Financial Management Strategic Management &

Paper 6
Financial Management
&
Strategic Management
Chapter-wise compilation
of RTPs, MTPs and PYPs
Modified as per Applicable for

new scheme Sept’24 & Jan’25
SAMPLE MATERIAL
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RTP’s, MTP’s, and PYP’s are extremely important to ensure that you reproduce ICAI language.
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Financial Management & Strategic Management
Reconciliation of chapters of the new scheme (May’24) with old course
New Chapter Name as per New Syllabus Old Old Chapter Name
Chapter Chapter
No. No.
Section A: Financial Management
1 Scope and Objectives of Financial 1 Scope and Objectives of Financial
Management Management
2 Types of Financing 2 Types of Financing
3 Financial Analysis and Planning – Ratio 3 Financial Analysis and Planning –
Analysis Ratio Analysis
4 Cost of Capital 4 Cost of Capital
5 Financing Decisions – Capital Structure 5 Financing Decisions – Capital
Structure
6 Financing Decisions – Leverages 6 Financing Decisions – Leverages
MODULE 2
7 Investment Decisions 7 Investment Decisions
8 Dividend Decision 9 Dividend Decision
9 Management of Working Capital
9.1 Introduction to Working Capital 10.1 Introduction to Working Capital
Management Management
9.2 Treasury and Cash Management 10.2 Treasury and Cash Management
9.3 Management of Inventory 10.3 Management of Inventory
9.4 Management of Receivables 10.4 Management of Receivables
9.5 Management of Payables (Creditors) 10.5 Management of Payables
(Creditors)
9.6 Financing of Working Capital 10.6 Financing of Working Capital
Section B: Strategic Management

1 Introduction to Strategic Management 6,8 Introduction to Strategic
Management & Strategic
Management Process
2 Strategic Analysis: External Environment 7,10 Dynamics of Competitive Strategy
& Business Level Strategies
3 Strategic Analysis: Internal Environment 7,10,11 Dynamics of Competitive Strategy,
Business & Functional Level
Strategies
4 Strategic Choices 9 Corporate Level Strategies
5 Strategy Implementation and Evaluation 8,12,13 Strategic Management Process,
Organisation & Strategic
Leadership and Strategy
Implementation & Control
Table of Contents
Sr. Particulars Page Number
No
Financial Management
1 Scope and Objectives of Financial Management 1.1 – 1.9
2 Types of Financing 2.1 – 2.14
3 Financial Analysis and Planning – Ratio Analysis 3.1 – 3.47
4 Cost of Capital 4.1 – 4.36
5 Financing Decisions – Capital Structure 5.1 – 5.34
6 Financing Decisions – Leverages 6.1 – 6.33
7 Investment Decisions 7.1 – 7.56
8 Dividend Decision 8.1 – 8.25
9.1 Introduction to Working Capital Management 9.1-1 – 9.1-32
9.2 Treasury and Cash Management 9.2-1 – 9.2-12
9.3 Management of Inventory 9.3-1
9.4 Management of Receivables 9.4-1 – 9.4-11
9.5 Management of Payables (Creditors) 9.5-1
9.6 Financing of Working Capital 9.6-1 – 9.6-3
10 Case Scenarios 10.1 – 10.6
Strategic Management
1 Introduction to Strategic Management 1.1 – 1.21
2 Strategic Analysis: External Environment 2.1 – 2.14
3 Strategic Analysis: Internal Environment 3.1 – 3.23
4 Strategic Choices 4.1 – 4.26
5 Strategy Implementation and Evaluation 5.1 – 5.35
6 Case Scenarios 6.1 – 6.33
MTPs: March’19, April’19, Oct’19, May’20, Oct’20, March’21, April’21, Oct ’21,
Nov ’21, March ’22, April ’22, Sep ’22, Oct ’22, March ’23, April '23,Sep ’23
,Oct ’23,March’24 & April ‘24
PYPs: May’19, Nov’19, Nov’20, Jan’21, July ’21, Dec ’21, May’22, Nov ’22, May’23,
Nov’23
RTPs: May’19, Nov’19, May’20, Nov’20, May’21, Nov ’21, May ’22, Nov ’22,
May ’23, Nov ’23, May’24
1.1
Chapter 1
Scope & Objectives of Financial Management
Question 1
STATE Agency Cost. DISCUSS The Ways to Reduce the Effect of It. (MTP 4 Marks, Aug’18)
OR
DISCUSS Agency Problem and Agency Cost.
(MTP 4 Marks, Oct’20, MTP 4 Marks March ’23, MTP 4 Marks Apr’21, MTP 5 Marks April ’23, RTP Nov 20,
May’22 & Nov ‘23)
Answer 1
Agency Cost: In a sole proprietorship firm, partnership etc., owners participate in management but in
corporate, owners are not active in management so, there is a separation between owner/ shareholders and
managers. In theory managers should act in the best interest of shareholders however in reality, managers
may try to maximize their individual goal like salary, perks etc., so there is a principal-agent relationship
between managers and owners, which is known as Agency Problem. In a nutshell, Agency Problem is the
chances that managers may place personal goals ahead of the goal of owners. Agency Problem leads to Agency
Cost. Agency cost is the additional cost borne by the shareholders to monitor the manager and control their
behavior so as to maximize shareholder’s wealth. Generally, Agency Costs are of four types (I) monitoring (ii)
bonding (iii) opportunity (iv) structuring
Addressing the agency problem
The agency problem arises if manager’s interests are not aligned to the interests of the debt lender and
equity investors. The agency problem of debt lender would be addressed by imposing negative covenants
i.e. the managers cannot borrow beyond a point. This is one of the most important concepts of modern day
finance and the application of this would be applied in the Credit Risk Management of Bank, Fund Raising,
Valuing distressed companies.
Agency problem between the managers and shareholders can be addressed if the interests of the managers
are aligned to the interests of the shareholders. It is easier said than done.
However, following efforts have been made to address these issues:
(A) Managerial compensation is linked to profit of the company to some extent and also with the long
term objectives of the company.
(B) Employee is also designed to address the issue with the underlying assumption that maximisation of
the stock price is the objective of the investors.
(C) Effecting monitoring can be done.
Question 2
EXPLAIN as to how the wealth maximization objective is superior to the profit maximization objective What
is the cost of these sources? [MTP 4 Marks, Mar’19] (RTP May ’24)
Answer 2
A firm’s financial management may often have the following as their objectives:
(i) The maximization of firm’s profit.
(ii) The maximization of firm’s value / wealth.
The maximization of profit is often considered as an implied objective of a firm. To achieve the aforesaid
objective various type of financing decisions may be taken. Options resulting into maximization of profit may
be selected by the firm’s decision makers. They even sometime may adopt policies yielding exorbitant profits
in short run which may prove to be unhealthy for the growth, survival and overall interests of the firm. The
profit of the firm in this case is measured in terms of its total accounting profit available to its shareholders.
The value/wealth of a firm is defined as the market price of the firm’s stock. The market price of a firm’s stock
represents the focal judgment of all market participants as to what the value of the particular firm is. It takes
into account present and prospective future earnings per share, the timing and risk of these earnings, the
dividend policy of the firm and many other factors that bear upon the market price of the stock.
Chapter 1 Scope & Objectives of Financial Management
1.2
The value maximization objective of a firm is superior to its profit maximization objective due to following
reasons.
1. The value maximization objective of a firm considers all future cash flows, dividends, earning per share,
risk of a decision etc. whereas profit maximization objective does not consider the effect of EPS, dividend
paid or any other returns to shareholders or the wealth of the shareholder.
2. A firm that wishes to maximize the shareholder’s wealth may pay regular dividends whereas a firm with
the objective of profit maximization may refrain from dividend payment to its shareholders.
3. Shareholders would prefer an increase in the firm’s wealth against its generation of increasing
flow of profits.
4. The market price of a share reflects the shareholders expected return, considering the long- term
prospects of the firm, reflects the differences in timings of the returns, considers risk and recognizes the
importance of distribution of returns.
The maximization of a firm’s value as reflected in the market price of a share is viewed as a proper goal of a
firm. The profit maximization can be considered as a part of the wealth maximization strategy.
Question 3
DISCUSS the Inter relationship between investment, financing and dividend decisions.
(MTP 4 Marks, Oct’19]
OR
DISCUSS the three major decisions taken by a finance manager to maximize the wealth of shareholders.
(MTP 4 Marks, Oct’18)
OR
BRIEFLY explain the three finance function decisions.
[MTP 4 Marks, Oct’21, RTP Nov ’19, RTP May’19, PYP 3 Marks Nov’19)
OR
What are the two main aspects of the Finance Function? (PYP 2 Marks, May ’18, Old & New SM)
Answer 3
Inter-relationship between Investment, Financing and Dividend Decisions: The finance functions are divided
into three major decisions, viz., investment, financing and dividend decisions. It is correct to say that these
decisions are inter-related because the underlying objective of these three decisions is the same, i.e.
maximization of shareholders’ wealth. Since investment, financing and dividend decisions are all interrelated,
one has to consider the joint impact of these decisions on the market price of the company’s shares and these
decisions should also be solved jointly. The decision to invest in a new project needs the finance for the
investment. The financing decision, in turn, is influenced by and influences dividend decision because retained
earnings used in internal financing deprive shareholders of their dividends. An efficient financial management
can ensure optimal joint decisions. This is possible by evaluating each decision in relation to its effect on the
shareholders’ wealth.
The above three decisions are briefly examined below in the light of their inter-relationship and to see how
they can help in maximizing the shareholders’ wealth i.e. market price of the company’s shares.
Investment decision: The investment of long term funds is made after a careful assessment of the various
projects through capital budgeting and uncertainty analysis. However, only that investment proposal is to be
accepted which is expected to yield at least so much return as is adequate to meet its cost of financing. This
have an influence on the profitability of the company and ultimately on its wealth.
Financing decision: Funds can be raised from various sources. Each source of funds involves different issues.
The finance manager has to maintain a proper balance between long-term and short-term funds. With the
total volume of long-term funds, he has to ensure a proper mix of loan funds and owner’s funds. The optimum
financing mix will increase return to equity shareholders and thus maximize their wealth.
Dividend decision: The finance manager is also concerned with the decision to pay or declare dividend. He
assists the top management in deciding as to what portion of the profit should be paid to the shareholders by
way of dividends and what portion should be retained in the business. An optimal dividend pay-out ratio
maximizes shareholders’ wealth.
1.3
The above discussion makes it clear that investment, financing and dividend decisions are interrelated and are
to be taken jointly keeping in view their joint effect on the shareholders’ wealth.
EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

This was a theoretical question based on explanation of three finance functions decision. Only
a handful number of examinees attempted the question, but performance observed was
above average.
Question 4
DISCUSS the advantages and disadvantages of Wealth maximization principle.
(MTP 4 Marks, Mar’21, PYP 2 Marks May’22)
Answer 4
Advantages and disadvantages of Wealth maximization principle.
Advantages:
(i) Emphasizes the long term gains
(ii) Recognizes risk or uncertainty
(iii) Recognizes the timing of returns
(iv) Considers shareholders’ return.
Disadvantages:
(i) Offers no clear relationship between financial decisions and share price.
(ii) Can lead to management anxiety and frustration.
Question 5
WRITE two main objectives of Financial Management. [MTP 2 Marks, Oct’21, PYP 2 Marks Nov ’18)
Answer 5
Two main objectives of Financial Management
Profit Maximization
It has traditionally been argued that the primary objective of a company is to earn profit; hence the objective
of financial management is also profit maximization. This implies that the finance manager has to make his
decisions in a manner so that the profits of the concern are maximized. Each alternative, therefore, is to be
seen as to whether or not it gives maximum profit.
Wealth / Value Maximization
We will first like to define what is Wealth / Value Maximization Model. Shareholders wealth are the result of
cost benefit analysis adjusted with their timing and risk i.e. time value of money.
So, Wealth = Present Value of benefits – Present Value of Costs
It is important that benefits measured by the finance manager are in terms of cash flow. Finance manager
should emphasis on Cash flow for investment or financing decisions not on Accounting profit. The shareholder
value maximization model holds that the primary goal of the firm is to maximize its market value and implies
that business decisions should seek to increase the net present value of the economic profits of the firm.
Question 6
A finance executive of an organisation plays an important role in the company’s goals, policies, and financial
success. WHAT his responsibilities include? (MTP 4 Marks, Sep’22)
Answer 6
A finance executive of an organisation plays an important role in the company’s goals,policies, and financial
success. His responsibilities include:
(i) Financial analysis and planning: Determining the proper amount of funds to employ in the firm, i.e. designating
the size of the firm and its rate of growth.
(ii) Investment decisions: The efficient allocation of funds to specific assets.
(iii) Financing and capital structure decisions: Raising funds on favourable terms as possible i.e. determining the
composition of liabilities.
1.4
(iv) Management of financial resources (such as working capital).

