CA SUNIL KESWANI PYQs of FM

S. No. Chapter Page No.

1 Cost of Capital 2 – 13
2 Leverage 14 – 26
3 Capital Structure 27 – 41
4 Working Capital Management 42 – 47
5 Receivables Management 48 – 51
6 Cash & Inventory Management 52 – 56
7 Ratio Analysis 57 – 70
8 Investment Decisions 71 – 88
9 Risk Analysis in Capital Budgeting 89 – 97
10 Dividend Decisions 98 – 103

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CA SUNIL KESWANI PYQs of FM

COST OF CAPITAL
PAST YEAR QUESTIONS
MAY – 2023 – 10 Marks
st
Capital structure of D Ltd. as on 31 March, 2023 is given below:
Particulars `
Equity share capital (`10 each) 30,00,000
8% Preference share capital (`100 each) 10,00,000
12% Debentures (`100 each) 10,00,000
Current market price of equity share is `80 per share. The company has paid dividend of `14.07
per share. Seven years ago, it paid dividend of `10 per share. Expected dividend is `16 per
share.
8% Preference shares are redeemable at 6% premium after five years. Current market price per
preference share is `104.
12% debentures are redeemable at 20% premium after 10 years. Flotation cost is `5 per
debenture.
The company is in 40% tax bracket.
In order to finance an expansion plan, the company intends to borrow 15% Long-term loan of
`30,00,000 from bank. This financial decision is expected to increase dividend on equity share
from `16 per share to `18 per share. However, the market price of equity share is expected to
decline from `80 to `72 per share, because investors' required rate of return is based on current
market conditions.
Required:
(i) Determine the existing Weighted Average Cost of Capital (WACC) taking book value
weights.
(ii) Compute Weighted Average Cost of Capital (WACC) after the expansion plan taking book
value weights.
Interest Rate 1% 2% 3% 4% 5% 6% 7%
FVIFi,5 1.051 1.104 1.159 1.217 1.276 1.338 1.403
FVIFi,6 1.062 1.126 1.194 1.265 1.340 1.419 1.501
FVIFi,7 1.072 1.149 1.230 1.316 1.407 1.504 1.606

Solution
(a) Growth rate in dividend
14.07 = 10 FVIF(i,7 years)

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CA SUNIL KESWANI PYQs of FM

FVIF(i, 7 years) = 1.407

FVIF(5%, 7 years) = 1.407
i = 5%
Growth rate in dividend = 5%
!" "%
(b) Ke = #$ + " = &$ + 0.05 = 25%
!"#$% )*+#)*,
#!'( ) &'( )
& -
(c) Kp = !"'$% = )*+')*, = 8%
( ) ( )
( (

!"#$% )(*#.-
*(",-)'( ) "/(",$.1)'( )
& )*
(d) Kd = !"'$% = )(*'.- = 9.02%
( ) ( )
( (

(i) Statement of WACC

Source Book Value Cost of capital Total cost
Equity share capital 30,00,000 25% 7,50,000
Preference share capital 10,00,000 8% 80,000
Debentures 10,00,000 9.02% 90,200
50,00,000 9,20,200
2,/$,/$$
WACC = 4$,$$,$$$ × 100 = 18.40%

(ii) Cost of long term debt = 15(1 - 0.40) = 9%

"&
Revised Ke = 5/ + 0.05 = 30%

Statement of WACC
Source Book Value Cost of capital Total cost
Equity share capital 30,00,000 30% 9,00,000
Preference share capital 10,00,000 8% 80,000
Debentures 10,00,000 9.02% 90,200
Long term debt 30,00,000 9% 2,70,000
80,00,000 13,40,200
"6,1$,/$$
WACC = &$,$$,$$$ × 100 = 16.76%

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CA SUNIL KESWANI PYQs of FM

NOV – 2022 – 5 Marks

The following is the extract of the balance sheet of M/s KD Ltd.:
Particulars Amount (`)
Ordinary shares (Face value `10 per share) 5,00,000
Share premium 1,00,000
Retained profits 6,00,000
8% Preference Shares (Face value `25 per share) 4,00,000
12% Debentures (Face value `100 each) 6,00,000
22,00,000
The ordinary shares are currently priced at `39 ex-dividend and preference share is priced at `18
cum-dividend. The debenture are selling at 120 percent ex-interest. The applicable tax rate to KD
Ltd. is 30 percent. KD Ltd.’s cost of equity has been estimated at 19 percent. Calculate the WACC
(weighted average cost of capital) of KD Ltd. on the basis of market value.

Solution
Price of preference shares ex-dividend = 18 – (25 8%) = 18 – 2 = `16
#789878:;8 !=>=?8:? (/4 ×&%)
Cost of preference shares = Kp = #$
= "%
= 0.125 = 12.5%
*(",-) ("$$×"/%)(",$.6$)
Cost of debt = Kd = #$
= ("$$×"/$%)
= 0.07 = 7%
Cost of equity = Ke = 19%
Cost of retained earnings = Kr = Ke = 19%
Statement of WACC
Sources Market Value Weight Cost of Capital Product
Equity shares 50,000 39 = 0.6664 0.19 0.1266
19,50,000
Preference 16 16,000 = 0.0875 0.125 0.0109
shares 2,56,000
Debentures 120 6,000 = 0.2461 0.07 0.0172
7,20,000
WACC 0.1547
WACC = 0.1547 = 15.47%

NOV – 2022 – 5 Marks

MR Ltd. is having the following capital structure, which is considered to be optimum as on
31.03.2022.
Equity share capital (50,000 shares) `8,00,000
12% Pref. share capital `50,000
15% Debentures `1,50,000
`10,00,000

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CA SUNIL KESWANI PYQs of FM

The earning per share (EPS) of the company were `2.50 in 2021 and the expected growth in equity
dividend is 10% per year. The next year’s dividend per share (DPS) is 50% EPS of the year 2021.
The current market price per share (MPS) is `25.00. the 15% new debentures can be issued by the
company. The company’s debentures are currently selling at `96 per debenture. The new 12%
Pref. Share can be sold at a net price of `91.50 (face value `100 each). The applicable tax rate is
30%.

You are required to calculate:

(i) After tax cost of
(a) New debt
(b) New preference share capital and
(c) Equity shares assuming that new equity shares comes from retained earnings.
(ii) Marginal cost of capital
(iii) How much can be spend for capital investment before sale of new equity shares assuming
that retained earnings for next year investment is 50% of 2021?

Solution
*(",-) "4(",$.6$)
(i) (a) Cost of new debt (Kd) = #$
= 2%
= 0.1094 = 10.94%
#! "/
(b) Cost of new preference shares (Kp) = #B = 2".4 = 0.1311 = 13.11%
!" (/.4$×4$%)
(c) Cost of equity (Ke) = #B + " = /4
+ 0.10 = 0.15 = 15%

(ii) Marginal cost of capital = (Ke)(We) + (Kd)(Wd) + (Kp)(Wp)

= (0.15)(0.80) + (.01994)(0.15) + (0.1311)(0.05) = 0.1430 = 14.30%

(iii) Amount that can be spend for capital investment = 50% EPS No. of shares
= 50% 2.50 50,000 = `62,500
Portion of equity capital is 80% of total capital.
Thus, `62,500 is 80% of total capital
%/,4$$
Amount of capital investment = &$%
= `78,125

MAY – 2022 – 5 Marks

A company issues:
15% convertible debentures of `100 each at par with a maturity period of 6 years. On maturity,
each debenture will be converted into 2 equity shares of the company. The risk-free rate of
return is 10%, market risk premium is 18% and beta of the company is 1.25. The company has
paid dividend of `12.76 per share. Five years ago, it paid dividend of `10 per share. Flotation
cost is 5% of issue amount.
5% preference shares of `100 each at premium of 10%. These shares are redeemable after 10
years at par. Flotation cost is 6% of issue amount.
Assuming corporate tax rate is 40%.

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CA SUNIL KESWANI PYQs of FM

(i) Calculate the cost of convertible debentures using the approximation method.
(ii) Use YTM method to calculate the cost of preference shares.

Year 1 2 3 4 5 6 7 8 9 10
PVIF0.03,t 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744
PVIF0.05,t 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614
PVIFA0.03,t 0.971 1.913 2.829 3.717 4.580 5.417 6.230 7.020 7.786 8.530
PVIFA0.05,t 0.952 1.859 2.723 3.546 4.329 5.076 5.786 6.463 7.108 7.722

Interest rate 1% 2% 3% 4% 5% 6% 7% 8% 9%
FVIFi,5 1.051 1.104 1.159 1.217 1.276 1.338 1.403 1.469 1.539
FVIFi,6 1.062 1.126 1.194 1.265 1.340 1.419 1.501 1.587 1.677
FVIFi,7 1.072 1.149 1.230 1.316 1.407 1.504 1.606 1.714 1.828

Solution
(i) As per CAPM, Ke = Rf + [β × (Rm – Rf)] = 10 + (18 1.25) = 32.5%
Also, let growth rate = g
Now, 10(1 + g)5 = 12.76
(1 + g)5 = 1.276
From the Interest rate table, we can say that g = 5% as for five years at 5% value is 1.276.
!"
As per Constant growth model, Ke = #B + "
"/.5%("'$.$4)
0.325 = #$
+ 0.05
"6.62&
0.275 = #$
P0 = 48.72
Thus, share price today = `48.72
Redemption value will be higher of:
(a) Cash value of debenture = `100
(b) Value of equity shares = 2 48.72 (1 + 0.05)6 = 2 48.72 1.340 = `130.57
Thus, redemption value will be `130.57
As per approximation method,
*(",-)'[(DE,F#)÷:]
Kd = [(F#'DE)÷/]
I = 15% 100 = 15 t = 0.40 RV = 130.57 NP = 100 – 5% = 95
"4 (",$.1$)'[{"6$.45,24}÷%] "1.26
Kd = [{24'"6$.65}÷/]
= ""/.5&4 = 0.1324 = 13.24%

(ii) Cost of Preference Shares using YTM Method:

Preference dividend = 5% 100 = 5
Redemption value = 100 years to maturity = 10
Investment = 100 + (100 10%) – (110 6%) = `103.40
NPV at 5% = PVCI – PVCO

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CA SUNIL KESWANI PYQs of FM

= PV of Preference dividend + PV of Redemption Value – Investment

= [5 × 7.722] + [100 × 0.614] – 103.40 = - `3.39
NPV at 3% = PVCI – PVCO
= PV of Preference dividend + PV of Redemption Value – Investment
= [5 × 8.530] + [100 × 0.744] – 103.40 = `13.65
F#E/ "6.%4
Cost of Preference (Kp) = L + (F#E ) (+ − -) = 3 + ("6.%4,(,6.62)) (5 − 3) = 4.60%
/ ,F#E0

DECEMBER – 2021 – 5 Marks

Book value of capital structure of B Ltd. is as follows:
Sources Amount
12% Debentures @`100 each `6,00,000
Retained earnings `4,50,000
4,500 Equity shares @`100 each `4,50,000
`15,00,000
Currently, the market value of debenture is `110 per debenture and equity share is `180 per share.
The expected rate of return to equity shareholder is 24% p.a. company is paying tax @30%.

Calculate WACC on the basis of market value weights.

Solution
K#L (/1%×"$$)
Ke = #$
= "&$
= 0.1333 = 13.33%
Kr = Ke = 13.33%
*(",-) ("/%×"$$)(",$.6$) &.1$
Kd = #B
= ""$
= ""$
= 7.64%

Computation of WACC (By Market Value Weights)

Source Market Value (A) Cost (B) A×B
12% Debentures %,$$,$$$ 7.64% 50,424
× 110 = 6,60,000
"$$
Equity Shareholder Fund 4,500 × 180 = 8,10,000 13.33% 1,07,973
14,70,000 1,58,397
",4&,625
Weighted Average Cost of Capital = "1,5$,$$$ × 100 = 10.77%

JULY – 2021 – 10 Marks

Following are the information of TT Ltd.:
Particulars
Earnings per share `10
Dividend per share `6
Expected growth rate in Dividend 6%
Current market price per share `120

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Tax rate 30%

Requirement of Additional Finance `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%
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

Solution
(a) Pattern of raising capital
Debt (30,00,000 × 2/3) = `20,00,000
Equity (30,00,000 × 1/3) = `10,00,000
Equity Fund:
Equity (additional) = `10,00,000
`10,00,000
Debt Fund:
10% Debt = `5,00,000
9% Debt = `5,00,000
8% Debt = `10,00,000
`20,00,000

*:-878M- (",-) [(4,$$,$$$×"$%)'(4,$$,$$$×2%)'("$,$$,$$$×&%)](",$.6$)

(b) Kd = #$
× 100 = /$,$$,$$$
× 100
",//,4$$
= /$,$$,$$$ × 100 = 6.125%

!("'N) %×("'$.$%) 4.6%

(c) Ke = #$
+"= "/$
+ 0.06 = "/$
+ 0.06 = 0.113 = 11.3%

(d) Weighted average cost of capital

Source Amount (`) Weight Cost of capital after tax WACC
Equity Fund 10,00,000 1/3 11.3 3.767
Debt Fund 20,00,000 2/3 6.125 4.083
Total 30,00,000 1 7.85

JAN – 2021 – 10 Marks

The capital structure of PQR Ltd. is as follows:

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CA SUNIL KESWANI PYQs of FM

`
10% Debentures 3,00,000
12% Preference Shares 2,50,000
Equity Share (face value `10 per share) 5,00,000
10,50,000
Additional Information:
(i) `100 per debenture redeemable at par has 2% flotation cost & 10 years of maturity. The
market price per debenture is `110.
(ii) `100 per preference share redeemable at par has 2% flotation cost & 10 years of maturity.
The market price per preference share is `108.
(iii) Equity share has `4 flotation cost and market price per share of `25. The next year expected
dividend is `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.

Solution
!" /
Ke = #$ + " = (/4,1) + 0.05 = 0.1452 = 14.52%
*(",-)'[(DE,F#)÷:] "$ (",$.6$)'[{"$$,(""$,/%)}÷"$] %.//
Kd = [(F#'DE)÷/]
= [{"$$'(""$,/%)}÷/]
= "$6.2$ = 5.99%
#!'[(DE,F#)÷:] "/'[{"$$,("$&,/%)}÷"$] "".1"%
Kp = [(F#'DE)÷/]
= [{"$$'("$&,/%)}÷/]
= "$/.2/ = 11.09%

Computation of WACC (By Market Value Weights)

Source Market Value (A) Cost (B) A×B
10% Debentures 6,$$,$$$ 5.99% 19,767
× 110 = 3,30,000
"$$
12% Preference Share Capital /,4$,$$$ 11.09% 29,943
"$$
× 108 = 2,70,000
Equity Share Capital 4,$$,$$$ 14.52% 1,81,500
"$
× 25 = 12,50,000
18,50,000 2,31,210
/,6",/"$
Weighted Average Cost of Capital = "&,4$,$$$ × 100 = 12.498%

NOV – 2020 – 5 Marks

TT Ltd. issued 20,000, 10% convertible debentures of `100 each with a maturity period of 5 years.
At maturity the debentures holders will have the option to convert debentures into equity shares of
the company in ratio of 1:5 (5 shares for each debentures). The current market price of the equity
share is `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:

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CA SUNIL KESWANI PYQs of FM

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

Solution
Value of equity shares after 5 years = 20 × (1 + 0.04)5 = `24.33
Redemption value of debenture will be higher of:
a) Cash value of debenture = `100
b) Value of equity shares = 5 × 24.33 = `121.65
\Higher redemption value of the above two = `121.65
Approximation Method:
*(",-)'{(DE,F#)÷:} "$(",$./4)'{("/".%4,"$$)÷4} "".&6
Cost of Debentures (Kd) = {(F#'DE)÷/}
= {("$$'"/".%4)÷/}
= ""$.&/4 = 10.67%
Internal Rate of Return Method:
NPV at 10% = PVCI – PVCO = PV of Interest + PV of Redemption Value – Investment
= [10 × (1 - 0.25) × 3.790] + [121.65 × 0.621] – 100 = `3.96965
NPV at 15% = PVCI – PVCO = PV of Interest + PV of Redemption Value – Investment
= [10 × (1 - 0.25) × 3.353] + [121.65 × 0.497] – 100 = -`14.39245
F#E/
Cost of Debentures (Kd) = L + (F#E ) (+ − -)
/ ,F#E0
6.2%2%4
= 10 + (6.2%2%4,(,"1.62/14)) (15 − 10) = 11.08%

NOV – 2019 – 5 Marks

A company wants to raise additional finance of `5 crore in the next year. The company expects to
retain `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 `25.
(iii) The debt capital raised by way of term loan will cost 10% for the first `75 lakhs and 12% for
the next `50 lakhs.
(iv) The net expected dividend on equity shares is `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.

Solution
(a) Pattern of raising capital
Debt (5,00,00,000 × ¼) = `1,25,00,000

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Equity (5,00,00,000 × ¾) = `3,75,00,000

Equity Fund:
Retained earnings = `1,00,00,000
Equity (additional) = `2,75,00,000
`3,75,00,000
Debt Fund:
10% Debt = `75,00,000
12% Debt = `50,00,000
`1,25,00,000

*:-878M- (",-) [(54,$$,$$$×"$%)'(4$,$$,$$$×"/%)](",$.6$)

(b) Kd = #$
× 100 = ",/4,$$,$$$
× 100
"$,"/,4$$
= ",/4,$$,$$$ × 100 = 8.10%

!("'N) / /
(c) Ke = #$
+ " = /4 + 0.05 = /4 + 0.05 = 0.13 = 13.00%

Kr = Ke = 13.00%

(d) Weighted average cost of capital

Source Amount (`) Weight Cost of capital after tax WACC
Equity Fund 3,75,00,000 0.75 13.00 9.75
Debt Fund 2,25,00,000 0.25 8.10 2.025
Total 5,00,00,000 1.00 11.775

MAY – 2019 – 5 Marks

Alpha Ltd. has furnished the following information:
- Earning per share (ESP) `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 `10 lakhs including debt of `4 lakhs. The cost
of debt (before tax) is 10% upto `2 lakhs and 15% beyond that. Compute the after tax cost of
equity and debt and the weighted average cost of capital.

Solution
(O×PQ%)(R'S.RS)
Cost of Equity Share Capital (Ke) = D1 + g = QS
+ 0.10 = 0.122 = 12.20%
P0
Cost of Debt (Kd) = I(1 - t) = 2,00,000 ´ 10% 2,00,000 ´ 15% 1 - 0.30
´ 100 = 8.75%
NP 4,00,000

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Weighted Average Cost of Capital (WACC)

Source Amount In ` Weights Cost of Weighted Average Cost
(1) (2) (3) capital (4) (5)= (3)x(4)
Equity 6,00,000 0.6 12.20 7.32
Debt 4,00,000 0.4 8.75 3.50
1 10.82
Weighted Average Cost of Capital (WACC) = 10.82%

[Note: Ke can be computed alternatively without taking growth rate into consideration (D0/P0 +g).
The values of Ke and WACC then would change accordingly.]

MAY – 2019 – Old Course – 5 Marks

The capital structure of Bright Ltd. as on 31.03.2019 is as follows:
Particulars `in lakhs
Equity share capital: 7,50,000 equity shares of `100 each 750
Retained Earnings 250
13.5% Preference share capital 240
12.5% Debentures 360
The current market price per equity share is `350. The prevailing default risk free interest rate is
6% and rate of return on market portfolio is 15%. The Beta of the company is 1.289.

The corporate tax rate is 30%. The average tax rate of shareholders is 25% and brokerage cost is
2% that they have to pay while investing dividends in alternative securities.

Required: Calculate the weighted average cost of capital on the basis of book value weights.

Solution
Calculation of weighted average cost of capital
Source `in lakhs Weights Cost WACC
Equity capital 750 0.46875 17.60 8.25
Retained Earnings 250 0.15625 12.936 2.021
13.5% Preference Share 240 0.15 13.50 2.025
12.5% Debentures 360 0.225 8.75 1.969
1,600 1 14.265

Working Notes:
(a) Cost of Equity (Ke) = Rf + [β × (Rm – Rf)] = 6 + [1.289 × (15 – 6)] = 17.60%

(b) Cost of Retained Earnings (Kr) = Ke × (1 – tp) × (1 – Brokerage)

= 17.6 × (1 – 0.25) × (1 – 0.02) = 12.936%

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(c) Cost of Preference shares (Kp) = 13.5%

(d) Cost of debentures (Kd) = I × (1 – t) = 12.5 × (1 – 0.30) = 8.75%

MAY – 2018 – Old Course – 5 Marks

JC Ltd. is planning an equity issue in current year. It has an earning per share (EPS) of `20 and
proposes to pay 60% dividend at the current year end. With a PE ratio 6.25, it wants to offer the
issue at market price. The flotation cost is expected to be 4% of the issue price.

Required: Determine the required rate of return for equity share (cost of equity) before the issue
and after the issue.

Solution
Current market price (P0) = EPS × PE Ratio = 20 × 6.25 = `125
Rate of return (r) = 1 ÷ PE Ratio = 1 ÷ 6.25 = 16%
Retention ratio (b) = 100 – Dividend payout ratio = 100 – 60% = 40% = 0.40
Growth rate = b × r = 0.40 × 0.16 = 0.064
D0 = EPS × Dividend payout ratio = 20 × 60% = `12
D1 = D0 × (1 + g) = 12 × (1+0.064) = `12.768
Proceeds from new issue of shares = 125 – (125 × 4%) = `120

!" "/.5%&
Cost of equity before issue (ke) = #$ + " = "/4
+ 0.064 = 0.1661 = 16.61%

!" "/.5%&
Cost of equity after issue (ke) = #$ + " = "/$
+ 0.064 = 0.1704 = 17.04%

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LEVERAGE
PAST YEAR QUESTIONS

MAY – 2023 – 5 Marks

Following information is given for X Ltd:
Total contribution (`) 4,25,000
Operating leverage 3.125
15% Preference shares (`100 each) 1,000
Number of equity shares 2,500
Tax rate 50%
Calculate EPS of X Ltd., if 40% decrease in sales will result EPS to zero.

