Paper8 Solution PDF

Answer to MTP_Intermediate_Syllabus 2012_Jun2014_Set 2
Paper-8: Cost Accounting & Financial Management
Time Allowed: 3 Hours Full Marks: 100
Section A- Cost Accounting

(Answer Question No.1 which is compulsory and any three from the rest in this section)
Working Notes should form part of the answer.
1. (a) A work measurement study was carried out in a firm for 20 hours and the following
information was generated.
Units produced 340
Idle time 15%
Performance rating 120%
Allowance time 10% of standard time
What is the Standard time for task? [2]
Answer:
Calculation of standard time for task
Total time= 20X60 =1200 minutes
(-) Down time or idle time @ 15% = 180 minutes
Actual time =1020 minutes
Normal time= 1020 X 120% =1224 minutes
(+) Relaxation allowance(10% or 1/10 on standard time = 136 minutes
i.e. 1/9 on normal time)
Standard time for job =1360 minutes
Standard time for each unit=1360/340 =4 minutes
(b) What is Sunk Cost? [2]
Answer.
Sunk costs are historical costs which are incurred i.e. sunk in the past and are not relevant to the
particular decision making problem being considered. Sunk costs are those that have been
incurred for a project and which will not be recovered if the project is terminated. While
considering the replacement of a plant, the depreciated book value of the old asset is irrelevant
as the amount is sunk cost which is to written-off at the time of replacement.
(c) Time allowed for a job is 45 hours; a worker takes 40 hours to complete the job. Time rate per
hour is `15. Compute the total earnings of the worker. [2]
Answer.
Total Earnings =H x R+ 50% [S-H] R
Total Earnings =40 x `15+50% [45-40] × `15
Total Earnings =`600+ `37.5= `637.50
(d) A firm requires 16,000 nos. of certain component, which it buys at `60 each. The cost of
placing an order and following it up is `120 and the annual storage charges work out to 10% of
Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 1
the cost of the item. To get maximum benefit the firm should place order for how many units at a
time? [2]
Answer.
Annual demand=16,000 units
Ordering cost=` 120
Storage cost=10% of `60 =` 6
2 Annualdemand orderingcost
EOQ=
10%of `60
2 16,000 120
= =800units
6
(e) Consider the following particulars for a month :

Budgeted fixed production overhead cost - ` 1,10,000
Budgeted production - 5,500 units
The fixed overhead cost was under absorbed by ` 12,000 and the fixed production overhead
expenditure variance was ` 2,500 (Adverse).
What is the number of units produced during the month was ? [2]
Answer.
Fixed overhead recovery rate = Fixed overhead cost / Production (units)
= ` 1,10,000/ 5,500 units
= ` 20 / unit
Budgeted fixed overhead ` 1,10,000
Add : Fixed overhead expenditure variance ` 2,500
Actual fixed overhead ` 1,12,500
Absorbed overhead = Actual fixed overhead – Under absorbed overhead

= ` 1,12,500 – 12,000 = ` 1,00,500
Actual production = Overhead absorbed / Fixed overhead rate = ` 1,00,500 / ` 20

= 5,025 units.
(f) If the minimum stock level and average stock level of raw material “A” are 4,000 and 9,000
units respectively, find out its reorder quantity. [2]
Answer.
Average stock level = Minimum stock level + ½ Reorder quantity
9,000 units = 4,000 units + ½ Reorder quantity
½ Reorder quantity = 9,000 units – 4,000 units
Reorder level = 5, 000 units / 0.5 = 10,000 units
2. (a) State the various causes of Labour Turnover? [6]
Answer:
The causes of Labour Turnover can be divided into two categories: Avoidable and unavoidable.
(i) Avoidable Causes: These causes include the following:
Dissatisfaction with the job.

Dissatisfaction with the working hou`
Dissatisfaction with the working environment.
Relationship with colleagues.
Dissatisfaction with monetary and non monetary incentives.
Relationship with superio`
Other reasons like lack of facilities like absence of group insurance, good canteens,
poor housing amenities, bad management etc.
(ii) Unavoidable causes: These causes include the following:
Personnel betterment
Retirement
Death
Illness or accident
Termination
Marriage
Pregnancy
Other reasons like family commitments, attitude, organizational culture, etc.
(b) For a production department of a manufacturing company you are required to:
(i) Prepare a flexible budget of overhead
(ii) Prepare flexible budget of overhead at 70% and 110% of budget volume;
(iii) Calculate a departmental hourly rate of overhead absorption as per (i) and (ii) above.
The budgeted level of activity of the department is 5,000 hours per period and the study of the
various items of expenditure reveals the following:
` ` per hour
Indirect wages 0.40
Repairs upto 2,000 hours 100
For each additional 500 hours
Upto a total of4,000 hours 35
Additional from 4,001 to 5,000 h` 60
Additional above 5,000 h` 70
Rent and Rates 350
Power upto 3,600 hrs 0.25
For hours above 3,600 0.20
Consumable supplies 0.24
Supervision upto 2,500 hours 400
Additional for each extra 500 hrs
Above 2,500 and upto 4,900 hrs 100
Additional above 4,900 hrs 150
Depreciation up to 5,000 hrs 650
Above 5,000 hrs and upto 6,500 h` 820
Cleaning upto 4,000 h` 60
Above 4,000 hrs 80
Heating and Lighting from 2,100 hrs to 3,500 120
hrs
Heating and Lighting from 3,500 hrs to 5,000 150
hrs
Above 5,000 hrs 175
(1½ + 3 + 1½)
Answer:
Fixed and Flexible budget showing overhead cost per hour:

Particulars (3,500) (5,000) (5,500)
70% 100% 110%
Indirect wages (0.4/h`) 1,400 2,000 2,200
Repairs 205 300 370
Rent & Rates 350 350 350
Power 875 1,180 1,280
Consumable supplies 840 1,200 1,320
Supervision 600 950 950
Depreciation 650 650 820
Cleaning 60 80 80
Heating & Lighting 120 150 175
5,100 6,860 7,545
OH rate per hour [5,100/3,500] [6,860/5,000] [7,545/5,500]
=1.457 =1.372 =1.371
1. If under absorbed OH is 10% or more of actual OH incurred-Supplementary OH rate is
applied. (or)
2. If the amount is considerable, supplementary OH rate applied otherwise we may follow,
transferring to P & L A/c or carry forward to next year.
Working Notes:
Repairs 100+(3×35) 100+(4×35)+60 100+(4×35)+60+70
=205 =300 =370
Power (3,500×0.25) (900+280) 900+280+100
=875 =1,180 =1,280
Supervision 400+(2×100) 400+(4×100)+150 400+(4×100)+150
=600 =950 =950
(c) Write a note on Perpetual Inventory. [4]
Answer:
Perpetual Inventory system means continuous stock taking. Under this system, a continuous
record of receipt and issue of materials is maintained by the store department and the
information about the stock of materials is always available. Entries in the Bin Card and the
Stores Ledger are made after every receipt and issue and the balance is reconciled on regular
basis with the physical stock.
The main advantage of this system is that it avoids disruptions in the production caused by
periodic stock taking.
Similarly this system helps in having detailed and more reliable check on the stocks. The stock
records are more reliable and stock discrepancies are investigated and appropriate action is
taken immediately.
3. (a) Calculation of a basic EOQ depends on certain assumptions. "List down these
assumptions. [3]
Answer
The computation of economic order quantity is subject to the following assumptions:
(i) Ordering cost (per order) and carrying cost (per unit/annum) are known and constant.
(ii) Anticipated usage (in units) of material for a period is uniform and known.
(iii) Cost per unit of the material (to be purchased) is known and it is constant.
(b) The New Enterprises Ltd. has Production Depts. A, B and C and two Service Depts. D and
E. The following figures are extracted from the records of the company.
Rent and Rates `5,000
General Lighting 600
Indirect Wages 1,500
Power 1,500
Depreciation of Machinery 10,000
Sundries 10,000
The following further details are available:

Total A B C D E
Floor Space (Sq. ft.) 10,000 2,000 2,500 3,000 2,000 500
Light Points 60 10 15 20 10 5
Direct Wages (`) 10,000 3,000 2,000 3,000 1,500 500
H.P. of Machines 150 60 30 50 10 -
Value of Machinery (`) 2,50,000 60,000 80,000 1,00,000 5,000 5,000
Working Hours - 6,226 4,028 4,066 - -
The expenses of D and E are allocated as following:
A B C D E
D 20% 30% 40% - 10%
E 40% 20% 30% 10% -
What is the total cost of an article if its raw material cost is ` 50, labour cost ` 30, and it passes
through departments A, B and C for 4, 5 and 3 hours respectively. [8]
Answer:
(i) OVERHEADS PRIMARY DISTRIBUTION SUMMARY
Items Basis of Charge Total Production Deptts. Service Deptts.
A B C D E
` ` ` ` ` `
Direct Wages Allocation 2,000 - - - 1,500 500
Rent and Rates ` 0.50 per sq. ft. 5,000 1,000 1,250 1,500 1,000 250
General Lighting ` 0.10 per point 600 100 150 200 100 50
Indirect Wages 15% of Direct
Wages 1,500 450 300 450 225 75
Power `10 per H.P. 1,500 600 300 500 100 -
Depreciation of 4% of the value
Machinery of Machinery 10,000 2,400 3,200 4,000 200 200
Sundries 100% of Direct
Wages 10,000 3,000 2,000 3,000 1,500 500
Total Departmental Overheads 30,600 7,550 7,200 9,650 4,625 1,575
(ii) OVERHEADS SECONDARY DISTRIBUTION SUMMARY

(REPEATED DISTRIBUTION METHOD)
Items Production Deptts. Service Deptts.
A B C D E
Total overheads as per (i) 7,550 7,200 9,650 4,625 1,575

