INDIAN INSTITUTE OF TECHNOLOGY

Date 19.09.2015 AN , Time : 2 Hrs ., Full Marks : 60

Department:Rajendra Mishra School of Engineering Entrepreneurship
No. of Students : 26 , Mid-Autumn Semester Examination
Subject No. : EP60005 Subject Name: Financial and Legal Aspects of Business

Instruction: Answer all questions in the question paper itself. Ask for working sheets, if needed.
Give necessary assumptions, if any.

I. State whether each of the following statements is True (T) or False (F). Each question carries
25% negative marks. (8x1 = 8 marks)

a) Commercial banks are important users of financial ratios and measures during the development and
start-up stages of ventures.
b) Distant cash flows are riskier than near-term cash flows. Therefore long-term projects require
higher risk-adjusted discount rates
c) Financial risk of a firm depends upon composition of capital structure
d) Variation in expected return from an investment is known as risk.
e) EBIT is also known as operating profit.
f) Every source of fund has an explicit cost of capital.
g) The risk-free interest rate is the interest rate on debt that is virtually free of inflation risk.
h) There is no need to defer a positive NPV proposal.

II. Tick the correct option for questions below. Each question carries 25% negative marks.
(32x1= 32 marks)
1. Which of the following is not a purpose of the statement of cash flows?
a. To show cash flow from operations.
b. To show cash flow from financing activities.
c. To show cash flow from investing activities.
d. To show all investing and financing transactions.
e. To show operating expenses for a period of time.

2. Which of the following is not a typical cash flow under financing activities?
a. cash inflow from sale of equity securities
b. cash inflow from sale of bonds
c. cash outflow for payment of dividends
d. cash outflow for loans to other entities
e. cash outflow for payment of amounts borrowed

3. Amortization of patents can be added to income in the operations section of the statement of cash
flows because:
a. it is not a tax deductible expense
b. it results in a cash inflow
c. it does not require the outlay of cash
d. patent amortization is not an expense
e. it represents an inflow of cash

4. T.Ltd. had sales of Rs. 30,000, increase in accounts payable of Rs. 5,000, decrease in accounts
receivable of Rs. 1,000, increase in inventories of Rs. 4,000, and depreciation expense of Rs. 4,000.
What was the cash collected from customers?
a. Rs. 31,000 b. Rs. 35,000
c. Rs. 35,000 d. Rs. 35,000

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5. Which of the following is not true for capital budgeting or Investment Decision?
(a) Sunk costs are ignored, (b) Opportunity costs are excluded,
(c)Incremental cash flows are considered, (d) Relevant cash flows are considered.

6. Which of the following is not a capital budgeting or investment decision?

(a) Expansion Programme, (b) Merger, (c) Replacement of an Asset,(d) Inventory Level.

7. If the closing balance of receivables is less than the opening balance for a month then
which one is true out of
(a)Collections>Current Purchases, (b)Collections>CurrentSales,
(c)Collections<Current Purchases, (d) Collections < Current Sales

8. Cost of capital may be defined as:

(a)Weighted Average cost of all debts,
(b) Rate of Return expected by Equity Shareholders,
(c) Average IRR of the Projects of the firm,
(d)Minimum Rate of Return that the firm should earn.

9. Inventory Turnover measures the relationship of inventory with:

(a) Average Sales, (b)Cost of Goods Sold, (c)Total Purchases, (d) Total Assets

10. There is deterioration in the management of working capital of XYZ Ltd. What does it
refer to?
(a)That the Capital Employed has reduced, (b)That the Profitability has gone up,
(c)That debtors collection period has increased, (d)That Sales has decreased

11. XYZ Ltd. has earned 8% Return on Total Assets of Rs. 50, 00,000 and has a Net Profit
Ratio of 5%. Find out the Sales of the firm.
(a) Rs. 4,00,000, (b)Rs. 2,50,000, (c)Rs. 80,00,000, (d)Rs. 83,33,333.

12. XYZ Ltd. has a Debt Equity Ratio of 1.5 as compared to 1.3 Industry average. It means
that the firm has:
(a) Higher Liquidity, (b)Higher Financial Risk,
(c)Higher Profitability, (d)Higher Capital Employed.