Solution
;B:-7=TU-=B:
Operating leverage (DOL) = KV*W
1,/4,$$$
3.125 = KV*W
EBIT = `1,36,000

% XYZN:8 =: K#L "$$

Combined leverage (DCL) = % XYZN:8 =: LZ[8M = 1$
= 2.5
!X\ /.4
Financial leverage = !]\ = 6."/4 = 0.80

KV*W
Financial leverage = KVW
",6%,$$$
0.8 = KVW
EBT = `1,70,000

Statement of calculation of EPS

Particulars Amount
EBT 1,70,000
(-) Tax @ 50% 85,000
EAT 85,000
(-) Preference dividend 15,000
Earning for equity 70,000
Number of equity shares 2,500
EPS 28

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NOV – 2022 – 10 Marks

The following information is available for SS Ltd.:
Profit volume (PV) ratio - 30%
Operating leverage - 2.00
Financial leverage - 1.50
Loan - `1,25,000
Post-tax interest rate - 5.6%
Tax rate - 30%
Market price per share (MPS) - `140
Price Earnings Ratio (PER) - 10
You are required to:
(a) Prepare the profit-loss statement of SS Ltd. and
(b) Find out the number of equity shares

Solution
DZ-8 Z9-87 -Z^ 4.%$%
Pre-tax interest rate = (",-)
= (",$.6$) = 8%
Interest = `1,25,000 8% = `10,000
KV*W
Financial leverage = KVW
KV*W
1.5 = (KV*W,"$,$$$)
(1.5)EBIT – 15,000 = EBIT
EBIT = `30,000

;B:-7=TU-=B:
Also, Operating leverage = KV*W
XB:-7=TU-=B:
2= 6$,$$$
Contribution = 60,000
Fixed cost = Contribution – EBIT = 60,000 – 30,000 = `30,000
;B:-7=TU-=B: %$,$$$
Sales = #E DZ-=B
= 6$%
= `2,00,000
Variable cost = Sales – Contribution = 2,00,000 – 60,000 = `1,40,000

(a) Statement of Profit or loss

Particulars Amount
Sales 2,00,000
(-) Variable cost 1,40,000
Contribution 60,000
(-) Fixed cost 30,000
EBIT 30,000
(-) Interest 10,000
EBT 20,000

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CA SUNIL KESWANI PYQs of FM

(-) Tax @ 30% 6,000

EAT 14,000

_#L "1$
(b) EPS = #K DZ-=B = "$
= `14
K`W "1,$$$
No. of equity shares = K#L = "1
= 10,000 shares

MAY – 2022 – 10 Marks

Details of a company for the year ended 31st March, 2022 are given below:
Sales `86 lakhs
Profit Volume (P/V) Ratio 35%
Fixed cost excluding interest expenses `10 lakhs
10% Debt `55 lakhs
Equity Share Capital of `10 each `75 lakhs
Income Tax rate 40%
Required:
(i) Determine company’s return on capital employed (pre-tax) and Eps.
(ii) Does the company have a favourable financial leverage?
(iii) Calculate operating and combine leverages of the company
(iv) Calculate percentage change in EBIT, if sales increases by 10%.
(v) At what level of sales, the Earning before Tax (EBT) of the company will be equal to zero?

Solution
Income Statement
Particulars Amount (`)
Sales 86,00,000
Less: Variable cost (86,00,000 65%) 55,90,000
Contribution 30,10,000
Less: Fixed cost 10,00,000
EBIT 20,10,000
Less: Interest (10% 55,00,000) 5,50,000
EBT 14,60,000
Less: Tax @ 40% 5,84,000
EAT/EAE 8,76,000

KV*W /$,"$,$$$
(i) Return on capital employed = XZa=-Z[ 8ba[Bc8? × 100 = ",6$,$$,$$$ × 100 = 15.46%
K`K &,5%,$$$
Earning per share = FB. B9 KdU=-c LYZ78M
= 5,4$,$$$ = `1.168
(ii) Since, the return on capital employed (15.46%) is more than the interest rate (10%), thus
the company has a favourable financial leverage.
XB:-7=TU-=B: 6$,"$,$$$
(iii) Operating leverage = KV*W
= /$,"$,$$$ = 1.498 times

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CA SUNIL KESWANI PYQs of FM

XB:-7=TU-=B: 6$,"$,$$$
Combined leverage = KVW
=
"1,%$,$$$
= 2.062 times
% XYZ:N8 =: KV*W
(iv) Operating leverage = % XYZ:N8 =: LZ[8M
% XYZ:N8 =: KV*W
1.498 = '"$
% Change in EBIT = +14.98
Thus, EBIT increases by 14.98%
e=^8? ;BM-'*:-878M- ("$,$$,$$$'4,4$,$$$)
(v) Required sales = #E DZ-=B
= 64%
= `44,28,571

DECEMBER – 2021 – 10 Marks

Information of A Ltd. is given below:
Earnings after tax: 5% on sales
Income tax rate: 50%
Degree of operating leverage: 4 times
10% Debenture in capital structure: `3 lakhs
Variable costs: `6 lakhs
Required:
(i) From the given data complete the following statement:
Sales XXXX
Less: Variable costs 6,00,000
Contribution XXXX
Less: Fixed costs XXXX
EBIT XXXX
Less: Interest expenses XXXX
EBT XXXX
Less: Income tax XXXX
EAT XXXX

(ii) Calculate Financial Leverage and Combined Leverage.

(iii) Calculate the percentage change in earning per share, if sales increased by 5%.

Solution
Let sales = y
XB:-=7TU-=B:
Degree of operating leverage = KV*W
XB:-=7TU-=B:
4= KV*W
4(EBIT) = Sales – Variable cost
4(EBIT) = Sales – 6,00,000
EBIT = 0.25(y) - 1,50,000…………………(i)
Also, given Earning after tax = 5% of sales
5% Sales = (EBIT – Interest)(1 – t)

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CA SUNIL KESWANI PYQs of FM

0.05y = [0.25y – 1,50,000 – (3,00,000 10%)](1 – 0.50)

0.05y = (0.25y – 1,80,000)(0.50)
0.05y = 0.125y – 90,000
0.075y = 90,000
y = 12,00,000
Thus, EBIT = 0.25(12,00,000) – 1,50,000 = 1,50,000
Fixed cost = Contribution – EBIT = (12,00,000 – 6,00,000) – 1,50,000 = 4,50,000

Income Statement
Sales 12,00,000
Less: Variable costs 6,00,000
Contribution 6,00,000
Less: Fixed costs 4,50,000
EBIT 1,50,000
Less: Interest expenses (3,00,000 10%) 30,000
EBT 1,20,000
Less: Income tax @50% 60,000
EAT 60,000
KV*W ",4$,$$$
(a) Financial Leverage = KVW
=
",/$,$$$
= 1.25 times
XB:-7=TU-=B: %,$$,$$$
Combined Leverage = KVW
=
",/$,$$$
= 5 times
% XYZ:N8 =: K#L
(b) Combined Leverage = % XYZ:N8 =: LZ[8M
% XYZ:N8 =: K#L
5= '4
% change in EPS = +25%
Thus, EPS increases by 25%.

JULY – 2021 – 10 Marks

A company had the following balance sheet as on 31st March, 2021:
Liabilities ` in crores Assets ` in crores
Equity share capital 7.50 Building 12.50
(75 lakhs shares of `10 each)
Reserve and Surplus 1.50 Machinery 6.25
15% Debentures 15.00 Current Assets
Current Liabilities 6.00 Stock 3.00
Debtors 3.25
Bank Balance 5.00
30.00 30.00
The additional information given is as under:
Fixed cost per annum (excluding interest) `6 crores
Variable operating cost ratio 60%

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CA SUNIL KESWANI PYQs of FM

Total assets turnover ratio 2.5

Income tax rate 40%
Calculate the following and comment:
(a) Earnings per share
(b) Operating leverage
(c) Financial leverage
(d) Combined leverage

Solution
LZ[8M
Total assets turnover ratio = WB-Z[ `MM8-M
LZ[8M
2.5 = 6$ ;7B78M
Sales = `75 Crores

Income Statement
Particulars Amount (`)
Sales 75,00,00,000
Less: Variable Cost@ 60% 45,00,00,000
Contribution 30,00,00,000
Less: Fixed Cost 6,00,00,000
EBIT 24,00,00,000
Less: Interest (15 crore × 15%) 2,25,00,000
EBT 21,75,00,000
Less: Income tax @ 40% 8,70,00,000
EAT/EAE 13,05,00,000

K`K "6,$4,$$,$$$
(a) Earning per share = FB. B9 8dU=-c MYZ78M
= 54,$$,$$$
= `17.40 per share
It indicates the amount the company earns per share. It is used as a guide for valuing the
share and making investment decisions by the investor.

XB:-7=TU-=B: 6$,$$,$$,$$$
(b) Operating Leverage = KV*W
= /1,$$,$$,$$$ = 1.25 times
It indicates the structure of fixed cost in the business. It indicates sensitivity of earnings
before interest and tax (EBIT) to changes in sales at a particular level.

KV*W /1,$$,$$,$$$
(c) Financial Leverage = KVW
= /",54,$$,$$$ = 1.103 times
It indicates the use of fixed financial cost in the capital structure. It indicates sensitivity of
earning per share (EPS) to changes in earnings before interest and tax (EBIT) at a particular
level.

(d) Combined Leverage = OL × FL = 1.2962 × 1.125 = 1.4582 times

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CA SUNIL KESWANI PYQs of FM

It indicates the choice of fixed cost and fixed financial cost in the capital structure used. It
indicates the sensitivity of earning per share (EPS) to changes in sales at a particular level.

JAN – 2021 – 10 Marks

The information related to XYZ Company Ltd. for the year ended 31st March, 2020 are as follows:
Equity Share capital of `100 each `50 lakhs
12% Bonds of `1,000 each `30 lakhs
Sales `84 lakhs
Fixed cost (excluding interest) `7.50 lakhs
Financial leverage 1.39
Profit-volume ratio 25%
Market price per equity share `200
Income tax applicable 30%
You are required to CALCULATE:
(a) Operating Leverage
(b) Combined Leverage
(c) Earnings per share
(d) Earning Yield

Solution
Income Statement
Particulars Amount (`)
Sales 84,00,000
Less: Variable cost (84,00,000 × 75%) 63,00,000
Contribution (84,00,000 × 25%) 21,00,000
Less: Fixed cost 7,50,000
EBIT 13,50,000
Less: Interest on bonds (12% × 30 lakhs) 3,60,000
Less: Other fixed interest (bal. figure) 18,777
EBT (13,50,000 ÷ 1.39) 9,71,223
Less: Tax @ 30% 2,91,367
EAT 6,79,856

XB:-7=TU-=B: /",$$,$$$
(a) Operating Leverage = KV*W
= "6,4$,$$$ = 1.56 times

(b) Combined Leverage = Operating Leverage × Financial Leverage = 1.56 × 1.39 = 2.13

K`W %,52,&4%
(c) Earnings per share (EPS) = FB. B9 MYZ78M BU-M-Z:?=:N
= 4$,$$$
= `13.597

K#L "6.425
(d) Earning yield = _Z7f8- a7=;8 a87 MYZ78 × 100 = /$$
× 100 = 6.798%

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NOV – 2020 – 10 Marks

The following data is available for Stone Ltd.:
(` )
Sales 5,00,000
(-) Variable cost @ 40% 2,00,000
Contribution 3,00,000
(-) Fixed cost 2,00,000
EBIT 1,00,000
(-) Interest _25,000
Profit before tax _75,000
Using the concept of leverage, find out
(i) The percentage change in taxable income if EBIT increases by 10%.
(ii) The percentage change in EBIT if sales increases by 10%.
(iii) The percentage change in taxable income fi sales increases by 10%.
Also verify the results in each of the above case.

Solution
;B:-7=TU-=B: 6,$$,$$$
Degree of operating leverage (DOL) = KV*W
=
",$$,$$$
=3
KV*W ",$$,$$$
Degree of financial leverage (DFL) = KVW
= 54,$$$
= 1.33
;B:-7=TU-=B: 6,$$,$$$
Degree of combined leverage (DCL) = KVW
= 54,$$$
=4
(i) Required % change in taxable income = DFL × Change in EBIT % = 1.33 × 10 = 13.33%
Verification
(` )
New EBIT (1,00,000 + 10%) 1,10,000
(-) Interest _25,000
Profit before tax _85,000
&4,$$$,54,$$$
% change in taxable income = 54,$$$
× 100 = 13.33%

(ii) Required % change in EBIT = DOL × Change in Sales % = 3 × 10 = 30%

Verification
(` )
New Sales (5,00,000 + 10%) 5,50,000
(-) Variable cost @ 40% 2,20,000
Contribution 3,30,000
(-) Fixed cost 2,00,000
EBIT 1,30,000
",6$,$$$,",$$,$$$
% change in taxable income = ",$$,$$$
× 100 = 30%

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CA SUNIL KESWANI PYQs of FM

(iii) Required % change in taxable income = DCL × Change in Sales % = 4 × 10 = 40%

Verification
(` )
New Sales (5,00,000 + 10%) 5,50,000
(-) Variable cost @ 40% 2,20,000
Contribution 3,30,000
(-) Fixed cost 2,00,000
EBIT 1,30,000
(-) Interest _25,000
Profit before tax 1,05,000
",$4,$$$,54,$$$
% change in taxable income = 54,$$$
× 100 = 40%

NOV – 2019 – 10 Marks

Following is the Balance Sheet of Gitashree Ltd. is given below:
Liabilities Amount (`)
Shareholder’s Fund
Equity Share Capital (`10 each) 1,80,000
Reserve & Surplus 60,000
Non-Current Liabilities (10% Debentures) 2,40,000
Current Liabilities 1,20,000
Total 6,00,000
Non-Current Assets 4,50,000
Current Assets 1,50,000
Total 6,00,000
The company’s total assets turnover ratio is 4. Its fixed operating cost is `2,00,000 and its variable
operating cost ratio is 60%. The income tax rate is 30%. Calculate:
(1) (a) Degree of operating leverage
(b) Degree of financial leverage
(c) Degree of combined leverage
(2) Find out EBIT if EPS is (a) `1; (b) `2; and (c) `0.

Solution
LZ[8M
Total assets turnover ratio = WB-Z[ `MM8-M
LZ[8M
4 = %,$$,$$$
Sales = `24,00,000

Income Statement
Particulars Amount (`)
Sales 24,00,000

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CA SUNIL KESWANI PYQs of FM

Less: Variable Cost@ 60% 14,40,000

Contribution 9,60,000
Less: Fixed Cost 2,00,000
EBIT 7,60,000
Less: Interest (2,40,000 × 10%) __24,000
EBT 7,36,000
Less: Income tax @ 30% 2,20,800
EAT/EAE 5,15,200

XB:-7=TU-=B: 2,%$,$$$
(1) (a) Operating Leverage = KV*W
= 5,%$,$$$ = 1.263 times

KV*W 5,%$,$$$
(b) Financial Leverage = KVW
= 5,6%,$$$ = 1.033 times

(c) Combined Leverage = OL × FL = 1.263 × 1.033 = 1.304 times

(KV*W,*:-878M-)(",-)
(2) (a) EPS = FB. B9 8dU=-c MYZ78M
(KV*W,/1,$$$)(",$.6$)
1= "&,$$$
EBIT = `49,714

(KV*W,*:-878M-)(",-)
(b) EPS = FB. B9 8dU=-c MYZ78M
(KV*W,/1,$$$)(",$.6$)
2= "&,$$$
EBIT = `75,429
(KV*W,*:-878M-)(",-)
(c) EPS = FB. B9 8dU=-c MYZ78M
(KV*W,/1,$$$)(",$.6$)
0= "&,$$$
EBIT = `24,000

MAY – 2019 – 10 Marks

The capital structure of the Shiva Ltd. consists of equity share capital of `20,00,000 (share of
`100 per value) and `20,00,000 of 10% debentures. Sales increased by 20% from 2,00,000 units
to 2,40,000 units, the selling price is `10 per unit; variable costs amount to `6 per unit and fixed
expenses amou1.4nt to `4,00,000. The income tax rate is assumed to be 50%.
(1) You are required to calculate the following:
(a) Percentage increase in earnings per share
(b) Financial leverage at 2,00,000 units and 2,40,000 units
(c) Operating leverage at 2,00,000 units and 2,40,000 units
(2) Comment on the behaviour of operating and financial leverages in relation to increase in
production from 2,00,000 units to 2,40,000 units.

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CA SUNIL KESWANI PYQs of FM

Solution
Income Statement
Particulars 2,00,000 units (`) 2,40,000 units (`)
Sales 20,00,000 24,00,000
Less: Variable Cost 12,00,000 14,40,000
Contribution 8,00,000 9,60,000
Less: Fixed Cost 4,00,000 4,00,000
EBIT 4,00,000 5,60,000
Less: Interest 2,00,000 2,00,000
EBT 2,00,000 3,60,000
Less: Tax @ 50% 1,00,000 1,80,000
EAT 1,00,000 1,80,000
No. of Equity shares 20,000 20,000
",$$,$$$ ",&$,$$$
EPS (EAT ÷ No. of equity shares) /$,$$$
=5 /$,$$$
=9
1,$$,$$$ 4,%$,$$$
Financial Leverage (EBIT ÷ EBT) /,$$,$$$
=2 6,%$,$$$
= 1.56
&,$$,$$$ 2,%$,$$$
Operating Leverage (Contribution ÷ EBIT) 1,$$,$$$
=2 4,%$,$$$
= 1.71
2,4 1
(a) Percentage change in EPS = 4
× 100 = 4 × 100 = 80%
(b) Financial leverage at 2,00,000 units and 2,40,0000 units are 2 and 1.56 respectively.
(c) Operating leverage at 2,00,000 units and 2,40,000 units are 2 and 1.71 respectively.
(2) Financial leverage is represented by organization ability to recover interest component of
debt. Here with every increase in unit sales, financial leverage comes down as interest on
debentures would remain the same.

Operating leverage indicates fixed cost in cost structure. Since, the fixed cost remains the
sales, every increase in sales volume will decrease the value of operating leverage.

NOV – 2018 – 10 Marks

Following is the Balance Sheet of Soni Ltd. as on 31st March, 2018:
Liabilities Amount (`)
Shareholder’s Fund
Equity Share Capital (`10 each) 25,00,000
Reserve & Surplus 5,00,000
Non-Current Liabilities (12% Debentures) 50,00,000
Current Liabilities 20,00,000
Total 1,00,00,000
Non-Current Assets 60,00,000
Current Assets 40,00,000
Total 1,00,00,000

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CA SUNIL KESWANI PYQs of FM

Additional information:
(i) Variable cost is 60% of sales
(ii) Fixed cost p.a. excluding interest `20,00,000
(iii) Total Assets Turnover Ratio is 5 times
(iv) Income tax rate 25%
You are required to:
(1) Prepare Income Statement
(2) Calculate the following and comment:
(a) Operating leverage
(b) Financial leverage
(c) Combined leverage

Solution
LZ[8M
Total assets turnover ratio = WB-Z[ `MM8-M
LZ[8M
5 = ",$$,$$,$$$
Sales = `5,00,00,000

Income Statement
Particulars Amount (`)
Sales 5,00,00,000
Less: Variable Cost@ 60% 3,00,00,000
Contribution 2,00,00,000
Less: Fixed Cost 20,00,000
EBIT 1,80,00,000
Less: Interest (50,00,000 × 12%) __6,00,000
EBT 1,74,00,000
Less: Income tax @ 30% _43,50,000
EAT/EAE 1,30,50,000

K`K ",6$,4$,$$$
(a) Earning per share = FB. B9 8dU=-c MYZ78M
= /,4$,$$$
= `52.20 per share

XB:-7=TU-=B: /,$$,$$,$$$
(b) Operating Leverage = KV*W
= ",&$,$$,$$$ = 1.111 times
It indicates the choice of technology and fixed cost in cost structure. It is level specific. When
firm operates beyond operating break-even level, then operating leverage is low which
indicates sensitivity of earnings before interest and tax (EBIT) to change in sales at a
particular level.

KV*W ",&$,$$,$$$
(c) Financial Leverage = KVW
= ",51,$$,$$$ = 1.034 times

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CA SUNIL KESWANI PYQs of FM

Financial leverage is very comfortable since the debt service obligation is small vis-à-vis
EBIT.
(d) Combined Leverage = OL × FL = 1.111 × 1.034 = 1.149 times
Combined leverage studies the choice of fixed cost in cost structure and choice of debts in
capital structure and also studies how sensitive the change in EPS is with the change in sales.

MAY – 2018 – 5 Marks

The following data have been extracted from the books of LM Ltd.:
Sales `100 lakhs
Interest payable per annum `10 lakhs
Operating leverage 1.2
Combined leverage 2.16
You are required to calculate:
(a) Financial leverage
(b) Fixed cost
(c) P/V Ratio

Solution
(a) Combined leverage = Financial Leverage × Operating Leverage
2.16 = Financial Leverage × 1.2
Financial Leverage = 1.8

KV*W
(b) Financial Leverage = KVW
KV*W
1.8 = KV*W,*:-878M-
KV*W
1.8 = KV*W,"$,$$,$$$
1.8(EBIT – 10,00,000) = EBIT
(0.8)EBIT = 18,00,000
EBIT = `22,50,000

XB:-7=TU-=B:
Operating Leverage = KV*W
KV*W'e=^8? XBM-
1.2 = KV*W
(1.2)EBIT = EBIT + Fixed Cost
1.2 × 22,50,000 = 22,50,000 + Fixed Cost
Fixed Cost = `4,50,000

(c) Contribution = EBIT + Fixed Cost = 22,50,000 + 4,50,000 = `27,00,000

XB:-7=TU-=B: /5,$$,$$$
P/V Ratio = LZ[8M
× 100 = "$$,$$,$$$ × 100 = 27%

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CA SUNIL KESWANI PYQs of FM

CAPITAL STRUCTURE
PAST YEAR QUESTIONS

MAY – 2023 – 10 Marks

The following information pertains to CIZA Ltd.:
`
Capital Structure:
Equity share capital (` 10 each) 8,00,000
Retained earnings 20,00,000
9% Preference share capital (` 100 each) 12,00,000
12% Long-term loan 10,00,000
Interest coverage ratio 8
Income tax rate 30%
Price – earnings ratio 25
The company is proposed to take up an expansion plan, which requires an additional investment
of 34,50,000. Due to this proposed expansion, earnings before interest and taxes of the company
will increase by 6,15,000 per annum. The additional fund can be raised in following manner:
• By issue of equity shares at present market price, or
• By borrowing 16% Long-term loans from bank.
You are informed that Debt-equity ratio (Debt/ Shareholders' fund) in the range of 50% to 80%
will bring down the price-earnings ratio to 22 whereas; Debt-equity ratio over 80% will bring
down the price-earnings ratio to 18.
Required:
Advise which option is most suitable to raise additional capital so that the Market Price per Share
(MPS) is maximized.

