CS Executive: Financial Management

Index
SN TOPIC NAME PAGE NO

1 TIME VALUE OF MONEY 1.1 - 1.11

2 LEVERAGE 2.1 - 2.15

3 COST OF CAPITAL & CAPITAL STRUCTURE 3.1 - 3.40

4 CAPITAL BUDGETING 4.1 - 4.38

5 WORKING CAPITAL 5.1 - 5.38

6 DIVIDEND DECISION 6.1 - 6.3

7 FINANCIAL STATEMENT & ANALYSIS 7.1 - 7.3

8 NATURE SIGNIFICANCE & SCOPE 8.1 - 8.3

9 PROJECT FINANCE 9.1 - 9.4

10 SECURITY ANALYSIS 10.1 - 10.7

11 PORTFOLIO MANAGEMENT 11.1 - 11.8

Unique Academy Prof. Ashish Parikh8007978700

CS Executive: Financial Management Time Value of Money

1 TIME VALUE OF MONEY

Question 1

An amount of Rs 50,000 is deposited today in a bank for 5 years at 14% p.a. simple interest. What will be the
accumulated amount at the end of 5 Years.

Question 2

An amount of Rs. 50,000 is deposited today at 14% p.a. compound annually. What is the accumulated deposit-
1) After 3 Months
2) After 9 Months
3) After 7 Months

Question 3

Imagine an amount of 600 standing 6 months from today. Find out PV today if discount rate 8% p.a. compounded
annually.

Question 4

An amount of 600 is standing 6 months from now, what is the PV today if discount rate is 9% p.a. compounded
monthly.

Question 5

Redo the previous sum if discount is 9% p.a. compounded quarterly.

Question 6

What if the discount rate is 9% p.a. compounded semi annually?

Question 7

We have to choose one bank out of the following three for investing our saving-
Bank A - 18% p.a. compounded monthly
Bank B - 19.2% p.a. compounded semi annually
Bank C - 20% p.a. compounded annually.

Question 8

Ascertain the compound value and compound interest of an amount of Rs. 75,000 at 8 % compounded semiannually
for 5 years.

Question 9

Suppose you wish to withdraw 80,000 at the end of each year from a bank for 5 years- The first withdrawal to take
place 1 year from now. If interest rate is 9% p.a., what should you deposit in the bank today?

Question 10

Akash Ltd takes a machine on lease. Lease rentals are 40000 at the end of each quarter for 5 years. If interest rate is
10% p.a. compounded quarterly, what is the PV of lease rentals?

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CS Executive: Financial Management Time Value of Money

Question 11

If lease rentals in the previous sum are payable at the beginning of each quarter, what is the PV of rentals?

Question 12

Mr. Yadnesh deposits 80,000 in a bank A/c today. What amount can be withdrawn at the end of each year for 10
years? Take interest rate as 9%.

Question 13

If a person deposits 5,000 at the end of each year in a bank for eight year, what is the accumulated amount at the end of
8 years, if interest rate is 7% p.a. compounded annually?

Question 14

A firm has on B/S 500 lakhs face value of debentures to be redeemed after 10 years. What amount should be set aside
at 8% p.a. in the sinking fund?

Question 15

Consider a stock of P Ltd. It is a growth company. It is expected to pay dividend of 50 at the end of each year forever.
If required rate of return is 10% p.a., what should be the share price?

Question 16

Sunil Ltd. just paid divided of 40. This is expected to grow at 5% p.a. forever. If required rate of return is 13%, what
should be the share price?

Question 17

Mr. Motilal, a retired army officer, has opened an account with a reputed bank. He is required to pay four equal annual
payments of Rs 15,000 each in his deposit account that pays 8% interest per year. Find out the future value of annuity
at the end of 4 years.

Question 18

Rolex Limited offers a fixed deposit scheme whereby Rs 20,000 matures to Rs 25,250 after two years on a half yearly
compounding basis. If the company desires to amend the scheme by compounding interest every quarter, you are
required to determine the revised maturity value?”

Question 19

Mr. Dayanand, an executive in an MNC, is thirty five years old. He has decide it is time to plan seriously for his
retirement. At the end of each per year until he is sixty five, he will save 10000 in a retirement account. If the account
earns 10% p.a., how much will Mr. Dayanand have saved at the age of sixty five?

Question 20

You are Required to Calculate the Effective Annual Rate of Interest of:
1) 15% Nominal p.a. Compounded Quarterly
2) 24% Nominal p.a. Compounded Monthly

Question 21

You are Required to Calculate:

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CS Executive: Financial Management Time Value of Money
1) The cost of a new mobile phone is Rs. 10,000. If the interest rate is 5% , how much would you have to set aside
now to provide this sum in five years ?
2) You have to pay tuition fees amounting to Rs. 12,000 a year at the end of each of the next six years. If the interest
rate is 8%, how much do you need to set aside today to cover these fees?
3) You have invested Rs 60,476 at 8%. After paying the above tuition fees, how much would remain at the end of
six years?

Question 22

Atlus Limited has borrowed Rs. 1,000 to be repaid in equal installments at the end of each of the next 3 years. The
interest rate is 15%. You are required to prepare an amortisation schedule for Atlus Limited.

Question 23

You need a sum of Rs. 1,00,000 at the end of 10 years. You know that the best you can do is to deposit some lump sum
amount today at 6% rate of interest or to make equal payments into a bank account, starting a year from now on which
you can earn 6% interest.

Find Out
1) What amount to be deposited today
2) What amount must be deposited annually?

Question 24

You need a sum of Rs. 1,00,000 at the end of 10 years. You know that the best you can do to deposit some lump sum
amount today at 6% rate of interest or to make equal payments into a bank account, starting a year from now on which
you can earn 6% interest.

Find Out
1) What amount to be deposited today
2) What amount must be deposited annually?

Question 25

If we deposit 60,000 today, what will be the accumulated amount after 9 months if –
Case 1 - Interest Rate = 10% p.a. compounded annually.
Case 2 - Interest Rate = 10% p.a. compounded semi annually.
Case 3 - Interest Rate = 10% p.a. compounded quarterly.
Case 4 - Interest Rate = 9% p.a. compounded monthly.

Question 26

1) Mr Chinto borrowed Rs 1,00,000 from a bank on a one-year 8% term loan, with interest compounded quarterly.
Determine the effective annual interest on the loan?
2) Suppose Sumit has borrowed a 3-year loan of Rs 10,000 at 9 per cent from his employer to buy a motorcycle. If
his employer requires three equal end-of-years repayments, then calculate the annual instalment.

Question 27

Mr. Sahil has bought a new car and has taken a 20 month car loan of 6,00,000. The rate of interest is 12 per cent per
annum. You are required to compute the amount of monthly loan amortization for Mr. Sahil?

Question 28

Whether the present value decreases at a liner rate, at an increasing rate, or at a decreasing rate with the discount rate
and why?

Question 29

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CS Executive: Financial Management Time Value of Money

A person is required to pay four annual payments of Rs 4,000 each in his Deposit account that pays 10 per cent interest
per year. Find out the future value of annuity at the end of 4 years.

Question 30

A doctor is planning to buy an X-Ray machine for his hospital. He has two options. He can either purchase it by
making a cash payment of Rs 5,00,000 or Rs. 6,15,000 are to be paid in six equal annual installments. Which option do
you suggest to the doctor assuming the Rate of Return is 12%? Present Value of Annuity of Re.1 at 12% Rate of
Discount for six years is 4.111.

Question 31

Soham Limited offers a fixed deposit scheme whereby Rs 20,000 matures to Rs 25,250 after two years on a half
yearly compounding basis. If the company desires to amend the scheme by compounding interest every quarter, you
are required to determine the revised maturity value?

Question 32

Mr. Suresh an executive in an MNC, is thirty-five years old. He has decided it is time to plan seriously for his
retirement. At the end of each per year until he is sixty-five, he will save 10,000 in a retirement account. If the account
earns 10 percent per year, how much will Mr. Suresh have saved at the age of sixty-five?

Question 33

You are Required to Calculate the Effective Annual Rate of Interest of:
1) 15% Nominal Per Annum Compounded Quarterly.
2) 24% Nominal Per Annum Compounded Monthly.

Question 34

You are Required to Calculate:

1) The cost of a new mobile phone is Rs 10,000 If the interest rate is 5%, how much would you have to set a side
now to provide this sum in five years?
2) You have to pay tution fee amounting to Rs 12,000 a year at the end of the next six years. If the interest rate is
8%, how much do you need to set aside today to cover these fees?
3) You have invested Rs 60,476 at 8%. After paying the above tuition fees, how much would remain at the end of
six years?

Question 35

Rohit is invested Rs 2,40,000 at annual rate of interest of 10%. What is the amount after 3 years if the compounding is
done?
1) Annually
2) Semi Annually.

Question 36

Explain the Relevance of Time Value of Money in Financial Decisions.

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CS Executive: Financial Management Time Value of Money

MULTIPLE CHOICE QUESTIONS

1. Discounting technique is used to find out: 9. A series of Constant Cash flows occurring at
(a) Terminal Value regular intervals forever is known as:
(b) Compounded Value (a) Growing Annuity
(c) Present Value (b) Perpetuity
(d) Future Value (c) Growing Perpetuity
(d) Annuity
2. The adjustment for time value of money is made
through: 10. Future Value and Present Value, both are based
(a) Interest Rate on:
(b) Inflation Rate (a) Number of Time periods
(c) Growth Rate (b) (b) Interest Rate
(d) None of the above (c) Both (a) and (b)
(d) None of the above
3. Equal annual Cash Flows occurring at the end
of each year for certain period is known as: 11. If the Interest Rate is greater than zero, which of
(a) Annuity the following series you would prefer to receive:
(b) Perpetuity Year 1 Year 2 Year 3 Year 4
(c) Annuity Due (a) ` 500 ` 400 ` 300 ` 200
(d) Deferred Payment
(b) ` 200 ` 300 ` 400 ` 500
4. Equal Annual amount occurring in the (c) ` 350 ` 350 ` 350 ` 350
beginning of certain years are known as:
(a) Annuity (d) Any of the above as all are equal in
(b) Perpetuity total amount.
(c) Annuity Due
(d) (d) Deferred Payment 12. Time Value of Money is an important concept in
finance because it takes into account:
5. Present Value of a future cash flow would (a) Risk
decrease if: (b) (b) Time
(a) Discount Rate is reduced (c) Compound Interest
(b) Discount Rate is increased (d) All of the above
(c) Time Period is decreased
(d) All of the above 13. Which of the following is called an annuity:
(a) Lump Sum after few years
6. Future cash flows are converted to present (b) A Series of Equal and Regular Amounts
values, so that these can be: (c) A Series of Unequal Amounts
(a) Aggregated (d) A Series of Equal and Irregular Amounts
(b) Compared
(c) Used in Decision-making 14. An investor wants to increase the Present Value.
(d) All of the above The rate of discount applied for should be:
(a) Increased
7. ‘Rule of 72, is a short-cut method to estimate (b) Decreased
the: (c) Any of (a) and (b)
(a) Present Values (d) None of the above
(b) Compounding Effect
(c) Both (a) & (b) 15. If n  1 and Rate of Interest > zero, which of
(d) None of the above the following interest factor is equal to one:
(a) Present Value Factor
8. Effective Interest Rate is a factor of: (b) Compound Value Factor
(a) Compounding Frequency (c) Present Value Annuity Factor
(b) (b) Basic Rate of Interest (d) None of the above
(c) Both (a) and (b)
(d) None of the above

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CS Executive: Financial Management Time Value of Money
16. If Time is ‘n’, Rate of Interest is ‘k’ then (c) More than total of Annuity Amount
1  k  (d) None of the above
n
may be called:
(a) Present Value Factor 19. Concept of Future Value and Present Value are:
(b) Compound Value Factor (a) Proportionately related
(c) Compound Value Annuity Factor (b) Inversely related
(d) None of the above (c) Directly related
(d) Not related
17. In a Loan Repayment Schedule, the interest
amount paid each period: 20. If a student is awarded scholarship receivable
(a) Remained Constant over next 12 months, what calculation he should use
(b) Increases to find out the worth of scholarship today?
(c) Decreases (a) Present Value of an Amount
(d) None of the above (b) Future Value of an Amount
(c) Present Value of an Annuity
18. Future Value of an annuity is: (d) Future Value of an Annuity
(a) Equal to Annuity Amount
(b) Less than Annuity Amount

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(c) (a) (a) (c) (b) (d) (b) (c) (b) (c)
11 12 13 14 15 16 17 18 19 20
(a) (d) (b) (b) (d) (b) (c) (c) (b) (c)

ADDITIONAL MULTIPLE CHOICE QUESTIONS

1. Time Value of Money is the reward of (d) Simple Interest

(a) Risk
(b) Inflation 5. Present Value Factor is used to find
(c) Sacrification of C. C (a) Future Value
(d) All of above (b) Present Annuity Value
(c) Present Value at T0
2. ` 1000 invested today will become ` 1210 after 2 (d) Future Annuity Value
years @ 10% P.A.
(a) Simple Interest 6. Future Value Factor is used to find
(b) Compounded Annually (a) Future Value
(c) Compounded Monthly (b) Present Annuity Value
(d) Compounded quarterly (c) Present Value at T0
(d) Future Annuity Value
3. ` 1000 invested today @10% for 3 years
1/ 1  r 
compounded annually will become T
7. is the symbol for
(a) ` 1300
(a) FVF
(b) ` 1331 (b) PVAF
(c) ` 1500 (c) PVF
(d) None of above (d) FVAF

4. Interest on Interest can not be computed in

1  r 
T
8. is the symbol for
following methods:
(a) Compounded Annually (a) FVF
(b) Compounded Monthly (b) PVAF
(c) Compounded Quarterly (c) PVF

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CS Executive: Financial Management Time Value of Money
(d) FVAF (d) A series of equal and Irregular amounts

9. Annuity Due starts from 17. Future cash flows are converted to present
(a) End of the month values, so that these can be:
(b) Mid of the month (a) Aggregated
(c) Beginning of the month (b) (b) Compared
(d) Any time in the month (c) Used in Decision-making
(d) All of the above
10. Ordinary Annuity starts from
(a) End of the month 18. A series of Constant Cash Flows occurring at
(b) Mid of the month regular intervals forever is known as:
(c) Beginning of the month (a) Growing Annuity
(d) Any time in the month (b) Perpetuity
(c) Growing Perpetuity
11. Time Value of Money is an important concept in (d) Annuity
finance because it takes into account:
(a) Risk 19. Future Value and Present Value, both are based
(b) Time on:
(c) Compound Interest (a) Number of Time Periods
(d) All of the above (b) Interest Rate
(c) Both (a) and (b)
12. Discounting technique is used to find out: (d) None of the above
(a) Terminal Value
(b) Compound Value 20. If the Interest Rate is greater than zero, which of
(c) Present Value the following series you would prefer to receive.
(d) Future Value Year 1 Year 2 Year 3 Year 4
(a) ` 500 ` 400 ` 300 ` 200
13. Equal Annual Cash Flows occurring at the end
of each year for certain period are known as: (b) ` 200 ` 300 ` 400 ` 500
(a) Annuity
(b) Perpetuity
(c) ` 350 ` 350 ` 350 ` 350
(c) Annuity Due (d) Any of the above as all are equal in total
(d) Deferred Payments amount

14. Equal annual amounts occurring in the

21. An investor wants to increase the Present Value.
beginning of certain years are known as: The rate of discount applied for should be:
(a) Annuity (a) Increased
(b) Perpetuity (b) Decreased
(c) Annuity Due (c) Any of (a) and (b)
(d) Deferred Payments
(d) None of the above
15. Present Value of a future cash flow would
22. If n  1 and Rate of interest > 0, which of the
decrease if:
following interest factor is equal to one:
(a) Discount Rate is reduced
(a) Present Value Factor
(b) Discount Rate is increased
(b) Compound Value Factor
(c) Time Period is decreased
(c) Present Value Annuity Factor
(d) All of the above
(d) None of the above
16. Which of the following is called an annuity:
23. If Time is ‘n’, Rate of Interest is ‘k’ then
(a) Lump Sum after few years
(b) A series of equal and regular amounts 1  k " may be called:
(c) A series of Unequal Amounts
Unique Academy 1.7 Prof. Ashish Parikh
CS Executive: Financial Management Time Value of Money
(a) Present Value Factor 28. A student deposits some amount daily to
(b) Compound Value Factor accumulate ` 5,000 to pay his tuition fees after one
(c) Compound Value Annuity Factor
year. Which of the following compounding methods
(d) None of the above
of interest should be opted by him:
(a) Compounded Quarterly
24. In a Loan Repayment Schedule, the interest
amount paid each period: (b) Compounded Daily
(a) Remained constant (c) Compounded Half-yearly
(b) Increases (d) Compounded Annually
(c) Decreases
29. Present Value can be calculated with the help of
(d) None of the above
formula
25. Future Value of an annuity is (a) 1  r  n
1 / 1  r  n
(a) Equal to Annuity Amount
(b)
(b) Less than Annuity Amount
(c) More than total of Annuity Amount (c) 1  r  n / 1
(d) None of the above
(d) None of the above
26. Concept of Future Value and Present Value are:
30. Present Value of a Rupee receivable after one
(a) Proportionately related
year is
(b) Inversely related
(a) More than One Rupee
(c) Directly related
(b) Equal to Present Value
(d) Not related
(c) Equal to One Rupee
(d) Equal to Future Value
27. If a student is awarded scholarship receivable
over next 12 months, what calculation he should use 31. Future Value of One Rupee invested today is
to find out the worth of scholarship today? (a) More than One Rupee
(a) Present value of an amount (b) Equal to One Rupee
(b) Future value of an amount (c) Equal to Present Value
(c) Present value of an annuity (d) Less than One Rupee
(d) Future value of an annuity

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(d) (b) (b) (d) (c) (a) (c) (a) (c) (a)
11 12 13 14 15 16 17 18 19 20
(d) (c) (a) (c) (b) (b) (d) (b) (b) (a)
21 22 23 24 25 26 27 28 29 30
(b) (d) (b) (c) (c) (b) (c) (b) (b) (a)
31
(a)

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CS Executive: Financial Management Time Value of Money

Theoretical Concept
TODAY IF WE GET ONE RUPEE ALSO WE CAN INVEST AND EARN INTEREST ALSO.
It means reason behind the concept of time value of money is “INTEREST”

Interest Rate
Comprises

Compensation for deferment Inflation Risk premium

of consumption

Single Amount
Future Value FV  PV 1  r  n
Present Value PV  FV
1  r 
n

Future Value Factor FV  1  r n Present Value Factor PV  1

1  r 
n
 It is future value of rupee one
 It will be equal to or more than 1
 Also known as compounding factor

Calculation of “r” in above formula:

Method 1:
r   FV / PV  To calculate 21/5 .
1/ n

 Type 2
 Press 12 times
 Deduct 1
 Divide by 5
 Add 1
 Square    12 times.

Three Important Functions of Finance Manger

1) Financing
2) Investing
3) Dividend Decision

“Main Objective of Financial Management is to Maximize Shareholder’s Wealth.”

When any Investor Invest his Money somewhere he always expects something in return.
1) Scarification of Current Consumption.
2) Inflation
3) Risk Premium
i.e. Interest.

 To go from Present to Future is Known as Compounding.

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CS Executive: Financial Management Time Value of Money
 To g from Future to Present is Known as Discounting.

Formula
F V = P V (𝟏 + 𝒓)𝒏

Where,
F V = Future Value
P V = Present Value
r = Rate of Interest for the Period
n = No. of Compounding / Period

Formula
𝑭𝑽
PV=
(𝟏 + 𝒓)𝒏

To Covert Present Value in to Future Value multiply with Compounded Value Factor (C V F) / Future Value Factor
(FVF)

1
To Covert Future Value in to Present Value Divide by PVF or Multiply by
(1 + 𝑟)𝑛

Examples % Converted into Factor

15% 16% 7% 2.5% 18.5%
1.15 1.16 1.07 1.025 1.185

Interest 12% P.a.

Compounded Compounded Compounded Compounded

Annually Semi-Annually Quartertly Monthly

No Amount Can Divide 12% by 2 Divide 12% by 4 Divide 12% by 1

Divide this Rate 12 M 12% 12 M 12% 12 M 12%
6M 𝑥 4M 𝑥 1M 𝑥

 If Rate of Interest (r) = 12% P.a (Compounded Annually) Find 6 Months Rate.

Here, We Can’t Say

12%
= 6%
2
This will be Absolutely Wrong.

12%
If Compounded Semi Annually then = 6% is Correct.
2

Example:
Axis Bank: Rate of Interest (r) 20% p.a Compounded Quarterly.

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CS Executive: Financial Management Time Value of Money
ICICI Bank Rate of Interest (r) 20% p.a Compounded Annually.
Out of the Above two which Bank gives more Return.

Answer : Axis Bank.

Reason : More Compounding more Benefits.

“Annuity means when we Pay or Receive Similar Sum of Money Regularly at Constant Internal.”

 If Annuity amount is starting from at the End of each Year it is Known as “Regular Annuity”.
P V of Annuity = Annuity × PVAF (r,t)

If Present Value of Annuity is given & you need to Calculate the Annuity Amount.
PV
Annuity = P V A F (r,t)

If Annuity Amount is given & you have to Find Out F V.

F V of Annuity = Annuity × FVAF (r,t)

To Find, Annuity × FVAF (r,t) Formula will be,

A
= [(1 + i)n- 1]
i

If Future Value of Annuity is given & you need to Calculate the Annuity Amount.
FV
Annuity = F V A F (r,t)

“Perpetuity is the Annuity will continue forever.”

A
Perpetuity = i

“Koi bhi Asset ki Aaj Ki Price Kya Honi Chahiye.”

P V of Future Cash Flows….
This Technique is known as Discounted Value of Future Cashflow (DCF).

Why we buying a Bond or Shares ????

To enjoy Future Cashflow

If Company’s Dividend Pay out Ratio is 100%, It means there is no Plogh Back. It means that it is no growth

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CS Executive: Financial Management Leverage

2 LEVERAGE

Question 1

FL = 1.4
The firm has 14% debt of Rs 100L, Calculate EBIT.

Question 2

Turnover = 2000 Crores

PV Ratio = 30%
OFC = 120 Crores
Interest Expenses = 40 Crores
Preference Dividend = 10 Crores
Tax Rate = 40%

Calculate the Operating Leverage, Financial Leverage and Combined Leverage.

Question 3

Consider the following information for Strong Ltd:

Particulars Rs in Lakh
EBIT 1,120
PBT 320
Fixed Cost 700

Calculate the Percentage of change in earnings per share if sales increased by 5%.

Question 4

The data relating to two Companies are as given below:

Particulars Company A Company B

Equity Capital RS 6,00,000 Rs 3,50,000
12% Debentures Rs 4,00,000 Rs 6,50,000
Output (Units) Per Annum 60,000 15,000
Selling Price / Unit Rs 30 Rs 250
Fixed Costs Per Annum Rs 7,00,000 Rs 14,00,000
Variable Cost Per Unit Rs 10 Rs 75

You are required to Calculate the Operating Leverage, Financial Leverage and Combined Leverage of Two Companies
Question 5

Annual sales of a company is Rs. 60,00,000. Sales to Variable Cost ratio is 150% and Fixed Cost other than interest is
Rs. 5,00,000 p.a. Company has 11% debentures of Rs. 30,00,000.

You are Required to Calculate the Operating Leverage, Financial Leverage and Combined Leverage of the Company.

Question 6

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CS Executive: Financial Management Leverage
From the following details of X Ltd. Prepare the Income Statements for the year ended 31 st December 2014:

Financial Leverage 2
Interest Rs 2,000
Operating Leverage 3
Variable Cost as a Percentage of Sales 75%
Income Tax Rate 30%

Question 7

Following information are related to four firms of the same industry :

Firm Change in Revenue Change in Operating Income Change in Earnings Per Share
P 27% 25% 30%
Q 25% 32% 24%
R 23% 36% 21%
S 21% 40% 23%

Find Out:
1) Degree of Operating Leverage
2) Degree of Combined Leverage for all the firms.

Question 8

From the following prepare Income Statement of Company A, B and C. Briefly comment on each company’s
performance:

Company A B C
Financial Leverage 3:1 2:1
Interest Rs 200 Rs 1,000
Operating Leverage 4:1 3:1
Variable Cost as a Percentage to Sales 66 2/3% 50%
Income Tax Rate 45% 45%

Question 9

The net sales of A Ltd is Rs 30 crores. Earnings before interest and tax of the company as a percentage of net sales is
12% The Capital employed comprises Rs 10 crores of equity Rs 2 crores of 13% Cumulative Preference Share Capital
and 15% Debentures of Rs 6 crores Income tax rate is 10%
1) Calculate the Return-on-equity for the company and indicate its segments due to the presence of Preference Share
Capital and Borrowing (Debentures).
2) Calculate the Operating Leverage of the Company given that combined leverage is 3.

Question 10

Consider the following information for Jaguar Ltd:

Particulars Rs in Lakh
EBIT 1,120
PBT 320 Rs in Lakh
Fixed Cost 700 Rs in Lakh

Calculate the Percentage of change in earnings per share, if sales increased by 5%.

Question 11

Consider the following information for XYZ Ltd:

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CS Executive: Financial Management Leverage

Particulars Rs in Lakh
EBIT (Earnings before Interest and Tax) 15,750
Earnings before Tax (EBT): 7,000
Fixed Operating Costs: 1,575

Required:
Calculate Percentage change in earnings per share, if sales increase by 5%

Question 12

Suresh Limited has estimated that for a new Product its break-even point is 20,000 units if the item is sold for 14 per
unit and variable cost Rs 9 per unit. Calculate the degree of Operating leverage for sales volume 25,000 units and
30,000 units.

Question 13

Ramdas Limited is considering the installation of a new project costing Rs 80,00,000

Expected annual sale revenue from the Projects is Rs 90,00,000 and its variable costs are 60% of sales. Expected
annual fixed cost other than interest is Rs 10,00,000 Corporate tax rate is 30 percent. The company wants to arrange
the funds through issue of 4,00,000 equity shares of Rs 10 each and 12 % debentures of Rs 40,00,000.

You are required to:

1) Calculate the operating financial and combined leverages and earnings per share (EPS); and also
2) Determine the likely level of EBIT, if EPS is (i) Rs 4, (ii) Rs 2, (iii) 0.

Question 14

You are required to compute the operating leverages for each of the four firms P, Q, R and S from the following price
and cost data. What inferences can you draw with respect to levels of fixed cost and the degree of operating leverage
result? Assume number of units sold is 5,000

Particulars Firms
P (Rs.) Q (Rs.) R (Rs.) S (Rs.)
Sale Price Per Unit 20 32 50 70
Variable Cost Per Unit 6 16 20 50
Fixed Operating Cost 80,000 40,000 2,00,000 Nil

Question 15

Calculate the Degree of Operating Leverages, Degree of Financial Leverages and the Degree of Combined Leverage
for the following firms and interpret the results:

Particulars X Y Z
Output (Units) 2,50,000 1,25,000 7,50,000
Fixed Cost (Rs) 5,00,000 2,50,000 10,00,000
Unit Variable Cost (Rs) 5 2 7.50
Unit Selling Price (Rs) 7.50 7 10.0
Interest Expense (Rs) 75,000 25,000 -

Question 16

You are given two financial plans of a company which has two financial situations. The detailed information are as
under:

Installed Capacity 10,000 Units

Actual Production and Sales 60% of Installed Capacity

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CS Executive: Financial Management Leverage
Selling Price Per Unit Rs 30
Variable Cost Per Unit Rs 20

Fixed Cost:
Situation ‘A’ = Rs 20,000
Situation ‘B’ = Rs 25,000

Capital structure of the company is as follows:

Financial Plans
Particulars AB (Rs.) AC (Rs.)
Equity 12,000 35,000
Debt (Cost of Debt 12%) 40,000 10,000
52,000 45,000

You are Required to Calculate Operating Leverage and Financial Leverage of both the plans.

Question 17

The capital structure of MKPL Ltd. is as follows:

Equity Share Capital of Rs 10 Each 8,00,000

8% Preferences Share Capital of Rs 10 Each 6,25,000
10% Debenture of Rs 100 Each 4,00,000
18,25,000

Additional Information:
1) Profit After Tax (Tax Rate 30%) Rs 1,82,000
2) Operating expenses (including depreciation Rs 90,000) being 1.50 times of EBIT
3) Equity share dividend paid 15%
4) Market price per equity share Rs 20.

Require to Calculate:
1) Operating Leverage and Financial Leverage
2) Cover for the Preference and Equity Share of Dividends
3) The Earning Yield and Price Earnings Ratio
4) The Net Funds Flow

MULTIPLE CHOICE QUESTIONS

1. Operating leverage helps in analysis of: (a) Addition
(a) Business Risk (b) Subtraction
(b) Financing Risk (c) Multiplication
(a) Production Risk (d) Any of these
(b) Credit Risk
4. High degree of financial leverage means:
2. Which of the following is studied with the help (a) High debt proportion
of financial leverage? (b) Lower debt proportion
(a) Marketing Risk (c) Equal debt and equity
(b) Interest Rate Risk (d) No debt
(c) Foreign Exchange Risk
(d) Financing Risk 5. Operating leverage arises because of:
(a) Fixed Cost of Production
3. Combined Leverage is obtained from OL and (b) Fixed Interest Cost
FL by their: (c) Variable Cost

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CS Executive: Financial Management Leverage
(d) None of the above (d) Sales and EPS

6. Financial Leverage arises because of: 14. Use of Preference Share Capital in Capital
(a) Fixed cost of production structure:
(b) Variable Cost (a) Increases OL
(c) Interest Cost (b) Increases FL
(d) None of the above (c) Decreases OL
(d) Decreases FL
7. Operating Leverage is calculated as:
(a) Contribution  EBIT 15. Relationship between change in sales and
(b) EBIT  PBT change in EPS is measured by:
(c) EBIT  Interest (a) Financial Leverage
(d) EBIT  Tax (b) Combined Leverage
(c) Operating Leverage
8. Financial Leverage is calculated as: (d) None of the above
(a) EBIT  Contribution
(b) EBIT  PBT 16. Operating leverage works when:
(c) EBIT  Sales (a) Sales Increases
(d) EBIT  Variable Cost (b) Sales Decreases
(c) Both (a) and (b)
9. Which combination is generally good for a firm? (d) None of (a) and (b)
(a) High OL, High FL
(b) Low OL, Low FL 17. Which of the following is correct?
(c) High OL, Low FL (a) CL  OL  FL
(d) None of these (b) CL  OL  FL
(c) CL  OL  FL
10. Combined leverage can be used to measure the (d) CL  OL  FL
relationship between:
(a) EBIT and EPS 18. If the fixed cost of production is zero, which one
(b) PAT and EPS of the following is correct?
(c) Sales and EPS (a) OL is zero
(d) Sales and EBIT (b) FL is zero
(c) CL is zero
11. FL is zero if: (d) None of the above
(a) EBIT  Interest
(b) EBIT  zero 19. If a firm has no debt, which one is correct?
(c) EBIT  Fixed Cost (a) OL is one
(d) EBIT  Pref. Dividend (b) FL is one
(c) OL is zero
12. Business risk can be measured by: (d) FL is zero
(a) Financial Leverage
(b) Operating Leverage 20. If a company issues new share capital to redeem
(c) Combined Leverage debentures, then:
(d) None of the above (a) OL will increase
(b) FL will increase
13. Financial Leverage measures relationship (c) OL will decrease
between: (d) FL will decrease
(a) EBIT and PBT
(b) EBIT and EPS 21. If a firm has a DOL of 2.8, it means:
(c) Sales and PBT

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CS Executive: Financial Management Leverage
(a) If sales increase by 2.8&, the EBIT will increase by (b) Equity
1%. (c) Fixed Cost
(b) If EBIT increase by 2.8&, the EPS will increase by (d) Variable Cost
1%.
(c) If sales rise by 1%, EBIT will rise by 2.8%. 23. Higher FL is related the use of:
(d) None of the above (a) Higher Equity
(b) Higher Debt
22. Higher OL is related to the use of higher: (c) Lower Debt
(a) Debt (d) None of the above

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(a) (d) (c) (a) (a) (c) (a) (b) (c) (c)
11 12 13 14 15 16 17 18 19 20
(b) (b) (b) (b) (b) (c) (c) (d) (b) (d)
21 22 23
(c) (c) (b)

24. In order to calculate EPS, Profit after Tax and (c) EPS is Infinite
Preference Dividend is divided by: (d) EPS is Negative
(a) MP of Equity Shares
(b) Number of Equity Shares 29. Relationship between change in Sales and
(c) Face Value of Equity Shares change in Operating Profit is known as:
(d) None of the above (a) Financial Leverage
(b) Operating Leverage
25. Trading on Equity is: (c) Net Profit Ratio
(a) Always beneficial (d) Gross Profit Ratio
(b) May be beneficial 30. If a firm has no Preference share capital,
(c) Never beneficial Financial Break-even level is defined as equal to:
(d) None of the above (a) EBIT
(b) Interest Liability
26. Benefit of ‘Trading on Equity’ is available only (c) Equity Dividend
if: (d) Tax Liability
(a) Rate of Interest < Rate of Return
(b) Rate of Interest > Rate of Return 31. At Indifference level of EBIT, different capital
(c) Both (a) and (b) plans have:
(d) None of (a) and (b) (a) Same EBIT
(b) Same EPS
27. Indifference Level of EBIT is one at which: (c) Same PAT
(a) EPS is zero (d) Same PBT
(b) EPS is Minimum
(c) EPS is highest 32. Which of the following is not a relevant factor in
(d) None of these EBIT-EPS Analysis of capital structure?
(a) Rate of Interest on Debt
28. Financial Break-even level of EBIT is one at (b) Tax Rate
which: (c) Amount of Preference Share Capital
(a) EPS is one (d) Dividend paid last year
(b) EPS is zero

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CS Executive: Financial Management Leverage
33. For a constant EBIT, if the debt level is further (b) Both plans are good
increased then: (c) One is better than other
(a) EPS will always increase (d) None of the above
(b) EPS may increase
(c) EPS will never increase 35. Financial break-even level of EBIT is:
(d) None of the above (a) Intercept at Y-axis
(b) Intercept at X-axis
34. Between two capital plans, if expected EBIT is (c) Slope of EBIT-EPS line
more than indifference level of EBIT, then (d) None of the above
(a) Both plans be rejected

ANSWER KEYS
24 25 26 27 28 29 30 31 32 33
(b) (b) (a) (d) (b) (b) (b) (b) (d) (b)
34 35
(c) (b)

ADDITIONAL MULTIPLE CHOICE QUESTIONS

1. EBIT / EBT is the formula for (a) 0.715

(a) Operating Leverage (b) 1.4
(b) Financial Leverage (c) 2.5
(c) Combined Leverage (d) 3.5
(d) None of the above
7. Operating Leverage of 2 gives us the relation
2. Contribution / EBIT is the formula for between
(a) Operating Leverage (a) Sales and EPS
(b) Financial Leverage (b) Sales and EBIT
(c) Combined Leverage (c) EBIT and EBT
(d) None of above (d) Sales and Contribution

3. Contribution / EBT is the Formula for 8. Financial Leverage of 2 gives us the relation
(a) Operating Leverage between
(b) Financial Leverage (a) Sales and EPS
(c) Combined Leverage (b) Sales and EBIT
(d) None of above (c) EBIT and EBT
(d) Sales and Contribution
4. If Sales  10 L, EBIT  5L, Contribution 
7L, EBT  2L then Operating Leverage will be 9. Combined Leverage of 2 gives us the relation
(a) 0.715 between
(b) 1.4 (a) Sales and EPS
(c) 2.5 (b) Sales and EBIT
(d) 3.5 (c) EBIT and EBT
(d) Sales and Contribution
5. If Sales  10L, EBIT  5L, Contribution 
7L, EBT  2L then Financial Leverage will be 10. Combined Leverage will be higher if
(a) 0.715 (a) we increase Fixed cost
(b) 1.4 (b) we increase Interest cost
(c) 2.5 (c) we increase Fixed and Interest cost both
(d) 3.5 (d) Any of above

6. If Sales  10L, EBIT  5L, Contribution  11. Operating Leverage will be higher if
7L, EBT  2L then Combined Leverage will be (a) we increase Fixed cost

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CS Executive: Financial Management Leverage
(b) we increase Interest cost (a) Fixed cost of production
(c) we increase Fixed and Interest cost both (b) Fixed Interest cost
(d) Any of above (c) Variable cost
(d) None of the above
12. Financial Leverage will be higher if
(a) we increase Fixed cost 21. Financial Leverage arises because of
(b) we increase Interest cost (a) Fixed cost of production
(c) we increase Fixed and Interest cost both (b) Variable cost
(d) Any of above (c) Interest cost
(d) None of the above
13. If Operating Leverage is 2 and Combined
Leverage is 5 then Financial Leverage will be 22. Operating Leverage is calculated as
(a) 10 (a) Contribution  EBIT
(b) 2/5 (b) EBIT  PBT
(c) 2.5 (c) EBIT  Interest
(d) 3 (d) EBIT  Tax

14. If Operating Leverage is 2 and Financial 23. Financial Leverage is calculated as:
Leverage is 5 then Combined Leverage will be (a) EBIT  Contribution
(a) 10 (b) EBIT  PBT
(b) 2/5 (c) EBIT  Sales
(c) 2.5 (d) EBIT  Variable cost
(d) 3
24. Which combination is generally good for a firm?
15. If Financial Leverage is 2 and Combined (a) High OL, High FL
Leverage is 5 then Operating Leverage will be (b) Low OL, Low FL
(a) 10 (c) High OL, Low FL
(b) 2/5 (d) None of these
(c) 2.5
(d) 3 25. Combined leverage can be used to measure the
relationship between
16. Operating Leverage helps in analysis of (a) EBIT and EPS
(a) Business risk (b) PAT and EPS
(b) Financial risk (c) Sales and EPS
(c) Production risk (d) Sales and EBIT
(d) Credit risk
26. FL is zero if:
17. Which of the following is studied with the help (a) EBIT  Interest
of financial leverage? (b) EBIT  Zero
(a) Marketing risk (c) EBIT  Fixed cost
(b) Interest rate risk (d) EBIT  Fixed cost
(c) Foreign Exchange risk
(d) Financial risk 27. Business risk can be measured by:
(a) Financial leverage
18. Combined Leverage is Obtained from OL and (b) Operating leverage
FL by their (c) Combined leverage
(a) Addition (d) None of the above
(b) Subtraction
(c) Multiplication 28. Financial Leverage measures relationship
(d) Any of these between
(a) EBIT and PBT
19. High degree of financial leverage means (b) EBIT and EPS
(a) High debt proportion (c) Sales and PBT
(b) Lower debt proportion (d) Sales and EPS
(c) Equal debt and equity
(d) No debt 29. Use of preference Share Capital in Capital
structure
20. Operating leverage arises because of (a) Increases OL
Unique Academy 2.8 Prof. Ashish Parikh
CS Executive: Financial Management Leverage
(b) Increases FL (c) Lower Debt
(c) Decreases OL (d) None of the above
(d) Decreases FL
39. If Operating Leverage  2, Sales increases by
30. Relationship between change in sale and change 20% then EBIT will
in EPS is measured by (a) Increased by 40%
(a) Financial leverage (b) Decreased by 40%
(b) Combined leverage (c) Will not changed
(c) Operating leverage (d) Will increase by 10%
(d) None of the above
40. If Operating Leverage  2, EBIT Increases by
31. Operating leverage works when 20% then Sales will
(a) Sales increases (a) Increased by 40%
(b) Sales Decreases (b) Decreased by 40%
(c) Both (a) and (b) (c) Will not changed
(d) None of (d) and (b) (d) Will increase by 10%
32. Which of the following is correct? 
CL  OL  FL
41. If Financial Leverage 2, EBIT increases by
(a)
CL  OL  FL
20% then EBT will
(b)
OL  OL  FL
(a) Increased by 40%
(c)
OL  OL  FL
(b) Decreased by 40%
(d) (c) Will not changed
(d) Will increase by 10%
33. If the fixed cost of production is zero, which one
of the following is correct? 42. If Financial Leverage  2, EBT increases by
(a) OL is zero 20% then EBIT will
(b) FL is zero (a) Increased by 40%
(c) CL is zero (b) Decreased by 40%
(d) None of the above (c) Will not changed
(d) Will increase by 10%
34. If a firm has no debt, which one is correct?
(a) OL is one 43. If Combined Leverage  2, Sales increases by
(b) FL is one 20% then EPS will
(c) OL is zero (a) Increased by 40%
(d) FL is zero (b) Decreased by 40%
(a) Will not changed
35. If a company issues new share capital to redeem (b) Will increase by 10%
debentures, then
(a) OL will increase 44. If Combined Leverage  2, EPS increases by
(b) FL will increase 20% then Sales will
(c) OL will decrease (a) Increased by 40%
(d) FL will decrease (b) Decreased by 40%
(c) Will not changed
36. If a firm has a DOL of 2.8, it means: (d) Will increase by 10%
(a) If Sales increases by 2.8%, the EBIT will increase
by 1%
(b) If EBIT increase by 2.8%, the EPS will increase by 45. If Combined Leverage  2, Sales decreases by
1% 20% then EPS
(c) If Sales rise by 1%, EBIT will rise by 2.8% (a) Increased by 40%
(d) None of the above (b) Decreased by 40%
(c) Will not changed
37. Higher OL is related to the use of higher (d) Will increase by 10%
(a) Debt (b) Equity
(c) Fixed cost (d) Variable cost 46. If Combined Leverage  2, Operating Leverage
is 1 then Financial Leverage will be
38. Higher FL is related the use of (a) 2.0
(a) Higher Equity (b) 3.0
(b) Higher Debt (c) 0.5
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CS Executive: Financial Management Leverage
(d) 1.0
49. Operating Leverage is 3:1, Financial Leverage is
47. Operating Leverage is 3:1, Financial Leverage is 2:1, Interest Charges  ` 20 Lakhs
2:1, Interest Charges  ` 20 Lakhs Tax Rate  50%,
Tax Rate  50% Variable cost as % of Sales  60%, Fixed cost will
Variable cost as % of Sales  60%, EBIT will be be
(a) ` 1,20,00,000 (a) ` 1,20,00,000
(b) ` 40,00,000 (b) ` 40,00,000
(c) ` 80,00,000 (c) ` 80,00,000
(d) ` 180,00,000 (d) ` 180,00,000

48. Operating Leverage is 3:1, Financial Leverage is 50. Operating Leverage is 3:1, Financial Leverage is
2:1, Interest Charges  ` 20 Lakhs 2:1, Interest Charges  ` 20 Lakhs
Tax Rate  50% Tax Rate  50%
Variable cost as % of Sales  60%, Contribution Variable cost as % of Sales  60%, Variable cost
will be will be
(a) ` 1,20,00,000 (a) ` 1,20,00,000
(b) ` 40,00,000 (b) ` 40,00,000
(c) ` 80,00,000 (c) ` 80,00,000
(d) ` 180,00,000 (d) ` 180,00,000
ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(b) (a) (c) (b) (c) (d) (b) (c) (a) (c)
11 12 13 14 15 16 17 18 19 20
(a) (b) (c) (a) (c) (a) (d) (c) (a) (a)
21 22 23 24 25 26 27 28 29 30
(c) (a) (b) (c) (c) (b) (b) (a) (b) (b)
31 32 33 34 35 36 37 38 39 40
(c) (a) (d) (b) (d) (c) (c) (b) (a) (d)
41 42 43 44 45 46 47 48 49 50
(a) (*) (a) (d) (b) (a) (b) (a) (c) (d)

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CS Executive: Financial Management Leverage

Theoretical Concept
Tendency of Disproportionate change is called LEVERAGE. It is created Due to Fixed Expenses. It Indicates risks.
Higher the leverage higher the risk.

TYPE OPERATING FINANCIAL TOTAL

 Operating Fixed cost
 Interest
Reason Operating Fixed Cost  Interest
 Dividend on preference share
 Dividend on preference shares
%Changein EBIT % Change in EPS % Change in EPS
Formula
% Changein Sales % Change in EBIT % Change in Sales
EBIT Contribution
Shortcut Contribution
Dp Dp
Formula Contribution  fixed Cost EBIT  Interest  Contribution  Fixed Cost  Interest 
1 t 1 t
Another Contribution EBIT
(only if D p  0) DOL  DFL
Shortcut EBIT PBT

CONCEPTS OF MARGINAL COSTING USED IN LEVERAGES:

1. Variable cost is variable and fixed cost is fixed in total.

2. Variable cost is fixed and fixed cost is variable per unit.
3. If Fixed cost per unit is given in the question then number of units at which it is calculated must also be given.
4 Contribution  Sales – Variable cost
5 Contribution per unit  Selling price – Variable cost per unit.

 Break Even Point  units  

Fixed Cost
Contribution per unit

 Break Even Point  amount   Fixed Cost

PV Ratio

 Margin of Safety (amount)  Sales – BEP

 Sales  BEP
Margin of Safety  %   100
Sales

IF MARGIN OF SAFETY BUSINESS RISK DOL ( = 1 MOS)

Rises Falls Falls
Falls Rises Rises

1. It may be used to forecast EBIT. If DOL is 2 it means that 10% change in Sales will bring 20% change in EBIT.

2. If Fixed cost rises DOL rises and EPS falls. Both are bad. Therefore fixed cost if preferable on lower side.

3. If Sales rises DOL reduces and EPS increase. Both are good. Therefore sales is preferable on higher side.

4. DOL is preferable on lower side. Because in that case business risk will be lower and EBIT will be higher.

SPECIAL POINTS IN QUESTIONS:

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CS Executive: Financial Management Leverage

1. If contribution and fixed cost are not given then we can calculate it as follows:
(a) Contribution  Sales  P/V ratio.
(b) Fixed Cost  B.E. P  P/V ratio.

2. Fixed cost per unit is ` 14 at 60,000 units. Means total fixed cost is 14  60,000  ` 8,40,000. Now even if we have
to calculate DOL at 70,000 units fixed cost will remain same, i.e. ` 8,40,000

COMMENTS ON DFL
1. It measures financial risk. Higher the DFL higher the financial risk and vice versa.
2. It may be used to forecast EPS. If DFL is 3 it means that if EBIT increase by 10%, EPS will increase by 30%.
3. If interest rate increases also DFL increases but EPS reduces. Both are bad. Hence interest rate is preferable on
lower side.
4. If EBIT increases DFL reduces and EPS increase. Both are good. Hence EBIT is preferable on higher side.
5. If debt equity ratio increases DFL also increases. But in that case impact on EPS is dependent on ROI.
(a) If ROI > r. EPS will also increase due to advantage of trading on equity. Hence higher debt is preferable.
(b) If ROI < r. EPS will reduce due to disadvantage of trading on equity. Hence lower debt is preferable.
(c) If ROI  R. EPS will remain same.
(d) ROI remains more than interest rate on an average hence debt is preferable on higher side but sometimes ROI
may reduce hence level of debt should not be very high.

SPECIAL POINTS IN QUESTIONS:

1. If dividend tax is given in the question than add it to amount of dividend on preference shares while calculation of
EPS or DFL.
2. If both rate of interest and rate of dividend on preference shares are same still debt option will have higher EPS
and lower DFL. Because you get tax benefit on interest but not on preference dividend. On the contrary you will
have to pay dividend tax on dividend.
3. If question ask to calculate new EPS after a change in EBIT, try to use DFL formula in place of making an income
statement.

 COMMENTS ON DTL
1. DTL measures total risk. Higher the DTL higher the total risk and vice versa.

2. It may be sued to forecast to EPS. If DTL is 6 it means that 10% increase in sales will bring 60% increase in EPS.

3. DTL is preferable on moderate side.

DOL DFL COMMENTS

Low Low Lower total risk. Can not take advantage of trading on equity.
High High Higher total risk. Very risky combination.
High Low Moderate total risk. Not a good combination. Lower EBIT due to higher DOL and lower
advantage of trading on equity due to low DFL.
Low High Moderate total risk. Best combination. Higher financial risk is balanced by lower total business
risk.

SPECIAL POINTS IN QUESTIONS:

1. If question ask to calculate new EPS after a change in sales try to use DTL formula in place of making income
statement.

Unique Academy 2.12 Prof. Ashish Parikh

CS Executive: Financial Management Leverage

2. If a question gives DOL, DFL, PV ratio and amount of interest then first put interest amount in DFL formula to
calculate EBIT. Then put EBIT in DOL formula to calculate contribution. Then put contribution in PV ratio formula to
calculate Sales.

3. If the question says that 25% decline in sales will wipe out EPS. It means that EPS will become zero means it will
reduce by 100%. Here DTL  100%  4 .
25

 Ratio means Mathematical relationship between Two or More Variables.

 Variable Cost which Vary Proportional with the Change in Level of Output.

 Fixed Cost which remain Constant in Totality upto a certain Level of Activity. In other words it does Not Change
with the Change in Level of Output.

 Operating Costs are the Expenses which are related to the Operation of a Business.

 Operating Fixed Costs means such Expenses which does not Change with the Change in Level of Output.

 Financing Cost known as Cost of Finance.

 Fixed Financing Cost

Eg. Interest on Debt, Preference Dividend Interest on Debt Company has to Pay whether there is Profit or No
Profit.