(v) Risk management: Protecting assets.
Question 7
EXPLAIN Financial Distress and explain its relationship with Insolvency. (MTP 4 Marks, Mar’18)
OR
‘Financial distress is a position where Cash inflows of a firm are inadequate to meet all its current
obligations.’ Based on above mentioned context, EXPLAIN Financial Distress along with Insolvency.
[MTP 4 Marks March 22]
Answer 7
There are various factors like price of the product/ service, demand, price of inputs e.g. raw material, Labour
etc., which is to be managed by an organization on a continuous basis. Proportion of debt also needs to be
managed by an organization very delicately. Higher debt requires higher interest and if the cash inflow is not
sufficient then it will put lot of pressure to the organization. Both short term and long term creditors will put
stress to the firm. If all the above factors are not well managed by the firm, it can create situation known as
distress, so financial distress is a position where Cash inflows of a firm are inadequate to meet all its current
obligations.
Now if distress continues for a long period of time, firm may have to sell its asset, even many times at a lower
price. Further when revenue is inadequate to revive the situation, firm will not be able to meet its obligations
and become insolvent. So, insolvency basically means inability of a firm to repay various debts and is a result
of continuous financial distress.
Question 8
DISTINGUISH between Profit maximisation vis-a-vis wealth maximization. (MTP 5 Marks, Apr’23)
OR
‘Profit maximisation is not the sole objective of a company. It is at best a limited objective. If profit is given
undue importance, a number of problems can arise.’ DISCUSS four of such problems.
(RTP May 22, RTP May 21)
OR
EXPLAIN “Wealth maximisation” and “Profit maximisation” objectives of financial management (Old & New
SM)
Answer 8
It has traditionally been argued that the primary objective of a company is to earn profit; hence the
objective of financial management is also profit maximisation. This implies that the finance manager has to
make his decisions in a manner so that the profits of the concern are maximised. Each alternative,
therefore, is to be seen as to whether or not it gives maximum profit.
However, profit maximisation cannot be the sole objective of a company. It is at best a limited objective. If
profit is given undue importance, a number of problems can arise. Some of these have been discussed
below:
(i) The term profit is vague. It does not clarify what exactly it means. It conveys a different meaning to
different people. For example, profit may be in short term or long term period; it may be total profit
or rate of profit etc.
(ii) Profit maximisation has to be attempted with a realisation of risks involved. There is a direct
relationship between risk and profit. Many risky propositions yield high profit. Higher the risk, higher
is the possibility of profits. If profit maximisation is the only goal, then risk factor is altogether ignored.
This implies that finance manager will accept highly risky proposals also, if they give high profits. In
practice, however, risk is very important consideration and has to be balanced with the profit
objective.
(iii) Profit maximisation as an objective does not take into account the time pattern of returns. Proposal A
may give a higher amount of profits as compared to proposal B, yet if the returns of proposal A begin
to flow say 10 years later, proposal B may be preferred which may have lower overall profit but the
returns flow is more early and quick.
(iv) Profit maximisation as an objective is too narrow. It fails to take into account the social considerations
4.1
Chapter 4
Cost of Capital
Question 1
PQR Ltd. has the following capital structure on October 31, 20X8:
Sources of capital (Rs.)
Equity Share Capital (2,00,000 Shares of Rs. 10 each) 20,00,000
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.
(MTP 5 Marks, Aug’18, MTP 5 Marks Oct’18, RTP Nov ’19)
Answer 1
Workings:
(i) Cost of Equity
D1 Rs.3
(k e ) = + g = Rs.30 + 0.07 = 0.1 + 0.07 = 0.17 = 17%
Po
(ii) Cost of Debentures (Kd) = I (1 - t) = 0.09 (1 - 0.4) = 0.054 or 5.4%
Computation of Weighted Average Cost of Capital (WACC using market value weights)
Source of capital Market Value of Weight Cost of capital (%) WACC (%)
capital (Rs.)
9% Debentures 30,00,000 0.30 5.40 1.62
12% Preference Shares 10,00,000 0.10 12.00 1.20
Equity Share Capital 60,00,000 0.60 17.00 10.20
(Rs.30 × 2,00,000 shares)
Total 1,00,00,000 1.00 13.02
Question 2
JKL Ltd. has the following book-value capital structure as on March 31, 20X8.
(Rs.)
Equity share capital (2,00,000 shares) 40,00,000
11.5% Preference shares 10,00,000
80,00,000
The equity shares of the company are sold at 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 by 5% p.a. forever. Assume a 35% corporate
tax rate.
Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital
structure.
(ii) COMPUTE the new WACC, if the company raises an 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.
(MTP 10 Marks, Oct’18, Oct ’23, RTP May’20) (Same concept different figures MTP 10 Marks Oct’20)
Answer 2
(i) Computation of Weighted Average Cost of Capital based on existing capital structure
Source of Capital Existing Capital Weights After tax cost of WACC (%)
structure (Rs.) (a) capital (%) (a)×(b)
(b)
Chapter 4 Cost of Capital

4.2
Equity share capital (W.N.1) 40,00,000 0.500 15.00 7.500

11.5% Preference share capital 10,00,000 0.125 11.50 1.437
(W.N.2)
10% Debentures (W.N.3) 30,00,000 0.375 6.50 2.438
80,00,000 1.000 11.375
Working Notes (W.N.)
1. Cost of equity capital:
𝐄𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 (𝐃𝟏)
𝐾𝑒 = + Growth (g)
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐌𝐚𝐫𝐤𝐞𝐭 𝐏𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐒𝐡𝐚𝐫𝐞 (𝐏𝟎)
Rs 2
= + 0.05 = 0.15 or 15%
Rs 20
2. Cost of preference share capital: =
𝐀𝐧𝐧𝐮𝐚𝐥 𝐩𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐬𝐡𝐚𝐫𝐞 𝐝𝐢𝐯𝐢𝐝𝐞𝐧𝐝(𝐏𝐃)
=
𝐍𝐞𝐭 𝐩𝐫𝐨𝐜𝐞𝐞𝐝𝐬𝐢𝐧 𝐭𝐡𝐞 𝐢𝐬𝐬𝐮𝐞 𝐨𝐟 𝐩𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞𝐬𝐡𝐚𝐫𝐞 (𝐍𝐏)
𝐑𝐬.𝟏,𝟏𝟓,𝟎𝟎𝟎
= 𝐑𝐬.𝟏𝟎,𝟎𝟎,𝟎𝟎𝟎 = 0.115 or 11.5%
3. Cost of 10% Debentures:
𝐈(𝟏−𝐭) Rs.3,00,000 (1− 0.35)
= = = 0.065 or 6.5%
𝐍𝐏 𝐑𝐬.𝟑𝟎,𝟎𝟎,𝟎𝟎𝟎
(ii) Computation of Weighted Average Cost of Capital based on new capital structure
Source of Capital New Capital Weights After tax WACC (%)
structure (Rs.) (b) cost of (a) ×(b)
capital (%)
(a)
Equity share capital (W.N. 4) 40,00,000 0.40 20.00 8.00
Preference share (W.N. 2) 10,00,000 0.10 11.50 1.15
10% Debentures (W.N. 3) 30,00,000 0.30 6.50 1.95
12% Debentures (W.N.5) 20,00,000 0.20 7.80 1.56
1,00,00,000 1.00 12.66
Working Notes (W.N.):

4. Cost of equity capital:
ExpectedDividend(D1) 𝐑𝐬.𝟐.𝟒𝟎
Ke = + Growth(g) = + 𝟓% = 𝟐𝟎%
Current Market Pr iceper share(P0 ) 𝐑𝐬.𝟏𝟔
5. Cost of 12% Debentures

𝟐,𝟒𝟎,𝟎𝟎𝟎(𝟏− 𝟎.𝟑𝟓)
Kd = = 0.078 or 7.8%
₹𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎
Question 3
DISCUSS the dividend-price approach to estimate cost of equity capital
(MTP 2 Marks, Mar’19 & Oct ’23 & Mar’24)
Answer 3
In dividend price approach, cost of equity capital is computed by dividing the expected dividend by market
price per share. This ratio expresses the cost of equity capital in relation to what yield the company should pay
to attract investors. It is computed as:
D
K e = P1
0
Where, 𝐊 𝒆 = Cost of equity

D1 = Expected dividend (also written as 𝐃𝟏 )
𝐏𝟎 = Market price of equity (ex- dividend)
Question 4
Annona Ltd is considering raising of funds of about Rs.250 lakhs by any of two alternative methods, viz.,

4.3
14% institutional term loan and 13% non-convertible debentures. The term loan option would attract no
major incidental cost and can be ignored. The debentures would have to be issued at a discount of 2.5% and
would involve cost of issue of 2% on face value.
ADVISE the company as to the better option based on the effective cost of capital in each case. Assume a
tax rate of 50%. (MTP 5 Marks, Apr’19)
Answer 4
Calculation of Effective Cost of Capital
Particulars Option 1 Option 2
14% institutional Term 13% Non-convertible
loan Debentures
(Rs. in Lakhs) (Rs. in lakhs)
(A) Effective capital to be raised Face value 250.00 250.00
Less: Discount Nil (6.25)
250.00 243.75
Less: Cost of issue Nil 5.00
Effective amount of capital 250.00 238.75
(B) Annual interest charges on face value of 35.0 32.50
Rs. 250 lakhs
Less: Tax benefit on interest @ 50% 17.5 16.25
17.5 16.25
(C) Effective cost of capital after tax 𝐵 16.25
× 100 × 100
𝐴 238.75
= 7.0% = 6.81% (approx.)
So, the better option is raising of funds of Rs.250 lakhs by issue of 13% Non-convertible Debenture
Question 5
Totto Ltd. has following capital structure as on 31st December 2023, which is considered to be optimum:
(₹)
12% Debenture 4,50,000
10% Preference share capital 1,50,000
Equity shares capital (2,00,000 shares) 24,00,000
The company’s share has a current market price of ₹ 30.25 per share. The expected dividend per share in
next year is 50 percent of the 2023 EPS. The EPS of last 10 years is as follows. The past trends are expected
to continue:
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
EPS (₹) 1.180 1.311 1.456 1.616 1.794 1.99 2.209 2.452 2.723 3.023
The company can issue 14 percent new debenture and 12 percent new preference share. The company’s
debenture is currently selling at ₹ 99. The new preference issue can be sold at a net price of ₹ 9.90, paying
a dividend of ₹ 1.25 per share. The company’s marginal tax rate is 50%.
(i) CALCULATE the after-tax cost (a) of new debts and new preference share capital, (b) of ordinary equity,
assuming new equity comes from retained earnings.
(ii) CALCULATE the marginal cost of capital for the new funds raised.
(iii) How much can be spent for capital investment before new ordinary share must be sold? Marginal cost of
capital remains to be constant. (Assuming that retained earnings available for next year’s investment is 50%
of 2023 earnings.)
(iv) What will be marginal cost of capital (cost of fund raised in excess of the amount calculated in part (iii) if the
company can sell new ordinary shares of ₹ 22 per share? Assuming both the cost of debt and of preference
share capital to be constant. (RTP May ’24) (MTP 10 Marks, Oct’19, Old & New SM, RTP May ’21)
Answer 5
(i) Calculation of after-tax cost of the followings:
𝐼(1−𝑡) ₹ 14(1−0.5)
(a) New 14% Debentures (Kd) = =
𝑁𝑃 ₹ 99
= 0.0707 or 7.07%

4.4
𝑃𝐷 ₹ 1.25
New 12% Preference Shares (Kp) = 𝑁𝑃 = ₹ 9.90
= 0.1263 or 12.63%
Where,
I = Interest
t = Tax rate
PD = Preference dividend
NP = Net proceeds
(b) Equity Shares (Retained Earnings) (Ke)
Expected dividend(D1)
= + Growth rate (G)
Current market price (p0)
50% of ₹ 3.023
= + 0.11* = 0.16 or 16%
₹ 3.025
* Growth rate (on the basis of EPS) is calculated as below:
EPSincurrent year−EPSinprevious year ₹ 3.023− ₹ 2.723

= = 0.11
EPSinprevious year ₹ 2.723
(Students may verify the growth trend by applying the aboveformula to last three or four years.
Growth Rate is rounded off)
(ii) Calculation of marginal cost of capital (on the basis of existing capital structure):
Source of capital Weight After tax Costof WACC
(a) capital (%) (b) (%)
(a) × (b)
14% Debenture 0.15 7.07 1.0605
12% Preference shares 0.05 12.63 0.6315
Equity shares 0.80 16.00 12.800
Marginal cost of capital 14.492
(iii) The company can spend for capital investment before issuing new equity shares and without
increasing its marginal cost of capital:
Retained earnings can be available for capital investment
= 50% of 2023 EPS × equity shares outstanding
= 50% of ₹ 3.023 × 2,00,000 shares = ₹3,02,300
Since, marginal cost of capital is to be maintained at the current level i.e. 14.492%, the retained
earnings should be equal to 80% of total additional capital for investment.
₹3,02,300
Thus, investment before issuing equity ( × 100) = ₹ 3,77,875
80
The remaining capital of ₹ 75,575 i.e. ₹ 3,77,875– ₹ 3,02,300 shall be financed by issuing 14%
Debenture and 12% preference shares in the ratio of 3: 1 respectively.
(iv) If the company spends more than ₹ 3,77,875 as calculated in part (iii) above, it will have to issue
new shares at ₹ 22 per share.
The cost of new issue of equity shares will be:
Expected dividend (D1) 50% of ₹ 3.023

Ke = + Growth rate (g) + 0.11
Current market price (p0) = ₹ 22
= 0.1787 or 17.87%
Calculation of marginal cost of capital (assuming the existing capital structure will be maintained):
Source of capital Weight(a) Cost (%)(b) WACC (%)
(a) × (b)
14% Debenture 0.15 7.07 1.0605
12% Preference shares 0.05 12.63 0.6315

4.5
Equity shares 0.80 17.87 14.296

Marginal cost of capital 15.988
Question 6
ABC Limited has the following book value capital structure:
Equity Share Capital (1 crore shares @ Rs.10 each) Rs.1,000 lakh
Reserves and Surplus Rs.2,250 lakh
9% Preference Share Capital (5 lakh shares @ Rs.100 each) Rs.500 lakh
8.5% Debentures (1.5 lakh debentures @ Rs.1,000 each) Rs.1,500 lakh
12% Term Loans from Financial Institutions Rs.500 lakh
• The debentures of ABC Limited are redeemable at par after five years and are quoting at Rs.985 per
debenture.
• 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 7%. The beta of the company is
1.85
• The preference shares of the company are redeemable at 10% premium after 5 years is currently
selling at Rs.102 per share.
• The applicable income tax rate for the company is 35%.
Required:
CALCULATE weighted average cost of capital of the company using market value weights.
(MTP 5 Marks, May’20)
Answer 6
Working Notes:
(1) Computation of cost of debentures (Kd):
(1,000−985)
Rs.85(1−0.35) + 55.25+3
5
ke = (1,000+985) = = 0.0586 or 5.86%
992.5
2
(2) Computation of cost of term loans (KT):

= r (1-t)
= 0.12 (1-0.35) = 0.078 or 7.8%
(3) Computation of cost of preference capital (Kp):

preferenc Divident + (RV − NP)/n
= Kp =
(RV + NP)/2
(110−102)
Rs.9 + 9 + 1.6
5
= (110−102) = = 0.1 or 10%
106
2
(4) Computation of cost of equity (Ke):
= Rf + ß (Rm – Rf)
Or, = Risk free rate + (Beta × Risk premium)
= 0.055 + (1.85 ×0.07) = 0.1845 or 18.45%
Calculation of Weighted Average cost of capital Using market value weights

Source of Capital Market value of Weights After tax cost WACC
capital structure of capital (%) (%)
(Rs. in lakh)
Equity share capital 6,000 0.71 18.45 13.09
(1 crore shares × Rs.60)
9% Preference
share capital 510 0.06 10.00 0.60
(5 lakh shares × Rs.102)