Solution
Working notes:
(a) Interest coverage ratio = 8
KV*W
*:-878M-
=8
EBIT = 8 1,20,000 = `9,60,000
(b) Proposed EBIT = 9,60,000 + 6,15,000 = 15,75,000

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CA SUNIL KESWANI PYQs of FM

(c) Option – 1
Debt = `10,00,000
Shareholder’s fund = 8,00,000 + 20,00,000 + 12,00,000 + 34,50,000 = `74,50,000
!8T- "$,$$,$$$
Debt equity ratio = LYZ78YB[?87 1 M 9U:? = 51,4$,$$$ = 0.1342 = 13.42%
PE Ratio in this case will be 25 times.
(d) Option - 2
Debt = 10,00,000 + 34,50,000 = `44,50,000
Shareholder’s fund = 8,00,000 + 20,00,000 + 12,00,000 = `40,00,000
!8T- 11,4$,$$$
Debt equity ratio = LYZ78YB[?87 1 M 9U:? = 1$,$$,$$$ = 1.1125 = 111.25%
PE Ratio in this case will remain at 18 times
61,4$,$$$
New number of equity shares to be issued = "4$
= 23,000
(e) Calculation of Existing EPS and MPS
Particulars `
Current EBIT 9,60,000
(-) Interest 1,20,000
EBT 8,40,000
(-) Tax 2,52,000
EAT 5,88,000
(-) Preference dividend (12,00,000 9%) 1,08,000
Net earnings for equity 4,80,000
Number of equity shares 80,000
EPS 6
PE Ratio 25
MPS 150

Calculation of EPS and MPS under two financial options

Particulars Option – 1 Option – 2
Equity shares issued 16% long term debt
EBIT 15,75,000 15,75,000
(-) Interest on 12% debentures 1,20,000 1,20,000
(-) Interest on 16% debt - 5,52,000
EBT 14,55,000 9,03,000
(-) Taxes @ 30% 4,36,500 2,70,900
EAT 10,18,500 6,32,100
(-) Preference dividend 1,08,000 1,08,000
Net earnings for equity 9,10,500 5,24,100
Number of equity shares 1,03,000 80,000
EPS 8.84 6.55
PE Ratio 25 18
MPS 221 117.90

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CA SUNIL KESWANI PYQs of FM

Equity option has higher market price per share therefore company should raise additional fund
through equity option.

NOV – 2022 – 5 Marks

The following are the costs and value for the firms A and B according to the traditional approach.
Particulars Firm A Firm B
Total value of firm, V (in `) 50,000 60,000
Market value of debt, D (in `) 0 30,000
Market value of equity, E (in `) 50,000 30,000
Expected net operating income (in `) 5,000 5,000
Cost of debt (in `) 0 1,800
Net income (in `) 5,000 3,200
Cost of equity, Ke = NI/E 10.00% 10.70%
(a) Compute the Equilibrium value for the firm A and B in accordance with the MM approach.
Assume that (i) taxes do not exist and (ii) the equilibrium value of Ke is 9.09%.
(b) Compute value of equity and cost of equity for both the firms.

Solution
(a) As per MM Model, Ko = Keu = 9.09%
Statement of Value of Firms
Particulars Firm A Firm B
EBIT (`) 5,000 5,000
Ko 9.09% 9.09%
Equilibrium value (`) 4,$$$ 4,$$$
= 55,005.50
2.$2% 2.$2%
= 55,005.50

(b) Statement of value of Equity

Particulars Firm A Firm B
Equilibrium value 55,005.50 55,005.50
(-) Value of debt - 30,000
Value of equity 55,005.50 25,005.50
Cost of equity of Firm A (unlevered) = 9.09%
F8- *:;Bb8 6,/$$
Cost of equity of Firm B (levered) = EZ[U8 B9 8dU=-c × 100 = /4,$$4.4$ × 100 = 12.80%
Or
!8T- 6$,$$$
Cost of equity of firm B = Ko + (Ko – Kd)5KdU=-c 6 = 9.09 + (9.09 – 6)5/4,$$4.4$6 = 12.80%
",&$$
Cost of debt (Kd) = 6$,$$$ × 100 = 6%

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CA SUNIL KESWANI PYQs of FM

MAY – 2022 – 10 Marks

The particulars relating to Raj Ltd. for the year ended 31st March, 2022 are given as follows:
Output (units at normal capacity) 1,00,000
Selling price per unit `40
Variable cost per unit `20
Fixed cost `10,00,000
st
The capital structure of a company as on 31 March, 2022 is as follows:
Particulars Amount in `
Equity share capital (1,00,000 shares of `10 each) 10,00,000
Reserve and surplus 5,00,000
Current liabilities 5,00,000
Total: 20,00,000
Raj Ltd. has decided to undertake an expansion project to use the market potential that will involve
`20 lakhs. The company expects an increase in output by 50%. Fixed cost will be increase by
`5,00,000 and variable cost per unit will be decreased by 15%. The additional output can be sold
at existing selling price without any adverse impact on the market.

The following alternative schemes for financing the proposed expansion program are planned:
(Amount in `)
Alternative Debt Equity Shares
1 5,00,000 Balance
2 10,00,000 Balance
3 14,00,000 Balance
Current market price per share is `200.
Slab wise interest rate for fund borrowed is as follows:
Fund Limit Applicable interest rate
Up-to `5,00,000 10%
Over `5,00,000 and up-to `10,00,000 15%
Over `10,00,000 20%
Find out which of the above-mentioned alternatives would you recommend for Raj Ltd. with
reference to the EPS, assuming a corporate tax rate is 40%?

Solution
Calculation of EBIT
Particulars Existing Proposed
Sale units 1,00,000 1,50,000
Contribution per unit 40 – 20 = 20 40 – (20 85%) = 23
Total contribution 20,00,000 34,50,000
Less: Fixed cost 10,00,000 15,00,000
EBIT 10,00,000 19,50,000

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CA SUNIL KESWANI PYQs of FM

Statement of EPS
Particulars Existing Alternative – 1 Alternative – 2 Alternative – 3
EBIT 10,00,000 19,50,000 19,50,000 19,50,000
Less: Interest - 50,000 1,25,000 2,55,000
(5,00,000 [(5lakh 10%) + [(5lakh 10%) +
10%) (5lakh 15%)] (5lakh 15%) +
(4lakh 20%)]
EBT 10,00,000 19,00,000 18,25,000 16,95,000
Less: Tax @ 40% 4,00,000 7,60,000 7,30,000 6,78,000
EAT / EAE (A) 6,00,000 11,40,000 10,95,000 10,17,000
No. of Equity Shares
- Existing 1,00,000 1,00,000 1,00,000 1,00,000
- New - "4,$$,$$$ "$,$$,$$$ %,$$,$$$
= 7,500 /$$
= 5,000 /$$
= 3,000
/$$
Total Equity Shares (B) 1,07,500 1,05,000 1,03,000
EPS (A B) 6.00 10.60 10.43 9.87
Since, Alternative – 1 has highest EPS, thus it is recommended to raise funds in combination of
debt of `5,00,000 and balance `15,00,000 from equity.

DECEMBER – 2021 – 10 Marks

Earnings before interest and tax of a company are `4,50,000. Currently the company has 80,000
Equity shares of `10 each, retained earnings of `12,00,000. It pays annual interest of `1,20,000
on 12% Debentures. The company proposes to take up an expansion scheme for which it needs
additional fund of `6,00,000. It is anticipated that after expansion, the company will be able to
achieve the same return on investment as at present. It can raise fund either through debts at rate
of 12% p.a. or by issuing Equity shares at par. Tax rate is 40%.

Required to compute the earning per share if:

(i) The additional funds were raised through debts.
(ii) The additional funds were raised by issue of Equity shares.
Advise whether the company should go for expansion plan and which sources of finance should
be preferred.

Solution
Existing capital employed = Equity + Retained Earnings + Debentures
= (80,000 10) + 12,00,000 + (1,20,000 12%) = `30,00,000
Capital employed after expansion = 30,00,000 + 6,00,000 = `36,00,000
K^=M-=:N KV*W 1,4$,$$$
New EBIT = K^=M-=:N XZa=-Z[ × 789 ;<=>?<@ = 6$,$$,$$$ × 36,00,000 = `5,40,000
Statement of EPS
Particulars Existing Additional fund Additional fund
as debt as equity

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CA SUNIL KESWANI PYQs of FM

EBIT 4,50,000 5,40,000 5,40,000

Less: Interest
- Existing Debt 1,20,000 1,20,000 1,20,000
- New Debt - 72,000 -
EBT 3,30,000 3,48,000 4,20,000
Less: Tax @ 40% 1,32,000 1,39,200 1,68,000
EAT/EAE (A) 1,98,000 2,08,800 2,52,000
No. of Equity shares (B) 80,000 80,000 1,40,000
EPS (A B) 2.475 2.610 1.800
EPS is higher when the additional funds are raised through debt, thus it is the recommended option
for the company.

JULY – 2021 – 5 Marks

The details about two companies R Ltd. and S Ltd. having same operating risk are given below:
Particulars R Ltd. S Ltd.
Profit before interest and tax ` 10 lakhs ` 10 lakhs
Equity share capital ` 10 each ` 17 lakhs ` 50 lakhs
Long term borrowings @ 10% ` 33 lakhs -
Cost of Equity (Ke) 18% 15%
You are required to:
(a) Calculate the value of equity of both the companies on the basis of M.M. Approach without
tax.
(b) Calculate the Total Value of both the companies on the basis of M.M. Approach without
tax.

Solution
(a) Computation of Value of Equity (` in lakhs)
Particulars R Ltd. (`) S Ltd. (`)
Profit before interest and tax 10 10
Less: Interest (33 lakhs 10%) 3.30 -
Earning available for Equity (EAE) 6.70 10
Cost of Equity (Ke) 18% 15%
Value of Equity (Ve = EAE Ke) 37.222 66.667

(b) Computation of Total Value of firm (` in lakhs)

Particulars R Ltd. (`) S Ltd. (`)
Value of Equity 37.222 66.667
Value of Debt 33.000 -
Total Value of Firm 67.222 66.667

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CA SUNIL KESWANI PYQs of FM

JAN – 2021 – 10 Marks

A Limited and B Limited are identical except for capital structures. A Ltd. has 60% debt and 40%
equity, whereas B Ltd. has 20% debt and 80% equity. (All percentages are in market-value terms).
The borrowing rate for both companies is 8% in a no-tax world, and capital markets are assumed
to be perfect.
(a) (i) If X owns 3% of the equity shares of A Ltd. determine his return if the company has net
operating income of `4,50,000 and the overall capitalization rate of the company, (Ko)
is 18%.
(ii) Calculate the implied required rate of return on equity of A Ltd.
(b) B Ltd. has the same net operating income as A Ltd.
(i) Calculate the implied required equity return of B Ltd.
(ii) Analyze why does it differ from that of A Ltd.

Solution
KV*W 1,4$,$$$
(a) (i) Value of A Ltd. = gB
= "&%
= `25,00,000
Value of Debt = `25,00,000 × 60% = `15,00,000
Value of Equity = `25,00,000 × 40% = `10,00,000

Income Statement
EBIT 4,50,000
Less: Interest (15,00,000 × 8%) 1,20,000
EBT / EAT / EAE 3,30,000
Return on 3% shares of Mr. X = `3,30,000 × 3% = `9,900

K`K 6,6$,$$$
(ii) Implied rate of return on equity = EZ[U8 B9 8dU=-c × 100 = "$,$$,$$$ × 100 = 33%

KV*W 1,4$,$$$
(b) (i) Value of B Ltd. = g8
= "&%
= `25,00,000
Value of debt = `25,00,000 × 20% = `5,00,000
Value of equity = `25,00,000 × 80% = `20,00,000

Income Statement
EBIT 4,50,000
Less: Interest (5,00,000 × 8%) 40,000
EBT / EAT / EAE 4,10,000

K`K 1,"$,$$$
Implied rate of return on equity = EZ[U8 B9 8dU=-c × 100 = /$,$$,$$$ × 100 = 20.50%

(ii) It is lower than the A Ltd. because B Ltd. uses less debt in its capital structure. As the
equity capitalization is a linear function of the debt-to-equity ratio when we use the net

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CA SUNIL KESWANI PYQs of FM

operating income approach, the decline in required equity return offsets exactly the
disadvantage of not employing so much in the way of “cheaper” debt funds.

NOV – 2020 – 10 Marks

J Ltd. is considering three financial plans. The key information is as follows:
(i) Total investment to be raised `4,00,000.
(ii) Plans of Financing

Plans Equity Debt Preference Shares

X 100% - -
Y 50% 50% -
Z 50% - 50%
(iii) Cost of Debt – 10%
Cost of preference shares – 10%
(iv) Tax rate is 50%
(v) Equity shares of the face value of `10 each will be issued at a premium of `10 per share
(vi) Expected EBIT is `1,00,000
You are required to compute the following for each plan:
(a) Earnings per share (EPS)
(b) Financial break-even point
(c) Indifference Point between the plans and indicate if any of the plans dominate.

Solution
(a) Computation of Earnings Per Share (EPS)
Particulars Plan X Plan Y Plan Z
EBIT 1,00,000 1,00,000 1,00,000
Less: Interest on debt - 20,000 -
EBT 1,00,000 80,000 1,00,000
Less: Tax @ 50% 50,000 40,000 50,000
EAT 50,000 40,000 50,000
Less: Preference Dividend - - 20,000
EAE (A) 50,000 40,000 30,000
No. of equity shares (B) 20,000 10,000 10,000
EPS (A ÷ B) 2.50 4.00 3.00

(b) Computation of Financial Break-even Point

#789878:;8 !=>=?8:?
Plan X – Financial BEP = Interest + (",-)
= 0 + 0 = `0
#789878:;8 !=>=?8:?
Plan Y – Financial BEP = Interest + (",-)
= 20,000 + 0 = `20,000
#789878:;8 !=>=?8:? /$,$$$
Plan Z – Financial BEP = Interest + (",-)
= 0 + (",$.4$) = `40,000

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CA SUNIL KESWANI PYQs of FM

(c) Indifference point

Between Plan X and Y
(KV*W,$)(",$.4$),$ (KV*W,/$,$$$)(",$.4$),$
/$,$$$
= "$,$$$
$.4(KV*W) $.4(KV*W,/$,$$$)
/$,$$$
= "$,$$$
EBIT = 2(EBIT) – 40,000
EBIT = `40,000

Between Plan Y and Z

(KV*W,/$,$$$)(",$.4$),$ (KV*W,$)(",$.4$),/$,$$$
"$,$$$
= "$,$$$
$.4(KV*W,/$,$$$) $.4(KV*W),/$,$$$
"$,$$$
= "$,$$$
0.5(EBIT) – 10,000 = 0.5(EBIT) – 20,000
There is no indifference point between Plan Y and Z.

Between Plan X and Z

(KV*W,$)(",$.4$),$ (KV*W,$)(",$.4$),/$,$$$
/$,$$$
= "$,$$$
$.4(KV*W) $.4(KV*W),/$,$$$
/$,$$$
= "$,$$$
0.5(EBIT) = EBIT – 40,000
EBIT = `80,000
The above indifference levels are presented in the following table:
Expected Level of EBIT Recommended plan
Less than `40,000 Plan X
Equal to `40,000 Plan X or Plan Y
Between `40,000 to `80,000 Plan Y
More than `80,000 Plan Y
From the above table, it can be clearly observed that Plan Y is more dominating than other
plans.

MAY – 2019 – 10 Marks

RM Steels Limited requires `10,00,000 for construction of a new plant. It is considering three
financial plans:
(i) The company may issue 1,00,000 ordinary shares at `10 per share;
(ii) The company may issue 50,000 ordinary shares at `10 per share and 5,000 debentures of
`100 denominations bearing at 8% rate of interest; and
(iii) The company may issue 50,000 ordinary shares at `10 per share and 5,000 preference shares
at `100 per share bearing a 8% rate of dividend.
If RM Steels Limited’s earnings before interest and taxes are `20,000; `40,000; `80,000;
`1,20,000 and `2,00,000, you are required to compute the earnings per share under each of the

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CA SUNIL KESWANI PYQs of FM

three financial plans? Which alternative would you recommend for RM Steels and why? Tax rate
is 50%.

Solution
Computation of EPS under (i) Plan
Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest - - - - -
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% 10,000 20,000 40,000 60,000 1,00,000
EAT 10,000 20,000 40,000 60,000 1,00,000
Less: Pref. Dividend - - - - -
EAE 10,000 20,000 40,000 60,000 1,00,000
No. of Equity Shares 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
EPS 0.10 0.20 0.40 0.60 1

Computation of EPS under (ii) Plan

Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 40,000 40,000 40,000 40,000 40,000
EBT (20,000) - 40,000 80,000 1,60,000
Less: Tax @ 50% 10,000* - 20,000 40,000 80,000
EAT (10,000) - 20,000 40,000 80,000
Less: Pref. Dividend - - - - -
EAE (10,000) - 20,000 40,000 80,000
No. of Equity Shares 50,000 50,000 50,000 50,000 50,000
EPS (0.20) - 0.40 0.80 1.60
*Assuming tax saving due to this loss

Computation of EPS under (iii) Plan

Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest - - - - -
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% 10,000 20,000 40,000 60,000 1,00,000
EAT 10,000 20,000 40,000 60,000 1,00,000
Less: Pref. Dividend 40,000* 40,000 40,000 40,000 40,000
EAE (30,000) (20,000) - 20,000 60,000
No. of Equity Shares 50,000 50,000 50,000 50,000 50,000
EPS (0.60) (0.40) - 0.40 1.20
*Assuming cumulative preference shares so dividend has to be paid to them.

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CA SUNIL KESWANI PYQs of FM

From the above EPS calculation tables under the three financial plans we can see that when EBIT
is `80,000 or more, Plan (ii) i.e. Debt-equity mix is preferable over the other plans as the EPS is
more under it.
On the other hand, EBIT of less than `80,000 or less, Plan (i) i.e. equity financing is preferable
over the other plans as the EPS is more under it.

The final choice of plan will depend on the performance of the company and other macro-economic
conditions.

NOV – 2018 – 10 Marks

The following data relate to two companies belonging to the same risk class:
Particulars A Ltd. B Ltd.
Expected Net Operating Income `18,00,000 `18,00,000
12% Debt `54,00,000 -
Equity Capitalization Rate - 18%

Required:
(a) Determine the total market value, equity capitalization rate and weighted average cost of
capital for each company assuming no taxes as per MM approach
(b) Determine the total market value, equity capitalization rate and weighted average cost of
capital for each company assuming 40% taxes as per MM approach.

Solution
KV*W "&,$$,$$$
(a) Value of B Ltd. (Unlevered firm) = g8
= "&%
= `1,00,00,000
Value of A Ltd. (Levered firm) = Value of B Ltd. + Tax benefit
= 1,00,00,000 + (54,00,000 × 0) = `1,00,00,000

Ke of B Ltd. = 18% (given)

KV*W,*:-878M- "&,$$,$$$,(41,$$,$$$×"/%) "",4/,$$$
Ke of A Ltd. = EZ[U8 9B KdU=-c = ",$$,$$,$$$ ,41,$$,$$$
= 1%,$$,$$$ = 0.2504 = 25.04%

WACC of B Ltd. = Ke = 18%

WACC of A Ltd.
Source Amount Weights Cost of Weighted Average Cost
(1) (2) (3) capital (4) (5)= (3)x(4)
Equity 46,00,000 0.46 25.04 11.52
Debt 54,00,000 0.54 12.00 6.48
1 18
Weighted Average Cost of Capital (WACC) = 18%

KV*W(",-) "&,$$,$$$(",$.1$)
(b) Value of B Ltd. (Unlevered firm) = g8
= "&%
= `60,00,000

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CA SUNIL KESWANI PYQs of FM

Value of A Ltd. (Levered firm) = Value of B Ltd. + Tax benefit

= 60,00,000 + (54,00,000 × 0.40) = `81,60,000

Ke of B Ltd. = 18% (given)

(KV*W,*:-878M-)(",-) ["&,$$,$$$,(41,$$,$$$×"/%)](",$.1$) %,2",/$$
Ke of A Ltd. = EZ[U8 9B KdU=-c
= &",%$,$$$ ,41,$$,$$$
= /5,%$,$$$ = 25.04%

WACC of B Ltd. = Ke = 18%

Kd of A LTd. = I × (1 – t) = 12 × (1 – 0.40) = 7.20%
WACC of A Ltd.
Source Amount Weights Cost of Weighted Average Cost
(1) (2) (3) capital (4) (5)= (3)x(4)
Equity 27,60,000 0.34 25.04 8.51
Debt 54,00,000 0.66 7.20 4.75
1 13.26
Weighted Average Cost of Capital (WACC) = 13.26%

NOV – 2018 – 5 Marks

Y Limited requires `50,00,000 for a new plant. This Plant is expected to yield earnings before
interest and taxes of `10,00,000. While deciding about the financial plan, the company considers
the objective of maximizing earnings per share. It has two alternatives to finance the project – by
raising debt of `5,00,000 or `20,00,000 and the balance in each case by issuing equity shares.
The company’s share is currently selling at `300 but is expected to decline to `250 in case the
funds are borrowed in excess of `20,00,000. The funds can be borrowed at the rate of 12% upto
`5,00,000, at 10% over `5,00,000. The tax rate applicable to the company is 25%. Which form
of financing should company choose?

