝑦 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝐶𝑜𝑠𝑡
(4,80,000+8,00,000)/2
= 1,23,20,000/365
=18.96 days
Production Cost: ₹
Opening Stock of WIP 4,80,000
Add: Raw Material Consumed 86,40,000
Add: Wages 24,00,000
Add: Production Expenses 16,00,000
1,31,20,000
Less: Closing Stock of WIP 8,00,000
Production Cost 1,23,20,000
(3) Finished Goods Storage Period (F)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝐺𝑜𝑜𝑑𝑠
Finished Goods Storage Period = 𝐷𝑎𝑖𝑙𝑦 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑆𝑜𝑙𝑑

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 Chapter 7- WCM Part A

(20,80,000 +24,00,000) / 2
= 1,20,00,000 / 365
Cost of Goods Sold ₹
Opening Stock of Finished Goods 20,80,000
Add: Production Cost 1,23,20,000
1,44,00,000
Less: Closing Stock of Finished Goods (24,00,000)
1,20,00,000
(4) Receivables Collection Period (D)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Receivables Collection Period = 𝐷𝑎𝑖𝑙𝑦 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
(12,00,000+16,00,000)/2
= 1,60,00,000/365
= 31.94 Days
(5) Payables Payment Period (C)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
Payables Payment Period = 𝐷𝑎𝑖𝑙𝑦 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒
(16,00,000+19,20,000)/2
= 88,00,000/365
= 73 days
(6) Duration of Operating Cycle (O)
O = R+W+F+D–C
= 64.21 + 18.96 + 68.13 + 31.94 – 73
= 110.24 days
Computation of Working Capital
(i) Number of Operating Cycles per Year = 365/Duration Operating Cycle =
365/110.24 = 3.311
(ii) Total Operating Expenses ₹
Total Cost of Goods sold 1,20,00,000
Add: Administration Expenses 14,00,000
Add: Selling Expenses 6,00,000
1,40,00,000
(iii) Working Capital Required
𝑇𝑜𝑡𝑎𝑙 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Working Capital Required = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑦𝑐𝑙𝑒𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
1,40,00,000
= 3.311
= ₹ 42,28,329.81

Solution 7:
Working Notes :
1. Raw material Storage Period (R)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙
= 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 × 365
₹ 45 + ₹ 65

= 2
₹ 380
× 365 = 52.83 or 53 days

Annual consumption of raw materials = Opening Stock + Purchases –

Closing Stock
= ₹ 45 + ₹ 400 – ₹ 65 = ₹ 380 Lakh

2. Work – in – progress (WIP) Conversion Period (W)

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝐼𝑃
WIP Conversion Period = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 × 365
₹ 35 + ₹ 51

= 2
₹ 450
× 365 = 34.87 or 35 days
3. Finished Stock Storage Period (F)

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠

= 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
× 365
₹ 60 + ₹ 70

= 2
₹ 525
× 365 = 45.19 or 45 days.
4. Receivable (Debtors) Collection Period (D)

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 Chapter 7- WCM Part A

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
= 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
× 365
₹ 112 + ₹ 135

= 2
₹ 585
× 365 = 77.05 or 77 days
5. Payable (Creditors) Payment Period (C)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑓𝑜𝑟 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠
= 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
× 365
₹ 68 + ₹ 71

= 2
₹ 400
× 365= 63.41 or 64 days
(i) Net Operating Cycle Period
=R+W+F+D–C
= 53 + 35 + 45 + 77 – 64
= 146 days
(ii) Number of Operating Cycles in the Year
365 365
= 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑦𝑐𝑙𝑒 𝑃𝑒𝑟𝑖𝑜𝑑 = 146 = 2.5 times
(iii) Amount of Working Capital Required
𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 ₹ 325
= 𝑁𝑜. 𝑜𝑓 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠
= 2.48 = ₹ 130 Lakh

Solution 8:
Maximum Permissible Bank Finance as per Tandon Committee Norms (Amounts In ₹ Lakhs)
1st Method
Total Current Assets required 1,480
Less: Current Liabilities (600)
Working Capital 880
Less: 25% of Long Term Sources (220)
MPBF 660

2nd Method
Current Assets required 1,480
Less: 25% to be provided (370)
Long term funds 1,110
Less: Current Liabilities (600)
MPBF 510

3rd Method
Current Assets 1,480
Less: Core Current Assets required (380)
Less: 25% provided for (275)
Long Term Funds 825
Less: Current Liabilities (600)
MPBF 225

Solution 10:

Statement showing the Working Capital Requirement of the Company

Current Assets: ₹
₹64,80,000
Stock of Raw materials ( 12 𝑚𝑜𝑛𝑡ℎ𝑠 × 2 months) = 10,80,000

₹1,51,20,000 × 4
Stock of Work-in-progress ( 52 𝑚𝑜𝑛𝑡ℎ𝑠
× 50%) = 5,81,538

₹1,51,20,000
Stock of Finished goods ( 12 𝑚𝑜𝑛𝑡ℎ𝑠
) = 12,60,000
2
Debtors (₹ 1,72,80,000 × 80% × 12
) = 23,04,000
Cash balance = 1,00,000

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 Chapter 7- WCM Part A

Total Current Assets (A) = 53,25,538

Current Liabilities:
₹64,80,000
Creditors for Purchases ( 12 𝑚𝑜𝑛𝑡ℎ𝑠 ) = 5,40,000

₹86,40,000
Outstanding Wages & Overheads ( 52 𝑤𝑒𝑒𝑘𝑠
× 1.5 weeks) = 2,49,231
Total Current Liabilities (B) = 7,89,231
Net working Capital [(A) – (B)] = 45,36,307

Working Notes: ₹
1. Annual Raw Materials Requirements [1,44,000 units × ₹ 45] = 64,80,000
Annual Direct Labour Cost [1,44,000 units × ₹ 20] = 28,80,000
Annual Overhead Cost [1,44,000 units × ₹ 40] = 57,60,000
Total Cost = 1,51,20,000