Dept. D overheads apportioned 925 1,387 1,850 (4,625) 463
Dept. E overheads apportioned
(1,575 + 463) 815 408 611 204 (2,038)
Dept. D overheads apportioned 41 61 82 (204) 20
Dept. E overheads apportioned 8 4 6 2 (20)
Dept. D overheads apportioned - 1 1 (2) -
Total 9,339 9,061 12,200
Working Hours 6,226 4,028 4,066
Rate per hour 1.50 2.25 3.00
STATEMENT SHOWING THE TOTAL COST OF THE ARTICLE
Direct Material ` 50.00

Direct Labour 30.00
80.00
Prime Cost
Overheads:
Department A : 4 hours @ ` 1.50 per hour 6.00
Department B : 5 hours @ ` 2.25 per hour 11.25
Department C : 3 hours @ ` 3.00 per hour 9.00 26.25
106.25
(c) Calculate the earnings of A and B from the following particulars for a month and allocate
the labour cost to each job X, Y and Z:
A B
(i) Basic Wages ` 100 160
(ii) Dearness Allowance 50% 50%
(iii) Contribution to Provident Fund (on basic wages) 8% 8%
(iv) Contribution to Employees‟ State Insurance
(on basic wages) 2% 2%
(v) Overtime Hours 10
The Normal working hours for the month are 200. Overtime is paid at double the total of
normal wages and dearness allowance. Employer‟s contribution to State Insurance and
Provident Fund are at equal rates and employees‟ contributions. The two workers were
employed on jobs X, Y and Z in the following proportions:
Jobs
X Y Z
Workers A 40% 30% 30%
Worker B 50% 20% 30%
Overtime was done on job Y.
[2+3]
Answer.
Statement Showing Earnings of Workers A and B
Workers: A B
` `
Basic Wages 100 160
Dearness Allowance
(50% of Basic Wages) 50 80
Overtime Wages 15 -
(Refer to Working Note 1)

Gross Wages earned 165 240
Less: - Provident Fund – 8% of Basic wages
- ESI – 2% of Basic wage 10 16
Net Wages paid 155 224
Statement of Labour Cost: ` `

Gross Wages 150 240
(excluding overtime)
Employer‟s Contribution to P.F. and E.S.I. 10 16
Ordinary wages 160 256
Labour Rate per hour 0.80 1.28
(` 160/200) (` 256/200)
Statement Showing allocation of Wages to Jobs

Jobs
Total Wages: X Y Z
` ` ` `
Worker A:
Ordinary Wages: 160 64 48 48
(4 : 3 :3)
Overtime 15 – 15 –
Workers B:
Ordinary Wages: 256 128 51.20 76.8
(5: 2 : 3)
431 192 114.2 124.8
Working Notes:
1. Normal Wages are considered as basic wages
2 (Basic wage D.A.)
Overtime 10 hours
200
= 2 × (` 150/200) × 10 hours = ` 15/-.
4. (a) What do you understand by ABC analysis of inventory control ? A factory uses 4,000
varieties of inventory. In terms of inventory holding and inventory usage, the following
information is compiled:
No. of varieties % % value of inventory % of inventory
of inventory holding (average) usage (in
end-product)
3,875 96.875 20 5
110 2.750 30 10
15 0.375 50 85
4,000 100.000 100 100
Classify the items of inventory as per ABC analysis with reasons. [3+2+2+2]
Answer
ABC Analysis: It is a system of selective inventory control whereby the measure of control over
an item of inventory varies with its usage value. It exercises discriminatory control over different
items of stores grouped on the basis of the investment involved. Usually the items of material are
grouped into three categories viz; A, B and C according to their use value during a period. In
other words, the high use value items are controlled more closely than the items of low use
value.
(i) 'A' Category of items consists of only a small percentage i.e., about 10% of the total items of
material handled by the stores but require heavy investment i.e., about 70% of inventory
value, because of their high prices and heavy requirement.
(ii) 'B' Category of items comprises of about 20% of the total items of material handled. by
stores. The percentage of investment required is about 20% of the total investment in
inventories.
(iii) 'C' category of items do not require much investment. It may be about 10% of total
inventory value but they are nearly 70% of the total items handled by stores.
'A' category of items can be controlled effectively by using a regular system which ensures
neither over-stocking nor shortage of materials for production: Such a system plans its total
material requirements by making budgets. The stocks of materials are controlled by fixing certain
levels like maximum level, minimum level and re-order level. A reduction in inventory
management costs is achieved by determining economic order quantities after taking into
account ordering cost and carrying cost. To avoid shortages and to minimize heavy investment
of funds in inventories, the techniques of value analysis, variety reduction, standardisation etc.
are used along with aforesaid techniques.
In the case of 'B' category of items, as the sum involved is moderate, therefore the same degree
of control as applied in 'A' category of items is not warranted. The orders for the items, belonging
to this category may be placed after reviewing their situation periodically. This category of items
can be controlled by routine control measures.
For 'C' category of items, there is no need of exercising constant control. Orders for items in this
group, may be placed either after six months or once in a year, after ascertaining consumption
requirements.
Classification of the items of inventory as per ABC analysis