Solution
Particulars Option A Option B
Fund from Equity 45,00,000 30,00,000
Fund from Debt 5,00,000 20,00,000
EBIT 10,00,000 10,00,000
Less: Interest 60,000 2,10,000
[5,00,000×12%] [(5,00,000×12%) +
(15,00,000×10%)]
EBT 9,40,000 7,90,000
Less: Tax @ 25% 2,35,000 1,97,500
EAT/EAE (A) 7,05,000 5,92,500
No. of Equity Shares (B) 15,000 10,000
[45,00,000÷300] [30,00,000÷300]
EPS (A ÷ B) 47 59.25

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CA SUNIL KESWANI PYQs of FM

Financing Option B i.e. raising debt of `20,00,000 and equity of `30,00,000 is the option which
maximizes the earning per share.

MAY – 2018 – 5 Marks

Stopgo Ltd. an all equity financed company, is considering the repurchase of `200 lakhs equity
and to replace it with 15% debentures of the same amount. Current market value of the company
is `1,140 lakhs and its’s cost of capital is 20%. It’s Earnings before Interest and Taxes (EBIT) are
expected to remain constant in future. Its entire earnings are distributed as dividend. Applicable
tax rate is 30%.

You are required to calculate the impact on the following on account of the change in the capital
structure as per Modigiliani and Miller (MM) hypothesis:
(a) The market value of the company
(b) Its cost of capital
(c) Its cost of equity

Solution
Working Note:
F8- *:;Bb8 (F*)9B7 KdU=-c hB[?87M
Market value of equity = g8
F8- *:;Bb8 (F*)9B7 KdU=-c hB[?87M
`1,140 lakhs = $./$
Net Income for Equity Holders = 1,140 × 0.20 = `228 lakhs
//&
EBIT = = `325.71 lakhs
",$.6$
(`in lakhs)
Particulars All Equity Debt and Equity
EBIT 325.71 325.71
(-) Interest - (30.00)
EBT 325.71 295.71
(-) Tax @ 30% (97.71) (88.71)
Income to shareholders 228.00 207.00

(a) Market value of company = Value of equity + Value of debt

= `1,140 lakhs + (200 lakhs × 0.30) = `1,200 lakhs
The impact is that the market value of the company has increased by `60 lakhs.

F8- =:;Bb8 -B 8dU=-c YB[?87M /$5 [ZfYM

(b) Ke = KdU=-c >Z[U8
= ",/$$ [ZfYM,/$$ [ZfYM = 0.207 = 20.70%

Kd = I × (1 – t) = 15% × (1 – 0.30) = 10.5%

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CA SUNIL KESWANI PYQs of FM

Weighted Average Cost of Capital (WACC)

Source Amount Weights Cost of Weighted Average Cost
(1) (2) (3) capital (4) (5)= (3)x(4)
Equity 1,000 lakhs 0.83 20.70 17.18
Debt 200 lakhs 0.17 10.50 1.79
1 18.97
Weighted Average Cost of Capital (WACC) = 18.97%
The impact is that WACC has fallen by 1.03% due to benefit of lower cost of capital of debt.

(c) Cost of equity (Ke) = 20.70% (as in part b)

The impact is that cost of equity has increase by 0.70% due to presence of financial risk.

MAY – 2018 – 5 Marks

Sun Ltd. is considering two financing plans: Details of which are as under:
(i) Fund’s requirement – `100 lakhs
(ii) Financial Plan
Plan Equity Debt
I 100% -
II 25% 75%
(iii) Cost of debt – 12% p.a.
(iv) Tax rate – 30%
(v) Equity share of `10 each, issued at a premium of `15 per share
(vi) Expected earnings before interest and taxes (EBIT) `40 lakhs
You are required to compute:
(a) EPS in each of the two plans
(b) The financial break-even point
(c) Indifference point between Plan I and Plan II

Solution
(a) Computation of EPS
Particulars Plan I Plan II
EBIT 40,00,000 40,00,000
Less: Interest - 9,00,000
(75,00,000×12%)
EBT 40,00,000 31,00,000
Less: Tax @ 30% 12,00,000 9,30,000
EAT/EAE (A) 28,00,000 21,70,000
No. of Equity Shares (B) 4,00,000 1,00,000
[100,00,000÷25] [25,00,000÷25]
EPS (A ÷ B) 7 21.70

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CA SUNIL KESWANI PYQs of FM

(b) Computation of Financial Break-even Point

#789878:;8 !=>=?8:?
Plan I = Interest + (",-)
= 0 + 0 = `0
#789878:;8 !=>=?8:?
Plan II = Interest + (",-)
= 9,00,000 + 0 = `9,00,000

(c) Computation of Indifference Point

(KV*W,*:-)(",-),#! (KV*W,*:-)(",-),#!
FB.B9 MYZ78M
= FB.B9 MYZ78M
(KV*W,$)(",$.6$),$ (KV*W,2,$$,$$$)(",$.6$),$
1,$$,$$$
= ",$$,$$$
($.5$)KV*W ($.5$)KV*W,%,6$,$$$
1
= "
(0.70)EBIT = (2.80)EBIT – 25,20,000
(0.21)EBIT = 25,20,000
EBIT = `12,00,000

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CA SUNIL KESWANI PYQs of FM

Working Capital
PAST YEAR QUESTIONS

MAY – 2022 – 5 Marks

Balance sheet of X Ltd. for the year ended 31st March, 2022 is given below:
(` in lakhs)
Liabilities Amount Assets Amount
Equity Shares `10 each 200 Fixed Assets 500
Retained Earnings 200 Raw materials 150
11% Debentures 300 WIP 100
Public Deposits (short Term) 100 Finished goods 50
Trade Creditors 80 Debtors 125
Bills Payable 100 Cash/Bank 55
980 980
Calculate the amount of maximum permissible bank finance under three methods as per Tandon
Committee lending norms. The total core current assets are assumed to be `30 lakhs.

Solution
Total current assets = 150 + 100 + 50 + 125 + 55 = `480 lakhs
Total current liabilities = 100 + 80 + 100 = `280 lakhs
Core current assets = `30 lakhs
1st Method
MPBF = 75% (CA – CL) = 75% (480 – 280) = `150 lakhs

2nd Method
MPBF = (75% ´ CA) – CL = (75% ´ 480) – 280 = `80 lakhs

3rd Method
MPBF = [75% ´ (CA – Hard core CA)] – CL = [75% ´ (480 – 30)] – 280 = `57.50 lakhs

JAN – 2021 – 5 Marks

The following information is provided by MNP Ltd. for the year ending 31st March, 2020:
Raw Material Storage Period 45 days
Work-in-Progress conversion period 20 days
Finished Goods storage period 25 days

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CA SUNIL KESWANI PYQs of FM

Debt Collection period 30 days

Creditors’ payment period 60 days
Annual Operating Cost `25,00,000
(Including Depreciation of `2,50,000)
Assume 360 days in a year.
You are required to calculate:
(i) Operating Cycle period
(ii) Number of Operating Cycle in a year
(iii) Amount of working capital required for the company on a cost basis.
(iv) The company is a market leader in its product and it has no competitor in the market. Based
on a market survey it is planning to discontinue sales on credit and deliver products based on
pre-payments in order to reduce its working capital requirement substantially You are
required to compute the reduction in working capital requirement in such a scenario.

Solution
(i) Statement showing Operating cycle
Raw Material storage Period = 45 days
WIP Conversion Period = 20 days
Finished goods storage period = 25 days
Debt collection period = 30 days
Less: Creditors’ payment period = (60 days)
Operating cycle period = 60 days

6%$ 6%$
(ii) Number of operating cycles in a year = ]a87Z-=:N ;c;[8 a87=B? = %$ ?ZcM = 6 cycles

(/4,$$,$$$,/,4$,$$$)
(iii) Amount of working capital required on cash cost basis = %
= `3,75,000

(iv) New operating cycle period = 60 days – Debt collection period = 60 – 30 = 30 days
6%$
Number of operating cycles in a year = 6$
= 12 cycles
New amount of working capital required on cash cost basis
(/4,$$,$$$,/,4$,$$$)
= "/
= `1,87,500
Saving in cash cost of working capital = `3,75,000 - `1,87,500 = `1,87,500

NOV – 2020 – 10 Marks

PK Ltd., a manufacturing company, provides the following information:
(`)
Sales 1,08,00,000
Raw Material Consumed 27,00,000
Labour Paid 21,60,000
Manufacturing Overhead 32,40,000

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CA SUNIL KESWANI PYQs of FM

(Including Depreciation for the year `3,60,000)

Administrative & Selling Overhead 10,80,000
Additional Information:
(a) Receivables are allowed 3 months’ credit.
(b) Raw Material Supplier extends 3 months’ credit.
(c) Lag in payment of Labour is 1 month.
(d) Manufacturing Overhead are paid one month in arrear.
(e) Administrative & Selling Overhead is paid 1 month advance.
(f) Inventory holding period of Raw Material & Finished Goods are of 3 months.
(g) Work-in-progress is Nil.
(h) PK Ltd. sells goods at Cost plus 33-1/3%.
(i) Cash Balance `3,00,000.
(j) Safety Margin 10%.
You are required to compute the Working Capital Requirements of PK Ltd. on Cash Cost basis.

Solution
Statement showing Working Capital Requirements of
Current Assets Amount (`)
Stock of raw material (27,00,000 × 3/12) 6,75,000
Stock of finished goods (77,40,000 × 3/12) 19,35,000
Debtors (88,20,000 × 3/12) 22,05,000
Outstanding Administrative & Selling Overheads (10,80,000 × 1/12) 90,000
Cash balance 3,00,000
Total Current Assets (A) 52,05,000
Current Liabilities
Creditors for raw material (27,00,000 × 3/12) 6,75,000
Outstanding Labour cost (21,60,000 × 1/12) 1,80,000
Outstanding Manufacturing Overheads (28,80,000 × 1/12) 2,40,000
Total Current Liabilities (B) 10,95,000
Net Current Assets (A - B) 41,10,000
Add: 10% safety margin 4,11,000
Working capital requirement 44,21,000
Working Note-1
Statement of Cash Cost
Particulars `
Raw material consumed 27,00,000
Add: Labour 21,60,000
Add: Manufacturing Overheads [32,40,000 – 3,60,000] 28,80,000
GFC/NFC/COGS 77,40,000
Add: Administrative & Selling Overheads 10,80,000
Cash cost of sales 88,20,000

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CA SUNIL KESWANI PYQs of FM

MAY – 2019 – 5 Marks

Bita Limited manufactures used in the steel industry. The following information regarding the
company is given for your consideration:
(i) Expected level of production 9,000 units per annum.
(ii) Raw materials are expected to remain in store for an average of two months before issue to
production.
(iii) Work-in-progress (50% complete as to conversion cost) will approximate to ½ month’s
production.
(iv) Finished goods remain in warehouse on av average for one month.
(v) Credit allowed by suppliers is one month.
(vi) Two month’s credit is normally allowed to debtors.
(vii) A minimum cash balance of `67,500 is expected to be maintained
(viii) Cash sales are 75% less than the credit sales.
(ix) Safety margin of 20% to cover unforeseen contingencies.
(x) The production pattern is assumed to be even during the year.
(xi) The cost structure for Bita Limited’s product is as follows:
`
Raw materials 80 per unit
Direct Labour 20 per unit
Overheads (including depreciation `20) _80 per unit
Total cost 180 per unit
Profit _20 per unit
Selling price 200 per unit
You are required to estimate the working capital requirement of Bita Limited.

Solution
Statement showing Working Capital Requirements of
Current Assets Amount (`)
Stock of raw material (9,000 × 80 × 2/12) 1,20,000
Stock of WIP - Material (9,000 × 80 × 0.5/12) 30,000
Wages (9,000 × 20 × 50% × 0.5/12) 3,750
Overheads (9,000 × 60 × 50% × 0.5/12) 11,250 45,000
Stock of finished goods (9,000 × 160 × 1/12) 1,20,000
Debtors (9,000 × 160 × 80% × 2/12) 1,92,000
Cash balance expected 67,500
Total Current Assets (A) 5,44,500
Current Liabilities
Creditors for raw material (9,000 × 80 × 1/12) 60,000
Total Current Liabilities (B) 60,000
Net Current Assets (A - B) 4,84,500

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CA SUNIL KESWANI PYQs of FM

Add: 20% safety margin 96,900

Working capital requirement 5,81,400
Note: Debtors has been calculated on the basis of cash cost. Alternatively, they can be calculated
on sales basis as well.

MAY – 2018 – 10 Marks

Day Ltd. a newly formed company has applied to the Private Bank for the first time for financing
its working capital requirements. The following information are available about the projects for
the current year:
Estimated level of activity Completed Units of Production 31,200 plus unit of work in
progress 12,000
Raw Material Cost `40 per unit
Direct Wages Cost `15 per unit
Overheads `40 per unit (inclusive of depreciation `10 per unit)
Selling price `130 per unit
Raw material in stock Average 30 days consumption
Work in Progress stock Material 100% and Conversion cost 50%
Finished goods stock 24,000 units
Credit allowed by the supplier 30 days
Credit allowed to purchases 60 days
Direct wages (lag in payment) 15 days
Expected cash balance `2,00,000
Assume that production is carried on evenly throughout the year (360 days) and wages and
overheads accrue similarly. All sales are on the credit basis. You are required to calculate the Net
Working Capital Requirement on Cash Cost Basis.

Solution
Statement showing Working Capital Requirements of
Current Assets Amount (`)
Stock of raw material (17,28,000 × 30/360) 1,44,000
Stock of work-in-progress [12,000 × (40 + 7.50 + 15)] 7,50,000
Stock of finished goods [24,000 × (40 + 15 + 30)] 20,40,000
Debtors for sale (6,12,000 × 60/360) 1,02,000
Cash 2,00,000
Total Current Assets (A) 32,36,000
Current Liabilities
Creditors for purchase (18,72,000 × 30/360) 1,56,000
Creditors for wages (5,58,000 × 15/360) 23,250
Total Current Liabilities (B) 1,79,250
Net working capital (A – B) 30,56,750

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Working Note-1
Statement of Cost
Particulars `
Opening stock of raw material -
Add: Purchases (Bal. fig.) 18,72,000
Less: Closing stock of raw material (17,28,000 × 30/360) (1,44,000)
Raw material consumed [(31,200 × 40) + (12,000 × 40)] 17,28,000
Add: Direct wages [(31,200 × 15) + (12,000 × 15 × 50%)] 5,58,000
Add: Overheads [(31,200 × 30) + (12,000 × 30 × 50%)] 11,16,000
Gross Factory Cost 34,02,000
Less: Closing work in progress [12,000 × (40 + 7.50 + 15)] (7,50,000)
Cost of goods produced 26,52,000
Less: Closing stock of finished goods (26,52,000 × 24,000/31,000) (20,40,000)
Cash cost of sales 6,12,000

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Receivables Management
PAST YEAR QUESTIONS

MAY – 2023 – 5 Marks

A company has current sale of `12 lakhs per year. The profit-volume ratio is 20% and post-tax
cost of investment in receivables is 15%. The current credit terms are 1/10, net 50 days and average
collection period is 40 days. 50% of customers in terms of sales revenue are availing cash discount
and bad debt is 2% of sales.

In order to increase sales, the company want to liberalize its existing credit terms to 2/10, net 35
days. Due to which, expected sales will increase to `15 lakhs. Percentage of default in sales will
remain same. Average collection period will decrease by 10 days. 80% of customers in terms of
sales revenue are expected to avail cash discount under this proposed policy.

Tax rate is 30%. Advise, should the company change its credit terms (assume 360 days in a year).

Solution
Statement of Evaluation of Proposal
Particulars Amount
Increase in contribution (15,00,000 – 12,00,000)(20%)(1 - 0.30) 42,000
Incremental bad debts [(15,00,000 – 12,00,000)(2%)(1 – 0.30) (4,200)
Incremental cash discount (12,600)
[(15,00,000 0.80 2%) – (12,00,000 0.50 1%)](1 – 0.30)
Saving in opportunity cost 1,000
[(15,00,000 0.8 (30 360) 15%) – (12,00,000 0.8 (40 360) 15%)]
Incremental Profit 26,200
Proposed policy should be adopted since the net benefit is increased by `26,200.

DECEMBER – 2021 – 5 Marks

A factoring firm has offered a company to buy its accounts receivables. The relevant information
is given below:
(i) The current average collection period for the company’s debt is 80 days and ½% of debtors
default. The factor has agreed to pay over money due to the company after 60 days and it will
suffer all the losses of bad debts also.
(ii) Factor will charge commission @2%.
(iii) The company spends `1,00,000 p.a. on administration of debtor. These are avoidable costs.

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(iv) Annual credit sales are `90 lakhs. Total variable costs is 80% of sales. The variable costs is
80% of sales. The company’s cost of borrowing is 15% per annum. Assume 365 days in a
year.
Should the company enter into agreement with factoring firm?

Solution
Presently, the debtors of the company pay after 80 days. However, the factor has agreed to pay
after 60 days only. So, the investment in debtors will be reduced by 20 days. The annual charge in
cash flows through entering into a factoring agreement is:
Particulars `
Factoring commission (90,00,000 × 2%) (1,80,000)
Administration cost saved 1,00,000
Bad debts saved (90,00,000 × 0.50%) 45,000
Interest saving [{(90,00,000 × 80/360) – (90,00,000 × 60/360)} × 80% × 15%] 59,178
Net Benefit 24,178
Recommended to enter into factoring agreement as it will provide annual benefit of `24,178.

JULY – 2021 – 5 Marks

Current annual sales of SKD Ltd. is `360 lakhs. Its directors are of the opinion that company’s
current expenditure on receivables management is too high and with a view to reduce the
expenditure they are considering following two new alternative credit policies:
Policy X Policy Y
Average collection period 1.5 months 1 month
% of default 2% 1%
Annual collection expenditure `12 lakhs `20 lakhs
Selling price per unit of product is `150. Total cost per unit is `120.
Current credit terms are 2 months and percentage of default is 3%.
Current annual collection expenditure is `8 lakhs. Required rate of return on investment of SKD
Ltd. is 20%. Determine which credit policy SKD Ltd. should follow.

Solution
Statement of Credit Policy Evaluation
Particulars Policy X Policy Y
Decrease in bad debts (working note – 1) 3,60,000 7,20,000
Increase in collection expenses (4,00,000) (12,00,000)
Increase in opportunity cost (working note – 2) 2,40,000 4,80,000
Net Benefit 2,00,000 0
Net benefit is higher in case of Policy X, thus Policy X should be followed.

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Working Note - 1
Statement of Bad Debts Calculation
Particulars Existing Policy X Policy Y
Sales 360,00,000 360,00,000 360,00,000
Bad Debts (in %) 3% 2% 1%
Bad Debts (in `) 10,80,000 7,20,000 3,60,000
Decrease in bad debts - 3,60,000 7,20,000

Working Note - 2
Statement of Opportunity Cost Calculation
Particulars Existing Policy X Policy Y
Total Cost [360 (120 150)] 288,00,000 288,00,000 288,00,000
Average collection period 2 month 1.5 month 1 month
Average invest. in debtors 48,00,000 36,00,000 24,00,000
Decrease in invest. in debtors - 12,00,000 24,00,000
Dec. in opportunity cost @ 20% - 2,40,000 4,80,000

NOV – 2018 – 10 Marks

MN Ltd. has a current turnover of `30,00,000 p.a. Cost of sales is 80% of turnover and Bad Debts
are 2% of turnover, cost of sales includes 70% variable cost and 30% fixed cost, while company’s
required rate of return is 15%. MN Ltd. currently allows 15 days credit to its customer, but it is
considering increase this to 45 days credit in order to increase turnover. It has been estimated that
this change in policy will increase turnover by 20%, while Bad Debts will increase by 1%. It is not
expected that the policy change will result in an increase in fixed cost and creditors and stock will
be unchanged.

Should MN Ltd. introduce the proposed policy? (Assume a 360 days year)

Solution
Statement of Credit Policy Evaluation
Particulars Amount
(` )
Increase in contribution (30,00,000 × 20% × 44%) 2,64,000
Increase in bad debts (working note – 1) (48,000)
Increase in opportunity cost (working note – 2) (36,300)
Net Benefit 1,79,700
Since there is net benefit, thus it is recommended to implement the proposed policy.

Working Note – 1
Variable cost ratio = 80 × 70% = 56%; P/v Ratio = 100- 56% = 44%
Fixed cost = 30,00,000 × 80% × 30% = `7,20,000

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Statement of Bad Debts Calculation

Particulars Existing Proposed
Sales 30,00,000 36,00,000
Bad Debts (in %) 2% 3%
Bad Debts (in `) 60,000 1,08,000
Increase in bad debts - 48,000

Working Note - 2
Statement of Opportunity Cost Calculation
Particulars Existing Proposed
Variable cost (sales × 56%) 16,80,000 20,16,000
Fixed cost 7,20,000 7,20,000
Total cost 24,00,000 27,36,000
Average credit period 15 days 45 days
Average invest. in debtors 1,00,000 3,42,000
Increase in invest. in debtors - 2,42,000
Inc. in opportunity cost @ 15% - 36,300

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CASH MANAGEMENT &

INVENTORY
MANAGEMENT
PAST YEAR QUESTIONS

NOV – 2022 – 5 Marks

K Ltd. has a Quarterly cash outflow of `9,00,000 arising uniformly during the Quarter. The
company has an Investment portfolio of Marketable Securities. It plans to meet the demands for cash
by periodically selling marketable securities. The marketable securities are generating a return of
12% p.a. Transaction cost of converting investments to cash is `60. The company uses Baumol
model to find out the optimal transaction size for converting marketable securities into cash.
Consider 360 days in a year.
You are required to calculate:
(a) Company’s average cash balance
(b) Number of conversions each year and
(c) Time interval between two conversions

Solution
(a) Annual cash outflows (U) = 9,00,000 4 = `36,00,000
Fixed cost per transaction (P) = `60
"/
Opportunity cost of one rupee p.a. (S) = "$$ × 1 = 0.12
/×i×# /×6%,$$,$$$×%$
Optimum cash balance = A L
=A $."/
= `60,000
%$,$$$
Average cash balance = /
= `30,000

`::UZ[ 78dU=78b8:- 6%,$$,$$$

(b) Number of conversions p.a. = ]a-=bUb ;ZMY TZ[Z:;8 = %$,$$$
= 60

6%$ 6%$
(c) Time interval between two conversion = FB. B9 ;B:>87M=B:M
= %$
= 6 days

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CA SUNIL KESWANI PYQs of FM

MAY – 2022 – 5 Marks

A company requires 36,000 units of a product per year at a cost of `100 per unit. Ordering cost
per order is `250 and the carrying cost is 4.5% per year of the inventory cost. Normal lead time is
25 days and safety stock is NIL.
Assume 360 working days in a year.
(i) Calculate the Reorder Inventory Level
(ii) Calculate the Economic Order Quantity (EOQ)
(iii) If the supplier offers 1% quantity discount for purchase in lots of 9,000 units or more,
should the company accept the proposal?