4.6
8.5 % Debentures 1,477.5 0.17 5.86 0.99

(1.5 lakh × Rs.985)
12% Term loans 500 0.06 7.80 0.47
8,487.50 1.000 15.15
Question 7
"Financing a business through borrowing is cheaper than using equity." Briefly EXPLAIN
(MTP 2 Marks, May’20 & Sep’23)
Answer 7
Financing a business through borrowing is cheaper than using equity”
(i) Debt capital is cheaper than equity capital from the point of its cost and interest being deductible for income
tax purpose, whereas no such deduction is allowed for dividends.
(ii) Issue of new equity dilutes existing control pattern while borrowing does not result in dilution of control.
(iii) In a period of rising prices, borrowing is advantageous. The fixed monetary outgo decreases in real terms as
the price level increases.
Question 8
CALCULATE the WACC by using Market value weights. The capital structure of the company is as under:
(Rs.)
Debentures (Rs.100 per debenture) 10,00,000
Preference shares (Rs.100 per share) 10,00,000
Equity shares (Rs.10 per share) 20,00,000
40,00,000
The market prices of these securities are:
Debentures Rs. 115 per debenture
Preference shares Rs. 120 per preference share
Equity shares Rs. 265 each.
Additional information:
(1) Rs.100 per debenture redeemable at par, 10% coupon rate, 2% floatation cost, 10-year maturity.
(2) Rs.100 per preference share redeemable at par, 5% coupon rate, 2% floatation cost and 10 - year
maturity.
(3) Equity shares have a floatation cost of Rs. 1 per share.
The next year expected dividend is Rs. 5 with an annual growth of 15%. The firm has the practice of
paying all earnings in the form of dividend.
Corporate tax rate is 30%. Use YTM method to calculate cost of debentures and preference shares.
(MTP 10 Marks, Mar’21, Old & New SM, RTP Nov ’20)
Answer 8
(i) Cost of equity (𝑲𝒆 )
D1 Rs.5
= +g= + 0.15 = 0.1689 or 16.89%
P0 −F Rs.265−Re.1
(ii) Cost of Debt (Kd)
Calculation of NPV at discount rate of 5% and 7%
Year Cash Discount Present Discount Present
flows factor @ 5% Value factor @ 7% Value (Rs.)
(Rs.)
0 112.7 1.000 (112.7) 1.000 (112.7)
1 to 10 7 7.722 54.05 7.024 49.17
10 100 0.614 61.40 0.508 50.80
NPV +2.75 -12.73
Calculation of IRR
𝟐.𝟕𝟓 𝟐.𝟕𝟓
IRR = 5% + 𝟐.𝟕𝟓−(−𝟏𝟐.𝟕𝟑) (7%-5%) = 5% + 𝟏𝟓.𝟒𝟖 (7%-5%) = 5.36%

4.7
Cost of Debt (Kd) = 5.36%

(iii) Cost of Preference shares (Kp)
Calculation of NPV at discount rate of 2% and 5%
Year Cash Discount Present Discount Present Value (Rs.)
flows (Rs.) factor @ 2% Value factor @ 5%
0 117.6 1.000 (117.6) 1.000 (117.6)
1 to 10 5 8.983 44.92 7.722 38.61
10 100 0.820 82.00 0.614 61.40
NPV +9.32 -17.59
Calculation of IRR
𝟗.𝟑𝟐 𝟗.𝟑𝟐
IRR = 2%+ 𝟗.𝟑𝟐−(−𝟏𝟕.𝟓𝟗) (5%-2%) = 2%+ 𝟐𝟔.𝟗𝟏 (𝟓% − 𝟐%) = 3.04%
Cost of Preference Shares (Kp) = 3.04%
Calculation of WACC using market value weights
Source of capital Market Value Weights After tax cost WACC (Koi)
of capital
(Rs.) (a) (b) (c) = (a)×(b)
10% Debentures (Rs.115× 10,000) 11,50,000 0.021 0.0536 0.00113
5% Preference shares 12,00,000 0.022 0.0304 0.00067
(Rs.120× 10,000)
Equity shares (Rs.265 × 2,00,000) 5,30,00,000 0.957 0.1689 0.16164
5,53,50,000 1.000 0.16344
WACC (Ko) = 0.16344 or 16.344%
Question 9
Development Finance Corporation issued zero interest deep discount bonds of face value of Rs. 1,50,000
each issued at Rs. 3,750 & repayable after 25 years. COMPUTE the cost of debt if there is no corporate tax.
(MTP 3 Marks Apr’21)
Answer 9
Here,
Redemption Value (RV)= Rs.1,50,000, Net Proceeds (NP) = Rs. 3,750, Interest = 0, Life of bond = 25 years
There is huge difference between RV and NP therefore in place of approximation method we should use trial
& error method.
FV = PV x (1 + r)n
1,50,000 = 3,750 x (1 + r)25
40 = (1 + r)25
Trial 1: r = 15%, (1.15)25 = 32.919
Trial 2: r = 16%, (1.16)25 = 40.874
Here:
L = 15%; H = 16%
𝑁𝑃𝑉𝐿 = 32.919 - 40 = - 7.081
𝑁𝑃𝑉𝐻 = 40.874 - 40 = + 0.874
NPVL
IRR = L + (H − L)
NPVL −NPVH
−7.081
=15% + × (16% − 15%) = 15.89%
−7.081−(0.874)
Question 10
The following is the capital structure of Shard Ltd. as on 31.12.2020:
(₹)
Equity shares: 2,00,000 shares (of Rs.100 each) 2,00,00,000
9% Preference Shares (of Rs.100 each) 60,00,000
4.8
3,50,00,000
The market price of the company’s share is Rs.120 and it is expected that a dividend of Rs.12 per share
would be declared for the year 2021. The dividend growth rate is 5% and the company is in the 30%
tax bracket.
(i) CALCULATE the company’s weighted average cost of capital.
(ii) Further, in order to finance an expansion plan, the company intends to borrow a fund of ₹ 2 crores
bearing 12% rate of interest. In this situation, WHAT will be the company’s revised weighted average
cost of capital? This financing decision is expected to increase dividend from Rs.12 to Rs.14 per share.
However, the market price of equity share is expected to decline from Rs.120 to Rs.115 per share.
In case of both (I) and (ii) above, use market value weight while calculating weighted average cost of
capital. (MTP 5 Marks, Oct’21)
Answer 10
(i) Computation of the weighted average cost of capital
Source of finance Market Weight After tax WACC (%)
(a) Value of (b) Cost of (d) = (b) × (c)
capital (₹) capital (%)
(c)
Equity share (Working note 1) 2,40,00,000 0.6154 15 9.231
[₹120 × 2,00,000 shares]
9% Preference share 60,00,000 0.1538 9 1.3842
8% Debentures 90,00,000 0.2308 5.60 1.2925
3,90,00,000 1.0000 11.9077
(ii) Computation of Revised Weighted Average Cost of Capital
Source of finance Market Weight After tax WACC
(a) Value of (b) Cost of (%)
capital (₹) capital (d) = (b)
(%) (c) × (c)
Equity shares (Working note 2) 2,30,00,000 0.3966 17.17 6.8096
[₹115 × 2,00,000 shares]
8% Debentures 90,00,000 0.1552 5.60 0.8691
12% Loan 2,00,00,000 0.3448 8.40 2.8963
5,80,00,000 1.0000 11.5056
Working Notes:
(1) Cost of Equity Shares
Ke = {Dividend Per Share (D1)/Market Price Share (P0)} + Growth Rate
= 12/120 + 0.05
= 0.15 or 15%
(2) Revised cost of equity shares (Ke)
Revised Ke= 14/115 + 0.05
= 0.1717 or 17.17%
Question 11
XYZ Company’s equity share is quoted in the market at ₹ 25 per share currently. The company pays a
dividend of ₹ 5 per share and the investor’s market expects a growth rate of 5% per year.
You are required to:
(i) CALCULATE the company’s cost of equity capital.
(ii) If the company issues 12% debentures of face value of Rs.100 each and realizes Rs.95 per debenture
while the debentures are redeemable after 10 years at a premium of 12%, CALCULATE cost of debenture
using YTM?
Assume tax rate to be 30%. (MTP 5 Marks, Nov’21, Mar’22 & Sep ’23)
Answer 11
4.9
(i) Cost of Equity Capital (Ke)

Ke = Expecteddividendper share(D1)
Marketpriceper share(P0)
= Growth rate(g)
𝑅𝑠.5×1.05
= + 0.05 = 26%
𝑅𝑠.25
(ii) Cost of Debenture (Kd):

Using Present Value method (or YTM)
Identification of relevant cash flows
Year Cash flows
0 Current market price (P0) = Rs.95
1 to 10 Interest net of tax [I(1-t)] = 12% of Rs.100 (1 – 0.30) = Rs.8.40
10 Redemption value (RV) = Rs.100 (1.12) = Rs.112
Calculation of Net Present Values (NPV) at two discount rates
Year Cash Discount factor Present Discount factor Present
flows @ 9% (L) Value @ 10% (H) Value
0 (95) 1.0000 (95.00) 1.0000 (95.00)
1 to 10 8.40 6.4176 53.91 6.1445 51.61
10 112 0.4224 47.31 0.3855 43.18
NPV +6.22 -0.21
Calculation of IRR=
𝑁𝑃𝑉𝐿
IRR = L + 𝑁𝑃𝑉 𝑁𝑃𝑉 (H-L)
𝐿 𝐻
6.22 6.22
= 9% + (10%-9%) =9% + = 9.97%
6.22−(−0.21) 6.43
= Therefore, Kd = 9.97%
Question 12
The capital structure of RV Limited as on 31st March, 2022 as per its Balance Sheet is as follows:
Particulars ₹
Equity shares of ₹ 10 each 25,00,000
10% Preference shares of ₹ 100 each 5,00,000
Retained earnings 5,00,000
13% debentures of ₹ 100 each 20,00,000
The market price of equity shares is ₹ 50 per share. Expected dividend on equity shares is ₹ 3 per
share. The dividend per share is expected to grow at the rate of 8%.
Preference shares are redeemable after eight years and the current market price is ₹ 80 per share.
Debentures are redeemable after five years and are currently selling at ₹ 90 per debenture. The tax
rate applicable to the company is 35%. CALCULATE weighted average cost of capital using:
(i) Book value proportions
(ii) Market value proportions (MTP 10 Marks Apr’22)
Answer 12
Working Notes:
(i) Cost of Equity (Ke)
𝐷1 𝑅𝑠.3
𝑃
+ g = 𝑅𝑠.50 + 0.08 = 0.14 i.e. 14%
(ii) Cost of preference Shares (Kp)

𝑅𝑉−𝑁𝑃 100−80
𝐷+ 10+ 12.5
𝑛 8
𝑅𝑉+𝑁𝑃 = 100+80 = 90
= 0.1389 = 13.89%
2 2
4.10
(iii) 𝐶𝑜𝑠𝑡 of debenture (kd)

𝑅𝑉−𝑁𝑃 100−90
𝐼(1−𝑡)+ 13(1−0.35)+ 8.45+2
𝑛 5
𝑅𝑉+𝑁𝑃 = 100+90 = = 0.11 i.e.11%
95
2 2
𝑂𝑟,
𝑅𝑉−𝑁𝑃 100−90
𝐼+ 13+
𝑛 5
[ 𝑅𝑉+𝑁𝑃 ](1-t) = [ 100+90 ] (1-0.35) = 0.1026 i.e.10.26%
2 2
Weighted Average cost of capital (Book Value)

Amount (₹) Weight (W) Cost (K) WxK
Equity shares 25,00,000 0.4546 0.14 0.0636
Preference shares 5,00,000 0.0909 0.1389 0.0126
Retained Earnings 5,00,000 0.0909 0.14 0.0127
Debentures 20,00,000 0.3636 0.1026 0.0373
55,00,000 0.1262
Or (if Kd is 11%) the WACC = 0.1289
Thus, WACC (Book value based) = 12.62% or 12.89%
Weighted Average cost of capital (Market Value)
Amount (₹) Weight (W) Cost (K) WxK
Equity shares 1,25,00,000 0.85 0.14 0.119
Preference shares 4,00,000 0.028 0.1389 0.0039
Debentures 18,00,000 0.122 0.1026 0.0125
1,47,00,000 0.1354
Or (if Kd is 11%) the WACC = 0.1363
Thus, WACC (Market value based) = 13.54% or 13.63%
Question 13
Answer the following:
The capital structure of a Company is given below:
Source of capital Book Value (₹)
Equity shares @ ₹ 100 each 24,00,000
9% Cumulative preference shares @ ₹ 100 each 4,00,000
40,00,000
The company had paid equity dividend @ 25% for the last year which is likely to grow @ 5% every year. The
current market price of the company’s equity share is ₹ 200.
Considering corporate tax @ 30%, you are required to CALCULATE:
(i) Cost of capital for each source of capital.
(ii) Weighted average cost of capital. (MTP 5 Marks Sep’22)
Answer 13
i. Calculation of Cost of Capital for each source of capital:
(a) Cost of Equity share capital:
𝐷0 (1+ g) 25% ×₹100(1+ 0.05)
𝐾𝑒 = +g= + 0.05
Market Pr iceper share(𝑝0 ) ₹𝟐𝟎𝟎
₹ 26.25
= ₹ 200 + 0.05 = 0.18125 or 18.125%
(b) Cost of Preference share capital (𝐾𝑝 ) = 9%
(c) Cost of Debentures ( 𝐾𝑑 ) = r (1 – t)
= 11% (1 – 0.3) = 7.7%
ii. Weighted Average Cost of Capital

4.11
Source Amount (₹) Weights After tax Cost of WACC (%)

(a) Capital (%) (b) (c) = (a) × (b)
Equity share 24,00,000 0.60 18.125 10.875
9% Preference share 4,00,000 0.10 9.000 0.900
11% Debentures 12,00,000 0.30 7.700 2.310
40,00,000 1.00 14.085
Question 14
The financial advisor of Sun Ltd is confronted with following two alternative financing plans for raising ₹ 10
lakhs that is needed for plant expansion and modernization
Alternative I: Issue 80% of funds with 14% Debenture [Face value (FV) ₹ 100] at par and redeem at a premium
𝟏
of 10% after 10 years and balance by issuing equity shares at 33 𝟑% premium.
Alternative II: Raise 10% of funds required by issuing 8% Irredeemable Debentures [Face value (FV) ₹ 100]
at par and the remaining by issuing equity shares at current market price of ₹125.
Currently, the firm has an Earnings per share (EPS) of ₹ 21 The modernization and expansion
programme is expected to increase the firm’s Earnings before Interest and Taxation (EBIT) by ₹ 200,000
annually.
The firm’s condensed Balance Sheet for the current year is given below:
Balance Sheet as on 31.3.2022
Liabilities Amount (₹) Assets Amount (₹)
Current Liabilities 5,00,000 Current Assets 16,00,000
10% Long Term Loan 15,00,000 Plant & Equipment (Net) 34,00,000
Reserves & Surplus 10,00,000
Equity Share Capital (FV: ₹ 100 each) 20,00,000
TOTAL 50,00,000 TOTAL 50,00,000
However, the finance advisor is concerned about the effect that issuing of debt might have on the firm. The
average debt ratio for firms in industry is 35%.He believes if this ratio is exceeded, the P/E ratio of the
company will be 7 because of the potentially greater risk.
If the firm increases its equity capital by more than 10 %, he expects the P/E ratio of the company will
increase to 8.5 irrespective of the debt ratio.
Assume Tax Rate of 25%. Assume target dividend pay-out under each alternative to be 60% for the next year
and growth rate to be 10% for the purpose of calculating Cost of Equity
SUGGEST with reason which alternative is better on the basis of each of the below given criteria:
I. Earnings per share (EPS) & Market Price per share (MPS)
II. Financial Leverage
III. Weighted Average Cost of Capital & Marginal Cost of Capital (using Book Value weights)
(MTP 10 Marks Oct’22)
Answer 14
Calculation of Equity Share capital and Reserves and surplus:
Alternative 1:
₹2,00,000×100
Equity Share capital = ₹20,00,000 + = ₹21,50,000
133.3333
₹2,00,000×33.3333
Reserves = ₹ 10,00,000 + = ₹10,50,000
133.3333
Alternative 2:
₹ 9,00,000×100
Equity Share capital = ₹20,00,000 + 125
= ₹27,20,000
₹9,00,000×25
Reserves = ₹ 10,00,000 + = ₹11,80,000
125
Capital Structure Plans