 Income Statement Chart

While Explaining the above Formula Explain This

Particulars Amount in (xxx)

Sales xxx
VC xxx
Contribution xxx
Fixed Cost xxx
EBIT xxx
Interest xxx
EBT xxx
Tax xxx
EAT xxx
Preference Dividend xxx
Amount Available for Equity or Dividend ESH xxx

Earning for Equity Share Holder

Rate on Equity (ROE) = Equity Share Holder Fund
× 100

 Higher the Fixed Cost Higher the D O L

Lower the Fixed Cost Lower the D O L
No Fixed Cost D O L will be 1

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CS Executive: Financial Management Leverage

Higher the Fixed Financial Cost

Higher the DFL

Lower the Fixed Financial Cost

Lower the DFL

No of Fixed Financial Cost

DFL = 1

 Return on Investment (ROI)

EBIT
Or =
Capital Employed
Return on Capital Employed (ROCE)

Capital Employed = E S C + R + S + P S C + Debt

PAT−Preference Dividend
 Return on Equity (ROE) =
Net Worth

Capital Employed = E S C + R + S

Turnover (Sales)
 Total Assets Turn Over Ratio =
Total Assets

Total Assets = Fixed Assets + Current Assets

How to Remember Formulae

 Write Formulae
Original Formula Downward to Upward
Short Cut Formula Upward to Downward

 If Preference Dividend is given then,

EBIT
DFL= Preferce Dividend
EBIT – Interest – 1−t
Where t = Tax Rate

 If Preference Dividend is given then,

Contribution
DCL= Preferce Dividend
EBIT – Interest – 1−t
Where t = Tax Rate

 To Convert PBT into PAT

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CS Executive: Financial Management Leverage
PAT = PBT (1 - t)

 To Convert PAT into PBT

PAT
PBT =
(1 − t)

 To Convert any Pre-Tax item to Post Tax item Multiply by (1 - t)

 To Convert any Post Tax item to Pre-Tax item Divide by (1 - t)

 If question requires to write Inferences or Interpretation.

Always write General Inferences.

Higher the Fixed Cost Higher the D O L

Lower the Fixed Cost Lower the D O L
If Fixed Cost = 0 , Then D O L = 1

(Same for the DFL)

Write instead of Fixed Cost Interest

(Same for the DFL)

Write instead of Fixed Cost Interest & Fixed Cost

 If Firm is Operating below BEP, Leverage is Negative.

Unique Academy 2.15 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

3 COST OF CAPITAL & CAPITAL STRUCTURE

Question 1

Consider a 4 years, ZCB of FV 1000 present by trading at 690. If floating cost is 2%, calculate the cost of ZCB to the
company?

Question 2

A firm issues a perpetual bond of FV 1000 at Rs 970.

Floating cost is Rs 10 per bond
Coupon rate on the bond is 10% and the firm’s tax rate is 35%. Find out the post tax cost of debenture.

Question 3

Consider a bond with the following features-

FV = 1000
Maturity = 5 Years
Coupon Rate = 12% Payable Annually
MP = 980
Floatation Cost = 2% on MP.
Bond is Redeemable at a Premium of 5% at the end of 5 year
Tax Rate =30%
Calculate Post Tax Cost of Debentures.

Question 4

FV of in Share = 100
Dividend Rate = 12%
Maturity = 5 years
MP = 90%
Floatation Cost = 3%
CDT = 10%
Calculate cost of preference capital

Question 5

The following is an extract of Balance Sheet of X Itd. As on 31 st Dec’15.

Particulars Amt (Rs in L)

Eq. Share Capital (10,000 eq. Share at 100 each) 10
Reserve and Surplus 190
10% Preference Capital (10,000 Share at 10 each) 10
9% Debentures (50,000 Debentures at 100 each) 50
12% Term loan 150

MP of Eq. Share = 800

MP of Preference Share = 11 (4 Years remaining to Maturity)
MP of Debenture = 108 (6 Years remaining to Maturity)
Floatation Cost of Preference Share = 1%
Floatation Cost of Debenture = 2%

Unique Academy 3.1 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
CDT Rate = 10%
Corporate Tax Rate = 30%
Cost of Equity = 16%

Calculate WACC Using -

1) BV as Weights
2) MV as Weights

Question 6

You are required to determine the weighted average cost of capital of a firm using 1) Book- Value Weights and 2)
Market Value Weights. The following information is available for your perusal :
Present book value of the firm’s capital structure is:

Particulars Rs
Debentures of Rs 100 each 8,00,000
Preference Shares of Rs 100 each 2,00,000
Equity Shares of Rs 10 each 10,00,000
20,00,000

All these securities are traded in the capital markets. Recent prices are: Debentures @ Rs 110, Preference Shares @
120 and Equity Shares @ Rs 22.
Anticipated external financing opportunities are as follows:
1) Rs 100 per Debenture Redeemable at Par : 20 Years Maturity 8% Coupon Rate, 4% Floatation Costs, Sale Price
Rs 100.
2) Rs 100 Preference Share Redeemable at Par : 15 Years Maturity, 10% Dividend Rate, 5% Floatation Costs, Sale
Price Rs 100.
3) Equity Shares : Rs 2 Per Share Floatation Costs, Sale Price Rs 22. In addition, the dividend expected on the
Equity Share at the end of the years is Rs 2 Per Share; the anticipated Growth Rate in Dividends is 5% and the firm has
the practice of paying all its earnings in the form of dividend. The Corporate Tax Rate is 50%.

Question 7

The following information is given for Gamma Limited. You are Required to Compute the Weighted Average Cost of
Capital of the company.

1) Total Capital Employed Rs. 20,00,000

2) Debt-Equity Mix 40% 60%
3) Cost of Debt:
Upto Rs 4,80,000 10% (Before Tax)
Beyond Rs 4,80,000 16% (Before Tax)
4) Earning Per Share Rs. 6
5) Dividend Payout 50% of Earnings
6) Expected Growth Rate in Dividend 10%
7) Current Market Price Per Share Rs. 66
8) Tax Rate 50%

Question 8

Vishwabharati Limited has the following Book Value Capital Structure:

Equity Capital (in Shares of Rs 10 each, Fully Paid Up-At Par) Rs. 15 Crores
11% Preference Capital (in Shares of Rs 100 each, Fully Paid Up-At Par) Rs. 1 Crore
Retained Earnings Rs. 20 Crores
13.5% Debentures (of Rs 100 each) Rs. 10 Crores
15% Term Loans Rs. 12.5 Crores

Unique Academy 3.2 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
The next expected Dividend on Equity Shares Per Share is Rs 3.60; the Dividend Per Share is expected to grow at the
Rate of 7%. The Market Price Per Share is Rs 40. Preference Share, Redeemable after ten years, is currently selling at
Rs 75 Per Share. Debentures, Redeemable after Six years, are selling at Rs 80 Per Debentures. The Income Tax Rate
for the company is 40%.

You are Required to Calculate the Weighted Average Cost of Capital using:
1) Book Value Proportions
2) Market Value Proportions

Question 9

You are Required to Compute the Weighted Average Cost of Capital (WACC) of Ganpati Limited considering the
given data by using:
1) Book Value Weights
2) Market Value Weights

The Capital Structure of Ganpati Limited is as under:

Particulars Rs.
Debentures (Rs 100 Per Debenture) 5,00,000
Preference Shares (Rs 100 Per Share) 5,00,000
Equity Shares (Rs 10 Per Share) 10,00,000
20,00,000

The Market Prices of these securities are:

Debentures : 105 Per Debenture
Preference Shares : 110 Per Preference Share
Equity Shares : 24 each.

Additional Information:
1) Rs 100 Per Debenture Redeemable at Par, 10% Coupon Rate, 4% Floatation Costs and 10 Years Maturity.
2) 100 Per Preference Share Redeemable at Par, 5% Coupon Rate, 2% Floatation Cost and 10 Year Maturity.
3) Equity Shares has Rs 4 Floatation Cost and Market Price Rs 24 Per Share.

The next year expected Dividend is Rs 1 with Annual Growth of 5%. The firm has practice of paying all earnings in
the form of Dividend. The Corporate Tax Rate is 50%.

Question 10

The R&G Company has following capital structure at 31st March, 2004, which is considered to be optimum:

Particulars Rs.
13% Debenture 3,60,000
11% Preference Share Capital 1,20,000
Equity Share Capital (2,00,000 Shares) 19,20,000

The company’s share has a Current Market Price of Rs 27.75 Per Share. The expected dividend per share in next year
is 50% of the 2004 EPS. The EPS of last 10 years is as follows. The past trends are expected to continue:
Expected to continue:

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
EPS (Rs.) 1.00 1.120 1.254 1.405 1.574 1.762 1.974 2.211 2.476 2.773

The company can issue 14 % New Debenture. The company’s Debentures is currently Selling at Rs. 98. The New
Preference issue can be sold at a Net Price of Rs. 9.80, paying a dividend of Rs. 1.20 Per Share. The company’s
Marginal Tax Rate is 50%.

Unique Academy 3.3 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
1) Calculate the After Tax (a) Cost of New Debts Preference Share Capital, (b) of Ordinary Equity, Assuming New
Equity comes from retained Earnings.
2) Calculate the Marginal Cost of Capital.
3) How much can be spent for capital investment before new ordinary share must be sold? (Assuming that retained
earnings available for the next year’s investment are 50% of 2004 earnings)
4) What will be Marginal Cost of Capital (Cost of Fund raised in excess of the amount Calculated in part 3) If the
company can sell New Ordinary Shares to Net Rs. 20 Per Share?)

The Cost of Debt and of Preference Capital is Constant.

Question 11

Sagar Ltd belongs to a risk class in which opportunity Cost of Capital is 10%. (K c Value of unlevered firm). Sagar
Ltd has EBIT of 70000 and it has 8% Perpetual Debt of 2L. If Tax Rate is 30%. Answer the following questions using
M – Model –
1) Calculate the Value of Sagar Ltd.
2) Calculate the Value of Equity for Sagar Ltd.
3) Calculate Cost of Equity and Cost of Capital for Sagar Ltd.

Question 12

There are two firms A and B which are identical except A does not use any debt in its capital structure while B has Rs
8,00,000, 9% Debentures in its Capitals Structure. Both the firms have Earnings Before Interest and Tax of Rs
2,60,000 p.a. and the Capitalization Rate is 10%. Assuming the Corporate Tax of 30%, Calculated the Value of these
firms according to MM Hypothesis.

Question 13

Shubham Ltd is an all equity financed company with a Market Value of Rs 25,00.000 and Cost of Equity K e = 21%.
The company wants to Buy Back Equity Shares worth Rs 5,00,000 by Issuing and Raising 15% Perpetual Debt of the
same amount. Rate of Tax may be taken as 30%. After the Capital Restructuring and Applying MM Model (With
Taxes), you are Required to Calculate:
1) Market Value of Shubham Ltd.
2) Cost of Equity K e .
3) Weighted Average Cost of Capital and comment on it.

Question 14
.
Alpha Limited has the following Capital Structure:

Equity Share Capital (Rs 10 each) Rs 150 lakhs

10% Debentures Rs 100 lakhs
Retained Earnings Rs 50 lakhs
Other Information :
Market Price Per Equity Share Rs 49
Price-Earnings Ratio 7
Income Tax Rate 30%

Alpha Limited is considering an expansion plan and needs Rs 100 lakhs. If expansion programme is undertaken,
company feels that there will be 25 % increase in present Earnings Before Interest and Tax. The company has the
following alternatives available for raising funds required for expansion:
1) Issue Equity Shares at Rs 50 each.
2) Issue 12% Debentures for Rs 50 lakhs and for the balance, Equity Shares of Rs 50 each
3) Issue 9% Preference Shares for Rs 60 lakhs and for the balance, Equity Shares of Rs 50 each

You are Required to Advice Alpha Limited regarding the best alternative assuming Price-Earnings Ratio 7.50,7.00 and
7.25 respectively for these alternatives.

Unique Academy 3.4 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

Question 15
.
Mahalaxmi Limited is setting up a project with a capital outlay of Rs 60,00,000. It has two alternatives in financing the
project cost.

Alternative (A) : 100% Equity Finance

Alternative (B) : Debt-Equity Ratio 2 : 1
The Rate of Interest Payable on the Debt is 18% p.a. The Effective Tax Rate is 40%.

Calculate the Indifference Point between the two alternative methods of financing.

Question 16
.
Kalyani Steels Limited requires Rs 5,00,000 for Construction of a New Plant. It is considering three financial plans:
1) The Company may issue 50,000 Ordinary Shares at Rs 10 Per Share.
2) The Company may issue 25,000 Ordinary Shares at Rs 10 Per Share and 2,500 Debentures of Rs 100
denominations bearing a 8% Rate of Interest.
3) The Company may issue 25,000 Ordinary Shares at Rs 10 Per Share and 2,500 Preference Shares at Rs 100 Per
Share bearing a 8% Rate of Dividend.

If Kalyani Steels Limited’s Earnings Before Interest and Taxes are Rs 10,000; Rs 20,000; Rs 40,000; Rs 60,000 and
Rs 1,00,000 plans? Which alternative would you recommend for Kalyani Steels and Why?

Question 17

Company Y and Z are identical in all respect including risk factors except for Debt / Equity, company Y having issued
10% Debentures of Rs 18 lakhs while company Z is unlevered. Both the companies earn 20% Before Interest and
Taxes on their Total Assets of Rs 30 lakhs.

Assuming a Tax Rate of 50% and Capitalization Rate of 15% from An All-Equity Company.

Compute the Value of Companies Y and Z using -

1) Net Income Approach
2) Net Operating Income Approach

Question 18

Amol Ltd. and ‘Sagar’ Ltd. are identical in every respect except Capital Structure. Amol Ltd does not Employ Debts in
its Capital Structure whereas Sagar Ltd. Employes 12% Debentures amounting to Rs 10 lakhs.

Assuming that:
1) All Assumptions of M - M Model are Met.
2) Income Tax Rate is 30%.
3) EBIT is Rs. 2,50,000.
4) The Equity Capitalizations Rate of Amol Ltd is 20%.

Calculate the Value of Both the Companies and also Find Out the Weighted Average Cost of Capital for both the
companies.

Question 19

A firm has a Target Debt-Equity Ratio of 2 : 1. Post Tax Cost of Debt K d = 12%, K e = 20%, What is the WACC?

Question 20

A firm’s Target Debt Equity Ratio = 0.5, Pre-Tax K d = 16%, K e = 20%, Tax Rate = 30%. Compute K c .

Unique Academy 3.5 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
Question 21

Consider the following Capital Structures of X Ltd.

1000 Equity Shares of Rs 100 Each 1,00,000

Reserves and Surplus 2,00,000
Net Worth = Book Value 3,00,000
12% 500 Preference Shares @ Rs 100 Each 50,000
18%, 1000 Debentures @ 100 Each 1,00,000
20%, 5 Year Term Loan 1,50,000
CAPITAL EMPLOYED or INVESTER CAPITAL 6,00,000

1) Equity Shares are presently trading at Rs 470.

2) Preference Shares are presently trading at Rs 110.
3) Debentures are presently trading at Rs 98.

Calculate weights as per Market Value and Book Value.

Question 22

Technomate Limited has the following Capital Structure:

9% Debentures Rs 2,75,000
11% Preference Shares Rs 2,25,000
Equity Shares (Face Value : Rs 10 Per Share) Rs 5,00,000
Rs 10,00,000

Additional Information:
1) Rs 100 Per Debenture Redeemable at Par has 2% Floatation Cost and 10 Years of Maturity. The Market Price Per
Debentures is Rs 105.
2) Rs 100 Per Preference Share Redeemable at Par has 3% Floatation Cost and 10 Years of Maturity. The Market
Price Per Preference Share is Rs 106.
3) Equity Share has Rs 4 Floatation Cost and Market Price Per Share of Rs 24. The next year expected Dividend is
Rs 2 Per Share with Annual Growth of 5%. The firm has a practice of paying all earnings in the form of dividends.
4) Corporate Income-Tax Rate is 35%.

You are Required to Calculate Weighted Average Cost of Capital (WACC) using Market Value Weights.

Question 23

The Capital Structure of Shamrao Limited as on 31 March, 2009 is as follows:

Particulars Rs
Equity Capital : 6,00,000 Equity Shares of Rs. 100 Each 6 crore
Reserve and Surplus 1.20 crore
12% Debenture of Rs. 100 each 1.80 crore

For the year ended 31st March, 2009 Shamrao Limited has paid Equity Dividend @ 24%. Dividend is likely to grow by
5% every year. The Market Price of Equity Share Rs 600 Per Share. Income-Tax Rate applicable to Shamrao Limited
is 30%.

Required :
1) Compute the Current Weighted Average Cost of Capital.
2) The company has planned to raise a further Rs 3 crore by way of Long-Term Loan at 18% Interest. If Loan is
raised, the Market Price of Equity Share is expected to Fall to Rs 500 Per share.

What will be the New Weighted Average Cost of Capital of Shamrao Limited?

Unique Academy 3.6 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

Question 24

Assume that a company is expected to pay a Dividend of Rs 5.00 Per Share this year. The company along with the
Dividend is expected to grow at a Rate of 6%. If the Current Market Price of the Share is Rs 60 Per Share, Calculate
the Estimated Cost of Equity ?

Question 25

Best Vision Compnay requires Rs 10,00,000 of financing and is considering two options as given under:

Options Amount of Equity Amount of Debt Before-Tax Cost of

Raised (Rs) Financing (Rs) Debt (p.a.)
A 7,00,000 3,00,000 8%
B 3,00,000 7,00,000 10%

In the first year operations, the company is expected to have Sales Revenues of Rs 5,00,000; Cost of Sales of Rs
2,00,000; and General and Administrative Expenses of Rs 1,00,000. The Tax Rate is 30%. All earnings are paid out as
Dividends at year end.

You are Required to Calculate:

1) The Weighted Average Cost of Capital under option A, if the Cost of Equity is 12%.
2) The Return on Equity and the Debt Ratio under the two options.

Question 26

Ganpati Limited has issued 10% Debebntures of Nominal Value of Rs 100. The Market Price is Rs 90 Ex-Interest.

You are Required to Calculate the Cost of Debentures if the Debentures are:
1) Irredeemable
2) Redeemable at Par After 10 Years

Question 27

Shubham Ltd. retains Rs 7,50,000 out of its Current Earnings. The expected Rate of Return to the Shareholders, if they
had invested the funds elsewhere is 10%. The Brokerage is 3% and the Shareholders come in 30% Tax Bracket.
Calculate the Cost of Retained Earnings.

Question 28

AK Limited has obtained funds from the following sources, the specific cost are also given against them:

Source of Funds Amount (Rs) Cost of Capital

Equity Shares 30,00,000 15%
Preference Shares 8,00,000 8%
Retained Earnings 12,00,000 11%
Debentures 10,00,000 9% (Before Tax)

You are Required to Calculate Weighted Average Cost of Capital. Assume that Corporate Tax Rate is 30%.

Question 29

XYZ Ltd. has the following Capital Structure on October 31,2010:

Particulars Rs
Equity Share Capital 20,00,000

Unique Academy 3.7 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
(2,00,000 Shares of Rs 10 each)
Reserves & Surplus 20,00,000
12% Preference Shares 10,00,000
9% Debentures 30,00,000
80,00,000

The Market Price of Equity Share is Rs 30. It is expected that the company will pay next year a Dividend of Rs 3 Per
Share, which will Grow at 7% forever. Assume 40% Income Tax Rate.

You are Required to Compute Weighted Average Cost of Capital using Market Value Weights.

Question 30

Sagar Ltd. has furnished the following information:

Earning Per Share (ESP) Rs 4

Dividend Payout Ratio Rs 25%
Market Price Per Share Rs 40
Rate of Tax 30%
Growth Rate of Dividend 8%

The company wants to raise Additional Capital of Rs 10 lakhs including Debt of Rs 4lakhs. The Cost of Debt (Before
Tax) is 10% upto Rs 2 lakhs and 15% beyond that.

Compute the After Tax Cost of Equity and Debt and the Weighted Average Cost of Capital.

Question 31

Rohit Ltd has the following Book-Value Capital Structure as on March 31, 2003.

Particulars Rs
Equity Share Capital (2,00,000 Shares) 40,00,000
11.5% Preference Shares 10,00,000
10% Debentures 30,00,000
80,00,000

The Equity Share of the company sells for Rs 20. It is expected that the company will pay next year a Dividend of Rs 2
Per Equity Share, which is expected to Grow at 5% p.a. forever. Assume a 35% Corporate Tax Rate.

Required:
1) Compute Weighted Average Cost of Capital (WACC) of the company based on the Exiting Capital Structure.
2) Compute the New Weighted Average Cost of Capital (WACC), if the company raised and additional Rs 20 lakhs
Debt by Issuing 12% Debentures. This would result in increasing the Expected Equity Dividend to Rs 2.40 and Leave
the Growth Rate unchanged, but the Price of Equity Share will Fall to Rs 16 Per Share.
3) Comment on the use of Weights in the Computation of Weighted Average Cost of Capital.

Question 32

Swapnil Limited has the following Book Value Capital Structure:

Particulars Rs.
Equity Share Capital (150 Million Shares, Rs 10 Par) 1,500 Million
Reserves and Surplus 2,250 Million
10.5% Preference Share Capital (1 Million Shares, Rs 100 Par) 100 Million
9.5% Debentures (1.5 Million Debentures, Rs 1000 Par) 1,500 Million
8.5% Term Loans from Financial Institutions 500 Million

Unique Academy 3.8 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
1) The Debentures of Swapnil Limited are Redeemable after three years and are quoting at Rs 981.05 Per Debenture.
The applicable Income Tax Rate for the company is 35%.
2) The Current Market Price Per Equity Share is Rs 60. The Prevailing Default-Risk Free Interest Rate on 10-year
GOI Treasury Bonds is 5.5%. The Average Market Risk Premium is 8%. The Swapnil of the company is 1.1875.
3) The Preferred Stock of the company is Redeemable after 5 year is currently selling at Rs 98.15 Per Preference
Share.

Required:
1) Calculate Weighted Average Cost of Capital of the company using Market Value Weights.
2) Define the Marginal Cost of Capital Schedule for the firm if it raises Rs 750 Million for a new project. The firm
plans to have a Target Debt to Value Ratio of 20%. The beta of new project is 1.4375. The Debt Capital will be raised
through Term Loans. It will carry Interest Rate of 9.5% for the First 100 Million and 10% for the next Rs 50 Million.

Question 33

The following is the Capital Structure of a Company:

Source of Capital Book Value (Rs) Market Value (Rs)

Equity Shares @ Rs 100 Each 80,00,000 1,60,00,000
9% Cumulative Preference Shares @ Rs 100 Each 20,00,000 24,00,000
11% Debentures 60,00,000 66,00,000
Retained Earnings 40,00,000 -
2,00,00,000 2,50,00,000

The Current Market Price of the Company’s Equity Share is Rs 200. For the last year the company had paid Equity
Dividend at 25% and its Dividend is likely to Grow 5% every year. The Corporate Tax Rate is 30% and Shareholders
Personal Income Tax Rate is 20%.

You are Required to Calculate:

1) Cost of Capital for each Source of Capital.
2) Weighted Average Cost of Capital on the basis of Book Value Weights.
3) Weighted Average Cost of Capital on the basis of Market Value Weights..

Question 34

The Capital Structure of a company as on 31st March, 2009 is as follows:

Particulars Rs
Equity Capital : 6,00,000 Equity Shares of Rs 100 each 6 Crore
Reserve and surplus 1.20 Crore
12% Debentures of Rs 100 each 1.80 Crore

For the year ended 31st March, 2009 the company has paid Equity Dividend @ 24%. Dividend is likely to Grow by 5%
every year. The Market Price of Equity Share is Rs 600 Per Share. Income-tax rate applicable to the company is 30%.

Required:
1) Compute the Current Weighted Average Cost of Capital.
2) The company has plan to raise a further Rs 3 crore by way of Long-Term Loan at 18% Interest. If Loan is raised,
the Market Price of Equity Share is Expected to Fall to Rs 500 Per Share. What will be the New Weighted Average
Cost of Capital of the Company?

Question 35

The Capital Structure of a company consists of Equity Shares of Rs 50 lakhs; 10% Preference Shares of Rs 10 lakhs
and 12% Debentures of Rs 30 lakhs. The Cost of Equity Capital for the Company is 14.7% and Income-Tax Rate for
this company is 30%.

Unique Academy 3.9 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
You are Required to Calculate the Weighted Average Cost of Capital (WACC).

Question 36

Amit Ltd. wishes to raise Additional Finance of Rs 20 lakhs for Meeting its Investment plans. The Company has Rs
4,00,000 in the form of Retained Earnings available for Investment Purposes.
The following are the further details:
1) Debt Equity Ratio 25:75.
2) Cost of Debt at the Rate of 10% (Before Tax) upto Rs 2,00,000 and 13% (Before Tax) beyond that.
3) Earnings Per Share, Rs 12.
4) Dividend Payout 50% of Earnings.
5) Expected Growth Rate in Dividend 10%.
6) Current Market Price Per Share, Rs 60.
7) Company’s Tax Rate is 30% and Shareholder’s Personal Tax Rate is 20%

Required:
1) Calculate the Post Tax Average Cost of Additional Debt.
2) Calculate the Cost of Retained Earnings and Cost of Equity.
3) Calculate the Overall Weighted Average (After Tax) Cost of Additional Finance.

MULTIPLE CHOICE QUESTIONS

1. Cost of Capital refers to: (b) After Tax basis
(a) Floating Cost (c) Risk-free Rate of Interest basis
(b) Divided (d) None of the above
(c) Required Rate of Return
(d) None of the above 6. Weighted Average cost of Capital is generally
denoted by:
2. Which of the following sources of funds has an (a) KA’
Implicit Cost of Capital? (b) KW’
(a) Equity Share Capital (c) KO’
(b) Preference Share Capital (d) KC’
(c) Debentures
(d) Retained earnings 7. Which of the following cost of capital require tax
adjustment?
3. Which of the following has the highest cost of (a) Cost of Equity Shares
capital? (b) Cost of Preference Shares
(a) Equity shares (c) Cost of Debentures
(b) Loans (d) Cost of Retained Earnings
(c) Bonds
(d) Preference shares 8. Which is the most expensive source of funds?
(a) New Equity Shares
4. Cost of Capital for Government securities is also (b) New Preference Shares
known as: (c) New Debts
(a) Risk-free Rate of Interest (d) Retained Earnings
(b) Maximum Rate of Return
(c) Rate of Interest on Fixed Deposits 9. Marginal cost of capital is the cost of:
(d) None of the above (a) Additional Sales
(b) Additional Funds
5. Cost of Capital for Bonds and Debentures is (c) Additional Interests
calculated on: (d) None of the above
(a) Before Tax basis

Unique Academy 3.10 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
10. In case the firm is all-equity financed, WACC (b) Rate of Return expected by Equity shareholders.
would be equal to: (c) Average IRR of the Projects of the firm.
(a) Cost of Debt (d) Minimum Rate of Return that the firm should earn.
(b) Cost of Equity
(c) Neither (a) nor (b) 18. Minimum Rate of Return that a firm must earn
(d) Both (a) and (b) in order to satisfy its investors, is also known as:
(a) Average Return on Investment
11. In case of partially debt-financed firm, k 0 is less (b) Weighted Average Cost of Capital
(c) Net Profit Ratio
than:
(d) Average Cost of borrowing
(a) kd'
(b) ke' 19. Cost of Capital for Equity Share Capital does
not imply that:
(c) Both (a) and (b)
(a) Market Price is equal to Book Value of share.
(d) None of the above
(b) Shareholders are ready to subscribe to right issue.
(c) Market Price is more than Issue Price.
12. In order to calculate Weighted Average Cost of
(d) All of the three above.
Capital, weights may be based on:
(a) Market Values
20. In order to calculate the proportion of equity
(b) Target Values
financing used by the company, the following should
(c) Book Values
be used:
(d) All of the above
(a) Authorized Share Capital.
(b) Equity Share Capital plus Reserves and Surplus.
13. Firm’s Cost of Capital is the average cost of:
(c) Equity Share Capital plus Preference Share Capital.
(a) All sources
(d) Equity Share Capital plus Long-term Debt.
(b) All borrowings
(c) All share capital
21. The term capital structure denotes:
(d) All Bonds & Debentures
(a) Total of Liability side of Balance Sheet.
(b) Equity Funds, Preference Capital and Long term
14. An implicit cost of increasing proportion of debt
Debt.
is:
(c) Total Shareholders Equity.
(a) Tax shield would not be available on new debt.
(d) Types of Capital Issued by a Company.
(b) P.E. ratio would increase.
(c) Equity shareholders would demand higher return.
22. Debt Financing is a cheaper source of finance
(d) Rate of Return of the company would decrease.
because of:
(a) Time Value of Money
15. Cost Redeemable Preference Share Capital is:
(b) Rate of Interest
(a) Rate of Dividend.
(c) Tax-deductibility of Interest
(b) After Tax Rate of Dividend.
(d) Dividends not payable to lenders.
(c) Discount Rate that equate4s PV of inflows and
outflows relating to capital.
23. In order to find out cost of equity capital under
(d) None of the above.
CAPM, which of the following is not required:
(a) Beta Factor
16. Which of the following is true?
(b) Market Rate of Return
(a) Retained earnings are cost free.
(c) Market Price of Equity Share
(b) External Equity is cheaper than Internal Equity.
(d) Risk-free Rate of Interest
(c) Retained Earnings are cheaper than External Equity
(d) Retained Earnings are costlier than External
24. Tax-rate is relevant and important for
calculation of specific cost of capital of:
17. Cost of capital may be defined as:
(a) Equity Share Capital
(a) Weighted Average cost of all debts.
Unique Academy 3.11 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
(b) Preference Share Capital
(c) Debentures 27. Cost of Equity Share Capital is more than cost
(d) (a) and (b) above of debt because:
(a) Face value of debentures is more than face value of
25. Advantage of Debt financing is: shares.
(a) Interest is tax-deductible (b) Equity shares have higher risk than debt.
(b) It reduces WACC (c) Equity shares are easily saleable.
(c) Does not dilute owners control (d) All of the three above.
(d) All of the above
28. Which of the following is not a generally
26. Cost of issuing new shares to the public is known accepted approach for Calculation of Cost of Equity?
as: (a) CAPM
(a) Cost of Equity (b) Dividend discount Model
(b) Cost of Capital (c) Rate of Pref. Dividend Plus Risk
(c) Flotation Cost (d) Price-Earnings Ratio
(d) Marginal Cost of Capital

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(c) (d) (a) (a) (b) (c) (c) (a) (b) (b)
11 12 13 14 15 16 17 18 19 20
(b) (d) (a) (c) (c) (c) (d) (b) (d) (b)
21 22 23 24 25 26 27 28
(b) (c) (c) (c) (d) (c) (b) (c)

29. Which of the following is true for Net Income (a) VF  VE  VD'
Approach? (b) VF  VF  VD'
(a) Higher Equity is better
(b) Higher Debt is better (c) VD  VF  VE'
(c) Debt Ratio is irrelevant (d) VF  VE  VD'
(d) None of the above
33. In Net Operating Income Approach, which one
30. In case of Net Income Approach, the Cost of of the following is constant?
equity is: (a) Cost of Equity
(a) Constant (b) Cost of Debt
(b) Increasing (c) WACC & K d'
(c) Decreasing
(d) K e and K d
(d) None of the above

31. In case of Net Income Approach, when the debt 34. NOI Approach advocates that the degree of debt
proportion is increased, the cost of debt: financing is:
(a) Increases (a) Relevant
(b) Decreases (b) May be relevant
(c) Constant (c) Irrelevant
(d) None of the above (d) May be irrelevant

32. Which of the following is true of Net Income 35. ‘Judicious use of leverage’ is suggested by:
Approach? (a) Net Income Approach

Unique Academy 3.12 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
(b) Net Operating Income Approach (b) k d
decreases constantly
(c) Traditional Approach
(d) All of the above
(c) k O
decreases constantly
(d) None of the above
36. Which one is true for Net Operating Income
43. Which of the following assumes constant k and
Approach? d

(a) VD  VF  VE' ke ?
(b) VE  VF  VD' (a) Net Income Approach
(b) Net Operating Income Approach
(c) VE  VF  VD'
(c) Traditional Approach
(d) VD  VF  VE' (d) MM Model

37. In the Traditional Approach, which one of the 44. Which of the following is true?
following remains constant? (a) Under Traditional Approach, overall cost of capital
(a) Cost of Equity remains same.
(b) Cost of Debt (b) Under NI Approach, overall cost of capital remains
(c) WACC same.
(d) None of the above (c) Under NOI Approach, overall cost of capital
remains same.
38. In MM-Model, irrelevance of capital structure is (d) None of the above.
based on:
(a) Cost of Debt and Equity 45. The Traditional Approach To Value of the firm
(b) Arbitrage Process assumes that:
(c) Decreasing KO' (a) There is no optimal capital structure.
(b) Value can be increased by judicious use of
(d) All of the above
leverage.
(c) Cost of Capital and Capital structure are
39. ‘That there is no corporate tax’ is assumed by:
independent.
(a) Net Income Approach
(d) Risk of the firm is independent of capital structure.
(b) Net Operating Income Approach
(c) Traditional Approach
(d) All of these 46. A firm has EBIT of ` 50,000. Market value of
debt is ` 80,000 and overall capitalization rate is
40. ‘That personal leverage can replace corporate 20%. Market value of firm under NOI Approach is:
leverage’ is assumed by: (a) ` 2,50,000
(a) Traditional Approach
(b) MM Model (b) ` 1,70,000
(c) Net Income Approach (c) ` 30,000
(d) Net Operating Income Approach (d) ` 1,30,000

41. Which of the following argues that the value of 47. Which of the following is incorrect for NOI?
levered firm is higher than that of the unlevered (a) k0 is constant
firm?
(a) Net Income Approach (b) k d
is constant
(b) Net Operating Income Approach (c) k e
is constant
(c) MM Model with taxes (d) k d
and k 0
are constant
(d) (d) Both (a) and (c)

48. Which of the following is incorrect for value of

42. In Traditional Approach, which one is correct?
the firm?
(a) ke rises constantly

Unique Academy 3.13 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
(a) In the initial preposition, MM Model argues that (b) Long-term debt
value is independent of the financing mix. (c) Preference Share Capital
(b) Total value of levered and unlevered firms be same (d) Equity Share Capital
otherwise arbitrage will take place.
(c) Total value incorporates borrowings by firm but 50. In MM Model with taxes, where ‘r’ is the
excludes personal borrowing. interest rate, ‘D’ is the total debt and ‘t’ is tax rate,
(d) Total value does not change because underlying then present value of tax-shields would be:
risk does not change with financing mix. (a) r  D  t
(b) r  D
49. Which of the following appearing in the balance
(c) D  t
sheet, generates tax advantage and hence affects the
capital structure decision? (d)  D  r 
(a) Reserves and Surplus 1  t 

ANSWER KEYS
29 30 31 32 33 34 35 36 37 38
(b) (a) (c) (a) (c) (c) (c) (c) (d) (b)
39 40 41 42 43 44 45 46 47 48
(d) (b) (d) (d) (a) (c) (b) (b) (c) (d)
49 50
(b) (c)

51. In order to design an optimal capital structure, a 55. Financial Structure refers to:
company should strive for: (a) All financial resources
(a) Maximum Debt (b) Short-term funds
(b) Minimum Debt (c) Long-term funds
(c) Minimum WACC (d) None of these
(d) Minimum Cost of Equity
56. An optimal capital structure is one when the MP
52. Capital structure of a firm influences the: of the equity share is:
(a) Risk of the firm (a) Zero
(b) Return of the Equity Shareholder (b) Maximum
(c) Risk but not return (c) Minimum
(d) Both (a) and (b) (d) Moderate

53. Which of the following is not considered while 57. Agency cost arises due to:
designing the capital structure? (a) Increase in Cost of Production
(a) Size of the company (b) Hiring more employees
(b) Tax rate (c) Increase in Debt
(c) Location of the plant (d) Sales decline
(d) Dilution of control
58. Which of the following is not affected by capital
54. Which of the following is not relevant for structure?
optimal capital structure? (a) Total tax liability
(a) Flexibility (b) Return on Equity
(b) Solvency (c) Operating Profit
(c) Liquidity (d) Earnings Per Share
(d) Control

Unique Academy 3.14 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
59. While increasing debt proportion in the capital (b) Debt capacity
structure, which one of the following should be (c) Interest charge
considered? (d) Debt Value
(a) Cash flow position
(b) Operating Profits 62. Cash flow required during a period to meet the
(c) Financial Risk interest and repayment commitments is known as:
(d) All of the above (a) Debt capacity
(b) Interest Coverage
60. Which of the following may be ignored while (c) Debt-service Coverage
designing a capital structure? (d) Market Value of debt
(a) Profitability
(b) Flexibility 63. In Pecking Order Theory, the first priority is
(c) Control Philosophy given to:
(d) Political Stability (a) Fresh Equity
(b) Fresh Loan
61. Maximum amount of Debt, a firm can (c) Mix of Debt & Equity
comfortably service is known as: (d) Retained Earnings
(a) Debt-service Coverage

ANSWER KEYS
51 52 53 54 55 56 57 58 59 60
(c) (d) (c) (b) (a) (b) (c) (c) (d) (d)
61 62 63
(b) (c) (d)

ADDITIONAL MULTIPLE CHOICE QUESTIONS

1. The optimal capital structure for a company is (b) Vertical capital Structure
the one which offers a balance between the ideal (c) Pyramid Shaped capital structure
debt-to-equity ranges thus minimizing the firm’s cost (d) Inverted Pyramid Shaped capital structure
of capital
(a) True 5. In a vertical capital structure, the base of the
(b) False structure is formed by a small amount of
(a) Debt
2. ______ is “The mix of a firm’s permanent long (b) Equity share capital
term financing represented by debt, preferred stock (c) Preference share capital
and common stock equity” (d) All of the above
(a) Capital Budgeting
(b) Capital Rationing 6. A ____ has a large proportion consisting of
(c) Capital Structure equity capital and retained earnings which have been
(d) Financial Leverage ploughed back into the firm over a considerably
large period of time.
3. Type of capital structure includes: (a) Horizontal capital structure
(a) Horizontal capital structure (b) Vertical capital structure
(b) Vertical capital structure (c) Pyramid Shaped capital structure
(c) Pyramid Shaped capital structure (d) Inverted Pyramid Shaped capital structure
(d) All of the above
7. In _____there is a small component of equity
4. In a _______ , the firm has zero debt capital, reasonable level of retained earnings but an
components in the structure mix ever increasing component of debt.
(a) Horizontal capital structure (a) Horizontal capital structure

Unique Academy 3.15 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
(b) Vertical capital structure 15. Which of the following is not the capital
(c) Pyramid Shaped capital structure structure theories / approach?
(d) Inverted Pyramid Shaped capital structure (a) Net Income approach
(b) Net Operating Income approach
8. Which of the following statement is correct? (c) Modigliani Miller (MM) approach
(a) The capital structure reflects the overall strategy of (d) Sensitivity Analysis approach
the firm
(b) Capital structure is an indicator of the risk profile 16. According to _______ approach, there is a
of the firm relationship between capital structure and the value
(c) Capital structure acts as a tax management tool of the firm and therefore, the firm can affect its value
(d) All of the above by increasing or decreasing the debt proportion in
the overall financial mix.
9. ______ relates to long term capital deployment (a) Net Income approach
for creation of long term assets. (b) Net Operating Income approach
(a) Capital Structure (c) Modigliani Miller (MM) approach
(b) Financial Structure (d) Traditional Approach
(c) Financial Leverage
(d) Operating Leverage 17. The Net Income Approach makes the following
assumptions:
10. ________ involves creation of both long term (a) The total capital requirement of the firm is given
and short term assets and remains constant.
(a) Capital Structure (b) Cost of debt (Kd) is less than cost of equity (Ke)
(b) Financial Structure (c) Both Kd and Ke. Remain constant and increase in
(c) Financial Leverage financial leverage
(d) Operating Leverage (d) All of the above

11. Which of the following statement is not correct? 18. According to Net Operating Income Approach
(a) Capital structure of the company should generate (NOI Approach), the market value of the firm
maximum returns to the shareholders without adding depends upon the net operating profit or EBIT and
additional cost to them. the _____
(b) The capital structure should be flexible. It should (a) Cost of debt
be possible for a company to adapt its capital structure (b) Cost of equity
with a minimum cost and delay if warranted by a (c) Cost of capital
changed situation. (d) Retained Earnings
(c) The capital structure should be determined without
considering the debt capacity of the company. 19. According to NOI Approach, the financing mix
(d) All of the above or the capital structure is _______ and does not affect
the value of the firm.
12. While designing capital structure, which point (a) Relevant
should be kept in view: (b) Irrelevant
(a) Design should be functional (c) Constant
(b) Design should be flexible (d) Infinite
(c) Design should be conforming statutory guidelines
(d) All of the above 20. The NOI Approach makes the following
assumption:
13. Factor affecting cost of capital includes: (a) The investors see the firm as a whole and thus
(a) Cash flow position capitalize the total earnings of the firms to find the value
(b) Interest coverage ratio and debt coverage ratio of the firm as a whole.
(c) Cost of debt (b) The overall cost of capital KO, of the firm is
(d) All of the above constant and depends upon the business risk which also
is assumed to be unchanged.
14. Factors affecting cost of capital does not include: (c) The cost of debt, Kd, is also taken as constant and
(a) Tax Rate there is no taxes.
(b) Operating or Business Risk (d) All of the above
(c) Cost of equity capital
(d) War between two nations 21. The _______ to capital structure advocates that
there is a right combination of equity and debt in the

Unique Academy 3.16 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
capital structure, at which the market value of a firm 28. EBITDA is calculated by taking net income and
is maximum. adding _________ expenses back to it.
(a) Net Income approach (a) Interest
(b) Net Operating Income approach (b) Taxes
(c) Modigliani Miller (MM) approach (c) Depreciation and amortization
(d) Traditional Approach (d) All of the above

22. As per Traditional approach, debt should exist 29. EBITDA can not be used to compare companies
in the capital structure only up to a specific point, against each other and against industry averages.
beyond which, any increase in leverage would result (a) True
in the _______ in value of the firm. (b) False
(a) Reduction
(b) Increase 30. Type of leverage includes:
(c) Constant (a) Operating Leverage
(d) No change (b) Financial Leverage
(c) Combined Leverage
23. Assumptions under traditional approach are: (d) All of the above
(a) The rate of interest on debt remains constant for a
certain period and thereafter with an increase in 31. _______ may be defined as the company’s ability
leverage, it increases. to use fixed operating costs to magnify the effects of
(b) The expected rate by equity shareholders remains changes in sales on its earnings before interest and
constant or increase gradually, after that, the equity taxes.
shareholders starts perceiving a financial risk and then (a) Operating Leverage
from the optimal point and the expected rate increases (b) Financial Leverage
speedily. (c) Combined Leverage
(c) WACC first decreases and then increases. (d) All of the above
(d) All of the above
32. _______ represents the relationship between the
24. As per __________ value of a firm depends on company’s earnings before interest and taxes (EBIT)
its future earnings stream, and hence its value is or operating profit and the earning available to
unaffected by its debt / equity mix. equity shareholders.
(a) Net Income approach (a) Operating Leverage
(b) Net Operating Income approach (b) Financial Leverage
(c) Modigliani Miller (MM) approach (c) Combined Leverage
(d) Traditional Approach (d) All of the above

25. The use of EBIT – EPS analysis indicates to 33. Financial leverage may be ______ depends upon
management the projected ______ for different the use of fixed cost funds.
financial plans. (a) Favorable
(a) Revenue (b) unfavorable
(b) Cost (c) favorable or unfavorable
(c) EPS (d) Neither (a) nor (b)
(d) Dividend
34. ________ depends upon fixed cost and variable
26. EBITDA, an acronym for: cost.
(a) Earnings before interest, taxes, depreciation and (a) Operating Leverage
amortization (b) Financial Leverage
(b) Earnings before tax (c) Combined Leverage
(c) Earnings before interest and tax (d) None of the above
(d) Earnings before Interest, tax and depreciation
35. _______ depends upon the operating profits.
27. EBITDA is used to analyze a company’s (a) Operating Leverage
operating profitability before: (b) Financial Leverage
(a) non-operating expenses (such as interest) (c) Both (a) and (b)
(b) non-cash charges (depreciation and amortization). (d) None of the above
(c) Both (a) and (b)
(d) None of the above 36. _________ is the level of EBIT which covers all
fixed financing costs of the company.
Unique Academy 3.17 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
(a) Financial Break Even Point (c) Total assets minus liabilities.
(b) Operating Break Even-up Point (d) Shareholders equity.
(c) Combined Break Even Point
(d) All of the above 45. The traditional approach towards the valuation
of a company assumes:
37. Financial BEP is the level of EBIT at which EPS (a) That the overall capitalization rate holds constant
is with changes in financial leverage.
(a) Zero (b) That there is an optimum capital structure.
(b) One (c) That total risk is not altered by changes in the
(c) Maximum capital structure.
(d) Minimum (d) That markets are perfect.