Solution
Annual requirement (A) = 36,000
Cost per order (O) = `250
Carrying cost per unit p.a. (C) = 100 × 4.5% = `4.50
6%,$$$
(i) Reorder level = Maximum lead time Maximum consumption = 25 6%$
= 2,500 units
/×`×] /×6%,$$$×/4$
(ii) EOQ = A X
=A 1.4$
= 2,000 units

(iii) Statement of Cost

Particulars Order size = 2,000 Order size = 9,000
Purchase cost 36,000 × 100 = 36,00,000 36,000 × (100 – 1%) = 35,64,000
Ordering cost 6%,$$$ 6%,$$$
/,$$$
× 250 = 4,5000 2,$$$
× 250 = 1,000
Carrying cost /,$$$ 2,$$$ 1.4
/
× 4.50 = 4,500 × "$$ × 99 = 20,048
/
Total cost 36,09,000 35,85,048
Offer of discount should be accepted as it will have lower cost.

DECEMBER – 2021 – 5 Marks

A garment trader is preparing cash forecast for first three months of calendar year 2021. His
estimated sales for the forecasted periods are as below:
January (` ‘000) February (` ‘000) March (` ‘000)
Total Sales 600 600 800
(i) The trader sells directly to public against cash payments and to other entities on credit.
Credit sales are expected to be four times the value of direct sales to public. He expects
15% customers to pay in the month in which credit sales are made, 25% to pay in the
next month and 58% to pay in the next to next month. The outstanding balance is
expected to be written off.
(ii) Purchase of goods are made in the month prior to sales and it amounts to 90% of sales
and are made on credit. Payments of these occur in the month after the purchase. No
inventories of goods are held.

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CA SUNIL KESWANI PYQs of FM

(iii) Cash balance as on 1st January, 2021 is `50,000.

(iv) Actual sales for the last two months of calendar year 2020 are as below:
November (` ‘000) December (` ‘000)
Total Sales 640 880
You are required to prepare a monthly cash budget for the three months from January to March,
2021.

Solution
Given, Cash sales = 25% of credit sales
Thus, let credit sales = y \ Cash sales = 0.25y
\ y + 0.25y = Total sales
1.25y = Total sales
WB-Z[ LZ8[M
y= "./4
y = 80% of total sales
Thus, Credit sales = 80% of total sales and Cash sales = 20% of total sales
Cash Budget
Particulars Jan. Feb. March
Opening Balance (A) 50 174.96 355.28
Receipts
20% of current month 120 120 160
12% of current month 72 72 96
20% of previous month 176 120 120
46.4% of previous to previous month 296.96 408.32 278.40
Total receipts (B) 664.96 720.32 654.40
Payments
Creditors payment 540 540 720
Total payments (C) 540 540 720
Closing Balance (A + B - C) 174.96 355.28 289.68

NOV – 2019 – 10 Marks

Slide Ltd. is preparing a cash flow forecast for the three months period from January to the end of
March. The following sales volumes have been forecasted:
Months December January February March April
Sales (units) 1,800 1,875 1,950 2,100 2,250
Selling price per units `600. Sales are all on one month credit. Production of goods for sale takes
place one month before sales. Each unit produced requires two units of raw material costing `150
per unit. No raw material inventory is held. Raw materials purchases are on one month credit.
Variable overheads and wages equal to `100 per unit are incurred during production and paid in
the month of production. The opening cash balance on 1st January is expected to be `35,000. A

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CA SUNIL KESWANI PYQs of FM

long term loan of `2,00,000 is expected to be received in the month of March. A machine costing
`3,00,000 will be purchased in March.
(a) Prepare a cash budget for the months of January, February and March and calculate the cash
balance at the end of each month in the three months period
(b) Calculate the forecast current ratio at the end of the three months period.

Solution
Working Notes:
1) Calculation of Collection from Trade Receivables
Particulars December January February March
Sales (units) 1,800 1,875 1,950 2,100
Sales @ `600 per unit 10,80,000 11,25,000 11,70,000 12,60,000
Collection from debtors 10,80,000 11,25,000 11,70,000

2) Calculation of payment to Trade Payables:

Particulars December January February March
Output (units) 1,875 1,950 2,100 2,250
Raw Material (2 units per output) 3,750 3,900 4,200 4,500
Raw Material @ `150 per unit 5,62,500 5,85,000 6,30,000 6,75,000
Payment to creditors 5,62,500 5,85,000 6,30,000

3) Calculation of Variable Overheads and Wages:

Particulars January February March
Output (units) 1,950 2,100 2,250
Payment in same month @ `100 per unit 1,95,000 2,10,000 2,25,000

(a) Preparation of Cash Budget

Particulars January (`) February (`) March (`)
Opening Balance (A) 35,000 3,57,500 6,87,500
Receipts:
Collection from debtors 10,80,000 11,25,000 11,70,000
Receipt of long term loan - - 2,00,000
Total receipt (B) 10,80,000 11,25,000 13,70,000
Payments:
Payment to creditors 5,62,500 5,85,000 6,30,000
Variable overheads and wages 1,95,000 2,10,000 2,25,000
Purchase of machinery - - 3,00,000
Total payments (C) 7,57,500 7,95,000 11,55,000
Closing Balance (A + B – C) 3,57,500 6,87,500 9,02,500

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CA SUNIL KESWANI PYQs of FM

(b) Calculation of Current Ratios

Particulars March (`)
Inventory [(2,250 × 2 × `150) + (2,250 × 100)] 9,00,000
Trade receivables 12,60,000
Cash Balance 9,02,500
Current Assets (A) 30,62,500
Trade payables 6,75,000
Current Liabilities (B) 6,75,000
Current Ratio (A ÷ B) 4.537

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Ratio Analysis
PAST YEAR QUESTIONS

MAY – 2023 – 10 Marks

Following information and ratios are given in respect of AQUA Ltd. for the year ended 31st March,
2023:
Current ratio 4.0
Acid test ratio 2.5
Inventory turnover ratio (based on sales) 6
Average collection period (days) 70
Earnings per share 3.5
Current liabilities 3,10,000
Total assets turnover ratio (based on sales) 0.96
Cash ratio 0.43
Proprietary ratio 0.48
Total equity dividend 1,75,000
Equity dividend coverage ratio 1.60
Assume 360 days in a year.
You are required to complete Balance Sheet as on 31st March, 2023.
Balance Sheet as on 31st March, 2023
Liabilities ` Assets `
Equity share capital (`10 per XXX Fixed assets XXX
share)
Reserve & surplus XXX Inventory XXX
Long-term debt XXX Debtors XXX
Current liabilities 3,10,000 Loans & advances XXX
Cash & bank XXX
Total XXX Total XXX

Solution
(a) Current ratio = 4
XU778:- ZMM8-M
XU778:- [=ZT=[=-=8M
=4
Current assets = 4 3,10,000 = `12,40,000

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(b) Acid test ratio = 2.5

XU778:- ZMM8-M,*:>8:-B7c
XU778:- [=ZT=[=-=8M
= 2.5
"/,1$,$$$,*:>8:-B7c
6,"$,$$$
= 2.5
12,40,000 – Inventory = 7,73,000
Inventory = `4,65,000

(c) Inventory turnover ratio (on sales) = 6

LZ[8M
*:>8:-B7c
=6
Sales = 6 4,65,000 = `27,90,000

(d) Debtors Collection period = 70 days

!8T-B7M
LZ[8M
× 360 = 70
5$
Debtors = 6%$ × 27,90,000 = `5,42,500

(e) Total assets turnover ratio (on sales) = 0.96

LZ[8M
WB-Z[ ZMM8-M
= 0.96
/5,2$,$$$
WB-Z[ ZMM8-M
= 0.96
Total assets = `29,06,250

(f) Fixed assets = Total assets – current assets = 29,06,250 – 12,40,000 = `16,66,250

XZMY
(g) Cash ratio = XU778:- [=ZT=[=-=8M = 0.43
Cash = 0.43 29,06,250 = `1,33,300

#7Ba7=8-Z7c 9U:?
(h) Proprietary ratio = WB-Z[ ZMM8-M
= 0.48
#7Ba7=8-Z7c 9U:?
/2,$%,/4$
= 0.48
Proprietary fund = `13,95,000

(i) Equity dividend coverage ratio = 1.6

KZ7:=:N 9B7 KdU=-c
KdU=-c !=>=?8:?
= 1.6
Earning for Equity = 1.6(Equity Dividend)
Divide both side by number of shares
KZ7:=:N 9B7 KdU=-c KdU=-c !=>=?8:?
FB. B9 8dU=-c MYZ78M
= 1.6 × FB. B9 8dU=-c MYZ78M
EPS = 1.6 (DPS)
6.4
DPS = ".%
DPS = `2.1875

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CA SUNIL KESWANI PYQs of FM

WB-Z[ !=>=?8:?
(j) DPS = FB. B9 8dU=-c MYZ78M
",54,$$$
2.1875 = FB. B9 8dU=-c MYZ78M
No. of equity shares = 80,000
Equity share capital = 80,000 10 = `8,00,000
Reserve & Surplus = 13,95,000 – 8,00,000 = `5,95,000

(k) Loans and advances = Current assets – Inventory – Receivables – Cash & Bank
= 12,40,000 – 4,65,000 – 5.42.500 – 1,33,000 = `99,200

Balance Sheet as on 31st March, 2023

Liabilities ` Assets `
Equity share capital (`10 per 8,00,000 Fixed assets 16,66,250
share)
Reserve & surplus 5,95,000 Inventory 4,65,000
Long-term debt (Bal. fig.) 12,01,250 Debtors 5,42,500
Current liabilities 3,10,000 Loans & advances 99,200
Cash & bank 1,33,300
Total 29,06,250 Total 29,06,250

NOV – 2022 – 5 Marks

The following figures are related to the trading activities of M Ltd.:
Total assets - `10,00,000
Debt to total assets - 50%
Interest cost - 10% per year
Direct cost - 10 times of the interest cost
Operating expenses - `1,00,000
The goods are sold to customers at a margin of 50% on the direct cost. Tax rate is 30%. You are
required to calculate:
(a) Net profit margin
(b) Net operating profit margin
(c) Return on assets
(d) Return on owner’s equity

Solution
Amount of debt = 10,00,000 50% = `5,00,000
Interest = 5,00,000 10% = `50,000
Direct cost = 50,000 10 = `5,00,000
Sales = 5,00,000 150% = `7,50,000

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Income Statement
Particulars Amount
Sales 7,50,000
(-) Direct costs (5,00,000)
(-) Operating expenses (1,00,000)
EBIT 1,50,000
(-) Interest (50,000)
EBT 1,00,000
(-) Tax @ 30% (30,000)
EAT 70,000

F8- #7B9=- 5$,$$$

(a) Net profit margin = LZ[8M
× 100 = 5,4$,$$$ × 100 = 10%
KV*W ",4$,$$$
(b) Net Operating profit margin = LZ[8M × 100 = 5,4$,$$$ × 100 = 20%
KV*W ",4$,$$$
(c) Return on Assets = WB-Z[ `MM8-M × 100 = "$,$$,$$$ × 100 = 15%
#`W 5$,$$$
(d) Return on Owner’s Equity = ]j:87 1 M KdU=-c × 100 = 4,$$,$$$ × 100 = 14%

MAY – 2022 – 5 Marks

Following information and ratios are given for W Limited for the year ended 31st March, 2022:
Equity share capital of `10 each `10 lakhs
Reserve & Surplus to shareholder’s fund 0.50
Sales / Shareholder’s fund 1.50
Current ratio 2.50
Debtors Turnover Ratio 6.00
Stock Velocity 2 Months
Gross Profit Ratio 20%
Net Working Capital Turnover Ratio 2.50
You are required to calculate:
(i) Shareholder’s fund
(ii) Stock
(iii) Debtors
(iv) Current liabilities
(v) Cash Balance

Solution
D8M87>8 & LU7a[UM
(i) LYZ78YB[?87 1 M 9U:?
= 0.5
D8M87>8 & LU7a[UM
KdU=-c LYZ78 XZa=-Z['D8M87>8 & MU7a[UM
= 0.5
Reserve & Surplus = 0.5(10,00,000 + Reserve & Surplus)
Reserve & Surplus = 5,00,000 + (0.5)Reserve & Surplus

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(0.5)Reserve & Surplus = 5,00,000

Reserve & Surplus = 10,00,000
Shareholder’s fund = 10,00,000 + 10,00,000 = `20,00,000

(ii) Sales = 1.5 Shareholder’s fund = 1.5 20,00,000 = `30,00,000

Gross profit = Sales GP Ratio = 30,00,000 20% = `6,00,000
Cost of goods sold (COGS) = Sales – Gross Profit = 30,00,000 – 6,00,000 = `24,00,000
Stock velocity = 2 month
`>87ZN8 M-B;f
X]lL
× 12 = 2
/×/1,$$,$$$
Average stock = "/
= `4,00,000

(iii) Debtors Turnover Ratio = 6

LZ[8M
`>87ZN8 !8T-B7M
=6
6$,$$,$$$
`>87ZN8 !8T-B7M
=6
Average Debtors = `5,00,000

(iv) Net working capital turnover ratio = 2.5

LZ[8M
F8- jB7f=:N ;Za=-Z[
= 2.5
6$,$$,$$$
F8- jB7f=:N ;Za=-Z[
= 2.5
Net working capital = 12,00,000
Current Assets – Current Liabilities = 12,00,000
Current Assets = 12,00,000 + Current Liabilities …………(1)
Current ratio = 2.5
XU778:- `MM8-M
XU778:- \=ZT=[=-=8M
= 2.5
Current Assets = (2.5)Current liabilities ………….(2)
Put value of current assets from equation (1) in equation (2)
12,00,000 + Current liabilities = (2.5)Current liabilities
(1.5)Current liabilities = 12,00,000
Current liabilities = 8,00,000
Thus, from equation (1), Current Assets = 12,00,000 + 8,00,000 = `20,00,000

(v) Total current assets = Debtors + Stock + Cash balance

20,00,000 = 5,00,000 + 4,00,000 + cash balance
Cash balance = `11,00,000

DECEMBER – 2021 – 10 Marks

Following are the data in respect of ABC Industries for the year ended 31st March, 2021:
Debt to Total assets ratio : 0.40

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Long-term debts to equity ratio : 30%

Gross profit margin on sales : 20%
Accounts receivables period : 36 days
Quick ratio : 0.9
Inventory holding period : 55 days
Cost of goods sold : `64,00,000
Liabilities ` Assets `
Equity Share Capital 20,00,000 Fixed assets
Reserve & surplus Inventories
Long-term debts Accounts receivable
Accounts payable Cash
Total 50,00,000 Total
Required:
Complete the balance sheet of ABC Industries as on 31st March, 2021. All calculations should be
in nearest rupee. Assume 360 days in a year.

Solution
Balance Sheet of ABC Industries as on 31st March, 2021
Liabilities ` Assets `
Equity Share Capital 20,00,000 Fixed assets 30,32,222
Reserve & surplus 10,00,000 Inventories 9,77,7778
Long-term debts 9,00,000 Accounts receivable 8,00,000
Accounts payable 11,00,000 Cash 1,90,000
Total 50,00,000 Total 50,00,000
Note:

Working Notes:
(1) Total liabilities = Total assets = `50,00,000
!8T-
WB-Z[ `MM8-M
= 0.40
!8T-
4$,$$,$$$
= 0.40
Debt = `20,00,000
(2) Reserve & Surplus = Total liabilities – Equity capital – Debt
= 50,00,000 – 20,00,000 – 20,00,000 = `10,00,000
\B:N -87b ?8T-
(3) KdU=-c MYZ78YB[?87 9U:?
= 30%
\B:N -87b ?8T-
(/$,$$,$$$'"$,$$,$$$)
= 30%
Long term debt = `9,00,000
(4) Accounts payable = total debt - long term debt = 20,00,000 – 9,00,000 = `11,00,000
(5) COGS ratio = 100 – GP Ratio = 100 – 20% = 80% of sales
XBM- B9 NBB?M MB[? %1,$$,$$$
(6) Sales = X]lL DZ-=B
= &$%
= `80,00,000

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XBM- B9 NBB?M MB[? %1,$$,$$$

(7) Closing inventory = *:8:-B7c ?ZcM
× 360 = 44
× 360 = `9,77,778
X78?=- MZ[8M &$,$$,$$$
(8) Account receivables = × 360 = × 360 = `8,00,000
`;;BU:- 78;8=>ZT[8 a87=B? 6%
mU=;f ZMM8-M
(9) Quick ratio = XU778:- [=ZT=[=-8M
XZMY'!8T-B7M
0.90 = "",$$,$$$
Cash + 8,00,000 = 9,90,000
Cash = `1,90,000
(10) Fixed assets = Total assets – current assets
= 50,00,000 – (9,77,778 + 8,00,000 + 1,90,000) = `30,32,222

JULY – 2021 – 10 Marks

Masco Limited has furnished the following ratios and information relating to the year ended 31st
March 2021:
Sales ` 75,00,000
Return on net worth 25%
Rate of income tax 50%
Share capital to reserves 6:4
Current ratio 2.5
Net profit to sales (After Income Tax) 6.50%
Inventory turnover (based on cost of goods sold) 12
Cost of goods sold ` 22,50,000
Interest on debentures ` 75,000
Receivables (includes debtors ` 1,25,000) ` 2,00,000
Payables ` 2,50,000
Bank Overdraft ` 1,50,000
You are required to:
(a) Calculate the operating expenses for the year ended 31st March, 2021.
(b) Prepare a balance sheet as on 31st March in the following format:
Liabilities ` Assets `
Share Capital Fixed Assets
Reserves and Surplus Current Assets
15% Debentures Stock
Payables Receivables
Bank Overdraft Cash

Solution
(a) Calculation of operating expenses for the year ended 31st March, 2021
Particulars (` )
Net Profit (6.5% 75,00,000) 4,87,500
Add: Income Tax @ 50% 4,87,500

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Profit before tax 9,75,000

Add: Debenture interest 75,000
Profit before interest and tax (A) 10,50,000
Sales 75,00,000
Less: COGS 22,50,000
Gross Profit (B) 52,50,000
Operating expenses (B – A) 42,00,000
(b) Balance Sheet as on 31st March, 2021
Liabilities ` Assets `
Share Capital 11,70,000 Fixed Assets 18,50,000
Reserve & Surplus 7,80,000 Current Assets
15% Debentures 5,00,000 Stock 1,87,500
Payables 2,50,000 Receivables 2,00,000
Bank Overdraft 1,50,000 Cash 6,12,500
28,50,000 28,50,000

Working Notes:
(1) Net worth = PAT 25% = 4,87,500 25% = `19,50,000
(2) Ratio of Share capital to reserve is 6:4
%
Thus, Share capital = 19,50,000 "$
= `11,70,000
1
Reserves = 19,50,000 "$
= `7,80,000
*:-878M- `bBU:- 54,$$$
(3) Value of Debentures = *:-878M- 7Z-8
= "4%
= `5,00,000
(4) Total current liabilities = Bank overdraft + Payables = 1,50,000 + 2,50,000 = `4,00,000
Given, current ratio = 2.5
Thus, current assets = 2.5 current liabilities = 2.5 4,00,000 = `10,00,000
(5) Total liabilities = Net worth + Debentures + Current liabilities
= 19,50,000 + 5,00,000 + 4,00,000 = `28,50,000
Total assets = Total liabilities = `28,50,000
Fixed assets = Total assets – Current assets = 28,50,000 – 10,00,000 = `18,50,000
XBM- B9 NBB?M MB[? //,4$,$$$
(6) Closing stock = *:>8:-B7c -U7:B>87 7Z-=B = "/
= `1,87,500
(7) Cash = Current assets – Stock – Receivables = 10,00,000 – 1,87,500 – 2,00,000 = `6,12,500

JAN – 2021 – 5 Marks

From the following information, complete the Balance sheet given below:
(i) Equity `2,00,000
(ii) Total debt to owner’s equity 0.75
(iii) Total assets turnover 2 times
(iv) Inventory turnover 8 times
(v) Fixed assets to owner’s equity 0.60

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(vi) Current debt to total debt 0.40

Solution
Equity = 2,00,000
Total Debt = Equity 0.75 = 2,00,000 0.75 = `1,50,000
Current Debt = total Debt 0.40 = 1,50,000 0.40 = `60,000
Long term debt = 1,50,000 – 60,000 = `90,000

Fixed Assets = Equity 0.60 = 2,00,000 0.60 = `1,20,000

Total Assets = Total Liabilities = Equity + Total Debt = 2,00,000 + 1,50,000 = `3,50,000
Current Assets = Total Assets – Fixed Assets = 3,50,000 – 1,20,000 = `2,30,000
Sales = 2 Total Assets = 2 3,50,000 = `7,00,000
LZ[8M 5,$$,$$$
Inventory = *WD
= &
= `87,500
Other CA = Current Assets – Inventory = 2,30,000 – 87,500 = `1,42,500
Balance Sheet
Equity 2,00,000 Fixed Assets 1,20,000
Long Term Debt 90,000 Inventory 87,500
Current Debts 60,000 Other CA 1,42,500
3,50,000 3,50,000