4.12
Amount in ₹
Capital Alternative 1 Alternative 2
Equity Share capital 21,50,000 27,20,000
Reserves and surplus 10,50,000 11,80,000
10% long term debt 15,00,000 15,00,000
14% Debentures 8,00,000 -
8% Irredeemable Debentures - 1,00,000
Total Capital Employed 55,00,000 55,00,000
Computation of Present Earnings before interest and tax (EBIT)

EPS (₹) 21
No. of equity shares 20,000
Earnings for equity shareholders (I x II) (₹) 4,20,000
Profit Before Tax (III/75%) (₹) 5,60,000
Interest on long term loan (1500000 x 10%) (₹) 1,50,000
EBIT (IV + V) (₹) 7,10,000
EBIT after expansion = ₹7,10,000 +₹ 2,00,000 = ₹9,10,000
Evaluation of Financial Plans on the basis of EPS, MPS and Financial Leverage
Amount in ₹
Particulars Alternative I Alternate II
EBIT 9,10,000 9,10,000
Less: Interest: 10% on long term loan (1,50,000) (1,50,000)
14% on Debentures (1,12,000) Nil
8% on Irredeemable Debentures Nil. (8000)
PBT 6,48,000 7,52,000
Less: Tax @25% (1,62,000) (1,88,000)
PAT 4,86,000 5,64,000
No. of equity shares 21,500 27,200
EPS 22.60 20.74
Applicable P/E ratio (Working Note 1) 7 8.5
MPS (EPS X P/E ratio) 158.2 176.29
Financial Leverage EBIT/PBT 1.40 1.21
Working Note 1
Alternative I Alternative II
Debt:
₹15,00,000 +₹8,00,000 23,00,000 -
₹15,00,000 +₹1,00,000 - 16,00,000
Total capital Employed (₹) 55,00,000 55,00,000
Debt Ratio (Debt/Capital employed) = 0.4182 = 0.2909
= 41.82% = 29.09%
Change in Equity: ₹21,50,000-₹20,00,000 1,50,000
₹27,20,000-₹20,00,000 7,20,000
Percentage change in equity 7.5% 36%
Applicable P/E ratio 7 8.5
Calculation of Cost of equity and various type of debt
Alternative I Alternative II
A) Cost of equity
EPS 22.60 20.74
DPS (EPS X 60%) 13.56 12.44
Growth (g) 10% 10%
4.13
Po (MPS) 158.2 176.29

𝑲𝒆 = Do (1 + g)/ Po 13.56(1.1) 12.44(1.1)
158.2 176.29
= 9.43% = 7.76%
B) Cost of Debt:
10% long term debt 10% + (1-0.25) 10% +(1-0.25)
= 7.5% = 7.5%
14% redeemable debentures 14(1 − 0.25) + (110 − 100/10) nil
110 + 100/2
= 10.5 + 1 / 10.5
= 10.95%
8% irredeemable debenture NA 8000(1-0.25)/1,00,00 = 6%
Calculation of Weighted Average cost of capital (WACC)
Alternative 1 Alternative 2
Cost WACC Weights Cost WACC
Capital Weights (%) (%)
Equity Share Capital 0.3909 9.43 3.69% 0.4945 7.76 3.84%
Reserves and Surplus 0.1909 9.43 1.80% 0.2145 7.76 1.66%
10% Long term Debt 0.2727 7.50 2.05% 0.2727 7.50 2.05%
14% Debenture 0.1455 10.95 1.59%
8% Irredeemable Debentures - 0.0182 6 0.11%
9.12% 7.66%
Calculation Marginal Cost of Capital (MACC)

Alternative 1 Alternative 2
Amount(weight) Cost MACC Amount (weight) Cost MACC
Capital (%) (%)
Equity Share Capital ₹ 1,50,000(0.15) 9.43 1.41% ₹7,20,000(0.72) 7.76 5.59%
Reserves and Surplus ₹ 50,000(0.05) 9.43 0.47% ₹1,80,000(0.18) 7.76 1.40%
14% Debenture ₹ 8,00,000(0.80) 10.95 8.76% - 0.00%
8% Irredeemable
Debentures - ₹1,00,000(0.10) 6 0.60%
Total Capital Employed ₹10,00,000 10.65% ₹10,00,000 7.58%
Summary of solution:
Alternate I Alternate II
Earnings per share (EPS) 22.60 20.74
Market price per share (MPS) 158.20 176.29
Financial leverage 1.4043 1.2101
Weighted Average cost of capital (WACC) 9.12% 7.66%
Marginal cost of capital (MACC) 10.65% 7.58%
Alternative 1 of financing will be preferred under the criteria of EPS, whereas Alternative II of financing will be
preferred under the criteria of MPS, Financial leverage, WACC and marginal cost of capital.
Question 15
The proportion and required return of debt and equity was recorded for a company with its increased
financial leverage as below. (MTP 5 Marks, Apr’19)
Debt Required return Equity Required Return (Key) Weighted Average Cost of
(%) (Kid) (%) (%) (%) Capital (WACC) (Ko) (%)
0 5 100 15 15

4.14
20 6 80 16 ?
40 7 60 18 ?
60 10 40 23 ?
80 15 20 35 ?
You are required to complete the table and IDENTIFY which capital structure is most beneficial for this
company. (Based on traditional theory, i.e., capital structure is relevant).
Answer 15
Computation of Weighted Average Cost of Capital (WACC) for each level of Debt-equity mix.
Debt (%) Required Equity (%) Required Kd× Proportion of debt + Weighted Average
return (Kd) return (Ke) Ke Proportion and equity Cost of Capital
(%) (%) (WACC)(Ko) (%)
0 5 100 15 0% (5%) +100% (15%) 15
20 6 80 16 20% (6%) +80% (16%) 14
40 7 60 18 40% (7%) +60% (18%) 13.6
60 10 40 23 60% (10%) +40% (23%) 15.2
80 15 20 35 80% (15%) +20% (35%) 19
The optimum mix is 40% debt and 60% equity, as this will lead to lowest WACC value i.e., 13.6%.
Question 17
As a financial analyst of a large electronics company, you are required to DETERMINE the weighted average
cost of capital of the company using (a) book value weights and (b) market value weights. The following
information is available for your perusal.
The Company’s present book value capital structure is:
(₹)
Debentures (₹100 per debenture) 8,00,000
Preference shares (₹100 per share) 2,00,000
Equity shares (₹10 per share) 10,00,000
20,00,000
All these securities are traded in the capital markets. Recent prices are:
Debentures, ₹110 per debenture, Preference shares, ₹120 per share, and Equity shares, ₹ 22 per share
Anticipated external financing opportunities are:
(i) ₹ 100 per debenture redeemable at par; 10-year maturity, 11 per cent coupon rate, 4 per cent flotation
costs, sale price, ₹ 100
(ii) ₹ 100 preference share redeemable at par; 10-year maturity, 12 per cent dividend rate, 5 per cent
flotation costs, sale price, ₹100.
(iii) Equity shares: ₹ 2 per share flotation costs, sale price = ₹ 22.
In addition, the dividend expected on the equity share at the end of the year is ₹ 2 per share, the
anticipated growth rate in dividends is 7 per cent and the firm has the practice of paying all its earnings in
the form of dividends. The corporate tax rate is 35 per cent. (RTP May’19)
Answer 17
Determination of specific costs:
(𝑅𝑉−𝑁𝑃) (𝑅𝑠.100−𝑅𝑠.96)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡(1−𝑡) + 𝑅𝑠.11(1−0.35) +
𝑁 10 𝑌𝑒𝑎𝑟𝑠
(i) Cost Debt(𝐾𝑑 ) = (𝑅𝑉+𝑁𝑃) = (𝑅𝑠.100+𝑅𝑠.96)
2 2
𝑅𝑠.7.15+𝑅𝑠.0.4
= 𝑅𝑠.98
= 0.077 or 7.70%
(𝑅𝑉−𝑁𝑃) (𝑅𝑠.100 − 𝑅𝑠.95)

𝑃𝐷 + 𝑅𝑠.12 +
𝑁 10 𝑌𝑒𝑎𝑟𝑠
(ii) Cost of Preference Shares(𝐾𝑝 ) = (𝑅𝑉+𝑁𝑃) =
(𝑅𝑠.100+ 𝑅𝑠.95)
2 2
𝑅𝑠.12+𝑅𝑠.0.5
= 𝑅𝑠.97.5 = 0.1282 or 12.82%
4.15
𝐷 𝑅𝑠.2
(iii) Cost of Equity Shares (𝐾𝑒 ) = 𝑃1 + G = 𝑅𝑠.22−𝑅𝑠.2 +0.07 = 0.17 or 17%
0
I – Interest, t – Tax, RV- Redeemable value, NP- Net proceeds, N- No. of years, PD- Preference dividend,
D1- Expected Dividend, P0- Price of share (net)
Using these specific costs we can calculate WACC on the basis of book value and market value weights
as follows:
(a) Weighted Average Cost of Capital (K0) based on Book value weights
Source of capital Book value Weights Specific WACC (%)
(₹) cost (%)
Debentures 8,00,000 0.40 7.70 3.08
Preferences shares 2,00,000 0.10 12.82 1.28
Equity shares 10,00,000 0.50 17.00 8.50
20,00,000 1.00 12.86
(b) Weighted Average Cost of Capital (K0) based on market value weights:
Source of capital Market value (₹) Weights Specific cost (%) WACC (%)
Debentures 8,80,000 0.265 7.70 2.04
𝑹𝒔. 𝟖, 𝟎𝟎, 𝟎𝟎𝟎
( × 𝑹𝒔. 𝟏𝟏𝟎)
𝑹𝒔. 𝟏𝟎𝟎
Preferences shares 2,40,000 0.072 12.82 0.92

𝑹𝒔. 𝟐, 𝟎𝟎, 𝟎𝟎𝟎
( × 𝑹𝒔. 𝟏𝟐𝟎)
𝑹𝒔. 𝟏𝟎𝟎
Equity shares 22,00,000 0.663 17.00 11.27

𝑹𝒔. 𝟏𝟎, 𝟎𝟎, 𝟎𝟎𝟎
( × 𝑹𝒔. 𝟐𝟐)
𝑹𝒔. 𝟏𝟎
33,20,000 1.000 14.23
Question 18
Kalyanam Ltd. has an operating profit of ₹ 34,50,000 and has employed Debt which gives total Interest
Charge of ₹ 7,50,000. The firm has an existing Cost of Equity and Cost of Debt as 16% and 8%
respectively. The firm has a new proposal before it, which requires funds of ₹ 75 Lakhs and is expected
to bring an additional profit of ₹ 14,25,000. To finance the proposal, the firm is expecting to issue an
additional debt at 8% and will not be issuing any new equity shares in the market. Assume no tax
culture.
You are required to CALCULATE the Weighted Average Cost of Capital (WACC) of Kalyanam Ltd.:
(i) Before the new Proposal
(ii) After the new Proposal (RTP Nov’21, Old & New SM)
Answer 18
Workings:
Interest
(a) Value of Debt =
Cost of debt(Kd )
𝑅𝑠.7,50,000
= = Rs. 93,75,000
0.08
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡−𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
(b) Value of equity capital =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 (Ke )
𝑅𝑠.34,50,000−𝑅𝑠.7,50,000
= = Rs. 1,68,75,000
0.16
(c) New Cost of equity (𝐊 𝐞 ) after proposal
𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑑 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡−𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑑 𝑑𝑒𝑏𝑡
=
𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

4.16
(𝑅𝑠.34,50,000+𝑅𝑠.14,25,000)−(𝑅𝑠.7,50,000+𝑅𝑠.6,00,000)
=
𝑅𝑠.1,68,75,000
𝑅𝑠.48,75,000−𝑅𝑠.13,50,000 𝑅𝑠.35,25,000
= = = 0.209 or 20.9%
𝑅𝑠.1,68,75,000 𝑅𝑠.1,68,75,000
(i) Calculation of Weighted Average Cost of Capital (WACC) before the new proposal
Sources Amount (₹) Weight Cost of WACC
Capital
Equity 1,68,75,000 0.6429 0.160 0.1029
Debt 93,75,000 0.3571 0.080 0.0286
Total 2,62,50,000 1 0.1315 or 13.15 %
(ii) Calculation of Weighted Average Cost of Capital (WACC) after the new proposal
Sources Amount (₹) Weight Cost of WACC
Capital
Equity 1,68,75,000 0.5000 0.209 0.1045
Debt 1,68,75,000 0.5000 0.080 0.0400
Total 3,37,50,000 1 0.1445 or 14.45 %
Question 19
The information relating to book value (BV) and market value (MV) weights of Ex Limited is given
below:
Sources Book Value (₹) Market Value (₹)
Equity shares 2,40,00,000 4,00,00,000
Retained earnings 60,00,000 -
Preference shares 72,00,000 67,50,000
Debentures 18,00,000 20,80,000
Additional information:
I. Equity shares are quoted at ₹ 130 per share and a new issue priced at ₹ 125 per share will be
fully subscribed; flotation costs will be ₹ 5 per share on face value.
II. During the previous 5 years, dividends have steadily increased from ₹ 10 to ₹ 16.105 per share.
Dividend at the end of the current year is expected to be ₹ 17.716 per share.
III. 15% Preference shares with face value of ₹ 100 would realise ₹ 105 per share.
IV. The company proposes to issue 11-year 15% debentures but the yield on debentures of similar
maturity and risk class is 16%; flotation cost is 2% on face value.
V. Corporate tax rate is 30%.
You are required to DETERMINE the weighted average cost of capital of Ex Limited using
both the weights. (RTP May’22) (Same concept different figures Old & New SM)
Answer 19
𝐷1 𝑅𝑠.17.716
(i) Cost of Equity (𝐾𝑒 ) = 𝑃 −𝐹 + g = 𝑅𝑠.125−𝑅𝑠.5 + 0.10*
0
𝐾𝑒 = 0.2476
∗ Calculation of g:
𝑅𝑠. 10 (1+g)5 = Rs. 16.105
16.105
𝑂𝑟, (1+g)5 = 10 = 1.6105
Table (FVIF) Suggests that Rs. 1 Compounds to Rs. 1.6105 in 5 years at the Compound rate of 10
percent. Therefore, g is 10 per cent.
𝐷 𝑅𝑠.17.716
(ii) Cost of Retained Earnings (𝐾𝑟 ) = 𝑃1 + g = 𝑅𝑠.130
+0.10 = 0.2363
0
𝑃𝐷 𝑅𝑠.15
(iii) Cost of Preference Shares (𝐾𝑝 ) = 𝑃0
= 𝑅𝑠.105 = 0.1429