Solution 13:
Statement showing the requirements of Working Capital (Cash Cost basis)
Particulars (₹) (₹)
A. Current Assets:
Inventory:
Stock of Raw material (₹ 27,00,000 × 3/12) 6,75,000
Stock of Finished goods (₹ 77,40,000 × 3/12) 19,35,000
Receivables (₹ 88,20,000 × 3/12) 22,05,000
Administrative and Selling Overhead (₹ 10,80,000 × 1/12) 90,000
Cash in Hand 3,00,000

Gross Working Capital 52,05,000 52,05,000

B. Current Liabilities:
Payables for Raw materials* (R 27,00,000 × 3/12) 6,75,000
Outstanding Expenses:
Wages Expenses (₹ 21,60,000 × 1/12) 1,80,000
Manufacturing Overhead (₹ 28,80,000 × 1/12) 2,40,000
Total Current Liabilities 10,95,000 10,95,000
Net Working Capital (A-B) 41,10,000
Add: Safety margin @ 10% 4,11,000
Total Working Capital requirements 45,21,000
Working Notes:
(i)
(A) Computation of Annual Cash Cost of Production (₹)
Raw Material consumed 27,00,000
Wages (Labour paid) 21,60,000
Manufacturing overhead (₹ 32,40,000 - ₹ 3,60,000) 28,80,000
Total cash cost of production 77,40,000
(B) Computation of Annual Cash Cost of Sales (₹)
Cash cost of production as in (A) above 77,40,000
Administrative & Selling overhead 10,80,000
Total cash cost of sales 88,20,000
*Purchase of Raw material can also be calculated by adjusting Closing Stock and Opening Stock (assumed
nil). In that case Purchase will be Raw material consumed + Closing Stock-Opening Stock i.e ₹ 27,00,000 + ₹
6,75,000 - Nil = ₹ 33,75,000. Accordingly, Total Working Capital requirements (₹ 43,35,375) can be calculated.

Solution 16:
Working Notes:
1) Raw material inventory: The cost of materials for the whole year is 60% of the Sales value.
54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (60 % 𝑜𝑓 ₹ 200)
= 12 𝑚𝑜𝑛𝑡ℎ𝑠
x 2 months = ₹ 10,80,000
2) Work-in-process (Each unit of production is expected to be in process for one month):

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 Chapter 7- WCM Part A

(₹)
(a) Raw materials in work-in-process (being one month’s
raw material requirements) 5,40,000
(b) Labour costs in work-in-process
(54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (10% 𝑜𝑓 ₹ 200 ) 𝑥 1 𝑚𝑜𝑛𝑡ℎ)
x 0.5 45,000
12 𝑚𝑜𝑛𝑡ℎ𝑠
(c) Overheads
(54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (20% 𝑜𝑓 ₹ 200 ) 𝑥 1 𝑚𝑜𝑛𝑡ℎ)
x 0.5 90,000
12 𝑚𝑜𝑛𝑡ℎ𝑠
6,75,000

54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (90 % 𝑜𝑓 ₹ 200)

3) Finished goods inventory = 12 𝑚𝑜𝑛𝑡ℎ𝑠
x 1 month = ₹ 8,10,000
54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (90 % 𝑜𝑓 ₹ 200)
4) Receivables = 12 𝑚𝑜𝑛𝑡ℎ𝑠
x 1.5 months = ₹ 12,15,000
54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (60 % 𝑜𝑓 ₹ 200)
5) Payable to suppliers = 12 𝑚𝑜𝑛𝑡ℎ𝑠
x 1 month = ₹ 5,40,000
54,000 𝑢𝑛𝑖𝑡𝑠 𝑥 (10 % 𝑜𝑓 ₹ 200)
6) Direct Wages payable = 12 𝑚𝑜𝑛𝑡ℎ𝑠
x 1 month = ₹ 90,000

Calculation of Working Capital Requirement on cash cost basis

Particulars (₹) (₹)
A. Current Assets
(i) Inventories:
- Raw Materials 10,80,000
- Work-in-process 6,75,000
- Finished goods 8,10,000 25,65,000
(ii) Receivables 12,15,000
(iii) Cash in hand (40% of ₹ 6,30,000) 2,52,000
Total Current Assets 40,32,000
B. Current Liabilities:
(i) Payables for raw materials 5,40,000
(ii) Direct wages payables 90,000
Total Current Liabilities 6,30,000
Net Working Capital (A – B) 34,02,000
Add: Safety margin 5,10,300
(15% of Net Working Capital)
Working capital requirement 39,12,300

Solution 19:
Statement of Working Capital requirements (Cash Cost Basis)
Particulars Amount (₹)
Current Assets:
Stock of Raw Materials (₹ 4,50,000 ÷ 12) 37,500
Stock of Finished Goods (₹ 12,90,000 ÷ 12) 1,07,500
Debtors (₹ 14,70,000 ÷ 6) 2,45,000
Cash in hand 1,00,000
Advance payment: Sales promotion expenses (₹ 60,000 × 3/12) 15,000
Total Current Assets (A) 5,05,000
Current Liabilities:
Creditors for Materials (₹ 4,50,000/12 months × 2 months) 75,000
Wages outstanding (₹ 3,60,000 ÷ 12) 30,000
Manufacturing expenses outstanding 40,000
Administrative expenses outstanding (₹ 1,20,000 ÷ 12) 10,000
Total Current Liabilities (B) 1,55,000
Net Working Capital (A) – (B) 3,50,000
Add: 15% Safety Margin 52,500
Working Capital Requirement 4,02,500