NOV – 2020 – 5 Marks

Following information relates to RM Co. Ltd.
(`)
Total Assets employed 10,00,000
Direct Cost 5,50,000
Other Operating Cost 90,000
Goods are sold to the customers at 150% of direct costs.
50% of the assets being financed by borrowed capital at an interest cost of 8% per annum.
Tas rate is 30%
You are required to calculate:
(i) Net profit margin
(ii) Return on Assets
(iii) Asset turnover
(iv) Return on owners’ equity

Solution
F8- #7B9=- ",$",4$$
(i) Net profit margin = LZ[8M
× 100 = &,/4,$$$ × 100 = 12.30%
KV*W ",&4,$$$
(ii) Return on Assets = × 100 = × 100 = 18.50%
WB-Z[ `MM8-M "$,$$,$$$
LZ[8M &,/4,$$$
(iii) Assets Turnover = WB-Z[ `MM8-M = "$,$$,$$$ = 0.825 times

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F8- #7B9=- `9-87 WZ^ ",$",4$$

(iv) Return on owner’s equity = ]j:87 1 M KdU=-c
× 100 = "$,$$,$$$×4$% × 100 = 20.30%

Working Notes:
1) Sales = Direct cost × 150% = 5,50,000 × 150% = `8,25,000
2) EBIT = Sales – Direct cost – Operating cost
= 8,25,000 – 5,50,000 – 90,000 = `1,85,000
3) Net Profit before tax = EBIT – Interest
= 1,85,000 – (10,00,000 × 50% × 8%) = `1,45,000
4) Net Profit after tax = 1,45,000 × (1 – 0.30) = `1,01,500

NOV – 2019 – 5 Marks

Following information has been gathered from the books of Tram Ltd. the equity share of which
is trading in the stock market at `14.
Particulars Amount (`)
Equity Share Capital (face value `10) 10,00,000
10% Preference Shares 2,00,000
Reserves 8,00,000
10% Debentures 6,00,000
Profit before Interest and Tax for the year 4,00,000
Interest 60,000
Profit after tax for the year 2,40,000
Calculate the following:
(a) Return on Capital Employed
(b) Earnings per share
(c) PE Ratio

Solution
(a) Capital employed = Equity shareholder’s fund + Debenture + Pref. shares
= 10,00,000 + 8,00,000 + 6,00,000 + 2,00,000 = `26,00,000
KV*W 1,$$,$$$
Return on capital employed (pre tax) = XZa=-Z[ Kba[Bc8? × 100 = /%,$$,$$$ × 100 = 15.38%
K`W /,1$,$$$
Return on capital employed (post tax) = XZa=-Z[ Kba[Bc8? × 100 = /%,$$,$$$ × 100 = 9.23%
KZ7:=:N Z>Z=[ZT[8 9B7 8dU=-c YB[?87M /,1$,$$$,/$,$$$
(b) Earning per share = FB.B9 8dU=-c MYZ78M
= ",$$,$$$
= `2.20
_#L "1
(c) PE Ratio = K#L
= /./$ = 6.364

MAY – 2019 – 5 Marks

Following figures and ratios are related to a company of Q Ltd.:
Sales for the year (all credit) `30,00,000
Gross profit ratio 25%

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Fixed assets turnover ratio (based on cost of goods sold) 1.5

Stock turnover ratio (based on cost of goods sold) 6
Liquid ratio 1:1
Current Ratio 1.5
Receivables (Debtors) collection period 2 months
Reserves & surplus to share capital 0.60:1
Capital gearing ratio 0.5
Fixed assets to net worth 1.20:1
You are required to calculate:
Closing stock, Fixed Assets, Current Assets, Debtors and Net Worth.

Solution
Calculation of Closing Stock:
Sales for the year = `30,00,000
GP Ratio = 25%
Gross Profit = 30,00,000 × 25% = `7,50,000
Cost of Goods Sold = Sales – Gross Profit = 30,00,000 – 7,50,000 = `22,50,000
X]lL //,4$,$$$
Closing Stock = L-B;f WU7:B>87 = %
= `3,75,000

Calculation of Fixed Assets:

XBM- B9 lBB?M LB[?
Fixed Assets Turnover Ratio = e=^8? `MM8-M
//,4$,$$$
1.5 = e=^8? `MM8-M
//,4$,$$$
Fixed Assets = ".4
= `15,00,000

Calculation of Current Assets:

Current Ratio = 1.5
XU778:- `MM8-M
XU778:- \=ZT=[=-=8M
= 1.5
Current Assets = Current Liabilities × 1.5
Also, Liquid Ratio = 1
\=dU=? `MM8-M
XU778:- \=ZT=[=-=8M
=1
Liquid Assets = Current Liabilities
Current Assets – Stock = Current Liabilities
(1.5 × Current Liabilities) – 3,75,000 = Current Liabilities
0.5 × Current Liabilities = 3,75,000
Current Liabilities = 7,50,000
Current Assets = 7,50,000 × 1.5 = `11,25,000

Calculation of Debtors:
LZ[8M × !8T-B7M XB[[8;-=B: #87=B? 6$,$$,$$$×/
Debtors = "/
= "/
= `5,00,000

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Calculation of Net Worth:

e=^8? `MM8-M
1.20 = F8- nB7-Y
e=^8? `MM8-M "4,$$,$$$
Net Worth = "./$
= "./$
= `12,50,000

NOV – 2018 – 5 Marks

The following is the information of XML Ltd. relate to the year ended 31-03-2018:
Gross Profit 20% of Sales
Net Profit 10% of sales
Inventory Holding Period 3 months
Receivable collection period 3 months
Non-current assets to sales 1:4
Non-current assets to current assets 1:2
Current Ratio 2:1
Non-current liabilities to current liabilities 1:1
Share capital to Reserve and Surplus 4:1
st
Non-current assets as on 31 March, 2017 `50,00,000
Assume that:
(a) No change in Non-current assets during the year 2017-18
(b) No depreciation changed on Non-Current Assets during the year
(c) Ignoring tax
You are required to calculate cost of goods sold, net profit, inventory, receivables and cash for the
year ended on 31st March, 2018.

Solution
Non-current assets to sale = 1:4
Sales = Non-current assets × 4
= 50,00,000 × 4 = `2,00,00,000
Net Profit = 10% × Sales = 10% × 2,00,00,000 = `20,00,000
Cost of Goods Sold = Sales – Gross Profit
= 2,00,00,000 – (20% × 2,00,00,000)
= `1,60,00,000
Inventory = COGS × (3/12)
= 1,60,00,000 × (3/12) = `40,00,000
Receivables = Sales × (3/12)
= 2,00,00,000 × (3/12) = `50,00,000
Non-Current Assets to current assets = 1:2
Current Assets = Non-current assets × 2
= 50,00,000 × 2 = `1,00,00,000
Cash = Current Assets – Inventory – Receivables
= 1,00,00,000 – 40,00,000 – 50,00,000
= `10,00,000

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MAY – 2018 – 5 Marks

The accountant of Moon Ltd. has reported the following data:
Gross Profit `60,000
Gross profit Margin 20 per cent
Total Assets Turnover 0.30:1
Net Worth to Total Assets 0.90:1
Current Ratio 1.5:1
Liquid Assets to Current Liability 1:1
Credit sales to total sales 0.80:1
Average collection period 60 days
Assume 360 days in a year.
You are required to complete the following:
Balance Sheet of Moon Ltd.
Liabilities ` Assets `
Net Worth Fixed Assets
Current Liabilities Stock
Debtors
Cash
Total Liabilities Total Assets

Solution
Balance Sheet of Moon Ltd.
Liabilities ` Assets `
Net Worth 9,00,000 Fixed Assets 8,50,000
Current Liabilities 1,00,000 Stock 50,000
Debtors 40,000
Cash 60,000
Total Liabilities 10,00,000 Total Assets 10,00,000
Working Notes:
Sales = Gross profit ÷ Gross Profit Margin
= 60,000 ÷ 20% = `3,00,000
Total Assets = Sales ÷ Total Assets Turnover
= 3,00,000 ÷ 0.30 = `10,00,000
Net Worth = 0.90 × Total Assets
= 0.90 × 10,00,000 = `9,00,000
Current Liability = Total Assets – Net Worth
= 10,00,000 – 9,00,000 = `1,00,000
Current Assets = 1.5 × Current Liabilities
= 1.5 × 1,00,000 = `1,50,000
Liquid Assets = Current Liabilities × 1
= 1,00,000 × 1 = `1,00,000

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Stock = Current Assets – Liquid Assets

= 1,50,000 – 1,00,000 = `50,000
Debtors = Credit sales × (Average collection period ÷ 12)
= 3,00,000 × 0.80 × (60/360) = `40,000
Cash = Current Assets – Stock – Debtors
= 1,50,000 – 50,000 - 40,000 = `60,000
Fixed assets = Total Assets – Current Assets
= 10,00,000 – 1,50,000 = `8,50,000

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Investment Decisions
PAST YEAR QUESTIONS

MAY – 2023 – 10 Marks

Four years ago, Z Ltd. had purchased a machine of `4,80,000 having estimated useful life of 8
years with zero salvage value. Depreciation is charged using SLM method over the useful life. The
company want to replace this machine with a new machine. Details of new machine are as below:
Cost of new machine is `12,00,000, Vendor of this machine is agreed to take old machine at
a value of ` 2,40,000. Cost of dismantling and removal of old machine will be `40,000. 80%
of net purchase price will be paid on spot and remaining will be paid at the end of one year.
Depreciation will be charged @ 20% p.a. under WDV method.
Estimated useful life of new machine is four years and it has salvage value of `1,00,000 at the
end of year four.
Incremental annual sales revenue is `12,25,000.
Contribution margin is 50%.
Incremental indirect cost (excluding depreciation) is `1,18,750 per year.
Additional working capital of `2,50,000 is required at the beginning of year and `3,00,000 at
the beginning of year three. Working capital at the end of year four will be nil.
Tax rate is 30%.
Ignore tax on capital gain.
Z Ltd. will not make any additional investment, if it yields less than 12%.
Advice, whether existing machine should be replaced or not.
Year 1 2 3 4 5
PVIF0.12, t 0.893 0.797 0.712 0.636 0.567

Solution
(i) Calculation of Net Initial Cash Outflow
Particulars `
Cost of New Machine 12,00,000
Less: Sale proceeds of existing machine 2,00,000
Net Purchase Price 10,00,000
Paid in year 0 8,00,000

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Paid in year 1 2,00,000

(ii) Calculation of Additional Depreciation

1 2 3 4
Year
` ` ` `
Opening WDV of machine 10,00,000 8,00,000 6,40,000 5,12,000
Depreciation on new machine@ 20% 2,00,000 1,60,000 1,28,000 1,02,400

Closing WDV 8,00,000 6,40,000 5,12,000 4,09,600

Depreciation on old machine 60,000 60,000 60,000 60,000
(4,80,000/8)
Incremental depreciation 1,40,000 1,00,000 68,000 42,400

(iii) Calculation of Annual Profit before Depreciation and Tax (PBDT)

Particulars Incremental Values
Sales 12,25,000
Contribution 6,12,500
Less: Indirect Cost 1,18,750
Profit before Depreciation and Tax (PBDT) 4,93,750

Calculation of Incremental NPV

Year PVF @ PBTD Incremental PBT Tax @ Cash PV of Cash
12% (` ) Depreciation (` ) 30% Inflows Inflows
(` ) (` ) (` )
(`)
(1) (2) (3) (4) (5) = (6) = (4) – (7) = (6) x (1)
(4)×0.30 (5) + (3)
1 0.893 4,93,750 1,40,000 3,53,750 106,125 3,87,625 3,46,149.125
2 0.797 4,93,750 1,00,000 3,93,750 1,18,125 3,75,625 2,99,373.125
3 0.712 4,93,750 68,000 4,25,750 1,27,725 3,66,025 2,60,609.800
4 0.636 4,93,750 42,400 4,51,350 1,35,405 3,58,345 2,27,907.420
* * 11,34,039.470
Add: PV of Salvage (1,00,000 x 0.636) 63,600
Less: Initial Cash Outflow – Year 0 8,00,000
Year 1 (2,00,000 × 0.893) 1,78,600
Less: Working Capital - Year 0 2,50,000
Year 2 (3,00,000 × 0.797) 2,39,100

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Add: Working Capital released – Year 4 (5,50,000 × 0.636) 3,49,800

Incremental Net Present Value 79,739.470
Since the incremental NPV is positive, existing machine should be replaced.

NOV – 2022 – 10 Marks

A firm is in need of a small vehicle to make deliveries. It is intending to choose between two
options. One option is to buy a new three wheeler that would cost `1,50,000 and will remain in
service for 10 years.

The other alternative is to buy a second hand vehicle for `80,000 that could remain in service for
5 years. Thereafter the firm, can buy another second hand vehicle for `60,000 that will last for
another 5 years. The scrap value of the discarded vehicle will be equal to its written down value
(WDV). The firm pays 30% tax and is allowed to claim depreciation on vehicles @25% on WDV
basis. The cost of capital of the firm is 12%.

You are required to advise the best option.

Given:
t 1 2 3 4 5 6 7 8 9 10
PVIF(t,12%) 0.892 0.797 0.711 0.635 0.567 0.506 0.452 0.403 0.360 0.322

Solution
Statement of Present Value of New Vehicle
Particulars Year Amount PVF PV
Cost of assets 0 1,50,000 1 1,50,000
Tax saving on
Depreciation 1 1,50,000 25% 30%= 11,250 0.892 (10,035)
2 1,12,500 25% 30%= 8,437 0.797 (6,724)
3 84,375 25% 30% = 6,328 0.711 (4,499)
4 63,281 25% 30% = 4,746 0.635 (3,014)
5 47,461 25% 30% = 3,560 0.567 (2,018)
6 35,596 25% 30% = 2,670 0.506 (1,351)
7 26,697 25% 30% = 2,002 0.452 (905)
8 20,023 25% 30% = 1,502 0.403 (605)
9 15,017 25% 30% = 1,126 0.360 (405)
10 11,263 25% 30% = 845 0.322 (272)
Scrap Value 10 8,447 0.322 (2,720)
PVCI 1,17,452

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Statement of Present Value of Second Hand Vehicle

Particulars Year Amount PVF PV
Cost of assets 0 80,000 1 80,000
5 60,000 0.567 34,020
Tax saving on
Depreciation 1 80,000 25% 30%= 6,000 0.892 (5,352)
2 60,000 25% 30%= 4,500 0.797 (3,587)
3 45,000 25% 30% = 3,375 0.711 (2,400)
4 33,750 25% 30% = 2,531 0.635 (1,607)
5 25,313 25% 30% = 1,898 0.567 (1,076)
6 60,000 25% 30%= 4,500 0.506 (2,277)
7 45,000 25% 30% = 3,375 0.452 (1,525)
8 33,750 25% 30% = 2,531 0.403 (1,020)
9 25,313 25% 30% = 1,898 0.360 (683)
10 18,985 25% 30% = 1,424 0.322 (459)
Scrap Value 5 18,985 0.567 (10,764)
10 14,239 0.322 (4,585)
PVCI 78,685
The PV of cash outflow is lower in case of buying second hand vehicles. Thus, it is advisable to
buy second hand vehicles.

NOV – 2022 – 10 Marks

A hospital is considering to purchase a diagnostic machine costing `80,000. The projected life of
the machine is 8 years and has an expected salvage value of `6,000 at the end of 8 years. The
annual operating cost of the machine is `7,500. It is expected to generate revenues of `40,000 per
year for 8 years. Presently the hospital is outsourcing the diagnostic work and is earning
commission income of `12,000 per annum. Consider tax rate of 30% and discounting rate as 10%.

Advise, whether it would be profitable for the hospital to purchase the machine?

Give your recommendations as per Net Present Value method and Present Value Index under
below mentioned two situations:
(a) If commission income of `12,000 p.a. is before taxes
(b) If commission income of `12,000 p.a. is net of taxes
Given:
t 1 2 3 4 5 6 7 8
PVIF(t,10%) 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

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Solution
Analysis of Investment Decisions
Determination of Cash inflows Situation-(i) Situation-(ii)
Commission Commission
Income before Income after
taxes taxes
Cash flow up-to 7th year: 40,000 40,000
Sales Revenue (7,500) (7,500)
Less: Operating Cost 32,500 32,500
Less: Depreciation (80,000 – 6,000) ÷ 8 (9,250) (9,250)
Net Income 23,250 23,250
Tax @ 30% (6,975) (6,975)

16,275 16,275
Earnings after Tax (EAT) Add:
Depreciation 9,250 9,250
Cash inflow after tax per annum 25,525 25,525
Less: Loss of Commission Income (8,400) (12,000)

Net Cash inflow after tax per annum 17,125 13,525

In 8th Year
Net Cash inflow after tax 17,125 13,525
Add: Salvage Value of Machine 6,000 6,000
Net Cash inflow in year 8 23,125 19,525

Calculation of NPV and Profitability Index

Particulars PV factor Situation-(i) Situation-(ii)
@10% [Commission [Commission
Income before Income after
taxes] taxes]
A Present value of cash inflows (1st to 7th 4.867 83,347.38 65,826.18
year) (17,125 × 4,867) (13,525 × 4.867)
B Present value of cash inflow at 8th year 0.467 10,799.38 9,118.18
(23,125 × 0.467) (19,525 × 0.467)
C PV of cash inflows 94,146.76 74,944.36
D Less: Cash Outflow 1.00 (80,000) (80,000)

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E Net Present Value (NPV) 14,146,76 (5,055.64)

F PI = (C ÷ D) 1.18 0.94

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

MAY – 2022 – 10 Marks

Alpha limited is a manufacturer of computers. It wants to introduce artificial intelligence while
making computers. The estimated annual saving from introduction of the artificial intelligence (AI)
is as follows:
Reduction of five employees with annual salaries of `3,00,000 each.
Reduction of `3,00,000 in production delays caused by inventory problem
Reduction in lost sales `2,50,000 and
Gain due to timely billing `2,00,000
The purchase price of the system for installation of artificial intelligence is `20,00,000 and
installation cost is `1,00,000. 80% of the purchase price will be paid in the year of purchase and
remaining will be paid in next year. The estimated life of the system is 5 years and it will be
depreciated on a straight-line basis.
However, the operation of the new system requires two computer specialists with annual salaries
of `5,00,000 per person.
In addition to above, annual maintenance and operating cost for five years are as below:
(Amount in `)
Year 1 2 3 4 5
Maintenance & Operating cost 2,00,000 1,80,000 1,60,000 1,40,000 1,20,000
Maintenance and operating cost are payable in advance.
The company’s tax rate is 30% and its required rate of return is 15%.
Year 1 2 3 4 5
PVIF0.10,t 0.909 0.826 0.751 0.683 0.621
PVIF0.12,t 0.893 0.797 0.712 0.636 0.567
PVIF0.15,t 0.870 0.756 0.658 0.572 0.497
Evaluate the project by using Net Present Value and Profitability Index.

Solution
Calculation of Cash Flows
Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Saving in 15,00,000 15,00,000 15,00,000 15,00,000 15,00,000
Salaries

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Reduction in 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000

production
delays
Reduction in 2,50,000 2,50,000 2,50,000 2,50,000 2,50,000
lost sales
Gain due to 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Timely
Billing
Salary to (10,00,000) (10,00,000) (10,00,000) (10,00,000) (10,00,000)
computer
specialist
Maintenance (2,00,000) (1,80,000) (1,60,000) (1,40,000) (1,20,000)
& Operating
cost
Depreciation (4,20,000) (4,20,000) (4,20,000) (4,20,000) (4,20,000)
Profit before 6,30,000 6,50,000 6,70,000 6,90,000 7,10,000
tax
Less: Tax @ (1,89,000) (1,95,000) (2,01,000) (2,07,000) (2,13,000)
30%
Add: 4,20,000 4,20,000 4,20,000 4,20,000 4,20,000
Depreciation
Add: 2,00,000 1,80,000 1,60,000 1,40,000 1,20,000
Maintenance
& Operating
cost
Less: (2,00,000) (1,80,000) (1,60,000) (1,40,000) (1,20,000) -
Maintenance
& Operating
cost
Net CF (2,00,000) 8,81,000 8,95,000 9,09,000 9,23,000 10,37,000

Statement of NPV
Particulars Time PVF Amount Present Value
Initial Investment 0 1 16,00,000 16,00,000
Installation expenses 0 1 1,00,000 1,00,000
Installment of Purchase Price 1 0.870 4,00,000 3,48,000
PVCO 20,48,000

Cash flows 0 1 (2,00,000) (2,00,000)

1 0.870 8,81,000 7,66,470
2 0.756 8,95,000 6,67,620

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3 0.658 9,09,000 5,98,122

4 0.572 9,23,000 5,27,956
5 0.497 10,37,000 5,15,389
PVCI 28,84,557
NPV (PVCI – PVCO) 8,36,557
Profitability Index (PVCI PVCO) 1.41
Since, NPV is positive and Profitability index is greater than one, thus it is recommended to
introduce the system.

DECEMBER – 2021 – 10 Marks

Stand Ltd. is contemplating replacement of one of its machines which has become outdated and
inefficient. Its financial manager has prepared a report outlining two possible replacement
machines. The details of each machine are as follows:
Machine 1 Machine 2
Initial investment `12,00,000 `16,00,000
Estimated useful life 3 years 5 years
Residual value `1,20,000 `1,00,000
Contribution per annum `11,60,000 `12,00,000
Fixed maintenance costs per annum `40,000 `80,000
Other fixed operating cost per annum `7,20,000 `6,10,000

The maintenance costs are payable annually in advance. All other cash flows apart from the initial
investment assumed to occur at the end of each year. Depreciation has been calculated by straight
line method and has been included in other fixed operating costs. The expected cost of capital for
this project is assumed at 12%p.a.