1. 15 number of varieties of inventory items, should be classified as 'A' category items because
of the following reasons:
(i) Constitute 0.375% of total number of varieties of inventory items handled by stores of
factory, which is minimum as per given classification in the table.
(ii) 50% of total use value of inventory holding (average) which is maximum according to
the given table.
(iii) Highest consumption of about 85% of inventory usage (in end-product).
2. 110 number of varieties of inventory items, should be classified as 'B' category items because
of the following reasons:
(i) Constitute 2.750% of total number of varieties of inventory items handled by stores of
factory.
(ii) Requires moderate investment of about 30% of total use value of inventory holding
(average).
(iii) Moderate consumption of about 10% of inventory usage (in end- product).
3. 3,875 number of varieties of inventory items, should be classified as 'C' category items
because of the following reasons:
(i) Constitute 96.875% of total varieties of inventory items handled by stores of factory.
(ii) Requires investment of 20% of total use value of inventory holding (average).
(iii) Minimum consumption i.e. about 5% of inventory usage (in end-product).
(b) Raw materials „AXE‟ costing ` 150 per kg. and „BXE‟ costing ` 90 per kg. are mixed in
equal proportions for making product „A‟. The loss of material in processing works out to 25%
of the product. The production expenses are allocated at 40% of direct material cost. The
end product is priced with a margin of 20% over the total cost.
Material „BXE‟ is not easily available and substitute raw material „CXE‟ has been found for
„BXE‟ costing ` 75 per kg. It is required to keep the proportion of this substitute material in the
mixture as low as possible and at the same time maintain the selling price of the end product
at existing level and ensure the same quantum of profit as at present.
You are required to compute the ratio of the mix of the raw materials „AXE‟ and „CXE. [7]
Answer
Working Notes:
(i) Computation of material mix ratio:
Let 1 kg. of product A requires 1.25 kg. of input of materials A X E and B X E
Raw materials are mixed in equal proportions.
1.25
Then raw material A X E = .625 kg.
2
1.25
Then raw material B X E = .625 kg.
2
(ii) Computation of selling price / kg. of product A
`
Raw material A X E .625 kg. 150 = ` 93.75
Raw material B X E .625 kg. 90 = ` 56.25 150.00
Production expenses (40% of material cost) 60.00
Total cost 210.00
Add: profit 20% of total cost 42.00
Selling price 252.00
Computation of proportions of materials A X E and C X E in „A‟
Let material C X E required in product A be m kg.
Then for producing 1 kg of product „A‟, material A X E requirement = (1.25 m) kg.
To maintain same level of profit and selling price as per Working note (ii), it is required that
the total cost of material in 1 kg. of product A should not exceed ` 150,
i.e., m kg. ` 75 + (1.25 m) kg. 150 = ` 150
or 75 m + 187.5 – 150 m = 150
or 75 m = 37.5
or m = 0.5 kg.
Raw material A X E requirement in product A = 1.25 – 0.5 = 0.75 kg.
So, proportion of material A X E and C X E = 0.75 : 0.50 i.e. 3 : 2.
5. (a) A Company is undecided as to what kind of wage scheme should be

introduced. The following particulars have been compiled in respect of three systems, which
are under consideration of the management.
Workers A B C
Actual hours worked in a week 38 40 34
Hourly rate of wages `6 `5 ` 7.20
Production in units
Product P 21 - 60
Product Q 36 - 135
Product R 46 25 -
Standard time allowed per unit of each product is:

P Q R
Minutes 12 18 30
For the purpose of piece rate, each minute is valued at ` 0.10
You are required to calculate the wages of each worker under:
(i) Guaranteed hourly rates basis
(ii) Piece work earnings basis, but guaranteed at 75% of basic pay (guaranteed hourly rate)
if his earnings are less than 50% of basic pay.
(iii) Premium bonus basis where the worker receives bonus based on Rowan scheme.
[2+3+3]
Answer
(i) Computation of wages of each worker under guaranteed hourly rate basis
Workers Actual hours Hourly rate of wages Wages
worked in a week ` `
(a) (b) (c) (d) = (b) × (c)
A 38 6.00 228.00
B 40 5.00 200.00
C 34 7.20 244.80
(ii) Computation of wages of each worker under piece work earnings basis
Workers Time Time Time Wage Earnings Bonus Total of

allowed taken saved rate/hour earning &
hours (Refer hours hours bonus
to W. Note ` `
`
2) `
A 38.00 38.00 - 6.00 228.00 - 228.00

B 12.50 40.00 - 5.00 200.00 - 200.00
C 52.50 34.00 18.50 7.20 244.80 86.26 331.06
Since each worker has been guaranteed at 75% of basic pay, if his earnings are less than
50% of basic pay, therefore, workers A and C will be paid the wages as computed viz., ` 228
and ` 315 respectively. The computed wage of worker B is ` 75 which is less than 50% of
basic pay viz., ` 100 therefore he would be paid 75% × ` 200 or s. 150.
Working Notes:
1. Piece rate / per unit
Product Standard time per Piece rate each Piece rate per unit `
unit in minutes minute `
(a) (b) (c) (d) = (b) × c
P 12 0.10 1.20
Q 18 0.10 1.80
R 30 0.10 3.00
2. Time allowed to each worker