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 Chapter 7- WCM Part A

Solution 21:
Statement showing the requirements of Working Capital
Particulars ₹ ₹
A. Current Assets:
Inventory:
Stock of raw materials (₹ 2,31,840 x 2/12) 38,640
Stock of Work-in-progress (As per Working Note) 39,240
Stock of Finished goods (₹ 3,51,600 x 10/100) 35,160
Receivables (Debtors) (₹ 3,04,992 x 2/12) 50,832
Cash in Hand 19,200
Prepaid Expenses:
Wages & Mfg. expense (₹ 1,59,000 x 1/12) 13,250
Administrative expenses (₹ 33,600 x 1/12) 2,800
Selling & Distribution Expenses (₹ 31,200 x 1/12) 2,600
Advance taxes paid {(70% of 24,000) x 3/12} 4,200
Gross Working Capital 2,05,922 2,05,922
B. Current Liabilities:
Payable for Raw materials (₹ 2,70,480 x 1.5/12) 33,810
Provision for Taxation (Net of Advance Tax) (₹ 24,000 x 30/100) 7,200
Total Current Liabilities 41,010 41,010
C. Excess of CA over CL 1,64,912
Add: 10% for unforeseen contingencies 16,491
Net Working Capital requirements 1,81,403
Working Notes:

(i) Calculation of Stock of Work-in-progress

Particulars ₹
Raw material (₹ 2,01,600 x 15%) 30,240
Wages & Mfg. Expenses (₹ 1,50,000 x 15% x 40%) 9,000
Total 39,240

(ii) Calculation of stock of finished goods and cost of sales

₹
Direct material cost [₹ 2,01,600 + ₹ 30,240] 2,31,840
Wages & Mfg. expenses [₹ 1,50,000 + ₹ 9,000] 1,59,000
Depreciation 0
Gross Factory Cost 3,90,840
Less: Closing W.I.P. (39,240)
Cost of goods produced 3,51,600
Add: Administrative Expenses 33,600
3,85,200
Less: Closing stock (35,160)
Cost of goods sold 3,50,040
Add: Selling and Distribution expenses 31,200
Total Cash Cost of sales 3,81,240
Debtors (80% of cash cost of sales) 3,04,992

(iii) Calculation of Credit Purchase

Particulars ₹
Raw material consumed 2,31,840
Add: Closing Stock 38,640
Less: Opening Stock -
Purchases 2,70,480

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 Chapter 7- WCM Part A

Solution 23:
(i) Projected Statement of Profit / Loss
(Ignoring Taxation)
Year 1 Year 2
Production (Units) 12,000 18,000
Sales (Units) 10,000 17,000
(₨) (₨)
Sales revenue (A) (Sales unit × ₨ 192) 19,20,000 32,64,000
Cost of production:
Materials cost 9,60,000 14,40,000
(Units produced × ₨ 80)
Direct labour and variable expenses (Units 4,80,000 7,20,000
produced × ₨ 40)
Fixed manufacturing expenses 2,88,000 2,88,000
(Production Capacity: 24,000 units × ₨ 12)
Depreciation 4,80,000 4,80,000
(Production Capacity : 24,000 units × ₨ 20)
Fixed administration expenses 1,92,000 1,92,000
(Production Capacity : 24,000 units × ₨ 8)
Total Costs of Production 24,00,000 31,20,000
Add: Opening stock of finished goods (Year 1 : Nil; --- 4,00,000
Year 2 : 2,000 units)
Cost of Goods available for sale 24,00,000 35,20,000
(Year 1: 12,000 units; Year 2: 20,000 units)
Less: Closing stock of finished goods at average (4,00,000) (5,28,000)
cost (year 1: 2000 units, year 2 : 3000 units)
(Cost of Production × Closing stock/ units
produced)
Cost of Goods Sold 20,00,000 29,92,000
Add: Selling expenses – Variable (Sales unit × ₨ 8) 80,000 1,36,000
Add: Selling expenses -Fixed (24,000 units × ₨ 2) 48,000 48,000
Cost of Sales : (B) 21,28,000 31,76,000
Profit (+) / Loss (-): (A - B) (-) 2,08,000 (+) 88,000

Working Notes:
1. Calculation of creditors for supply of materials:
Year 1 (₨) Year 2 (₨)
Materials consumed during the year 9,60,000 14,40,000
Add: Closing stock (2 month’s average 1,60,000 2,40,000
consumption)
11,20,000 16,80,000
Less: Opening Stock --- 1,60,000
Purchases during the year 11,20,000 15,20,000
Average purchases per month (Creditors) 93,333 1,26,667

2. Creditors for expenses:

Year 1 (₨)Year 2 (₨)
Direct labour and variable expenses 4,80,000 7,20,000
Fixed manufacturing expenses 2,88,000 2,88,000
Fixed administration expenses 1,92,000 1,92,000
Selling expenses (variable + fixed) 1,28,000 1,84,000
Total 10,88,000 13,84,000
Average per month 90,667 1,15,333

(ii) Projected Statement of Working Capital requirements

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 Chapter 7- WCM Part A

Year 1 (₨) Year 2 (₨)

Current Assets:
Inventories:
-Stock of materials 1,60,000 2,40,000
(2 month’s average consumption)
-Finished goods 4,00,000 5,28,000
Debtors (2 month’s average sales) (including 3,20,000 5,44,000
profit)
Cash 1,00,000 1,00,000
Total Current Assets/ Gross working capital (A) 9,80,000 14,12,000
Current Liabilities:
Creditors for supply of materials (Refer to 93,333 1,26,667
working note 1)
Creditors for expenses (Refer to working note 2) 90,667 1,15,333
Total Current Liabilities: (B) 1,84,000 2,42,000
Estimated Working Capital Requirements: (A-B) 7,96,000 11,70,000