38. Indifference Point is the point at which different 46. Two firms that are virtually identical except for
sets of debt ratios (percentage of debt to total capital their capital structure are selling in the market at
employed in the company) gives the same _______ different values. According to M&M:
(a) EPS (a) one will be at greater risk of bankruptcy.
(b) EBIT (b) the firm with greater financial leverage will have
(c) Revenue the higher value.
(d) Cost (c) this proves that markets cannot be efficient.
(d) this will not continue because arbitrage will
39. _______ expresses the relationship between the eventually cause the firms to sell at the same value.
revenue in the account of sales and the taxable
income. 47. Retained earnings are:
(a) Operating Leverage (a) an indication of a company’s liquidity.
(b) Financial Leverage (b) the same as cash in the bank.
(c) Combined Leverage (c) not important when determining dividends.
(d) None of the above (d) the cumulative earnings of the company after
dividends.
40. ________ measures the sensitivity of return in
investment of charges in the level of current assets. 48. Operating leverage analyses the relationship
(a) Operating Leverage between sales level and EPS.
(b) Financial Leverage (a) True
(c) Combined Leverage (b) False
(d) Working Capital Leverage
49. Financial leverage depends upon the operating
41. The Proportion of ________ in the financial plan leverage.
of a firm is called leverage. (a) True
(a) Debt to equity (b) False
(b) Revenue to Cost
(c) Debt to interest 50. Dividend on Preference shares is a factor of
(d) Revenue to EPS operating leverage.
(a) True
42. As the financial leverage increases, the (b) False
breakeven point of the company ________
(a) Increase 51. Operating leverage may be defined as
(b) Decrease Contribution – EPS.
(c) Constant (a) True
(d) Zero (b) False

43. Increase in financial leverage, increases the risk 52. Financial leverage depends upon the fixed
to stockholders. financial charges.
(a) True (a) True
(b) False (b) False

44. The term “capital structure” refers to: 53. Combined leverage establishes the relationship
(a) Long-term debt, preferred stock, and common stock between operating leverage and financial leverage.
equity. (a) True
(b) Current assets and current liabilities. (b) False
Unique Academy 3.18 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
(d) EBIT / Tax
54. Financial leverage is always beneficial to the
firm. 64. Financial Leverage is calculated as:
(a) True (a) EBIT / Contribution
(b) False (b) EBIT / PBT
(c) EBIT / Sales
55. Total risk of a firm is determined by the (d) EBIT / Variable Cost
combined effect of operating and financial leverages.
(a) True 65. Which combination is generally good for firms?
(b) False (a) High Operating Leverage, High Financial Leverage
(b) Low Operating Leverage, Low Financial Leverage
56. Combined leverage helps in analyzing the effect (c) High Operating Leverage, Low Financial Leverage
of change in sales level on the EPS of the firm. (d) None of these
(a) True
(b) False 66. Combined Leverage can be used to measure the
relationship between:
57. Operating leverage helps in analysis of: (a) EBIT and EPS
(a) Business Risk (b) PAT and EPS
(b) Financial Risk (c) Sales and EPS
(c) Production Risk (d) Sales and EBIT
(d) Credit Risk
67. Financial Leverage is zero if:
58. Which of the following is studied with the help (a) EBIT  Interest
of financial leverage? (b) EBIT  zero
(a) Marketing Risk (c) EBIT  Fixed Cost
(b) Interest Rate Risk (d) EBIT  Dividend
(c) Foreign Exchange Risk
(d) Financing Risk 68. Business risk can be measured by:
(a) Financial Leverage
59. Combined Leverage is obtained from Operating (b) Operating Leverage
Leverage and Financial Leverage by their: (c) Combined Leverage
(a) Addition (d) None of the above
(b) Subtraction
(c) Multiplication 69. Financial Leverage measures relationship
(d) Any of these between
(a) EBIT and PBT
60. High degree of financial leverage means: (b) EBIT and EPS
(a) High debt proportion (c) Sales and PBT
(b) Lower debt proportion (d) Sales and EPS
(c) Equal debt and equity
(d) No debt 70. Uses of Preference Share Capital in Capital
structure.
61. Operating leverage arises because of: (a) Increases Operating Leverage
(a) Fixed Cost of Production (b) Increases Financial Leverage
(b) Fixed Interest Cost (c) Decreases Operating Leverage
(c) Variable Cost (d) Decreases Financial Leverage
(d) None of the above
71. Which of the following is correct?
62. Financial Leverage arises because of: (a) Combined Leverage  Operating Leverage 
(a) Fixed cost of production Financial Leverage
(b) Variable Cost (b) Combined Leverage  Operating Leverage 
(c) Interest Cost Financial Leverage
(d) None of the above (c) Combined Leverage  Operating Leverage 
Financial Leverage
63. Operating Leverage is calculated as: (d) Combined Leverage  Operating Leverage 
(a) Contribution / EBIT Financial Leverage
(b) EBIT / PBT
(c) EBIT / Interest
Unique Academy 3.19 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
72. If the fixed cost of production is zero, which one
of the following is correct? Given the above information, what is the projected
(a) Operating Leverage is zero degree of operating leverage for XYZ Ltd.?
(b) Financial Leverage is zero (a) 0.78
(c) Combined Leverage is zero (b) 0.57
(d) None of the above (c) 0.74
(d) 1.36
73. If a firm has no debt, which one is correct?
(a) Operating Leverage is one 79. Trout Ltd. produces a single product that has a
(b) Financial Leverage is one contribution margin of 60% per unit and sold
(c) Operating Leverage is zero 500,000 unit last year. Trout has a degree of
(d) Financial Leverage is zero operating leverage of 1.60 and a degree of financial
leverage of 1.20 for the current year. If the sales
74. If a firm has a Degree of Operating Leverage of volume were to increase by 10% this coming year,
2.8, it means: what would be the expected percentage increase in
(a) If sales increase by 2.8% , the EBIT will increase earnings per share (rounded to the nearest percent)?
by 1% (a) 16%
(b) If EBIT increase by 2.896, the EPS will increase by (b) 12%
1% (c) 6%
(c) If sales rise by 1% EBIT will rise by 2.8% (d) 19%
(d) None of the above
80. SSC Inc. has the following financial
75. Higher Operating Leverage is related to the use information:
of higher:
Current liabilities $ 900,000
(a) Debt
(b) Equity Long-term debt $ 1,300,000
(c) Fixed Cost Total liabilities $ 2,200,000
(d) Variable Cost Preferred shares $ 3,500,000
Common equity $ 6,200,000
76. Higher Financial Leverage is related the use of:
(a) Higher Equity The long-term debt consists of a single bond issue
(b) Higher Debt paying 6% interest annually. These bonds currently
(c) Lower Debt yield 7.5% in the market. The current cost of the
(d) None of the above preferred shares is 8%. The current cost of the
common shares is 12%. The company’s tax rate is
77. Which of the following is not the source of long 40%. What is SCC inc.’s weighted average cost of
term finance? capital (rounded to the nearest tenth of a percent)?
(a) Equity shares (a) 9.4%
(b) Preference shares (b) 10.2%
(c) Commercial Paper (c) 9.8%
(d) Reserves and Surplus (d) 9.2%

78. XYZ Ltd. has the following current and 81. Flower inc. is issuing preferred shares to raise
projected information: capital. Each preferred share will be issued with a
par value of $200 and a cumulative dividend of $18.
Current Projected The preferred shares will result in after-tax
Sales LKR LKR underwriting expenses of $3 per share. What is the
700,00 800,000 cost of issuing the preferred shares?
Variable costs (35% of LKR LKR (a) 9.14%
sales) 245,000 280,000 (b) 9.00%
Fixed costs (excluding LKR LKR 120, (c) 7.50%
interest and taxes) 120,000 000 (d) 10.50%
Earnings per share LKR 0.90 LKR 1.00

Unique Academy 3.20 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

ANSWER KEYS

1 2 3 4 5 6 7 8 9 10
(a) (c) (d) (a) (b) (c) (d) (d) (a) (b)
11 12 13 14 15 16 17 18 19 20
(c) (d) (d) (d) (d) (a) (d) (c) (b) (d)
21 22 23 24 25 26 27 28 29 30
(d) (a) (d) (c) (c) (a) (c) (d) (b) (d)
31 32 33 34 35 36 37 38 39 40
(a) (b) (c) (a) (b) (a) (a) (a) (c) (d)
41 42 43 44 45 46 47 48 49 50
(a) (a) (a) (a) (b) (d) (d) (b) (b) (b)
51 52 53 54 55 56 57 58 59 60
(b) (a) (b) (b) (a) (a) (a) (d) (c) (a)
61 62 63 64 65 66 67 68 69 70
(a) (c) (a) (b) (c) (c) (b) (b) (b) (b)
71 72 73 74 75 76 77 78 79 80
(c) (d) (b) (c) (c) (b) (c) (d) (d) (c)
81
(a)
82. The optimal capital structure for a company is
the one which offers a balance between the ideal 87. A ____ has a large proportion consisting of
debt-to-equity ranges thus minimizing the firm’s cost equity capital and retained earnings which have been
of capital ploughed back into the firm over a considerably
(c) True large period of time.
(d) False (a) Horizontal capital structure
(b) Vertical capital structure
83. ______ is “The mix of a firm’s permanent long (c) Pyramid Shaped capital structure
term financing represented by debt, preferred stock (d) Inverted Pyramid Shaped capital structure
and common stock equity”
(a) Capital Budgeting 88. In _____there is a small component of equity
(b) Capital Rationing capital, reasonable level of retained earnings but an
(c) Capital Structure ever increasing component of debt.
(d) Financial Leverage (a) Horizontal capital structure
(b) Vertical capital structure
84. Type of capital structure includes: (c) Pyramid Shaped capital structure
(a) Horizontal capital structure (d) Inverted Pyramid Shaped capital structure
(b) Vertical capital structure
(c) Pyramid Shaped capital structure 89. Which of the following statement is correct?
(d) All of the above (a) The capital structure reflects the overall strategy of
the firm
85. In a _______ , the firm has zero debt (b) Capital structure is an indicator of the risk profile
components in the structure mix of the firm
(a) Horizontal capital structure (c) Capital structure acts as a tax management tool
(b) Vertical capital Structure (d) All of the above
(c) Pyramid Shaped capital structure
(d) Inverted Pyramid Shaped capital structure 90. ______ relates to long term capital deployment
for creation of long term assets.
86. In a vertical capital structure, the base of the (a) Capital Structure
structure is formed by a small amount of (b) Financial Structure
(a) Debt (c) Financial Leverage
(b) Equity share capital (d) Operating Leverage
(c) Preference share capital
(d) All of the above
Unique Academy 3.21 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
91. ________ involves creation of both long term (a) The total capital requirement of the firm is given
and short term assets and remains constant.
(a) Capital Structure (b) Cost of debt (Kd) is less than cost of equity (Ke)
(b) Financial Structure (c) Both Kd and Ke. Remain constant and increase in
(c) Financial Leverage financial leverage
(d) Operating Leverage (d) All of the above

92. Which of the following statement is not correct? 99. According to Net Operating Income Approach
(a) Capital structure of the company should generate (NOI Approach), the market value of the firm
maximum returns to the shareholders without depends upon the net operating profit or EBIT and
adding additional cost to them. the _____
(b) The capital structure should be flexible. It should (a) Cost of debt
be possible for a company to adapt its capital (b) Cost of equity
structure with a minimum cost and delay if (c) Cost of capital
warranted by a changed situation. (d) Retained Earnings
(c) The capital structure should be determined without
considering the debt capacity of the company. 100. According to NOI Approach, the financing mix
(d) All of the above or the capital structure is _______ and does not affect
the value of the firm.
93. While designing capital structure, which point (a) Relevant
should be kept in view: (b) Irrelevant
(a) Design should be functional (c) Constant
(b) Design should be flexible (d) Infinite
(c) Design should be conforming statutory guidelines
(d) All of the above 101. The NOI Approach makes the following
assumption:
94. Factor affecting cost of capital includes: (a) The investors see the firm as a whole and thus
(a) Cash flow position capitalize the total earnings of the firms to find the
(b) Interest coverage ratio and debt coverage ratio value of the firm as a whole.
(c) Cost of debt (b) The overall cost of capital KO, of the firm is
(d) All of the above constant and depends upon the business risk which
also is assumed to be unchanged.
95. Factors affecting cost of capital does not include: (c) The cost of debt, Kd, is also taken as constant and
(a) Tax Rate there is no taxes.
(b) Operating or Business Risk
(c) Cost of equity capital (d) All of the above
(d) War between two nations
102. The _______ to capital structure advocates that
96. Which of the following is not the capital there is a right combination of equity and debt in the
structure theories / approach? capital structure, at which the market value of a firm
(a) Net Income approach is maximum.
(b) Net Operating Income approach (a) Net Income approach
(c) Modigliani Miller (MM) approach (b) Net Operating Income approach
(d) Sensitivity Analysis approach (c) Modigliani Miller (MM) approach
(d) Traditional Approach
97. According to _______ approach, there is a
relationship between capital structure and the value 103. As per Traditional approach, debt should exist
of the firm and therefore, the firm can affect its value in the capital structure only up to a specific point,
by increasing or decreasing the debt proportion in beyond which, any increase in leverage would result
the overall financial mix. in the _______ in value of the firm.
(a) Net Income approach (a) Reduction
(b) Net Operating Income approach (b) Increase
(c) Modigliani Miller (MM) approach (c) Constant
(d) Traditional Approach (d) No change
98. The Net Income Approach makes the following 104. Assumptions under traditional approach are:
assumptions:

Unique Academy 3.22 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
(a) The rate of interest on debt remains constant for a
certain period and thereafter with an increase in 112. _______ may be defined as the company’s ability
leverage, it increases. to use fixed operating costs to magnify the effects of
(b) The expected rate by equity shareholders remains changes in sales on its earnings before interest and
constant or increase gradually, after that, the equity taxes.
shareholders starts perceiving a financial risk and (a) Operating Leverage
then from the optimal point and the expected rate (b) Financial Leverage
increases speedily. (c) Combined Leverage
(c) WACC first decreases and then increases. (d) All of the above
(d) All of the above
113. _______ represents the relationship between the
105. As per __________ value of a firm depends on company’s earnings before interest and taxes (EBIT)
its future earnings stream, and hence its value is or operating profit and the earning available to
unaffected by its debt / equity mix. equity shareholders.
(a) Net Income approach (a) Operating Leverage
(b) Net Operating Income approach (b) Financial Leverage
(c) Modigliani Miller (MM) approach (c) Combined Leverage
(d) Traditional Approach (d) All of the above

106. The use of EBIT – EPS analysis indicates to 114. Financial leverage may be ______ depends upon
management the projected ______ for different the use of fixed cost funds.
financial plans. (a) Favorable
(a) Revenue (b) unfavorable
(b) Cost (c) favorable or unfavorable
(c) EPS (d) Neither (a) nor (b)
(d) Dividend
115. ________ depends upon fixed cost and variable
107. EBITDA, an acronym for: cost.
(a) Earnings before interest, taxes, depreciation and (a) Operating Leverage
amortization (b) Financial Leverage
(b) Earnings before tax (c) Combined Leverage
(c) Earnings before interest and tax (d) None of the above
(d) Earnings before Interest, tax and depreciation
116. _______ depends upon the operating profits.
108. EBITDA is used to analyze a company’s (a) Operating Leverage
operating profitability before: (b) Financial Leverage
(a) non-operating expenses (such as interest) (c) Both (a) and (b)
(b) non-cash charges (depreciation and amortization). (d) None of the above
(c) Both (a) and (b)
(d) None of the above 117. _________ is the level of EBIT which covers all
fixed financing costs of the company.
109. EBITDA is calculated by taking net income and (a) Financial Break Even Point
adding _________ expenses back to it. (b) Operating Break Even-up Point
(a) Interest (c) Combined Break Even Point
(b) Taxes (d) All of the above
(c) Depreciation and amortization
(d) All of the above 118. Financial BEP is the level of EBIT at which EPS
is
110. EBITDA can not be used to compare companies (a) Zero
against each other and against industry averages. (b) One
(a) True (c) Maximum
(b) False (d) Minimum

111. Type of leverage includes: 119. Indifference Point is the point at which different
(a) Operating Leverage sets of debt ratios (percentage of debt to total capital
(b) Financial Leverage employed in the company) gives the same _______
(c) Combined Leverage (a) EPS
(d) All of the above (b) EBIT
Unique Academy 3.23 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
(c) Revenue (b) the firm with greater financial leverage will have
(d) Cost the higher value.
(c) this proves that markets cannot be efficient.
120. _______ expresses the relationship between the (d) this will not continue because arbitrage will
revenue in the account of sales and the taxable eventually cause the firms to sell at the same value.
income.
(a) Operating Leverage 128. Retained earnings are:
(b) Financial Leverage (a) an indication of a company’s liquidity.
(c) Combined Leverage (b) the same as cash in the bank.
(d) None of the above (c) not important when determining dividends.
(d) the cumulative earnings of the company after
121. ________ measures the sensitivity of return in dividends.
investment of charges in the level of current assets.
(a) Operating Leverage 129. Operating leverage analyses the relationship
(b) Financial Leverage between sales level and EPS.
(c) Combined Leverage (a) True
(d) Working Capital Leverage (b) False

122. The Proportion of ________ in the financial plan 130. Financial leverage depends upon the operating
of a firm is called leverage. leverage.
(a) Debt to equity (a) True
(b) Revenue to Cost (b) False
(c) Debt to interest
(d) Revenue to EPS 131. Dividend on Preference shares is a factor of
operating leverage.
123. As the financial leverage increases, the (a) True
breakeven point of the company ________ (b) False
(a) Increase
(b) Decrease 132. Operating leverage may be defined as
(c) Constant Contribution – EPS.
(d) Zero (a) True
(b) False
124. Increase in financial leverage, increases the risk
to stockholders. 133. Financial leverage depends upon the fixed
(a) True financial charges.
(b) False (a) True
(b) False
125. The term “capital structure” refers to:
(a) Long-term debt, preferred stock, and common stock 134. Combined leverage establishes the relationship
equity. between operating leverage and financial leverage.
(b) Current assets and current liabilities. (a) True
(c) Total assets minus liabilities. (b) False
(d) Shareholders equity.
135. Financial leverage is always beneficial to the
126. The traditional approach towards the valuation firm.
of a company assumes: (a) True
(a) That the overall capitalization rate holds constant (b) False
with changes in financial leverage.
(b) That there is an optimum capital structure. 136. Total risk of a firm is determined by the
(c) That total risk is not altered by changes in the combined effect of operating and financial leverages.
capital structure. (a) True
(d) That markets are perfect. (b) False

127. Two firms that are virtually identical except for 137. Combined leverage helps in analyzing the effect
their capital structure are selling in the market at of change in sales level on the EPS of the firm.
different values. According to M&M: (a) True
(a) one will be at greater risk of bankruptcy. (b) False

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CS Executive: Financial Management Cost of Capital & Capital Structure
138. Operating leverage helps in analysis of: (a) EBIT and EPS
(a) Business Risk (b) PAT and EPS
(b) Financial Risk (c) Sales and EPS
(c) Production Risk (d) Sales and EBIT
(d) Credit Risk
148. Financial Leverage is zero if:
139. Which of the following is studied with the help (a) EBIT  Interest
of financial leverage? (b) EBIT  zero
(a) Marketing Risk (c) EBIT  Fixed Cost
(b) Interest Rate Risk (d) EBIT  Dividend
(c) Foreign Exchange Risk
(d) Financing Risk 149. Business risk can be measured by:
(a) Financial Leverage
140. Combined Leverage is obtained from Operating (b) Operating Leverage
Leverage and Financial Leverage by their: (c) Combined Leverage
(a) Addition (d) None of the above
(b) Subtraction
(c) Multiplication 150. Financial Leverage measures relationship
(d) Any of these between
(a) EBIT and PBT
141. High degree of financial leverage means: (b) EBIT and EPS
(a) High debt proportion (c) Sales and PBT
(b) Lower debt proportion (d) Sales and EPS
(c) Equal debt and equity
(d) No debt 151. Uses of Preference Share Capital in Capital
structure.
142. Operating leverage arises because of: (a) Increases Operating Leverage
(a) Fixed Cost of Production (b) Increases Financial Leverage
(b) Fixed Interest Cost (c) Decreases Operating Leverage
(c) Variable Cost (d) Decreases Financial Leverage
(d) None of the above
152. Which of the following is correct?
143. Financial Leverage arises because of: (a) Combined Leverage  Operating Leverage 
(a) Fixed cost of production Financial Leverage
(b) Variable Cost (b) Combined Leverage  Operating Leverage 
(c) Interest Cost Financial Leverage
(d) None of the above (c) Combined Leverage  Operating Leverage 
Financial Leverage
144. Operating Leverage is calculated as: (d) Combined Leverage  Operating Leverage 
(a) Contribution / EBIT Financial Leverage
(b) EBIT / PBT
(c) EBIT / Interest 153. If the fixed cost of production is zero, which one
(d) EBIT / Tax of the following is correct?
(a) Operating Leverage is zero
145. Financial Leverage is calculated as: (b) Financial Leverage is zero
(a) EBIT / Contribution (c) Combined Leverage is zero
(b) EBIT / PBT (d) None of the above
(c) EBIT / Sales
(d) EBIT / Variable Cost 154. If a firm has no debt, which one is correct?
(a) Operating Leverage is one
146. Which combination is generally good for firms? (b) Financial Leverage is one
(a) High Operating Leverage, High Financial Leverage (c) Operating Leverage is zero
(b) Low Operating Leverage, Low Financial Leverage (d) Financial Leverage is zero
(c) High Operating Leverage, Low Financial Leverage
(d) None of these 155. If a firm has a Degree of Operating Leverage of
2.8, it means:
147. Combined Leverage can be used to measure the (a) If sales increase by 2.8% , the EBIT will increase
relationship between: by 1%
Unique Academy 3.25 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
(b) If EBIT increase by 2.896, the EPS will increase by 160. Trout Ltd. produces a single product that has a
1% contribution margin of 60% per unit and sold
(c) If sales rise by 1% EBIT will rise by 2.8% 500,000 unit last year. Trout has a degree of
(d) None of the above operating leverage of 1.60 and a degree of financial
leverage of 1.20 for the current year. If the sales
156. Higher Operating Leverage is related to the use volume were to increase by 10% this coming year,
of higher: what would be the expected percentage increase in
(a) Debt earnings per share (rounded to the nearest percent)?
(b) Equity (a) 16%
(c) Fixed Cost (b) 12%
(d) Variable Cost (c) 6%
(d) 19%
157. Higher Financial Leverage is related the use of:
(a) Higher Equity 161. SSC Inc. has the following financial
(b) Higher Debt information:
(c) Lower Debt
Current liabilities $ 900,000
(d) None of the above
Long-term debt $ 1,300,000
158. Which of the following is not the source of long Total liabilities $ 2,200,000
term finance? Preferred shares $ 3,500,000
(a) Equity shares Common equity $ 6,200,000
(b) Preference shares
(c) Commercial Paper The long-term debt consists of a single bond issue
(d) Reserves and Surplus paying 6% interest annually. These bonds currently
yield 7.5% in the market. The current cost of the
159. XYZ Ltd. has the following current and preferred shares is 8%. The current cost of the
projected information: common shares is 12%. The company’s tax rate is
40%. What is SCC inc.’s weighted average cost of
Current Projected capital (rounded to the nearest tenth of a percent)?
Sales LKR LKR (a) 9.4%
700,00 800,000 (b) 10.2%
Variable costs LKR LKR (c) 9.8%
(35% of sales) 245,000 280,000 (d) 9.2%
Fixed costs LKR LKR 120,
(excluding interest 120,000 000 162. Flower inc. is issuing preferred shares to raise
and taxes) capital. Each preferred share will be issued with a
Earnings per share LKR 0.90 LKR 1.00 par value of $200 and a cumulative dividend of $18.
The preferred shares will result in after-tax
Given the above information, what is the projected underwriting expenses of $3 per share. What is the
degree of operating leverage for XYZ Ltd.? cost of issuing the preferred shares?
(a) 0.78 (a) 9.14%
(b) 0.57 (b) 9.00%
(c) 0.74 (c) 7.50%
(d) 1.36 (d) 10.50%

ANSWER KEYS

82 83 84 85 86 87 88 89 90 91
(a) (c) (d) (a) (b) (c) (d) (d) (a) (b)
92 93 94 95 96 97 98 99 100 101
(c) (d) (d) (d) (d) (a) (d) (c) (b) (d)
102 103 104 105 106 107 108 109 110 111
(d) (a) (d) (c) (c) (a) (c) (d) (b) (d)
112 113 114 115 116 117 118 119 120 121
(a) (b) (c) (a) (b) (a) (a) (a) (c) (d)

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CS Executive: Financial Management Cost of Capital & Capital Structure
122 123 124 125 126 127 128 129 130 131
(a) (a) (a) (a) (b) (d) (d) (b) (b) (b)
132 133 134 135 136 137 138 139 140 141
(b) (a) (b) (b) (a) (a) (a) (d) (c) (a)
142 143 144 145 146 147 148 149 150 151
(a) (c) (a) (b) (c) (c) (b) (b) (b) (b)
152 153 154 155 156 157 158 159 160 161
(c) (d) (b) (c) (c) (b) (c) (d) (d) (c)
162
(a)

163. Cost of capital of company plays an important (b) Term loans

role in deciding the capital structure of a company. (c) Both (a) and (b)
(a) True (d) None of the above
(b) False
170. __________ represents the investment made by
164. Which of the following statement is not correct? the owners of the business.
(a) Long Term Finance involves financing for fixed (a) Equity Share Capital
capital required for investment in fixed assets. (b) Preference Share Capital
(b) Long Term Finance is obtained from Capital (c) Retained Earnings
Market. (d) Debentures
(c) Long term sources of finance have a short term
impact on the business. 171. ________ represents the investment made by the
(d) Long term finance is used for financing big preference shareholders.
projects, expansion plans, increasing production, (a) Equity Share Capital
funding operations. (b) Preference Share Capital
(c) Retained Earnings
165. Purpose of long term finance includes: (d) Debentures
(a) To Finance Fixed Assets.
(b) To finance the permanent part of working capital. 172. ________ enjoy preference over payment of
(c) To finance growth and expansion of business. dividend.
(d) All of the above (a) Equity Share Capital
(b) Preference Share Capital
166. Factors determining long term finance needs of (c) Retained Earnings
a company includes: (d) None of the above
(a) Nature of Business
(b) Nature of good produced 173. ________ represents the earnings not distributed
(c) Technology used to shareholders.
(d) All of the above (a) Equity Share Capital
(b) Preference Share Capital
167. Source of long term finance includes: (c) Retained Earnings
(a) Ownership capital (d) Debentures
(b) Borrowed Capital
(c) Both (a) and (b) 174. Debenture holders have voting rights and there
(d) None of the above is a dilution of ownership.
(a) True
168. Which of the following is not the part of (b) False
ownership capital?
(a) Equity Share Capital 175. Debentures can be:
(b) Preference Share Capital (a) Convertible debentures
(c) Debentures (b) Non-convertible debentures
(d) Retained Earnings (c) Both (a) and (b)
(d) None of the above
169. Which of the following forms the part of
borrowing capital? 176. Terms loans from banks include loan from:
(a) Debentures (a) Industrial development banks

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CS Executive: Financial Management Cost of Capital & Capital Structure
(b) Cooperative banks (c) Dividend policy
(c) Commercial Bank (d) All of the above
(d) All of the above
184. Which of the following factor is the non-
177. Loan from financial institutions include loan controllable factor affecting the cost of capital:
from: (a) Tax Rates
(a) Industrial Finance Corporation of India (IFCI) (b) Level of interest rates
(b) Industrial Development Bank of India (DBI) (c) Both (a) and (b)
(c) Small Industrial Development Bank of India (d) Dividend Policy
(SIDBI)
(d) All of the above 185. Tax rate does not affect the cost of capital of
company
178. Which of the following statement is not correct? (a) True
(a) Financial Institutions grant loans for a longer (b) False
period to industrial establishment.
(b) Financial Institutions grant loans to help the 186. Capital structure of the company affects the cost
establishment of business units that require small of capital of company.
amount of funds. (a) True
(c) Financial Institutions grant loans to provide support (b) False
for the speedy development of the economy in general
and backward regions in particular. 187. Tax rates and interest rates prevailing in
(d) Financial Institutions grant loans to provide economy are the non-controllable factor that affects
technical and professional management services and the cost of company.
help in identification, evaluation and execution of new (a) True
projects. (b) False

179. Cost of capital is the rate of return that a firm 188. __________ refers to the cost of long term
_____ earn on its project investments to maintain its debentures / bond
market value and attract funds. (a) Cost of retained earnings
(a) Must (b) Cost of debt
(b) Can (c) Cost of company
(c) Should (d) Cost of short term debt
(d) None of the above
189. Cost of Debt is calculated ….
180. ________ is the rate of return the firm required (a) Before tax
from investment in order to increase the value of the (b) After tax
firm in the market place. (c) Both (a) and (b)
(a) Cost of capital (d) None of the above
(b) Cost of equity share capital
(c) Cost of Retained earnings 190. If the cost of debt for Cowboy Energy Services is
(d) Cost debentures 10% (effective rate) and its tax rate is 40% then Kd
is:
181. Cost of capital is used to make: (a) 10%
(a) Capital budgeting decision (b) 5%
(b) Capital structure decision (c) 6%
(c) Evaluate the financial performance of company (d) 4%
(d) All of the above
191. If the cost of debt for Rainbow Services is 15%
182. Factors affecting cost of capital can be: (effective rate) and its tax rate is 20% then Kd is:
(a) Controllable factors (a) 15%
(b) Uncontrollable factors (b) 12%
(c) Both (a) and (b) (c) 18%
(d) None of the above (d) 3%

183. Which of the following factor is not the 192. Jain & Co. sells a new issue of 6% irredeemable
controllable factor affecting the cost of capital: debentures to raise ` 100,000. The company falls in
(a) Capital structure policy
(b) Level of interest rates
Unique Academy 3.28 Prof. Ashish Parikh
CS Executive: Financial Management Cost of Capital & Capital Structure
40% tax bracket. Debts are issued at par. Find Cost 198. X Limited issues its Bond at par @ ` 1,000 per
of Capital.
bond. These bonds will mature after 20 years at par
(a) 4%
and bears coupon rate of 10%. Coupons are annual.
(b) 6%
The bond will sell for par but flotation costs amount
(c) 2.4%
(d) 3.6% to ` 50 per bond. What is the after-tax cost of debt
for X Limited?
193. Classic Industries sells a new issue of 8% (a) 10%
irredeemable debentures to raise ` 1,00,000 and (b) 6%
(c) 8%
realizes the full face value of ` 100. The company (d) 7%
falls in 40% tax bracket. Debts are issued at par.
Find Cost of Capital. 199. Which of the following statement is correct?
(a) 8% (a) Preference shares are entitled to a fixed dividend.
(b) 6% (b) Preference shares are not entitled to a fixed
(c) 6.4% dividend.
(d) 1.6% (c) Preference shares are entitled to a fixed dividend,
but subject to availability of profit for distribution.
194. Jain & Co sells a new issue of 6%, 1000 (d) None of the above.
irredeemable debentures of ` 100 each @ 10%
200. Preference shares can be:
premium. The company falls in 40% tax bracket.
(a) Irredeemable preference shares
(a) 4%
(b) Redeemable preference shares
(b) 6%
(c) Both (a) and (b)
(c) 2.4%
(d) None of the above
(d) 3.27%
201. _________ are those shares issuing by which the
195. Classic Industries sells a new issue of 8%, 1000
company has no obligation to pay back the principal
irredeemable debentures of ` 100 each @ 20% amount of the shares during its lifetime.
premium. The company falls in 20% tax bracket. (a) Irredeemable preference shares
Find cost of capital. (b) Redeemable preference shares
(a) 8% (c) Cumulative preference shares
(b) 6% (d) Non-cumulative preference shares
(c) 5.33%
(d) 1.6% 202. ________ are those shares whose dividends will
get accumulated if they are not paid.
196. Jain & Co sells a new issue of 6%, 1000 (a) Irredeemable preference shares
irredeemable debentures of ` 100 each @ 10% (b) Redeemable preference shares
(c) Cumulative preference shares
discount. The company falls in 40% tax bracket.
(d) Non-cumulative preference shares
Find cost of capital.
(a) 4%
203. Calculate the cost of 10% preference capital of
(b) 6%
(c) 2.4% 10,000 preference shares whose face value is ` 100.
(d) 3.27% The market price of the share is currently ` 115.
(a) 10%
197. A firm issues debentures worth ` 1,00,000 and (b) 12%
realizes ` 98,000 after allowing 2% commission to (c) 8.7%
(d) 11.5%
brokers. They carry an interest rate of 10% and are
due for maturity at the end of 10th year. The
204. A limited company issues 8% preference shares
company has 40% tax bracket. Calculate cost of debt
after tax. which are irredeemable. The face value of share is `
(a) 10% 100 but they are issued at ` 105. The floatation cost is
(b) 6%
(c) 6.18% ` 3 per share, calculate case of capital.
(d) 4% (a) 8%
(b) 6%

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CS Executive: Financial Management Cost of Capital & Capital Structure
(c) 6.84% (d) 20%
(d) 7.84%
212. Given, the yield on debt is 12% and the risk
205. A company issues 10,000, 8% preference shares premium as 2%, calculate the cost of equity.
of ` 100 each redeemable after 20 years at face value. (a) 10%
(b) 12%
The floatation costs are ` 3 per share find case of (c) 8%
capital. (d) 14%
(a) 8%
(b) 6% 213. As per ________ , a judgmental risk premium to
(c) 8.27% the observed yield on the long-term bonds of the firm
(d) 7.84% is added to get the cost of equity.
(a) CAPM Model
206. _______ are the last claimant on the profit of the (b) Bond Yield Plus Risk Premium Approach
company. (c) Dividend Growth Model Approach
(a) Equity shareholders (d) Earning Price Ratio Approach
(b) Preference shareholders
(c) Debenture holders 214. A company has issued 5,000 equity shares of `
(d) All of the above
100 each. Its current market price is ` 95 per share
207. _______ is the minimum rate of return that a and the current dividend is ` 4.5 per share. The
company must earn on the equity financed portion of
dividends are expected to grow at the rate of 6%.
its investments in order to maintain the market price
Compute the cost of equity capital.
of the equity share at the current level.
(a) 10%
(a) Cost of equity capital
(b) 11%
(b) Cost of preference share capital
(c) 12%
(c) Cost of debentures
(d) 9%
(d) Cost of retained earnings
215. Capital structure can vary according to
208. Ke  Rf  β  Rm  Rf  is a formula to calculate
changing requirements of the firm.
cost of equity as per: (a) True
(a) CAPM Model (b) False
(b) Bond Yield Plus Risk Premium Approach
(c) Dividend Growth Model Approach 216. Ke = E1 / Po is a formula to calculate cost of
(d) Earning Price Ratio Approach equity as per:
(a) CAPM Model
209. Calculate the cost of equity capital for a (b) Bond Yield Plus Risk Premium Approach
company whose Risk-free rate = 10%, equity market (c) Dividend Growth Model Approach
required return = 18% with a beta of 0.5. (d) Earning Price Ratio Approach
(a) 10%
(b) 14% 217. A company has currently 10,000 equity shares of
(c) 15%
` 100 each and its earnings are ` 150,000. Its current
(d) 12%
market price is ` 112 and the growth rate of EPS is
210. Calculate the cost of equity capital for a expected to be 5%. Calculate the cost of equity.
company whose Risk-free rate = 8%, equity market (a) 10%
required return = 15% with a beta of 0.4. (b) 12%
(a) 10% (c) 14%
(b) 14% (d) 16%
(c) 10.8%
(d) 9.2%
218. Kritika Limited is currently financed with `
211. Given, the yield on debt is 10% and the risk 1,000,000 of 7% bonds, and ` 2,000, 000 of common
premium as 5%, calculate the cost of equity. stock. The stock has a beta of 1.5, and the risk free
(a) 10% rate is 4%, and the market risk premium is 3.5%.
(b) 5% What is Kritika Limited WACC?
(c) 15% (a) 5.68%

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CS Executive: Financial Management Cost of Capital & Capital Structure
(b) 6.68% 226. The weights to be used for calculation of WACC
(c) 7.68% can be:
(d) 8.68% (a) Based on the book value
(b) Based on the market value of the funds
219. The firm is not required to pay dividends on (c) Both (a) and (b)
retained earnings, so it may be argued that the (d) None of the above
retained earnings have no cost.
(a) True 227. _________ can be defined as the cost of
(b) False additional capital introduced in the capital structure
(a) Weighted average cost of capital
220. There is an opportunity cost involved in the (b) Simple Average cost of capital
firms retaining the earnings and an estimation of this (c) Marginal Cost of capital
cost may be taken up as a measure of cost of capital (d) Liquid cost of capital
of retained earnings.
(a) True 228. Information costs both increase the marginal
(b) False cost of capital and reduce the internal rate of return
on investment projects.
221. The cost of retained earnings are often taken as (a) True
equal to the ________ (b) False
(a) Cost of debt
(b) Cost of preference share 229. Depreciation expenses involve no direct cash
(c) Cost of equity outlay and can be safely ignored in investment
(d) None of the above project evaluation.
(a) True
222. The weighted average cost of capital (WACC) is (b) False
the ________ of the costs of different components of
the capital structure of a firm. 230. The marginal cost of capital will be less elastic
(a) Weighted average for larger firms than for smaller firms.
(b) Simple average (a) True
(c) Timely average (b) False
(d) Quarterly average
231. In practice, the component costs of debt and
223. ________ is calculated after assigning different equity are jointly rather than independently
weights to the components according to the portion determined.
of that component in the capital structure. (a) True
(a) Cost of equity (b) False
(b) Cost of debt
(c) Weighted Average cost of capital 232. Investments necessary to replace worn-out or
(d) Simple Average cost of capital damaged equipment tend to have low levels of risk.
(a) True
224. A company has currently 10,000 equity shares of (b) False
` 100 each and its earnings are ` 180,000. Its current
233. ABC Limited has the following capital structure.
market price is ` 198 and the growth rate of EPS is
expected to be 10%. Calculate the cost of equity. `
(a) 10% Equity (expected dividend 12%) 10,00,000
(b) 12% 10% preference 5,00,000
(c) 14% 8% loan 15,00,000
(d) 16%
You are required to calculate the weighted average
225. The weights are said to be book value weights if cost of capital, assuming 50% as the rate of income-
the proportion of different sources are ascertained on tax, before and after tax.
the basis of the ______ (a) 6.66%
(a) Face value (b) 7.66%
(b) Market value (c) 8%
(c) Both (a) and (b) (d) 9%
(d) None of the above

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CS Executive: Financial Management Cost of Capital & Capital Structure
234. A company has on its books the following (a) 6%
amounts and specific costs of each type of capital. (b) 7.17%
(c) 8.17%
Type of Book Market Specific
(d) 10.84%
Capital Value (`) Value (`) Costs (%)
Debt 4,00,000 3,80,000 5 239. The Mountaineer Airline Company has
Preference 1,00,000 1,10,000 8 consulted with its investment bankers and
Equity 6,00,000 9,00,000 15 determined that they could issue new debt with a
Retained 2,00,000 3,00,000 13 yield of 8%. If Mountaineer marginal tax rate is
Earnings 39%, what is the after-tax cost of debt to
13,00,000 16,90,000 Mountaineer?
(a) 8%
Determine the weighted average cost of capital using (b) 6%
Book value weights. (c) 4.88%
(a) 10% (d) 6.88%
(b) 10.1%
(c) 11.1% 240. Funds required for a business may be classified
(d) 11.9% as long term and short term.
235. Weighted cost of capital is not the accepted (a) True
discounting rate for evaluating investment decisions. (b) False
(a) True
(b) False 241. For an investment to be worthwhile, the
expected return on capital must be greater than the
236. ABC Ltd. has expected earnings at ` 30 per cost of capital.
(a) True
share which is growing at 8% annually. Company
(b) False
follows fixed payout ratio of 50%. The market price
of its share is ` 300. Find the current cost of equity. 242. Rama Company issued 1,20,000 10% debentures
(a) 10% of ` 10 each at a premium of 10%. The costs of
(b) 11%
floatation are 4%. The rate of tax applicable to the
(c) 12%
company is 55%. Complete the cost of debt capital.
(d) 13%
(a) 4%
237. ABC Ltd. has expected earnings at ` 30 per (b) 4.34%
(c) 4.24%
share which is growing at 8% annually. Company (d) 4.26%
follows fixed payout ratio of 50%. The market price
of its share is ` 300. Find the cost of new equity if the 243. Suraiya Limited issued 4,000 12% preference
firm issues fresh shares at current market price but shares of ` 100 each at a discount of 5%. Costs of
with floatation cost of 5%.
(a) 13.68% raising capital are ` 8,000. Compute the cost of
(b) 11% preference capital.
(c) 12% (a) 12%
(d) 13% (b) 12.1%
(c) 12.9%
238. Oxford Company has complied the information (d) 12.8%
shown in the following table.
244. In weighted average cost of capital, a company
Source of Book value Market After tax can affect its capital cost through.
capital value cost (a) Policy of capital structure
Equity 1080000 3000000 17 (b) Policy of dividends
Preference 50000 60000 13 (c) Policy of investment
stock (d) All of the above
Long term 4500000 3840000 6
debt 245. Cost of common stock is 13% and bond risk
Total 5630000 6900000 premium is 5% then bond yield would be.
Calculate the weighted average cost of capital using (a) 18%
book value weights. (b) 26%

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CS Executive: Financial Management Cost of Capital & Capital Structure
(c) 8% of the stock is $24.80 and the growth rate is 3
(d) 18% percent. What is the firm’s cost of equity?
(a) 7.58 percent
246. The cost of equity capital is all of the following (b) 7.91 percent
except: (c) 8.24 percent
(a) The minimum rate that a firm should earn on the (d) 8.40 percent
equity-financed part of an investment.
(b) A return on the equity-financed portion of an 252. The cost of equity capital is all of the following
investment that, at worst, leaves the market price of the except:
stock unchanged. (a) The minimum rate that a firm should earn on the
(c) By far the most difficult component cost to equity-financed part of an investment.
estimate. (b) A return on the equity-financed portion of an
(d) Generally lower than the before-tax cost of debt. investment that, at worst, leaves the market price of the
stock unchanged.
247. To compute the required rate of return for (c) By far the most difficult component cost to
equity in a company using the CAPM, it is necessary estimate.
to know all of the following except: (d) Generally lower than the before-tax cost of debt.
(a) The Risk free rate
(b) The Beta for the firm 253. A firm has the following capital structure and
(c) The earnings for the next time period after-tax costs for the different sources of funds used:
(d) The market return expected for the time period
Source of Amount ` Proportion After-
248. In calculating the costs of the individual Funds % tax-cost
components of a firm’s financing, the corporate tax Debt 15,00000 25 5
rate is important to which of the following Preference 12,00,000 20 10
component cost formulas? Shares
(a) Equity share capital Equity 18,00,000 30 12
(b) Debt Shares
(c) Preference shares Retained 15,00,000 25 11
(d) None of the above Earnings
Total 60,00,000 100
249. If the CAPM is used to estimate the cost of
equity capital, the expected excess market return is You are required to compute the weighted average
equal to the: cost of capital.
(a) Return on the stock minus the risk-free rate. (a) 9.6%
(b) Difference between the return on the market and (b) 8.6%
the risk-free rate. (c) 10%
(c) Beta times the market risk premium. (d) 11%
(d) Beta times the risk-free rate. 254. Continuing above question, the firm has 18,000
250. Music’s Audio Shop has a cost of debt of 7%, a equity shares of ` 100 each outstanding and the
cost of equity of 11%, and a cost of preferred stock of current market price is ` 300 per calculate he
8%. The firm has 104,000 shares of common stock market, value weighted average cost of capital
outstanding at a market price of $20 a share. There assuming that the market values and book values of
are 40,000 shares of preferred stock outstanding at a the debt and preference capital are same.
market price of $34 a share. The bond issue has a (a) 9.6%
total face value of $500,000 and sells at 102% of face (b) 8.6%
value. The tax rate is 34%. What is the weighted (c) 10.41%
average cost of capital: (d) 11.41%
For Peter’s Audio Shop?
(a) 6.14% 255. You are given the following facts about a firm:
(b) 6.54% 1. Risk free rate of returns is 11%.
(c) 8.60% 2. Beta co-efficient of the firm is 1.25.
(d) 9.14%
Compute the cost of equity capital using Capital
251. PKL Industries is expected to pay an annual Asset Pricing Model (CAPM) assuming a market
dividend of $1.30 a share next year. The market price return of 15 percent next year.

Unique Academy 3.33 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
(a) 14% (d) 11.75%
(b) 16%
(c) 18% 258. The return on the Satyam Corporation’s stock is
(d) 20% relatively volatile as reflected by the company’s beta
of 1.8. The return on the S&P 500 is currently 12%
256. Weighted average cost of capital represents an
and is expected to remain at that level.
averaging of all risks of the company and can be used
Treasury bills are yielding 6.5%. Estimate Satyam’s
to evaluate investments.
cost of retained earnings.
(a) True
(a) 10.4%
(b) False
(b) 12.4%
(c) 14.4%
257. Calculate the WACC for the Zodiac Company
(d) 16.4%
given the following information about its capital
structure.
259. Periwinkle Inc. paid a dividend of $1.65 last
year and its stock is currently selling for $33.60 a
Capital Component Value Cost
share. The company is expected to grow at 7.5%
Debt 60,000 9% indefinitely. Estimate the firm’s cost of retained
Preferred stock 50,000 11% earnings.
Common stock 90,000 14% (a) 10%
Total 2,00,000 (b) 12.8%
(c) 13.8%
(a) 10% (d) 12%
(b) 11%
(c) 12%

ANSWER KEY

163 164 165 166 167 168 169 170 171 172
(a) (c) (d) (d) (c) (c) (c) (a) (b) (b)
173 174 175 176 177 178 179 180 181 182
(c) (b) (c) (d) (d) (b) (a) (a) (d) (c)
183 184 185 186 187 188 189 190 191 192
(b) (c) (b) (a) (a) (b) (b) (c) (b) (d)
193 194 195 196 197 198 199 200 201 202
(c) (d) (c) (a) (c) (d) (c) (c) (a) (c)
203 204 205 206 207 208 209 210 211 212
(c) (d) (c) (a) (a) (a) (b) (c) (c) (d)
213 214 215 216 217 218 219 220 221 222
(b) (b) (a) (d) (c) (c) (b) (a) (c) (a)
223 224 225 226 227 228 229 230 231 232
(c) (a) (a) (c) (c) (a) (b) (b) (a) (a)
233 234 235 236 237 238 239 240 241 242
(b) (c) (b) (d) (a) (c) (c) (a) (a) (d)
243 244 245 246 247 248 249 250 251 252
(c) (d) (c) (d) (c) (b) (b) (d) (c) (d)
253 254 255 256 257 258 259
(a) (c) (b) (a) (d) (d) (b)

Unique Academy 3.34 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

Theoretical Concept
“Every profit Seeking Corporation has Own Risk – Return characteristics. Each group in investors in the Corporation
- Bond Holders, Preferred Stock Holders, and Common Stock Holders - requires a Minimum Rate of Return
commensurate with the risks it accepts by investing in the firm. From the stand point of the corporation, these groups
provide the capital needed to finance the firm’s investments. The minimum Rate of Return that the corporation must
earn in order to satisfy the overall Rate of Return required by its investors is called the Corporation’s Cost of Capital.
”

The concept of Cost of Capital is an important and fundamental concept of theory of financial management. In
particular, the concept of Cost of Capital has two applications. First, in Capital Budgeting it is used to discount the
future cash flows to obtain their present values, and second, it is also used in optimization of the financial plan or
Capital Structure of a firm. The second aspect of the concept of Cost of Capital will be taken up in Chapter 13. In the
present chapter, an attempt has been made towards the determination and measurement of this Discount Rate i.e. the
Cost of Capital besides analyzing other related aspects.

Note :
“Here Capital word is Long Term sources of Finance.”
 Equity Share Capital….. Perpetual (Long Term).
 Preference Share Capital
 Debenture
 Term Loan

 The Main Objective of this Topic is to find (WACC) Weighted Average Cost of Capital (K C / K O ) and to
Compare with Return on Investment (ROI).

 If ROI > K C , then Accept the Project.

 If ROI < K C , then Reject the Project.

 Main Components of 𝐊𝐂
Post Tax Specific Cost of Capital Specific Weights of Fund
Ke We
Kp Wp
Kd Wd
KT WT

Formula of Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) K c = K e We + K p Wp + K d Wd + K T WT

 It is the Weighted Average of Component Cost, Equity is the Comp. of K c

 It is the minimum Rate of Return required by Long Term Sources of Finance.

 (K c) It is the Rate of Return (ROR) that a firm must Earn to maintain its Share Price.
But Main Objective Financial Management is to maximize Shareholder Wealth.

 It is the Hurdle Rate in Capital Budgeting i.e. thye Project will be accepted only if
IRR > K c

Weights
Book Value Weights Market Value Weights
1) B V of Equity = ESC + R & S 1) M V of Equity = No. Equity Shares × Market Price

Unique Academy 3.35 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
Per Equity Share
(As shown by Books of Account or Balance Sheet)
2) B V of Preference = PSC 2) M V of Preference = No. Preference × Market
Price Per Preference Share
(As shown by Books of Account or Balance Sheet)
3) B V of Debenture = Debenture 3) M V of Debenture = No. Debenture × Market Price
Per Debenture
(As shown by Books of Account or Balance Sheet)
4) B V of Term Loan = Term Loan 4) Generally M V of Term Loan = B V Of Term
Loan (As shown by Books of Account or Balance
(As shown by Books of Account or Balance Sheet)
Sheet)

IMP Note : We never consider Reserve & Surplus in Market Value of Equity.

Preference of Weights
1) Target Value Weights 2) Market Value 3) Book Value

Cost of Debenture / Bond 𝐊𝐝

Redeemable Bond Zero Coupon Irredeemable Bond

R V − NP 1 I (1−t)
I ( 1 − t) + RV n Kd = × 100
n
Kd = R V + NP
Kd = ( ) − 1 NP
NP
2

Where,
I = Coupon (Interest) Amount
= F V × Interest Rate (i)
t = Tax Rate
R V = Redemption Value
N P = Net Process
= Market Price – Flotation Cost
n = No of Yrs. Remaining to Maturity

Interest on Debenture & Term Loan are Tax deductible, it means you get Tax Advantage / Tax Shield / Tax Saving on
amount of Interest.

E.g. 10%, 10,000 Debenture of Rs. 10 each = Rs. 1,00,000.

∴ Tax Advantage / Tax Shield / Tax Saving = Interest × Tax Rate

∴ Tax Advantage / Tax Shield / Tax Saving = 1,00,000 × 10% × 0.40

= 10,000 × 0.40
= 4,000

In above example,

Net amount of Interest Paid = Interest – Interest × Tax Rate

= Interest (1 – Tax Rate)
= 10,000 (1 – 0.40)

Unique Academy 3.36 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
= 10,000 (0.60)
= 6,000.

Cost of Preference Capital (𝐊 𝐩 )

Redeemable Bond Irredeemable Bond

R V − NP D
D+ Kp = × 100
n NP
Kp = R V + NP
2

Where,
D = Dividend Amount
R V = Redemption Value
N P = Net Process
= Market Price – Flotation Cost
n = No of Yrs. Remaining to Maturity

Note
 If no information is given in question except 12% Preference Capital.
Then , K p = 12% Only. No Formula need to Apply

 If Corporate Dividend Tax is given, Assume (CDT = 10%)

Replace D by D (1 + CDT) in the above Formula.

 If Maturity Period (n) is not given then always assume it is Perpetual Bond / Debenture.

 Suppose data in question only states that it is a 12% Debentures.

In this Case
K d = 12% (1 − t) Just Like Term Loan.

Cost of Equity 𝐊𝐞
 K e is the Rate of Return, the firm must earn on (P Net) in order to give to the Equity Shares Holder the Rate of
Return required (R e ) on Po .

 Explanation
Suppose Market Price (Po ) equal to 800.

Expectations of Equity R e = 15%

(P net) Net Process Per Share = 780
Calculate K e

Solution
Share Holder wants 15% of 800 = Rs. 120.

Co. has to earn 120 on 780.

120
∴ Ke = × 100
780
∴ K e = 15.38%

Unique Academy 3.37 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure
 In above example 20 is Floatation Cost, If you Calculate in %.

20
× 100 = 2.5
780

Expectation Equity Share Holder is 15% i.e. Rs. 15 on 100, But Due to Cost Co, will receive
100 – 2.5 = 97.5 (Now Company has to earn 15 on 97.5.)
15
∴ = 15.38%
97.5%

Re 15%
∴ Formula K e = =
1 −f 1 −0.025

Where,
R e = Rate of Return required by Equity Share Holder
f = Floatation Cost

In this Sum Floatation Cost is Rs. 20.

20
∴ Floatation Cost % = × 100
800
= 2.5 %

So we have,
Re
K e = 1 −f

15 15
= = 0.975
1 −0.025

∴ K e = 15.38%

 Is Floatation Cost always there (?).

Solution: There are 2 types of Equity – Internal Equity & External Equity i.e. amount raised by issuing fresh
Equity Share. This definitely involves Floatation Cost.

Internal Equity
This refers to retained Earning ploughed Back in Business. There is no Floatation Cost.

E.g. What Formula do we use to Calculate Cost of Equity.