Worker A = 21 units × 12 minutes + 36 units × 18 minutes + 46 units × 30 minutes
= 2,280 minutes = 38 hours
Worker B = 25 units × 30 minutes = 750 minutes = 12.5 hours
Worker C = 60 units × 12 minutes + 135 units × 18 minutes

= 720 minutes + 2.430 minutes = 3,150 minutes = 52.50 hours
(iv) Computation of wages of each worker under Premium bonus basis (where each worker
receives bonus based on Rowan Scheme)
Workers Time Time Time Wage Earnings Bonus Total of

allowed taken saved rate/hour earning
hours hours hours ` ` & bonus
(Refer to ` `
W. Note 2)
A 38.00 38.00 - 6.00 228.00 - 228.00
B 12.50 40.00 - 5.00 200.00 - 200.00
C 52.50 34.00 18.50 7.20 244.80 86.26 331.06
(b) SK Enterprise manufactures a special product “ZE”. The following particular s were
collected for the year 2013:
Annual consumption 12,000 units (360 days)
Cost per unit `1
Ordering cost ` 12 per order
Inventory carrying cost 24%
Normal lead time 15 days
Safety stock 30 days consumption
Required:
(i) Re-order quantity
(ii) Re-order level
(iii) What should be the inventory level (ideally) immediately before the material order
is received? (2+1+1)
Answer
(i) How much should be ordered each time i.e., Economic Order Quantity (EOQ)
2 AB
EOQ =
CS
Where A is the annual consumption
B is the ordering cost per order
CS is the carrying cost per unit per annum
2 12,000 12
= 12,00,000
1 (24 / 100)
= 1095.4 units or say 1,100 units.
(ii) When should the order be placed i.e., reordering level
Reordering level = *Safety stock normal lead time consumption
12000 12,000
Reordering level = 30 15
360 360
= 1,000 500 = 1,500 units.
(iii) What should be the inventory level (ideally) immediately before the material ordered is
received i.e. the Safety Stock.
12,000
*Safety Stock = 30
360
= 1,000 units.
(c) Explain the treatment of overtime premium in cost accounting. Suggest steps for
controlling overtime. [2+2]
Answer
Treatment of Overtime premium is Cost Accounting
In cost accounting the treatment of overtime premium will be as follows:
(i) If the overtime is resorted to at the desire of the customer, then the entire amount of
overtime including overtime premium should be charged to the job directly.
(ii) If it is due to a general pressure of work to increase the output, the premium as well as
overtime wages may be charged to general overheads.
(iii) If it is due to the negligence or delay of workers of a particular department, it may be
charged to the concerned department.
(iv) If it is due to circumstances beyond control, it may be charged to Costing Profit & Loss
Account.
Steps for Controlling Overtime:

Important steps for controlling overtime work are as follows:
(i) Entire overtime work should be duly authorized after investigating the reasons for it.
(ii) Overtime cost should be shown against the concerned department. Such a practice
should enable proper investigation and planning of production in future.
(iii) If overtime is a regular feature, the necessity for recruiting more men and adding a shift
should be considered.
(iv) If overtime is due to lack of plant and machinery or other resources, steps may be taken
to install more machines, or to resort to sub-contracting.
(v) If possible an upper limit may be fixed for each category of workers in respect of
overtime.
Section B–Financial Management
(Answer Question no.6 which is compulsory and any two from the rest in this section.)
6. (a) GEMINI LTD. has total assets of `60 crore and a Debt/equity ratio of 0.5. Its sales are
`27 crore and it has total fixed cost of `7 crore. If the company‟s EBIT is `6 crore, its tax rate is
40% and the interest rate on debt is 12%, the ROE of GEMINI LTD. would be how much? [2]
Answer.
Total Equity+ Total Debt =`60 crore
Total equity= (60/1.5) =`40 crore
Total Debt= (60-40) =`20 crore
Net income= [(EBIT)-1] × (1-t) =(6-2.40) (1-.40)
=3.60×0.6
= `2.16 crore.
ROE = (2.16/40) ×100 = 5.40%
(c) The budgeted annual sales of firm are `80 lakhs and 25% of the same is cash sales. If the
average amount debtors of the firm are 5 lakhs, the average collection period of credit sales will
be how many months‟ ? [2]
Answer.
Cash Sales = 80 lakhs×25%= 20 lakhs
Credit sales = (80-20) lakhs= 60 lakhs
Average Collection Period = Debtors/(Credit Sales/month)
= (5÷60/12)
= 5÷5
=1 month.
(c) A chemical company has net sales of `50 million, cash expenses (including Taxes) of `35
million and depreciation expenses of `5 million. If Debtors decrease over the period by `6
million, what will be the cash from operation? [2]
Answer.
Cash from operation = Operation profit + Non cash charges + Decrease in debtors
= ` [(50-35-5) +5+6] million = `21 million
(d) Consider the following for strong Ltd: [2]