Solution 29:
Workings:
(1) Statement of cost at single shift and double shift working
24,000 units 48,000 Units
Per unit Total Per unit Total
(₨) (₨) (₨) (₨)
Raw materials 24 5,76,000 21.6 10,36,000
Wages:
Variable 12 2,88,000 12 5,76,000
Fixed 8 1,92,000 4 1,92,000
Overheads:
Variable 4 96,000 4 1,92,000
Fixed 16 3,84,000 8 3,84,000
Total cost 64 15,36,000 49.6 23,80,800
Profit 8 1,92,000 22.4 10,75,200
Sales 72 17,28,000 72 34,56,000
𝑆𝑎𝑙𝑒𝑠 𝑅𝑠 17,28,000
(2) Sales in units 2020-21 = 𝑈𝑛𝑖𝑡 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒
= 𝑅𝑠 72
= 24,000 units
(3) Stock of Raw Materials in units on 31.3.2021
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑆𝑡𝑜𝑐𝑘𝑅𝑠 1,44,000
= 𝑅𝑠 24 = 6,000 units
𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
(4) Stock of work-in-progress in units on 31.3.2021
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑤𝑜𝑟𝑘−𝑖𝑛−𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠
𝑅𝑠 88,000
- 𝑅𝑠 (24+20) = 2,000 units
𝑃𝑟𝑖𝑚𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
(5) Stock of finished goods in units 2020-21
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠𝑡𝑜𝑐𝑘 𝑅𝑠 2,88,000
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
= 𝑅𝑠 64
= 4,500 units

Comparative Statement of Working Capital Requirement

Single Shift (24,000 units) Double Shift (48,000 units)
Units Rate (₨) Amount (₨) Units Rate (₨) Amount(₨)
Current Assets
Inventories:
Raw Materials 6,000 24 1,44,000 12,000 21.6 2,59,200
Work-in-Progress 2,000 44 88,000 2,000 37.6 75,200
Finished Goods 4,500 64 2,88,000 9,000 49.6 4,46,400
Sundry Debtors 6,000 64 3,84,000 12,000 49.6 5,95,200
Total Current Assets (A) 9,04,000 13,76,000
Current Liabilities
Creditors for Materials 4,000 24 96,000 8,000 21.6 1,72,800
Creditors for Wages 2,000 20 40,000 4,000 16 64,000
Creditors for Overheads 2,000 20 40,000 4,000 12 48,000

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 Chapter 7- WCM Part A

Total Current Liabilities (B) 1,76,000 2,84,800

Working Capital (A) – (B) 7,28,000 10,91,200
Analysis: Additional Working Capital requirement = ₨ 10,91,200 – ₨ 7,28,000 = ₨ 3,63,200, if the policy to
increase output is implemented.

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 08- Management of Receivables 7b - Solutions

08- Management of Receivables 7b - Solutions

Solution 02:
Statement Showing Evaluation of Various Credit Policies under Consideration
Particulars Policy I Policy II Policy III Policy IV
Incremental gains:
Contribution 1,50,000 3,00,000 4,20,000 4,50,000
Total Incremental Gains (A) 1,50,000 3,00,000 4,20,000 4,50,000
Incremental Costs:
Opportunity cost of Investment of debtor 42,014 88,889 1,38,194 1,82,639
Total Incremental Costs (B) 42,014 88,889 1,38,194 1,82,639
Net incremental Gains (A) – (B) 1,07,986 2,11,111 2,81,806 2,67,361

Working Notes:
(i) Computation of Incremental Contribution (₹ In Lakhs)
Particulars Existing Policy I Policy II Policy III Policy IV
Sales 60 65 70 74 75
Less: Variable contribution of sales
(70%) (42) (45.5) (49) (51.8) (52.5)
Contribution 18 19.5 21 22.2 22.5
Incremental Contribution 1.5 3 4.2 4.5

(ii) Computation of Incremental Opportunity cost of Investment in Debtors

Particulars Existing Policy I Policy II Policy III Policy IV
Total Cost of Sales (Variable Cost +
Total Fixed Cost) 50,00,000 53,50,000 57,00,000 59,80,000 60,50,000
Average collection period (Days) 20 30 40 50 60
Average Investment in Debtors 2,77,778 4,45,834 6,33,333 8,30,556 10,08,334
Incremental investment in Debtors 1,68,056 3,55,555 5,52,778 7,30,556
Opportunity cost of Incremental
investment in Debtors 42,014 88,889 1,38,194 1,82,639

Solution 07:
A. Statement showing the Evaluation of Debtors Policies (Total Approach)
Particulars Present Proposed Proposed Proposed Proposed
Policy Policy A Policy B Policy C Policy D
30 days 40 days 50 days 60 days 75 days
` ` ` ` `
A. Expected Profit:
(a) Credit Sales 6,00,000 6,30,000 6,48,000 6,75,000 6,90,000
(b) Total Cost other than
Bad Debts
(i) Variable Costs [Sales 4,00,000 4,20,000 4,32,000 4,50,000 4,60,000
× 2/ 3]
(ii)Fixed Costs 50,000 50,000 50,000 50,000 50,000
4,50,000 4,70,000 4,82,000 5,00,000 5,10,000
(c) Bad Debts 6,000 9,450 12,960 20,250 27,600
(d) Expected Profit [(a) – 1,44,000 1,50,550 1,53,040 1,54,750 1,52,400
(b) – (c)]
B. Opportunity Cost of 7,500 10,444 13,389 16,667 21,250
Investments in
Receivables
C. Net Benefits (A – B) 1,36,500 1,40,106 1,39,651 1,38,083 1,31,150
Recommendation: The Proposed Policy A (i.e. increase in collection period by 10 days or total 40 days) should
be adopted since the net benefits under this policy are higher as compared to other policies.