4.17
𝑅𝑉−𝑁𝑃
𝐼(1−𝑡) + ( )
𝑛
(iv) Cost of Debentures (𝐾𝑑 ) = 𝑅𝑉+𝑁𝑃
2
𝑅𝑠.100−𝑅𝑠.91.75∗
𝑅𝑠.15(1−0.30) + ( )
11 𝑦𝑒𝑎𝑟𝑠
= 𝑅𝑠.100+𝑅𝑠.91.75∗
2
𝑅𝑠.15×0.70+𝑅𝑠.0.75 𝑅𝑠.11.25
= 𝑅𝑠.95.875
= 𝑅𝑠.95.875 = 0.1173
*Since yield on similar type of debentures is 16 per cent, the company would be required to offer
debentures at discount.
Market price of debentures (approximation method)
= ₹ 15 ÷ 0.16 = ₹ 93.75
Sale proceeds from debentures = ₹ 93.75 - ₹ 2 (i.e., floatation cost) = ₹ 91.75
Market value (P0) of debentures can also be found out using the present value method:
P0 = Annual Interest × PVIFA (16%, 11 years) + Redemption value × PVIF (16%, 11 years)
P0 = ₹ 15 × 5.0287 + ₹ 100 × 0.1954
P0 = ₹ 75.4305 + ₹ 19.54 = ₹ 94.9705
Net Proceeds = ₹ 94.9705 – 2% of ₹ 100 = ₹ 92.9705
Accordingly, the cost of debt can be calculated
Sale proceeds from debentures = ₹ 93.75 – ₹ 2 (i.e., floatation cost) = ₹91.75
Total Cost of capital [BV weights and MV weights]
(Amount in (₹) lakh)
Source of capital Weights Specific Total cost
BV MV Cost (K) (BV × K) (MV × K)
Equity Shares 240 320** 0.2476 59.4240 79.2320
Retained Earnings 60 80** 0.2363 14.1780 18.9040
Preference Shares 72 67.50 0.1429 10.2888 9.6458
Debentures 18 20.80 0.1173 2.1114 2.4398
Total 390 488.30 86.0022 110.2216
**Market Value of equity has been apportioned in the ratio of Book Value of equity and retained earnings
i.e., 240:60 or 4:1.
Weighted Average Cost of Capital (WACC):
𝐑𝐬.𝟖𝟔.𝟎𝟎𝟐𝟐
Using Book Value = 𝐑𝐬.𝟑𝟗𝟎 = 0.2205 or 22.05%
𝐑𝐬.𝟏𝟏𝟎.𝟐𝟐𝟏𝟔
Using Market Value = 𝐑𝐬.𝟒𝟖𝟖.𝟑𝟎
= 0.2257 or 22.57%
Question 20
Bounce Ltd. evaluates all its capital projects using discounting rate of 15%. Its capital structure consists of
equity share capital, retained earnings, bank term loan and debentures redeemable at par.
Rate of interest on bank term loan is 1.5 times that of debenture. Remaining tenure of debenture and bank
loan is 3 years and 5 years respectively. Book value of equity share capital, retained earnings and bank loan
is ₹ 10,00,000, ₹ 15,00,000 and ₹ 10,00,000 respectively. Debentures which are having book value of
₹ 15,00,000 are currently trading at ₹ 97 per debenture. The ongoing P/E multiple for the shares of the
company stands at 5. You are required to CALCULATE the rate of interest on bank loan and debentures if
tax rate applicable is 25%. (RTP Nov’22)
Answer 20
Let the rate of Interest on debenture be x
∴ Rate of Interest on loan = 1.5x
𝑅𝑉−𝑁𝑃
𝐼𝑛𝑡(1−𝑡)+ 𝑛
∴ 𝐾𝑑 on debentures = 𝑅𝑉+𝑁𝑃
2
100−97
100 × (1−0.25) + 75𝑥+1
3
= 100+97 =
98.5
2

4.18
∴ 𝑘𝑑 on bank loan = 1.5x (1 – 0.25) = 1.125x

𝐸𝑃𝑆 1 1 1
𝑘𝑒 = 𝑀𝑃𝑆 = 𝑀𝑃𝑆/𝐸𝑃𝑆 = 𝑃/𝐸 = 5 = 0.2 𝑘𝑦 = 𝑘𝑒 = 0.2
Computation of WACC
Capital Amount (₹) Weights Cost Product
Equity 10,00,000 0.2 0.2 0.04
Reserves 15,00,000 0.3 0.2 0.06
Debentures 15,00,000 0.3 (75x+1)/98.5 (22.5x + 0.3)/98.5
Bank Loan 10,00,000 0.2 1.125x 0.225x
50,00,000 1 0.1 + 0.225x +
22.5x + 0.3
98.5
WACC = 15%
22.5𝑥 0.3
∴ 0.1 + 0.225× 98.5 + 98.5= 0.15
∴ 9.85+22.1625x+22.5x+0.3 = (0.15) (98.5)
∴ 44.6625x = 14.775 – 9.85 – 0.3
∴ 44.6625x = 4.625
4.625
∴x=
44.6625
∴ x = 10.36 %.
∴ Rate of interest on debenture = x= 10.36%
Rate of interest on Bank loan = 1.5x = (1.5) (10.36%) = 15.54%.
Question 21
Amrit Corporation has the following book value capital structure:
Equity Capital (50 lakh shares of ₹ 10 each). ₹ 5,00,00000
15% Preference share (50,000 shares ₹ 100 each) ₹ 50,00,000
Retained earnings ₹ 4,00,00,000
Debentures 14% (2,50,000 debentures ₹ 100 each) ₹ 2,50,00,000
Term loan 13% ₹ 4,00,00,000
The companies last year earnings per share was ₹ 5, and it maintains a dividend pay-out ratio of 60% and
returns on equity is 10%. The market price per share is ₹ 20.8. Preference share redeemable after 10 years
is currently selling for ₹ 90 per share. Debentures redeemable after 6 years are currently selling for ₹ 75
per debenture. The income tax rate is 40%.
(a) CALCULATE the Weighted Average Cost of Capital (WACC) using market value proportions.
(b) DETERMINE the Marginal Cost of Capital (MACC) if it needs ₹ 5,00,00000 next year assuming the amount
will be raised by 60% equity, 20% debt and 20% retained earnings. Equity issues will fetch a net price of
₹ 14 and cost of debt will be 13% before tax up to ₹ 40,00,000 and beyond ₹ 40,00,000 it will be 15%
before tax. (RTP May’23)
Answer 21
(a) Calculation of Cost of Equity
(i) 𝐷0 = ₹ 5x 60%= ₹ 3
g=bxr
= (1-0.6) x 10% = 4%
𝐷1 = 𝐷0 x (1 + g)= 3 x (1 + 4%)= 3 x 1.04 = 3.12
𝐷 3.12
𝐾𝑒 = 𝑃1 + g = 20.8 + 0.04= 19%
0
(ii) Calculation of Cost of Preference Shares

N =10 years ,NP = ₹ 90 ,PD = ₹ 15, RV = ₹ 100
𝑃𝐷+(𝑅𝑉−𝑁𝑃 )/𝑁
𝐾𝑃 = (𝑅𝑉+𝑁𝑃)
X 100
15+(100−90 )/10
𝐾𝑃 = (100+90)/2
X 100

4.19
𝐾𝑃 = 16/95 x 100= 16.84%
(iii) Calculation of Cost of Debentures

N = 6 years, NP = ₹ 75, Interest = ₹ 14, RV =₹100, T = 40%
𝑖𝑛𝑡(1−𝑡)+(𝑅𝑉−𝑁𝑃 )/𝑁
𝐾𝑑 = (𝑅𝑉+𝑁𝑃)/2
X 100
14(1−0.4)+(100−75 )/6 8.4−4.17
𝐾𝑑 = (100+75)/2
X 100= 𝐾𝑑 = 87.5
X 100=14.37%
(iv) Cost of Term Loan

Kd = Interest rate (1-t)
Kd = 13% (1-40%) = 7.8%
Calculation of Weighted Average Cost of Capital (WACC) (using market weights)

Capital Cost of Market Value Market Product
Capital Value (Cost x
Weights weights)
Equity 19.00% 20.8 x 50,00,000 ₹10,40,00,000 0.6218 11.81%
Preference Shares 16.84% 90 x 50,000 ₹ 45,00,000 0.0269 0.45%
Debentures 14.37% 75 x 2,50,000 ₹ 1,87,50,000 0.1121 1.61%
Term Loan 7.80% ₹ 4,00,00,000 0.2392 1.87%
Total ₹16,72,50,000 1 15.74%
WACC= 15.74%
(b) Calculation of Marginal Cost of Capital (MACC)

The required capital of ₹ 50,000,000 will be raised as follows:
Equity = 60% of ₹ 50,000,000 = ₹ 3,00,00,000
Deby = 20% of ₹ 50,000,000 = ₹1,00,00,000
Retained Earnings= 20% of ₹ 50,000,000 = ₹ 1,00,00,000
3.12
Marginal Cost of Equity = + 0.04
1.4
= 26.28%
Marginal Cost of Debt
13 % 𝑜𝑓 𝑅𝑠.40,00,000+15 % 𝑜𝑓 𝑅𝑠.60,00,000
Cost of Debt (before tax) =
𝑅𝑠.1,00,00,000
𝑅𝑠.5,20,000 + 𝑅𝑠.9,00,000
= = 14.2%
𝑅𝑠.1,00,00,000
Cost of Debt (after tax). = 14.2% (1-t)

= 14.2% (1-0.4)
= 8.52%
Calculation of marginal cost of capital
Capital Cost of Capital Value Weights Product (Cost x weights)
Equity 26.28% ₹ 3,00,00,000 0.6 15.77%
Reserves 26.28% ₹ 1,00,00,000 0.2 5.26%
Debt 8.52% ₹ 1,00,00,000 0.2 1.70%
Total ₹ 5,00,00,000 1 22.73%
Marginal Cost of Capital (MACC) = 22.73%
Question 22
Jason Limited is planning to raise additional finance of ₹ 20 lakhs for meeting its new project plans. It
has ₹ 4,20,000 in the form of retained earnings available for investment purposes. Further details are as
following:
Debt / Equity Mix 30 / 70
4.20
Cost of Debt
Up-to ₹ 3,60,000 8 % (before tax)
Beyond ₹ 3,60,000 12 % (before tax)
Earnings per share ₹4
Dividend pay-out 50% of earnings
Current Market Price per share ₹ 44
Expected Growth rate in Dividend 10 %
Tax 40%
You are required:
(a) To determine the cost of retained earnings and cost of equity.
(b) To determine the post-tax average cost of additional debt.
(c) To determine the pattern for raising the additional finance, and
(d) Compute the overall weighted average after tax cost of additional finance. (RTP Nov’23)
Answer 22
(a) Cost of Equity / Retained Earnings (using dividend growth model)
𝐷
Ke = 𝑃1
0
where D1 = Do (1 + g) = 2 (1 + .10) = 2.2
2.2
Ke = 44 + 0.10 = 0.15 o r 15%
(b) Cost of Debt (Post Tax)

Kd = I (1-t)
Upto 3,60,000 Kd = .08 (1-0.4) = 0.048
Beyond 3,60,000 = .12 (1-0.4) = 0.072
Thus, post-tax cost of additional debt = 0.048 x 3,60,000 / 6,00,000 + 0.072 x 2,40,000/ 6,00,000 =
0.0288 + 0.0288 = 0.0576 or 5.76%
(c) Pattern for Raising Additional Finance

Debt = 20,00,000 x 30% = 6,00,000
Equity = 20,00,000 x 70 % = 14,00,000
Out of this total equity amount of ₹ 14,00,000 –
Equity Shares = 14,00,000 – 4,20,000
= 9,80,000
And Retained Earnings = 4,20,000
(d) Overall Weighted Average after tax cost of additional finance

WACC = Kd x Debt Mix + Ke x Equity Mix = 0.0576 x 30% + 0.15 x 70% = 0.01728 + 0.105 = 0.1223
or 12.23% (approx.)
Question 23
Following are the information of TT Ltd.:
Particulars
Earnings per share Rs.10
Dividend per share Rs.6
Expected growth rate in Dividend 6%
Current market price per share Rs.120
Tax Rate 30%
Requirement of Additional Finance Rs.30 lakhs
Debt Equity Ratio (For additional finance) 2:1
Cost of Debt
0-5,00,000 10%
5,00,001 - 10,00,000 9%
Above 10,00,000 8%
4.21
Assuming that there is no Reserve and Surplus available in TT Ltd. You are required to:
(a) Find the pattern of finance for additional requirement
(b) Calculate post tax average cost of additional debt
(c) Calculate cost of equity
(d) Calculate the overall weighted average after tax cost of additional finance. (PYP 10 Marks, Jul’21)
Answer 23
(a) Pattern of raising additional finance
Equity 1/3 of Rs.30,00,000 = Rs.10,00,000
Debt 2/3 of Rs.30,00,000 = Rs.20,00,000
The capital structure after raising additional finance:
Particulars (₹)
Shareholder’s Funds
Equity Capital 10,00,000
Debt (Interest at 10% p.a.) 5,00,000
(Interest at 9% p.a.) 5,00,000
(Interest at 8% p.a.) (20,00,000–10,00,000) 10,00,000
Total Funds 30,00,000
(b) Determination of post-tax average cost of additional debt
𝐾𝑒 = I (1 – t)
Where,
I = Interest Rate
t = Corporate tax-rate
On First ₹ 5,00,000 = 10% (1 – 0.3) = 7% or 0.07
On Next ₹ 5,00,000 = 9% (1 – 0.3) = 6.3% or 0.063
On Next Rs.10,00,000 = 8% (1 – 0.3) = 5.6% or 0.056
Average Cost of Debt
(₹ 5,00,000× 0.07)+ (₹ 5,00,000 ×0.063)+ (Rs.10,00,000 × 0.056)
= × 100 = 6.125%
20,00,000
(c) Determination of cost of equity applying Dividend growth model:
D1
𝐾𝑒 = +g
p0
Where,
𝐾𝑒 = Cost of equity
D1 = D0 (1+ g)
D0 = Dividend paid
g = Growth rate = 6%
P0 = Current market price per share = Rs.120
Rs.6(1+0.06) Rs.6.36
𝐾𝑒 = Rs.120 + 0.06 = Rs.120 + 0.06 = 0.113 or 11.3%
(d) Computation of overall weighted average after tax cost of additional finance
Particulars (Rs) eights Cost of funds Weighted Cost (%)
Equity 10,00,000 1/3 11.3% 3.767
Debt 20,00,000 2/3 6.125% 4.083
WACC 30,00,000 7.85
(Note: In the above solution different interest rate have been considered for different slab of Debt)
Alternative Solution
(a) Pattern of raising additional finance
Equity 1/3 of Rs.30,00,000 = Rs.10,00,000
Debt 2/3 of Rs.30,00,000 = Rs.20,00,000