Case I – Internal Equity

Ke = Re

Case II – External Equity

Ke > Re

Unique Academy 3.38 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

Ke > Re

The Formula of R e The Formula of R e

does not use Po uses Po

R e Re
K e = 1 −f K e ≠ 1 −f

Instead K e will be
Computed by the the same
Formula as R e but we will
use P net instead of Po in
Formula
Note
1) β It is the Sensitivity of a Stock w.r.t Market Portfolio (Sensex).
It Stock has a β of 2 it means that when the Market changes by 1% Stock is Expected to change
by 2%.

2) Risk Types.
Risk Types.

Systematic Risk Unsystematic Risk

Risk related to the Risk related to firm’s

Economy captured by β Internal factors.

Capm assumes that investors invest in diversified Portfolio in which Unsystematic Risk gets cancelled away.

Hence return depends on only on Systematic Risk i.e. β

R e = R f + (R m − Rf ) β

3) Be careful in interpreting Market Return as R m + Market Risk Premium as (R m − Rf )

R f = 6%
Market Risk Premium = 5%

Stock β Re = 6 + 5 β
A 0.8 6 + 5 × 0.8 = 10%
B 1.2 6 + 5 × 1.2 = 12%
C 1.5 6 + 5 × 1.5 = 13.5%
D 2 6 + 5 × 2 = 16%

Dividend Discount Model

D
Re = P 1 + g
o

D
Re = P 1 + g
o

Unique Academy 3.39 Prof. Ashish Parikh

CS Executive: Financial Management Cost of Capital & Capital Structure

Where,
Po = Current Share Price
D1 = Expected Dividend Per Share
g = Sustainable Growth Rate

D1
Ke = P +g
net

Explanation : Presently Share Price is 500 Investor expects to receive DPS of 60 next year. Sustainable
Growth Rate 4% p.a. Forever.
D
Re = P 1 + g
o

60
R e = 500 + 0.04

= 0.16 = 16%

Earning Yield Approach

R e = Earning Yield
EPS
Re = × 100
Po

Note : It is more popular to learn this formula as

1
R e = P⁄
E Ratio

Model 𝐑𝐞 𝐊 𝐞 Internal 𝐊 𝐞 External

Camp R f + (R m − Rf ) β = Re Re
1 −f
Dpm D1 = Re D1
+g +g
Po Pnet

Earning Yield E 1 = Re E Re
Or 1 −f
𝑜𝑟 Pnet
Po P⁄E

Unique Academy 3.40 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting

4 CAPITAL BUDGETING

Question 1

Give the Cash Flow of a Project

Years 0 1 2 3
Net Cash Flow (in Lacs) (800) 300 400 500

How do we decide whether to Accept or Reject the Project given K c = 11.75%

Question 2

Consider a Project with Initial Investment of Rs 500 L funded as follows:

Equity = 300 L
Long Term Loan = 200 L
Interest Rate on Loan = 14%, Tax Rate = 30%, Cost of Equity = 21%,

The Project is Expected to Generate the following After Tax Cash Flows.

Years 1 2 3 4
Cash Flow 220 200 240 210

Find Out the NPV of the Project

Question 3

Consider a Project with Initial Investment of 500 lakhs. Annual Cash Flow 60 lakhs (Perpetuity) K c = 12.5% ,
Calculate NPV.3

Question 4

Initial Investment = 600L

Life = 5 years
Kc = 15%
NPV = 62 L
Calculate Annual Cash Flows.

Question 5

Initial Investment = 700 L

Life of the project = 8 years.
Kc = 14%
Annual Cash Flow = 150 lakhs
Calculate NPV

Question 6

Consider the following project cash flows

Year 0 1 2 3 4 5
NCF (80) 60 100 (30) 50 70
Unique Academy 4.1 Prof. Ashish Parikh
CS Executive: Financial Management Capital Budgeting

Kc = 18%, Calculate NPV

Question 7

Consider the following projects

Years Net Cash Flows (Rs in Lakhs)

0 (70)
1 50
2 (30)
3 80
4 120

Kc = 10%, Find PI

Question 8

Year 0 1 2 3 4
NCF (800) 300 400 200 500

Calculate IRR and give us advice if cost of capital is 15%.

Question 9

Consider the following project –

Year 0 1 2 3
NCF (600) 400 300 200

Kc = 20%, Calculate IRR and advice.

Question 10

Consider the following project –

Year 0 1 2 3 4
NCF (1200) 400 500 300 700

Ke = 20%, Calculate IRR and advice.

Question 11

For a project,
IRR = 16%
Annual cash flow = 57,500
Life = 5 years
1) Calculate initial investment.
2) It is known that if Kc goes up by 60% from its current level, NPV = 0. Calculate Kc.
3) Hence calculate NPV and PI.

Question 12

Consider the following project –

Year 0 1 2 3 4
NCF (1200) 400 500 300 700

Unique Academy 4.2 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting

1) Calculate IRR.
IRR = 19.67% (as calculated earlier)
2) What is the assumption taken in the calculation of IRR ?
The assumption is that the intermediate cash flow are reinvested at itself.
3) If you consider re-investment at Kc = 15%, calculate modified IRR.

Question 13

Consider a project with initial investment of Rs 500 L funded as follows.

Equity - 300 L
Long Term Loan - 200 L
Interest rate on loan =14%,
Tax Rate = 30%,
Cost of Equity = 21%,
The project is expected to generate the following after tax cash flows.

Years 1 2 3 4
Cash Flows 220 200 240 210

Find out NPV, IRR & PI.

Question 14

Given below are the data on a capital project ‘X’ for Theta Limited for your consideration:

Annual Cost Saving Rs 60,000

Useful Life 4 years
Internal Rate of Return 15%
Profitability Index 1.064
Salvage Value 0

You are Required to calculate for the Project X:

1) Cost of Project
2) Payback Period
3) Cost of Capital
4) Net Present Value.

Question 15

Initial Investment = 800 L, Project Life = 5 Years, Salvage Value = 40 L. The forecast of Cash Flow for the 5 year
Period are:

Years 1 2 3 4 5
CFs 240 230 190 180 170

Calculate ARR.

Question 16

There is a 10 year project where Initial Investment = 60 Lakhs and the sum total of after tax profit for the 10 years = 50
Lakhs. The firm has specified a hurdle ARR of 22% based on initial investment. Should the project be accepted?

Question 17

Unique Academy 4.3 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
Sagar Ltd an exiting profit-making company, is planning to introduce a new product with a projected life of 8 years.
Initial equipment cost will be Rs 120lakhs and additional equipment costing Rs 20 lakhs will be needed at the
beginning of third year.

At the end of the 8 years, the original equipment will have resale value equivalent to the cost of removal, but the
additional equipment would be sold for Rs 1 lakhs will be needed. The 100% capacity of the plant is of 4,00,000 units
per annum, but the production and sales-volume expected are as under:

Year Capacity in Percentage

1 20
2 30
3-5 75
6-8 50

A sale price of Rs 100 per unit with a profit volume ratio of 60% is likely to be obtained. Fixed Operating Cash Cost
are likely to be Rs 16 lakhs per annum. In addition to this the advertisement expenditure will have to be incurred as
under:

Question 18

Sagar Limited is trying to decide whether to buy a machine for Rs 80,000 which will save costs of Rs 20,000 per
annum for 5 years and which will have a resale value of Rs 10,000 at the end of 5 years. If it is the company’s policy to
undertake projects only if they are expected to yield a return of 10 percent or more, you are required to advise Sagar
Limited whether to undertake this project or not

Question 19

Ramesh Limited is considering buying a new machine which would have a useful economic life of five years, a cost of
1,25,000 and a scrap value of 30,000, with 80 per cent of the cost being payable at the start of the project and 20 per
cent at the end of the first year.

The machine would produce 50,000 units per annum of a new project with an estimated selling price of 3 per unit.
Direct costs would be 1.75 per unit and annual fixed costs, including depreciation calculated on a straight- line basis,
would be 40,000 per annum. In the first year and the second year, special sales promotion expenditure, not included in
the above costs, would be incurred, amounting to Rs 10,000 and Rs 15,000 respectively.

Evaluate the project using the NPV method of investment appraisal, assuming the company’s cost of capital to be 10
percent.

Question 20

An iron ore company presently extracts 1 lakhs tonnes a year

SP=1000 per ton and extraction cost = 700 per ton.
The firm is evaluating installing an equipment worth Rs 100 lakhs and putting in additional W.W. of 10 lakhs with a
view to further process 25% of the output at Rs 100 per ton Normal loss would be 20% and SP of the processed output
would be 1350 per ton.
Ke = 15%, for rate = 30%, useful life = 5 years, SV = NIL
Dep. = SLM
Check the viability of the project.

Question 21

Consider a project –
Initial Investment = 100L in plant and 40 L in WC
Sales = 1 Lakh units p.a.
Price = 120 per unit
V.C. = 60 per unit

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CS Executive: Financial Management Capital Budgeting
Cash FC = 15 L per annum
Depreciation = 25% WDV
Life = 5 years
SV = Book value at the end of 5 years.
T = 40%
Kc = 12%

Calculate NPV.

Question 22

Ganpati Limited is considering the following investment projects:

Cash Flows (Rs)

Projects C0 C1 C2 C3
A -10,000 +10,000
B -10,000 +17,500 +7,500
C -10,000 +12,000 +4,000 +12,000
D -10,000 +10,000 +3,000 +13,000

1) Rank the projects according to each of the following methods: (i) Pay back, (ii) ARR, (iii) IRR and (iv) NPV,
assuming discount rates of 10 and 30 per cent.
2) Assuming the projects ate independent, which one should be accepted? If the projects are mutually exclusive,
which project is the best?

Question 23

Consider the mutually exclusive projects –

Port Project A Project B

NPV 40 L 110 L
Life 6 years 10 years

If Kc = 11% which project should be chosen?

Question 24

Company Rohit is forced to choose between two machines A and B. The two machines are designed differently, but
have identical capacity and do exactly the same job. Machine A costs Rs 1,50,000 and will last for 3 years. It costs Rs
40,000 per year to run. Machine B is an ‘economy’ model costing only Rs 1,00,000, but will last only for 2 years, and
costs Rs 60,000 per year to run. Ignore tax. Opportunity cost of capital is 10 per cent. Which machine company Amol
should buy?

Question 25

Sagar Limited is considering the purchase of a new automatic machine which will carry out same operations which are
at present performed by manual labour. NM-A1 and NM-A2, two alternative models are available in the market. The
following details are collected:

Machine
Particulars NM-A1 NM-A2
Cost of Machine (Rs) 20,00,000 25,00,000
Estimated working life 5 Years 5 Years
Estimated Saving in direct wages per annum (Rs) 7,00,000 9,00,000
Estimated saving in scrap per annum (Rs) 60,000 1,00,000
Estimated additional cost of indirect material per annum (Rs) 30,000 90,000
Estimated additional cost of indirect labour per annum (Rs) 40,000 50,000

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CS Executive: Financial Management Capital Budgeting
Estimated additional cost of repairs and maintenance per annum (Rs) 45,000 85,000

Depreciation will be charged on a straight line method. Corporate tax rate is 30 percent and expected rate of return may
be 12 percent.

You are required to evaluate the alternatives by calculating the:

1) Pay-back Period
2) Accounting (Average) Rate of Return; and
3) Profitability Index or P.V. Index (P. V. factor for Rs 1@ 12% 0.893;0.797;0.712;0.636;0567;0507)

Question 26

Pawan Ltd presently uses a machine with book value 5L, SV now = 4L, remaining life = 5 years and SV after 5 years =
50000. Its annual operating cost is 90000.
Pawan Ltd is evaluating whether to replace this machine with a new one costing 7L, useful life = 5 years. SV at the end
of 5 Years = 2L, annual operating cost = 40000.
Taking Kc as 12%, tax rate @ 40% and depreciation on the basis of SLM, Advice Pawan Ltd.

Question 27

Rohit Ltd is evaluating whether to replace an old machine with a new one. Details provided below

Particulars Old Mc. New Mc.

BV today - 40000 Cost today – 120000
SV today - 30000 Life – 4 years
Remaining life - 4 years SV after 4 years – 2000
SV after 4 years - 5000 Dep - SLM
Dep. SLM

The purpose of replacement is cost reduction cost reduction each year would be 45000.
Tax rate = 30%
Kc = 14%
Determine NPV of the replacement decision.

Question 28

A company wants to replace its old machine with a new automatic machine. Two models A and B are available at the
same cost of Rs 5 lakhs each. Salvage value of the old machine is Rs 1 lakh. The utilities of the existing machine can
be used if the company purchases A.

Additional cost of utilities to be purchased in that case are Rs 1 lakh. If the company purchases B then all the existing
utilities will have to be replaced with new utilities costing Rs 2 lakhs. The salvage Value of the old utilities will be Rs
0.20 lakhs. The earnings after taxation are expected to be:

(Cash in – Flows of)

Year A Rs. B Rs. P.V. Factor @ 15%
1 1,00,000 2,00,000 0.87
2 1,50,000 2,10,000 0.76
3 1,80,000 1,80,000 0.66
4 2,00,000 1,70,000 0.57
5 1,70,000 40,000 0.50
Salvage Value at the end of year 5,50,000 60,000

The targeted return on capital 15%. You are required to

1) Compute, for the two machines separately, net present value, discounted payback period and desirability factor.
2) Advice which of the machines is to be selected?

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CS Executive: Financial Management Capital Budgeting
Question 29

You are the financial advisor for Garmma Limited. The management has requested you to analyse two proposed
capital investment, Projects X and Y. Each project has a cost of 10,000, and the cost of capital for each projects is 12
per cent. The expected net cash flows in the two projects are as follows.

Year Expected Net Cash Flows

Project X Project Y
0 (10,000) (10,000)
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500

You are Required to:

1) Calculate each Project’s payback period, net present value (NPV), international rate of return (IRR), and modified
international rate of return (MIRR),
2) Which project or projects should be accepted if they are independent?

Question 30

FH Hospital is considering 10 purchase a CT – Scan machine Presently the hospital is outstanding the CT – Scan
Machine and is earnings commission of RS 15,000 per month (net of tax). The following details are given regarding
the machine:

Particulars Rs.
Cost of CT – Scan Machine 15,00,000
Operating Cost Per Annum (Excluding 2,25,000
Depreciation)
Expected Revenue Per Annum 7,90,000
Salvage Value of the Machine (After 5 Years) 3,00,000
Expected Life of the Machine 5 years

Assuming tax rate @ 30% whether it would be profitable for the hospital to purchase the machine?

Give your recommendation under:

1) Net Present Value, Method
2) Profitability Index Method.

PV factors at 12% are given below:

Year 1 2 3 4 5
PV Factor 0.893 0.797 0.712 0.636 0.567

Question 32

Given below are the data on a capital project ‘M’:

Annual cash inflows Rs 60,000

Useful life 4 years
Internal rate of return 15%
Profitability index 1.064
Salvage value 0

You are required to calculate for this project ‘M’

1) Cost of Project
2) Pay Back Period
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CS Executive: Financial Management Capital Budgeting
3) Cost of Capital
4) Net Present Value

PV factors at different rates are given below:

Discount Factor 15% 14% 13% 12%

1 Year 0.869 0.877 0.885 0.893
2 Year 0.756 0.769 0.783 0.797
3 Year 0.658 0.675 0.693 0.712
4 Year 0.572 0.592 0.613 0.636

Question 33

Following are the data on a capital project being evaluated by the management of Swapnil Ltd:

Particulars Project M
Annual cost saving Rs 40,000
Useful life 4 years
I.R.R 15%
Profitability index (PI) 1.064
NPV ?
Cost of capital ?
Cost of project ?
Payback ?
Salvage value 0

Home Work
Question 34

The PI of a different projects is shown below

Project PI Initial Investment

A 1.2 500 Lacks
B 0.7 400 Lacks
C 1.5 300 Lacks
D 1.7 600 Lacks
E 1.1 800 Lacks

Rank the project in the descending order on the basis of NPV.

Question 35

You are required to compute the internal rate of return (IRR) of the project given below and adviss whether the project
should be accepted if the company requires a minimum return of 17%.

Time Rs
0 (4,000)
1 1,200
2 1,410
3 1,875
4 1,150

Question 36

Given below are the data on a capital project ‘X’ for Theta Limited for your consideration:

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CS Executive: Financial Management Capital Budgeting
Annual Cost Saving Rs 60,000
Useful Life 4 years
Internal Rate of Return 15%
Profitability Index 1.064
Salvage Value 0

You are Required to Calculate for Project X:

1) Cost of Project
2) Payback Period
3) Cost of Capital
4) Net Present Value.

Question 37

Sagar Limited is considering to spend Rs 4,00,000 on a project to manufacture and sell a new product. The unit
variable cost of the product is Rs 6. It is expected that the new product can be sold at Rs 10 per unit. The annual fixed
cost (only cash) will be Rs 20,000. The cost of capital of the company is 15%. The only uncertain factor is the volume
of sales. To start with, the company expects to sell at least 40,000 units during the first year, Ignore taxation.

You are Required to Calculate:

1) Net Present value of the project based on the sales expected during the first year and on the assumption that it will
continue at the same level during the remaining years,
2) The minimum volume of sales required to justify the project.

Question 38

Saurab Electronics is considering the proposal of taking up a new project which requires an investment of Rs 400 lakhs
on machinery and other assets. The project is expected to yield the following earnings (before depreciation and taxes)
over the next five years:

Year Earnings (Rs in Lakhs)

1 160
2 160
3 180
4 180
5 150

The cost of raising the additional capital is 12% and assets have to be depreciated at 20% on ‘Written Down Value’
basis. The scrap value at the end of the five years’ period may be taken as zero. Income-tax applicable to the company
is 50%.

You are required to calculate the net present value of the project and advise the management to take appropriate
decision. Also calculate the Internal Rate of Return of the Project.

Note: Present value of Rs 1 at different rates of interest is as follows:

Year 10% 12% 14% 16%

1 0.91 0.89 0.88 0.86
2 0.83 0.80 0.77 0.74
3 0.75 0.71 0.67 0.64
4 0.68 0.64 0.59 0.55
5 0.62 0.57 0.52 0.48

Question 39

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CS Executive: Financial Management Capital Budgeting
A machine purchased six years back for Rs 1,50,000 has been depreciated to a book value of Rs 90,000. It originally
had a projected life of fifteen years and zero salvage value. A new machine will cost Rs 2,50,000 and result in a
reduced operating cost of Rs 30,000 per year for the next time years. The older machine could be sold for Rs 50,000.
The new machine shall also be depreciated on a straight-line method on nine-year life with salvage value of Rs 25,000.
The company’s tax rate is 50% and cost of capital is 10%.
Determine whether the old machine should be replaced.
Given: Present Value of Re. 1 at 10% on 9th year = 0.424; and Present Value of an annuity of Rs 1 at 10% for 8 years =
5.335.

Question 40

Beta Limited receives Rs 15,00,000 a year after taxes from an investment in an automatic plant that has 12 more years
of service life. The company’s required rate is 12%. Beta Limited can make improvements to the plant to raise its
service life to 20 years and its annual after tax cash flow to Rs 48,00,000 per year.

These investments would cost Rs 2,10,00,000. With the improvements, the plant’s value at the end of 12 years would
rise from Rs 7,50,000 to Rs 75,00,000. Would the improvements produce a return satisfactory to Beta Limited?

Question 41

A hospital is considering purchasing a diagnostic machine costing Rs 80,000. The projected life of the machine is 8
years and has an expected salvage value of Rs 6,000 at the end of 8 years. The annual operating cost of the machine Rs
7,500. It is expected to generate revenues of Rs 40,000 per year for eights years. Presently, the hospital is outsourcing
the diagnostic work and is earning commission income of Rs 12,000 per annum; net of taxes.

Required:
Whether it would be profitable for the hospital to purchase the machine? Give your recommendation under:
1) Net Present Value method
2) Profitability Index method.

PV factors at 10% are given below:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

Question 42

Akashy Ltd is considering the purchase machine which will perform some operations which are at present performed
by workers. Machines X and Y are alternatives models.

The following details are available:

Machine X Machine Y
Particulars (Rs) (Rs)
Cost of machine 1,50,000 2,40,000
Estimated life of machine 5 years 6 years
Estimated cost of maintenance p.a. 7,000 11,000
Estimated cost of indirect material, p.c. 6,000 8,000
Estimated saving in scrap p.a. 10,000 15,000
Estimated cost of supervision p.a. 12,000 16,000
Estimated savings in wages pa. 90,000 1,20,000

Depreciation will be charged on straight line basis. The tax rate is 30%. Evaluate the alternatives according to :
1) Average Rate of Return Method,
2) Present Value Index Method assuming cost of being 10%. (The present value of Rs 1.00 @ 10%. p.a. for 5 years
is 3.79 and for 6 years is 4.354)

Unique Academy 4.10 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
Question 43

ANP Ltd. is providing the following information:

Annual cost of saving Rs 96,000

Useful life 5 years
Salvage value Zero
Internal rate of return 15%
Profitability index 1.05

Table of Discount Factor:

Discount factor Years

1 2 3 4 5 Total
15% 0.870 0.756 0.658 0.572 0.497 3.353
14% 0.877 0.769 0.675 0.592 0.519 3.432
13% 0.886 0.783 0.693 0.614 0.544 3.52

You are Required to Calculate:

1) Cost of the Project
2) Pay Back Period
3) Net Present Value of Cash Inflow
4) Cost of Capital.

Question 44

A large profit making company’s considering the installation of a machine to process the waste produced by one of its
existing manufacturing process to be converted into marketable product. At present , the waste is removed by a
contractor for disposal on payment by the company of Rs 50 lacs per annum for the next four years. The Contract can
be terminated upon installation of the aforesaid machine on payment of a compensation of Rs 30 lacs before the
processing operation starts. This compensation is not allowed as deduction for tax purposes.

The machine required for carrying out the processing will cost Rs 200 lacs to be financed by a loan repayable in 4
equal installments commencing from the end of year 1. The interest rate is 16% per annum. At the end of the 4th year,
the machine can be sold for Rs 20 lacs and the cost of dismantling and removal will be Rs 15 lacs. Sales and direct
costs of the product emerging form waste processing for 4 years are estimated as under:

Year 1 2 3 4
Sales 322 322 418 418
Material consumption 30 40 85 85
Wages 75 75 85 100
Other expenses 40 45 54 70
Factory overheads 55 60 110 145
Depreciation (as per income tax rules) 50 38 28 21

Initial stock of materials required before commencement of the processing operations is Rs 20 lacs at the start of year1.
The stock levels of materials to be maintained at the end of year1,2 and 3 will be Rs 55 lacs and the stocks at the end of
year 4 will be nil. The storage of materials will utilise space which would otherwise have been rented out for Rs 10
lacs per annum.

Labour costs include wages of 40 workers, whose transfer to this process will reduce idle time payments of Rs 15 lacs
in the year 1 and Rs 10 lacs in the year 2. Factory overheads include per annum payable on this volume. The
company’s tax rate is 50%.

Present value factors for four years are as under:

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CS Executive: Financial Management Capital Budgeting
Year 1 2 3 4
Present value factors 0.870 0.756 0.658 0.572
Advise the management on the desirability of installing the machine for processing the waste.
All calculations should from part of the answer.

Question 45

A company has to make a choice between two projects namely A and B. The initial capital outplay of two Projects are
Rs 1,35,000 and Rs 2,40,000 respectively for A and B. There will be no scrap value at the end of the life of both the
projects. The opportunity Cost of Capital of the company is 16%.
The annual incomes are as under:

Year Project A Project B Discounting Factor @ 16%

1 - 60,000 0.862
2 30,000 84,000 0.743
3 1,32,000 96,000 0.641
4 84,000 1,02,000 0.552
5 84,000 90,000 0.476

You are Required to Calculate for each project:

1) Discounted Payback Period
2) Profitability Index
3) Net Present Value.

MULTIPLE CHOICE QUESTIONS

1. Capital Budgeting is a part of: 6. Which of the following is not a capital budgeting
(a) Investment Decision decision?
(b) Working Capital Management (a) Expansion Programme
(c) Marketing Management (b) Merger
(d) Capital Structure (c) Replacement of an Asset
(d) Inventory Level
2. Capital Budgeting deals with:
(a) Long-term Decisions 7. A sound Capital Budgeting technique is based
(b) Short-term Decisions on:
(c) Both (a) and (b) (a) Cash Flows
(d) Neither (a) Nor (b) (b) Accounting Profit
(c) Interest Rate on Borrowings
3. Which of the following is not used in Capital (d) Last Dividend Paid
Budgeting?
(a) Time Value of Money 8. Which of the following is not a relevant cost in
(b) Sensitivity Analysis Capital Budgeting?
(c) Net Assets Method (a) Sunk Cost
(d) Cash Flows (b) Opportunity Cost
(c) Allocated Overheads
4. Capital Budgeting Decisions are: (d) Both (a) and (c) above
(a) Reversible
(b) Irreversible 9. Capital Budgeting Decisions are based on:
(c) Unimportant (a) Incremental Profit
(d) All of the above (b) Incremental Cash Flows
(c) Incremental Assets
5. Which of the following is not incorporate (d) Incremental Assets
Capital Budgeting?
(a) Tax-Effect 10. Which of the following does not effect cash flows
(b) Time Value of Money from a proposal?
(c) Required Rate of Return (a) Salvage Value
(d) Rate of Cash Discount (b) Depreciation Amount
(c) Tax Rate Change

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CS Executive: Financial Management Capital Budgeting
(d) Method of Project Financing (a) Cash flows be calculated in incremental terms
(b) All costs and benefits are measured on cash basis
11. Cash Inflows from a project include: (c) All accrued costs are revenues be incorporated
(a) Tax Shield of Depreciation (d) All benefits are measured on after-tax basis
(b) After-tax Operating Profits
(c) Raising of Funds 17. Evaluation of Capital Budgeting Proposals is
(d) Both (a) and (b) based on Cash Flows because:
(a) Cash Flows are easy to calculate
12. Which of the following is not true with reference (b) Cash Flows are suggested by SEBI
to capital budgeting? (c) Cash is more important than profit
(a) Capital budgeting is related to asset replacement (d) None of the above
decisions 18. Which of the following is not included in
(b) Cost of capital is equal to minimum required rate of incremental cash flows?
return (a) Opportunity Costs
(c) Existing investment in a project is not treated as (b) Sunk Costs
sunk cost (c) Change in Working Capital
(d) Timing of cash flows is relevant (d) Inflation effect
13. Which of the following is not followed in capital 19. A proposal is not a Capital Budgeting proposal
budgeting? if it:
(a) Cash Flows Principle (a) is related to Fixed Assets
(b) Interest Exclusion Principle (b) Brings long-term benefits
(c) Accrual Principle (c) Brings short-term benefits only
(d) Post-tax Principle (d) Has very large investment
14. Depreciation is incorporated in cash flows 20. In Capital Budgeting, Sunk cost is excluded
because it: because it is:
(a) Is unavoidable (a) of small amount
(b) Is a cash flow (b) not incremental
(c) Reduces Tax liability (c) not reversible
(d) Involves an outflow (d) All of the above
15. Which of the following is not true for capital 21. Savings in respect of a cost is treated in capital
budgeting? budgeting as:
(a) Sunk costs are ignored (a) An inflow
(b) Opportunity costs are excluded (b) An outflow
(c) Incremental cash flows are considered (c) Nil
(d) Relevant cash flows are considered (d) None of the above
16. Which of the following is not applied in capital
budgeting?
ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(a) (a) (c) (b) (d) (d) (a) (d) (b) (d)
11 12 13 14 15 16 17 18 19 20
(d) (c) (c) (c) (b) (c) (c) (b) (c) (b)
21
(a)

22. In capital budgeting, the term Capital Rationing 23. Feasibility Set Approach to Capital Rationing
implies: can be applied in:
(a) That no retained earnings available (a) Accept-Reject Situations
(b) That limited funds are available for investment (b) Divisible Projects
(c) That no external funds can be raised (c) Mutually Exclusive Projects
(d) That no fresh investment is required in current year (d) None of the above

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CS Executive: Financial Management Capital Budgeting
24. In case of divisible projects, which of the 31. If the Money Discount Rate is 19% and Inflation
following can be used to attain maximum NPV? Rate is 12%, then the Real Discount Rate is:
(a) Feasibility Set Approach (a) 7%
(b) Internal Rate of Return (b) 5%
(c) Profitability Index Approach (c) 5.70%
(d) Any of the above (d) 6.25%

25. In case of the indivisible projects, which of the 32. Money Discount Rate is equal to:
following may not give the optimum result? (a) (1 + Inflation Rate) (1 + Real Rate) – 1
(a) Internal Rate of Return (b) (1 + Inflation Rate)  (1 + Real Rate) – 1
(b) Profitability Index (c) (1 + Real Rate)  (1 + Inflation Rate) – 1
(c) Feasibility Set Approach (d) (1 + Real Rate) + (1 + Inflation Rate) – 1
(d) All of the above
33. Real Discount Rate is equal to:
26. Profitability Index, when applied to Divisible (a) (1 + Inflation Rate) (1 + Money Discount Rate) – 1
Projects, impliedly assumes that: (b) (1 + Money Discount Rate) + (1 + Inflation Rate) –
(a) Project cannot be taken in parts 1
(b) NPV is linearly proportionate to part of the project (c) (1 + Money Discount Rate)  (1 + Inflation Rate)
taken up –1
(c) NPV is additive in nature (d) (1 + Money Discount Rate) – (1 + Inflation Rate) –
(d) Both (b) and (c) 1

27. If there is no inflation during a period, then the 34. Which of the following cannot be true?
Money Cashflow would be equal to: (a) Inflation Rate > Money Discount Rate
(a) Present Value (b) Real Discount Rate < Money Discount Rate
(b) Real Cashflow (c) Inflation Rate < Real Discount Rate
(c) Real Cashflow + Present Value (d) Inflation Rate = Real Discount Rate
(d) Real Cashflow – Present Value
35. Money Cash flows should be adjusted for:
28. The Real Cashflows must be discounted to get (a) Only Inflation Effect
the present value at a rate equal to: (b) Only Time Value of Money
(a) Money Discount Rate (c) None of (a) and (b)
(b) Inflation Rate (d) Both of (a) and (b)
(c) Real Discount Rate
(d) Risk free rate of interest 36. EAV should be used in case of
(a) Divisible Projects
29. Real rate of return is equal to: (b) Repetitive Projects
(a) Nominal  Inflation Rate (c) One-off Investments
(b) Nominal Rate  Inflation Rate (d) Indivisible Projects
(c) Nominal Rate – Inflation Rate
(d) Nominal Rate + Inflation Rate 37. EVA is equal to:
(a) NPV  PVAF (r,n)
30. If the Real rate of return is 10% and Inflation is (b) NPV + PVAF (r,n)
4%, the Money Discount Rate is: (c) NPV  PVAF (r,n)
(a) 14.4% (d) NPV – PVAF (r,n)
(b) 2.5%
(c) 25% 38. If a project has positive NPV, its EAV is:
(d) 14% (a) Equal to NPV
(b) More than NPV
(c) Less than NPV

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CS Executive: Financial Management Capital Budgeting
(d) Any of the above (a) Internal Rate of Return
(b) Profitability Index
39. Two mutually exclusive projects with different (c) Net Present Value
economic lives can be compared on the basis of (d) Equivalent Annuity Value

ANSWER KEYS
22 23 24 25 26 27 28 29 30 31
(b) (a) (c) (c) (d) (b) (c) (b) (a) (d)
32 33 34 35 36 37 38 39
(a) (c) (a) (c) (b) (c) (c) (d)

40. Risk in Capital budgeting implies that the (d) Salvage value
decision-maker knows …. of the cash flows
(a) Variability 46. NPV of a proposal, as calculated by RADR
(b) Probability method and CE Approach will be:
(c) Certainty (a) Same
(d) None of the above (b) Unequal
(c) Both (a) and (b)
41. In Certainty – equivalent approach, adjusted (d) None of (a) and (b)
cash flows are discounted at:
(a) Accounting Rate of Return 47. Risk of a Capital budgeting can be incorporated
(b) Internal Rate of Return by:
(c) Hurdle Rate (a) Adjusting the Cash flows
(d) Risk-free Rate (b) Adjusting the Discount Rate
(c) Adjusting the life
42. Risk is Capital budgeting is same as: (d) All of the above
(a) Uncertainty of Cash flows
(b) Probability of Cash flows 48. Which element of the basic NPV equation is
(c) Certainty of Cash flows adjusted by the RADR?
(d) Variability of Cash flows (a) Denominator
(b) Numerator
43. Which of the following is a risk factor in capital (c) Both
budgeting? (d) None
(a) Industry specific risk factors
(b) Competition risk factors 49. In CE Approach, The CE Factors for different
(c) Project specific risk factors years are:
(d) All of the above (a) Generally increasing
(b) Generally decreasing
44. In Risk-Adjusted Discount Rate method, the (c) Generally same
normal rate of discount is: (d) None of the above
(a) Increased
50. Which of the following is correct for RADR?
(b) Decreased
(a) Accept a project if NPV at RADR is negative
(c) Unchanged
(b) Accept a project if IRR is more than RADR
(d) None of the above
(c) RADR is overall cost of capital plus risk-premium
(d) All of the above
45. In Risk-Adjusted Discount Rate method, which
one is adjusted? 51. In Payback approach to risk the target payback
(a) Cash flows period is:
(b) Life of the proposal (a) Not adjusted
(c) Rate of discount (b) Adjusted upward

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CS Executive: Financial Management Capital Budgeting
(c) Adjusted downward (a) Certain to occur
(d) (b) or (c) (b) Most likely Cashflows
(c) Arithmetic Average Cashflow
52. In Sensitivity Analysis, the emphasis is on
(d) Geometric Average Cashflow
assessment of sensitivity of:
(a) Net Economic Life 55. Concept of joint probability is used in case of:
(b) Net Present Value (a) Independent Cashflows
(c) Both of (a) and (b) (b) Uncertain Cashflows
(d) None of (a) and (b) (c) Dependent Cashflows
(d) Certain Cashflows
53. Most sensitive variable as given by the
Sensitivity Analysis should be: 56. Decision-tree approach is used in:
(a) Ignored (a) Proposal with longer life
(b) Given Least important (b) Sequential decisions
(c) Given the maximum importance (c) Independent Cashflows
(d) None of the above (d) Accept-Reject Proposal

54. Expected Value of Cashflow, EVCF is:

ANSWER KEYS
40 41 42 43 44 45 46 47 48 49
(b) (d) (d) (d) (a) (c) (b) (d) (a) (b)
50 51 52 53 54 55 56
(c) (c) (b) (c) (b) (c) (b)

ADDITIONAL MULTIPLE CHOICE QUESTIONS

1. Money in hand today is worth more than money (d) Infinite value
that is expected to be received in the future.
(a) True 5. _______ The fund which is created for a
(b) False specified purpose by way of sequence of periodic
payments over a time period at a specified interest
2. _______ refers to the current worth of a future rate.
sum of money or stream of cash flows given a (a) Mutual Fund
specified rate of return. (b) Sinking Fund
(a) Present value (c) Debt Fund
(b) Future value (d) Liquid Fund
(c) Annuity
(d) Infinite value 6. _______ is the difference between the sum total
of present values of all the future cash inflows and
3. ______ refers to the value after a certain period outflows.
of time at the given rate of interest. (a) Net Present Value
(a) Present value (b) Internal Rate of Return
(b) Future value (c) Probability Index
(c) Annuity (d) All of the above
(d) Infinite value
7. ______ is concerned with the allocation of the
4. ________ is a stream of regular periodic firm source financial resources among the available
payment made or received for a specified period of opportunities.
time. (a) Capital Budgeting
(a) Present value (b) Working Capital
(b) Future value (c) Capital Structure
(c) Annuity (d) None of the above
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CS Executive: Financial Management Capital Budgeting
15. Which of the following is traditional/non-
8. Which of the following is not an example of discounted cash flow technique?
capital expenditure? (a) Net Present Value (NPV) Method
(a) Purchase of fixed assets such as land and building, (b) Internal Rate of Return (IRR) Method
plant and machinery, goodwill, etc. (c) Profitability Index (PI)
(b) The expenditure relating to addition, expansion, (d) Pay back method
improvement and alteration to the fixed assets.
(c) Expenditure on payment of current liabilities 16. Which of the following is modern / discounted
(d) The replacement of fixed assets cash flow technique?
(a) Net Present Value (NPV) Method
9. Need of capital budgeting is due to: (b) Internal Rate of Return (IRR) Method
(a) Wear and tear of old equipment (c) Profitability Index (PI)
(b) Expansion (d) Average Rate of Return (ARR) Method
(c) Productivity improvement
(d) All of the above 17. _________ technique estimates the time required
by the project to recover, through cash inflows, the
10. A capital budgeting decision has its effect over a firms initial outlay.
long time span and inevitably affects the company’s (a) Net Present Value (NPV) Method
future cost structure and growth. (b) Internal Rate of Return (IRR) Method
(a) True (b) False (c) Average Rate of Return (ARR) Method
(d) Pay back Method
11. A capital budgeting decision has its effect over a
long time span and inevitably affect the company’s 18. ________ method is designated to consider the
future cost structure and growth. relative profitability of different capital investment
(a) True proposals as the basis for ranking them.
(b) False (a) Net Present Value (NPV) Method
(b) Internal Rate of Return (IRR) Method
12. Which of the following statement is not correct? (c) Average Rate of Return (ARR) Method
(a) Capital budgeting decision is surrounded by great (d) Pay back Method
number of uncertainties
(b) Capital budgeting decisions in most of the cases are 19. Payback period method may be successfully
irreversible applied in which of the following circumstance:
(c) Capital budgeting decision making is an easy (a) where the firms suffers from liquidity problem and
exercise is interested in quick recovery of fund than profitability.
(d) Capital budgeting decisions need substantial (b) high external financing cost of the project.
amount of capital outlay (c) for projects involving very uncertain return; and
(d) All of the Above
13. Which of the following is one of the type of
capital budgeting decisions? 20. Which of the following statement is not correct?
(a) Accept reject decisions (a) Average return on investment method ignore the
(b) Mutually exclusive decision time value of money.
(c) Capital rationing decision (b) The Average Rate of Return on original investment
(d) All of the above approach can be applied to a situation where part of the
investment is to be made after beginning of the project.
14. Capital budgeting process includes: (c) Average Rate of Return is based on accounting
(a) Identification of investment opportunities principle and not on cash flow analysis.
(b) Decision making (d) Average Rate of Return method is easy to
(c) Implementation and controlling of projects understand, simple to follow.
(d) All of the above

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CS Executive: Financial Management Capital Budgeting
21. _______ is the difference between the sum total (d) Pay back period
of present values of all the future cash inflows and
outflows. 27. Profitability Index is expressed as:
(a) Net Present Value (a) Profitability Index  Present Value of future cash
(b) Internal Rate of Return flows / Initial cash investment
(c) Profitability Index (b) Profitability Index  Total of future cash flows /
(d) Pay back period Initial cash investment
(c) Profitability Index  Present Value of future cash
22. Which of the following is the disadvantage of flows of first year / Initial cash investment
Net Present Value Method? (d) Profitability Index  Initial cash investment /
(a) Income over the entire life of the project is not Present Value of future cash flows
considered
(b) The method does not take into account time value 28. If the profitability index is  1 , then:
of money (a) Accept the project
(c) It is difficult to determine the firm cost of capital or (b) Reject the project
appropriate rate of discount (c) Profitability index method does not determine the
(d) None of the above feasibility of the project
(d) None of the above
23. _______ refers to the rate which equates the
present value of cash inflows and present value of 29. Which of the following statement is not correct?
cash outflows (a) Under the net present value method rate of interest
(a) Net Present Value is assumed as the known factor whereas it is unknown in
(b) Internal Rate of Return case of internal rate of return method.
(c) Profitability Index (b) The net present value method took to ascertain the
(d) Pay back period amount which can be invested in a project so that its
expected yields will exactly match to repay this amount
24. Internal Rate of Return is the rate at which net with interest at the market rate.
present value of the investment is _____ (c) Net Present value attempts to find out the rate of
(a) One interest which is maximum to repay the invested fund
(b) Zero out of the cash inflows.
(c) Infinite (d) Net present value method is more reliable than
(d) Negative internal rate of return method for ranking two or more
projects.
25. Advantage of Internal Rate of Return (IRR)
method include: 30. Net Present Value Method generally is
(a) This method takes into account the time value of considered to be superior since:
money (a) It is simple to operate as compared to internal rate
(b) This method considers cash benefits, i.e. of return method.
profitability of the project for the whole of its economic (b) It does not suffer from the limitations of multiple
life rates.
(c) This method is considered to be a sophisticated and (c) The reinvestment assumption of the Net Present
more reliable technique of evaluating capital investment Value Method is more realistic than internal rate of
proposals return method.
(d) All of the above (d) All of the above.

26. ________ is defined as the rate of present value 31. A firm with ______ constraint attempts to select
of the future cash benefits at the required rate of the combination of investment projects that will be
return to the initial cash outflow of the investment. within the specified limits of investments to be made
(a) Net Present Value during a given period of time and at the same time
(b) Internal Rate of Return provide greatest profitability.
(c) Profitability Index (a) Capital Budgeting

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CS Executive: Financial Management Capital Budgeting
(b) Capital Structure 39. The span of time within which the investment
(c) Capital Rationing made for the project will be recovered by the net
(d) All of the above returns of the project is known as
(a) Period of return
32. ________ refers to the outcomes of a given event (b) Payback period
which are too unsure to be assigned probabilities (c) Span of return
(a) Uncertainty (d) None of the above
(b) Risk
(c) Both (a) and (b) 40. With limited finance and a number of project
(d) None of the above proposals at hand, select that package of projects
which has:
33. ______ refers to a set of unique outcomes for a (a) The maximum net present value
given event which can be assigned probabilities. (b) Internal rate of return is greater than cost of capital
(a) Uncertainty (c) Profitability index is greater than unity
(b) Risk (d) Any of the above
(c) Both (a) and (b)
(d) None of the above 41. Which of the following techniques does not take
into account the time value of money?
34. Risk and uncertainty are not inherent in capital (a) Internal Rate of Return Method
budgeting decisions (b) Simple payback period Method
(a) True (c) Net Present Value Method
(b) False (d) Discounted payback period Method

35. Higher value of standard deviation indicates 42. The current worth of a sum of money to be
(a) Higher Risk received at the future date is called
(b) Lower Risk (a) Real Value
(c) No impact on risk (b) Future Value
(d) None of the above (c) Present Value
(d) Salvage Value
36. Risk adjusted discount rates method is used in
investment and budgeting decisions to cover: 43. If present value of total cash outflow is $ 15,000
(a) Time value of money and present value of total cash inflow is $ 14,000,
(b) Risk what is the net present value of the project?
(c) Both (a) and (b) (a) $ 1,000
(d) None of the above (b) -$1,000
(c) 0
37. ________ helps in assessing information as to (d) 2000
how sensitive are the estimated parameters of the
project such as cash flows, discount rate, and the
44. If present value of total cash outflow is `
project life to the estimation errors.
(a) Certainty Equivalent Approach 2,00,000 and present value of total cash inflow is $
(b) Risk Adjusted Discount Rate Method 2,30,000, what is the net present value of the project?
(c) Sensitivity Analysis (a) 30,000
(d) Decision Tree Analysis (b) -30,000
(c) 0
38. Capital Budgeting models are used to evaluate a (d) 10,000
wide variety of working capital expenditure
decisions. 45. If present value of total cash outflow is equal to
(a) True present value of total cash inflow, then the net
(b) False present value of the project will be
(a) Positive

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CS Executive: Financial Management Capital Budgeting
(b) Negative (c) Have no impact on the present value of future cash
(c) Zero flows
(d) Infinite (d) None of the above

51. Using profitability index, the preference rule for

46. Generally a project is considered acceptable if
ranking projects is:
its net present value is:
(a) the lower the profitability index, the more desirable
(a) Negative or Zero
the project
(b) Negative or Positive
(b) the higher the profitability index, the more
(c) Positive or Zero
desirable the project
(d) Negative
(c) the lower the sunk cost, the more desirable the
47. A company is considering the following three project
investment proposals: (d) the higher the sunk cost, the more desirable the
(i) Investment required: ` 80,000, present value of project
future cash inflows: ` 96,000 52. The net present value of four projects is given
(ii) Investment required: ` 75,000, present value of below:
future cash inflows: ` 120,000 (a) Project A : ` 25,000
(iii) Investment required: ` 100,000, present value of (b) Project B : ` 10,000
future cash inflows: ` 150,000 (c) Project C : ` 22,000
How would you rank the above investment proposals (d) Project D : ` 15,000
using profitability index method? The four projects given above require the same amount
(a) B, A, C of investment. How would you rank them using Net
(b) C, A, B Present Value (NPV) method?
(c) A, B, C (a) B, D, C, A
(d) B, C, A
(b) A, B, C, D
48. In capital budgeting, a negative net present (c) A, C, D, B
value results in (d) B, C, D, A
(a) zero economic value added
(b) percent economic value added 53. If the Profitability index of a project is 0.75, it
(c) negative economic value added means
(d) positive economic value added (a) The NPV of the project is greater than zero
(b) The project’s cost is less than the present value of
49. Consider the following data on a proposed its cash flows
investment: (c) The NPV of the project is greater than 1
Investment required : ` 160,000 (d) The project returns 75 cents in present value for
Annual cash inflows : ` 40,000 each dollar invested in it
Life of the investment : 6 years
Salvage value :0 54. A project whose acceptance prevents the
Discount rate : 10% acceptance of another project is known as:
(a) dependent project
Based on the above data, what is the payback period of (b) an independent project
the proposed investment project? (c) a mutually exclusive project
(a) 0.25 years
(d) a rational project
(b) 3 years
(c) 4 years 55. What are the two drawbacks associated with the
(d) 5 years payback period?
50. An increase in the discount rate will: (a) The time value of money is ignored. It ignores cash
(a) Reduce the present value of future cash flows flows beyond the payback period
(b) Increase the present value of future cash flows (b) The time value of money is considered. It ignores
cash flows beyond the payback period

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CS Executive: Financial Management Capital Budgeting
(c) The time value of money is considered. It includes (d) 16.8%
cash flows beyond the payback period
(d) The time value of money is ignored. It includes 61. Which of the following statements is true about
cash flows beyond the payback period mutually exclusive projects?
(a) They are not in direct competition with each other.
56. The XYZ purchases a new equipment. The (b) They are in direct competition with each other.
selected data is given below: (c) They are not evaluated based on shareholder
Cost of equipment : $ 25,000 wealth.
Useful life of equipment : 5 years (d) They are never evaluated.
Tax rate : 30%
If equipment is depreciated using straight line method, 62. What is the net present value?
what is the depreciation tax shield associated with the
(a) The future value of a project’s cash flows plus its
new equipment?
(a) $ 5,000 initial cost
(b) $ 35,000 (b) The present value of a project’s cash flows plus its
(c) $ 1,500 initial cost
(d) $ 7,500 (c) The future value of a project’s cash flow minus its
initial cost
57. The ABC purchases a new equipment. The (d) The present value of a project’s cash flows minus
selected data is given below: its initial cost
Cost of equipment : 1,00,000
Useful life of equipment : 10 years 63. Why are projects with negative net present
Tax rate : 20% values (NPVs) unacceptable to a firm?
If equipment is depreciated using straight line method, (a) Returns lower than the cost of capital result in firm
what is the depreciation tax shield associated with the failure.
new equipment? (b) Returns with negative NPVs cause and equal profit
(a) 10,000
ratio.
(b) 50,000
(c) Returns with negative NPVs are acceptable to a
(c) 2,000
firm.
(d) 1,000
(d) Returns lower than the cost of capital result in
higher profit ratios.
58. If the interest expenses of a company is $300,000
and tax rate is 40%, the after-tax cost of interest is:
64. The Internal Rate of Return is defined as
(a) $ 1,20,000
(a) The discount rate which causes the payback to
(b) $ 3,00,000
equal one year.
(c) $ 1,80,000
(b) The discount rate which causes the NPV to equal
(d) $ 75,000
zero.
(c) The ROE when the NPV equals 0.
59. If an interest expenses of a company is 10,00,000
(d) The ROE associated with project maximization.
and tax rate is 30%, the after-tax cost of interest is:
(a) 3,00,000
65. A project whose acceptance requires the
(b) 7,00,000
acceptance of another project is known as:
(c) 1,00,000
(a) dependent project
(d) 75,000
(b) an independent project
(c) a mutually exclusive project
60. Calculate the internal rate of return:
(d) a rational project
Project initial investment is ` 18,000
The annual cash flow will be ` 5,600 for a period of 5 66. Each of the following techniques use to
years. discounted cash flows to incorporate the time value
(a) 14% of money into their analysis except
(b) 15% (a) Net Present Value (NPV)
(c) 16% (b) Payback Method

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CS Executive: Financial Management Capital Budgeting
(c) Internal rate of Return (IRR)
(d) Modified Internal Rate of returns 73. In calculation of internal rate of return, an
assumption states that received cash flow from
67. What is a way to operationalize shareholder project must
wealth maximization? (a) be reinvested
(a) Identify and select projects that are expected to (b) not be reinvested
have negative net future values. (c) be earned
(b) Identify and select projects that are expected to (d) not be earned
have positive net future values.
(c) Identify and select projects that are expected to 74. Process in which managers of company identify
have positive net present values. projects to add value is classified as
(d) Identify and select projects that are not expected to (a) capital budgeting
have positive net present values. (b) cost budgeting
(c) book value budgeting
68. The Net Present Value method of evaluating (d) equity budgeting
projects is consistent with:
(a) the maximization of earnings per share 75. Number of years forecasted to recover an
(b) the maximization of shareholder wealth original investment is classified as
(c) the maximization of net income (a) payback period
(d) None of the above (b) forecasted period
(c) original period
69. The reinvestment assumption using the Internal (d) investment period
Rate of Return method is that:
(a) intermediate cash flows are reinvested at the 76. Situation in which firm limits expenditures on
required rate of return. capital is classified as
(b) intermediate cash flows are reinvested at the (a) optimal rationing
internal rate of return. (b) capital rationing
(c) intermediate cash flows are reinvested at the (c) marginal rationing
modified internal rate of return. (d) transaction rationing
(d) None of the above
77. Initial cost is $ 5000 and probability index is 3.2
70. In mutually exclusive projects, project which is then present value of cash flows is
selected for comparison with others must have (a) 8200
(a) higher net present value (b) 16000
(b) lower net present value (c) 0.0064
(c) zero net present value (d) 1562.5
(d) all of the above
78. Present value of future cash flows is divided by
71. Present value of future cash flows is $2000 and an initial cost of project to calculate
an initial cost is $ 1100 then profitability index will (a) negative index
be (b) exchange index
(a) 0.55 (c) project index
(b) 1.82 (d) profitability index
(c) 0.55
(d) 0.0182 79. If net present value is positive then profitability
index will be
72. Profitability index in capital budgeting is used to (a) greater than two
(a) negative projects (b) equal to
(b) relative projects (c) less than one
(c) evaluate projects (d) greater than one
(d) earned projects

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CS Executive: Financial Management Capital Budgeting
80. Sum of discounted cash flows is best defined as (c) dependent projects
(a) technical equity (d) net value projects
(b) defined future value
(c) project net present value 83. Net present value, profitability index, payback
(d) equity net present value and discounted payback are methods to
(a) evaluate cash flow
81. An initial cost is $6000 and probability index is (b) evaluate projects
5.6 then present value of cash flow will be (c) evaluate budgeting
(a) 25000 (d) evaluate equity
(b) 28000
(c) 33600 84. Payback period in which an expected cash flows
(d) 30000 are discounted with help of project cost of capital is
classified as
82. A type of project whose cash flows would not (a) discounted payback period
depend on each other is classified as (b) discounted rate of return
(a) project net gain (c) discounted cash flows
(b) independent projects (d) discounted project cost

ANSWER KEYS

1 2 3 4 5 6 7 8 9 10
(a) (a) (b) (c) (b) (a) (a) (c) (d) (a)
11 12 13 14 15 16 17 18 19 20
(b) (c) (d) (d) (d) (d) (d) (c) (d) (b)
21 22 23 24 25 26 27 28 29 30
(a) (c) (b) (b) (d) (c) (a) (a) (c) (d)
31 32 33 34 35 36 37 38 39 40
(c) (a) (b) (b) (a) (c) (c) (b) (b) (a)
41 42 43 44 45 46 47 48 49 50
(b) (c) (b) (a) (c) (c) (d) (c) (c) (a)
51 52 53 54 55 56 57 58 59 60
(b) (c) (d) (c) (a) (c) (c) (c) (b) (d)
61 62 63 64 65 66 67 68 69 70
(b) (d) (a) (b) (a) (b) (c) (b) (b) (a)
71 72 73 74 75 76 77 78 79 80
(b) (c) (a) (a) (a) (b) (b) (d) (d) (c)
81 82 83 84
(c) (b) (b) (a)

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CS Executive: Financial Management Capital Budgeting

Theoretical Concept
REVENUE BUDGET CAPITAL BUDGET
Prepared for one year Prepared for long term
Contains only revenue items Contains both revenue & capital items
Prepared to set goals for next one year Prepared to take long term investment decision

IMPORTANT BECAUSE

Huge Investment Long Term Irreversible

Mutually Exclusive If one is selected reaming

all will be automatically
Types of Proposals rejected

If anybody cross cut off he

Independent will selected it means all
will select or reject also

Playback Period

Discounted Payback Period

Evaluation Methods
Payback Reciprocal

Net Present Value (NPV)

Internal Rate of Return (IRR)

Profitability Index (PI)

Accounting Rate of Return (ARR)

 CALCULATION OF ANNUAL CASH FLOWS:

Method 1:
This method is preferable when both inflows and outflows are given in the question. If only outflows are given then
“Method-2” is preferable.