CA Nitin Guru | [Link] 8.1

 08- Management of Receivables 7b - Solutions

Working Notes:
(i) Calculation of Fixed Cost = [Average Cost per unit – Variable Cost per unit] × No. of Units sold
= [` 2.25 - ` 2.00] × (` 6,00,000/3)
= ` 0.25 × 2,00,000 = ` 50,000

(i) Calculation of Opportunity Cost of Average Investments

Opportunity Cost = Total Cost × (Collection period/360) × (Rate of Return/100)

Present Policy = 4,50,000 × (30/360) × (20/100) = 7,500

Policy A = 4,70,000 × (40/360) × (20/100) = 10,444
Policy B = 4,82,000 × (50/360) × (20/100) = 13,389
Policy C = 5,00,000 × (60/360) × (20/100) = 16,667
Policy D = 5,10,000 × (75/ 360) × (20/100) = 21,250

Another method of solving the problem is Incremental Approach. Here we assume that sales are all
credit sales.
Particulars Present Proposed Proposed Proposed Proposed Policy D 75
Policy 30 Policy Policy Policy C 60 days
days days
A 40 days B 50 days
` ` ` ` `
A. Incremental Expected
Profit:
(a) Incremental Credit --- 30,000 48,000 75,000 90,000
Sales
(b) Incremental Costs
(i) Variable Costs --- 20,000 32,000 50,000 60,000
(ii)Fixed Costs --- - - - -
(c) Incremental --- 3,450 6,960 14,250 21,600

Bad Debt Losses

(d) Incremental 6,550 9,040 10,750 8,400
Expected

Profit (a – b –c)]
B. Required Return on

Incremental
Investments:
(a) Cost of Credit Sales 4,50,000 4,70,000 4,82,000 5,00,000 5,10,000
(b) Collection period 30 40 50 60 75
(c) Investment in 37,500 52,222 66,944 83,333 1,06,250
Receivable (a × b/360)
(d) Incremental --- 14,722 29,444 45,833 68,750
Investment in
Receivables
(e) Required Rate of 20 20 20 20
Return (in %)
(f) Required Return on --- 2,944 5,889 9,167 13,750
Incremental
Investments (d× e)
C. Net Benefits (A – B) --- 3,606 3,151 1,583 - 5,350
Recommendation: The Proposed Policy A should be adopted since the net benefits under this policy are higher
than those under other policies.

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 08- Management of Receivables 7b - Solutions

Solution 13:
Evaluation of Alternative Credit Policies
Particulars Present (₹) Policy A (₹) Policy B (₹) Policy C (₹) Policy D (₹)
Sales 50,00,000 56,00,000 60,00,000 62,00,000 63,00,000
Variable Cost at 80% 40,00,000 44,80,000 48,00,000 49,60,000 50,40,000
Contribution 10,00,000 11,20,000 12,00,000 12,40,000 12,60,000
Less: Fixed Costs 6,00,000 6,00,000 6,00,000 6,00,000 6,00,000
Profit 4,00,000 5,20,000 6,00,000 6,40,000 6,60,000
Cost of Debtors p.a.
= Total Costs 46,00,000 50,80,000 54,00,000 55,60,000 56,40,000
Collection Period 30 days 45 days 60 days 75 days 90 days
Average Debtors =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 × 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
360 3,83,333 6,35,000 9,00,000 11,58,333 14,10,000
Interest on Average
Debtors @ 20% 76,667 1,27,000 1,80,000 2,31,667 2,82,000
Net Benefit (Profit –
Interest) 3,23,333 3,93,000 4,20,000 4,08,333 3,78,000
Conclusion: The Company may choose Policy B to maximize Net Benefit.

Solution 17:
Statement showing evaluation of Credit Policies
(Amount in lakhs)
Particulars Present (₹.) Proposed Policy (₹.)
Option I Option II
A Expected Profit:
(a) Credit Sales 180 220 280
(b) Total Cost other than Bad Debts:
Variable Costs (60%) 108 132 168
(c) Bad Debts 6 18 38
(d) Expected Profit [(a)-(b)-(c)] 66 70 74
B Opportunity Cost of Investment in Debtors (Refer workings) 6.75 10.31 17.5
C Net Benefits [A - B] 59.25 59.69 56.5
Recommendation: The Proposed Policy I should be adopted since the net benefits under this policy is higher
than those under other policies.
Workings:
Calculation of Opportunity Cost of Investment in Debtors
𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑* 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛
Opportunity Cost = Total Cost x 12
x 100

*Collection period (in months) = 12/Debtors turnover ratio

12/4 25
Present Policy = ₹. 108 x 12 x 100 = ₹. 6.75 lakhs
12/3.2 25
Proposed Policy I = ₹. 132 x 12
x 100 = ₹. 10.31 lakhs
12/2.4 25
Proposed Policy II = ₹. 168 x 12
x 100 = ₹. 17.5 lakhs

Solution 18:
Particulars Present (₹) Proposed Policy (₹)
Sales (18,90,000 ÷ 21 = 90,000 units) 18,90,000 23,62,500
Proposed Sales (90,000 units + 25% = 1,12,500 units
at ₹ 21 p.u.)
Less: Variable Cost at ₹ 14 p.u. 12,60,000 15,75,000
Contribution 6,30,000 7,87,500
Cost of Debtors p.a. (Variable Cost only) 12,60,000 15,75,000
Average Collection Period 1 Month 2 Months

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 08- Management of Receivables 7b - Solutions

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 × 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑

Average Debtors = 12 1,05,000 2,62,500
Interest on Average Debtors [Average Debtors × 40%] 42,000 1,05,000
Net Benefit (Contribution – Interest) 5,88,000 6,82,500
Note: Variable Cost Approach has been applied here. Alternatively, Total Cost Approach may also be applied.
Conclusion: The Company may choose the proposed policy to maximize Net Benefit.

