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FINANCIAL MANAGEMENT SUGGESTIONS
Cost of Capital
1. Indrani Ltd. Has the following Capital Structure:
Rs. (in Lakhs)
Equity share capital (10 Lakh shares) 100
12% Preference share Capital(10,000 shares) 10
Retained earnings 120
14% debentures(70,000 Debentures) 70
14% term loan 100
----------------
400
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The market price per equity share is Rs. 25. The next expected dividend per share is Rs. 2 and is
expected to grow at 8%. The preference shares are redeemable after 7 years at par and are currently
quoted as Rs. 75 per share. The Debentures are redeemableafter 6 years at parand their current
market quotation is Rs. 90 per debenture. The tax rate applicable to this firm is 50%.
You are required to compute weighted Average Cost of Capital of the Company using a)book value
b) market value as weights.
2. X Ltd. Requires additional finance of Rs. 20 lakh for meeting the investment plans. It has Rs.
4 lakh in the form of retained earnings available for investment purposes. The following are
the further details:
a. debt-equity mix 40:60
b. cost of debt: up toRs. 4,00,000, 10 %(before tax)
Beyond Rs. 4,00,000 12%(before tax)
c. earnings per share, Rs.5
d. dividend pay-out, 60% of earnings
e. expected growth rate in dividend, 5%
f. current market price per share RS. 35
g. tax rate 35%
Compute the overall weighted average after tax cost of additional finance.
3. The capital structure of a company is given below:
Equity share capital (5,000 shares of Rs. 100 each) Rs. 5,00,000
10% preference share capital (2,000 shares of Rs.100 each) Rs. 2,00,000
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12% debentures RS. 3,00,000
Rs. 10,00,000
Its operating profit is Rs. 2,90,000. The market price of each equity share is Rs. 250 and of each
preference share is Rs.125.
Find the cost of each source of capital assuming
a) Corporate tax to be 30% and
b) Corporate dividend tax to be 10%
Leverage
1. The capital structure of Moon Ltd. is given below:
Rs.
(Lakhs)
Equity share capital (Rs. 10 each per share) 10.00
Retained earnings 6.00
10% preference share capital 4.00
-----------------------
20.00
----------------------
The firm has planned to undertake an expansion scheme of Rs. 10,00,000 which can be
financed (a)entirely by issue of equity shares of Rs. 10 each; (b) by issue of 12% debentures
of . 100 each at par.as a result of expansion, sales and operating fixed cost will increase by
60% and 75% respectively. The other relevant informations are given below:
Sales Rs. 50,00,000
Variable cost 60%
Operating fixed cost 5,00,000
Corporate tax 40%
Calculate leverages and EPS before and after expansion and give your opinion for taking appropriate
decision with respect to financing.
2. MalanchaPlast Ltd. provides you the following information:
Capital Gearing Ratio 3
Fixed Cost : 1/3rd of the total operating cost
Dividend yield 6%
Operating Ratio 75%
Ratio of 18% preference Shares to 15% debentures 12.5%
Dividend Payment Ratio 30%
Accumulated Reserves 4,00,000
Capital Employed 24,00,000
Market Price of an Equity Share of Rs.10 135
Tax rate: 40%
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Prepare an Income Statement and calculate the degree of operating leverage, financial
leverage and combined leverage.
3. Zica Ltd. provides you the following information:
Capital structure; 12% debenture Rs. 2,00,000; 9% preference Share CapitalRs. 3,00,000 and
4,000 equity share of Rs. 100 each.
Revenue operating cost details : sales 3,000 units @ Rs. 600 p.u.; Variable operating cost p.u.
Rs.350; Fixed operating cost Rs. 3,20,000.
Corporate Income tax rate and Dividend Distribution Tax rate may be assumed at 30% and
10% respectively.
Calculate DOL, DFL and DCL of Zica Ltd. using the concept of leverage, find the percentage
change in EPS when sales increases by 10%.
Capital Structure Theories
1. A company provides you with the following information:
Capital structure:
10,000 equity shares of Rs. each 1,00,000
Debenture
EBIT 2,00,000
Tax Rate 50%
Change in EBIT (+-)20%
Show the effect of proposed change in EBIT on EPS and comment on it.