Particulars (₹)

4.22
Shareholders’ Funds
Equity Capital 10,00,000
Debt (Interest at 8% p.a.) 20,00,000
Total Funds 30,00,000
(b) Determination of post-tax average cost of additional debt Kd = I (1 – t)

Where,
I = Interest Rate
𝐾𝑑 = 8% (1 – 0.3) = 5.6%
(c) Determination of cost of equity applying Dividend growth model:
D
Then, k e = p 1 +g
0
Where,
𝐾𝑒 = Cost of equity
𝐷1 = 𝐷0 (1+ g)
𝐷0 = Dividend paid
g = Growth rate =6%
𝑃0 = Current market price per share = Rs.120
Rs.6(1+0.06) Rs.6.36
𝐾𝑒 = + 0.06 = + 0.06 = 0.13 or 11.3%
Rs.120 Rs.120
(d) Computation of overall weighted average after tax cost of additional finance
Particulars (₹) Weights Cost of funds Weighted Cost (%)
Equity 10,00,000 1/3 11.3% 3.767
Debt 20,00,000 2/3 5.6% 3.733
WACC 30,00,000 7.50
(Note: In the above solution single interest rate have been considered for Debt)
Question 24
The Capital structure of PQR Ltd. is as follows:
₹
10% Debenture 3,00,000
12% Preference Shares 2,50,000
Equity Share (face value Rs.10 per share) 5,00,000
10,50,000
Additional Information:
(i) Rs.100 per debenture redeemable at par has 2% floatation cost & 10 years of maturity. The market price
per debenture is Rs.110.
(ii) Rs.100 per preference share redeemable at par has 3% floatation cost & 10 years of maturity. The market
price per preference share is Rs.108.
(iii) Equity share has Rs.4 floatation cost and market price per share of Rs.25. 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.
(iv) Corporate Income Tax rate is 30%. Required:
Calculate Weighted Average Cost of Capital (WACC) using market value weights. (PYP 10 Marks, Jan’21)
Answer 24
Workings:
D1 Rs.2
1. Cost of Equity (𝐾𝑒 ) = +g = + 0.050 = 0.145 (approx. )
p0−F Rs.25−Rs.4
(RV−NP)
I(1−t) +
n
2. Cost of Debt (𝐾𝑑 ) = (RV−NP)
2
4.23
(100−98)
10(1−0.03)+ 7+0.2
10
= (100+98) = 99 =0.073(approx.)
10
(RV−NP)
PD+
n
3. Cost of Preference Shares (𝐾𝑝 ) = (RV+NP)
2
(100−97)
12 + 12+0.3
10
= (100+97) = = 0.125(approx.)
98.5
2
Calculation of WACC using market value weights

Source of capital Market Weights After tax WACC (Ko)
Value cost of
capital
(₹) (a) (b) (c) = (a) × (b)
10% Debentures (Rs.110 × 3,000) 3,30,000 0.178 0.073 0.013
(Rs.108 × 2,500)
Equity shares (Rs.25 × 50,000) 12,50,000 0.676 0.145 0.098
18,50,000 1.00 0.129
WACC (𝐾𝑜 ) = 0.129 or 12.9% (approx.)
Question 25
TT Ltd. issued 20,000, 10% convertible debenture of Rs.100 each with a maturity period of 5 years. At
maturity the debenture holders will have the option to convert debentures into equity shares of the
company in ratio of 1:5 (5 shares for each debenture). The current market price of the equity share is
Rs.20 each and historically the growth rate of the share is 4% per annum. Assuming tax rate is 25%.
Compute the cost of 10% convertible debenture using Approximation Method and Internal Rate of Return
Method.
PV Factor are as under:
Year 1 2 3 4 5
PV Factor @ 10% 0.909 0.826 0.751 0.683 0.621
PV Factor @ 15% 0.870 0.756 0.658 0.572 0.497
(PYP 5 Marks, Nov’20)
Answer 25
Determination of Redemption value:
Higher of -
(i) The cash value of debentures = ₹100
(ii) Value of equity shares = 5 shares × Rs.20 (1+0.04)5
= 5 shares × Rs.24.333
= ₹121.665 rounded to ₹121.67
₹121.67 will be taken as redemption value as it is higher than the cash option and attractive to the
investors.
Calculation of Cost of 10% Convertible debenture
(i) Using Approximation Method:
(RV−NP) (121.67−100)
I(1−t)+ 10(1−0.25)+ 7.5+4.334
n 5
𝐾𝑑 = (RV+NP) = (121.67−100) =
110.835
2 2
= 10.676%
(ii) Using Internal Rate of Return Method
Year Cash flows Discount factor Present Discount factor Present Value
(₹) @ 10% Value @ 15% (₹)
0 100 1.000 (100.00) 1.000 (100.00)
1 to 5 7.5 3.790 28.425 3.353 25.148
5 121.67 0.621 75.557 0.497 60.470
4.24
NPV +3.982 -14.382

𝐍𝐏𝐕𝐥 𝟑.𝟗𝟖𝟐
IRR = L+ (𝐇 − 𝐋) = 𝟏𝟎% + (𝟏𝟓% − 𝟏𝟎%)
𝐍𝐏𝐕𝐥 −𝐍𝐏𝐕𝐡 𝟑.𝟗𝟖𝟐—(−𝟏𝟒.𝟑𝟖𝟐)
= 0.11084 or 11.084% (approx.)
Question 26
A Company wants to raise additional finance of ₹ 5 crore in the next year. The company expects to retain
Rs.1 crore earning next year. Further details are as follows:
(i) The amount will be raised by equity and debt in the ratio of 3: 1.
(ii) The additional issue of equity shares will result in price per share being fixed at Rs.25.
(iii) The debt capital raised by way of term loan will cost 10% for the first ₹ 75 lakh and 12% for the next
₹ 50 lakh.
(iv) The net expected dividend on equity shares is Rs.2.00 per share. The dividend is expected to grow at
the rate of 5%.
(v) Income tax rate is 25%.
You are required:
(a) To determine the amount of equity and debt for raising additional finance.
(b) To determine the post-tax average cost of additional debt.
(c) To determine the cost of retained earnings and cost of equity.
(d) To compute the overall weighted average cost of additional finance after tax. (PYP 10 Marks, Nov’19)
Answer 26
a. Determination of the amount of equity and debt for raising additional finance:
Pattern of raising additional finance
Equity 3/4 of ₹ 5 Crore = Rs.3.75 Crore
Debt 1/4 of ₹ 5 Crore = Rs.1.25 Crore
Particulars (₹ In crore)
Shareholders’ Funds
Equity Capital (3.75 – 1.00) 2.75
Retained earnings 1.00
Debt (Interest at 10% p.a.) 0.75
(Interest at 12% p.a.) (1.25-0.75) 0.50
Total Funds 5.00
b. Determination of post-tax average cost of additional debt
𝐾𝑑 = I (1 – t)
Where,
I = Interest Rate
On ₹ 75,00,000 = 10% (1 – 0.25) = 7.5% or 0.075
On ₹ 50,00,000 = 12% (1 – 0.25) = 9% or 0.09
Average Cost of Debt
(₹ 𝟕𝟓,𝟎𝟎,𝟎𝟎𝟎 ×𝟎.𝟎𝟕𝟓)+ (₹ 𝟓𝟎,𝟎𝟎,𝟎𝟎𝟎 ×𝟎.𝟎𝟗)

=
𝟏,𝟐𝟓,𝟎𝟎,𝟎𝟎𝟎
× 𝟏𝟎𝟎
₹ 𝟓,𝟔𝟐,𝟓𝟎𝟎 + ₹ 𝟒,𝟓𝟎,𝟎𝟎𝟎
= x 100 = 8.10%
𝟏,𝟐𝟓,𝟎𝟎,𝟎𝟎𝟎
c. Determination of cost of retained earnings and cost of equity (Applying Dividend growth model):

4.25
D
ke = p1 + g
0
Where,
k e = Cost of equity
D1 = D0 (1+ g)
D0 = Dividend paid (i.e = Rs.2)
g = Growth rate
p0 = Current market price per share
Rs.2(1.05) Rs.2.1
Then, k e = + 0.05 = + 0.05 = 0.084 + 0.05 = 0.134 = 13.4%
Rs.25 Rs.25
Cost of retained earnings equals to cost of Equity i.e. 13.4%
d. Computation of overall weighted average after tax cost of additional finance
Particular (₹) Weights Cost of Weighted Cost
funds (%)
Equity (including 3,75,00,000 3/4 13.4% 10.05
retained earnings)
Debt 1,25,00,000 1/4 8.1% 2.025
WACC 5,00,00,000 12.075
Question 27
Explain the significance of Cost of Capital. (PYP 4 Marks, Nov’19)
Answer 27
Significance of the Cost of Capital: The cost of capital is important to arrive at correct amount and helps the
management or an investor to take an appropriate decision. The correct cost of capital helps in the following
decision making:
(i) Evaluation of investment options: The estimated benefits (future cash flows) from available
investment opportunities (business or project) are converted into the present value of benefits by
discounting them with the relevant cost of capital. Here it is pertinent to mention that every investment
option may have different cost of capital hence it is very important to use the cost of capital which is
relevant to the options available. Here Internal Rate of Return (IRR) is treated as cost of capital for
evaluation of two options (projects).
(ii) Performance Appraisal: Cost of capital is used to appraise the performance of a particulars project
or business. The performance of a project or business in compared against the cost of capital which
is known here as cut-off rate or hurdle rate.
(iii) Designing of optimum credit policy: While appraising the credit period to be allowed to the
customers, the cost of allowing credit period is compared against the benefit/ profit earned by
providing credit to customer of segment of customers. Here cost of capital is used to arrive at the
present value of cost and benefits received.
Question 28
Alpha Ltd. has furnished the following information:
- Earning Per Share (EPS) Rs.4
- Dividend payout ratio 25%
- Market price per share ₹ 50
- Rate of tax 30%
- Growth rate of dividend 10%
The company wants to raise additional capital of Rs.10 lakhs including debt of Rs.4 lakhs. The cost of debt
(before tax) is 10% up to Rs.2 lakhs and 15% beyond that. Compute the after tax cost of equity and debt
and also weighted average cost of capital. (PYP 5 Marks, May’19)
Answer 28
i. Cost of Equity Share Capital (𝐤 𝐞 )
D0 (1+ g) 25% of Rs.4(1+0.10) Rs.1.10
ke = +g= + 0.10 = + 0.10 = 𝟎. 𝟏𝟐𝟐 𝐨𝐫 𝟏𝟐. 𝟐%
P0 Rs.50 Rs.50

1.1
Chapter 1
Introduction of Strategic Management
Question 1
Mr. Raj has been hired as a CEO by XYZ ltd a FMCG company that has diversified into affordable
cosmetics. The company intends to launch Feelgood brand of cosmetics. XYZ wishes to enrich the lives
of people with its products that are good for skin and are produced in ecologically beneficial manner
using herbal ingredients. Draft vision and mission statement that may be formulated by Raj.
( RTP Nov’20, Nov’19, New SM)
Answer 1
Feelgood brand of cosmetics may have following vision and mission:
Vision: Vision implies the blueprint of the company’s future position. It describes where the organisation
wants to land. Mr. Raj should aim to position “Feelgood cosmetics” as India’s beauty care company.
It may have vision to be India’ largest beauty care company that improves looks, give extraordinary
feeling and bring happiness to people.
Mission: Mission delineates the firm’s business, its goals and ways to reach the goals. It explains the
reason for the existence of the firm in the society. It is designed to help potential shareholders and
investors understand the purpose of the company:
Mr. Raj may identify mission in the following lines:
 To be in the business of cosmetics to enhance the lives of people, give them confidence to lead.
 To protect skin from harmful elements in environment and sun rays.
 To produce herbal cosmetics using natural ingredients.
Question 2
“Strategy is partly proactive and partly reactive.” Discuss.
(MTP Oct ‘19, Mar’21 5 Marks, PYP 5 Marks Nov ’18, RTP May 18 & Nov ’20, Old & New SM)
Answer 2
Strategy is partly proactive and partly reactive. In proactive strategy, organizations will analyze possible
environmental scenarios and create strategic framework after proper planning and set procedures and
work on these strategies in a predetermined manner. However, in reality no company can forecast both
internal and external environment exactly. Everything cannot be planned in advance. It is not possible
to anticipate moves of rival firms, consumer behaviour, evolving technologies and so on.
There can be significant deviations between what was visualized and what actually happens.
Strategies need to be attuned or modified in the light of possible environmental changes. There can be
significant or major strategic changes when the environment demands. Reactive strategy is triggered
by the changes in the environment and provides ways and means to cope with the negative factors ortake
advantage of emerging opportunities.

Candidates had sufficient knowledge of strategy as being partly proactive and partly reactive.
The overall performance was good.
Question 3
Briefly explain the importance of strategic management.
(MTP-March ‘18, Oct’18 5 Marks, RTP-Nov ’18 & Nov ’22, PYP 5 Marks Dec ‘21)
Answer 3
Importance of Strategic Management: Strategic Management is very important for the survival and
growth of business organizations in dynamic business environment. Other major benefits of strategic
management are as follows:
• It helps organizations to be more proactive rather than reactive in dealing with its future. It
facilitates the organisations to work within vagaries of environment and remains adaptable
with the turbulence or uncertain future. Therefore, they are able to control their own destiny in
a better way.
• It provides better guidance to entire organization on the crucial point – what it is trying to do. Also
provides framework for all major business decisions of an enterprise such a decision on businesses,
Chapter 1 Introduction of Strategic Management

1.2
products, markets, organization structures, etc.