Return on Government Securities : 12%
Share Beta : 1.50
Market Return : 16%
Based on CAPM, find out the cost of equity capital.
Answer.
Cost of equity Capital (K e ) Rf β(Rm Rf )
= 0.12+1.50 (0.16-0.12)
= 0.18 i.e., 18%
7. (a) From the following details of HPL Ltd. Calculate the Cost of Capital.
Debt Amount Nominal Interest

Foreign Loan US $ 100 million 5%
Local Currency Loan ` 2200 million 12%
Expected depreciation of rupee 3% per annum

Current exchange rate ` 45 per US $
Bank /F1 guarantee for raising foreign capital 1%
Equity Capital ` 3000 million

Unlevered Beta 0.6
Risk-free Rate 6%
Market Premium 8%
The project expected to have an effective tax rate of 30 per cent. [6]
Answer:
HPL Ltd.
Amount Interest
(` Million) (%)
Foreign loan 4,500 (100 x 45) 5+3+1 = 9%
Local currency 2,200 12%
Total 6,700
Average interest rate (i) = (9 x 4,500 + 12 x 2,200)/6,700 = 9.985%

After tax cost of borrowing (K d) = I x (1-t) = 9.985 x (1- 0.30) = 6.99%
Debt-equity ratio = 6,700/3,000 = 2.23
Levered beta (βL) = (βUL) x {E + D (1-t)}/E

= 0.6 x {1 + 2.23 (1-0.30)}/1
= 0.6 x (1 + 1.561)
= 1.537
Cost of equity = Rf + βL x (Rm - Rf)

= 0.06 + 1.537 x 0.08
= 0.18296 i.e. 18.30%
Weighted average Cost of Capital is given by :

WACC = Ke (E/E+D) + Kd(D/E+D)
= 0.1830 x (3000/{3000 + 6700}) + 0.0699 x (6700/(3000 + 6700})
= 0.1830 x 0.31 + 0.0699 x 0.691
= 0.1050 i.e. 10.50%
(b) Complete the Balance Sheet given below with help of the following information:
Gross Profits ` 40,500

Shareholders‟ Funds ` 5,75,000
Gross Profit margin 15%
Credit sales to Total Sales 60%
Total Assets turnover 0.3 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.35
Long-term Debt to Equity 45%
Balance Sheet
Creditor ………… Cash …………
Long-term debt ………… Debtors …………
Shareholder‟s funds ………… Inventory …………
Fixed assets …………
[10]
Answer:
Gross Profit ` 40,500
Gross Profit Margin 15%
Gross Profits
Sales =
Gross Profit Margin
= ` 40,500 / 0.15
= ` 2,70,000
Credit Sales to Total Sales = 60%
Credit Sales = ` 2,70,000 x 0.60
= ` 1,62,000
Total Assets Turnover = 0.3 times
Sales
Total Assets =
Total Assets Turnover
` 2,70,000
=
0.3
= ` 9,00,000
Sales – Gross Profits = COGS
COGS = ` 2,70,000 – 40,500 = ` 2,29,500
Inventory turnover = 4 times
Inventory = COGS / Inventory turnover = 229500/4 = ` 57375
Average Collection Period = 20 days
360
Debtors turnover =
Average Collection Period
= 360 / 20 = 18
Credit Sales
Debtors =
Debtors turnover
= 162000 / 18
= ` 9000
Current ratio = 1.35
1.35 = [Debtors + Inventory + Cash] / Creditors
1.35 Creditors = (` 9000 + ` 57375 + Cash]
1.35 Creditors = ` 66375 + Cash]
Long-term Debt to Equity = 45%
Shareholders Funds = ` 575000
Long-term Debt = ` 5,75,000 x 45%
= ` 258750
Creditors (Balance figure) = 9,00,000 – (575000 + 258750)
= ` 66250
Cash = (66250 x 1.35) – 66375
= ` 23062.50
Balance Sheet (In `)

Creditors (Bal. Fig.) 66,250 Cash 23,063
Debtors 9,000
Long-term debt 2,58,750 Inventory 57,375
Shareholders‟ funds 5,75,000 Fixed Assets (Bal. Fig.) 8,10,562
9,00,000 9,00,000
8. (a) The net Sales of W Ltd. is ` 45 crores. Earnings before interest and tax of the company as a
percentage of net sales is 12%. The capital employed comprises ` 15 crores of equity, ` 3 crores
of 12% Cumulative Preference Share Capital and 13% Debentures of ` 9 crores. Income-tax rate
is 30%.
(i) Calculate the Return-on-equity for the company
(ii) Calculate the Operating Leverage of the Company given that combined leverage is 4.5.
[3+2]
Answer
(i) Net Sales : ` 45 crores

EBIT ` 5.4 crores @ 12% on sales
ROI = EBIT/Capital Employed × 100 = 5.4/(15+3+9) × 100 = 20%
` in crores
EBIT 5.4
Interest on Debt 1.17
EBT 4.23
Less : Tax @ 30% 1.269
EAT 2.961
Less : Preference dividend 0.36
Earnings available for Equity Shareholders 2.601
Return on equity = 2.6 / 15 × 100 = 17.33%
EBIT
(ii) Degree of Financial Leverage =
EBIT - Interest - Preference dividend
= 5.4 /(5.4 – 1.17–.36) = 5.4/ 3.87 = 1.395
Degree of Combined Leverage = DFL × DOL