13. A business has prepared its accounts for a financial year and these show a profit of
Rs.500 000. Theaccounts do not include the following items:
 a likely loss on a contract of Rs.25 000
 a possible Court ruling in favour of the company which is likely to increase profits by
Rs.10 000
 a possible Court ruling against the company which could result in damages of between
Rs.5 000 toRs.15 000.
Having regard to the fundamental accounting concepts, which of the following revised profit
figures is correct when the above factors are taken in to account?
(a) Rs.480 000. (b) Rs.460 000. (c) Rs.510 000. (d) Rs.475 000.

14. The following figures relate to the rent and rates payable expense for a business in 2014.
Rs.000
Rent paid in advance at 1 January 2014 5
Rates in arrears at 1 January 2014 2
Payments in 2014 35
Rates paid in advance at 31 December 2014 4
Rent in arrears at 31 December 2014 6

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Which is the correct figure for rent and rates expense in the profit and loss account for the
year ended 31 December 2014?
(a) Rs.34 000. (b) Rs.35 000. (c) Rs.36 000 (d) Rs.40 000

15. XYZ Ltd has declared an ordinary share dividend of Rs.200 000 at 31.12.2014.Which of
the following correctly explains the accounting entries for the dividend at the year end?
(a) Expense in profit and loss account, creditor on the balance sheet.
(b) Appropriation of profit, reserve on the balance sheet.
(c) Appropriation of profit, current liability on the balance sheet.
(d) Expense in profit and loss account, reserve on the balance sheet.

The following data was extracted from the records of XYZ Ltd at 31 December 2014 and is
to be used for Questions 16 and 17.
Rs.000
Sales 2500
Cost of sales 1200
Stock at 31 December 2014 350
Stock at 1 January 20014 300
Debtors 340
Creditors 400

16. The debtors collection period in days was?

(a) 43. (b) 45. (c) 50. (d) 58.

17. The rate of stock turnover was?

(a) 3.5 times. (b) 3.7 times. (c) 6.3 times. (d) 7.7 times.

18. The following balances were extracted from the records of XYZ Ltd:
2013 2014
Rs.000 Rs.000
Sales 3000 4000
Gross profit 600 720
Gross profit percentage 20% 18%
Which of the following is the most likely reason for the fall in the gross profit percentage
despite the increase in sales in 2014?
(a) An increase in selling prices.
(b) A decrease in the costs of purchasing raw materials for the business.
(c) Offering higher discounts to customers to secure extra sales.
(d) An increase in wages and salaries.

19. Which of the following is not considered to be an appropriate form of finance for capital
investment projects?
(a) An issue of share capital. (b) A bank overdraft.
(c) The issue of a debenture. (d) Leasing.

20. Which of the following is true?

(a) Higher the Beta, lower the risk, (b)Higher the Beta, higher the risk,
(c)Risk is constant, (d)Beta is constant.

21. If a company's required rate of return is 10% and, in using the net present value method,
a project's net present value is zero, this indicates that the
a) project's rate of return exceeds 10%.
b) project's rate of return is less than the minimum rate required.
c) project earns a rate of return of 10%.
d) project earns a rate of return of 0%.

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22. BG Ltd. is considering a bid to take over SM Ltd. Should the takeover occur, BG Ltd.
would benefit from SM Ltd’s before-tax operating cash flows of:
i) Rs. 500,000 per year for the first three years,
ii) Rs. 700,000 per year from the fourth year into perpetuity, and
iii) Rs. 225,000 per year of synergistic savings before taxes in perpetuity starting from the
first year. Assume that the cash flows occur at the end of each year, the tax rate is 40% for
both companies, and BG Ltd’s after-tax required rate of return is 13%. What is the
maximum amount that BG Ltd. should be willing to pay to take over SM Ltd. (rounded to
the nearest thousand Rupees)?
a) Rs. 4,978,000 b) Rs. 2,947,000 c) Rs. 1,909,000 d) Rs. 3,986,000

The following information pertains to questions 23 to 25.

ABC Manufacturing has the following results:

(in ’000s) Year 7 Year 6

Current assets Rs.15,640 Rs.14,825
Long-term investments 3,500 3,500
Property, plant and equipment 8,500 8,300
Goodwill 1,000 1,000
Other non-current assets 5,330 5,025
Rs.33,970 Rs. 32,650

Current liabilities Rs. 10,355 Rs.10,200

Long-term debt 5,500 5,550
Other non-current liabilities 4,365 4,150
Preferred stock 2,500 2,500
Common stock 7,500 7,500
Retained earnings 3,750 2,750
Rs.33,970 Rs.32,650

Sales Rs.24,200 Rs.20,500

Cost of sales 11,250 9,400
Gross profit 12,950 11,100
Operating expenses 8,250 7,250
Operating income 4,700 3,850
Other income/expenses (net) 425 600
Earnings before interest and tax 5,125 4,450
Interest expense 330 333
Income tax expense 1,438 1,235
Net Income Rs. 3,357 Rs. 2,882

23. What is ABC’s times interest earned for Year 7?

a) 15.53 b) 10.17 c) 14.24 d) 13.36

24. What is ABC’s return on total assets for Year 7?

a) 22.04% b) 15.39% c) 8.65% d) 10.08%

25. Based on the Year 7 current ratio, ABC has

a) bettered its use of assets. b) greater liquidity.
c) improved profitability. d) higher inventory turnover.