Particulars Amount
Cash Income (Sales) 2,00,000 Cash Income Means
 Sales or

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CS Executive: Financial Management Capital Budgeting
 Any Saving in Expenses
Cash Expenses 1,10,000
Cash Flows before Tax 90,000 Cash Expenses may be in the form of
Depreciation 30,000  Variable and fixed cost or
Profit Before Tax 60,000  Raw material, wages, cash overhead or
Tax @ 30% 18,000  Repairs, maintenance or
Profit After Tax 42,000  Any other revenue expenditure
Depreciation 30,000
Cash Flow After Tax 72,000

Method 2:
This is shorter then first method and also suitable to situation when only outflows are given

CFAT  Cash income 1  t   Cash Expenses 1  t   Depreciation  t

Situation 1:
If Sales, Variable Cost, Fixed Cost and Depreciation are given:
CFAT  Sales 1  t   Variable Cost 1  t   Fixed Cost 1  t   Depreciation  t
 2,00,000  0  7  1,10,000  7  30,000  0  3

 1,40,000  77,000  9000  72,000

Situation 2:
If Saving in wages, Maintenance and Depreciation are given:
CFAT  Saving in wages 1  t   Maintenance 1  t   Depreciation  t
Situation 3:
If only Repairs and Depreciation are given:
CFAT   Repairs 1  t   Depreciation  t

 90,000  0  7  30,000  0  3  63,000  9,000  72,000

TREATMENT OF LOSS

If profit before tax is negative

Question is silent or Question says that the company Set-off loss and consider inflow of tax benefit in the
has other profitable business activities. same year.
Question says that the company does not have any Carry forward loss in next year(s) and deduct it from
other profitable business activities profit of that year.

EXAMPLE: Initial Investment 100000, Life 4 years, Value NIL, Depreciation SLM CFBT for year 1, 2, 3 & 4 are
15000, 20000, 30000, 50000. Tax rate 30%

Same Year Carry Forward

Year CFBT PBT
Tax PAT CFAT Tax PAT CFAT
1 15000 10000 3000 7000 18000 0 10000 15000
2 20000 5000 1500 3500 21500 0 5000 20000
3 30000 5000 1500 3500 28500 0 5000 30000
4 50000 25000 7500 17500 42500  4500 20500 45500

 OTHER TAX TREATMENT POINTS:

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CS Executive: Financial Management Capital Budgeting

1. If the question says ignore taxation then:

(a) Ignore Income Tax
(b) Ignore Depreciation
(c) Ignore tax on capital gain / loss

2. Tax treatment is to be done on all revenue (P & L) items whether it is an annual, initial or terminal cash flow. But
not any of capital (Balance Sheet) items.

3. Tax on capital gain / loss should always be treated with following exceptions:
(a) When the question says ignore taxation.
(b) When depreciation is calculated after deducting salvage value. In this case actually there will be no gain / loss.
(c) If we are following block of assets theory and there are several other assets in the block.

 TREATMENT ON WORKING CAPITAL

1. Amount of working capital should be treated as an outflow of cash at year 0 and the same amount should be
treated as an inflow of cash at the end of life of the project.
2. If working capital increases in any year then amount of increase should be treated as an outflow of cash in that
year.
3. If working capital decreases in any year then the amount of decrease should be treated as an inflow of cash in that
year.

 TREATMENT OF SPECIAL ITEMS IN CAPITAL BUDGETING

Item Description Treatment Reason

The expenses we are doing on
It is not an additional outflow of
Allocated cost previous project now it is merged in Ignore
cash.
old and new project.
Opportunity Working on new proposal, getting loss Avoidance of inflow is outflow of
Consider
loss in old. cash.
Cost of idle A proposal which was getting waste. It is not an additional outflow of
Ignore
resources cash.
If decision is taken after doing any
Sunk cost Ignore Cash flow has already occurred.
expenditure is called sunk cost.
Any cash flow which is occurring in If we ignore answer will be
Ignore /
Common items both of two mutually exclusive different but decision will be
consider
proposals. same.

If you are making two mutually exclusive proposals then there is no need to consider benefits of one proposal as
opportunity loss of other proposal.

“Item considered tax considered – Item ignored tax ignored”

Means if any of the above special item is considered then its tax treatment will also be considered and if any special
item is ignored then its tax treatment will also be ignored.

PAYBACK PERIOD METHOD

It is the length of time required to recover initial investment.

1. If annual cash inflows are equal:

InitialInvestment
Pay back Period 
AnnualCash Flows

Unique Academy 4.26 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting

2. If annual cash inflows are unequal:

Make cumulative total of annual cash flows and then use following formula:

Unrecovered Investment in last full year

Pay back Period  Full years
Cash flowsof next year

Decision:

1. Mutually Exclusive Proposals: Select the proposal with lowest payback period.
2. Independent proposal: Accept the project if its payback period is less or equal to cut off period.

Easy to understand & calculate

Advantages
Consider Risk Factor indirectly

Payback Period
Doesn’t consider time value of money

Disadvantages
Doesn’t consider cash flows occurring after
the payback period

 IMPORTANT POINT:
If annual cash flows are insufficient to recover initial investment and we have to u se salvage value to recover initial
investment then:

Payback Period  Life of the project

 DISCOUNTED PAYBACK METHOD:

It is the length of time required to recover initial investment along with desired return.

Calculate present value of annual and terminal cash flows and make cumulative total then use following formula:
PVof Unrecovered Investment in last full year
Discounted Payback Period  Full years 
PVof Cash flow of next year
Decision:
1. Mutually Exclusive Proposals: Select the proposal with lowest discounted payback period.
2. Independent proposal: Accept the project if its discounted payback period is equal to less than life of the project.

IMPORTANT POINT:
If present value of annual cash flows are insufficient to recover initial investment and we have to use present value of
salvage value to recover initial investment then:

Discounted Payback Period  Life of the project

 PAYBACK RECIPROCAL METHOD

Unique Academy 4.27 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
1
Payback Reciprocal 
Payback Period

Payback reciprocal gives a rough idea about Internal rate of return (IRR) of the project if both the following
conditions are fulfilled:

1. All the annual cash inflows are equal.

2. Life of the project is very long. At least twice the payback period.

NET PRESENT VALUE METHOD:

Steps for Calculation:
1. Determine Initial cash flows:
(a) Outflows of Cost of assets
(b) Outflows of installation cost.
(c) Outflow of Working capital.
(d) Inflow of sale of old asset
(e) Cash flow of tax on capital gain/loss.
(f) Outflow of initial repairs.
(g) Inflow of tax benefit on initial repairs etc.
2. Calculate Annual Cash Flows (as already discussed)

3. Estimate Terminal cash flows:

(a) Inflow of salvage value.
(b) Cash flow of tax on capital gain / loss.
(c) Inflow of working capital.
4. Estimate other cash flows:
(a) Outflow of purchase of additional assets.
(b) Cash flow of working capital.
(c) Outflow of repayment of loan etc.
5. Calculate present value of above cash flows: We have to calculate present of all cash flows except which
occur at year zero.

6. Calculate NPV.
INTERPRETATION:
If NPV is positive it means that we are able to recover
(1) Initial investment; and
(2) Desired rate of return; and
(3) Also getting surpluses which have present value equal to NPV

DECISION:
(1) Independent proposals:
If NPV is zero or positive accept the proposal, if NPV is negative reject it.

(2) Mutually exclusive proposals:

Accept the proposal with highest NPV. If both proposals have negative NPV then chose the proposal which has lower
negative NPV.

IMPORTANT POINTS IN QUESTIONS

1. If in a question it is asked that what should be the amount of sales to make acceptable the proposal then assume
sales  ‘X’ and NPV  0.

Unique Academy 4.28 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
2. Also if the question says that selling price should be double the variable cost it means that if variable cost is ` 5
then the selling price should be ` 10. Hence, in this case PV ratio will be 50%.

3. Also in the question rather then calculating present value of CFAT we should use the following concept:

(PV of Contribution – PV of fixed cost) 1  t   PV of depreciation  t  PV of CFAT.

4. If in a question inflation rate is given and CURRENT price is also given then apply inflation from the first year.

5. If depreciation to be charged on Sum of Years Digit method then we can use following formula:

Cost  SalvageValue
Depreciation   Years Digit
SOYD

6. If the question says to start a project additional investment in debtors or current assets is ` 50,000. Hence it
should be treated as an initial outflow and terminal inflow.

7. If there is a one time cash flow during the life of project, like investment in additional machinery or investment in
additional working capital then be careful to not to deduct it from CFBT. If you do that tax benefit of this balance sheet
item will be considered. This item should be either be treated in a separate step or should be deducted from CFAT.
8. If a project is to be started in a foreign country then first calculate CFAT in terms of foreign currency and the
convert it into home currency and then calculate is present value.

PROJECTS WITH UNEQUAL LIVES

If two or more mutually exclusive proposals have unequal lives then we can not take decision simply on the basis of
their NPV. Here we have to use one of the following two methods:

1. Common time horizon method:

If project A has life of 3 years and project B has life of 6 years then start project A again at the end of 3 rd year to make
it effective life equal to 6 years.

2. Equivalent Net Present Value (ENPV method):

It is the method of spreading NPV over the life of project. ENPV is actually NPV per year.

Net Present Value

ENPV 
Present ValueAnnuity Factor

Important Note:
1. If question is silent use ENPV method, use common time horizon method only if asked by question.

2. If there is not terminal cash flow and annual cash flows are all equal then one can use following shortcut:

Initialcash flow
ENPV   Annualcash flow
PVAF

3. Optimum replacement decision:

If in a question more than one salvage value is given (like salvage value at the end of 1 st, 2nd, 3rd and 4th year) it means
that it is a question it means that it is a question to decide optimum life of the project and then calculate ENPV of each
proposal.
REPLACEMENT DECISION:
If a question says that there is an existing asset and it has some remaining life but you can replace it now with a new
asset and life of new asset is equal to remaining life of existing asset then there are two methods to solve the question:
Unique Academy 4.29 Prof. Ashish Parikh
CS Executive: Financial Management Capital Budgeting

1. Calculate NPV of proposal to “Replace” (Buy new and sale old) and proposal to “Continue” separately and
accept the proposal with higher NPV. You can not pursue this method if only incremental data is given. For example,
increase in sales due to new asset is ` 50,000. Even if full information is given it is better to calculate incremental NPV
because calculating NPV individually requires more effort.

2. Calculate incremental NPV (Replace - Continue) and replace the asset if NPV is positive but continue the asset if
NPV is negative. Just keep in mind that:
(a) Decrease in expenditure is incremental inflow; and
(b) Increase in sale is increment outflow and vice versa.

(c) If the question says that old machine requires repairs of ` 5000 which new one will not require. It means annual
incremental inflow is ` 5000.

(d) If the question says that working capital requirement will reduce by ` 10,000 if the new machine is installed. It
means that Incremental Initial inflow is ` 10,000 and Incremental terminal outflow is ` 10,000.

In replacement decision if we have to charge depreciation on written down value method then:
 Assume block of assets theory for charging depreciation and
 Don’t consider tax on capital gain / loss on disposal of new asset at year zero because the block is still continued
with new asset.
 Charges depreciation on the balance of block and not on cost of new asset.

INTERNAL RATE OF RETURN METHOD

Definition:
It is the rate at which present value of inflows is equal to present value of outflows means NPV is zero.
Meaning:
It indicates the rate of return which a project is generating on outstanding balance year by year. For example, if initial
investment is ` 2487 and annual cash inflows for 3 years are ` 1000 p.a. then IRR is 10%. Here we will get return of:
 10% on 2487 in the first year.
 10% on 1736 (2487 + 10% - 1000) in the second year.
 10% on 909 (1736 + 10% - 1000) in the third year.

How to Calculate:

1. If PV factors are given with exam question then calculate NPV with those rates.
2. If not then guess the rate by following formula:

sumof inflows  Initialoutflow

approx.IRR   150
Initialoutflow  lifeof project

3. When you get one positive and one negative NPV then use this formula:

NPV
IRR  Lower Rate    Higher rate  Lower rate 
NPVL  NPVH

MODIFIED IRR

Unique Academy 4.30 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
IRR tells us about return on capital which remained invested but it
does not consider return on reinvestment. Modified IRR is solution
to this problem. In MIRR first we calculate future value of all
inflows with given reinvestment rate. Then use this formula:

Future Value of Inflows  Initial Investment 

1  MIRR  (Life of project )

 NPV vs. IRR

In case of two mutually exclusive proposals there may be conflict
in decisions of NPV and IRR methods due to:

1. Size disparity: Project smaller in size may have lower NPV

even if it has higher IRR.

2. Time disparity: Project having higher total inflows may have higher NPV. Still its IRR may be lower if it has
lower inflow in initial years and higher inflows in later years.
In this situation we will go with the decision of NPV. NPV is better than IRR on the following grounds:

1. Reinvestment assumption:
IRR will give correct decision only if reinvestment rate is same as IRR but NPV does not suffer from this problem.

2. IRR gives answer in relative (%) terms which does not assure wealth maximization while NPV gives answer in
absolute (amount) terms which assures wealth maximization.
3. Different rates of discounting:
If cost of capital changes from year to year then it is difficult to arrive at a decision with IRR but simple with NPV.

4. Lending vs. Borrowing:

IRR can not distinguish between lending and borrowing of money but NPV can.

5. Multiple IRR:
In case of abnormal cash flows there may be more than one IRRs but
there is always one NPV for one project.

6. No IRR:
In case of abnormal cash flows there may be no IRR for a project but
there is always one NPV for one project.

Note:
If life on the project is two years then the situation of multiple IRR or no
IRR may be verified by solving a quadratic equation as follows:
CF1 CF2
0  CF0  1 
1  r  1  r 
2

Formula for solving quadratic equation is

b  b 2  4ac
r
2a

 PROFITABILITY INDEX METHOD

Calculation:
Popular Formula Logical Formula

Unique Academy 4.31 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
Present Valueof Inflow Present Valueof Other Cash Flows
PI  PI 
Present Valueof Outflow InitialCash Flow

If initial outflow is the only outflow then both formula will give same answer. But if there are outflows in later years
also then one should use logical formula and give following note in exam:

“Availability of funds is limited only at year zero therefore key factor is “Fund at year zero” and we should divide
with key factor only hence other outflows of other years are considered in numerator.”

INTERPRETATION:
If the discounting rate is 15% and PI is 1.2 it means that we are able to recover initial investment in the project and a
return @ 15% and a surplus of `0.20 for each rupee invested.

DECISION:
1. Independent proposals:Accept the proposal if PI is more than or equal to one. Reject it if PI less than one.

2. Mutually exclusive proposals:Accept the proposal with highest PI.

3. Capital Rationing: if there are several independent proposals all having PI equal to or more than one then we
should accept all proposals. But if funds are limited then we should rank proposals as per PI and start allocation of
fund from 1st rank. This method of allocation of funds is called capital rationing.
DIVISIBILITY OF PROJECTS:

1. If projects are divisible then projects selected with PI ranking will give highest total NPV.

2. If projects are indivisible then start fund allocation with PI ranking and if any fund is left which is insufficient for
accepting next rank then:
(a) Try some combinations which maximize total NPV.
(b) Still if some fund is left then advise management of company to invest it in short term securities.

NPV vs PI
In case of two mutually exclusive proposals, if there is conflict in decision of NPV and PI then:
1. We will accept the decision of NPV method if availability of funds is unlimited;
2. We will accept the decision of PI method if availability of funds is limited.

QUESTIONS WITH MISSING INFORMATION:

1. If in a question NPV and initial investments are given then we can calculate present value of inflows as follows:
PV1  Initial Investment  NPV.

2. If in a question annual cash flows, life and IRR are given then we can calculate Initial investment as follows:
Initial Investment  Annual Cash flows  PVAF (IRR % , n)

3. If in a question Initial Investment, PI, Annual cash flows and Life are given then we can calculate cost of capital
as follows:

 PV1 (at cost of capital)  Initial Investment  PI

 PV1  Annual cash flows  PVAF (Cost of capital %, n)
Here we can found out cost of capital by trial and error.

TREATMENT OF FINANCING CASH FLOWS

Unique Academy 4.32 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
Following are financing cash flows:
1. Inflow of loan amount.
2. Out flow of repayment of loan (Careful: deduct it from CFAT. If you deduct it from CFBT and then calculate tax,
it means you are considering tax benefit on repayment of loan which is wrong)
3. Outflow of interest payment.
4. Inflow of tax benefit on interest (if you deduct interest and then calculate tax then tax benefit will be considered
automatically. You need not to consider it separately.)
SHORT TERM FINANCE:
In case of short term finance like bank overdraft, cash credit limit, book debts limit etc. all the above financing cash
flows should be considered for evaluation of the project.

LONG TERM FINANCE:

(Money lenders are part of family)

Ignore all above cash flows use cost
Project point of view
of capital as discounting rate
(hum)
Long term
Loans
(Money lenders are outsiders)
Equity point of view Consider all above cash flows use
(main) cost of equity as discounting rate

WHICH POINT OF VIEW TO USE

 If question specifies the point of view then solve it accordingly.

 If question is silent but all financing cash flows are given or may be calculated then use “Equity point of view”.
 If question is silent and financing cash flows are also not available then use “Project point of view”

Note:
If in a question Project CFAT is given while we have to solve it from Equity point of view then we can use the
following shortcut:

Equity CFAT  Project CFAT  Interest 1  t 

ACCOUNTING RATE OF RETURN METHOD

It is the only method based on profits and not on cash flows. So be careful. Don’t think from the point of view of cash
flows. Think from the point of view of accounting profits and accounting balances.

Averageannualprofit after tax

ARR   100
Averageinvestment

Here,
Average annual profit after tax  Sumof profitsof all years
lifeof project

Average Investment  Opening Balance  Closing Balance

2

Note:
Sometimes initial investment is also taken in place of average investment. If question is silent better to take average
investment.

Unique Academy 4.33 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting

Decision:

1. Independent proposals: If ARR is more than cut off rate then accept the proposal.

2. Mutually exclusive proposals: Accept the proposal with highest ARR.

Operating Lease Means a lease which is not a finance lease

Means a lease in which asset is given for

whole/substantial life and pv or rents is equal to
Finance Lease
cost of asset.

Types of Owner of an asset sales the asset and take it back

Lease Sale and lease back on lease.

Lessor borrows some money to buy the asset to be

Leveraged Lease given on lease

Close ended (Walk away): Lessor bears risk of

reduction in salvage value.
Open & Close ended Open ended: Lessee bears risk of reduction in
Lease salvage value.

Cash flows under Lease:

 Rent  Tax benefit on rent
For user of asset
(Financing Decision)
Leasing Cash flows under Loan
Decision  Installment  TB on int.  TB on
dep  Salvage  Tax on Capital gain
/ loss

For lessor s- Cost of asset

(Investing Decision)  Rent  Tax on rent  TB on dep
 Salvage value  Tax on Capital
gain / loss

Note:
1. For user:
Chose the option which has lower pv of outflows. If discounting rate is not given use r  1  t  as the discounting
rate.

Unique Academy 4.34 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
2. For lessor:
Question may be one of the following two types
(a) If lease rent is given calculate NPV and accept the proposal if NPV is positive.
(b) If lease rent is not given assume it to be ‘x’ and set NPV equal to zero. Solve the equation to get value of “x”.

IMPORTANT POINT:
 Shortcut for lease option: Lease rent  1  t   PVAF  r %, n 
 Don’t use this shortcut if lease rents is to be paid at the beginning of each year. In this case calculate present value
of lease rents using present value of annuity due formula and calculate present value of tax benefits using present value
of annuity formula.

 Shortcut for Balance under WDV method

WDV  Cost  1  d 
n

Here d rate of depreciation

 Capital Budgeting is also called “Project Management”.

 There are Three main function Finance Manger.

1) Financing
2) Investing
3) Dividend Decision

 Capital Budgeting refers to Investment of Long Term Project.

 We are Buying a New Plant replacing Old with New Launching a New Product. Replacing a Labour System
with a Machinery System.

 Investment of Fund for a Long Term Project is called Capital Budgeting.

 In CB Large amount money involved significant Capital is involved. Of Course these are Long Term Decisions.

 Hence CB decision are very IMP. They are very difficult to take.

 If I am launching a New Product, Future sales will be How much, Cost will be how much? These are Certain or
Uncertain?

 In this topic there will be given Cash Outflows and Cash Inflow.

T0 T1 T2 T3 T4

(800 L) 200 300 400 300

 Investors always expect certain returns. Return should be Higher or Lower of course Higher.

 If Return is Higher Profit will Go Up Share Price will Go Up Market Capitalisation

will Go Up.

 Ultimately it maximize Share Holder Wealth.

(800) 200 300 400 300 These are Cash Flows.

 How to calculate the CFs we will learn,

 From Above time line 800 is going out & 1,200 comes in,
Unique Academy 4.35 Prof. Ashish Parikh
CS Executive: Financial Management Capital Budgeting

1st Story Line Cash Flow Banana

2nd Story Line whether to Accept or Reject.
That is known Slection Criteria or Appraisal Criteria.

1st Part : Generation of Cash Flows

T0 T1 T2 T3 T4

(800 L)

600 Equity 200 L & D

Appropriation i = 15%, Tax Rate 30%

Blow Line Changed Against Profit

Above Line
K d = i (1 - t)
= 15 (1 - 0.30)
= 10.5%
Post Tax Cost of Debt

WACC (K e ) = We K e + Wd K d
6 2
= × 18% + × 10.5%
8 8

= 13.5% + 0.25 × 10.5%

= 16.125%

 It means this project should be Accepted only when project generates Post Tax Cost of Debt more than
16.125%.

 Cost of Capital shows a Rate of Return that a firm must earn to maintain its share price.

 But what is the objective of FM to maintain or maximize the share price of course maximise.

 ∴ You Accept the project if Return is Greater than 16.125%.

∴ Objective is to maximize.

∴ 16.125% is the Hurdle or required Rate of Return for the Project.

 How to check Return > Hurdle Rate for that there are many criteria.

Criteria 1:

Find PV of all Future CFs, Suppose its 820.

It means if Invest 820 today & we receive above CFs then our Return is 16.125%.

Unique Academy 4.36 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting
But you Invested only 800, Extra 20 is Called NPV.

Present Value Kiya to PV fir 800 Less Kiya to NPV.

 Next Chapter if shares of Bond ka Future CFs are given, PV 820 Aaya.

 But today Price is 800 then what you say its underpriced but it.

 Shares are trading on BSE or NSE But projects are not trading.

 Share trade ho rahe hai.

∴ PV Karan eke Bad 800 se minus nahi karate. Compare & Comment Karate Hai.

 In case of Project you can’t Compare because its not traded.

 PV me se 800 minus karo.

If NPV is + Ve Accept
If NPV is - Ve Reject

 If NPV is 20L If we Accept this project then Demand for the Share Increase Hoga , then Share Price Hoga.

 If share price is go up then No. of Shares × Increased Share Price = 20 L.

20 L is nothing but in Market Top.

∴ This project is make Share Holder neither or poorer.

∴ Project should be Accepted.

 NPV is not Three Letters that you mug up.

800 Laga Ke 820 Aa Raha Hai.
Then 1 Laga Ke 1.025 Aa Raha Hai.
This is known as Profitability Index.
Or
Benefit Cost Ratio = 1.025

Benefit PCCFF
=
Cost PVCOF

 NPV me PV Karke – Initial

PI me PV Karke – Divide by Initial

 If we tell any Business Man that this project has NPV of 20 L. He will think Profit is 20 L.

Profit = Revenue – Cost

1st, 2nd, 3rd or 4th Year : K e end me jo aya i.e.

Revenue – Cost = Profit

No Revenue – Cost Ka PV Nikale then new got Extra Value, Value Not Income.

 Income aur Value mai Difference Hai.

 If you find PV then it is Value IMP Wealth. Last word of NPV is Value

∴ Its measurement of how much your wealth is going to Increase..

Unique Academy 4.37 Prof. Ashish Parikh

CS Executive: Financial Management Capital Budgeting

 Businessman does not understand NPV he understand only Profit or Return.

 It Return is 18% (IRR) and we want 16.125% then project is vible.

 How to calculate 18% that we learned in last class of TVM (Hit + Trial Method).

 Chupa hua Rate of Return i.e. Internal Rate of Return because Businessman only understand %.

 In this world IRR does not require NPV is the best.

If NPV is + Ve, then IRR > 16.125% ( K e )
PI > 1 then , NPV > 0.

 IRR means Outflow = Inflow.

Unique Academy 4.38 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement

5 WORKING CAPITAL: PLANNING & MANAGEMENT

Question 1:

Sagar Company is considering its working capital investment and financial policies for the next year. Estimated fixed
assets and current liabilities for the next year are Rs 2.60 crores and Rs 2.34 crores respectively. Estimated Sales and
EBIT depend on current assets investments, particularly inventories and book-debts. The financial controller of the
company is examining the following alternative Working Capital Policies:

Working Capital Policy Investment in Current Assets Estimated Sales EBIT

Conservative 4.50 12.30 1.23
Moderate 3.90 11.50 1.15
Aggressive 2.60 10.00 1.00

After evaluating the working capital policy, the Financial Controller has advised the adoption of the moderate working
capital policy. The company is now examining the use of long-term and short-term borrowings for financing its assets.
The company will use Rs 2.50 crores of the equity funds. The corporate tax rate is 35%. The company is considering
the following debt alternatives.

Financing Policy Short-term Debt Long-term Debt

Conservative 0.54 1.12
Moderate 1.00 0.66
Aggressive 1.50 0.16
Interest rate-Average 12% 16%

You are required to calculate the following:

(1) Working Capital Investment for each policy:
(a) Net Working Capital position
(b) Rate of Return
(c) Current ratio

(2) Financing for each policy:

(a) Net Working Capital position.
(b) Rate of Return on Shareholder’s equity.
(c) Current ratio.

Question 2:

Sagar Limited manufactures foundry equipment and caters to the steel industry. To assess the need of working capital,
the following data relating to Sagar Limited is given for your consideration:

Turnover for the year Rs 15,00,000

Costs as Percentage of Sales %
Direct Materials 30
Direct Labour 25
Variable Overheads 10
Fixed Overheads 15
Selling and Distribution Overheads 5

Additional information:
Unique Academy 5.1 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
On an average:
(a) Debtors take 2.5 months before payment.
(b) Raw materials are in stock for three months.
(c) Work-in-progress represents two months of half produced goods.
(d) Finished goods represent one month’s production.
(e) Credit is taken as follows:

Direct Materials 2 months

Direct Labour 1 week
Variable Overheads 1 month
Fixed Overheads 1 month
Selling and Distribution 0.5 months

Work-in-progress and finished goods are valued at material, labour and variable expenses cost.
You are required to prepare a projected statement of working requirement of Sagar Limited assuming that the labour
force is paid for 50 working weeks a year.

Question 3:

Eshant Limited manufactures products used in the steel industry. The following information regarding the company is
given for your consideration:
(i) Expected level of production 6000 units.
(ii) Raw materials are expected to remain in stores for an average of two months before issue to production.
(iii) Work-in-progress (50% complete as to conversion cost will approximate to ½) month’s production.
(iv) Finished goods remain in warehouse on an average for one month.
(v) Credit allowed by suppliers is one month.
(vi) Two month’s credit is normally allowed to debtors.
(vii) A minimum cash balance of Rs 45,000 is expected to be maintained.
(viii) Cash sale are 75% less than the credit sales
(ix) Safety margin of 20% to cover unforeseen contingencies
(x) The production pattern is assumed to be even during the year.
(xi) The cost structure for Eshant Limited’s product is as follows:

Rs
Raw Materials 80 per unit
Direct Labour 20 per unit
Overheads (including depreciation Rs 20) 80 per unit
Total Cost 180 per unit
Profit 20 per unit
Selling Price 200 per unit

You are required to estimate the working capital requirement Eshant Limited.

Question 4:

The following annual figures relate to Richie Limited:

Sales (at 3 months credit) 90,00,000

Materials consumed (Suppliers extend 1 ½ month’s credit) 22,50,000
Wages paid (one month in arrear) 18,00,000
Manufacturing expenses outstanding at the end of year(cash expenses are paid on month in 2,00,000
arrear)
Total administration expenses(Cash expenses are paid one month in arrear) 6,00,000
Sales promotion expenses for the year (Paid quarterly in advance) 12,00,000

The company sells its products on gross profit of 25% assuming deprecation as a part of cost of production. It Keeps
two month’s stock of raw materials as inventory. It keeps cash balance of Rs 2,50,000.

Unique Academy 5.2 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
You are required to work out the working capital requirement of the company one cash- cost basis Ignore work-in-
progress.

Question 5:

Aliya Limited sells its product on a gross profit of 20% on sales. The following information is extracted from its
annual for the current year ended March31.

Rs
Sales at 3 months’ credit 40,00,000
Raw Material 12,00,000
Wages paid-average time lag 15 days 9,60,000
Manufacturing expenses paid-one month in arrears 12,00,000
Administrative expenses paid-one month in arrears 4,80,000
Sales promotion expenses-payable half-yearly in advance 4,80,000

The Company Enjoys one month’s credit from the suppliers of raw materials and maintains 2 month’s stock of raw
materials and one and a half month’s stock finished goods. The cash balance is maintained at Rs 1,00,000 as a
precautionary measure. Assuming a 10% margin,
You are required to estimate the working capital requirements of Aliya Limited.

Question 6:

Krushna Ltd. Sells goods at a uniform rate of gross Profit of 20% on Sales including depreciation as part of cost of
Production. Its annual figures are as under:

Rs
Sales (At 2 months’ credit) 24,00,000
Materials consumed (Suppliers credit 2 months) 6,00,000
Wages paid (Monthly at the beginning of the subsequent month) 4,80,000
Manufacturing expenses (Cash expenses are paid – one month in arrear) 6,00,000
Administration expenses (Cash expenses are paid – one month in arrear) 1,50,000
Sales promotion expenses (Paid quarterly in advance) 75,000

The company Keeps one month stock each of raw materials and finished goods. A minimum cash balance of Rs 80,000
is always Kept. The company wants to adopt a 10% safety margin in the maintenance of working capital.
The Company has no work in progress
Find Out the requirements of working capital of the company on cost basis.

Question 7:

The management of Mayur Company Ltd. is planning to expand its business and consults you to prepare an estimated
working capital Statement. The records of the company reveal the following annual information:

Sales – Domestic at one month’s credit 24,00,000

Export at three month’s credit (sales price 10% below domestic price) 10,80,000
Materials used (Suppliers extend two months credit) 9,00,000
Lag in payment of wages – ½ month 7,20,000
Lag in payment of manufacturing expenses (cash) – 1 month 10,80,000
Lag in payment of Adm. Expenses – 1 month 2,40,000
Sales promotion expenses payable quarterly in advance 1,50,000
Income tax payable in four instalments of which one falls in the next financial year 2,25,000
Rate of gross profit is 20%
Ignore work – in progress and depreciation.

The company Keeps one month’s stock of raw materials and finished goods (each) and believes in keeping Rs
2,50,000 available to it including the overdraft limit of Rs 75,000 not yet utilized by the company.
Unique Academy 5.3 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
The management is also of the opinion to make 12% margin for contingencies on computed figure.
You are required to prepare the estimated working capital statement for the next year.

Question 8:

Creditor quotes the following credit terms – 2/10, net 60. If cost of funds to the company is 14%, should the company
avail the discount and pay on the 10th day on should it pay on the 60th day?

Question 9:
1
Supplier quotes credit terms 10 net 50. If the cost of funds to the company is 12% p.a., should the company avail the
Discount ?

Question 10:

A Customers Approaches us to purchases goods on credit 2 times i.e. one after another.
1st order:
Probability of Default =20%
Sales = 50000
Cost = 45000
2nd order:
(Contingent on payment of the first)
Probability of default = 12%
Sales = 1,00,000
Cost = 86,000
Should credit be granted ?

Question 11:

A Company is presently having credit sales of Rs 12 lakh. The existing credit terms are 1/10, net 45 days and average
collection period is 30 days. The current bad loss is 1.5%. In order to accelerate the collection process further as also to
increase sales, the company is contemplating liberalization of its existing credit terms to 2/10, net 45days. It is
expected that sale are likely to increase by 1/3 of existing sales, bad debts increase to 2% of sales and average
collection period to decline to 20 days. The contribution to sales ratio of the company is 22% and opportunity cost of
investment in receivables is 15% (pre-tax). 50% and 80% of customers in terms of sales revenue are expected to avail
cash discount under existing and liberalization scheme respectively. The tax rate is 30%. Should the company change
its credit terms ? (Assume 360 days in a year).

Question 12:

Dinesh Limited currently makes all sales on credit and offers no cash discounts. It is considering a 2% discount for
payments within 10 days (terms offered ‘2/10 net 30’). The firm’s current average collection period is 30 days, sales
are 10,000 units, selling price is Rs 100 per unit and variable cost per unit is Rs 50; its existing total fixed costs are Rs
2,00,000 which are likely to remain unchanged with production/ sales volume of 12,000 units.
It is expected that the offer of cash discount will result in an increase in sales to 11,000 units and the working capital
required will be for Rs 20,000 (without taking into account the effect to debtors). Assuming that 50 percent of the total
sales will be on cash discount and 20 percent is the required return on investment, should the proposed discount be
offered?

Question 13:

Japan Metals Limited is considering a change of credit policy which will result in slowing down in the average
collection period form one to two months. The relaxation in credit standards is expected to produce an increase in sales
each year amounting to 25% of the current sales volume.

Sales Price per unit Rs 10.00

Profit per unit (before interest) Rs 1.50

Unique Academy 5.4 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
Current Sales Revenue per annum Rs 24,00,000
Required Rate of Return on Investment 20%

Assume that the 25% increase in sales would result in additional stocks of Rs 1,00,000 and additional creditors of Rs
20,000. You are to advise the company on whether or not it should extend the credit period offered to customers, in the
following circumstances:
(i) If all customers take the longer credit of two months.
(ii) If existing customers do not change their payment habits, and only the new customers take a full two month’s
credit.

Question 14:

Shubham Ltd presently manages its debtors in house. Its credit terms are 2 net 60. 70% of the customers are expected
to avail the discount and pay in 10 days. The remaining 30% would on an average pay in 50 days. Funding cost under
in house arrangement is 18%. For the next year, firm is contemplating evaluating whether to opt for factoring –
recourse or non recourse. For the next year, credit sales would be 500 lakhs under in house management and 580 lakhs
under factoring. Bad debt loss is 1%Total administrative cost incurred annually on receivables management is 3 lakhs
out of which 40% is avoidable if factoring is chosen. Factor will advance 80% at a discount charge in 19%. You many
assume that the factor reserve i.e. 20% shall be financed at the same rate as in house. Guaranteed payment period under
factoring is 30% days. Commission for recourse / non-recourse factoring is 2.5% / 3.7% respectively. Firms GP margin
is 22%. Advise the firm.

Question 15:

Ankita Ltd has total sales of Rs 3.2 crores and its average collection period is 90 days. The past experience indicates
that bad-debt losses are 1.5% on sales. The expenditure incurred by the firm in administering its receivable collection
efforts are Rs 5,00,000. Ankita factor is prepared to buy the firm’s receivables by charging 2% commission. The factor
will pay advance on receivable to the firm at an interest rate of 18% p.a. after withholding 10% as reserve.
Calculate the effective cost of factoring to the firm.

Question 16:

Neha limited faces an interest rate of 0.5% per day and its broker charges Rs 75 for each transaction in short-term
securities the managing director hapur stated that the minimum cash balance that is acceptable is Rs 2,000 and that the
variance of cash flows on a daily basis is Rs 16,000. You are required to determine the maximum level of cash Neha
Limited should hold and at what point should it start to purchase or sell securities?

Question 17:

Lucky Limited has a present annual sales turnover of Rs 40,00,000. The unit sale price is Rs 20. The variable cost are
Rs 12 per unit and fixed costs amount to Rs 5,00,000 per annum. The present credit period of one month is proposed to
be extended to either 2 or 3 months whichever will be more profitable. The following additional information is
available:

On the basis of Credit Period of

1 month 2 month 3 month
Increase in sales by - 10% 30%

The company requires a pre-tax return on investment at 20%. Evaluate the profitability of the proposals and
recommended best credit period best credit period for Lucky Limited.

Question 18:

A new customer has approached a firm to establish new business connection. The customer require 1.5 month of
credit. If the Proposal is accepted, the sales of firm will go up by Rs 2,40,000 per annum. The new customer is being
considered as a member of 10% risk of non-payment group.
The cost of sales amounts to 80% of sales. The tax rate is 30% and the desired rate of return is 40% (after tax).

Unique Academy 5.5 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
Should the firm accept the offer? Give your opinion on the basis of calculations.

Question 19:

Kanchan Ltd. having an annual sales of Rs 30 lakhs. Is re-considering its present collection policy. At present, the
average collection period is 50 days and the bad debt losses are 5% of sales. The company is incurring an expenditure
of Rs 30,000 on account of collection of receivables.
The alternative policies are as under:

Alternative I Alternative II
Average Collection Period 40 days 30 days
Bad Debt Losses 4% of sales 3% of sales
Collection Expenses Rs 60,000 Rs 95,000

Evaluate the alternatives on the basis of incremental approach and state which alternative is more beneficial.

Question 20:

Black Limited has furnished the following cost sheet

Rs / per unit
Raw material 98
Direct Labour 53
Factory overhead 88
(includes depreciation of Rs 15 per unit at budgeted level of activity)
Total Cost 239
Profit 43
Selling Profit 282

Additional information:

i) Average raw material in stock – 3 weeks

ii) Average work-in-progress(0% of completion with respect to 75% Labour & Overhead – 70%) – 2 weeks
iii) Finished goods in stock – H weeks
iv) Credit allowed no debtors – 2.5 weeks
v) Credit allowed by creditors – 3.5 weeks
vi) Time lag in payments of labour -2weeks
vii) Time lag in payments of factory overheads – 1.5 weeks
viii) Company sells 25% of the output against cash
ix) Cash in hand and bank is desired to be maintained – 2,2500/-
x) Provision for contingencies is required @ 4% of working capital requirement including that Provision.
You may assume that production as earned on evenly throughout the year and labour and factory overheads accrue
similarly.
You are required to prepare a statement showing estimate of working capital needed to finance a budgeted activity
level of 104000 units of production. Finished stock, debtors and overhead are taken at cash cost.

Question 21:

The present credit terms of Prashant company are 1/10 net 30. Its annual sales are Rs. 80 lakhs, its average collection
period is 20 days. Its variable cost and average total costs to sales are 0.85 and 0.95 respectively and its cost of capital
is 10%. The proportion of sales on which customers currently take discount is 0.5. Prashant company is considering
relaxing is discount terms to 2/10 net 30.Such relaxation expected to increase sales by Rs. 5 lakhs, reduce the average
collection period to 14 days and increase the proportion of discount sales to 0.8. What will be the effect of relaxing the
discount policy on company’s profit? Take year as 360 days.

Question 22:

Unique Academy 5.6 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
(a) Krushna Electronics has total sales of Rs 3.2 crores and its average collection period is 90 days. The past
experience indicates that bad-debt losses are 1.5% on sales. The expenditure incurred by the company in administering
its receivable collection efforts are Rs 5,00,000. A factor is prepared to buy the company’s receivables by charging 2%
commission. The factor will pay advance on receivables to Krushana Electronics at an interest rate of 18% p.a. after
withholding 10% as reserve. You are required to compute the effective cost of factoring to Krushna Electronics.

(b) Vikrant Limited a newly formed company, has applied to a commercial bank for the first time for financing its
working capital requirements. The following information is available about the projections for the current year:
Estimated level of activity: 1,04,000 completed units of production plus 4,000 units of work-in-progress. Based on the
above activity, estimated cost per unit is:

Raw material Rs 80 per unit

Direct wages Rs 30 per unit
Overheads (exclusive of depreciation) Rs 60 per unit
Total cost Rs 170 per unit
Selling price Rs 200 per unit

Raw materials in stock: Average 4 weeks consumption, work-in-progress (assume 50% completion stage in respect of
conversion cost) (materials issued at the start of the processing).

Finished goods in stock 8,000

Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors/ receivables Average 8 weeks
Lag in payment of wages Average 1 ½ weeks
Cash at banks (for smooth operation) is expected to be Rs 25,000.

Assume that production is carried on evenly throughout the year (52 weeks) and wages and overheads accure similarly.
All Sales are on credit basis only.

You are required to determine:

(i) The net working capital required
(ii) The maximum permissible bank finance under first and second method of financing as per Tandon Committee
Norms.

Question 23:

Ankita Toys maintains a separate account for cash disbursement. Total disbursements are Rs 2,62,500 per month,
Administrative and transaction cost of transferring cash to disbursement account is Rs 25 per transfer. Marketable
securities yield is 7.5% per annum, Determine the optimum cash balance according to William j Baumol model.

Question 24:

Saniya Limited has the following data for your consideration:

(i) The minimum cash balance is Rs 8,000.
(ii) The variance of daily cash flows is 40,00,000, equivalent to a standard deviation of Rs 2,000 per day.
(iii) The transaction cost for buying or selling securities is Rs 50.
(iv) The interest rate is 0.025% per day.

You are required to formulate a decision rule using the Miller-Orr model for cash management.

Question 25:
Justin Limited is a small manufacturing company which is suffering cash flow problems. The Company already
utilizes its maximum overdraft facility. Justin Limited sells an average of Rs 4,00,000 of goods per month at invoice
value, and customers are allowed 40 days to pay from the date of invoice. Two possible solutions to the company’s
cash flow problems have been suggested. They are as follows:

Unique Academy 5.7 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
Option 1: Justin Limited would factor its trade debts. A factor has been found who would advance Justin Limited’s
75% of the value of the invoices immediately on receipt of the invoices, at an interest rate of 10% per annum. The
factor would also charge a service fee amounting to 2% of the total invoices. As a result of using the factor, Justin
Limited would save administration costs estimated at Rs 5,000 per month.

Option 2: The company could offer a cash discount to customers for prompt Payment. It has been suggested that
customers could be offered a 2% discount for payments made within 10 days of invoicing.

You required to:

(a) Discuss the issues that should be considered by management when a policy for credit control is formulated.
(b) Identify the services that may be provided by factoring organizations.
(c) Calculate the annual. Net cost (in Rs) of the proposed factoring agreement.
(d) Compute the annualized cost (in percentage terms) of offering a cash discount to customers.

Question 26:

Shweta Limited currently has sales of Rs 30 lakhs, with an average collection period of two months and no discounts
are given. The management of the company is undecided as to whether to allow a discount on sales of 2% to settle
within one month. The company assumes that all customers would take advantage of the discount. The company can
obtain a return of 30% on its investments, Advise the management of Shweta Limited regarding the change in Policy.

Question 27:

Manshi Limited, dealing in textiles, provides the following information for your consideration:

Rs
Cost (per unit)
Raw materials 52.0
Direct labour 19.5
Overheads 39.0
Total cost (per unit) 110.5
Profit 19.5
Selling price 130.0

Average raw material in stock is one month; average materials in process is half a month. Credit allowed by suppliers
is one month; credit to debtors is two months. Time lag in payment of wages is one and a half weeks and Overheads is
1 month. ¼ of sale are on cash basis. Cash balance is expected to be Rs 1,20,000.
You are required to prepare a statement showing the working capital needed to finance a level of activity of 70,000
units of output. You may assume that production is carried on evenly, throughout the year and wages and overheads
accrue similarly.

Question 28:

Rohini Limited is considering relaxing its present credit policy and is in the process of evaluating tow proposed
polices. Currently, the firm has annual credit sales of Rs 225 laksh and accounts receivable turnover ratio of 5 times a
year. The current level of loss due to bad debts is Rs 7,50,000. The firm is required to give a return of 20% on the
investment in new accounts receivables. The company’s variable costs are 60% of the selling price. Given the
following information, which is a better option?

Present Policy Policy Option I Policy Option II

Annual credit sales (Rs) 225 275 350
Accounts receivable turnover ratio 5 4 3
Bad debt losses (Rs) 7.5 22.5 47.5

Question 29:
The following information has been extracted from the record of a Company:

Unique Academy 5.8 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
Product Cost Sheet Rs/unit
Raw materials 45
Direct labour 20
Overheads 40
Total 105
Profit 15
Selling price 120

. Raw Materials are in stock on an average of two months.

. The Materials are in process on an average fro 4 Weeks. The degree of completion is 50%.

. Finished goods stock on an average is for one month.

. Time lag in payment of wages and overheads is 1 ½ weeks.

. Time lag in receipt of proceeds from debtors is 2 months

. Credit allowed by suppliers is 1 months.

. 20% if the output us sold against cash.

. The Company expects to Keep a Cash balance of Rs 1,00,000.

. Take52weeks per annum.

The Company is poised for a manufacture of 1,44,000 units in the year.

You are required to prepare a statement showing the Working Capital requirements of the Company.