4.5 = 1.395 × DOL
Degree of operating leverage = 4.5/1.395 = 3.22.
(b) Write short note on Venture Capital Financing. [4]
Answer.
Venture capital financing refers to financing of new high-risk ventures promoted by qualified
entrepreneurs who lack experience and funds to give shape to their ideas. A venture capitalist
invests in equity or debt securities floated by such entrepreneurs who undertake highly risky
ventures with a potential of success.
Common methods of venture capital financing include :
(i) Equity financing : The undertaking‟s requirements of long-term funds are met by
contribution by the venture capitalist but not exceeding 49% of the total equity capital;
(ii) Conditional Loan : Which is repayable in the form of royalty after the venture is able to
generate sales;
(iii) Income Note : A hybrid security combining features of both a conventional and
conditional loan, where the entrepreneur pays both interest and royalty but at substantially
lower rates;
(iv) Participating debenture : The security carries charges in three phases – start phase, no
interest upto a particular level of operations; next stage, low interest; thereafter a high rate.
(c) Y Ltd. has ` 15,00,000 allocated for capital budgeting purposes. The following proposals and
associated profitability indexes have been determined:
Project Amount ` Profitability Index

1 4,50,000 1.22
2 2,25,000 0.95
3 5,25,000 1.20
4 6,75,000 1.18
5 3,00,000 1.20
6 6,00,000 1.05
Which of the above investments should be undertaken? Assume that projects are indivisible and
there is no alternative use of the money allocated for capital budgeting.
Answer:
Statement showing ranking of projects on the basis of Profitability Index
Project Amount P.I. Rank

1 450,000 1.22 1
2 225,000 0.95 5
3 525,000 1.20 2
4 675,000 1.18 3
5 300,000 1.20 2
6 600,000 1.05 4
Assuming that projects are indivisible and there is no alternative use of the money allocated for
capital budgeting on the basis of P.I., the Y Ltd., is advised to undertake investment in projects 1,
3, and 5.
However, among the alternative projects the allocation should be made to the projects which
adds the most to the shareholders wealth. The NPV method, by its definition, will always select
such projects.
Statement showing NPV of the projects

Project Amount (`) P.I. Cash inflows of project (`) N.P.V. of Project (`)
(i) (ii) (iii) (iv) = [(ii) x (iii)] (v) = [(iv)-(ii)]
1 450,000 1.22 549,000 99,000
2 225,000 0.95 213750 (-)11250
3 525,000 1.20 630000 105000
4 675,000 1.18 796500 121500
5 300,000 1.20 360000 60,000
6 600,000 1.05 630000 30,000
The allocation of funds to the projects 1,3 and 5 (as selected above on the basis of P.I.) will give
N.P.V. of ` 264,000 and ` 225,000 will remain unspent.
However, the N.P.V. of the projects 3, 4 and 5 is ` 286500 which is more than the N.P.V. of
projects 1, 3 and 5. Further, by undertaking projects 3, 4 and 5, the total money gets exhausted.
Therefore, Y Ltd. is advised to undertake investments in projects 3, 4 and 5.
9. (a) Superior Engineering proposes a project with the following data :

i. Total asset :` 450 lakhs (` 250 lakhs of Fixed Assets and ` 200 lakhs of Current Assets)
ii. Scheme of financing : ` 100 lakhs equity, ` 200 lakhs term loan, ` 100 lakhs working
capital advance and ` 50 lakhs trade credito`
iii. Interest rate : Term loan 12% p.a. and working capital advance : 15% p.a.
iv. Term loan is repayable in 5 equal installments, commencing from 3 rd year of operations.
(Assume that installment for each year is paid on the last day of the year).
v. Depreciation : 30% on written down value.
vi. Production is expected to reach 60% of capacity in the 1 st year of operations, 70% in the
2nd year and 80% from the 3rd year onwards.
vii. Expected revenue from the project will be ` 500 lakhs p.a. on 10% capacity utilization
and corresponding Direct Costs are ` 200 lakhs. Fixed costs are ` 100 lakhs p.a. Working
capital advance of ` 100 lakhs is on 80% capacity and proportionately reduced in the
first two yea`
viii. Tax rate applicable is 50%.
Assuming that each year‟s production is sold away in the same year, draw the projected profit &
loss account for each year of operation and the operational cash flow. Also calculate the Debt
Service Coverage Ratio. [10]
Answer.
Projected Profit & Loss Account
Year of operation 1 2 3 4 5 6 7
Capacity utilization 60 70 80 80 80 80 80
(%)
(` In lakhs)
Revenue 300 350 400 400 400 400 400
Direct variable costs 120 140 160 160 160 160 160
Fixed costs 100 100 100 100 100 100 100
Int. on working cap. 11.25 13.13 15.00 15.00 15.00 15.00 15.00
adv.
Profit before 68.75 96.87 125.00 125.00 125.00 125.00 125.00
depreciation &
interest on term loan
Depreciation 75.00 52.50 36.75 25.73 18.01 12.61 8.82
Interest on term loan 24.00 24.00 24.00 19.20 14.40 9.60 4.80
Profit after dep. & int. (-)30.25 20.37 64.25 80.07 92.59 102.80 111.38
Tax @ 50% - 10.19 32.13 40.04 46.30 51.40 55.69
PAT - 10.19 32.13 40.04 46.30 51.40 55.69
Operational cash 68.75 86.68 92.87 84.96 78.70 73.60 69.31
flow (PAT + Dep. + Int.
on term loan)
Payments
Int. on term loans 24.00 24.00 24.00 19.20 14.40 9.60 4.80
Repayment of terms - - 40.00 40.00 40.00 40.00 40.00
loan
Total 24.00 24.00 64.00 59.20 54.40 49.60 44.80
DSCR (Op. cash flow/ 2.86 3.61 1.45 1.44 1.45 1.48 1.55
Total payments)
Average DSCR= (Total operation cash flow) / (Total payment against debts)
= (554.87 ÷ 320.00) = 1.73.
(b) The following information relates to nana Ltd.