26. Prior to recording the December 31, Year 5, year-end adjusting entries for a small
business, revenues exceed expenses by Rs. 50,000. The following information was known at

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December 31, Year 5:
 Services amounting to Rs. 8,000 had been performed by the business but not yet been
billed or recorded,
 An advertising campaign is scheduled to run from January 1 to June 30, Year 6. The Rs.
6,000 costs for the campaign were paid for and expensed on November 30, Year 5,
 Amortization of capital assets for Year 5 of which Rs. 7,000 has not yet been recorded,
 The December, Year 5, bank reconciliation shows that the bank recorded interest expense
of Rs. 2,000 on December 31, Year 5, but was not recorded by the company until January
10, Year 6.
Assuming the company prepares financial statements only at year-end, what is its
accounting income before taxes for Year 5?
a) Rs. 49,000 b) Rs. 55,000 c) Rs. 37,000 d) Rs. 62,000

27. A measure of asset utilization is

a. sales divided by working capital b. return on total assets
c. return on equity capital d. operating profit divided by sales e. none of the above

28. XYZ Ltd. wants to increase its current ratio from the present level of 1.5 when it closes
the books next week. The action of __________ will have the desired effect.
a. payment of current payables from cash
b. sales of current marketable securities for cash
c. write down of impaired assets
d. delay of next payroll
e. none of the above

29. The level of real income of a firm can be distorted by the reporting of depreciation and
interest expense. During periods of high inflation, the level of reported depreciation tends to
__________ income, and the level of interest expense reported tends to _________ income.
a. understate, overstate b. understate, understate c. overstate, understate
d. overstate, overstate e.There is no discernable pattern.

30. ______ is a measure of what the firm would have earned if it didn't have any obligations
to creditors or tax authorities.
a. Net Sales b. Operating Income c. Net Income
d. Non-operating Income e. Earnings Before Interest and Taxes

31. To create a common size income statement ____________ all items on the income
statement by ____________.
a. multiply; net income b. multiply; total revenue c. divide; net income
d. divide; total revenue e. multiply; COGS

32. Common size financial statements make it easier to compare firms ____________.
a. of different sizes b. in different industries
c. with different degree of leverage d. none of the above

III.Which of the following should be treated as incremental cash flows when

decidingwhether to invest in a new manufacturing plant? The site is already owned by the
company,but existing buildings would need to be demolished. (There can be multiple
answers) (3 marks)
a. Demolition costs and site clearance.
b. The cost of a new access road put in last year.
c. Lost earnings on other products due to executive time spent on the new facility.
d. Future depreciation of the new plant.

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e. The initial investment in inventories of raw materials.
f. Money already spent on engineering design of the new plant.

IV. The Income statement and other selected data for P.G. Ltd. are shown below.

P. G. Ltd.
Accrual Basis Income Statement
For the Year Ended December 31, 2014

Net sales Rs.900,000

Expenses
Cost of goods sold 550,000
Selling and administrative expense 133,000
Total expenses Rs.683,000
Income before income taxes 217,000
Income taxes 65,400
Net income Rs.151,600

Other data:
a. Cost of goods sold includes depreciation expense of Rs. 20,000.
b. Selling and administrative expense includes goodwill amortization of Rs. 10,000.
c. Decrease in deferred income taxes (a liability account), Rs. 5,000.
d. Increase in accounts receivable, Rs. 20,000.
e. Increase in accounts payable, Rs. 10,000.
f. Increase in inventories, Rs. 30,000.
g. Decrease in income taxes payable, Rs. 20,000.
Prepare the cash flows from operating activities using the indirect approach. ( 7 marks)

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V. What are the different types of IP and how are they useful for a company? Give examples
of how companies have used IP to make successful products.
( 4+3 = 7 marks)

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VI. What is the TOC way of managing an organisation? (3 marks)