Solution 19:
Particulars Present (₹) Proposed Policy (₹)
60,000 + 25% = 75,000
Sales Quantity 60,000 units units
60,000 × 100 =
Sales Value at ₹ 100 p.u. 60,00,000 75,000 × 100 = 75,00,000
Less: Variable Costs at ₹ 80 p.u. 60,000 × 80 = 48,00,000 75,000 × 80 = 60,00,000
Contribution 12,00,000 15,00,000
Less: Fixed Costs at ₹ 10 p.u. of present
sales 60,000 × 10 = 6,00,000 60,000 × 10 = 6,00,000
Profit 6,00,000 9,00,000
Cost of Debtors p.a. = Total Cost (VC +
FC) 54,00,000 66,00,000
Average Collection Period 1 month 2 months
Average Debtors =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 × 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
12 4,50,000 11,00,000
Interest on Average Debtors at 20% 90,000 2,20,000
Net Benefit (Profit – Interest) 5,10,000 6,80,000
Conclusion: There is an increase in Net Benefit by ₹ 1,70,000. So, the relaxation of credit standards is justified.

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

Chapter 9 - Treasury & Cash Management 7C

Solution 2:
Monthly Cash Budget for first six months of 2021
(Amount in ₹.)
Particulars Jan. Feb. Mar. April May June
Opening balance 40,000 40,000 40,000 40,000 40,000 40,000
Receipts:
Cash sales 15,000 20,000 25,000 30,000 20,000 15,000
Collection from debtors 1,72,500 97,500 67,500 67,500 82,500 70,500
Total cash available (A) 2,27,500 1,57,500 1,32,500 1,37,500 1,42,500 1,25,500
Payments:
Purchases 64,000 80,000 96,000 64,000 48,000 96,000
Operating Expenses 22,000 25,000 30,000 30,000 25,000 24,000
Interest on debentures 3,000 - - 3,000 - -
Tax payment - - - 5,000 - -
Total payments (B) 89,000 1,05,000 1,26,000 1,02,000 73,000 1,20,000
Minimum cash balance 40,000 40,000 40,000 40,000 40,000 40,000
desired
Total cash needed (C) 1,29,000 1,45,000 1,66,000 1,42,000 1,13,000 1,60,000
Surplus/(deficit) (A - C) 98,500 12,500 (33,500) (4,500) 29,500 (34,500)
Investment/financing
Temporary Investments (98,500) (12,500) - - (29,500) -
Liquidation of temporary 33,500 4,500
investments or temporary - 34,500
borrowings
Total effect of
investment/financing(D) (98,500) (12,500) 33,500 4,500 (29,500) 34,500
Closing cash balance (A + D
-B) 40,000 40,000 40,000 40,000 40,000 40,000

Workings:
1. Collection from debtors: (Amount in ₹.)
Year 2020 Year 2021
Oct. Nov. Dec. Jan. Feb. Mar. April May June
Total sales 2,00,000 2,20,000 2,40,000 60,000 80,000 1,00,000 1,20,000 80,000 60,000
Credit sales (75% of 1,50,000 1,65,000 1,80,000 45,000 60,000 75,000 90,000 60,000 45,000
total sales)
Collections: 90,000
One month 99,000 1,08,000 27,000 36,000 45,000 54,000 36,000
Two months 45,000 49,500 54,000 13,500 18,000 22,500 27,000
Three months 15,000 16,500 18,000 4,500 6,000 7,500
Total collections 1,72,500 97,500 67,500 67,500 82,500 70,500

2. Payment to Creditors: (Amount in ₹.)

Year 2021
Jan Feb Mar Apr May Jun Jul
Total sales 60,000 80,000 1,00,000 1,20,000 80,000 60,000 1,20,000
Purchases 48,000 64,000 80,000 96,000 64,000 48,000 96,000
(80% of total sales)
Payment: 64,000 80,000 96,000 64,000 48,000 96,000

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

Solution 4:
Projected Profit and Loss Account for the year 3 (₹ In Lakhs)
Year 2 Year 3 Year 2 Year 3
Particulars (Actual) (Projected) Particulars (Actual) (Projected)
To Materials
consumed 350 420 By Sales 1,000 1,200
By
Miscellaneous
To Stores 120 144 Income 10 10
To Manufacturing
Expenses 160 192
To Other
expenses 100 150
To Depreciation 100 100
To Net Profit 180 204
1,010 1,210 1,010 1,210

Cash Flow
Particulars Amount (₹ In lakhs)
Profit 204
Add: Depreciation 100
304
Less: Cash required for increase in stock (50)
Net Cash Inflow 254
Available for servicing the loan: 75% of ₹ 2,54,00,000 = ₹ 1,90,50,000

Working Notes:
(i) Material consumed in year 2: 35% of sales.
35
Likely consumption in year 3: ₹ 1,200 × 100 or ₹ 420 (Lakhs)
(ii) Stores are 12% of sales, as in year 2.
(iii) Manufacturing expenses are 16% of sales.

Solution 6:
Cash Budget
Particulars Jan (₹) Feb (₹) March (₹) April (₹) May (₹) June (₹) Total (₹)
Receipts:
Cash sales 36,000 48,500 43,000 44,300 51,250 54,350 2,77,400
Collections from
debtors - 36,000 48,500 43,000 44,300 51,250 2,23,050
Bank loan - - - - 30,000 30,000
Total Receipts (A) 36,000 84,500 91,500 87,300 1,25,550 1,05,600 5,30,450
Payments:
Materials - 25,000 31,000 25,500 30,600 37,000 1,49,100
Salaries and
wages 10,000 12,100 10,600 25,000 22,000 23,000 1,02,700
Production
overheads - 6,000 6,300 6,000 6,500 8,000 32,800
Office & selling
overheads - 5,500 6,700 7,500 8,900 11,000 39,600
Sales Commission 2,160 2,910 2,580 2,658 3,075 3,261 16,644
Capital
expenditure - 8,000 - 25,000 - - 33,000
Dividend - - - - - 35,000 35,000
Total Payments
(B) 12,160 59,510 57,180 91,658 71,075 1,17,261 4,08,844
New cash flow (A)
– (B) 23,840 24,990 34,320 (4,358) 54,475 (11,661) 1,21,606

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

Balance at the
beginning of
month 72,500 96,340 1,21,330 1,55,650 1,51,292 2,05,767 1,94,106
Balance at the end
of month 96,340 1,21,330 1,55,650 1,51,292 2,05,767 1,94,106 3,15,712