Earnings of the Company `10, 00,000
Dividend payout ratio 60%
No. of shares outstanding 2, 00,000
Rate of Return on Investment 15%
Equity Capitalization Rate 12%
i) What would be the Market Value per Share as per Walter‟s Model?
ii) What is the optimum Dividend Payout Ratio according to Walter‟s Model, and the
Market Value of Company‟s Share at that payout ratio? [2+2+2]
Answer.
R
EPS DPS
Value per share DPS Ke
Ke Ke
Computation of Factors:
Earnings Per Share `10 lakhs÷ 2 lakhs = `5 Cost of Equity (Ke) 12%
(EPS)
Dividend Per Share EPS`5×payout60% =`3 Return on Investment (R) 15%
(DPS)
0.15
`5 `3
i) Value per Share ` 3 0.12 ` 25 ` 20.83 ` 45.83
0.12 0.12
ii) Optimum payout Ratio: since the company‟s earning capacity i.e. ROI (of 15%)
is greater than Shareholder‟s Expectation (of 12%), the shareholder‟s Wealth
would be maximized at “Zero” payout, i.e. Nil Dividend.
iii) Value Per Share at Optimum Payout
0.15
`5 `0
`0 0.12 ` 0 52.08 ` 52.08
0.12 0.12

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Answer to MTP_Intermediate_Syllabus 2012_Jun2014_Set 2

Paper-8: Cost Accounting & Financial Management

Time Allowed: 3 Hours Full Marks: 100

Section A- Cost Accounting

Working Notes should form part of the answer.

(b) What is Sunk Cost? [2]

(e) Consider the following particulars for a month :

Absorbed overhead = Actual fixed overhead – Under absorbed overhead

Actual production = Overhead absorbed / Fixed overhead rate = ` 1,00,500 / ` 20

2. (a) State the various causes of Labour Turnover? [6]

Dissatisfaction with the job.

Fixed and Flexible budget showing overhead cost per hour:

(c) Write a note on Perpetual Inventory. [4]

The following further details are available:

The expenses of D and E are allocated as following:

(ii) OVERHEADS SECONDARY DISTRIBUTION SUMMARY

Total overheads as per (i) 7,550 7,200 9,650 4,625 1,575

Direct Material ` 50.00

(Refer to Working Note 1)

Statement of Labour Cost: ` `

Statement Showing allocation of Wages to Jobs

Classification of the items of inventory as per ABC analysis

5. (a) A Company is undecided as to what kind of wage scheme should be

Standard time allowed per unit of each product is:

Workers Time Time Time Wage Earnings Bonus Total of

A 38.00 38.00 - 6.00 228.00 - 228.00

2. Time allowed to each worker

Worker C = 60 units × 12 minutes + 135 units × 18 minutes

Workers Time Time Time Wage Earnings Bonus Total of

Steps for Controlling Overtime:

Section B–Financial Management

(d) Consider the following for strong Ltd: [2]

Debt Amount Nominal Interest

Expected depreciation of rupee 3% per annum

Equity Capital ` 3000 million

Average interest rate (i) = (9 x 4,500 + 12 x 2,200)/6,700 = 9.985%

Levered beta (βL) = (βUL) x {E + D (1-t)}/E

Cost of equity = Rf + βL x (Rm - Rf)

Weighted average Cost of Capital is given by :

Gross Profits ` 40,500

Balance Sheet (In `)

(i) Net Sales : ` 45 crores

Degree of Combined Leverage = DFL × DOL

(b) Write short note on Venture Capital Financing. [4]

Project Amount ` Profitability Index

Project Amount P.I. Rank

Statement showing NPV of the projects

9. (a) Superior Engineering proposes a project with the following data :

(b) The following information relates to nana Ltd.

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