Question 30:

A Proforma cost sheet of a Company provides the following data:

Rs
Raw material cost per unit 45
Direct Labour cost per unit 20
Factory overheads cost per unit (includes depreciation of Rs 18 per unit at budgeted level of activity) 40
Total cost per unit 105
Profit 15
Selling price per unit 120

Following additional information is available:

Average raw material in stock: 4 weeks
Average work-in-process stock: 2 weeks
(% Completion with respect to
Materials: 80%
Labour and Overheads: 60%)
Finished goods in stock: 3 weeks
Credit perod allowed to debtors: 6 weeks
Time lag in payment of Wages: 1 week
Time lag in payment of overheads: 2 weeks
The Company sells one-fifth of the output against cash and maintains cash balance of Rs 2,50,000.

Required:

Unique Academy 5.9 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
Prepare a statement showing estimate of working capital needed to finance a budgeted activity level of 78,000 units of
production. You may assume that production is carried on evenly throughout year and wages accrue similarly.

Question 31:

The turnover of Prakash Ltd. is Rs 120 lakhs of which 75% is on credit. The variable cost ratio is 80%. The credit
terms are 2/10, net 30. On the current level of sales, the bad debts are 1%. The company spends Rs 1,20,000 per annum
on administering its credit sales. The cost includes salaries of staff who handle credit checking, collection etc. These
are avoidable costs. The past experience indicates that 60% of the customers avail of the sale. The Book debts
(receivable) of the company are presently being financed in the ratio of 1:1 by a mix of bank borrowings and owned
funds which cost per annum 15% and 14% respectively.
A factoring firm has offered to buy the firm’s receivables. The main elements of such deal structured by the factor are:

(i) Factor reserve, 12%

(ii) Guaranteed payment, 25 days
(iii) Interest charges, 15%, and
(iv) C omission 4% of the value of receivables. Assume 360 days in a year.
What advice would you give to Prakash Ltd. – whether to continue with the in house management of receivables or
accept the factoring firm’s offer?

MULTIPLE CHOICE QUESTIONS

1. Management of working capital implies trade- (c) Conservative Approach
off between: (d) All of the above
(a) Cost and Revenue
(b) Assets and Liabilities 6. Negative Net Working Capital implies that:
(c) Debtors and Creditors (a) Long-term funds have been used for long-term
(d) Liquidity and Profitability assets.
(b) Long-term funds have been used for current assets.
2. Gross Working Capital is equal to: (c) Short-term funds have been used for fixed assets.
(a) Total Assets (d) Short-term funds have been used for current assets.
(b) Total Liabilities
(c) Total Current Assets 7. Positive Net Working Capital implies that:
(d) Total Current Liabilities (a) Liquidity position is not comfortable.
(b) Current Ratio is less than one.
3. Permanent Working Capital is also known as: (c) Current Assets are partly financed out of long-term
(a) Gross Working Capital sources.
(b) Net Working Capital (d) All of the above.
(c) Total Current Asset
(d) None of the above
8. Operating Cycle of a firm can be shortened by
4. Hedging Approach to Working Capital deals (a) Increasing credit period to customers.
with: (b) Increasing stock of raw material
(a) Financing of CA (c) Increasing working-in-progress period
(b) Financing of CL (d) Increasing credit period from suppliers.
(c) Level of CA
(d) Level of CL 9. Which of the following does not usually affect
working capital requirement?
5. In which of the following, the permanent (a) Operating leverage
working capital is financed by long-term sources of (b) Financial leverage
funds? (c) Both of (a) and (b)
(a) Hedging Approach (d) None of (a) and (b)
(b) Aggressive Approach

Unique Academy 5.10 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
10. Which of the following is not a feature of (b) Raw Materials Stock
current assets? (c) Finished Goods Stock
(a) Shorter liquidity (d) Creditors Payment Period
(b) Longer life
(c) Controllable 18. Working Capital is defined as excess of:
(d) Relevant (a) Current Assets Over Capital
(b) Current Liabilities over Capital
11. Net Operating Cycle is equal to: (c) Current Assets over Current liabilities
(a) GOC  DP (d) Share capital over Resources
(b) GOC  DP
(c) RMCP  RCP 19. Deferral Period refers to the credit period
(d) RMCP  RCP allowed by:
(a) Creditors
12. Net Operating Cycle increases if: (b) Debtors
(a) More raw materials are purchased (c) Bank holders
(b) Payment to creditors is made earlier (d) Shareholders
(c) Goods are sold in shorter period
(d) Both (a) and (b) 20. Operating Cycle is a technique of:
(a) Working Capital Management
13. Find out the Cash Conversion Period if (b) Receivables Management
Receivable Conversion Period is 40 days, Deferral (c) Inventory Management
Period in 30 days and Inventory Holding Period in 25 (d) Creditors Management
days:
(a) 30 days 21. Operating Cycle is equal to Inventory
(b) 25 days Conversion Cycle Plus:
(c) 35 days (a) Receivable Conversion Period
(d) 45 days (b) Creditors Deferral Period
(c) (a) Minus (b)
14. Which of the following is a determinant of (d) (a) Plus (b)
working capital?
(a) Production Schedule 22. Permanent Working Capital:
(b) Production Capacity (a) Includes Fixed Assets
(c) Depreciation Policy (b) Is minimum level of Current Assets
(d) Tax Policy (c) Varies with seasonal pattern
(d) Includes Equity Capital
15. Gross operating cycle is defined as:
(a) Equal to accounting period 23. Working Capital Management involves
(b) One calendar year financing and management of
(c) Either of (a) and (b) (a) All Assets
(d) None of (a) and (b) (b) All Current Assets
(c) Cash and Bank Balance
16. Management of Working Capital deals with: (d) Receivable and Payable
(a) Short-term Liquidity
(b) Long-term Liquidity 24. Which of the following is classified as Current
(c) Cash Balance Liability?
(d) Issue of Share capital (a) Inventory
(b) Marketable Securities
17. Which of the following is not included in (c) Provision for Tax
Operating Cycle? (d) Investments
(a) Fixed Assets Level

Unique Academy 5.11 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
25. Current liabilities are those obligations which
are generally to be discharged in: 28. What is generally applicable to a retail firm?
(a) 1 month (a) High level of fixed assets
(b) 1 year (b) Higher capital intensity
(c) 1 week (c) Low inventory turnover
(d) 1 day (d) Higher liquidity

26. With reference to Creditors, the cash discount 29. Which of the following is generally untrue for
date is missed, when the payment be made? manufacturing firm?
(a) As early as possible (a) High level of Raw material
(b) On the Scheduled day (b) High level of cash balance
(c) On receipt of Notice (c) High level of Fixed Assets
(d) Never (d) Higher level of Debtors and Creditors

27. Which of the following is not a component of 30. Which of the following is not true for aggressive
working capital? working capital policy?
(a) Debtors (a) Low level of current assets
(b) Term / loan (b) Greater reliance of long-term finance
(c) Creditors (c) Low level of cash
(d) Short term Marketable Investments. (d) Greater reliance on short-term finance

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(d) (c) (d) (a) (a) (c) (c) (d) (d) (b)
11 12 13 14 15 16 17 18 19 20
(a) (d) (c) (a) (d) (a) (a) (c) (a) (a)
21 22 23 24 25 26 27 28 29 30
(c) (b) (b) (c) (b) (b) (b) (d) (b) (b)

31. Cash Budget does not include: 34. Difference between the bank balance as per
(a) Dividend Payable Cash Book and Pass Book may due to:
(b) Capital Expenditure (a) Overdraft
(c) Issue of Capital (b) Float
(d) Total Sales Figure (c) Factoring
(d) None of the above
32. Which of the following is not a motive to hold
cash? 35. Concentration Banking helps in:
(a) Transactionary Motive (a) Reducing Idle Bank Balance
(b) Precautionary Motive (b) Increasing Collection
(c) Capital Investment (c) Increasing Creditors
(d) None of the above (d) Reducing Bank Transactions

33. Cheques deposited in bank may not be available 36. The Transaction Motive for holding cash is for:
for immediate use due to: (a) Safety Cushion
(a) Payment Float (b) Daily Operations
(b) Receipt Float (c) Purchase of Assets
(c) Total Net Float (d) Payment of Dividends
(d) Playing the Float

Unique Academy 5.12 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
37. Which of the following should be reduced to (a) Cash budget indicates timings of short-term
minimum by a firm? borrowing.
(a) Receipt Float (b) Cash budget is based on accrual concept.
(b) Payment Float (c) Cash budget is based on cash flow concept.
(c) Concentration Banking (d) Repayment of principal amount of law is shown in
(d) All of the above cash budget.

38. Cash required for meeting specific payments 43. Baumol’s Model of Cash Management attempts
should be invested with an eye on: to:
(a) Yield (a) Minimize the holding cost
(b) Maturity (b) Minimization of transaction cost
(c) Liquidity (c) Minimization of total cost
(d) All of the above (d) Minimization of cash balance

39. Miller-Orr Model deals with: 44. Which of the following is not considered by
(a) Optimum Cash Balance Miller-Orr Model?
(b) Optimum Finished goods (a) Variability in cash requirement
(c) Optimum Receivable (b) Cost of transaction
(d) All of the above (c) Holding cost
(d) Total annual requirement of cash
40. ]Float management is related to:
(a) Cash Management 45. Basic characteristic of short-term marketable
(b) Inventory Management securities:
(c) Receivables Management (a) High Return
(d) Raw Materials Management (b) High Risk
(c) High Marketability
41. Which of the following is not an objective of (d) High Safety
cash management?
(a) Maximization of cash balance 46. Marketable securities are primarily:
(b) Minimization of cash balance (a) Equity shares
(c) Optimization of cash balance (b) Preference shares
(d) Zero cash balance (c) Fixed deposits with companies
(d) Short-term debt investments.
42. Which of the following is not true of cash
budget?

ANSWER KEYS
31 32 33 34 35 36 37 38 39 40
(d) (c) (b) (b) (b) (b) (a) (b) (a) (a)
41 42 43 44 45 46
(c) (b) (c) (d) (c) (d)

47. 5 Cs of the credit does not include: (a) Credit Terms

(a) Collateral (b) Collection Policy
(b) Character (c) Cash Discount Terms
(c) Condition (d) Sales Price
(d) None of the above
49. Ageing schedule incorporates the relationship
48. Which of the following is not an element of between:
credit policy? (a) Creditors and Days Outstanding

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CS Executive: Financial Management Working Capital : Planning & Mangement
(b) Debtors and Days Outstanding
(c) Average Age of Directors 57. If the closing balance of receivables is less than
(d) Average Age of All Employees the opening balance for a month then which one is
true out of:
50. Bad debt cost is not borne by factor in case of: (a) Collections > Current Purchases
(a) Pure Factoring (b) Collections > Current Sales
(b) Without Recourse Factoring (c) Collections < Current Purchases
(c) With Recourse Factoring (d) Collections < Current Sales
(d) None of the above
58. If the average balance of debtors has increased,
51. Which of the following is not a technique of which of the following might not show a change in
receivables management? general?
(a) Funds Flow Analysis (a) Total Sales
(b) Ageing Schedule (b) Average Payables
(c) Days sales outstanding (c) Current Ratio
(d) Collection Matrix (d) Bad Debt loss

52. Which of the following is not a part of credit 59. Securitization is related to conversion of:
policy? (a) Receivables
(a) Collection Effort (b) Stock
(b) Cash Discount (c) Investments
(c) Credit Standard (d) Creditors
(d) Paying Practices of debtors
60. 80% of sales of ` 10,00,000 of a firm are no
53. Which is not a service of a factor? credit. It has a Receivable Turnover of 8. What is the
(a) Administrating Sales Ledger Average collection period (360 days a year) and
(b) Advancing against Credit Sales Average Debtors of the firm?
(c) Assuming bad debt losses (a) 45 days and ` 1,00,000
(d) None of the above (b) 360 days and ` 1,00,000
(c) 45 days and ` 8,00,000
(d) 360 days and ` 1,25,000
54. Credit Policy of a firm should involves a trade-
off between increased:
61. In response to market expectations, the credit
(a) Sales and Increased Profit
period has been increased from 45 days to 60 days.
(b) Profit and Increased Costs of Receivables
This would result in:
(c) Sales and Cost of goods sold
(a) Decrease in Sales
(d) None of the above
(b) Decrease in Debtors
(c) Increase in Bad Debts
55. Out of the following, what is not true in respect
(d) Increase in Average Collection Period
of factoring?
(a) Continuous Arrangement between Factor and Seller
62. If a company sells its receivable to another party
(b) Sales of Receivables to the factor
to raise funds, it is known as:
(c) Factor provides cost free finance to seller
(a) Securitization
(d) None of the above
(b) Factoring
(c) Pledging
56. Payment to creditors is a manifestation of cash
(d) None of the above
held for:
(a) Transactionary Motive
63. Cash Discount term 3 , net 40 means:
(b) Precautionary Motive 15
(c) Speculative Motive (a) 3% Discount if payment in 15 days, otherwise full
(d) All of the above payment in 40 days.

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CS Executive: Financial Management Working Capital : Planning & Mangement
(b) 15% Discount if payment in 3 days, otherwise full (c) Debt collection period
payment 40 days. (d) All of the above
(c) 3% Interest if payment made in 40 days and 15%
interest thereafter. 66. Receivables Management deals with:
(d) None of the above. (a) Receipts of raw materials
(b) Debtors collection
64. If the sales of the firm are ` 60,00,000 and the (c) Creditors Management
average debtors are ` 15,00,000 then the receivables (d) Inventory Management
turnover is:
(a) 4 times (b) 25% (c) 400%
67. Which of the following is related to Receivables
(d) 25 times
Management?
65. If cash discount is offered to customers, then (a) Cash Budget
which of the following would increase? (b) Economic Order Quantity
(a) Sales (c) Ageing schedule
(b) Debtors (d) All of the above

ANSWER KEYS
47 48 49 50 51 52 53 54 55 56
(d) (d) (b) (c) (a) (d) (d) (b) (c) (a)
57 58 59 60 61 62 63 64 65 66
(b) (b) (a) (a) (d) (b) (a) (a) (a) (b)
67
(c)

68. EOQ is the quantity that minimizes: (a) Material Purchase Cost
(a) Total Ordering Cost (b) Penalty charge for default
(b) Total Inventory Cost (c) Interest on loan
(c) Total Interest Cost (d) None of the above
(d) Safety Stock Level
73. Use of safety stock by a firm would:
69. ABC Analysis is used in: (a) Increase Inventory Cost
(a) Inventory Management (b) Decrease Inventory Cost
(b) Receivable Management (c) No effect on cost
(c) Accounting Policies (d) None of the above
(d) Corporate Governance
74. Which of the following is true for a company
70. If no information is available, the General Rule which uses continuous review inventory system:
for valuation of stock for balance sheet is: (a) Order Interval is fixed
(a) Replacement Cost (b) Order Interval varies
(b) Realizable Value (c) Order Quantity if fixed
(c) Historical Cost (d) Both (a) and (c)
(d) Standard Cost
75. In the EOQ Model:
71. In ABC inventory management system, class A (a) EOQ will increase if order cost increases.
items may require: (b) EOQ will decrease if holding cost decreases.
(a) Higher Safety Stock (c) EOQ will decrease if annual usage increases.
(b) Frequent Deliveries (d) None of these
(c) Periodic Inventory system
76. EOQ determines the order size when:
(d) Updating of inventory records
(a) Total Order cost is Minimum
72. Inventory holding cost may include: (b) Total Number of order is least

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CS Executive: Financial Management Working Capital : Planning & Mangement
(c) Total Inventory costs are minimum (d) Stock-out Cost
(d) None of the above
82. Which of the following is not a benefit of
carrying inventories?
77. ABC Analysis is useful for analyzing the
(a) Reduction in ordering cost
inventories:
(b) voiding lost sales
(a) Based on their Quality
(c) Reducing carrying cost
(b) Based on their Usage and value
(d) Avoiding Production Shortages
(c) Based on Physical Volume
(d) All of the above 83. Which of the following is not a standard method
of inventory valuation?
78. If A = Annual Requirement, O = Order Cost
(a) First in First out
and C = Carrying Cost per unit per annum, then
(b) Standard Cost
EOQ is:
(c) Average Pricing
(a)  2AO / C2
(d) Realizable Value
(b) 2 AO / C
84. System of procuring goods when required, is
(c) 2A  OC known as:
(d) 2 AOC (a) Free on Board (FOB)
79. Inventory is generally valued as lower of: (b) Always Butter Control (ABC)
(a) Market Price and Replacement Cost (c) Just in Time (JIT)
(b) Cost and Net Realizable Value (d) Economic Order Quantity
(c) Cost and Sales Value 85. A firm has inventory turnover of 6 and cost of
(d) Sales Value and Profit goods sold is ` 7,50,000. With better inventory
management, the inventory turnover is increased to
80. Which of the following is not included in cost of 10. This would result in:
inventory? (a) Increase in inventory by ` 50,000
(a) Purchase cost (b) Decrease in inventory by ` 50,000
(b) Transport in Cost (c) Decreases in cost of goods sold
(c) Import Duty (d) Increase in cost of goods sold
(d) Selling Costs 86. What is Economic Order Quantity?
81. Cost of not carrying sufficient inventory is (a) Cost of an order
known as: (b) Cost of Stock
(a) Carrying Cost (c) Recorder level
(b) Holding Cost (d) Optimum order size
(c) Total Cost

ANSWER KEYS
68 69 70 71 72 73 74 75 76 77
(a) (a) (c) (a) (d) (a) (b) (a) (c) (b)
78 79 80 81 82 83 84 85 86
(b) (b) (d) (d) (c) (c) (c) (b) (d)

87. The type of collateral (security) used for short- (b) Commercial papers
term loan is: (c) Certificate of Deposits
(a) Real estate (d) Junk Bonds
(b) Plant & Machinery
(c) Stock of good 89. Commercial paper is a type of:
(d) Equity share capital (a) Fixed coupon Bond
(b) Unsecured short-term debt
88. Which of the following is a liability of a bank? (c) Equity share capital
(a) Treasury Bills (d) Government Bond
Unique Academy 5.16 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
(b) More than face value
90. Which of the following is not a spontaneous (c) Less than face value
source of short-term funds? (d) Equal to redemption value
(a) Trade credit
(b) Accrued expenses 94. Which of the following is not applicable to
(c) Provision for dividend commercial paper
(d) All of the above (a) Face Value
(b) Issue Price
91. Concept of Maximum Permissible Bank finance (c) Coupon Rate
was introduced by: (d) None of the above
(a) Kannan Committee
(b) Chore Committee 95. The basic objective of Tandon Committee
(c) Nayak Committee recommendations is that the dependence of industry
(d) Tandon Committee on bank finance should gradually:
(a) Increase
92. In India, Commercial Papers are issued as per (b) Remain Stable
the guidelines issued by: (c) Decrease
(a) Securities and Exchange Board of India (d) None of the above
(b) Reserve Bank of India
(c) Forward Market Commission 96. Cash discount terms offered by trade creditors
(d) None of the above should never be accepted because
(a) Benefit is very small
93. Commercial paper are generally issued at a (b) Cost is very high
price: (c) No sense to pay earlier
(a) Equal to face value (d) None of the above

ANSWER KEYS
87 88 89 90 91 92 93 94 95 96
(c) (c) (b) (c) (d) (b) (c) (d) (c) (d)

ADDITIONAL MULTIPLE CHOICE QUESTIONS

1. The capital which is required to finance current (c) Receivable

assets is called ________ (d) Cash and cash equivalents
(a) Long Term Capital
(b) Equity Capital 4. Inventory is an example of:
(c) Working Capital (a) Fixed Assets
(d) Owner’s Capital (b) Current Assets
(c) Both (a) and (b)
2. An asset is classified as current when: (d) None of the above
(a) It is expected to be realized or intends to be sold or
consumed in normal operating cycle of the entity. 5. Prepaid expenses is an example of:
(b) The asset is held primarily for the purpose of (a) Fixed Assets
trading. (b) Current Assets
(c) It is expected to be realized within twelve months (c) Both (a) and (b)
after the reporting period. (d) None of the above
(d) All of the above.
6. A liability is classified as current when:
3. Which of the following is not an example of (a) It is expected to be settled in normal operating
current assets? cycle of the entity.
(a) Inventory (b) The liability is held primarily for the purpose of
(b) Land trading.
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CS Executive: Financial Management Working Capital : Planning & Mangement
(c) It is expected to be settled within twelve months (c) Both (a) and (b)
after the reporting period. (d) None of these
(d) All of the above.
16. Factors which need to be considered while
7. Outstanding payments (wages & salary etc.) is planning for working capital requirement includes:
an example of: (a) Nature of business
(a) Current liabilities (b) Degree of seasonality
(b) Long term liabilities (c) Production policies
(c) Non-current liabilities (d) All of the above
(d) None of the above
17. Which of the following is not the factor that
8. Management of working capital is not an needs to be considered while planning for working
essential task of the finance manager. capital requirement?
(a) True (a) Sales policies
(b) False (b) Size of business
(c) Nature of business
9. A current ratio of ……. For a manufacturing (d) Owner’s name
firm implies that the firm has an optimum amount of
working capital. 18. Working capital needs vary on the basis of sales
(a) 1:2 policy of the same industry.
(b) 1:1 (a) True
(c) 2:1 (b) False
(d) 3:1
19. The greater the uncertainty of receipt and
10. A Liquid ratio should be: expenditure, lower the need for working capital.
(a) 1:2 (a) True
(b) 1:1 (b) False
(c) 2:1
(d) 3:1 20. Which of the following is the correct statement?
(a) Investment in working capital does not depend on
11. Type of working capital can be: the nature of industry.
(a) Initial working capital (b) Investment in working capital vary based on the
(b) Regular working capital industry i.e. manufacturing vs. trading vs. service
(c) Fluctuating working capital (c) Credit policy of the company does not affect the
(d) All of the above amount of investment of working capital.
(d) All of the above.
12. Gross working capital refers to the firm’s
investment in …. 21. As per _________ , investment in working
(a) Current assets capital is kept at minimal investment in current
(b) Current liabilities assets.
(c) Fixed Assets (a) Aggressive approach
(d) Long term liabilities (b) Conservative approach
(c) Moderate approach
13. Net working capital refers to: (d) None of the above
(a) Current Assets
(b) Current Liabilities 22. As per aggressive approach, company as
(c) Current Assets – Current Liabilities follows:
(d) Fixed Assets – Current Assets (a) Hold Lower level of inventory
(b) Follow strict credit policy
14. A positive net working capital will arise when: (c) Keeps Less cash balance
(a) Fixed assets exceed Fixed liabilities (d) All of the above
(b) Current assets exceed current liabilities
(c) Current assets exceed long term liabilities 23. In the approach, organization use to invest high
(d) Current liabilities exceed current assets capital in current assets.
(a) Aggressive approach
15. Working capital management is concerned with: (b) Conservative approach
(a) Maintaining adequate working capital (c) Moderate approach
(b) Financing of the working capital (d) None of the above
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CS Executive: Financial Management Working Capital : Planning & Mangement
Outstanding day
24. Disadvantage of conservative approach is: (340 days
(a) Increase the cost of capital assumed)
(b) Higher risk of bad debts Raw Material 1,80,000
(c) Shortage of liquidity in long run inventory
(d) All of the above Work-in-progress 96,000
inventory
25. Higher current assets / fixed assets ratio Finished goods 1,20,000
indicates a _________ inventory
(a) Aggressive current assets approach Debtors 1,50,000
(b) Conservative current asset approach Creditors 1,00,000
(c) Moderate current assets approach Purchase of Raw 2,500
(d) None of the above Material
Cost of Sales 4,000
26. ________ is one of the most reliable methods of Sales 5,000
Computation of Working Capital.
(a) Operating cycle (a) 100 days
(b) Recurring cycle (b) 116 days
(c) Non recurring cycle (c) 120 days
(d) None of the above (d) 140 days
27. Which of the following is the method to estimate 32. The following information is available for Swati
the working capital needs? Ltd.
(a) Current Assets holding period
(b) Ratio to Sales
Average stock of raw materials and stores 2,00,000
(c) Ratio of Fixed Assets
Average work-in-progress inventory 3,00,000
(d) All of the above
Average finished goods inventory 1,80,000
Average accounts receivable 3,00,000
28. Current assets usually are converted into cash
within …. Average accounts payable 1,80,000
(a) One year Average raw materials and stores 10,000
(b) One month purchased on credit and consumed per day
(c) 2 years Average work-in-progress value of raw 12,500
(d) 5 years materials committed per day
Average cost of goods sold per day 18,000
29. The _______ is the length of time between the Average sales per day 20,000
company’s outlay on raw materials, wages and other Calculate the duration of operating cycle.
expenditures and the inflow of cash from the sale of (a) 45 days
the goods. (b) 50 days
(a) Operating cycle (c) 51 days
(b) Recurring cycle (d) 55 days
(c) Non recurring cycle
(d) None of the above 33. Working capital requirement assessment
requires:
30. Operating Cycle  R  W  F  D C (a) Calculation of average value of Raw Material
Where, Inventory, Work in Progress inventory and Finished
R  Raw material storage period Goods inventory.
W  Work-in-progress holding period (b) Calculation of Trade receivables and trade
F  Finished goods storage period payables.
D  Receivables (Debtors) collection period (c) Calculation of Cash and Cash Convertibles required
C = Credit period allowed by suppliers (Creditors) for normal running of business.
(a) True (d) All of the above.
b) False
34. Negative working capital is a sign that the
31. Calculate the Operating cycle from the following company may be:
figures related to company ‘X’: (a) Solvent
Average Average (b) Facing bankruptcy
Particulars
amount value per
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CS Executive: Financial Management Working Capital : Planning & Mangement
(c) Both (a) and (b) (a) Emphasized need for reducing the dependence of
(d) None of the above large and medium scale units on bank finance for
working capital.
35. _________model is used to judge the (b) To supplant the cash credit system by loans and
relationship of two variables for estimating the bills wherever possible.
working capital needs for the given amount of (c) To follow simplified information system but with
working capital needs. penalties when such information is not coming within
(a) Simple Regression the specified limit.
(b) Average Regression (d) All of the above.
(c) Linear Regression
(d) Multiple Regression 43. The position at the end of a day is a static
position which is not representative of the entire year
36. Sources of permanent working capital is under: for assessing the working capital.
(a) Owner’s Fund (a) True
(b) Bond Financing (b) False
(c) Term loan from banks and short term borrowing
(d) All of the above 44. ________, means the management of cash in
currency form, bank balances and readily
37. Which of the following is not the source of marketable securities.
variable/temporary working capital? (a) Cash management
(a) Commercial Paper (b) Working capital management
(b) Owner’s Fund (c) Capital management
(c) Tax liabilities (d) Capital budgeting
(d) All of the above
45. Motive for holding cash includes:
38. The level of a firm’s Net Working Capital (a) Transactional motive
(Current Assets – Current Liabilities) has a bearing (b) Speculative motive
on its ______ (c) Contingency motive
(a) Profitability (d) All of the above
(b) Risk
(c) Both (a) and (b) 46. _________ for holding cash because is the
(d) None of the above medium through which all the transactions of the
firm are carried out.
39. The relationship between Net Working Capital (a) Transactional motive
and risk is such that if net working capital increases, (b) Speculative motive
the firm’s risk _______ (c) Contingency motive
(a) Increases (d) All of the above
(b) Decreases
(c) Remains Constant 47. Which one is not the transactional motive for
(d) None of the above holding cash?
(a) Purchase of Capital Goods like plant and
40. The greater the amount of Net Working Capital, machinery
the less risky the firm is, and vice-versa. (b) Payment of rent and wages
(a) True (c) Investing cash in short term investments to have
(b) False better returns
(d) None of the above
41. Working capital leverage may refer to the way
in which a company’s profitability is affected in part 48. Level of cash holding depends on the following:
by its ________ (a) Nature of business
(a) Working capital management (b) Extend and reach of business
(b) Debt management (c) Both (a) and (b)
(c) Cash management (d) None of the above
(d) Equity management
49. Cash and bank balances are held by the firms in
42. The Chore Committee has, inter alia, three major forms:
recommended: (a) Cash and cheques in hand
(b) Balances with banks
(c) Investment in liquid securities
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CS Executive: Financial Management Working Capital : Planning & Mangement
(d) All of the above (b) Wages cost of personnel assigned to storing and
securing it
50. Essential elements of a successful cash (c) Cost of utilities and insurance
management strategy are: (d) All of the above
(a) Realistic cash forecasting
(b) Speeding up collections 59. Inventory carrying cost is directly proportional
(c) Spreading out payments to the level of inventory.
(d) All of the above (a) True
(b) False
51. By realistic cash forecasting we mean that a cash
forecast for the entire next year should be prepared 60. ________ is the cost associated with placing each
at its _______ individual order for supply of raw materials, stores,
(a) Commencement packing materials etc:
(b) End (a) Carrying cost
(c) Mid of the year (b) Ordering cost
(d) None of the above (c) Stock out cost
(d) None of the above
52. After the cash forecast has been prepared, the
firm should ensure that in day to day operations cash 61. ________ is the cost associated with procuring
(including cheques) should be collected speedily. an inventory item, which has gone out of stock and is
(a) True needed for immediate supply.
(b) False (a) Carrying cost
(b) Ordering cost
53. With speeding up collection, the firm should (c) Stock out cost
spread out payments as far as possible. (d) None of the above
(a) True
(b) False 62. If the items are procured in small lots, then the
ordering cost per unit of inventory would be less and
54. Working capital management does not include: vice versa.
(a) Cash Management (a) True
(b) Debtors Management (b) False
(c) Capital Budgeting
(d) None of the above 63. Cost of inventory can be lowered by:
(a) Entering into long term arrangements for supply of
55. Which of the following is the component of raw materials at market driven prices.
inventory? (b) Arranging for direct supply of raw material at
(a) Raw Material manufacturing locations.
(b) Work in Progress (c) Availing quantity discounts and spot payment
(c) Finished Goods discounts if the carrying cost and financing cost is less
(d) All of the above than the discount.
(d) All of the above.
56. The cost of holding inventory has the following
elements: 64. Inventory level can be managed by adopting the
(a) Carrying cost ________ model.
(b) Ordering cost (a) Economic Order Quantity
(c) Stock out cost (b) Economic Order Quality
(d) All of the above (c) Economic Bulk Quantity
(d) None of the above
57. _________ is the cost of keeping or maintaining
the inventory in a usable condition. 65. The EOQ model is based on the following
(a) Carrying cost assumptions except:
(b) Ordering cost (a) The total usage of that particular item for a given
(c) Stock out cost period is known.
(d) None of the above (b) There is time gap between placing an order and
receiving supply.
58. Carrying cost includes: (c) The cost per order of an item is constant and the
(a) Storage costs cost of carrying inventory is also fixed and is given asa
percentage of the average value of inventory.
Unique Academy 5.21 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
(d) There are only two costs associated with the Figures in brackets indicate percentage of time the
inventory and these are the cost of ordering and the cost firm has been out of stock.
of carrying the inventory. 1. Stock out costs are ` 40 per unit
2. Carrying cost of inventory per unit is ` 20
66. ________ is represented as under:
Determine the optimal level of stock out inventory.
2AO
EOQ  (a) 20 units
C
(b) 30 units
Where, (c) 40 units
A = Total annual requirement for the item (d) 50 units
O = Ordering cost per order of that item
C = Carrying cost per unit per annum. 70. A publishing house purchases 72,000 rims of a
(a) Economic Order Quantity special type of paper per annum at cost ` 90 per rim.
(b) Economic Order Quality Ordering cost per order is ` 500 and the carrying cost
(c) ABC Analysis is 5 per cent per year of the inventory cost. Normal
(d) None of the above lead time is 20 days and safety stock is Nil. Assume
300 working days in a year.
67. _______ is based on the assumption that in view You are required: Calculate the Economic Order
of the scarcity of managerial time and efforts, more Quantity (E.O.Q)
attention should be paid to those items which account (a) 4000 Rims
for a larger chunk of the value of consumption rather (b) 5000 Rims
than the quantity of consumption. (c) 6000 Rims
(a) Economic Order Quantity (d) 8000 Rims
(b) Economic Order Quality
(c) ABC Analysis 71. In the above question, calculate the Reorder
(d) None of the above Inventory Level?
(a) 200 Rims
68. The following details are available respect of a (b) 240 Rims
firm: (c) 300 Rims
(d) 400 Rims
1 Annual requirement of inventory 40,000 units
2 Cost per unit (other than carrying ` 16 72. Based on the above question, if a 1 per cent
and ordering cost) quantity discount is offered by the supplier for
3 Carrying cost are likely to be 15% per purchases in lots of 18,000 rims or more, should the
year publishing house accept the proposal?
4 Cost of placing order ` 480 per (a) Accepted
order. (b) Rejected

Determine the economic ordering quantity. 73. _______ are near the terminating point of the
(a) 2000 units operating cycle.
(b) 3000 units (a) Receivables
(c) 4000 units (b) Stock
(d) 5000 units (c) Cash
(d) Creditors
69. The experience of the firm being out of stock is
summarized below: 74. Receivables are generally referred to by the
name of “_________” in the books of account.
Stock out (No. of No. of (% (a) Sundry Debtors
units) times Probability) (b) Sundry Creditors
500 1 (1) (c) Asset Management
400 2 (2) (d) Liability Management
250 3 (3)
100 4 (4) 75. Timely realization of receivables is not an
important element of working capital management.
50 10 (10)
(a) True
0 80 (80)
(b) False

76. Factors determining credit policy includes:

Unique Academy 5.22 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
(a) The effect of credit on the volume of sales (a) Factor
(b) Credit terms (b) Drawer
(c) Cash discount (c) Bank
(d) All of the above (d) Owner

77. _________ is a type of financial services which 84. Type of factoring can be:
involves an outright sale of the receivables of a firm (a) Recourse Factoring
to a financial institution called the factor which (b) Non-Recourse Factoring
specializes in the management of trade credit. (c) Agency Factoring
(a) Leasing (d) All of the above
(b) Tendor
85. ________ are used to find changes in assets over
(c) Factoring
a period of time showing uses of funds and sources of
(d) None of the above
funds.
(a) Balance Sheet
78. Under a typical factoring arrangement, a
(b) Profit and Loss Statement
________ collect the accounts on the due dates,
(c) Fund flow statements
effects payments to the firm on these dates and also
(d) Fixed Assets
assumes the credit risks associated with the collection
of the account. 86. Forfeiting Services denotes the purchase of trade
(a) Factor bills/promissory notes by a bank/financial institution
(b) Licensor _______ to the seller.
(c) Licensee (a) With recourse
(d) None of the above (b) Without recourse
(c) Either (a) or (b)
79. Factor may be defined as a relationship between (d) None of the above
the financial institution or banker (‘factor’) and a
business concern (the ‘supplier’) selling goods or 87. The salient feature of forfeiting as a form of
providing services to trade customers (the customer) export relating financing is:
whereby the factor purchases book debts with or (a) The exporter sells and delivers goods to the
without recourse. importer on deferred payment basis.
(a) True (b) The importer draws a series of promissory notes in
(b) False favour of the exporter for payment including interest
charge. Alternatively the exporter draws a series of bill
80. Factoring includes: which are accepted by the importer.
(a) Assumption of credit and collection function (c) The bills/notes are sent to the exporter. The
(b) Credit protection promissory notes/ are sent to the exporter. The
(c) Encashing of receivables promissory notes/bills are guaranteed by a bank may not
(d) All of the above necessarily be the importer’s bank.
(d) All of the above.
81. ______ loan is simply a loan secured by a firm’s
accounts receivable by way of hypothecation or 88. A forfeiter discounts the entire value of the
assignment of such receivables with the power to note/bill but the factor finances between 75-85% and
collect the debts under a power of attorney. retains a factor reserve which is paid after maturity.
(a) Accounts receivable (a) True
(b) Factoring (b) False
(c) Bill discounting
(d) Leasing 89. Current Assets/Current Liabilities is used to
calculate:
82. Under a _________ arrangement, the drawer (a) Current Ratio
undertakes the responsibility of collecting the bills (b) Acid Test Ratio
and remitting the proceeds to the financing agency. (c) Inventory Turnover Ratio
(a) Accounts receivable (d) Receivable Turnover
(b) Factoring
(c) Bill discounting 90. Cost of Goods sold / Average Inventory is used
(d) Leasing to calculate:
(a) Current Ratio
83. Under factoring agreement, the ________ (b) Acid Test Ratio
collects client’s bills. (c) Inventory Turnover Ratio
Unique Academy 5.23 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
(d) Receivable Turnover 97. Find the average cash conversion period with
the help of the following data:
91. Sales / Average Inventory is used to calculate:
(a) Current Ratio Gross operating cycle 88 days
(b) Acid Test Ratio Net operating cycle 65 days
(c) Inventory Turnover Ratio Raw material storage period 45 days
(d) Receivable Turnover Work-in-progress conversion period 4 days
Finished goods storage period 25 days
92. Total long term debts / Shareholders Funds is
used to calculate: (a) 10 days
(a) Current Ratio (b) 12 days
(b) Acid Test Ratio (c) 14 days
(c) Debt-Equity Ratio (d) 16 days
(d) Receivable Turnover
98. Calculate the finished goods conversion period
93. Calculate inventory conversion period from the if:
financial variables given hereunder:
(` in lakhs) (` lakh)
Year Year Year Finished goods opening stock 525
2011-12 2011-12 2012-13 Finished goods closing stock 850
Sales 7,936 Cost of production 8,000
Cost of Goods 7,036 Administrative expenses 2,250
sold Excise duty 3,000
Inventory 940 936
Bills Receivables 942 962 (a) 18.42 days
Bills Payable 608 606 (b) 19.42 days
(c) 20.42 days
(a) 61 days (d) 21.42 days
(b) 31.5 days
(c) 48.7 days 99. Firm uses 1,100 units of a raw material per
(d) 43.8 days annum, the price of which is ` 1,500 per unit. The
order is ` 150 and the carrying cost of the inventory
94. Based on the above question, calculate the Bill is ` 200 per unit. Find the EOQ.
Receivable conversion period from the financial the (a) 40 days
financial variable given above: (b) 41 days
(a) 61 days (c) 42 days
(b) 31.5 days (d) 45 days
(c) 48.7 days
(d) 43.8 days 100. Based on the above question, calculate the
number of orders that are to be made during the
95. Based on the above question, calculate the year.
payables conversion period from the financial (a) 27
variables given above: (b) 28
(a) 61 days (c) 30
(b) 31.5 days (d) 32
(c) 48.7 days
(d) 43.8 days 101. A factory uses 40,000 tonnes of raw material
priced at ` 50 per tonne. The holding cost is ` 10 per
96. Based on the above question, calculate the cash tonne of inventory. The order cost is ` 200 per order.
conversion period from the financial variables given Find the EOQ.
above: (a) 1200
(a) 61 days (b) 1230
(b) 31.5 days (c) 1250
(c) 48.7 days (d) 1265
(d) 43.8 days
102. Based on the above question, what is the total
cost that the company has to bear with EOQ level.
(a) 12,000
Unique Academy 5.24 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
(b) 12,500 (c) 875 units
(c) 12,565 (d) 1300 units
(d) 12,650
106. Based on the above data, calculate minimum
103. Based on the above question, what is the total level?
cost in case the supplier introduces 5% discount if (a) 450 units
the order lot is 2000 tonnes or more. (b) 1050 units
(a) 12,000 (c) 875 units
(b) 12,500 (d) 1300 units
(c) 12565
(d) 12,650 107. Based on the above data, calculate average
level?
104. Below is the data: (a) 450 units
(b) 1050 units
Normal usage 100 units per week (c) 875 units
Maximum usage 150 units per week (d) 1300 units
Minimum usage 50 units per week
units 108. EOQ determine the order size that will minimize
Re-order quantity (EOQ) 500 5 to 7 weeks the total _________
Lag in time (a) Working capital cost
(b) Inventory cost
Calculate Re-order Level? (c) Fixed Asset cost
(a) 420 units (d) Idle cost
(b) 1050 units
(c) 875 units 109. Technical tools used in inventory management
(d) 1300 units is:
(a) ABC analysis
105. Based on the above data, calculate maximum (b) Economic Order Quantity (EOQ)
level? (c) Inventory turnover analysis
(a) 450 units (d) All of the above
(b) 1050 units

ANSWERS
1 2 3 4 5 6 7 8 9 10
(c) (d) (b) (b) (b) (d) (a) (b) (c) (b)
11 12 13 14 15 16 17 18 19 20
(d) (a) (c) (b) (c) (d) (d) (a) (b) (b)
21 22 23 24 25 26 27 28 29 30
(a) (d) (b) (d) (b) (a) (d) (a) (a) (a)
31 32 33 34 35 36 37 38 39 40
(b) (c) (d) (b) (c) (b) (b) (c) (b) (a)
41 42 43 44 45 46 47 48 49 50
(a) (d) (a) (a) (d) (a) (c) (c) (d) (d)
51 52 53 54 55 56 57 58 59 60
(a) (a) (a) (c) (d) (d) (a) (d) (a) (b)
61 62 63 64 65 66 67 68 69 70
(c) (b) (d) (a) (b) (a) (c) (c) (d) (a)
71 72 73 74 75 76 77 78 79 80
(b) (a) (a) (a) (b) (d) (c) (a) (a) (d)
81 82 83 84 85 86 87 88 89 90
(a) (c) (a) (d) (c) (b) (d) (a) (a) (c)
91 92 93 94 95 96 97 98 99 100
(d) (c) (c) (d) (b) (a) (c) (b) (b) (a)
101 102 103 104 105 106 107 108 109
Unique Academy 5.25 Prof. Ashish Parikh
CS Executive: Financial Management Working Capital : Planning & Mangement
(d) (d) (a) (b) (d) (a) (c) (b) (d)

Unique Academy 5.26 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement

Theoretical Concept
IN THIS CHAPTER WE ESTIMATE WORKING CAPITAL REQUIREMENT FOR THE COMING YEAR

Gross Working Capital Total of all current assets

Types of Working
Capital
Current assets less operating
Net Working Capital current liabilities

Operating Cycle Method

Method of estimation of Working
Capital

WC Component Method

 OPERATING CYCLE METHOD

In this method we make a rough estimate of working capital on the basis of number of operating cycles in a year.

Cost of Production
Working Capital 
1 number of cycles

360 or 12
Number of cycles 
2 Period of operating cycle

Period of operating cycle  Raw material storage period  WIP period  Finished goods storage period
3  Debtors collection period  Creditors payment period
Averagestock of raw material
Raw materialstorageperiod   360
4 Raw materialconsumed

Average WIP
Work in progress period   360
5 Cost of production

Averagestock of finished goods

Finished goodsstorageperiod 
6 Cost of goodssold

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CS Executive: Financial Management Working Capital : Planning & Mangement
Averagedebtors
Debtorscollection period   360
7 Credit sales

Averagecreditors
8 Creditors payment period   360
Credit purchase

Here,

Particulars Amount
Raw material consumed
Direct wages & expenses
Factory overheads
Add: Opening WIP
Less: Closing WIP
Cost of production
Add: Opening stock of finished goods
Less: Closing stock of finished goods
Cost of goods sold
Administrative overheads
Selling & distribution overheads
Cost of sales

WORKING CAPITAL COMPONENTS METHOD

This is a better method of estimation of WC. In this method we estimate each component of current asset & current
liability separately as follows:

Raw material stock  Raw material consumed  RMstorageperiod

360

Work in progress  Cash cost of production  WIP period

360

Finished goods stock  Cash cost of goods sold  finished goods storage period
360
Debtor  Cash cost of credit sales  debtors collection period
360
Creditors  Credit purchase  Creditors payment period
360
Outstanding expenses  Expenses Incurred  Outstanding period
360

Particulars Amount
Raw material consumed
Direct wages & expenses
Cash Factory overheads
Add: Opening WIP
Less: Closing WIP
Cash Cost of production
Add: Opening stock of finished goods
Less: Closing stock of finished goods
Cash Cost of goods sold
Administrative overheads
Selling & distribution overheads

Unique Academy 5.28 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement
Cash Cost of sales
X proportion of credit sales to total sales
Cash cost of credit sales
Notes:
1. While calculating working capital we ignore depreciation and profit. Because these are not required to be paid in
cash and purpose of estimation of WC. In this chapter it to make advance arrangement of fund for financing WC.
2. We also don’t consider provision for tax and proposed dividend as current liability because these are paid from
profit and we have ignore entire profit.
3. If the question is silent we will assume that production is carried on evenly throughout the year. Means if annual
production is 3,60,000 units then daily production is 1000 units  3,60,000  .
 
 360 
4. If the question is silent we will assume that opening balance of all current assets and current liabilities are equal to
their respective closing balance. Means:

“unit bought  units consumed  units produced  units sold”

5. For calculation of WIP:

(a) If any input (RM, wages, factory overheads) is introduced at the beginning of the process then WIP is 100%
 100  complete with respect to that input.
100  
 2 
(b) If any input accrue evenly throughout the process then WIP is 50%  0  100  complete with respect to that input.
 
 2 
(c) If 50% of any input is introduced at the beginning of the process and remaining accrue evenly throughout the
process then WIP is 75%  50  100  complete with respect to that input.
 
 2 
(d) If % completion stage for any input is given then we will use it. For example, if the question says that WIP is 25%
complete with respect to manufacturing expenses then we will use 25% (and no 100%, 50%, 75% as discussed in point
a, b & c above.)
(e) If question is silent then we will assume that WIP is 100% complete with respect to raw material and 50%
complete with respect to wages & overheads.

IMPORTANT POINTS IN QUESTIONS

1. If question is silent then we will assume 360 days in a year and 30 days in a month.
2. If question is silent we will assume 52 weeks in a year. But if it says 1 month = 4 weeks then we will take 48
weeks in a year.
3. If question is silent we will assume that overheads are “factory overheads”.
4. If question says that cash is 5% of gross working capital then:

RM  WIP  FG  Debtors
Cash   0.05
0.95

5. If question says that assume 50% completion stage for WIP then we may assume that WIP is 50% complete with
respect to RM, wages & Factory overheads.
6. If cash sales is 25% of credit sales then Credit sales  X, Cash sales  0.25X, Total sales  1.25X. Credit sales
 X .
 80%
1.25X
7. If sales tax is given in the question then we will include it ONLY for the purpose of calculation of debtors. Also if
sales tax is paid in arrear then outstanding sales tax will be included in current liabilities.
8. Packing material should not be included in WIP.
9. If excise duty is given in the question then it should be included only in calculation of debtors.

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CS Executive: Financial Management Working Capital : Planning & Mangement
10. If questions says that company is required to carry cash equivalent to one month’s payment of wages and
overheads then use this information to calculate cash balance. Not for outstanding wages and overheads.
11. If question says that assuming 15% margin calculate WC, it means that after calculating “current assets less
current liabilities”, add 15%.
12. If question says “Provision for contingencies is required @ 10% of working capital requirement including that
provision”. It means:
Current Assets  Current Liabilities
Provision   0.10
0.90

13. If sales of January, February & March are 4000, 6000 & 8000 then debtors at march end may be calculated as
follows:

Credit period March end debtors

1 month 8000
1.5 months 8000 + 6000  11000
2
2 months 8000 + 6000 = 14000
2.5 months 8000 + 6000 + 4000  16000
2
3 months 8000 + 6000 + 4000 = 18,000

EFFECT OF DOUBLE SHIFT ON WORKING CAPITAL

To double the quantum of production and sales a company may start working an extra shift. In this case working
capital requirement will not be doubled due to following reasons:
1. Trade discount for bulk purchase of raw material.
2. Higher wage rate for workers of second shift.
3. Total amount of fixed overheads will remain same.
4. Pipe line theory or working capital: units in process will remain same.

1000 liters holding capacity

Example:
You were supplying water from a pipe line for 8 hours a day and 1000 liters water is blocked in the pipeline. Now even
if you make a supply for 16 hours a day still 1000 liters water will remain blocked in the pipeline.

Note:
Just keep in mind when you make ‘unit cost sheet’ for double shift and number of units doubles then fixed cost per
unit will be half but variable cost per unit will remain same.

FIRST YEAR OF BUSINESS

If we have to estimate WC for first year of business then:
(1) All the opening balances will be zero.
(2) You don’t use formulas to calculate closing stock of finished goods & WIP, rather than you make cost sheet for
the same.
(3) For calculation of creditors, Purchase  Consumption + Closing stock.

CHANGE IN LEVEL OF ACTIVITY

If level of production & sales changes in any year then:
(1) Opening & closing balances will be different.
(2) You don’t use formulas to calculate closing stock of finished goods & WIP, rather than you make cost sheet for
the same.

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CS Executive: Financial Management Working Capital : Planning & Mangement
(3) Purchase  Consumption + Closing stock – Opening stock

IMPORTANT POINTS IN QUESTIONS

(1) If WIP is to be valued at prime cost then take 100% raw material, 100% wages & 0% factory overheads in WIP.
(2) If semi variable expenses are given, divided into fixed and variable expenses.
(3) If in a question monthly cost sheet is given then ignore ‘ 12 ’ element in formulas.
(4) If we start working two shifts of 6 hours a day in place of one shift of 8 hours a day then production will become
1.5 times  12hours  .
 
 8hours 
(5) In the above case if workers are to be paid same wages per shift as they formerly earned per day then even if
production is 1.5 times, total wages will be double.

MAXIMUM PERMISSIBLE BANK FINANCE (MPBF)

Tandon committee formulas
1. MPBF  (Current assets – Current liabilities)  75%

2. MPBF  (Current assets  75% - Current liabilities)

3. MPBF  (Current assets – Core current assets)  75% - Current liabilities

FINANCING THE WORKING CAPITAL

Also named as hard core WC. Its is

Permanent Working Capital the basic minimum level of WC.
Types of Working
Capital
Temporary Working Capital Also named as variable WC. It is
due to seasonal fictuations.