• It facilitates to prepare the organization to face the future and act as path finder to various
business opportunities. Organizations are able to identify the available opportunities and identify
ways and means as how to reach them.
• It serves as a corporate defense mechanism against mistakes and pitfalls. It helps organizations
to avoid costly mistakes in product market choices or investments.
• Over a period of time, strategic management helps organizations to evolve certain core
competencies and competitive advantages that assist in the fight for survival and growth.

Most of the examinees were explained well the benefits of strategic management. Hence, the
performance was above average.
Question 4
Kamal Sweets Corner, a very popular sweets shop in Ranchi, was facing tough competition from branded
stores of packaged sweets and imported goods. The owners realised that their business reduced by 50%
in the last six months, and this created a stressful business environment for them. To find a solution,
they consulted a business consultant to help them develop a strategy to fight competition and sustain
their century old family business. The business consultant advised them to innovate a new snack for the
public and market it as a traditional snack of the region. The owners liked the idea and developed a new
snack called Dahi Samosa, which very quickly became popular amongst the public and it helped regain
the lost business of Kamal Sweets Corner.
One of the very crucial importance of strategic management was used by the business consultant to help
the owners of Kamal Sweets Corner. Which one could it be? Also, was this strategy Reactive or Proactive?
According to you who are more beneficial in general parlance? (MTP 5 Marks April 21, Old SM)
Answer 4
The strategy used here was of developing a competitive advantage via product which helped Kamal
Sweets Corner regain their lost business. This is also one of the major importance cum advantage of
strategic management, that is helps to develop core competencies and competitive advantages to
overcome competition.
This strategy was a Reactive strategy. Wherein, the owners saw their business fall to 50% of revenue
and then seeking a strategic advisory. They did not plan proactively as to when the new shops were
already opening. They reacted only when the business started to lose up.
Generally, it is always beneficial to develop strategies proactively, so that the dip in businesses is
small and manageable, and even if they are huge, the management has ample time to fix it.
Question 5
Yummy Foods and Tasty Foods are successfully competing in the business of ready to eat snacks in Patna.
Yummy has been pioneer in introducing innovative products. These products will give them good sale.
However, Tasty Foods will introduce similar products in reaction to the products introduced by the
Yummy Foods taking away the advantage gained by the former
(MTP 5 Marks Oct 21 & April ’23, Old & New SM, RTP Nov ’18)
Answer 5
Yummy foods are proactive in its approach. On the other hand, Tasty Food is reactive. Proactive
strategy is planned strategy whereas reactive strategy is adaptive reaction to changing circumstances.
A company’s strategy is typically a blend of proactive actions on the part of managers to improve the
company’s market position and financial performance and reactions to unanticipated developments
and fresh market conditions.
If organisational resources permit, it is better to be proactive rather than reactive. Being proactive in
aspects such as introducing new products will give you advantage in the mind of customers.
At the same time, crafting a strategy involves stitching together a proactive/intended strategy and
then adapting first one piece and then another as circumstances surrounding the company’s situation
change or better options emerge-a reactive/adaptive strategy. This aspect can be accomplished by
Yummy Foods.

1.3
Question 6
What is strategic decision making? What tasks are performed by a strategic Manager?
(MTP- Oct ’19 & Sep ‘23, 5 Marks, RTP Nov’20, RTP Nov’23, Old SM)
Answer 6
Decision making is a managerial process of selecting the best course of action out of several alternative
courses for the purpose of accomplishment of the organizational goals. Decisions may be operational
i.e., which relate to general day-to-day operations. They may also be strategic in nature. According to
Jauch and Glueck “Strategic decisions encompass the definition of the business, products to be handled,
markets to be served, functions to be performed and major policies needed for the organisation to
execute these decisions to achieve the strategic objectives.”
The primary task of the strategic manager is conceptualizing, designing and executing company
strategies. For this purpose, his tasks include:
• Defining the mission and goals of the organization.
• Determining what businesses it should be in.
• Allocating resources among the different businesses.
• Formulating and implementing strategies that span individual businesses.
• Providing leadership for the organization
Question 7
"A business organization cannot always plan all their strategies in advance and often need to blend
planned strategies with reactive strategies." Do you agree with the statement? Give reasons.
(MTP 5 Marks April 22, RTP May 23)
Answer 7
Yes, a business organization cannot always plan all their strategies in advance and often need to blend
planned strategies with reactive strategies. In planned strategy, organisations will analyse possible
environmental scenarios and create strategic framework after proper planning and set procedures and
work on these strategies in a pre-determined manner. However, in reality no company can forecast both
internal and external environment exactly. Everything cannot be planned in advance. It is not possible to
anticipate moves of rival firms, consumer behaviour, evolving technologies and so on. There can be
significant deviations between what was visualised and what actually happens. There can be significant
or major strategic changes when the environment demands. Reactive strategy is triggered by the changes
in the environment and provides ways and means to cope with the negative factors or take advantage
of emerging opportunities.
Question 8
Define Strategic Management. Also discuss the limitations of Strategic Management.
(MTP 5 Marks Sep’22, March ‘19, May’20, Apr’21, Mar’22, Oct’22 & Oct ‘23 5 Marks, PYP May 18 & May
'19, RTP May’19, May’21, May ’18, Nov ’21, Nov’23 Old SM)(RTP May’24)
OR
The strategic management cannot counter all hindrances and always achieve success for an
organization." Do you agree with this statement? Give arguments in support of your answer.
(RTP Nov ’23) (PYP 5 Marks Nov 22)
Answer 8
The term ‘strategic management’ refers to the managerial process of developing a strategic vision,
setting objectives, crafting a strategy, implementing and evaluating the strategy, and initiating
corrective adjustments where deemed appropriate.
The presence of strategic management cannot counter all hindrances and always achieve success as
there are limitations attached to strategic management. These can be explained in the following lines:
 Environment is highly complex and turbulent. It is difficult to understand the complex environment
and exactly pinpoint how it will shape-up in future. The organisational estimate about its future shape
may awfully go wrong and jeopardise all strategic plans. The environment affects as the
organisationhas to deal with suppliers, customers, governments and other external factors.
 Strategic Management is a time-consuming process. Organisations spend a lot of time in preparing,
communicating the strategies that may impede daily operations and negatively impact the routine
business.
 Strategic Management is a costly process. Strategic management adds a lot of expenses to an

1.4
organization. Expert strategic planners need to be engaged, efforts are made for analysis of external
and internal environments devise strategies and properly implement. These can be really costly for
organisations with limited resources particularly when small and medium organisation create
strategies to compete.
 Competition is unpredictable. In a competitive scenario, where all organisations are trying to move
strategically, it is difficult to clearly estimate the competitive responses to the strategies.
Question 9
CDE Holdings operates in various sectors, including manufacturing fitness equipment, organic foods,
eco-friendly products and children's educational tools. The organization is currently in the process of
recruiting Chief Executive Officer. In this scenario imagine yourself as a HR consultant for CDE
Holdings. Identify the strategic level that encompasses this role within CDE Holdings. (1 Mark)
Provide an overview of the key duties and responsibilities falling under the Chief Executive Officer's
scope. (PYP 5 Marks Nov’23)
OR
ABC Limited is in a wide range of businesses which include apparels, lifestyle products, furniture, real
estate and electrical products. The company is looking to hire a suitable Chief Executive Officer. Consider
yourself as the HR consultant for ABC limited. You have been assigned the task to enlist the activities
involved with the role of the Chief Executive Officer. Name the strategic level that this role belongs to
and enlist the activities associated with it.
(MTP 5 Marks Oct’22 & Sep ‘23, PYP Jan ’21 5 Marks, Old & New SM)
Answer 9
The Chief Executive Officer (CEO) position within CDE Holdings operates at the Corporate Level. This
executive level is key in leading the overall direction, performance, and success of the entire organization.
The CEO assumes a central role in shaping the company's strategic vision, overseeing diverse business
sectors, and ensuring alignment with organizational goals.
Key Duties and Responsibilities of the CEO:
The CEO's role encompasses various strategic responsibilities at the Corporate Level, involving:
1. oversee the development of strategies for the whole organization;
2. defining the mission and goals of the organization;
3. determining what businesses, it should be in;
4. allocating resources among the different businesses;
5. formulating, and implementing strategies that span individual businesses;
6. providing leadership for the organization;
7. ensuring that the corporate and business level strategies which company pursues are consistent
with maximizing shareholders wealth; and
8. managing the divestment and acquisition process.
Given the diverse nature of CDE Holdings, spanning manufacturing, organic foods, eco- friendly products,
and children's educational tools, the CEO's responsibilities are tailored to navigate the unique challenges
and opportunities presented by each sector. In conclusion, the CEO at the Corporate Level plays a critical
role in guiding CDE Holdings strategically, ensuring cohesive leadership, and driving sustainable success
across its diverse business domains.
Question 10
Explain the difference between three levels of strategy formulation.
(MTP 5 Marks March ’23, MTP Aug’18 5 Marks, Old & New SM, RTP May’20)
Answer 10
A typical large organization is a multidivisional organisation that competes in several different
businesses. It has separate self-contained divisions to manage each of these. There are three levels of
strategy in management of business - corporate, business, and functional.
The corporate level of management consists of the chief executive officer and other top level

1.5
executives. These individuals occupy the apex of decision making within the organization. The role of
corporate-level managers is to oversee the development of strategies for the whole organization. This
role includes defining the mission and goals of the organization, determining what businesses it should
be in, allocating resources among the different businesses and so on rests at the Corporate Level.
The development of strategies for individual business areas is the responsibility of the general
managers in these different businesses or business level managers. A business unit is a self - contained
division with its own functions - for example, finance, production, and marketing. The strategic role of
business-level manager, head of the division, is to translate the general statements of direction and
intent that come from the corporate level into concrete strategies for individual businesses.
Functional-level managers are responsible for the specific business functions or operations such as
human resources, purchasing, product development, customer service, and so on. Thus, a functional
manager’s sphere of responsibility is generally confined to one organizational activity, whereas
general managers oversee the operation of a whole company or division.
Question 11
Distinguish between vision and mission statement.
(MTP-Aug. ‘18, April’22 5 Marks, RTP May’18, RTP May’19, Old SM)
Answer 11
A Mission statement tells you the fundamental purpose of the organization. It concentrates on the
present. It defines the customer and the critical processes. It informs you of the desired level of
performance. On the other hand, a vision statement outlines what the organization wants to be. It
concentrates on the future. It is a source of inspiration. It provides clear decision-making criteria.
A mission statement can resemble a vision statement in a few companies, but that can be a grave
mistake. It can confuse people. Following are the major differences between vision and mission:
1. The vision states the future direction while the mission states the ongoing activities of the
organisation.
2. The vision statement can galvanize the people to achieve defined objectives, even if they are stretch
objectives, provided the vision is specific, measurable, achievable, relevant and time bound. A
mission statement provides a path to realize the vision in line with its values. These statements
have a direct bearing on the bottom line and success of the organization.
3. A vision statement defines the purpose or broader goal for being in existence or in the business
and can remain the same for decades if crafted well while a mission statement is more specific in
terms of both the future state and the time frame. Mission describes what will be achieved if the
organization is successful.
Question 12
Enumerate the task to be performed as a strategic manager of a company.
(MTP-April ‘19, 5 Marks)
Answer 12
The primary tasks of the strategic manager is conceptualizing, designing and executing company
strategies.
For this purpose, his tasks will include:
• Defining the mission and goals of the organization.
• Determining what businesses it should be in.
• Allocating resources among the different businesses.
• Formulating strategies.
• Implementing strategies.
• Providing leadership for the organization.
Question 13
Mission statement of a company focuses on the question: ‘who we are’ and ‘what we do’. Explain briefly.
(MTP 5 Marks Oct 20, Apr’21, RTP May’23)
Answer 13
A company’s mission statement is typically focused on its present business scope — “who we are and
what we do”; mission statements broadly describe an organizations present capability, customer focus