2. One-third of total market value of Vishnu limited consists of loan stock, which has a cost of
10%. Another company ,Shiva Ltd. is identical in every respect to Vishnu Ltd., except that its
capital structure is all – equity , and its cost of equity is 16%. According to Modigliani and
Miller, if we ignored taxation and tax relief on debt capital, what would be the cost of equity
of Vishnu Limited?
3. KFC Ltd. is an all equity finance company with a market value of RS. 25,00,000 and cost of
equity, K€ = 21%.the company wants to buy-back Equity Shares worth RS. 5,00,000 by
issuing and raising 15% Perpetual Debt of the same amount. Rate of tax may be taken as
30%. After the re-structuring and applying MM Model (with taxes, you are required to
calculate-
a. Market value of KFC Ltd.
b. Cost of equity K(e)
c. Weighted average cost of capital and comment on it.
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4. There are two firms U and L having same NOI of Rs. 20,000. Firm L is a levered firm having
Debt of Rs. 1,00,000 @ 7% and cost of equity of U and L are 10% and 18% respectively. Show
how arbitrage process will work in this case.
Working Capital Management
1. The production of Quick Profit Ltd. is 5,20,000 units p.a. Due to power crisis , the company
can operate at 80% of the capacity level. You are asked to ascertain the working capital
requirement at the current level of operation. Add 10% to your computed figure, to allow
for contingencies.
Other information’s:
a) Selling price RS. 20 per unit
b) Elements of cost per unit (% of selling price): raw material- 40%,labour –
30%,Budgeted Overhead – RS. 32,000 per week(overhead includes a
depreciation of Rs. 8,000 per week)
c) Planned stock will include 24,000 units of finished goods.
d) Time lag information: Raw material in stock – 3 weeks ;material will stay in
process – 2 weeks, credit allowed to debtors – 5 weeks ; credit allowed to
creditors – 1 month; lag in payment of wages of OH – ½ month. 25% of
sales may be consideredto be for cash.
Assume that production is carried on evenly throughout the year and wages
and overhead accrue similarly.
A time period of 52 weeks is equivalent to a year and a month comprises 4
weeks.
2. From the following data compute the money block period of working capital:
(RS. in ‘000)
Stock : Raw material 20
W.I.P 14
Finished goods 21
Purchases 96
Cost of goods sold 140
Sales 160
Debtors 32
Creditors 16
1 year = 360 days
3. Mr. Roy wants to start a new trading business and gives the following information:
a) The projected annual sales – RS.60,00,000
b) He has estimated fixed expenses Rs. 10,000 per month and variable expenses equal to
two per cent of turnover.
c) % of gross profit on cost of purchase will be 25%.
d) Average expected credit period allowed to debtors – 1 month.
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e) Average expected credit period from suppliers – 15 days.
f) He expected to turnover his stock 5 times in a year.
g) Average cash holding – 1 month’s expenses.
you are required to forecast his working capital requirement.
4. A manufacturing company has a capacity to produce 60,000 units p.a. The cost structure at
that capacity and selling price p.u. are given below :
Material Rs. 5
Labour Rs. 2
Overhead Rs. 5 (60% variable; of the fixed overhead
-------- Rs. 30,000 represents depriciation)
RS. 12
Profit Rs. 3
---------
Selling price Rs. 15
The other details are-
. Raw material storage period – 2 months; processing time -1 month and finished goods in
store – 1 month.
. Debtors and creditors turnover are 6 and 12 times in a year respectively.
.lag in payment of overhead is ½ month.
Assuming that the company will be able to utilize 80% of its capacity.
Capital Expenditure Decisions
1. From the following information of MAK Ltd. calculate Pay Back Period
a) Purchase price of new machinery – Rs. 10,00,000
b) Installation expenses – Rs. 1,50,000
c) Workers training expenses incurred to put the assets to use – Rs. 50,000
d) Subsidy from government 60% of purchase price
e) Working capital Rs. 3,00,000
f) Useful life of the machine – 5 years
g) Book salvage value – 10% of purchase price
h) Cash salvage value- 1,20,000
i) Method of depreciation – straight line
j) Tax rate – 30%
k) Sales unit 1,00,00 unit p.a.