Required to compute which machine is more beneficial, using annualized equivalent approach.
Ignore tax.
Year 1 2 3 4 5 6
PVIF0.12,t 0.893 0.797 0.712 0.636 0.567 0.507
PVIFA0.12,t 0.893 1.690 2.402 3.038 3.605 4.112

Solution
Statement of Calculation of Cash Flows of Machine-1
Particulars Year 0 Year 1 Year 2 Year 3
Initial investment (12,00,000) - - -
Contribution - 11,60,000 11,60,000 11,60,000
Fixed maintenance cost (40,000) (40,000) (40,000) -
Other fixed operating cost* - (3,60,000) (3,60,000) (3,60,000)
Residual value - - - 1,20,000
Net Cash flow (12,40,000) 7,60,000 7,60,000 9,20,000

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"/,$$,$$$,",/$,$$$
*Other fixed operating cost (excluding depreciation0 = 7,20,000 - 5 6
6 = 3,60,000

Statement of Calculation of Cash Flows of Machine-2

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial invest. (16,00,000) - - - - -
Contribution - 12,00,000 12,00,000 12,00,000 12,00,000 12,00,000
Fixed maint. (80,000) (80,000) (80,000) (80,000) (80,000) (80,000)
Cost
Other fixed - (3,10,000) (3,10,000) (3,10,000) (3,10,000) (3,10,000)
operating cost*
Residual value - - - - - 1,00,000
Net Cash flow (16,80,000) 8,10,000 8,10,000 8,10,000 8,10,000 9,10,000
"%,$$,$$$,",$$,$$$
*Other fixed operating cost (excluding depreciation0 = 6,10,000 - 5 4
6 = 3,10,000

Statement of NPV
Machine 1 Machine 2
Year PVF@12% Cash Flow Present Value Cash Flow Present Value
0 1.000 (12,40,000) (12,40,000) (16,80,000) (16,80,000)
1 0.893 7,60,000 6,78,680 8,10,000 7,23,330
2 0.797 7,60,000 6,05,720 8,10,000 6,45,570
3 0.712 9,20,000 6,55,040 8,10,000 5,76,720
4 0.636 - - 8,10,000 5,15,160
5 0.567 - - 9,10,000 5,61,330
NPV 6,99,440 13,42,110
PVAF 2.402 3.605
2,91,191 3,72,291
Machine 2 is better as it has more equivalent annualized NPV.

Calculation of Sensitivity
Difference in equivalent annualized NPV = 3,72,291 – 2,91,191 = `81,100
Contribution of Machine 1 = `11,60,000
&","$$
Sensitivity relating to contribution of machine 1 = "",%$,$$$ × 100 = 7%

JULY – 2021 – 10 Marks

An existing company has a machine which has been in operation for two years, its estimated
remaining useful life is 4 years with no residual value in the end. Its current market value is ` 3
lakhs. The management is considering a proposal to purchase an improved model of a machine
gives increase output. The details are as under:
Particulars Existing Machine New Machine
Purchase Price ` 6,00,000 ` 10,00,000

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Estimated Life 6 years 4 years

Residual Value 0 0
Annual Operating days 300 300
Operating hours per day 6 6
Selling price per unit ` 10 ` 10
Material cost per unit `2 `2
Output per hour in units 20 40
Labour cost per hour ` 20 ` 30
Fixed overhead per annum excluding depreciation ` 1,00,000 ` 60,000
Working Capital ` 1,00,000 ` 2,00,000
Income-tax rate 30% 30%
Assuming that - cost of capital is 10% and the company uses written down value of depreciation
@ 20% and it has several machines in 20% block.

Advice the management on the Replacement of Machine as per the NPV method. The discounting
factors table given below:
Discounting Factors Year 1 Year 2 Year 3 Year 4
10% 0.909 0.826 0.751 0.683

Solution
Statement of NPV
Particulars Time PVF Amount Present Value
Cost of new machine 0 1 10,00,000 10,00,000
(+) Add. working cap. (2,00,000 –
1,00,000) 0 1 1,00,000 1,00,000
(-) Cash flow from sale of old assets 0 1 (3,00,000) (3,00,000)
PVCO 8,00,000

Incremental Cash flows (w.n.-1) 1 0.909 2,59,000 2,35,431

2 0.826 2,50,600 2,06,996
3 0.751 2,43,880 1,83,154
4 0.683 2,38,504 1,62,898
Incremental working capital realization 4 0.683 1,00,000 68,300
PVCI 8,56,779
NPV (PVCI – PVCO) 56,779
Since the incremental NPV is positive, thus existing machine should be replaced.

Working Note – 1: Calculation of profit before depreciation (PBD)

Particulars Existing Machine New Machine
Annual output 300 6 20 = 36,000 300 6 40 = 72,000
Sales @ `10 per unit 3,60,000 7,20,000

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Less: Cost of operation

Material @`2 per unit 72,000 1,44,000
Labour 1800 20 = 36,000 1800 30 = 54,000
Fixed OHs 1,00,000 60,000
Profit before Depreciation 1,52,000 4,62,000
Thus, Annual Incremental Profit Before Depreciation = 4,62,000 – 1,52,000 = `3,10,000

Working Note – 2: Calculation of basis of depreciation

Particulars Existing After Replacement
Purchase price of existing 6,00,000 6,00,000
Less: Depreciation of Yr. 1 1,20,000 1,20,000
Less: Depreciation of Yr. 2 96,000 96,000
WDV of existing machine 3,84,000 3,84,000
Add: Purchase of new - 10,00,000
Less: Sale of existing - 3,00,000
Basis for Depreciation 3,84,000 10,84,000

Working Note – 3: Incremental cash flow from sale of assets

Particulars Year 1 Year 2 Year 3 Year 4
Incremental PBD (A) 3,10,000 3,10,000 3,10,000 3,10,000
New Depreciation 2,16,800 1,73,440 1,38,752 1,11,002
Less: Existing Depreciation 76,800 61,440 49,152 39,322
Incremental Depreciation (B) 1,40,000 1,12,000 89,600 71,680
Incremental PBT (A – B) 1,70,000 1,98,000 2,20,400 2,38,320
Tax @ 30% (C) 51,000 59,400 66,120 71,496
Incremental CFs (A – C) 2,59,000 2,50,600 2,43,880 2,38,504

JAN – 2021 – 10 Marks

A company wants to buy a machine, and two different models namely A and B are available.
Following further particulars are available:
Particulars Machine – A Machine – B
Original Cost (`) 8,00,000 6,00,000
Estimated Life in years 4 4
Salvage Value (`) 0 0
The company provides depreciation under straight line method. Income tax rate applicable is 30%.
The present value of `1 at 12% discounting factor and net profit before depreciation and tax are
as under:
Year Net Profit Before Depreciation and tax PV Factor
Machine – A (`) Machine – B (`)
1 2,30,000 1,75,000 0.893
2 2,40,000 2,60,000 0.797

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3 2,20,000 3,20,000 0.712

4 5,60,000 1,50,000 0.636
Calculate:
(1) NPV (Net Present Value)
(2) Discounted pay-back period
(3) PI (Profitability Index)
Suggest: Purchase of which is more beneficial under Discounted pay-back period method, NPV
method and PI method.

Solution
Statement of Cash flows and PV of Cash flows of Machine A
Year CFBT Depreciation PBT Tax@30% CFAT PVF PVCI
A B C=A-B D=C×30% E=A-D F E×F
1 2,30,000 2,00,000 30,000 9,000 2,21,000 0.893 1,97,353
2 2,40,000 2,00,000 40,000 12,000 2,28,000 0.797 1,81,716
3 2,20,000 2,00,000 20,000 6,000 2,14,000 0.712 1,52,368
4 5,60,000 2,00,000 3,60,000 1,08,000 4,52,000 0.636 2,87,472
Total 11,15,000 8,18,909

Statement of Cash flows and PV of Cash flows of Machine B

Year CFBT Depreciation PBT Tax@30% CFAT PVF PVCI
A B C=A-B D=C×30% E=A-D F E×F
1 1,75,000 1,50,000 25,000 7,500 1,67,500 0.893 1,49,578
2 2,60,000 1,50,000 1,10,000 33,000 2,27,000 0.797 1,80,919
3 3,20,000 1,50,000 1,70,000 51,000 2,69,000 0.712 1,91,528
4 1,50,000 1,50,000 - - 1,50,000 0.636 95,400
Total 8,13,500 6,17,425

(1) NPV of Machine A = PVCI – PVCO = 8,18,909 – 8,00,000 = `18,909

NPV of Machine B = PVCI – PVCO = 6,17,909 – 6,00,000 = `17,909

(2) Statement of Cumulative PVCI

Year 1 Year 2 Year 3 Year 4
PVCI – Machine A 1,97,353 1,81,716 1,52,368 2,87,472
Cumulative PVCI – Machine A 1,97,353 3,79,069 5,31,437 8,16,909
PVCI – Machine B 1,49,578 1,80,919 1,91,528 95,400
Cumulative PVCI – Machine B 1,49,578 3,30,497 5,22,025 6,17,425
(&,$$,$$,4,6",165)
Discounted Pay-back period of Machine A = 3 + /,&5,15/
= 3.93 years
(%,$$,$$,4,//,$/4)
Discounted Pay-back period of Machine B = 3 + 24,1$$
= 3.82 years

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#EX* &,"&,2$2
(3) Profitability Index of Machine A = #EX] = &,$$,$$$ = 1.024
#EX* %,"5,1/4
Profitability Index of Machine B = #EX] = %,$$,$$$ = 1.029

Method Recommendation
Discounted Pay-back period Machine B as it has lower discounted pay-back period
NPV Machine A as it has higher NPV
Profitability Index Machine B as it has higher PI

NOV – 2020 – 5 Marks

CK Ltd. is planning to buy a new machine. Details of which are as follows:
Cost of the Machine at the commencement `2,50,000
Economic Life of the Machine 8 years
Residual Value Nil
Annual Production Capacity of the machine 1,00,000 units
Estimated Selling Price per unit `6
Estimated annual fixed cost (excluding depreciation) `1,00,000
Estimated variable cost per unit (excluding depreciation) `3
st
Advertisement expenses in 1 year in addition of annual fixed cost `20,000
th
Maintenance expenses in 5 year in addition of annual fixed cost `30,000
Cost of capital 12%
Ignore tax
Analyze the above mentioned proposal using the Net Present Value Method and advice.
PV Factor at 12% are as under:
Year 1 2 3 4 5 6 7 8
PV Factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404

Solution
Statement of Present Value of Cash Flows
Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Units 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
Contribution 3 3 3 3 3 3 3 3
per unit (6–3)
Total 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000
Contribution
(-) Fixed Cost 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
(-) Advert. 20,000 - - - - - - -
(-) Maint. - - - - 30,000 - - -
Profit Before 1,80,000 2,00,000 2,00,000 2,00,000 1,70,000 2,00,000 2,00,000 2,00,000
Dep. or CF
PVF @ 12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404
Present Value 1,60,740 1,59,400 1,42,400 1,27,200 96,390 1,01,400 90,400 80,800

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Total Present value of cash inflows = 9,58,730 (from above table)

NPV = PVCI – PVCO = 9,58,730 – 2,50,000 = `7,08,730
It is recommended to accept the proposal as it has positive NPV.

NOV – 2019 – 5 Marks

A company has `1,00,000 available for investment and has identified the following four
investments in which to invest.
Project Investment (`) NPV (`)
C 40,000 20,000
D 1,00,000 35,000
E 50,000 24,000
F 60,000 18,000
You are required to optimize the returns from a package of projects within the capital spending
limit if:
(a) The projects are independent of each other and are divisible
(b) The projects are not divisible

Solution
(a) Computation of NPV per `1 of investment and Ranking of Projects
Project Investment (`) NPV (`) NPV per `1 Ranking
invested (`)
C 40,000 20,000 0.50 1
D 1,00,000 35,000 0.35 3
E 50,000 24,000 0.48 2
F 60,000 18,000 0.30 4

Calculation of Package of Projects

Project Investment (`) NPV (`)
C 40,000 20,000
E 50,000 24,000
th
D (1/10 of Project) 10,000 3,500
Total 1,00,000 47,500
The company would be well advised to invest in Project C, E and D (1/10th) and reject Project F
to optimize return within the amount of `1,00,000 available for investment.

(b) Calculation of Package of Projects

Package of Project Investment (`) NPV (`)
C and E 90 000 44,000
(40,000 + 50,000) (20,000 + 24,000)
C and F 1,00,000 38,000
(40,000 + 60,000) (20,000 + 18,000)

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Only D 1,00,000 35,000

The company would be well advised to invest in Projects C and E to optimize return within the
amount of `1,00,000 available for investment.

MAY – 2019 – 10 Marks

AT Limited is considering three projects A, B and C. The cash flows associated with the projects
are given below:
Cash flows associated with the Three Projects (`)
Project C0 C1 C2 C3 C4
A (10,000) 2,000 2,000 6,000 0
B (2,000) 0 2,000 4,000 6,000
C (10,000) 2,000 2,000 6,000 10,000
You are required to:
(a) Calculate the payback period of each of the three projects.
(b) If the cut-off period is two years, then which projects should be accepted?
(c) Projects with positive NPVs if the opportunity cost of capital is 10%.
(d) “Payback gives too much weight to cash flows that occur after the cut-off date” True of false?
(e) “If a firm used a single cutoff period for all projects, it is likely to accept too many short-lived
projects.” True or false?
PV Factor @ 10%
Year 0 1 2 3 4 5
P.V. 1 0.909 0.826 0.751 0.683 0.621

Solution
Year Project A Project B Project C
CF Cumulative CF Cumulative CF Cumulative
1 2,000 2,000 0 0 2,000 2,000
2 2,000 4,000 2,000 2,000 2,000 4,000
3 6,000 10,000 4,000 6,000 6,000 10,000
4 - - 6,000 12,000 10,000 20,000

(a) Payback period of Project A = 3 years

Payback period of Project B = 2 years
Payback period of Project C = 3 years

(b) Project B is the only acceptable project if cut-of period is 2 years.

(c) Statement of NPV

Year PVF Project A Project B Project C
@10% CF PV CF PV CF PV
0 1 (10,000) (10,000) (2,000) (2,000) (10,000) (10,000)

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1 0.909 2,000 1,818 - - 2,000 1,818

2 0.826 2,000 1,652 2,000 1,652 2,000 1,652
3 0.751 6,000 4,506 4,000 3,004 6,000 4,506
4 0.683 - - 6,000 4,098 10,000 6,830
NPV (2,024) 6,754 4,806
Project B and C have positive NPVs.

(d) Payback period doesn’t give weightage to the cash flows after the cut off date so the
statement given is false.

(e) The statement given is true. Payback period ignores all cash flows after the cut off date which
means that future cash flows are not considered. Thus, payback period is biased towards
short-term projects.

NOV – 2018 – 10 Marks

PD Ltd. an existing company, is planning to introduce a new product with projected life of 8 years.
Project cost will be `2,40,00,000. At the end of 8 years no residual value will be realized. Working
capital of `30,00,000 will be needed. The 100% capacity of the project is 2,00,000 units p.a. but
the Production and Sales Volume is expected are as under:
Year Number of Units
1 60,000 units
2 80,000 units
3–5 1,40,000 units
6–8 1,20,000 units
Other information:
(i) Selling price per unit `200
(ii) Variable cost is 40% of sales
(iii) Fixed cost p.a. `30,00,000
(iv) In addition to this advertisement expenditure will have to be incurred as under:
Year 1 2 3–5 6-8
Expenditure (`) 50,00,000 25,00,000 10,00,000 5,00,000
(v) Income tax is 25%
(vi) Straight line method of depreciation is permissible for tax purpose
(vii) Cost of capital is 10%
(viii) Assume that loss cannot be carried forward.
Present Value Table
Year 1 2 3 4 5 6 7 8
PVF @ 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

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Solution Statement of NPV

Particulars Time PVF Amount Present Value
Cost of equipment 0 1 2,40,00,000 2,40,00,000
Working capital 0 1 30,00,000 30,00,000
PVCO 2,70,00,000

Incremental Cash flows (w.n.-1) 1 0.909 (8,00,000) (7,27,200)

2 0.826 38,25,000 31,59,450
3-5 2.055 1,03,50,000 2,12,69,250
6-8 1.544 89,25,000 1,37,80,200
Working capital realization 8 0.467 30,00,000 14,01,000
PVCI 3,88,82,700
NPV (PVCI – PVCO) 1,18,82,700
It is recommended to accept the project in view of positive NPV.

Working Note – 1
Year 1 2 3-5 6-8
Sales (units) 60,000 80,000 1,40,000 1,20,000
Contribution @ `120 p.u. 72,00,000 96,00,000 1,68,00,000 1,44,00,000
Fixed Cost 30,00,000 30,00,000 30,00,000 30,00,000
Advertisement 50,00,000 25,00,000 10,00,000 5,00,000
PBD (A) (8,00,000) 41,00,000 1,28,00,000 1,09,00,000
Depreciation 30,00,000 30,00,000 30,00,000 30,00,000
PBT (38,00,000) 11,00,000 98,00,000 79,00,000
Tax @ 25% (B) - 2,75,000 24,50,000 19,75,000
Cash Inflow (A - B) (8,00,000) 38,25,000 1,03,50,000 89,25,000

MAY – 2018 – 10 Marks

A company is evaluating a project that requires initial investment of `60 lakhs in fixed assets and
`12 lakhs towards additional working capital.

The project is expected to increase annual real cash inflow before taxes by `24,00,000 during its
life. The fixed assets would have zero residual value at the end of life of 5 years. The company
follows straight line method of depreciation which is expected for tax purposes also. Inflation is
expected to be 6% per year. For evaluating similar projects, the company uses discounting rate of
12% in real terms. Company’s tax rate is 30%.

Advise whether the company should accept the project, by calculating NPV in real terms.
PVIF (12%, 5 years) PVIF (6%, 5 years)
Year 1 0.893 Year 1 0.943
Year 2 0.797 Year 2 0.890

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Year 3 0.712 Year 3 0.840

Year 4 0.636 Year 4 0.792
Year 5 0.567 Year 5 0.747
Solution Statement of NPV
Particulars Time PVF Amount Present Value
Cost of equipment 0 1 60,00,000 60,00,000
Working capital 0 1 12,00,000 12,00,000
PVCO 72,00,000

Cash flows (w.n.-1) 1-5 3.605 24,60,000 73,54,200

Working capital realization 5 0.567 12,00,000 6,80,400
PVCI 80,34,600
NPV (PVCI – PVCO) 8,34,600
It is recommended to accept the project in view of positive NPV.

Working Note – 1
Year 1
PBD (A) 24,00,000
Depreciation (60,00,000 ÷ 5) 12,00,000
PBT 12,00,000
Tax @ 30% (B) 3,60,000
Cash Inflow (A - B) 20,40,000

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Risk Analysis in Capital

budgeting
PAST YEAR QUESTIONS

MAY – 2023 – 5 Marks

A company wants to invest in a project. This requires an initial investment of `4,50,000. Salvage
value after estimated useful life of 5 years is `50,000. Other details of project are as follows:
Worst case Most likely Best case
Contribution (`) 3,30,000 5,40,000 6,31,250
Fixed cost (excluding depreciation) (`) 75,000 1,50,000 2,00,000
Tax rate is 40%. Expected cost of capital of project is 12%. Ignore tax on capital gain.
(a) Calculate NPV in each scenario
(b) The company is certain about most likely result in first two years, but uncertain about
remaining period. In such a situation, calculate NPV expecting worst case scenario during next
two years and best case scenario in the remaining period.
Year 1 2 3 4 5
PVIF0.12,t 0.893 0.797 0.712 0.636 0.567
PVIFA0.12,t 0.893 1.690 2.402 3.038 3.605

Solution
(a) Calculation of Cash Flows in each scenario
Particulars Worst Case Most Likely Best Case
Contribution 3,30,000 5,40,000 6,31,250
Less: Fixed cost 75,000 1,50,000 2,00,000
Less: Depreciation 80,000 80,000 80,000
Profit before tax 1,75,000 3,10,000 3,51,250
Less: Taxes@40% 70,000 1,24,000 1,40,500
Profit after tax 1,05,000 1,86,000 2,10,750
Add: Depreciation 80,000 80,000 80,000
Cash flow after tax 1,85,000 2,66,000 2,90,750

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Statement of NPV
Year PVF Worst Case Most likely Best case
@12% CF PV CF PV CF PV
0 1 (4,50,000) (4,50,000) (4,50,000) (4,50,000) (4,50,000) (4,50,000)
1-5 3.605 1,85,000 6,66,925 2,66,000 9,58,930 2,90,750 10,48,154
5 0.567 50,000 28,350 50,000 28,350 50,000 28,350
NPV 2,45,275 5,37,280 6,26,504

(b) Statement of NPV

Years Scenario PVF CF PV
0 Initial 1 (4,50,000) (4,50,000)
1 Most likely 0.893 2,66,000 2,37,538
2 Most likely 0.797 2,66,000 2,12,002
3 Worst case 0.712 1,85,000 1,31,720
4 Worst case 0.636 1,85,000 1,17,660
5 Best case 0.567 2,90,750 1,64,855
5 Salvage 0.567 50,000 28,350
NPV 4,42,125

NOV – 2022 – 5 Marks

Determine the risk adjusted net present value of the following projects:
Particulars A B C
Net cash outlays (`) 70,000 1,20,000 2,20,000
Project life 5 years 5 years 5 years
Annual cash inflow (`) 30,000 42,000 70,000
Coefficient of variation 2.2 1.6 1.2
The company selects the risk-adjusted rate of discount on the basis of the coefficient of variation:
Coefficient of Variation Applicable risk-Adjusted PVIFA(I,5)
Discount (i)
0 10% 3.791
0.4 12% 3.605
0.8 14% 3.433
1.2 16% 3.274
1.6 18% 3.127
2 22% 2.864
>2.0 25% 2.689
Which project should be selected by the company based on Risk Adjusted NPV?