1.6
activities and business makeup. An organisation’s mission states what customers it serves, what need
it satisfies, and what type of product it offers. It is an expression of the growth ambition of the
organisation. It helps organisation to set its own special identity, business emphasis and path for
development. Mission amplifies what brings the organization to this business or why it is there, what
existence it seeks and what purpose it seeks to achieve as a business organisation.
In other words, the mission serves as a justification for the firm's very presence and existence; it
legitimizes the firm's presence.
Question 14
Explain briefly the. key areas in which the strategic planner should concentrate his mind to achieve
desired results. (5 Marks March ’22) (RTP Nov ’22 & May ’21)
Answer 14
A strategic manager defines the strategic intent of the organisation and take it on the path of achieving
the organisational objectives. There can be a number of areas that a strategic manager should
concentrate on to achieve desired results. They commonly establish long-term objectives in seven
areas as follows.
• Profitability.
• Productivity.
• Competitive Position.
• Employee Development.
• Employee Relations.
• Technological Leadership.
• Public Responsibility.
Question 15
What are 'objectives'? What characteristics it must possess to be meaningful?
(MTP 5 Marks April ’23, RTP May’22, May’21, PYP 5 Marks May’19)
Answer 15
Objectives are organizations performance targets — the results and outcomes it wants to achieve.
They function as yardstick for tracking an organization’s performance and progress.
Objectives with strategic focus relate to outcomes that strengthen an organization’s overall business
position and competitive vitality. Objectives, to be meaningful to serve the intended role, must
possess the following characteristics:
• Objectives should define the organization’s relationship with its environment.
• Objectives should be facilitative towards achievement of mission and purpose.
• Objectives should provide the basis for strategic decision-making.
• Objectives should provide standards for performance appraisal.
• Objectives should be understandable.
• Objectives should be concrete and specific.
• Objectives should be related to a time frame.
• Objectives should be measurable and controllable.
• Objectives should be challenging.
• Different objectives should correlate with each other.
• Objectives should be set within constraints.
Question 16
Dharma Singh, the procurement department head of Cyclic, a mountain biking equipment company, was
recently promoted to look after sales department along with procurement department. His seniors at
the corporate level have always liked his way of leadership and are assures that he would ensure the
implementation of policies and strategies to the best of his capacity but have never involved him in
decision making for the company.
Do you think this is the right approach? Validate your answer with logical reasoning around management
levels and decision making. (RTP May’21, Old & New SM)
Answer 16
Functional managers provide most of the information that makes it possible for business and corporate
level managers to formulate realistic and attainable strategies.
1.7
This is so because functional managers like Dharma Singh are closer to the customer than the typical
general manager is. A functional manager may generate important ideas that subsequently may become
major strategies for the company. Thus, it is important for general managers to listen closely to the ideas
of their functional managers and invoice them in decision making.
An equally great responsibility for managers at the operational level is strategy implementation: the
execution of corporate and business level plans, and if they are involved in formulation, the clarity of
thoughts while implementation can benefit too.
Thus, the approach of Cylix Corporate management is not right. They should involve Dharma Singh, as
well as other functional managers too in strategic management.
Question 17
Ramesh Sharma has fifteen stores selling consumer durables in Delhi Region. Four of these stores were
opened in last three years. He believes in managing strategically and enjoyed significant sales of
refrigerator, televisions, washing machines, air conditioners and like till four years back. With shift to
the purchases to online stores, the sales of his stores came down to about seventy per cent in last four
years.
Analyze the position of Ramesh Sharma in light of limitations of strategic management.
(RTP Nov’19 & Nov ’20, Old & New SM)
Answer 17
Ramesh Sharma is facing declining sales on account of large scale shift of customers to online stores.
While he is using the tools of strategic management, they cannot counter all hindrances and always
achieve success. There are limitations attached to strategic management as follows:
 Environment under which strategies are made is highly complex and turbulent. Entry of online
stores, a new kind of competitor brought a different dimension to selling consumer durables. Online
stores with their size power could control the market and offer stiff competition to traditional stores.
 Another limitation of strategic management is that it is difficult to predict how things will shape-up
in future. Ramesh Sharma, although managing strategically failed to see how online stores will
impact the sales.
 Although, strategic management is a time-consuming process, he should continue to manage
strategically. The challenging times require more efforts on his part.
 Strategic management is costly. Ramesh Sharma may consider engaging experts to find out
preferences of the customers and attune his strategies to better serve them in a customized manner.
Such customized offerings may be difficult to match by the online stores.
 The stores owned by Ramesh Sharma are much smaller than online stores. It is very difficult for him
to visualize how online stores will be moving strategically.
Question 18
Strategic management helps an organization to work through changes in environment to gain
competitive advantage. In light of statement discuss its benefits. (RTP Nov’19)
Answer 18
Strategic management involves developing the company’s vision, environmental scanning, strategy
formulation, implementation, evaluation and control. It emphasizes the monitoring and evaluation of
external opportunities and threats in the light of a company’s strengths and weaknesses and designing
strategies for the survival and growth. It helps in creation of competitive advantage to outperform the
competitors and also guide the company successfully through all changes in the environment.
The major benefits of strategic management are:
(a) Strategic management gives a direction to the company to move ahead. It defines the goals and
mission.
(b) It helps organizations to be proactive instead of reactive in shaping its future.
(c) It provides framework for all major decisions of an enterprise such as decisions on businesses,
products, markets, manufacturing facilities, investments and organizational structure. It provides
better guidance to entire organization on the crucial point - what it is trying to do.
(d) It helps organizations to identify the available opportunities and identify ways and means to achieve
them.
(e) It serves as a corporate defense mechanism against mistakes and pitfalls.
(f) It helps to enhance the longevity of the business.

1.8
(g) It helps the organization to develop certain core competencies and competitive advantages that
would facilitate survival and growth.
Question 19
Mr. Mehta sharing with his friend in an informal discussion that he has to move very cautiously in his
organization as the decisions taken by him has organization wide impact and involves large
commitments of resources. He also said that his decisions decide the future of his organization. Where
will you place Mr. Mehta in the organizational hierarchy and explain his role in the organization.
(RTP Nov’21)
Answer 19
Mr. Mehta works in an organization at top level. He participates in strategic decision making within the
organization. The role of corporate-level managers is to oversee the development of strategies for the
whole organization. This role includes defining the mission and goals of the organization, determining
what businesses it should be in, allocating resources among the different businesses, formulating and
implementing strategies that span individual businesses, and providing leadership for the organization.
Question 20
Distinguish between the following: Corporate and business level. (RTP May 19)
Answer 20
A typical large organization is a multi-divisional organization that competes in several different
businesses. There are three main levels of management: corporate, business, and functional. Corporate
level occupies the highest level of strategic decision making and cover actions dealing with the objective
of the firm, acquisition and allocation of resources and coordination of strategies of various businesses
for optimal performance. The corporate level of management consists of the Chief Executive Officer
(CEO), other senior executives. The role of corporate level managers is to oversee the development of
strategies for the whole organization. This role includes defining the mission and goals of the
organization, determining what businesses it should be in, allocating resources and so on.
Business level comes below corporate level. Business level strategies are the courses of action adopted
by an organization for each of its businesses separately, to serve identified customer groups and provide
value to the customers by satisfaction of their needs.
Question 21
ABC Ltd. currently sells its product in two major markets – Europe and Asia. While it is a market leader
in Europe, ABC Ltd. has struggled to penetrate the more competitive Asian market. ABC Ltd. hired a
strategic consultant to analyze the situation and submit his report to them. After the report received
from the strategic consultant, it has therefore decided to pull out of Asia entirely and focus on its
European markets only. This decision relates to which level in ABC Ltd. and explain the role of managers
at this level in the organization. (RTP May ’22)
Answer 21
Corporate level strategy relates to the markets and industries that the organization chooses to operate
in, as well as other decisions that affect the organization as a whole. The role of corporate-level managers
is to oversee the development of strategies for the whole organization. This role includes defining the
mission and goals of the organization, determining what businesses it should be in, allocating resources
among the different businesses, formulating and implementing strategies that span individual
businesses, and providing leadership for the organization.
Question 22
Falguni, CFO of Warships Advertisement Agency, stated that strategic management helps the
organisation to develop certain core competencies and competitive advantages that facilitate
management in the turbulent environment. Do you agree, if yes, then what and how does it facilitate
in? (RTP Nov ’23)
Answer 22
Yes, strategic management plays a crucial role in an organization's survival and growth, particularly in a
turbulent environment. It provides the framework for developing and leveraging core competencies and
competitive advantages that enable the organization to not only withstand challenges but also seize
opportunities for expansion and success.

1.9
• Survival: In a turbulent environment characterized by rapid changes, uncertainties, and challenges,

strategic management helps an organization adapt and respond effectively. By developing core
competencies and competitive advantages, an organization becomes better equipped to navigate
unexpected disruptions and stay relevant in the market.
• Growth: Strategic management goes beyond survival. It enables an organization to identify
opportunities, innovate, and create value for its customers. By leveraging core competencies and
competitive advantages, the organization can capture market share, expand its offerings, and
achieve sustained growth.
Question 23
Define strategic intent. Briefly explain the elements of strategic intent. (RTP May’18, May’19, May’20)
OR
"Strategic intent provides the framework within which the firm would adopt a predetermined direction
and would operate to achieve strategic objectives." In the light of this statement, discuss the elements
of strategic intent. (PYP 5 Marks Nov 22)
Answer 23
Strategic Management is defined as a dynamic process of formulation, implementation, evaluation, and
control of strategies to realize the organization’s strategic intent. Strategic intent refers to purposes for
what organization strives for. Top management must define “what they want to do” and “why they want
to do”. “Why they want to do” represents strategic intent of the firm. Clarity in strategic intent is
extremely important for the future success and growth of the enterprise, irrespective of its nature and
size.
Strategic intent can be understood as the philosophical base of strategic management. It implies the
purposes which an organization endeavors to achieve. It is a statement that provides a perspective of the
means, which will lead the organization, reach its vision in the long run. Strategic intent gives an idea of
what the organization desires to attain in future.
Strategic intent provides the framework within which the firm would adopt a predetermined direction
and would operate to achieve strategic objectives. Strategic intent could be in the form of vision and
mission statements for the organization at the corporate level. It could be expressed as the business
definition and business model at the business level of the organization.
Strategic intent is generally stated in broad terms but when stated in precise terms it is an expression of
aims to be achieved operationally i.e., goals and objectives.
Elements of Strategic Intent
(i) Vision: Vision implies the blueprint of the company’s future position. It describes where the organization
wants to land. It depicts the organization’s aspirations and provides a glimpse of what the organization
would like to become in future. Every sub system of the organization is required to follow its vision.
(ii) Mission: Mission delineates the firm’s business, its goals and ways to reach the goals. It explains the
investors understand the purpose of the company. A mission statement helps to identify, ‘what business
the company undertakes.’ It defines the present capabilities, activities, customer focus and business
makeup.
(iii) Business definition: It seeks to explain the business undertaken by the firm, with respect to the customer
needs, target markets, and alternative technologies. With the help of business definition, one can
ascertain the strategic business choices. Organizational restructuring also depends upon the business
definition.
(iv) Business model: Business model, as the name implies is a strategy for the effective operation of the
business, ascertaining sources of income, desired customer base, and financial details. Rival firms,
operating in the same industry rely on the different business model due to their strategic choice.
(v) Goals and objectives: These are the base of measurement. Goals are the end results, that the
organization attempts to achieve. On the other hand, objectives are time-based measurable targets,
which help in the accomplishment of goals. These are the end results which are to be attained with the
help of an overall plan, over the particular period. However, in practice no distinction is made between
goals and objectives and both terms are used interchangeably.
The vision, mission, business definition, and business model explain the philosophy of the organization
but the goals and objectives represent the results to be achieved in multiple areas of business.

1.10
Question 24
What should be the major components of a good mission statement? (RTP Nov’22)
Answer 24
Mission statements broadly describe an organizations’ present capabilities, customer focus, activities,
and business makeup. Following points are useful while writing a good mission statement of a company:
• Good mission statement is highly personalized – unique to the organization for which it is developed.
• *Mission statement should emphasize on giving an organization its own special identity, business
emphasis and path for development.
• *Mission statement should clearly specify that, what needs it is trying to satisfy, customer groups it is
targeting, technologies and competencies it uses and the activities it performs.
• Technology, competencies and activities are important in defining a company’s business because they
indicate the boundaries on its operation.
• The mission should not be to make profit.
Question 25
ABC Pharmaceuticals, a leading pharmaceutical company, is in the process of formulating its strategic
intent. The top management of ABC Pharmaceuticals wants to define the company's future direction,
objectives, and goals. They aim is to create a vision that sets the organization apart and provides a
roadmap for future growth. ABC Pharmaceuticals aspires to enrich the lives of people by producing
high-quality pharmaceutical products at competitive prices and wants to become the world's leading
pharmaceutical company by 2030." Based on this context, draft a vision and mission statement that
could be formulated by the top management of ABC Pharmaceuticals. (RTP Nov ’23 & May ’24)
Answer 25
ABC Pharmaceuticals may have following vision and mission:
Vision: Vision implies the blueprint of the company’s future position. It describes where the organisation
wants to land. ABC Pharmaceuticals may have vision "To be the globally recognized leader in
pharmaceutical innovation and enriching the lives of people worldwide by providing high-quality,
affordable, and accessible pharmaceutical products."
Mission: Mission delineates the firm’s business, its goals and ways to reach the goals. It explains the
investors understand the purpose of the company.
ABC Pharmaceuticals may identify mission in the following lines:
• To improve the well-being of individuals and communities by relentlessly pursuing excellence in
pharmaceutical research, development, and manufacturing.
• Committed to producing safe, effective, and sustainable medicines that address unmet medical
needs and enhance the quality of life for patients.
• Through innovation, collaboration, and ethical practices, we aim to make a positive impact on global
healthcare and become the trusted partner of healthcare providers and patients alike.
Question 26
How strategic decisions differ in nature from other routine decisions taken in day-to-day working of an
organization? Explain. (RTP Nov’21)
Answer 26
Strategic decisions are different in nature than all other decisions which are taken at various levels of the
organization during day-to-day working of the organizations. The major dimensions of strategic decisions
are given below:
 Strategic issues require top management decisions.
 Strategic issues involve the allocation of large amounts of company resources.
 Strategic issues are likely to have a significant impact on the long term prosperity of the organization.
 Strategic issues are future oriented.
 Strategic issues usually have major multifunctional or multi-business consequences.
 Strategic issues necessitate consideration of factors in the organization’s external environment.

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Paper 6

Modified as per Applicable for

3. What is the bene昀椀t of Chapter-wise?

4. What does amended for the latest a琀琀empt mean?

6. What if a new a琀琀empt is added post my purchase?

7. What does N/A mean?

*This is on an average based on the last 11 a琀琀empts

Section B: Strategic Management

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

(iv) Management of financial resources (such as working capital).

Chapter 4 Cost of Capital

Equity share capital (W.N.1) 40,00,000 0.500 15.00 7.500

Working Notes (W.N.):

5. Cost of 12% Debentures

Where, 𝐊 𝒆 = Cost of equity

Chapter 4 Cost of Capital

Chapter 4 Cost of Capital

(b) Equity Shares (Retained Earnings) (Ke)

EPSincurrent year−EPSinprevious year ₹ 3.023− ₹ 2.723

Expected dividend (D1) 50% of ₹ 3.023

Chapter 4 Cost of Capital

Equity shares 0.80 17.87 14.296

(2) Computation of cost of term loans (KT):

(3) Computation of cost of preference capital (Kp):

Calculation of Weighted Average cost of capital Using market value weights

Chapter 4 Cost of Capital

8.5 % Debentures 1,477.5 0.17 5.86 0.99

Chapter 4 Cost of Capital

Cost of Debt (Kd) = 5.36%

(i) Cost of Equity Capital (Ke)

(ii) Cost of Debenture (Kd):

(ii) Cost of preference Shares (Kp)

(iii) 𝐶𝑜𝑠𝑡 of debenture (kd)

Weighted Average cost of capital (Book Value)

Chapter 4 Cost of Capital

Source Amount (₹) Weights After tax Cost of WACC (%)

Capital Structure Plans

Chapter 4 Cost of Capital

Computation of Present Earnings before interest and tax (EBIT)

Po (MPS) 158.2 176.29

Calculation Marginal Cost of Capital (MACC)

Chapter 4 Cost of Capital

(𝑅𝑉−𝑁𝑃) (𝑅𝑠.100 − 𝑅𝑠.95)

Preferences shares 2,40,000 0.072 12.82 0.92

Equity shares 22,00,000 0.663 17.00 11.27

33,20,000 1.000 14.23

Chapter 4 Cost of Capital

Chapter 4 Cost of Capital

Chapter 4 Cost of Capital

∴ 𝑘𝑑 on bank loan = 1.5x (1 – 0.25) = 1.125x

(ii) Calculation of Cost of Preference Shares

Chapter 4 Cost of Capital

𝐾𝑃 = 16/95 x 100= 16.84%

(iii) Calculation of Cost of Debentures

(iv) Cost of Term Loan

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

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

Cost of Debt (after tax). = 14.2% (1-t)

(b) Cost of Debt (Post Tax)