Solution 9:
Cash Budget for the months of June, July, August and September
August September
Particulars June (₹) July (₹) (₹) (₹)
Opening Balance 45,000 45,500 45,500 45,000
Add: Receipts
Cash Sales (20% of respective month's
Sales) 1,00,000 98,000 1,08,000 1,22,000
Collection from Debtors 3,48,000 3,80,000 3,96,000 4,12,000
Interest on Investments 25,000 - - -
Total Receipts (A) 5,18,000 5,23,500 5,49,500 5,79,000
Payments:
Creditors (2 months) April paid in June, and so
on. 2,00,000 2,10,000 2,60,000 2,82,000
Wages (½ of previous month + ½ of Current
month) 1,62,500 1,65,000 1,65,000 1,67,500
Overheads (1 month), previous month expenses
paid now 40,000 38,000 37,500 60,800
Interest on Debentures (6% on ₹ 5,00,000) 30,000 - - -
Instalment on Machinery (₹ 4,00,000 ÷ 20
months) - 20,000 20,000 20,000
Advance Tax - - 15,000 -
Total Payments (B) 4,32,500 4,33,000 4,97,500 5,30,300
Closing Balance before investment in FD (A) –
(B) 85,500 90,500 52,000 48,700
Investment in Fixed Deposit (multiples of 1,000)
(Balancing Figure) 40,000 45,000 7,000 3,000
Closing Balance (required around ₹ 45,000) 45,500 45,500 45,000 45,700

Working Notes:
Computation of Collection from Debtors
Particulars April (₹) May (₹) June (₹) July (₹) August (₹) September (₹)
Total Sales 4,20,000 4,50,000 5,00,000 4,90,000 5,40,000 6,10,000
Cash Sales 84,000 90,000 1,00,000 98,000 1,08,000 1,22,000
Credit Sales 3,36,000 3,60,000 4,00,000 3,92,000 4,32,000 4,88,000
Receipt:
50% 1,68,000 1,80,000 2,00,000 1,96,000 2,16,000
50% 1,68,000 1,80,000 2,00,000 1,96,000
Total Receipts 3,48,000 3,80,000 3,96,000 4,12,000

Solution 12:
Monthly Cash Budget (April-September)
April May June July August September
Opening cash balance - 10,50,000 - 1,37,500 5,25,000 7,25,000
A. Cash inflows
Equity shares 50,00,000 - - - - -
Loans (Refer to working 6,50,000 1,25,000 - - - -
note 1)
Receipt from Debtors - - 15,00,000 17,50,000 17,50,000 20,00,000
Total (A) 56,50,000 11,75,000 15,00,000 18,87,500 22,75,000 27,25,000

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

B. Cash Outflows
Plant and Machinery 10,00,000 - - - - -

Land and Building 20,00,000 - - - - -

Furniture 5,00,000 - - - - -
Motor Vehicles 5,00,000 - - - - -
Stock of raw 5,00,000 - - - - -
materials (Minimum
stock)
Miscellaneous 50,000 - - - - -
expenses
Payment to creditors - 10,25,000 12,12,500 12,12,500 14,00,000 14,00,000
for credit purchases
(Refer to working note
2)
Wages and - 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
salaries
Admn. expenses 50,000 50,000 50,000 50,000 50,000 50,000
Total :(B) 46,00,000 11,75,000 13,62,500 13,62,500 15,50,000 15,50,000
Closing balance (A)-(B) 10,50,000 - 1,37,500 5,25,000 7,25,000 11,75,000

Budgeted Income Statement for six-month period ending 30th September

Particulars (₹) Particulars (₹)
To Purchases 83,37,500 By Sales 1,12,50,000
To Wages and Salaries 6,00,000 By Closing stock 5,00,000
To Gross profit c/d 28,12,500
1,17,50,000 1,17,50,000
To Admn. expenses 3,00,000 By Gross profit b/d 28,12,500
To Depreciation 2,00,000
(10% on ₹ 40 lakhs for six
months)
To Accrued interest on loan 45,250
(Refer to working note 3)

To Miscellaneous expenses 50,000

To Net profit c/d 22,17,250
28,12,500 28,12,500

Projected Balance Sheet as on 30th September, 2021

Liabilities Amount (₹) Assets Amount
(₹)
Share Capital: Fixed Assets:
Authorised Land and Building 20,00,000
capital Less: Depreciation 1,00,000 19,00,000

10,00,000 equity 1,00,00,000 Plant and 10,00,000

shares of ₹ 10 Machinery
each Less: Depreciation 50,000 9,50,000

Issued, Furniture 5,00,000

subscribed Less: Depreciation 25,000 4,75,000
and paid up 50,00,000

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

capital 5,00,000 Motor Vehicles 5,00,000

equity Less: Depreciation 25,000 4,75,000 38,00,000
shares of ₹ 10 Current Assets:
each Stock
Sundry debtors 5,00,000
Reserve 22,17,250 Cash 42,50,000
and Surplus: 11,75,000 59,25,000
7,75,000
Profit and Loss