Conservative Approach

Financial Working Capital Matching (Hedging) Approach

Aggressive Approach

Approach Permanent WC Temporary WC Comments

Conservative LTS LTS + STS More liquidity, less profitability
Matching LTS STS Trade off (balance) between liquidity & Profitability
Aggressive LTS + STS STS Less liquidity, more profitability
LTS = Long term sources STS = Short term sources

Unique Academy 5.31 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement

Just keep in mind that Conservative approach may be more or less conservative, while
aggressive approach may be more or less aggressive.

IMPORTANT POINTS IN QUESTIONS:

1. If the amount of permanent working capital is not given then we may assume that minimum amount of WC given
in the question is the permanent WC.
2. If the question does not specify level of conservatism then we may assume it to be Fully Conservative. Similarly
if the question does not specify level of Aggression then we will assume it to be fully aggressive.

Cash Budget
Reducing the float
Cash Management
Aspects of Cash Techniques
Management Playing the float

William J Baumal’s EOQ

Cash Management Models

Miller-Orr Model

SPECIAL POINTS IN QUESTIONS OF CASH BUDGET:

1. If a new business is to be started then opening balance of cash will be zero.
2. If cash balance is negative in any month then borrow amount to make balance zero.
3. If the question says that GP ratio is 25% and Sales and wages are given then to Consumption / Purchase = Sales
 75% - Wages.
4. If the question says that “20% sales are on cash, 50% of the credit sales are collected next month and the
balance in the following month” Then
Receipts of June  20% of June sales  40% of May sales  40% of April Sales.

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CS Executive: Financial Management Working Capital : Planning & Mangement
5. If the question says that delay in payment of wages is half a month then Payment of June  50% of June wages
+ 50% of May Wages.
6. If the question says that company wants to keep cash balance at ` 45,000. Any excess will be invested in multiple
of ` 1000. Now if cash balance of any month is ` 50900 then ` 5000 will be invested and cash balance will be ` 45900.

CASH FLOW STYLE QUESTION:

If the question gives balance sheet figures for each month then we can open various accounts for calculation purpose.
(a) For example debtors account will give receipt from debtors.
(b) Creditors account will be payment to creditors.
(c) Cost of goods sold + closing stock – opening stock = Purchase.
(d) Change in balance sheet figures:
(i) Decrease in asset is cash inflow
(ii) Increase in asset is cash outflow
(iii) Decrease in liability is cash outflow
(iv) Increase in liability is cash inflow
7. If the question says that “Variable overheads are paid in the month following production and are expected to
increase by 25% in February”. It means that payment in February will be on the normal rate, while payment in March
will be at the increased rate.

CASH MANAGEMENT TECHNIQUES

Lock box system

Concentration Banking
Reducing the float
Virtual Banking
Management Float
(time gap between two
activities)
Take advantage of float
Playing the float
while making payment

CASH MANAGEMENT MODELS

William J. Baumal’s Economic Order Quantity Model:

2AO A = Annual requirement of cash

EOQ  O = Ordering cost per order
i
i = Interest rate (carrying cost per rupee per annum)
Note:
Periodicity of A and I should be same. For example, If A is half yearly then i should also be half yearly.

Millier Orr Model:

3TV T = Transaction cost per

Z V = transaction
4i
i = Variance of daily cash flows
Interest rate per day
Return point = Lower Level + Z
Higher Level = Lower Level + Z

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CS Executive: Financial Management Working Capital : Planning & Mangement
Average Balance = Lower Level +  4  Z
 
3

SPECIAL POINTS IN QUESTIONS:

1. If in an EOQ question lot sizes are given then calculate holding cost, ordering cost and total cost. Chose the lot
which has minimum total cost.
2. If in a Miller-Orr question standard deviation of cash flows is given then calculate its square to get the value of V.

Credit Period
Credit Policy
Cash Discount Policy

Aspects of Debtors Credit Analysis

Management

Credit Collection

Change in Contribution

Change in Cost of funds blocked in debtors (interest)

Change in Bad Debts

Factors determining Credit Change in Collection Expenses

Period

Industry Trend

Competitor’s policys

Elasticity of demands

Important points to remember:

1. Increase in contribution is a plus point and decrease in contribution is a minus point.
2. Increase in Interest, Bad Debts & collection expenses is minus point and vice versa.
3. Calculate debtors on cost of sales (variable cost + Fixed cost).

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CS Executive: Financial Management Working Capital : Planning & Mangement
4. If fixed cost is not given in the question assume it to be zero.
5. If fixed cost per unit is given then multiply it by number of units at which it is given.
6. If no information of cost is given then calculate debtors on sales.
7. Bad debts should be calculated on sales. (If you calculate bad debts on cost of sales then take contribution on
realized credit sales and not on total credit sales. Final answer will remain same. Therefore it is better to calculate bad
debts on sales.)
8. Whether the question gives interest rate or required rate of return, both are cost for the company. Interest is cost of
borrowing while required rate of return is the cost of equity. The only difference between the two is that interest is
deducted before tax while required return is deducted after tax.
9. Each proposal in the question may be solved either individually or on incremental basis.

Special Points in Questions

1. If question says that credit period is 30 days but customer makes payment in 45 days for the purpose of
calculation.
2. If question says that fixed cost will increase then treat it as a minus point. Also include increased fixed cost in
calculation of cost of sales for calculation of debtors.
3. If question says that stock and creditors will also increase. Then calculate interest on “Increase in debtors +
Increase in stock – Increase in creditors”.

Note:
1. If there are more than one credit periods then to calculate debtors we can calculate average collection period. For
example, 40% of debtors pay in 30 days while remaining 60% pay in 60 days. Then average collection period is
30  0.40  60  0.60  48 days.

2. If sales does not change with change in credit period then we can calculate incremental debtors from change in
credit period. For example cost of sales is ` 12,00,000 and credit period changes from 30 days to 45 days then change
in debtors 12,00,000  15  50,000 .
360
Cost of Cash Discount

Bad Debts Saving

Factors determining
Cash discount Policy Saving in Collection Expenses

Saving in Interest Cost

Increase in Contribution
Special Points in Questions
1. If fixed cost is given as a % of existing sales and question also gives proposed sales then apply the % on existing
sales only to calculate fixed cost. Now use same fixed cost for calculation of proposed debtors also.

2. If average credit period calculated dosen’t matches with the average credit period given in the question then use
the credit period given in the question.

Unique Academy 5.35 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement

Trade Reference

Bank Reference
Credit Analysis of Customers
Analysis of Financial Statements

Credit Rating

Special Points in Questions

If income tax rate is also given in the question then use it after deducting interest. But if required rate of return is given
then first apply tax rate then deduct interest rate.
Decision Tree Technique
Sample Decision Tree:

Note:
1. Decision box is made when you have more than one options and you have to choose one. Decision box.

2. Event note is made when there may be more than one outcomes which are not under your control.

3. Decision tree always starts with a single box and ends at arrows.

4. Decision tree is drawn left to right but it is solve right to left and this technique is called roll back technique.

Ageing Schedule
When debtors are classified according to age of outstanding then it is called ageing schedule. In this schedule after
determining amount for each group % for each group is also calculated on the basis of total debtors.

There may be time series or cross sectional analysis of ageing schedule. In a time series analysis current ageing
schedule is compared with past ageing schedule. In a cross sectional analysis ageing schedule of entity is compared
with ageing schedule of industry of with ageing schedule of competitor.

This comparison gives better insight of collection pattern from customers. If the actual collection pattern differ from
collection policy then corrective action may be taken timely.

Age Group As on 30th June 2016 As on 31st March 2016

(Days ) Month of Amount of % Month of sales Amount of receivables %
sales receivables
0 – 30 June 60,000 40 March 30,000 25
31 – 60 May 40,000 27 February 30,000 25
61 – 90 April 30,000 20 January 30,000 25
Above 90 Earlier 20,000 13 Earlier 30,000 25
TOTAL 1,50,000 100 1,20,000 100

In the above table we can observe that in the June quarter collection are faster as compared to March quarter.

Unique Academy 5.36 Prof. Ashish Parikh

CS Executive: Financial Management Working Capital : Planning & Mangement

1. Supplier provides goods and copy of invoice to the Customer.

2. Second copy of Invoice is given to factor.
3. Factor provides advance (say 80%) to the supplier.
4. Factor follows up customer for recovery of payment.
5. Customer makes payment to factor.
6. Factor makes payment of balance amount after deducting commission and interest.

FUNCTIONS OF A FACTOR:
1. Collection of debtors of supplier.
2. Assumption of credit risk/credit control.
3. Financing the receivables.
4. Administration of sales ledger.
5. Provide advisory services.

Therefore, we can say that the factoring is not a single financial service rather than it is a portfolio of financial and
administrative services.
If risk of bad debts is borne by factor it is Non-recourse factoring and if it is
borne by supplier it is Recourse Factoring

If factor make advance payment (say 80%) against each invoice it is Advance
Factoring. If payment is made only on maturity it is Maturity Factoring.

If customer know about factoring it is Disclosed Factoring. If he doesn’t know

it is Undisclosed Factoring.
Types of Factoring

Guaranteed Payment date: Factor makes payment within guaranteed time.

Even if he recovers payment late.

Bank Participation: If factor does not make advance payment and loan is taken
from bank for funding debtors.

Export Factoring: In case of export sales.

Forfaiting: Purchase of long term bills by fortfaiter.

EVALUATION FRAMEWORK
Cost associated with in house management:
1. Cash discount,

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CS Executive: Financial Management Working Capital : Planning & Mangement
2. Cost of fund invested in receivables, Interest to bank, Interest on own finance.
3. Bad debts.
4. Cost of sales ledger administration and credit monitoring.
5. Lost contribution on foregone sales and

Cost associated with recourse and non-recourse factoring:

1. Factoring commission * (calculated on credit sales)
2. Cost of long term funds invested in receivables Interest factor * (calculated on amount advanced by factor).
Interest on own finance.
3. Cost of Bad Debts (in case of recourse factoring).

Unique Academy 5.38 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm

6 DIVIDEND DECISION & VALUATION OF THE FIRM

MULTIPLE CHOICE QUESTIONS

1. Walter’s Model suggests for 100% DP Ratio (d) Hedging
when:
(a) ke  r 7. Which of the following is not true for MM
Model?
(b) ke  r (a) Share price goes up if dividend is paid.

ke  r
(b) Share price goes down if dividend is not paid.
(c) (c) Market value is unaffected by Dividend policy.
(d) ke  0 (d) All of the above.

8. Which of the following stresses on investor’s

2. In a firms has ke  r , the Walter’s Model preference for current dividend than higher future
suggests for: capital gains?
(a) 0% Payout (a) Walter’s Model
(b) 100% Payout (b) Residuals Theory
(c) 50% Payout (c) Gordon’s Model
(d) 25% Payout (d) MM Model

3. Walter’s Model suggests that a firm can always 9. MM Model of Dividend irrelevance uses
increase the value of the share by: arbitrage between:
(a) Increasing Dividend (a) Dividend and Bonus
(b) Decreasing Dividend (b) Dividend and Capital Issue
(c) Constant Dividend (c) Profit and Investment
(d) None of the above (d) None of the above

4. ‘Bird in hand’ argument is given by: 10. If ke  r , then under Walter’s Model, which of
(a) Walter’s Model the following is irrelevant?
(b) Gordon’s Model (a) Earnings per share
(c) MM Model (b) Dividend per share
(d) Residuals Theory (c) DP Ratio
(d) None of the above
5. Residuals Theory argues that dividend is a:
11. MM Model argues that dividend is irrelevant as:
(a) Relevant Decision
(a) The value of the firm depends upon earning power.
(b) Active Decision
(b) The investors buy shares for capital gain.
(c) Passive Decision
(c) Dividend is payable after deciding the retained
(d) Irrelevant Decision
earnings.
(d) Dividend is a small amount.
6. Dividend irrelevance argument of MM Model is
based on: 12. Which of the following represents passive
(a) Issue of Debentures dividend policy?
(b) Issue of Bonus Share (a) That dividend is paid as a % of EPS.
(c) Arbitrage (b) That dividend is paid as a constant amount.

Unique Academy 6.1 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
(c) That dividend is paid after retaining profits for (a) No-growth Model of equity valuation.
reinvestment. (b) Constant growth Model of equity valuation.
(d) All of the above (c) Price-Earnings Ratio.
(d) Inverse of Price Earnings Ratio.
13. In case of Gordon’s Model, the MP for zero
payout is zero. It means that: 15. If 'r'  'ke' , than MP by Walter’s Model and
(a) Shares are not traded. Gordon’s Model for different payout ratios would
(b) Shares available free of cost. be:
(c) Investors are not ready to offer any price. (a) Unequal
(d) None of the above. (b) Zero
(c) Equal
14. Gordon’s Model of dividend relevance is same
as: (d) Negative

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(c) (a) (d) (b) (c) (c) (c) (c) (b) (c)
11 12 13 14 15
(a) (c) (c) (b) (c)

16. Dividend Payout Ratio is: 20. Which of the following generally not result in
(a) PAT  Capital increase in total dividend liability?
(b) DPS  EPS (a) Share-split
Pref. Dividend  PAT
(b) Right Issue
(c)
Pref. Dividend  Equity Dividend
(c) Bonus Issue
(d)
(d) All of the above

17. Dividend declared by a company must be paid

21. Dividends are paid out of:
in:
(a) Accumulated Profits
(a) 20 days
(b) Gross Profit
(b) 30 days
(c) Profit after Tax
(c) 32 days
(d) General Reserve
(d) 42 days
22. In India, if dividend on equity shares is not paid
18. Dividend Distribution Tax is payable by:
within 30 days, it is transferred to Investors
(a) Shareholders to Government
Education Fund in:
(b) Shareholders to Company
(a) 2 days
(c) Company to Government
(b) 3 days
(d) Holding to Subsidiary Company
(c) 4 days
(d) 7 days
19. Shares of face value of ` 10 are 80% paid up.
The company declares a dividend of 50%. Amount of 23. Every company should follow:
dividend per share is: (a) High Dividend Payment
(a) ` 5 (b) Low Dividend Payment
(c) Stable Dividend Payment
(b) ` 4 (d) Fixed Dividend Payment
(c) ` 80
(d) ` 50 24. ‘Constant Dividend Per Share’ Policy is
considered as:
(a) Increasing Dividend Policy
Unique Academy 6.2 Prof. Ashish Parikh
CS Executive: Financial Management Dividend Decision & Valuation of the Firm
(b) Decreasing Dividend Policy 28. Stock split is a form of:
(c) Stable Dividend Policy (a) Dividend Payment
(d) None of the above (b) Bonus issue
(c) Financial restructuring
25. Which of the following is not a type of dividend (d) Dividend in kind
payment?
(a) Bonus Issue 29. In stock dividend
(b) Right Issue (a) Authorized capital always increase
(c) Share Split (b) Paid up capital always increases
(d) Both (a) & (b) (c) Face value per share decreases
(d) Market price for share decreases
26. Which of the following is an element of dividend
policy? 30. Which of the following is not considered in
(a) Production capacity Lintner’s Model?
(b) Change in Management (a) Dividend payout ratio
(c) Informational content (b) Current EPS
(d) Debt service capacity (c) Speed of Adjustment
(d) Preceding year
27. Stability of dividend policy means that
(a) Same amount of dividend be paid every year. 31. Which of the following is not relevant for
(b) Dividends be paid regularly two-three time in a dividend payment for a year?
year. (a) Cash flow position
(c) Extra dividend be paid every year. (b) Profit position
(d) There need not be much variation in dividend (c) Paid up capital
payment over years. (d) Retained Earnings

ANSWER KEYS
16 17 18 19 20 21 22 23 24 25
(b) (b) (c) (b) (a) (c) (d) (c) (c) (c)
26 27 28 29 30 31
(c) (d) (c) (d) (d) (d)

ADDITIONAL MULTIPLE CHOICE QUESTIONS

1. Dividend policy determines what portion of 3. Retained earnings is not the source of funds for
earnings will be paid out to stock holders and what financing the corporate growth.
portion will be retained in the business to finance (a) True
long-term growth. (b) False
(a) Dividend Policy
(b) Investment Policy 4. Higher dividend means less retained earnings
(c) Procurement Policy and vice versa.
(d) Capital Budgeting Policy (a) True
(b) False
2. Dividend constitutes the cash flow that accrues
to _________ 5. Type of dividend policy can be:
(a) Equity holders (a) Regular dividend policy
(b) Preference Shareholders (b) Irregular dividend policy
(c) Debentures (c) Stable dividend policy
(d) None of the above (d) All of the above

Unique Academy 6.3 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
6. In _______ the investors get dividend at usual
rate 15. If the dividend is paid in the form of cash to the
(a) Regular dividend policy shareholders, it is called _______
(b) Irregular dividend policy (a) Cash dividend
(c) Stable dividend policy (b) Bond dividend
(d) No dividend policy (c) Stock dividend
(d) Property dividend
7. In _________ payment of certain sum of money
is regularly made to the shareholders. 16. Which of the following approach is not the part
(a) Regular dividend policy of relevant theory of dividend.
(b) Irregular dividend policy (a) Walter’s Model
(c) Stable dividend policy (b) Gordon’s Model
(d) No dividend policy (c) M.M. Approach
(d) All of the above
8. Merit of regular dividend policy are:
(a) It helps in creating confidence among the 17. Which approach is based on this formula:
shareholders. r
(b) It stabilizes the market value of shares. D  E  D
(c) It helps in giving regular income to the P k
shareholders. k
(d) Al of the above Where:
P : Market price per share of common stock
9. Stable dividend policy can be: D : Dividend per share
(a) Constant dividend per share E : Earnings per share
(b) Constant payout ratio r : Return on investment
(c) Stable rupee dividend + extra dividend k : Market capitalization rate
(d) All of the above
(a) Walter’s Model
10. As per _______ the company does not pay (b) Gordon’s Model
regular dividend to the shareholders. (c) M.M. Approach
(a) Irregular dividend policy (d) All of the above
(b) No dividend policy
(c) Both (a) and (b) 18. According to Walter’s Model, the optimum
(d) None of the above dividend policy depends on the relationship between
the firm’s internal rate of return and ______
11. Dividend policy is determined by: (a) Cost of capital
(a) Manager (b) Cost of debt
(b) Trade Union (c) Cost of equity
(c) Shareholders (d) Cost of retained earnings
(d) Board of Directors
19. According to Walter’s Model, if return on
12. Determinants/constraints of dividend policy investment (r) > market capitalization rate (k) then
include: firm should _________
(a) Legal and Financial constraints (a) Retain the entire earnings
(b) Economic Constraints (b) Distribute the earnings
(c) Financial needs of the company (c) Both (a) and (b)
(d) All of the above (d) None of the above

13. Needs of the Company for additional capital 20. If return on investment (r) > market
affects the dividend policy. capitalization rate (k) then firm is referred to as:
(a) True (a) Growth firms
(b) False (b) Normal firms
(c) Declining firms
14. Dividend can be in the form of: (d) None of the above
(a) Cash dividend
(b) Bond dividend/Stock dividend 21. If return on investment (r) < market
(c) Property dividend capitalization rate (k) then firm is referred to as:
(d) All of the above (a) Growth firms
Unique Academy 6.4 Prof. Ashish Parikh
CS Executive: Financial Management Dividend Decision & Valuation of the Firm
(b) Normal firms
(c) Declining firms 28. According to Gordon, when r > ke the price per
(d) None of the above share increases as the dividend payout ratio
(a) Decreases
22. If return on investment (r)  market (b) Increases
capitalization rate (k) then firm is referred to as: (c) Constant
(a) Growth firms (d) None of the above
(b) Normal firms
(c) Declining firms 29. Determine the market price of a share of LMN
(d) None of the above Ltd. as per Gordon’s Model, given
Ke = 11%
23. According to Walter, the optimum payout ratio E = ` 20
is:
R = 12%
(a) 0% (when r > k)
B = 90%
(b) 100% (when r < k)
(c) Both (a) and (b) (a) ` 500
(d) None of the above (b) ` 1,000
24. Walter’s model is based on the following (c) ` 210.52
assumptions: (d) ` 2,000
(a) The firm finances all investment through retained
earnings; that is debt or new equity is not issued.
30. Determine the market price of a share of LMN
(b) The firm’s internal rate of return (r), and its cost of
Ltd. as per Gordon’s Model, given
capital (k) are constant.
ke = 11%
(c) All earnings are either distributed as dividend or
reinvested internally immediately. E = ` 20
(d) All of the above. r = 12%
b = 60%
25. Given that: (a) ` 500
r = Return on investment is given as 0.12
k = Market capitalization rate is as 0.10 (b) ` 1,000
E = Earnings per share ` 4/- (c) ` 210.52
D = Dividend per share is ` 2/- (d) ` 2,000
Then, the market price per share as per Walter’s
Model would be: 31. Determine the market price of a share of LMN
(a) ` 20 Ltd. as per Gordon’s Model, given
ke = 11%
(b) ` 34
E = ` 20
(c) ` 44 r = 10%
(d) ` 50 b = 90%
(a) ` 100
26. Which approach is based on this formula: (b) ` 1,000
E 1  b  (c) ` 210.52
P
k e  br (d) ` 2,000
(a) Walter’s Model
(b) Gordon’s Model 32. Determine the market price of a share of LMN
(c) M.M. Approach Ltd. as per Gordon’s Model, given
(d) All of the above ke = 11%
E = ` 20
27. Gordon’s Model is also known as:
(a) Dividend capitalization model r = 12%
(b) Dividend Growth model b = 60%
(c) Both (a) and (b) (a) ` 100
(d) Walter’s Model
(b) ` 1,000

Unique Academy 6.5 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
(c) ` 160 (b) ` 85
(d) ` 200 (c) ` 100
(d) ` 120
33. As per _______ the manner in which earnings
are dividend nito dividends and retained earnings
39. A company has the following facts:
does not affect this value.
Cost of capital (ke) = 0.10
(a) Walter’s Model
(b) Gordon’s Model Earnings per share (E) = ` 10
(c) M.M. Approach Rate of return on investments (r) = 8%
(d) All of the above Dividend payout ratio = 25%
What is the market price of the shares.
34. Assumptions under M-M hypothesis includes: (a) ` 90
(a) Capital markets are perfect – Investors are rational,
information is freely available, transaction cost are nil. (b) ` 85
(b) There are no taxes – No difference between tax (c) ` 100
rates on dividends and capital gains.
(c) The firm has a fixed investment policy which will (d) ` 120
not change. So if the retained earnings are reinvested,
there will not be any change in the risk of the firm. 40. Determination of value of shares, given the
(d) All of the above. following data:
D/P Ratio = 40%
35. X company earns ` 5 per share, is capitalized at Retention Ratio = 60%
Cost of capital = 17%
a rate of 10 percent and has a rate of return on
R = 12%
investment of 18 per cent. According to Walter’s
model, what should be the price per share at 25 per EPS = ` 20
cent dividend payout ratio? (a) ` 80
(a) ` 60
(b) ` 81.63
(b) `80
(c) ` 62.50
(c) ` 90
(d) ` 100
(d) ` 100
41. Determination of value of shares, given the
36. If the above question, what is the optimum following data:
payout ratio according to Walter? D/P Ratio = 30%
(a) 0% Retention Ratio = 70%
(b) 1% Cost of capital = 18%
(c) 100% (d) 50% R = 12%
EPS = ` 20
37. In the above question, calculate the price based
on the optimum payout ratio as per Walter? (a) ` 80
(a) ` 60 (b) ` 81.63
(b) ` 80 (c) ` 62.50
(c) ` 90 (d) ` 100
(d) ` 100
42. From the following information supplied to you,
determine the theoretical market value of equity
38. A company has the following facts:
shares of a company as per Walter’s model:
Cost of capital (ke) = 0.10
Earnings of the company : ` 5,00,000
Earnings per share (E) = ` 10
Rate of return on investments (r) = 8% Dividend paid : ` 3,00,000
Dividend payout ratio = 50% Number of shares outstanding : ` 1,00,000
What is the market price of the shares.
Price earnings ratio : 8
(a) ` 90 Rate of return on investment : 0.15

Unique Academy 6.6 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
(a) ` 40 (a) 2,000
(b) 3,000
(b) ` 42 (c) 2,634
(c) ` 46 (d) 2,165

(d) ` 43.20 49. X Company Ltd. has 1,00,000 shares

outstanding the current market price of the shares `
43. In the above question, are you satisfied with the
current dividend policy of the firm? 15 each. The company expects the net profit of `
(a) Yes 2,00,000 during the year and it belongs to a rich class
(b) No for which the appropriate capitalization rate has
(c) Both (a) and (b) been estimated to be 20%. The company is
(d) None of the above considering dividend of ` 2.50 per share for the
current year. What will be the price of the share at
44. In question no.42, what should be the optimal
the end of the year if the dividend is paid.
dividend payout ratio?
(a) 0% (a) ` 10
(b) 100% (b) ` 15.50
(c) 1%
(d) 50% (c) ` 16
(d) ` 18
Answer for Question no. 45 to 48 based on the
following data:
50. X Company Ltd. has 1,00,000 shares
A company has 10,000 shares of `100 each. The
outstanding the current market price of the share `
capitalization rate is 12%. Income before tax is `
15 each. The company expects the net profit of `
1,50,000. Tax rate is 30%. Dividend pay-out ratio is
2,00,000 during the year and it belongs to a rich class
60%. The company has to take up a project costing ` for which the appropriate capitalization rate has
4,00,000. been estimated to be 20%. The company is
considering dividend of ` 2.50 per share for the
45. Find Market Price Per Share (MPS) at the end
current year. What will be the price of the share at
of the current year if dividend is paid as per MM
the end of the year if the dividend is not paid.
approach.
(a) 100 (a) ` 10
(b) 105.70 (b) ` 15.50
(c) 110
(d) 112 (c) ` 16
(d) ` 18
46. Find the number of shares to be issued for
financing the new project if dividend is paid as per 51. Dividend payout ratio is:
MM approach. (a) The dividend yield plus the capital gains yield.
(a) 2,000 (b) Dividends per share divided by earnings per share.
(b) 3,000 (c) Dividends per share divided by par value per share.
(c) 2,634 (d) Dividends per share divided by current price per
(d) 2,165 share.
52. A payment of either cash or stock out of a
47. Find Market Price Per Share (MPS) at the end
corporation’s earnings to a firm’s owners is called
of the current year if dividend is not paid as per MM
(a) Normal distribution
approach.
(b) Retained distribution
(a) 100
(c) Operating distribution
(b) 105.70
(d) Dividend
(c) 110
(d) 112 53. In Walter model formula D stands for
(a) Dividend per share
48. Find the number of shares to be issued for (b) Direct Dividend
financing the new project if dividend is not paid as (c) Dividend Earning
per MM approach. (d) None of these

Unique Academy 6.7 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
54. In MM model Mm stands for …. 58. Which of the following is NOT a cash outflow
(a) M. Khan and Modigiliani for the firm?
(b) Miller and M.Khan (a) Depreciation
(c) Modigiliani and M.Khan (b) Dividends
(d) Miller and Modigliani (c) Interest Payments
(d) Taxes
55. What are the earnings per share (EPS) for a
company that earned ` 100,000 last year in after-tax 59. Dividend payout ratio refers to that portion of
total earnings which is distributed among
profits, has 200,000 common shares outstanding and
shareholders.
` 1.2 million in retained earnings at the year end? (a) True
(a) ` 100,000 (b) False

(b) ` 6.00 60. Walters model supports the view that dividend
is relevant for value of the firm.
(c) ` 0.50 (a) True
(d) ` 6.50 (b) False
61. Gordon’s model suggests that dividend payment
56. ________ and _______ carry a fixed rate of
does not affect the market price of the share.
interest and are to be paid off irrespective of the
(a) True
firm’s revenues.
(b) False
(a) Debentures, Dividends\
(b) Debentures, Bond 62. MM model deals with irrelevance of dividend
(c) Dividends, Bond decision.
(d) Dividends, Treasury notes (a) True
(b) False
57. How are earnings per share calculated?
(a) Use the income statement to determine earnings 63. MM model asserts that value of the firm is not
after taxes (net income) and divide by the previous affected whether the firm pays dividend or not.
period’s earnings after taxes. Then subtract 1 from the (a) True
previously calculated value. (b) False
(b) Use the income statement to determine earnings
64. Walter’s Model suggests that a firm can always
after taxes (net income) and divide by the number of
increase i.e. of the share by
common shares outstanding.
(a) Increasing Dividend
(c) Use the income statement to determine earnings
(b) Decreasing Dividend
after taxes (net income) and divide by the number of
(c) Constant Dividend
common and preferred shares outstanding.
(d) None of the above
(d) Use the income statement to determine earnings
after taxes (net income) and divide by the forecasted 65. MM Model argues that dividend is irrelevant as
period’s earnings after taxes. Then subtract 1 from the (a) The value of the firm depends upon earning power.
previously calculated value. (b) The investors buy shares for capital gain.
(c) Dividend is payable after deciding the retained
earnings.
(d) Dividend is a small amount.

ANSWER S

1 2 3 4 5 6 7 8 9 10
(a) (a) (b) (a) (d) (a) (c) (d) (d) (c)
11 12 13 14 15 16 17 18 19 20
(d) (d) (a) (d) (a) (c) (a) (a) (a) (a)
21 22 23 24 25 26 27 28 29 30
(c) (b) (c) (d) (c) (b) (c) (a) (b) (c)
31 32 33 34 35 36 37 38 39 40
(a) (c) (c) (d) (b) (a) (c) (a) (b) (b)
41 42 43 44 45 46 47 48 49 50
(c) (d) (b) (a) (b) (d) (d) (c) (b) (d)

Unique Academy 6.8 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
51 52 53 54 55 56 57 58 59 60
(b) (d) (a) (d) (c) (b) (b) (a) (a) (a)
61 62 63 64 65
(b) (a) (a) (d) (a)

Unique Academy 6.9 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm

Most important consideration while deciding policy is to consider its effect on wealth. There are two schools of
thought:

Relevance of dividend theories : Dividend affects wealth

Irrelevance of dividend theories : Dividend does not affect wealth

Dividend Capitalization Approach

Relevance of dividend
theories Walter’s Formula
Dividend
Theories
Gordon’s Model
Irrelevance of dividend
theories
Graham & Dodd Model

Earning Modigiaiani & Miller

Capitalization Approach

SOME BASIC FORMULAS

Dividend per share
1. Dividend Rate  100
Face Value

Dividend per share

2. Dividend Yield  100
Market price per share

Dividend per share

3. Dividend payout ratio   100
Earning per share

EPS  DPS
4. Retention ratio   100  100  Payout ratio
EPS

Equityshareholders Fund
5. Book Value PerShare   100
Number of equityshares

Earning available toequityshareholders

6. Return on Equity   100
Equityshareholders fund

Earning per share

7. Return on Equity   100
Book value per share

MPS 1
8. Priceearning ratio  
EPS K e

Unique Academy 6.10 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
9. CAPM equation: K e  R f   R m  R f  β

INTERPOLATION FORMULA:
NPV
Rate  Lower rate    Higher rate  Lower rate 
NPVL  NPVH

ROE says that how much company earn & Ke says that how much investor demand to the company.

DIVIDEND CAPITALIZATION APPROACH:

D
P
Ke
Conclusion: Dividend directly affect price. More than dividend more the market .

GRAHAM AND DODD MODEL:

 EPS 
P  m  DPS  
 3 
Conclusion: Dividend gets more importance in valuation of share as compared to earnings.

WALTER’S FORMULA
r
DPS   EPS  DPS
Ke
P
Ke

Here “r” means the rate of return earned by the company. In an exam question it may be given in the name of rate or
return, internal rate of return, return on equity etc.

Conclusion:

Situation Interpretation Conclusion Best Policy

r  Ke Company is earning more than expectation of investors Give less dividend 0% Payout
r  Ke Company is earning less than expectation of investors. Give more dividend 100% Payout

r  Ke Company is earning equal to expectation of investors Give any dividend -

GORDON’S MODEL
E 1  b 
P0 
D1
 Here, D1  D0 1  g 
K e  g K e  br

How to recognize D 0 How to recognize D1

Company has paid dividend Company will pay dividend
Company is currently paying dividend Company is expected to pay dividend
Company is about to pay dividend Dividend at the end of current year
Dividend for year zero Dividend for year 1

Growth Rate:
 
Is equal to Return on Equity Retention Ratio.
 Should be less than cost of equity.
 Should be constant.

Unique Academy 6.11 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
Interpretation Formula:
Fair value of share is present value of all future dividends.
CHANGING GROWTH RATES
If growth rate is not constant then there are two ways to calculate intrinsic value:
1. Calculate present value of dividends separately for the year for which growth rate is not constant & apply
formula from the year from which growth rate is constant.

Year 0 1 2 3 4 5 6 7 8
P0 D1 D2 D3 D4 D5 D6 D7 D8

P4

2. Apply formula from the year from which growth rate is constant. Then roll it to back year by year. That way
you will know not only fair value at year zero but also fair value at other years.

Yea 0 1 2 3 4 5 6 7 8
r
D1 D2 D3 D4 D5 D6 D7 D8

+ + + +
P1 P1 P2 P3 P4

IMPORTANT POINT TO NOTE:

If in a question growth is given or it can be calculated in that case solve the question by Gordon’s Model.
EARNING CAPITALIZATION APPROACH
EPS
P
Ke
As per this approach dividend does not affect fair value of share. Dividend is just like drawings of a proprietorship.
Hence performance of a company is measured by EPS and not DPS.

MODIGLIANI & MILLER APPROACH

Following are the steps for calculation:
D1  P1
Step 1: Calculate P1 P0 
1  Ke

1  E  nD1
Step 2: Calculate Delta n n 
P1

nP0 
 n  n  P  I  E1
Step 3: Calculate current wealth nP0
1  Ke

Unique Academy 6.12 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm

Constant Dividend (` 2)

Constant Payout Ratio (40%)

Dividend Payment
approaches Constant Dividend Plus
(higher of ` 2 or 40%)

Lintner’s Model

Residual approach

LINTNER’S MODEL
D1  D0   EPS  Pay out ratio  D0  Adjustment Factor
 Adjustment factor may take a value from zero to one.
 If AF is zero, dividend will be same as constant dividend approach
 If AF is one, dividend will be same as constant payout ratio approach.
 Lower the AF, lower the volatility of dividend as compared to volatility of earnings.

CORPORATE ACTIONS OTHER THAN DIVIDEND

Bonus Shares Stock Split

Bonus of 2 : 1 means two bonus shares for one share 2:1 split means two shares of half face value in place of
held. Hence total 3 shares after bonus. one original share. Hence total 2 shares after split.
Effects
Number of shares increases Number of shares increases
Face value per share remains same Face value per share reduces
Paid us capital increases Paid up capital remains same
Reserves reduces hence B/S total remains same Paid up capital remains same hence B/S total also
remains same
Market price per share reduces Market price per share reduces
Market capitalization remains same Market capitalization remains same

Unique Academy 6.13 Prof. Ashish Parikh

CS Executive: Financial Management Dividend Decision & Valuation of the Firm
DIVIDEND POLICY DECISION
Provisions of the Companies Act,
2013

Provisions of Income Tax act *

Other Factors determining

Stability of earnings
Dividend Policy

Reinvestment Opportunities

Availability of Cash flows

Level of inflation

* As per Section 115-O, dividend is subject to dividend distribution tax (DDT) in the hands of the company. Under the
existing provisions of Section 10(34) of the Income Tax Act, 1961, dividend which suffer dividend distribution tax
(DDT) under section 115-O is exempt in the hands of the shareholder.
Further, any income by way of dividend in excess of ` 10 lakhs shall be chargeable to tax in the case of an individual,
HUF or a firm who is resident in India, at the rate of ten percent.

Unique Academy 6.14 Prof. Ashish Parikh

CS Executive: Financial Management Financial Statements & Analysis

7 FINANCIAL STATEMENTS AND ANALYSIS

MULTIPLE CHOICE QUESTIONS

1. Accounting Ratios are important tools used by: (d) Cost of goods sold
(a) Managers
(b) Researchers 8. Inventory Turnover measures the relationship
(c) Investors of inventory with:
(d) All of the above (a) Average Sales
(b) Cost of Goods Sold
2. Net profit Ratio signifies: (c) Total Purchases
(a) Operational Profitability (d) Total Assets
(b) Liquidity Position
(c) Long-term Solvency 9. The term ‘EVA’ is used for:
(d) Profit for Lenders (a) Extra Value Analysis
(b) Economic Value Added
3. Working Capital Turnover measures the (c) Expected Value Analysis
relationship of working Capital with: (d) Engineering Value Analysis
(a) Fixed Assets
(b) Sales 10. Return on Investment may be improved by:
(c) Purchases (a) Increasing Turnover
(d) Stock (b) Reducing Expenses
(c) Increasing Capital Utilization
4. In Ratio Analysis, the term Capital Employed (d) All of the above
refers to:
(a) Equity Share Capital 11. In Current Ratio, Current Assets are compared
(b) Net worth with:
(c) Shareholders’ Funds (a) Current Profit
(d) (d) None of the above (b) Current Liabilities
(c) Fixed Assets
5. Dividend Payout Ratio is: (d) Equity Share Capital
(a) PAT  Capital
(b) DPS  EPS 12. ABC Ltd. has a Current Ratio of 1.5 : 1 and Net
(c) Pref. Dividend  PAT Current Assets of ` 5,00,000. What are the Current
(d) Pref. Dividend  Equity Dividend Assets?
(a) `5,00,000
6. DU PONT Analysis deals with:
(a) Analysis of Current Assets (b) `10,00,000
(b) Analysis of Profit (c) `15,00,000
(c) Capital Budgeting (d) `25,00,000
(d) Analysis of Fixed Assets
13. There is a deterioration in the management of
7. In Net Profit Ratio, the denominator is: working capital of XYZ Ltd. What does it refer to?
(a) Net Purchases (a) That the Capital Employed has reduced.
(b) Net Sales (b) That the profitability has gone up.
(c) Credit Sales (c) That debtors collection period has increased.
Unique Academy 7.1 Prof. Ashish Parikh
CS Executive: Financial Management Financial Statements & Analysis
(d) That Sales has decreased. (d) `83,33,333

14. Which of the following does not help to increase 21. Suppliers and Creditors of a firm are interested
Current Ratio? in
(a) Issue of Debentures to buy Stock (a) Profitability Position
(b) Issue of Debentures to pay Creditors (b) Liquidity Position
(c) Sale of Investment to pay Creditors (c) Market Share Position
(d) Avail Bank Overdraft to buy Machine (d) Debt Position

15. Debt to Total Assets Ratio can be improved by: 22. Which of the following is a measure of Debt
(a) Borrowing More Service Capacity of a firm:
(b) Issue of Debentures (a) Current Ratio
(c) Issue of Equity Shares (b) Acid Test Ratio
(d) Redemption of Debt (c) Interest Coverage Ratio
(d) Debtors Turnover
16. Ratio of Net Income to Number of Equity Shares
is known as: 23. Gross Profit Ratio for a firm remains same but
(a) Price Earnings Ratio the Net Profit Ratio is decreasing. The reason for
(b) Net Profit Ratio such behavior could be:
(c) Earnings per Share (a) Increase in Cost of Goods Sold
(d) Dividend per Share (b) Increase in Expenses
(c) Increase in Dividend
17. Trend Analysis helps comparing performance of (d) Decrease in Sales
a firm:
(a) With other firms 24. Which of the following statements is correct?
(b) Over a period of firm (a) A Higher Receivable Turnover is not desirable.
(c) With other industries (b) Interest Coverage Ratio depends upon Tax Rate.
(d) None of the above (c) Increase in Net Profit Ratio means increase in
Sales.
18. A current Ratio of Less than one means: (d) Lower Debt-Equity Ratio means lower Financial
(a) Current Liabilities < Current Assets Risk.
(b) Fixed Assets > Current Assets
(c) Current Assets < Current Liabilities 25. Debt to Total Assets of a firm is 2. The Debt to
(d) Share Capital > Current Assets Equity Ratio would be:
(a) 0.80
19. A firm has Capital of`10,00,000 Sales of (b) 0.25
`5,00,000; Gross Profit of `2,00,000 and Expenses of (c) 1.00
(d) 0.75
`1,00,000. What is the Net Profit Ratio?
(a) 20%
26. Which of the following helps analyzing return to
(b) 50%
(c) 10% equity shareholders?
(d) 40% (a) Return on Assets
(b) Earnings Per Share
20. XYZ Ltd. has earned 8% Return on Total (c) Net Profit Ratio
Assets of `50,00,000 and has a Net Profit Ratio of 5%. (d) Return on Investment
Find out the Sales of the firm.
27. Returns on Assets and Return on Investment
(a) `4,00,000
Ratios belong to:
(b) `2,50,000 (a) Liquidity Ratios
(c) `80,00,000 (b) Profitability Ratios

Unique Academy 7.2 Prof. Ashish Parikh

CS Executive: Financial Management Financial Statements & Analysis
(c) Solvency Ratios (a) Solvency
(d) Turnover (b) Liquidity
(c) Profitability
28. XYZ Ltd. has a Debt Equity Ratio of 1.5 as (d) Turnover
compared to 1.3 Industry average. It means that the
firm has: 30. In Inventory Turnover calculation, what is
(a) Higher Liquidity taken in the numerator?
(b) Higher Financial Risk (a) Sales
(c) Higher Profitability (b) Cost of Goods Sold
(d) Higher Capital Employed (c) Open Stock
(d) Closing Stock
29. Ratio Analysis can be used to study liquidity,
turnover, profitability, etc. of a firm. What does
Debt-Equity Ratio help to study?

ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
(d) (a) (a) (d) (b) (b) (b) (b) (b) (d)
11 12 13 14 15 16 17 18 19 20
(b) (c) (c) (d) (d) (c) (b) (c) (a) (c)
21 22 23 24 25 26 27 28 29 30
(b) (c) (b) (d) (b) (b) (b) (b) (a) (b)

Unique Academy 7.3 Prof. Ashish Parikh

CS Executive: Financial Management Nature Significance & Scope

8 NATURE SIGNIFICANCE & SCOPE

MULTIPLE CHOICE QUESTIONS

1. Financial management means the management 7. _________ ensures that firm utilizes its available
of finance of a business or an organization in order to resources most efficiently under conditions of
achieve the ………….. objectives competitive markets
(a) Financial (a) Profit maximization
(b) Social (b) Wealth maximization
(c) Financial and Social (c) Goal maximization
(d) None of the above (d) None of the above
8. __________ means the management of an
2. ………. is that business activity which concerns organization maximizes the present value not only
with the acquisition and conversion of capital funds for shareholders but for all including employees,
in meeting financial needs and overall objectives of a customers, suppliers and community at large
business enterprise. (a) Profit maximization
(a) Structured Finance (b) Wealth maximization
(b) Business Finance (c) Goal maximization
(c) Legal (d) None of the above
(d) Sourcing
3. ………. is broadly concerned with raising of 9. Which of the following is not a correct
funds, creating value to the assets of the business statement?
enterprise by efficient allocation of funds (a) Profit maximization is vague conceptually.
(a) Financial management (b) Profit maximization ignores timing of returns
(b) Treasury management (c) Profit maximization emphasis is generally on short
(c) Liquidity management run projects.
(d) Fund management (d) Profit maximization considers timing of returns.