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Solution
Statement of Risk Adjusted NPV
Particulars A B C
Co-efficient of variation 2.2 1.6 1.2
Applicable discount rate (%) 25 18 16
Annual cash inflow (`) 30,000 42,000 70,000
PVIFA 2.689 3.127 3.275
PV of cash inflow (`) 80,670 1,31,334 2,29,180
Less: Cash outflow (`) 70,000 1,20,000 2,20,000
Risk adjusted NPV (`) 10,670 11,334 9,180
Project B should be selected as its risk adjusted NPV is high.

MAY – 2022 – 5 Marks

P Ltd. is considering a project with the following details:
Initial Project Cost `1,00,000
Annual Cash Inflow (`) 1 2 3 4
30,000 40,000 50,000 60,000
Project Life (Years) 4
Cost of Capital 10%
(i) Measure the sensitivity of the project to change in initial project cost and annual cash inflows
(considering each factor at a time) such that NPV become zero.
(ii) Identify which of the two factors; the project is most sensitive to affect the acceptability of
the project?
Year 1 2 3 4 5
PVIF0.10,t 0.909 0.826 0.751 0.683 0.621

Solution
Statement of NPV
Particulars Time PVF Amount Present Value
Investment 0 1 1,00,000 1,00,000
PVCO 1,00,000

Cash inflows 1 0.909 30,000 27,270

2 0.826 40,000 33,040
3 0.751 50,000 37,550
4 0.683 60,000 40,980
PVCI 1,38,840
NPV (PVCI – PVCO) 38,840
(i) Sensitivity Analysis with respect to Initial Project Cost:
NPV of the project will become zero when the initial project cost is increased by `38,840.

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6&,&1$
Thus, percentage change in initial project cost = ",$$,$$$ × 100 = 38.84%

Sensitivity Analysis with respect to Annual Cash Flows:

NPV of the project will become zero when the annual cash flow is
decreased by `38,840.
6&,&1$
Thus, percentage change in annual cash flows = ",6&,&1$ × 100 = 27.97%

(ii) Annual cash flows factor is the most sensitive factor as only a change beyond 27.97% in
annual cash flows will make the project unacceptable.

JULY – 2021 – 5 Marks

K.P. Ltd. is investing ` 50 lakhs in a project. The life of the project is 4 years. Risk free rate of
return is 6% and risk premium is 6%, other information is as under:
Sales of 1st year `50 lakhs
Sales of 2nd year `60 lakhs
Sales of 3rd year `70 lakhs
Sales of 4th year `80 lakhs
P/V Ratio (same in all the years) 50%
Fixed Cost (Excluding Depreciation) of 1st year `10 lakhs
Fixed Cost (Excluding Depreciation) of 2nd year `12 lakhs
Fixed Cost (Excluding Depreciation) of 3rd year `14 lakhs
Fixed Cost (Excluding Depreciation) of 4th year `16 lakhs
Ignoring interest and taxes,
You are required to calculate NPV of given project on the basis of Risk Adjusted Discount Rate.
Discount factor @ 6% and 12% are as under:
Year 1 2 3 4
Discount Factor @ 6% 0.943 0.890 0.840 0.792
Discount Factor@ 12% 0.893 0.797 0.712 0.636

Solution
When risk free rate is 6% and risk premium expected is 6%, then risk adjusted rate would
be 6% + 6% = 12%.
Statement of PVCI (` in Lakhs)
Particulars Year 1 Year 2 Year 3 Year 4
Sales 50 60 70 80
PV Ratio 50% 50% 50% 50%
Contribution 25 30 354 40
Less: Fixed cost 10 12 14 16
PBT or CFs 15 18 21 24
PVF @ 12% 0.893 0.797 0.712 0.636

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PVCI 13.395 14.346 14.952 15.264

Total PVCI (` in lakhs) = 13.395 + 14.346 + 14.952 + 15.264 = `57.957
NPV (` in lakhs) = PVCI – PVCO = 57.957 – 50 = `7.957

JAN – 2021 – 5 Marks

A project requires an initial outlay of `3,00,000.
The company uses certainty equivalent method approach to evaluate the project. The risk free rate
is 7%.
Following information is available:
Year CFAT (Cash Flow After CE (Certainty-equivalent
Tax) ` coefficient)
1 1,00,000 0.90
2 1,50,000 0.80
3 1,15,000 0.60
4 1,00,000 0.55
5 50,000 0.50
PV Factor at 7%
Year 1 2 3 4 5
PV Factor 0.935 0.873 0.816 0.763 0.713
Evaluate the above. Is investment in the project beneficial?

Solution
Statement of NPV
Year Expected Certainty- Adjusted PVF @ 7% PV
Cash Flow equivalent cash flow
0 (3,00,000) 1.00 (3,00,000) 1.000 (3,00,000)
1 1,00,000 0.90 90,000 0.935 84,150
2 1,50,000 0.80 1,20,000 0.873 1,04,760
3 1,15,000 0.60 69,000 0.816 56,304
4 1,00,000 0.55 55,000 0.763 41,965
5 50,000 0.50 25,000 0.713 17,815
NPV 5,004
As the NPV is positive, the project should be accepted.

NOV – 2020 – 10 Marks

A Ltd. is considering two mutually exclusive projects X and Y.
You have been given below the Net Cash flow probability distribution of each project:
Project X Project Y
Net Cash Flows Probability Net Cash Flow Probability
(` ) (` )
50,000 0.30 2,30,000 0.20

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60,000 0.30 1,10,000 0.30

70,000 0.40 90,000 0.50
(i) Compute the following:
(a) Expected Net Cash Flow of each project.
(b) Variance of each project.
(c) Standard Deviation of each project
(d) Coefficient of Variation of each project.
(ii) Identify which project do you recommend? Give reason.

Solution
Project X
Net Cash Prob. Expected (X – M)2 P × (X – M)2
Flow (X) (P) Value (X × P)
50,000 0.30 15,000 12,10,00,000 3,63,00,000
60,000 0.30 18,000 10,00,000 3,00,000
70,000 0.40 28,000 8,10,00,000 3,24,00,000
61,000 6,90,00,000

Project Y
Net Cash Prob. (P) Expected (Y – M)2 P × (Y – M)2
Flow (Y) Value (P ×
Y)
2,30,000 0.20 46,000 11,23,60,00,000 2,24,72,00,000
1,10,000 0.30 33,000 19,60,00,000 5,88,00,000
90,000 0.50 45,000 1,15,60,00,000 57,80,00,000
1,24,000 2,88,40,00,000

Particulars Project X Project Y

(a) Expected Net Cash Flow `61,000 `1,24,000
(b) Variance `6,90,00,000 `2,88,40,00,000
(c) Standard Deviation √6,90,00,000 = `8,307 √2,88,40,00,000 = `53,703
(d) Coefficient of Variation &,6$5 46,5$6
%",$$$
× 100 = 13.62% × 100 = 43.31%
",/1,$$$

(ii) Project X is recommended to be accepted as it has lower variance, standard deviation and
coefficient of variation.

NOV – 2019 – 5 Marks

Door Ltd. is considering an investment of `4,00,000. This investment is expected to generate
substantial cash inflows over the next five years. Unfortunately, the annual cash flows from this
investment is uncertain, but the following probability distribution has been established.

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Annual cash flows (`) Probability

50,000 0.30
1,00,000 0.30
1,50,000 0.40
At the end of its 5 years life, the investment is expected to have a residual value of `40,000. The
cost of capital is 5%.
(a) Calculate NPV under the three different scenarios.
(b) Calculate expected net present value
(c) Advise Door Ltd. on whether the investment is to be undertaken.
Year 1 2 3 4 5
DF @ 5% 0.952 0.907 0.864 0.823 0.784

Solution
(a) Calculation of NPV under three different scenarios
Particulars 1st Scenario 2nd Scenario 3rd Scenario
Annual Cash inflow 50,000 1,00,000 1,50,000
PVAF @ 5% 4.33 4.33 4.33
PV of cash inflow 2,16,500 4,33,000 6,49,500
PV of residual value 31,360 31,360 31,360
(40,000 × 0.784)
Total PV of cash inflow 2,47,860 4,64,360 6,80,360
(-) Initial investment 4,00,000 4,00,000 4,00,000
NPV (1,52,140) 64,360 2,80,360

(b) Calculation of expected NPV under three different scenarios

Expected annual cash inflow = (50,000 × 0.30) + (1,00,000 × 0.30) + (1,50,000 × 0.40)
= `1,05,000

Expected NPV = PV of cash inflows – PV of cash outflows

= (1,05,000 × 4.33) + (40,000 × 0.784) – 4,00,000
= `86,010

(c) Since the expected NPV of the investment is positive, the investment should be undertaken.

MAY – 2019 – 5 Marks

Kanoria Enterprises wishes to evaluate two mutually exclusive projects X and Y. The particulars
are as under:
Project X (`) Project Y (`)
Initial investment 1,20,000 1,20,000
Estimated cash inflows (per annum for 8 years)

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Pessimistic 26,000 12,000

Most Likely 28,000 28,000
Optimistic 36,000 52,000
The cut off rate is 14%. The discount factor at 14% are:
Year 1 2 3 4 5 6 7 8 9
Discount factor 0.88 0.77 0.68 0.592 0.519 0.456 0.4 0.351 0.308
Advise management about the acceptability of projects X and Y.

Solution
Statement of calculation of NPV of Project X
Cash Inflows PVAF @ PVCI PVCO NPV
(` ) 14%
Pessimistic 26,000 4.639 1,20,614 1,20,000 614
Most Likely 28,000 4.639 1,29,892 1,20,000 9,892
Optimistic 36,000 4.639 1,67,004 1,20,000 47,004

Statement of calculation of NPV of Project Y

Cash Inflows PVAF @ PVCI PVCO NPV
(` ) 14%
Pessimistic 12,000 4.639 55,668 1,20,000 -64,332
Most Likely 28,000 4.639 1,29,892 1,20,000 9,892
Optimistic 52,000 4.639 2,41,228 1,20,000 1,21,228

In pessimistic situation project X will be better as it gives low but positive NPV whereas Project
Y yield highly negative NPV under this situation. In most likely situation both the project will give
same result. However, in optimistic situation Project Y will be better as it will give very high NPV.
So, project X is a risk less project as it gives positive NPV in all the situation whereas Y is a risky
project as it will result into negative NPV in pessimistic situation and highly positive NPV in
optimistic situation. So, acceptability of project will largely depend on the risk taking capacity
(Risk seeking/ Risk aversion) of the management.

NOV – 2018 – 5 Marks

From the following details relating to a project, analyze the sensitivity of the project to changes
in the Initial Project Cost, Annual Cash Inflow and Cost of Capital:
Particulars
Initial Project Cost `2,00,00,000
Annual Cash Inflow `60,00,000
Project Life 5 years
Cost of Capital 10%
To which of the 3 factors, the project is most sensitive if the variable is adversely affected by 10?
Cumulative Present Value Factor for 5 years for 10% is 3.791 and for 11% is 3.696.

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Solution
Calculation of NPV
Particulars Amount in `
Annual cash inflows 60,00,000
PVAF @10% for 5 years 3.791
PV of annual cash inflows 2,27,46,000
Less: Initial Project Cost (2,00,00,000)
NPV 27,46,000
If initial project cost is varied adversely by 10%
PV of annual cash inflows 2,27,46,000
Less: Initial project cost (2,00,00,000 × 110%) (2,20,00,000)
NPV 7,46,000
/5,1%,$$$,5,1%,$$$ 72.83%
Change in NPV ( /5,1%,$$$
× 100)
If annual cash inflow is varied adversely by 10%
Revised annual cash inflows (60,00,000 × 90%) 54,00,000
PVAF @10% for 5 years 3.791
PV of annual cash inflows 2,04,71,400
Less: Initial Project Cost (2,00,00,000)
NPV 4,71,400
/5,1%,$$$,1,5",1$$ 82.83%
Change in NPV ( /5,1%,$$$
× 100)
If cost of capital is varied adversely by 10%
Annual cash inflow 60,00,000
PVAF @ 11% for 5 years 3.696
PV of annual cash inflows 2,21,76,000
Less: Initial project cost (2,00,00,000)
NPV 21,76,000
/5,1%,$$$,/",5%,$$$ 20.76%
Change in NPV ( /5,1%,$$$
× 100)

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Dividend Decisions
PAST YEAR QUESTIONS

MAY – 2023 – 5 Marks

Following information are given for a company:
Earnings per share `10
PE Ratio 12.5
Rate of return on investment 12%
Market price per share as per Walter’s Model `130
You are required to calculate:
(a) Dividend payout ratio
(b) Market price of share at optimum dividend payout ratio
(c) PE Ratio at which the dividend policy will have no effect on the price of share
(d) Market price of share at this PE ratio
(e) Market price of share using Dividend growth model

Solution
" "
(a) Cost of equity = Ke = #K DZ-=B = "/.4 = 0.08 = 8%
Rate of return on investment = r = 12%
As per Walter model,
2
!'( )(K,!)
34
P0 =
g8
*.)(
!'( )("$,!)
*.*6
130 = $.$&
10.40 = D + 15 – (1.5)(D)
D = 9.20
! 2./$
Thus, dividend payout ratio = K#L × 100 = "$
× 100 = 92%

(b) Since, return (12%) is more than cost of equity (8%), thus optimal dividend payout ratio
should be zero as per Walter model.
2 *.)(
!'( )(K,!) $'( )("$,$)
34 *.*6
Price at optimum dividend ratio = g8
= $.$&
= `187.50

(c) When Ke is equal to rate of return then dividend will have no effect on value of share.
Thus, r = Ke = 12%
" "
PE ratio = g8 = $."/ = 8.33 times

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2 *.)(
!'( )(K,!) 2./$'( )("$,2./$)
34 *.)(
(d) Market price = g8
= $."/
= `83.33

(e) Ke = 8% r = 12% D0 = 9.20 b = 0.08

g = (b)(r) = (0.08)(0.12) = 0.0096
!" 2./$("'$.$$2%)
P = g8,N = ($."/,$.$$2%)
= `131.936

DECEMBER – 2021 – 5 Marks

X Ltd. is a multinational company. Current market price per share is `2,185. During the FY 2020-
21, the company paid `140 as dividend per share. The company is expected to grow @12% p.a.
for next four years, then 5% p.a. for an indefinite period. Expected rate of return of shareholders is
18% p.a.
(i) Find out intrinsic value per share.
(ii) State whether shares are overpriced or underpriced.
Year 1 2 3 4 5
Discounting factor @18% 0.847 0.718 0.608 0.515 0.436

Solution
Year Particulars Amount PVF @ 16% Present Value
1 Dividend 140 × (1+0.12) = 156.80 0.847 132.81
2 Dividend 156.8 × (1+0.12) = 175.62 0.718 126.10
3 Dividend 175.62 × (1+0.12) = 196.69 0.608 119.59
4 Dividend 196.69 (1+0.12) = 220.29 0.515 113.45
Total 491.95
!4 //$./2("'.$.$4)
Price at end of 4th year, P4 = g8,N = $."&,$.$4
= `1,779.27

Intrinsic value of equity share = `491.95 + (`1,779.26 × 0.515) = `1,408.27

Intrinsic value (`1,408.27) is higher as compared to market price (`2,185), thus, the share is over-
priced by `776.73.

JULY – 2021 – 10 Marks

The following information relates to LMN Ltd.
Earning of the company ` 30,00,000
Dividend pay-out ratio 60%
No. of shares outstanding 5,00,000
Rate of return on investment 15%
Equity capitalized rate 13%
Required:
(a) Determine what would be the market value per share as per Walter's model.

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(b) Compute optimum dividend pay-out ratio according to Walter's model and the market value
of company's share at that pay-out ratio.

Solution
!'(K,!)(7÷g8)
(a) As per Walter Model, P = g8
Where,
P = Market price per share
E = Earnings per share = `30,00,000 ÷ 5,00,000 = `6
D = Dividend per share = `6 60% = `3.60
r = Return earned on investment = 15% = 0.15
Ke = Cost of equity capital = 13% = 0.13

6.%$'(%,6.%)($."4÷$."6)
⸫P= $."6
= `49

(b) According to Walter’s Model, when the reurn on investment ® is more than the cost of equity
capital (Ke), the price per share increases as the dividend pay-out ratio decreases. Hence, the
optimum dividend pay-out ratio in this case is nil.
$'(%,$)($."4÷$."6)
Price at nil pay-out ratio = $."6
= `53.25

JAN – 2021 – 5 Marks

The following information is taken from ABC Ltd.
Net profit for the year `30,00,000
12% Preference share capital `1,00,00,000
Equity share capital (Share of `10 each) `60,00,000
Internal rate of return on investment 22%
Cost of equity capital 18%
Retention ratio 75%
Calculate the market price of the share using:
(1) Gordon’s Model
(2) Walter’s Model

Solution
Earning available for equity = Net Profit – Preference Dividend
= 30,00,000 – (1,00,00,000 × 12%) = `18,00,000
KZ7:=:N Z>Z=[ZT[8 9B7 KdU=-c "&,$$,$$$
Earnings per share = FB. B9 KdU=-c LYZ78M
= (%$,$$,$$$÷"$) = `3
Dividend payout ratio = 100 – 75% = 25%
Dividend per share = EPS × Dividend payout ratio = 3 × 25% = `0.75
Rate of return (r) = 22% = 0.22
Cost of equity (Ke) = 18% = 0.18

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K(",T) 6×(",$.54) $.54

(1) As per Gordon’s Formula, P = g8,(T×7) = $."&,($.54×$.//) = $.$"4 = `50

!'(K,!)(7÷g8) $.54'(6,$.54)($.//÷$."&)
(2) As per Walter Model, P = g8
= $."&
= `19.44

NOV – 2020 – 5 Marks

The following figures are extracted from the annual report of RJ Ltd.:
Net Profit `50 Lakhs
Outstanding 13% preference shares `200 Lakhs
No. of Equity shares 6 Lakhs
Return on Investment 25%
Cost of Capital (Ke) 15%
You are required to compute the approximate dividend pay-out ratio by keeping the share price at
`40 by using Walter’s Model.

Solution
Earning available for equity = Net Profit – Preference Dividend
= 50 lakhs – (200 lakhs × 13%) = `24 Lakhs
KZ7:=:N Z>Z=[ZT[8 9B7 KdU=-c /1,$$,$$$
Earnings per share = FB. B9 KdU=-c LYZ78M
= %,$$,$$$
= `4
!'(K,!)(7÷g8)
As per Walter Model, P = g8
Where,
P = Market price per share = `40
E = Earnings per share = `4
D = Dividend per share
r = Return earned on investment = 25% = 0.25
Ke = Cost of equity capital = 15% = 0.15
!'(1,!)($./4÷$."4)
⸫P= $."4
!'(1,!)(".%%%5)
40 = $."4
6 = D + 6.667 - (1.667)D
0.667D = 0.6667
D = `1
!=>=?8:? a87 MYZ78 "
Required dividend pay-out ratio = KZ7:=:N a87 MYZ78
× 100 = 1 × 100 = 25%

NOV – 2019 – 5 Marks

Following figures and information were extracted from the company A Ltd.
Earnings of the company `10,00,000
Dividend paid `6,00,000
No. of shares outstanding 2,00,000
Price Earnings Ratio 10

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Rate of return on investment 20%

You are required to calculate:
(a) Current market price of the share
(b) Capitalization rate of its risk class
(c) What should be the optimum pay-out ratio
(d) What should be the market price per share at optimal pay-out ratio? (Use Walter’s Model)

Solution
!'(K,!)(7÷g8)
(a) As per Walter Model, P = g8
Where,
P = Market price per share
E = Earnings per share = `10,00,000 ÷ 2,00,000 = `5
D = Dividend per share = `6,00,000 ÷ 2,00,000 = `3
r = Return earned on investment = 20% = 0.20
" "
Ke = Cost of equity capital = #K DZ-=B = "$ = 0.10

6'(4,6)($./$÷$."$) 5
⸫P= $."$
= $."$ = `70

(b) Capitalization rate of risk class = Ke = 10%

(c) According to Walter’s model when the return on investment (20%) is more than the cost of
equity capital (10%), the price per share increases as the dividend pay-out ratio decreases.
Hence, the optimum dividend pay-out ratio in this case is zero.

$'(4,$)($./$×$."$) "$
(d) At a zero payout ratio, market price per share = $."$
= $."$ = `100

MAY – 2019 – 5 Marks

The following information is supplied to you:
Total Earning `40 lakhs
No. of equity shares (of `100 each) 4,00,000
Dividend per share `4
Cost of capital 16%
Internal rate of return on investment 20%
Retention ratio 60%
Calculate the market price of a share of a company by using:
(a) Walter’s Formula
(b) Gordon’s Formula

Solution

102
CA SUNIL KESWANI PYQs of FM

1$ [ZfYM
Earning per share (E) = 1,$$,$$$
= `10
!'(K,!)(7÷g8) 1'("$,1)($./$÷$."%) "".4
(a) As per Walter’s Formula, P = g8
= $."%
= $."% = `71.88
K(",T) "$(",$.%$) 1
(b) As per Gordon’s Formula, P = g8,(T×7) = $."%,($.%$×$./$) = $.$1 = `100

NOV – 2018 – 5 Marks

Following information relating to Jee Ltd. are given:
Particulars
Profit after tax `10,00,000
Dividend payout ratio 50%
Number of equity shares 50,000
Cost of equity 10%
Rate of return on investment 12%
(a) What would be the market value per share as per Walter’s Model?
(b) What is the optimum dividend payout ratio according to Walter’s Model and Market value of
equity share at that payout ratio?

Solution
!'(K,!)(7÷g8)
(a) As per Walter Model, P =
g8
Where,
P = Market price per share
E = Earnings per share = `10,00,000 ÷ 50,000 = `20
D = Dividend per share = 50% × 20 = `10
r = Return earned on investment = 12% = 0.12
Ke = Cost of equity capital = 10% = 0.10

"$'(/$,"$)($."/÷$."$) //
⸫P= $."$
= $."$ = `220

(b) According to Walter’s model when the return on investment is more than the cost of equity
capital, the price per share increases as the dividend pay-out ratio decreases. Hence, the
optimum dividend pay-out ratio in this case is Nil. So, at a payout ratio of zero, the market
value of the company’s share will be:
$'(/$,$)($."/÷$."$) /1
P= $."$
= $."$ = `240

103