Long-term loans

Current liabilities 15,87,500

and 45,250 17,32,750
provisions: 1,00,000

Sundry creditors
Accrued interest
Outstanding
expenses
97,75,000 97,75,000

Working Notes:
Subsequent Borrowings Needed (₹)
April May June July August September
A. Cash Inflow
Equity shares 50,00,000
Loans 6,50,000
Receipt from debtors
- - 15,00,000 17,50,000 17,50,000 20,00,000
Total (A) 56,50,000 - 15,00,000 17,50,000 17,50,000 20,00,000
B. Cash Outflow
Purchase of fixed
40,00,000
assets
Stock 5,00,000
Miscellaneous
50,000
expenses
Payment to creditors - 10,25,000 12,12,500 12,12,500 14,00,000 14,00,000
Wages and salaries - 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
Administrative
expenses 50,000 50,000 50,000 50,000 50,000 50,000
Total 46,00,000 11,75,000 13,62,500 13,62,500 15,50,000 15,50,000
Surplus/ (Deficit) 10,50,000 (11,75,000) 1,37,500 3,87,500 2,00,000 4,50,000
Cumulative balance 10,50,000 (1,25,000) 12,500 4,00,000 6,00,000 10,50,000
1. There is shortage of cash in May of ₹ 1,25,000 which will be met by borrowings in May.
2. Payment to Creditors
Purchases = Cost of goods sold - Wages and salaries
Purchases for April = (75% of 15,00,000) - ₹ 1,00,000 = ₹ 10,25,000
(Note: Since gross margin is 25% of sales, cost of manufacture i.e. materials plus wages and salaries should
be 75% of sales)
Hence, Purchases = Cost of manufacture minus wages and salaries of ₹ 1,00,000) The creditors are paid in the
first month following purchases.
Therefore, payment in May is ₹ 10,25,000
The same procedure will be followed for other months.
April (75% of 15,00,000) - ₹ 1,00,000 = ₹ 10,25,000
May (75% of 17,50,000) - ₹ 1,00,000 = ₹ 12,12,500
June (75% of 17,50,000) - ₹ 1,00,000 = ₹ 12,12,500
July (75% of 20,00,000) - ₹ 1,00,000 = ₹ 14,00,000

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

August (75% of 20,00,000) - ₹ 1,00,000 = ₹ 14,00,000

September (75% of 22,50,000) - ₹ 1,00,000 = ₹ 15,87,500
Minimum Stock ₹ 5,00,000
Total Purchases ₹ 83,37,500

3. Accrued Interest on Loan

12% interest on ₹ 6,50,000 for 6 months 39,000
Add: 12% interest on ₹ 1,25,000 for 5 months 6,250
45,250

Solution 19:
(i) Total time saving = 3 & ½ days
Time savings × Daily average collection = Reduction in cash balances achieved
3 & ½ days × ₹ 5,00,000 = ₹ 17,50,000

(ii) 5% × ₹ 17,50,000 = ₹ 87,500

(iii) Since the opportunity cost of the present system (₹ 87,500) exceeds the cost of the lock box
system (₹ 80,000), the system should be initiated.

Solution 20:
Computation of Savings in Interest Cost:
₹7,30,00,000
Sales per week = 50 𝑤𝑒𝑒𝑘𝑠 = ₹ 14,60,000

Interest Cost per week for existing BillFloat

% of week's Sales Sales Amount (₹) Days delay Interest Cost per week at 20% (₹)
3
20% 14,60,000 × 20% = 2,92,000 3 2,92,000 × 20% × 365
= 480
4
10% 14,60,000 × 10% = 1,46,000 4 1,46,000 × 20% × 365
= 320
5
40% 14,60,000 × 40% = 5,84,000 5 5,84,000 × 20% × 365
= 1,600
6
30% 14,60,000 × 30% = 4,38,000 6 4,38,000 × 20% × 365
= 1,440
14,60,000 Total 3,840

Interest Cost per week after hiring the agency

% of week's Sales Sales Amount (₹) Days delay Interest Cost per week at 20% (₹)
40% 14,60,000 × 40% = 5,84,000 0 Nil
1
40% 14,60,000 × 40% = 5,84,000 1 5,84,000 × 20% × 365 = 320
3
20% 14,60,000 × 20% = 2,92,000 3 2,92,000 × 20% × 365
= 480
14,60,000 Total 800
Savings in Interest Cost per annum = (₹ 3,840 – ₹ 800) × 50 weeks = ₹ 1,52,000

Cost Benefit Analysis of hiring the agency

Credit
Nature of Work Invoicing Collection Both
Benefits:
Interest Saved 1,52,000 - 1,52,000
Postage Expenses Saved (₹ 4,000 × 12) 48,000 - 48,000
Savings due to fast collection of Debtors 36 – 30 = 6 days
6
(₹ 730 Lakhs × 20% × 365 ) - 2,40,000 2,40,000
Total Benefits 2,00,000 2,40,000 4,40,000
Less: Cost of Hiring 2,00,000 2,50,000 4,00,000
Net Benefit Nil (10,000) 40,000
Indifference
Decision Point Reject Accept

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 Chapter 9 - Treasury & Cash Management 7C - Solutions

Solution 21:
Cleared Funds Forecast
7 Aug 20 8 Aug 20 9 Aug 20 10 Aug 20 11 Aug 20
(Friday) (Saturday) (Sunday) (Monday) (Tuesday)
₹ ₹ ₹ ₹ ₹
Receipts
W Ltd 1,30,000 0 0 0 0
X Ltd 0 0 0 1,80,000 0
(a) 1,30,000 0 0 1,80,000 0
A Ltd 45,000 0 0 0 0
B Ltd 0 0 75,000 0 0
C Ltd 0 0 95,000 0 0
Wages 0 0 0 0 12,000
Salaries 56,000 0 0 0 0
Petty Cash 200 0 0 0 0
Stationery 0 0 300 0 0
(b) 1,01,200 0 1,70,300 0 12,000
Cleared excess Receipts over payments (a) – (b) 28,800 0 (1,70,300) 1,80,000 (12,000)
Cleared balance b/f 2,00,000 2,28,800 2,28,800 58,500 2,38,500
Cleared balance c/f (c) 2,28,800 2,28,800 58,500 2,38,500 2,26,500
Uncleared funds float
Receipts 1,80,000 1,80,000 1,80,000 0 0
Payments (1,70,000) (1,70,300) 0 (6,500) (6,500)
(d) 10,000 9,700 1,80,000 (6,500) (6,500)
Total book balance c/f 2,38,800 2,38,500 2,38,500 2,32,000 2,20,000
(c) + (d)

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