4. Finance Management is concerned with: 10. Advantage of profit maximization is:

(a) Investment Decision (a) Easy to calculate profits
(b) Financing Decision (b) Easy to determine the link between financial
(c) Dividend Decision decisions and profits.
(d) All of the above (c) Both (a) and (b)
(d) None of the above
5. ________ are concerned with the determination
of how much funds to procure from amongst the 11. Which of the following is not the advantage of
various avenues available i.e. the financing mix or wealth maximization?
capital structure: (a) Emphasizes long term
(a) Investment Decision (b) Recognizes risk and uncertainty
(b) Financing Decision (c) Recognizes the timings of return
(c) Dividend Decision (d) Easy to determine the link between financial
(d) All of the above decisions and profits
12. Wealth maximization objective is superior to the
6. _________ is to decide whether the firm should profit maximization concept.
distribute all profits or retain them or distribute a (a) True
portion and retain the balance: (b) False
(a) Investment Decision
(b) Financing Decision 13. Profit maximization is the narrow objective of
(c) Dividend Decision financial management because profit is a test of
(d) All of the above economic efficiency.
(a) True

Unique Academy 8.1 Prof. Ashish Parikh

CS Executive: Financial Management Nature Significance & Scope
(b) False (b) False
14. Profit maximization goes beyond the 23. Which of the following statement is correct?
quantitative aspects as it also considers quantitative (a) Current Ratio is the ratio of current assets to current
benefits in a firm. liabilities.
(a) True (b) Current Ratio is the ratio of current assets to short
(b) False term liabilities.
15. _______ is the after tax cash flow generated by a (c) Current Ratio is the ratio of current assets to long
business minus the cost of the capital it has deployed term liabilities.
to generate that cash flow. (d) Current Ratio is the ratio of current assets and fixed
(a) Net Present Value (NPV) assets to current liabilities.
(b) Economic value added (EVA)
(c) Internal Rate of Return (IRR) 24. Liquidity ratio enables a company to assess its:
(d) Discounted Cash Flow (a) Current Assets only
(b) Current liabilities only
16. Representing real profit versus paper profit. (c) Net Working Capital
EVA underlines shareholder value, increasingly the (d) Fixed Assets
main target of leading companies strategies.
(a) True 25. Net working capital is:
(b) False (a) Current Assets  Current Liabilities
17. There is growing evidence that EVA, not (b) Current Assets  Current Liabilities
earnings, determines the value of a firm. (c) Current Assets  Total Liabilities
(a) True (d) Current Assets  Fixed Assets  Current Liabilities
(b) False
26. Average Collection Period (ACP) tells us the
18. Which of the following statement is not correct? average number of days receivable are outstanding
(a) There are two key components to EVA. The net i.e., the average time a bill takes to convert into cash.
operating profit after tax (NOPAT) and the capital (a) True
charge, which is the cost of capital times the amount of (b) False
capital.
(b) EVA underlines shareholder value. 27. Financial decisions are affected by liquidity
(c) There is no difference between EVA, earnings per analysis of a company in the following areas:
share, return on assets, and discounted cash flow, as a (a) Management of cash and marketable securities
measure of performance (b) Credit policy of a firm and procedures for
(d) EVA  (Operating Profit) – (A Capital Charge) realization
(c) Management and control of inventories
19. Finance Manager has to take following decision: (d) All of the above
(a) Investment decision
(b) Financing decision 28. The gross profit margin ratio indicates the
(c) Dividend decision profits relative to sale after deduction of direct
(d) All of the above production cost
(a) True
20. A finance manager is not required to trade-off (b) False
between the risk and return.
(a) True 29. Failure of a firm is technical if it is unable to
(b) False meet its ……… obligations.
(a) Current
21. At risk return trade off, market price of share (b) Non-current
is: (c) Both (a) and (b)
(a) Minimize (d) None of the above
(b) Maximized
(c) No affect 30. Which of the following is solvency ratio:
(d) Uncertain (a) Debt to Equity ratio
(b) Debt to total Funds Ratios
22. Liquidity is not an important aspect of financial (c) Interest coverage ratio
management. (d) All of the above
(a) True

Unique Academy 8.2 Prof. Ashish Parikh

CS Executive: Financial Management Nature Significance & Scope
31. Study of Financial Management: (b) Liquidity Ratio
(a) Is an art (c) Solvency Ratio
(b) Is a science as well as art (d) Net Working Capital
(c) Mixture of science as well as art
(d) None of the above 34. Affairs of the firm should be managed in such a
way that the total risk business as well as financial
32. Which of the following is not a direct function of borne by equity shareholders is minimized and is
Finance Manager: manageable.
(a) Forecasting of cash flow (a) True
(b) Raising funds (b) False
(c) To facilitate cost control
(d) To arrange board meeting 35. With the evolution of finance from the being
mere a descriptive study to the one that is highly
33. __________ reflects on the ability of developed discipline, the role of financial managers
management to earn a return on resources put in by has also undergone a sea change.
the shareholders evaluating the performance of the (a) True
company in different spheres. (b) False
(a) Profitability ratio

ANSWER KEY

1 2 3 4 5 6 7 8 9 10
(a) (b) (a) (d) (b) (c) (a) (b) (d) (c)
11 12 13 14 15 16 17 18 19 20
(d) (a) (a) (b) (b) (a) (a) (c) (d) (b)
21 22 23 24 25 26 27 28 29 30
(b) (b) (a) (c) (b) (a) (d) (a) (a) (d)
31 32 33 34 35
(c) (d) (a) (a) (a)

Unique Academy 8.3 Prof. Ashish Parikh

CS Executive: Financial Management Project Finance

9 PROJECT FINANCE

MULTIPLE CHOICE QUESTIONS

1. The _______ is the financing of long-term 6. A______ is a formal, approved document that is
infrastructure, industrial projects and public services used to manage and control a project.
based upon a non-recourse or limited recourse (a) Documented Plan
financial structure, in which project debt and equity (b) Strategy
used to finance the project are paid back from the (c) Project plan
cash flow generated by the project, without any (d) Any of the above
claims (with some very specific exceptions) on the
companies that develop these projects. 7. The project planning process consists of the
(a) Project Finance following basic tasks:
(b) Project Restructuring (a) Define the technical approach used to solve the
(c) Capital Restructuring problem.
(d) Financial Management (b) Define and sequence the tasks to be performed and
identify all deliverables associated with the project.
2. ________ is a loan structure that relies primarily (c) Define the dependency relations between tasks.
on the project’s cash flow for repayment, with the (d) All of the above.
project’s assets, rights and interests held as
secondary security or collateral. 8. The project report is an extremely important
(a) Capital Restructuring aspect of the project.
(b) Project Finance (a) True
(c) Project Restructuring (b) False
(d) Financial Management
9. _____ is a working plan for implementation of
3. Project Finance, comes from a combination of project proposal after investment decision by a
both equity and _____ company has been taken.
(a) Share Capital (a) Documented Plan
(b) Asset (b) Project report
(c) Debt (c) Project plan
(d) Current liabilities (d) Any of the above

4. _________ defines the project activities and end 10. There is no prescribed format for the
products that will be performed and describes how preparation of a project report-but a project report
the activities will be accomplished. should contain mainly the following set of
(a) Project Planning information in general:
(b) Capital Restructuring (a) Information about industry and its status in the
(c) Project Financing economy, present production and demand.
(d) Project Restructuring (b) Broad market trend of the product within and
outside the states for 5 years.
5. The project planning activities and goals include (c) Raw material survey, giving specifications and
defining. quality of raw materials required and their availability.
(a) The specific work to be performed and goals that (d) Process-broad description of different processes
define and bind the project. and their relative economics.
(b) Estimates to be documented for planning, tracking, (e) All of the above
and controlling the project.
(c) Commitments that are planned, documented, and 11. Timing for project appraisal is most important
agreed to by affected groups. consideration for all types of appraisers.
(d) All of the above. (a) True
(b) False

Unique Academy 9.1 Prof. Ashish Parikh

CS Executive: Financial Management Project Finance
(b) Financial Analysis
12. Under inflationary conditions, the appraisal of (c) Economic Analysis
the project generally be done keeping in view the (d) Societal / Distributive Analysis
following guidelines:
(a) Make provisions for delay in project 18. _______ is the basis for financial analysis.
implementation. (a) Balance-sheet
(b) Sources of finance should be carefully scrutinized (b) Profit and Loss Statement
with reference to revision in the rate of interest. (c) Cash Flow Statement
(c) Profitability and cash flow projections as made in (d) Statement of changes in equity
the project report require revision and adjustment should
be made to take care of the inflationary pressures 19. In the last year, the inflow is _________ due to
affecting adversely future projections. the residual value adding to the cash inflow.
(d) All of the above. (a) Lower
(b) Equal
13. Project appraisal under inflationary and (c) Higher
deflationary conditions can be done using same (d) Zero
approach.
(a) True 20. What are the measures of Financial Viability?
(b) False (a) NPV
(b) BCR
14. Project appraisal, in general, by the financial (c) IRR
institutions seek to consider inter alia the following (d) All of the above
aspects:
(a) The project profile, its reliable and formulation and 21. ________ representing wealth creation by the
project report. Project, is calculated by taking the discounted sum of
(b) The promoter’s capacity and competence. the stream of cash flows during the project life.
(c) Viability Tests. (a) NPV
(d) All of the above (b) BCR
(c) IRR
15. Viability Tests includes: (d) All of the above
(a) Technical Aspects
(b) Financial Aspects 22. When two or more mutually exclusive projects
(c) Economic Aspects are being appraised, the project with the ________
(d) All of the above NPV should be selected.
(a) Highest
16. _______ involves studying the feasibility of (b) Lowest
selected technical processes and its suitability under (c) Same
Indian conditions, Location of the project, Plant (d) None of the above
layout, appropriateness of the chosen equipment,
machinery and technology, availability of raw 23. ________ is the ratio of discounted value of
material, power and other inputs, appropriateness of benefit and discount value of cost.
technology chosen from social point of view, (a) NPV
availability of infrastructure for the project, the (b) BCR (Benefit Cost Ratio)
techno economic assumption and parameters used (c) IRR
for analyzing costs and benefits and viability (d) All of the above
provision for treatment of effluents, training of
manpower, legal requirement on documentation, 24. The project is viable when BCR is one or more
license and registration. than ______
(a) Technical Analysis (a) Zero
(b) Financial Analysis (b) One
(c) Economic Analysis (c) Minus one
(d) Societal / Distributive Analysis (d) None of the above

17. The primary aim of _______ is to determine 25. ___________ represents the returns internally
whether the project satisfies the investment criteria generated by the project.
of generating acceptable level of profitability. (a) NPV
(a) Technical Analysis (b) BCR (Benefit Cost Ratio)

Unique Academy 9.2 Prof. Ashish Parikh

CS Executive: Financial Management Project Finance
(c) IRR (b) Social Appraisal
(d) All of the above (c) Risk Analysis
(d) Economic Appraisal
26. This is also the rate which makes the net present
value equal to 0. 33. The organizational and managerial aspects
(a) NPV evaluate the managerial capacity of the organization
(b) BCR (Benefit Cost Ratio) of the entrepreneur, responsible for implementing
(c) IRR the project.
(d) All of the above (a) Sensitivity Analysis
(b) Social Appraisal
27. The calculation of ________ is a process of trial (c) Organizational and managerial aspects
and error. (d) Economic Appraisal
(a) NPV
(b) BCR (Benefit Cost Ratio) 34. Lending policy and appraisal norms by banks
(c) IRR are decided by the _________
(d) All of the above (a) State bank of India
(b) Reserve bank of India
28. ________ helps us in finding out that how (c) Commercial bank of India
sensitive is the project to various fluctuations. (d) None of the above
(a) Sensitivity Analysis
(b) Scenario Analysis 35. Bank lending must necessarily be based on
(c) None of the above principles. Principles includes:
(d) Either of the above (a) Safety
(b) Liquidity
29. Under ________ scenario of certain prices, cost (c) Profitability and risk diversion
and other variables are created and the financial (d) All of the above
parameters are computed.
(a) Sensitivity Analysis 36. The loan policy typically lays down lending
(b) Scenario Analysis guidelines in the following areas
(c) None of the above (a) Level of Lending-deposit ratio
(d) Either of the above (b) Targeted portfolio mix and Collateral security
(c) Hurdle ratings and Loan pricing
30. Under _______, probabilistic analysis is done by (d) All of the above
identification of key risk variables, finding out values
of each risk variable, assigning probabilities for each 37. CRR stands for
value to each of the risk variables, using these values (a) Credit Reserve Ration
for risk analysis and finding out the probability of (b) Cash Reserve Ratio
negative outcome of the project. (c) Credit Reserve Rate
(a) Sensitivity Analysis (d) None of the above
(b) Scenario Analysis
(c) Risk Analysis 38. SLR stands for
(d) None of the above (a) Small Liquid Ration
(b) Statutory Liquid Ratio
31. The objective of economic appraisal is to (c) Statutory Liquid Rate
examine the project from the entire economy’s point (d) None of the above
of view to determine whether the project will
improve the economic welfare of the country. 39. A bank can lend out only a certain proportion of
(a) Sensitivity Analysis its deposits, since some part of deposits have to be
(b) Scenario Analysis statutorily maintained as _________
(c) Risk Analysis (a) Credit Reserve Ration
(d) Economic Appraisal (b) Cash Reserve Ratio
(c) Credit Reserve Rate
32. The ________ consists of two parts: (d) None of the above
measurement of the distribution of the income due to
the project and identification of the impact on the 40. For new borrowers, a bank usually lays down
basic needs objectives of the society. guidelines regarding minimum rating to be achieved
(a) Sensitivity Analysis by the borrower to become eligible for the loan. This

Unique Academy 9.3 Prof. Ashish Parikh

CS Executive: Financial Management Project Finance
is also known as the ‘______’ criterion to be achieved (a) 10% of Capital fund (Additional 5 percent on
by a new borrower. infrastructure exposure)
(a) Credit rating (b) 15% of Capital fund (Additional 5 percent on
(b) Hurdle rating infrastructure exposure)
(c) Risk rating (c) 20% of Capital fund (Additional 5 percent on
(d) Lending rating infrastructure exposure)
(d) 25% of Capital fund (Additional 5 percent on
41. In the case of term loans and working capital
infrastructure exposure)
assets, banks take as ‘primary security’ the property
or goods against which loans are granted. In addition
47. What is the exposure norms for Commercial
to this, banks often ask for additional security or
banks in India to a Group Borrower.
______ in the form of both physical and financial
(a) 10% of Capital fund (Additional 10 percent on
assets to further bind the borrower.
infrastructure exposure)
(a) Loan security
(b) 20% of Capital fund (Additional 10 percent on
(b) Support security
infrastructure exposure)
(c) Collateral security
(c) 30% of Capital fund (Additional 10 percent on
(d) None of the above
infrastructure exposure)
(d) 40% of Capital fund (Additional 10 percent on
42. CAR stand for ______
infrastructure exposure)
(a) Credit adequacy ration
(b) Collateral adequacy ration
48. What is the maximum exposure norms for
(c) Capital additional ration
Commercial banks in India to capital market.
(d) Capital adequacy ratio
(a) 10% of net worth as on 31st of the Previous year.
43. _______ is the ratio is the capital with the bank (b) 20% of net worth as on 31st of the Previous year.
as a (c) 30% of net worth as on 31st of the Previous year.
(a) Credit adequacy ration (d) 40% of net worth as on 31st of the Previous year.
(b) Collateral adequacy ration
(c) Capital additional ration 49. The Reserve Bank of India has brought a new
(d) Capital adequacy ratio methodology of setting lending rate by commercial
banks under the name _________.
44. The Basel committee specifies a CAR of at least (a) Marginal Cost of Funds based Lending Rate
_____% for banks: (b) Securities Lending rate
(a) 7 (b) 8 (c) Credit Lending rate
(c) 9 (d) 10 (d) Marginal lending rate

45. The Reserve Bank of India (RBI) has specified a 50. The _____ is an agreement expressed in writing
CAR of at least______% for banks: and entered into between the borrower and the
(b) 7 (b) 8 lender bank, institution or other creditors.
(d) 9 (d) 10 (a) Loan agreement
(b) Credit arrangement
46. What is the exposure norms for Commercial (c) Risk Agreement
banks in India to a Single Borrower. (d) None of the above

ANSWERS
1 2 3 4 5 6 7 8 9 10
(a) (b) (c) (a) (d) (c) (d) (a) (b) (e)
11 12 13 14 15 16 17 18 19 20
(a) (d) (b) (d) (d) (a) (b) (c) (c) (d)
21 22 23 24 25 26 27 28 29 30
(a) (a) (b) (b) (c) (c) (c) (a) (b) (c)
31 32 33 34 35 36 37 38 39 40
(d) (b) (c) (b) (d) (d) (a) (b) (b) (b)
41 42 43 44 45 46 47 48 49 50
(c) (d) (d) (b) (c) (b) (d) (d) (a) (a)

Unique Academy 9.4 Prof. Ashish Parikh

CS Executive: Financial Management Security Analysis

10 SECURITY ANALYSIS

MULTIPLE CHOICE QUESTIONS

1. _______ is defined as instruments issued by (d) Gambling
seekers of funds in the investment market to the
providers of funds in lieu of funds. 8. Time horizon of Speculation is:
(a) Investment (a) Short Term
(b) Securities (b) Long Term
(c) Speculation (c) Both (a) and (b)
(d) Gambling (d) None of the above

2. Securities include: 9. Time horizon of Investment is:

(a) Shares, scrips, stocks, bonds, debentures, debenture (a) Short Term
stock of other marketable securities of a like nature. (b) Long Term
(b) Government securities. (c) Both (a) and (b)
(c) Derivatives. (d) None of the above
(d) All of the above.
10. Risk in speculation is:
3. Securities include “security receipt as defined in (a) Low
clause (zg) of Section 2 of the Securitization and (b) Moderate
Reconstruction of Financial Assets and Enforcement (c) High
of Security Interest Act, 2002.” (d) Nil
(a) True
(b) False 11. Which of the following statement is not correct?
(a) Risk in case of investment is moderate as compared
4. ________ is the employment of funds on assets to speculation.
with the aim of earning income or capital (b) Expected rate of return is moderate in case of
appreciation. investment as compared to speculation.
(a) Investment (c) Time horizon is short term in case of investment as
(b) Securities compared to speculation.
(c) Speculation (d) The purchase of an asset with the hope of getting
(d) Gambling returns is called investment.

5. Investment has the following attribute: 12. ________ is the game of chance in which return
(a) Time is dependent upon a particular event happening.
(b) Risk (a) Investment
(c) Both (a) and (b) (b) Securities
(d) None of the above (c) Speculation
(d) Gambling
6. Investment and Speculation are one and the
same thing. 13. Which of the following statement is not correct?
(a) True (a) In case of gambling, decision is based on rumours.
(b) False (b) Normally, gambling is an unplanned activity.
(c) Safety of principal and stability of returns is the
7. _________ is an act of conducting a risky motive for gambling.
financial transaction, in the hope of substantial (d) None of the above.
profit.
(a) Investment 14. Risk in security analysis is generally associated
(b) Securities with the possibility that the realized returns will be
(c) Speculation …….. than the returns that were expected.
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CS Executive: Financial Management Security Analysis
(a) More 23. Type of systematic risk include:
(b) Less (a) Business or liquidity risk
(c) Constant (b) Financial or credit risk
(d) Nil (c) Both (a) and (b)
(d) None of the above
15. Risk can be:
(a) Systematic risk 24. __________ originates from the sale and
(b) Unsystematic risk purchase of securities affected by business cycles,
(c) Both (a) and (b) technological changes, etc.
(d) None of the above (a) Business or liquidity risk
(b) Financial or credit risk
16. Those forces that are uncontrollable, external (c) Both (a) and (b)
and broad in their effect are called sources of (d) None of the above
________
(a) Systematic risk 25. _________ arises due to change in the capital
(b) Unsystematic risk structure of the organization.
(c) Both (a) and (b) (a) Business or liquidity risk
(d) None of the above (b) Financial or credit risk
(c) Both (a) and (b)
17. Systematic risk is due to the influence of (d) None of the above
________ factors on an organization.
(a) Internal 26. Total return for any security is defined as:
(b) External (a) Total return = Current return
(c) Both (a) and (b) (b) Total return = Current return
(d) None of the above (c) Total return = Current return + Capital return
(d) Total return = Current return  Capital return
18. Systematic risk is a macro in nature as it affects
a large number of organizations operating under a 27. _____ is the periodic cash flow (income), such as
similar stream or same domain. dividend or interest, generated by the investment.
(a) True (a) Current Return
(b) False (b) Capital Return
(c) Both (a) and (b)
19. Systematic risk can be planned by the (d) None of the above
organization.
(a) True 28. _______ is the price appreciation (or
(b) False depreciation) divided by the beginning price of the
asset.
20. Type of systematic risk includes: (a) Current Return
(a) Interest rate risk (b) Capital Return
(b) Market risk (c) Both (a) and (b)
(c) Purchasing power or inflationary risk (d) None of the above
(d) All of the above
29. Which of the following formula is correct?
21. Economic, political and sociological changes are (a) Holding Period Return = (End of Period Value –
sources of ________ Initial Value) / Initial Value.
(a) Systematic risk (b) Holding Period Return = Income + (End of Period
(b) Unsystematic risk Value – Initial Value) / Initial Value.
(c) Both (a) and (b) (c) Holding Period Return = Income / Initial Value.
(d) None of the above (d) None of the above.
30. Holding period return is calculated on the basis
22. Unsystematic risk is due to the influence of of total returns from the asset or portfolio- i.e.
_______ factors prevailing within an organization. income plus changes in value.
(a) Internal (a) True
(b) External (b) False
(c) Both (a) and (b)
(d) None of the above 31. Mr. A invested ` 10,000 in shares of XYZ
Company 10 years ago, and that is shares (including

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CS Executive: Financial Management Security Analysis
reinvested dividends) are currently worth ` 23,800. 38. Which of the following is correct?
Using this information, calculate total investment (a) Fundamental approach say that a security is worth
return of Mr. A. the present value (discounted) of a stream of future
(a) 100% income to be received from the security.
(b) 38% (b) Technical approach assert that the price trend data
(c) 138% should be studied regardless of the underlying data.
(d) 238% (c) Efficient market approach contend that a share of
stock is generally worth whatever it is selling for.
32. What is the annualized return of Mr. A based on (d) All of the above.
the data of above question?
(a) 8% 39. __________ of the security is the denominating
(b) 9.06% value. It is also called the normal value.
(c) 10% (a) Book value
(d) 11% (b) Face value
(c) Market value
33. Mr. X invested ` 10,000 in shares of XYZ (d) Intrinsic value
Company 20 years ago, and that his shares (including
reinvested dividends) are currently worth ` 18,800. 40. Money has a “time value.”
Using this information, calculate total investment (a) True
return of Mr. A. (b) False
(a) 100%
(b) 38% 41. The investor seeks to arrive at the real value or
(c) 58% the intrinsic value of a security through the process
(d) 88% of ______
(a) Value Analysis
34. Approach to valuation of security can be: (b) Market Analysis
(a) Fundamental Approach (c) Price Analysis
(b) Technical Approach (d) Security Analysis
(c) Efficient Capital Market Theory
(d) All of the above 42. An investor is holding 1000 shares of Right
Choice Ltd. The current rate of dividend paid by the
35. The ________ suggests that every stock has an company is ` 5/- per share. The long term growth
intrinsic value and the intrinsic value is more than rate is expected to be 10% and the expected rate of
the market value, the fundamentalists recommend return is 19.62%. Find the current market price of
buying of the security and vice versa. the share.
(a) Fundamental Approach (a) ` 50
(b) Technical Approach (b) ` 57.17
(c) Efficient Capital Market Theory (c) ` 60.17
(d) None of the above (d) ` 65

36. _______(ECMH) is based on the assumption 43. Fundamental analysis is a _________ level
that in efficient capital markets prices of traded systematic process that analyze the overall external
securities always fully reflect all publicly available and internal environment of the company before
information concerning those securities. placing a value on its shares.
(a) Fundamental Approach (a) Two
(b) Technical Approach (b) Three
(c) Efficient Capital Market Theory (c) Four
(d) None of the above (d) Five

37. The _________ endeavours to predict future 44. The level / analysis at which the fundamental
price levels of stocks by examining one or many analysis is carried out before placing a value on its
series of past data from the market itself. shares is:
(a) Fundamental Approach (a) Analysis of the company
(b) Technical Approach (b) Industry Level Analysis
(c) Efficient Capital Market Theory (c) Company Analysis
(d) None of the above (d) All of the above

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CS Executive: Financial Management Security Analysis
45. If the country has an improving GDP growth
rate, controlled inflation and increasing investment 53. As per Dow Jones Theory, a secondary trend
activity then chances are that the valuation of moves in the same direction of the primary trend.
securities shall be liberal. (a) True
(a) True (b) False
(b) False
54. As per Dow Jones Theory, minor trends are
46. Industry level analysis focuses on: changes occurring every day within a narrow range
(a) Economy and are not decisive of any major movement.
(b) Particular industry (a) True
(c) Particular company (b) False
(d) All of the above
55. Technical Analysts use following type of tool for
47. Which of the following is not the assumption of their analysis:
Technical analysis? (a) Technical Charts
(a) The inter-play of demand and supply determines (b) Technical Price Indicators
the market value of shares. (c) Both (a) and (b)
(b) Stock values tend to move in trends that persist for (d) None of the above
a reasonable time.
(c) These trends do not change as a result of change in 56. A _______ is a style of chart that is created by
demand-supply equilibrium. connecting a series of past prices together with a line.
(d) Chart patterns tend to repeat themselves and this (a) Bar Chart
repetition can be used to forecast future price (b) Candle Stick Chart
movements. (c) Point and Figure Chart
(d) Line Chart
48. Dow Jones Theory was given by:
(a) Charles H. Dow 57. Which of the statement is correct?
(b) Charles K. Dow (a) Bar chart is made up of a series of vertical lines that
(c) Chris H. Dow represent the price range for a given period with a
(d) Chris K. Dow horizontal dash on each side that represents the open and
closing prices.
49. According to Dow Jones Theory, share prices (b) Candle Stick charts have a thin vertical line
demonstrate a pattern over ________ showing the price range for a given period that is shaded
(a) Four to five years different colors based on whether the stock ended higher
(b) One year or lower.
(c) One to two years (c) In Point and Figure Chart, emphasis is laid on
(d) Ten to Twenty years charting price changes only and time and volume
elements are ignored.
50. Share price demonstrate a pattern over a period (d) All of the above.
of time as per Dow Jones Theory. Pattern can be:
(a) Primary Trend 58. A __________ indicates the bottom which the
(b) Secondary or intermediate trend share values are unable to pierce.
(c) Minor Trend (a) Support Level
(d) All of the above (b) Resistance Level
(c) Both (a) and (b)
51. If the primary trend is upward, it is called as: (d) None of the above
(a) Bullish phase of the market
(b) Bearish phase of the market 59. A __________ is that level after which the share
(c) Constant phase of the market price refuses to move up in repeated efforts.
(d) None of the above (a) Support Level
(b) Resistance Level
52. In Dow theory, a _________ is the main (c) Both (a) and (b)
direction in which the market is moving. (d) None of the above
(a) Primary Trend
(b) Secondary or intermediate trend 60. Double Top Formation represents a bearish
(c) Minor Trend development, signaling that the price is expected to
(d) None of the above _______

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CS Executive: Financial Management Security Analysis
(a) Rise individuals. As such, the movement in share values is
(b) Fall absolutely random and there is no need to study the
(c) Remain constant trends and movements prior to making investment
(d) None of the above decisions.
(a) Random walk Theory
61. Double bottom formation represents a bearish (b) Random Cake Theory
development, signaling that the price is expected to (c) Fundamental analysis Theory
_______ (d) Technical Analysis Theory
(a) Rise
(b) Fall 69. Efficient market hypothesis accords supremacy
(c) Remain constant to ________
(d) None of the above (a) Internal forces
(b) Employees
62. Which of the following is the limitation of charts (c) Market forces
while analyzing price of a share? (d) Equity market
(a) Interpretation of charts is prone to subjective
analysis 70. As per Efficient market hypothesis, a market is
(b) Often contradictory analysis being derived from the treated as efficient when all known information is
same charts. immediately discounted by all investors and reflected
(c) Decisions are made on the basis of chart alone and in share prices and the only price changes that occur
other factors are ignored. are those resulting from new information.
(d) All of the above. (a) True
(b) False
63. Which of the following is an example of
technical price indicators? 71. Major requirement for an efficient securities
(a) Advance Decline Ratio market include:
(b) Market Breadth Index (a) Prices must be efficient so that new inventions and
(c) Moving Averages better products will cause a firms’ securities prices to
(d) All of the above rise and motivate investors to buy the stocks.
(b) Information must be discussed freely and quickly
64. Advance Decline ratio is the ratio of the number across the nations so that all investors can react to the
of stocks that increase to the number of stocks that new information.
have declined. (c) Transaction costs such as brokerage on sale and
(a) True purchase of securities are ignored.
(b) False (d) All of the above.

65. If the Advance Decline ratio is more than one, 72. Which of the following is not the category of
the trend is assumed to be _________ Efficient Capital Market Hypothesis (ECMH)?
(a) Bullish (a) The strong form of Efficiency
(b) Bearish (b) The semi-strong form of Efficiency
(c) Constant (c) The weak form theory of Efficiency
(d) None of the above (d) The Nil form theory of Efficiency

66. A moving average is the average of share values 73. _______ holds that the prices reflect all
of a set of consecutive number of ____ information that is known and contemplates that
(a) Weeks even the corporate officials cannot benefit from the
(b) Months inside information of the company.
(c) Years (a) The strong form of Efficiency
(d) Days (b) The semi-strong form of Efficiency
(c) The weak form theory of Efficiency
67. If share value is below the moving average, it (d) The Nil form theory of Efficiency
has scope for appreciation.
(a) True 74. The _________ is that part of the capital
(b) False markets that deals with the issuance of new
securities.
68. According to the ________ share prices will rise (a) Primary Market
and fall on the whims and fancies of manipulative (b) Secondary Market

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CS Executive: Financial Management Security Analysis
(c) Both (a) and (b) 82. Which type of market efficiency declares that
(d) None of the above current security prices totally reflect all information,
equally public and private?
75. ________ market enables participants who held (a) Weak
securities to adjust their holdings in response to (b) Semi-strong
changes in their assessment of risks and returns. (c) Strong
(a) Primary Market (d) None of these
(b) Secondary Market
(c) Both (a) and (b) 83. Equity does not include
(d) None of the above (a) cash and paid-in capital
(b) common stock and paid-in capital
76. Suppose one has bought a share of PQR Limited (c) paid-in capital and retained earnings
at ` 224 one year back. Over the last year PQR has (d) common stock, paid-in capital and retained
distributed dividend of `8 per share. If the share of earnings
PQR sells at `250 today, what is the return in `?
84. Dow Jones theory shows that share prices
(a) `8
demonstrate a pattern over four to five years.
(b) `26 (a) True
(c) `34 (b) False
(d) ` 50
85. Which of the following statement is not correct?
77. Based on the above question, what is the annual (a) Investment is conscious act of deployment of
return in percentage terms? money in securities issued by firms.
(a) 11.6% (b) Gambling and betting are games of chance in which
(b) 14% return is dependent upon a particular event happening.
(c) 15.18% (c) Speculation also involves deployment of funds but
(d) 16% it is not backed by a conscious analysis of pros and cons.
(d) None of the above.
78. Based on the above question, if the share is
trading at `220 today, what is the return earned? 86. “A” buy one share of SBI at the beginning of the
(a) 1% year for `500. He hold the stock for one year. `20 in
(b) 1.79% dividends is collected at year-end, and the share is
(c) 1.89% sold for `530. Calculate the return in `?
(d) 2% (a) `20
(b) `30
79. Financial statement analysis helps in:
(c) `40
(a) Evaluating past performance and financial position.
(b) Predicting future performance. (d) `50
(c) Estimating risk, cost of capital and capitalization
rate. 87. Based on the above question, calculate the
(d) All of the above. return in percentage terms?
(a) 5%
80. The major techniques of financial statement (b) 8%
analysis are: (c) 10%
(a) Trend analysis (d) 12%
(b) Comparative analysis
(c) Ratio analysis 88. ________ is the primary motivating force that
(d) All of the above drives investment?
(a) Return
81. A price weighted index is an arithmetic mean of: (b) Risk
(a) Future prices (c) Time
(b) Current prices (d) None of the above
(c) Quarter prices
(d) None of these 89. One of the important property of a security that
the investors are concerned with is the return that
can be expected from holding a security.
(a) True
(b) False
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CS Executive: Financial Management Security Analysis
(b) Current Return > Capital Return
90. Which of the following statement is correct? (c) Capital Return > Current Return
(a) Total Return = Current Return + Capital Return (d) All of the above

ANSWERS

1 2 3 4 5 6 7 8 9 10
(b) (d) (a) (a) (c) (b) (c) (a) (a) (c)
11 12 13 14 15 16 17 18 19 20
(c) (d) (c) (b) (c) (a) (b) (a) (b) (d)
21 22 23 24 25 26 27 28 29 30
(a) (a) (c) (a) (b) (c) (a) (b) (b) (a)
31 32 33 34 35 36 37 38 39 40
(c) (b) (d) (d) (a) (c) (b) (d) (b) (a)
41 42 43 44 45 46 47 48 49 50
(d) (b) (b) (d) (a) (b) (c) (a) (a) (d)
51 52 53 54 55 56 57 58 59 60
(a) (a) (b) (a) (c) (d) (d) (a) (b) (b)
61 62 63 64 65 66 67 68 69 70
(a) (d) (d) (a) (a) (d) (a) (a) (c) (a)
71 72 73 74 75 76 77 78 79 80
(d) (d) (a) (a) (b) (c) (c) (b) (d) (d)
81 82 83 84 85 86 87 88 89 90
(b) (c) (a) (a) (d) (d) (c) (a) (a) (a)

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CS Executive: Financial Management Portfolio Management

11 PORTFOLIO MANAGEMENT

MULTIPLE CHOICE QUESTIONS

1. _______ is the art and science of making (d) None of the above
decision about investment mix.
(a) Portfolio Management 8. _______ management thus refers to managing
(b) Strategic Management efficiently the investment in the securities by
(c) Both (a) and (b) diversifying the investments across industry lines or
(d) None of the above market types.
(a) Portfolio
2. __________ is the policy matching investment to (b) Financial
objectives, asset allocation and balancing risk against (c) Strategic
performance. (d) Resource
(a) Strategic Management
(b) Portfolio management 9. Portfolio theory was originally proposed by
(c) Both (a) and (b) (a) Harry Markowitz
(d) None of the above (b) Henry Fayol
(c) Peter Drucker
3. Who defined Portfolio Management as not a (d) Kenneth Fisher
science, more an art and involves lots of judgment?
(a) Neil Woodford 10. According to Markowitz, investor attitudes
(b) Kenneth Fisher towards portfolio depend upon
(c) Hammer (a) Expected return and risk
(b) Quantification of risk
4. Tasks involved in investment process are (c) Both of the above
(a) Security analysis (d) None of the above
(b) Portfolio selection
(c) Both of the above 11. ______ and _______ are conceptually analogous
(d) None of the above in the series that both of them reflect the degree of
co-movements between two variables.
5. Process that focuses on assessing the risk and (a) Covariance, Correlation
return characteristics of the available investment (b) Coefficient, Correlation
alternatives. (c) Covariance, Coefficient
(a) Security analysis (d) Standard deviation, Correlation
(b) Portfolio selection
(c) Both of the above 12. The ______ the correlation of securities in the
(d) None of the above portfolio, the _______risky the portfolio will be
(a) Lower, Less
6. Process that involves choosing the best possible (b) Higher, Less
portfolio from the set of feasible portfolios. (c) Lower, More
(a) Security analysis (d) Higher, More
(b) Portfolio selection
(c) Both of the above 13. Portfolio risk is sensitive to
(d) None of the above (a) Proportions of funds devoted to each stock
(b) Standard deviation of each stock
7. _________ is the combination of securities. (c) Covariance between the two stocks.
(a) Portfolio (d) All of the above.
(b) Investment
(c) Both of the above

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CS Executive: Financial Management Portfolio Management
14. Who developed the first modern portfolio (b) 4%
analysis model? (c) 5%
(a) Dr. Harry M. Markowitz (d) 5.5%
(b) Peter Drucker
(c) Kenneth Fisher 22. Based on the data of above question, calculate
(d) None of the above the utility?
(a) 6%
15. A portfolio is efficient when it yields _____ (b) 7.5%
return for a particular level of risk or _____ risk for (c) 8.5%
a specified level of expected return. (d) 17.5%
(a) Highest, Minimizes
(b) Lowest, Minimizes 23. Limitation of Markowitz Model include:
(c) Highest, Maximizes (a) The amount of calculations required to be done
(d) Lowest, Maximizes becomes enormous.
(b) In the real world, portfolio analysts do not keep
16. The Markowitz model makes the following track of correlations between stocks of diverse
assumptions regarding investor behavior: industries.
(a) Investors consider each investment alternative as (c) Both (a) and (b).
being represented by a probability distribution of (d) None of the above.
expected returns over some holding period.
(b) Investors maximize one period expected utility and 24. The capital Asset Pricing Model is developed by:
possess utility curve, which demonstrates diminishing (a) Willam F Sharpe, John Linter and Jan Mossin.
marginal utility of wealth. (b) William S Sharpe
(c) Individuals estimate risk on the basis of variability (c) Bow Jones
of expected returns. (d) Key Jones
(d) All of the above.
25. Beta is the ______ risk in a portfolio.
17. Utility is: (a) Diversifiable
(a) Expected return of the portfolio minus a risk (b) Non-Diversifiable
penalty. (c) Both (a) and (b)
(b) Expected return of the portfolio plus a risk penalty. (d) None of the above
(c) Expected return of the portfolio multiply a risk
penalty. 26. _______ measures the relative risk associated
(d) None of the above. with any individual portfolio as measured in relation
to the risk of the market portfolio.
18. Risk penalty  Risk squared / Risk tolerance. (a) Alpha
(a) True (b) Beta
(b) False (c) Gamma
(d) None of the above
19. ______ is the variance of return of the portfolio.
(a) Risk penalty 27. Beta is arrived by
(b) Risk tolerance Non-diversifiable risk of asset or portfolio
Beta 
(c) Risk squared Risk of market portfolio
(d) None of the above (a) True
(b) False
20. The size of the risk tolerance number reflects the
investor’s willingness to bear more risk for more 28. If Beta is more than 1, then:
return and Low (high) tolerance indicates low (high) (a) the stock is riskier than the market
willingness. (b) the stock is not risker than the market
(a) True (c) asset of average
(b) False (d) None of the above
21. If a portfolio’s expected return is 13 percent, 29. If Beta is less than one, then:
variance of return (risk squared) is 225 percent, and (a) the stock is riskier than the market
the investor’s risk tolerance is 50, then the risk (b) market is riskier than stock
penalty is ______ (c) asset of average risk
(a) 4% (d) None of the above

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CS Executive: Financial Management Portfolio Management
(a) Sum of expected rate of return and risk-free rate of
30. A _______ describes the expected return for all return.
assets and portfolios of assets, efficient or not. (b) Difference between expected rate of return and
(a) Security market line risk-free rate of return.
(b) Interest market line (c) Product of expected rate of return and risk-free rate
(c) Risk free market line of return.
(d) Exchange market line (d) None of the above.

31. As per Security Market Line, difference between 39. The capital asset pricing model (CAPM) asserts
the expected return on any two assets can be related that only a single number i.e. a security’s beta
simply to their difference in ________ against the market is required to measure risk.
(a) Market condition (a) True
(b) Risk (b) False
(c) Beta
(d) Alpha 40. The major assumption of Sharpe’s single-index
model is that all the co-variation of security returns
32. The higher beta is for any security, the lower can be explained by a _______
must be its expected return. (a) Single factor
(a) True (b) Two factors
(b) False (c) Three factors
(d) Multiple factors
33. The relationship between beta and expected
return is linear. 41. Below formula is as per:
(a) True R i  α i β i R m  ei
(b) False
Where,
34. Beta is an index of ______ Ri  Expected return on a security
(a) Systematic Risk αi  Alpha Coefficient
(b) Unsystematic Risk
(c) Both (a) and (b) βi  Beta Coefficient
(d) None of the above Rm  Expected Return in market (an index)
35. CAPM is based on various assumptions except: ei  Error term with a mean of zero and a constant
(a) Investors are risk averse and use the expected rate standard deviation.
of return and standard deviation of return as appropriate
measures of risk and return for their portfolio. (a) CAPM Model
(b) Investors make their investments decisions based (b) Single Index Model
on a single period horizon which is the immediate next (c) Multi Index Model
time period. (d) None of the above
(c) Transaction costs are either absent or so low that
these can be ignored. 42. Single Index Model assumes that stocks move
(d) Taxes do affect the choice of buying assets. together only because of a common co-movement
with the market.
36. In the CAPM, the expected rate of return is (a) True
equal to the required rate of return because the (b) False
market is in _______
(a) Risk 43. A multi-index model augments the single index
(b) Safe model by incorporating these extra market factors as
(c) Equilibrium additional independent variables.
(d) None of the above (a) True
(b) False
37. The risk premium can be calculated as:
(a) The sum of Beta and market risk premium.
44. The ________ is a risk-adjusted measure of
(b) The difference of Beta and market risk premium.
return that is often used to evaluate the performance
(c) The product of Beta and market risk premium.
of a portfolio.
(d) None of the above.
(a) Sharpe ratio
38. The risk premium can be calculated as: (b) Index Ratio

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CS Executive: Financial Management Portfolio Management
(c) Both (a) and (b) he can determine the price to pay for the security.
(d) None of the above What is the required rate of return on the security?
(a) 10%
45. Economic Value Added (EVA) is a measurement (b) 10.7%
tool that provides a clear picture of whether a (c) 11%
business is creating or destroying shareholder (d) 11.7%
wealth.
(a) True 51. The market portfolio has a historically based
(b) False expected return of 0.10 and a standard deviation of
0.04 during a period when risk-free assets yielded
46. _______ measures the firm’s ability to earn 0.03. The 0.07 risk premium is thought to be constant
more than the true cost of capital. through time. Riskless investments may now be
(a) Economic Value Added purchased to yield 0.09. A security has a standard
(b) Profit and Loss Statement deviation of 0.08 and a co-efficient to correlation with
(c) Balance Sheet the market portfolio is 0.85. The market portfolio is
(d) Cash Flow Statement now expected to have a standard deviation of 0.04.
You are required to find market’s return-risk trade-
47. If a firm’s earnings exceed the true cost of off.
capital it is creating wealth for its shareholders. (a) 1
(a) True (b) 1.25
(b) False (c) 1.5
(d) 1.75
48. Investor made a ` 20,000 capital investment in
52. Calculate security beta based on the above data?
company. Company’s operating profit, after taxes, is
(a) 1.4
` 10,000. The opportunity cost of that investment is (b) 1.5
10%. Calculate EVA. (c) 1.6
(a) ` 6,000 (d) 1.7

(b) ` 8,000 53. Calculate equilibrium required expected return

(c) ` 10,000 of the security based on the above data?
(a) 20%
(d) ` 20,000 (b) 20.9%
(c) 21.2%
49. You have been asked to estimate the beta of a (d) 23%
high-technology firm which has three divisions with
the following characteristics. 54. The Security Market Line (SML) graphs the
Division Beta Market Value expected relationship between:
Personal 1.60 ` 100 million (a) Business risk and financial risk
Computer (b) Systematic risk and unsystematic risk
(c) Risk and return
Software 2.00 ` 150 million
(d) None of the above
Computer 1.20 ` 250 million
55. Modern portfolio theory assumes that most
What is the beta of the equity of the firm? investors are:
(a) 1 (a) Risk averse
(b) 1.2 (b) Risk neutral
(c) 1.52 (c) Risk tolerant
(d) 1.6 (d) None of the above

50. Dhanpat, an investor, is seeking the price to pay 56. An individual who select the investment that
for a security, whose standard deviation is 5%. The offers greater certainty when everything else is the
correlation coefficient for the security with the same is known as a risk averse investor.
market is 0.75 and the market standard deviation is (a) True
4%. The return from risk-free securities is 6% and (b) False
from the market portfolio is 11%. Dhanpat knows
that only by calculating the required rate of return,

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CS Executive: Financial Management Portfolio Management
57. Although derivatives can be used as speculative (a) Standard deviation
instruments, businesses most often use them to: (b) Coefficient of variation
(a) Hedge (c) Correlation coefficient
(b) Offset debt (d) Beta
(c) Appease stakeholders
(d) Attract customers 65. The greater the beta, the ________ of the
security involved.
58. Which of the following statements regarding (a) Greater the unavoidable
risk averse investors are true? (b) Greater the avoidable risk
(a) They only accept risky investments that offer risk (c) Less the unavoidable risk
premiums over the risk-free rate. (d) Less the avoidable risk
(b) They accept investments that are fair games.
(c) The only care about the rate of return. 66. Plaid Pants, Inc. common stock has a beta of
(d) They are willing to accept lower returns and high 0.90. The expected return on the market is 10
risk. percent, and the risk-free rate is 6 percent.
According to the capital-asset pricing model (CAPM)
59. Olivia is a risk-averse investor. Alex is a less and making used of the information above, the
risk-averse investor than Olivia. Therefore, required return on Plaid Pants’ common stock
(a) For the same risk, Alex requires a higher rate of should be:
return than Oliva. (a) 3.6%
(b) For the same return, Alex tolerates higher risk than (b) 9.6%
Olivia. (c) 9.0%
(c) For the same risk, Oliva requires a lower rate of (d) 14.0%
return than Alex.
(d) Cannot be determined. 67. Acme Dynamite Company common stock has a
beta of 1.80. The expected return on the market is 10
60. This type of risk is avoidable through proper percent, and the risk-free rate is 6 percent.
diversification: According to the capital-asset pricing model (CAPM)
(a) Portfolio risk and making use of the information above, the
(b) Systematic risk required return on common stock should be:
(c) Unsystematic risk (a) 7.2%
(d) Total risk (b) 13.2%
(c) 18.0%
61. A statistical measure of the degree to which two (d) 23.0%
variables (e.g., securities’ returns) move together:
(a) Coefficient of variation 68. The beta of the market portfolio is:
(b) Variance (a) Zero
(c) Covariance (b) One
(d) Certainty equivalent (c) Ten
(d) Negative
62. An “aggressive” common stock would have a
“beta”: 69. The market risk premium is 15% and the risk-
(a) Equal to zero free rate is 5%. The beta of Asset D is 0.2. What is
(b) Greater than one Asset D’s expected return under the CAPM?
(c) Equal to one (a) 5%
(d) Less than one (b) 7%
(c) 8%
63. The risk-free security has a beta equal to (d) 10%
_______, while the market portfolio’s beta is equal to
_______ 70. The beta of the risk-free asset is:
(a) One; more than one (a) Zero
(b) One; less than one (b) One
(c) Zero; one (c) Ten
(d) Less than zero; more than zero (d) Negative

64. ______ is a measure of “risk per unit of expected 71. Two alternative expected returns are compared
return.” with help of:

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CS Executive: Financial Management Portfolio Management
(a) coefficient of variation (b) sell short CAT because it is overpriced.
(b) coefficient of deviation (c) sell stock short CAT because it is underpriced.
(c) coefficient of standard (d) Buy CAT because it is underpriced.
(d) None of the above
79. The risk-free rate is 4 percent. The expected
72. Dollar return is divided by amount invested is market rate of return is 11 percent. If you expect
used to calculate: CAT with a beta of 1.0 to offer a rate of return of 10
(a) Rate of return percent, you should
(b) Return amount (a) buy CAT because it is overpriced.
(c) Investment rate (b) sell short CAT because it is overpriced.
(d) Received amount (c) sell stock short CAT because it is underpriced.
(d) buy CAT because it is underpriced.
73. Yield on bond is 7% and market required
return is 14% then market risk premium is: 80. You invest $600 in a security with a beta of 1.2
(a) 2% and $400 in another security with a beta of 0.90. The
(b) 21% beta of the resulting portfolio is
(c) 5% (a) 1.40
(d) 7% (b) 1.00
(c) 0.36
74. Yield on bond is 10% and market required (d) 1.08
return is 18% then market risk premium is:
(a) 10% 81. In a well-diversified portfolio
(b) 28% (a) market risk is negligible
(c) 5% (b) systematic risk is negligible
(d) 8% (c) unsystematic risk is negligible
(d) risk does not exist.
75. Risk which affects firms with factors such as
war, recessions, inflation and high interest rates is 82. The risk-free rate and the expected market rate
classified as: of return are 5.6% and 12.5%, respectively.
(a) Diversifiable risk According to the capital asset pricing model
(b) Market risk (CAPM), the expected rate of return on a security
(c) Stock risk with a beta of 1.25 is equal to:
(d) Portfolio risk (a) 14.2%
(b) 14.5%
76. You invest 55% of your money in security A (c) 15%
with a beta of 1.4 and the rest of your money in (d) 15.5%
security B with a beta of 0.9. The beta of the resulting
portfolio is: 83. The risk-free rate and the expected market rate
(a) 1.12 of return are 6% and 12% respectively. According to
(b) 0.97 the capital asset pricing model (CAPM), the expected
(c) 1.08 rate of return on security X with a beta of 1.2 is equal
(d) 1.18 to:
(a) 10%
77. You invest 60% of your money in security A (b) 12%
with a beta of 1.2 and the rest of your money in (c) 13.2%
security B with a beta of 0.8. The beta of the resulting (d) 14.2%
portfolio is:
(a) 1.04 84. Assume that a security is fairly priced and has
(b) 1.08 an expected rate of return of 0.17. The market
(c) 1.12 expected rate of return is 0.11 and the risk-free rate
(d) 1.16 is 0.04. The beta of the stock is:
(a) 1.25
78. The risk-free rate is 4 percent. The expected (b) 1.86
market rate of return is 11 percent. If you expect (c) 1
CAT with a beta of 1.0 to offer a rate of return of 13 (d) 0
percent, you should
(a) buy CAT because it is overpriced.

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CS Executive: Financial Management Portfolio Management
85. You invest 50% of your money in security A 92. Security A has a higher standard deviation of
with a beta of 1.6 and the rest of your money in returns than Security B. We would expect that
security B with a beta of 0.7. The beta of the resulting ______
portfolio is: (I) Security A would have a higher risk premium than
(a) 1.40 Security B.
(b) 1.15
(II) The likely range of returns for Security A in any
(c) 0.36
given year would be higher than the likely range of
(d) 1
returns for Security B.
86. You invest $200 in security A with a beta of 1.4 (III) The Sharpe measure of A will be higher than the
and $800 in security B with a beta of 0.3. The beta of Sharpe measure of B.
the resulting portfolio is:
(a) 1.40 (a) (I) only
(b) 1 (b) (I) and (II) only
(c) 0.52 (c) (II) and (III)
(d) 1.1 (d) (I), (II), (III)

87. You invest $200 in security A with a beta of 1.4 93. Other things equal, diversification is most
and $800 in security B with a beta of 0.3. The beta of effective when
the resulting portfolio is: (a) securities’ returns are uncorrelated.
(a) 1.25 (b) securities’ returns are positively correlated.
(b) 1.7 (c) securities’ returns are high.
(c) 0.7 (d) securities’ returns are negatively correlated.
(d) 1
94. Assume that CAPM is true and alive and the
88. In the context of the Capital Asset Pricing Model expected market return is 15% and the expected
(CAPM) the relevant measure of risk is: return on a stock with a beta of 2 is 22%. What is the
(a) Unique risk risk-free rate?
(b) Beta (a) 2%
(c) Standard deviation of return (b) 4%
(d) Variance of return (c) 8%
(d) 10%
89. No matter how large the number of stocks in the
portfolio is, the risk that cannot be diversified away 95. Which of the following sayings illustrates the
is the: concept of diversification?
(a) Systematic risk (a) Don’t throw the baby out with the bath water.
(b) Unsystematic risk (b) A stitch in time saves nine.
(c) Both (a) and (b) (c) Neither a borrower nor a lender be.
(d) None of the above (d) Don’t put all your eggs in one basket.

90. CAPM stands for: 96. Consider the CAPM. The risk-free rate is 5%
(a) Capital assets for Pricing & Monitoring and the expected return on the market is 15%. What
(b) Capital assets for Pricing Model is the beta on a stock with an expected return of
(c) Capital Account and Pricing Mechanism 17%?
(d) None of the above (a) 0.5%
(b) 0.7
91. A portfolio comprises two securities and the (c) 1
expected return on them is 12% and 16% (d) 1.2
respectively. Determine return of portfolio if first
security constitutes 40% of total portfolio? 97. You have a $50,000 portfolio consisting of Intel,
(a) 12.4% GE and Con Edison. You put $20,000 in Intel,
(b) 13.4% $12,000 in GE and the rest in Con Edison. Intel GE
(c) 14.4% and Con Edison have betas of 1.3, 1.0 and 0.8
(d) 15.4% respectively. What is your portfolio beta?
(a) 1.048
(b) 1.033
(c) 1,000

Unique Academy 11.7 Prof. Ashish Parikh

CS Executive: Financial Management Portfolio Management
(d) 1.037 the market expected rate of return is 15%.
According to the capital asset pricing model, security
98. Security X has an expected rate of return of X is _________.
13% and a beta of 1.15. The risk-free rate is 5% and (a) fairly priced
the market expected rate of return is 15%. (b) overpriced
According to the capital asset pricing model, security (c) underpriced
X is ________ (d) None of the above
(a) fairly priced
(b) overpriced 100. In the CAPM, the expected rate of return is
(c) underpriced equal to the required rate of return because the
(d) None of the above market is in equilibrium.
(a) True
99. Security X has an expected rate of return of (b) False
18% and a beta of 1.15. The risk-free rate is 5% and

ANSWERS

1 2 3 4 5 6 7 8 9 10
(a) (b) (a) (c) (a) (b) (a) (a) (a) (c)
11 12 13 14 15 16 17 18 19 20
(a) (a) (d) (a) (a) (d) (a) (a) (c) (a)
21 22 23 24 25 26 27 28 29 30
(b) (c) (c) (a) (b) (b) (a) (a) (b) (a)
31 32 33 34 35 36 37 38 39 40
(c) (b) (a) (a) (d) (c) (c) (b) (a) (a)
41 42 43 44 45 46 47 48 49 50
(b) (a) (a) (a) (a) (a) (a) (b) (c) (b)
51 52 53 54 55 56 57 58 59 60
(d) (d) (b) (c) (a) (a) (a) (a) (b) (c)
61 62 63 64 65 66 67 68 69 70
(c) (b) (c) (b) (a) (b) (b) (b) (c) (a)
71 72 73 74 75 76 77 78 79 80
(a) (a) (d) (d) (b) (d) (a) (c) (b) (d)
81 82 83 84 85 86 87 88 89 90
(c) (a) (c) (b) (b) (c) (d) (b) (a) (b)
91 92 93 94 95 96 97 98 99 100
(c) (b) (d) (c) (d) (d) (a) (b) (c) (a)

Unique Academy 11.8 Prof. Ashish Parikh