Initial selling price per unit is Rs.10 and variable cost is 40% of initial selling price
annual fixed cost other than depreciation is Rs. 2,00,000.
2. Beta company is considering the purchase of one of the following machines, relevant data
given below:
Machine A Machine B
Original cost Rs. 1,00,000 Rs. 1,00,000
Estimated life 3 years 3 years
Earnings (after tax): RS. Rs.
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Year 1 30,000 20,000
Year 2 50,000 80,000
Year 3 40,000 40,000
The firm follows the straight line method of depreciation, estimated salvage value of both
the machine is zero. Determine the ARR of both the machines.
3. A company has to select one of the two alternative projects whose particulars are given
below :
Initial Net cash flow (Rs.)
Outlay (Rs.) Y1 Y2 Y3 Y4
Project | 11.872 10,000 2,000 1,000 1,000
Project || 10,067 1,000 1,000 2,000 10,000
The company can arrange the fund at 8%.compute the NPV and IRR of each project and
comment on the result.
The present value of Rs. 1 at different cost of capital is given below:
Year 8% 10% 12% 14%
1 0.926 0.909 0.893 0.877
2 0.857 0.826 0.797 0.770
3 0.794 0.751 0.712 0.675
4 0.735 0.683 0.636 0.592
4. X Ltd. has been producing a chemical product by using machine Z for the last 2 years. Now,
the management of the company is thinking to replace this machine either by X or by Y
machine. The following details are furnished to you:
Z X Y
Book value (RS.) 1,00,000 _ _
Resale value now (RS) 1,10,000 _ _
Purchase price (RS.) _ 1,80,000 2,15,000
Annual fixed costs( including depreciation) (RS.) 92,000 1,08,000 1,32,000
Variable running cost (including labour) per unit (RS.) 3 1.50 2.50
Production per hour (unit) 8 8 12
You are also provided the following additional information :
Selling price per unit Rs.20
Cost of materials per unit Rs.10
Annual operating hours 2,000
Working life of each of the 3 machines (as from now) – 5 years
Salvage value of machines – Z Rs. 10,000,XRs. 15,000 and Y Rs. 33,000.
The company charges depreciation using straight line method. It is anticipated that an
additional cost of Rs.8,000 p.a. would be incurred on special advertising to sale the extra
output of machine Y.
Assume tax rate of 50% and cost of capital 10%.
The present value of RS.1 to be received at the end of each year at 10% is as under:
Year 1 2 3 4 5
Present value 0.909 0.826 0.751 0.683 0.621
Using NPV method, analyse the feasibility of the proposal and make recommendations.
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5. An enterprise can make either of the two investments at the beginning of 2016. Assuming a
required rate of return at 10% p.a., evaluate the investments proposals under each one of
the following criteria :
a) Return on investments
b) Discounted Payback Period and
c) Profitability Index
The forecasted figures are given :
Investment Cost of Estimated Scrap
proposals investment life value
year Rs. 2016 2017 2018 2019 2020
Rs. Rs Rs. Rs. Rs
P Rs. 40,000 4 NIL 1,000 4,000 7,000 5,000 -
Q Rs. 56,000 5 NIL NIL 6,800 6,800 6,800 6,800
It is estimated that each of the alternative projects would require an additional working capital of Rs.
4,000 which would be received back in full after the expiry of each project. Depreciation is provided
under straight line method.
Dividend Decisions
1. From the following data calculate the value of an equity share of each of the following 3
companies according to Walter’s Model when dividend pay-out ratio is
(a) Nil, (b) 25% and (c) 75%
Companies M.Ltd. L.Ltd. N. Ltd.
Internal rate of return ® 15% 12% 10%
Cost of capital (k) 12% 12% 12%
Earnings per share (E) Rs.10 Rs.10 Rs.10
What conclusion would you draw from the observation?
2. The following information are available from Essar Co. Ltd.
Net earnings – Rs.1,00,000; equity capital- 5,000 shares of Rs.10 each, cost of capital – 10%,
expected rate of return (a) 9%; (b) 10%and (c)12%.
Assuming the dividend ratios are (a) 0%; (b) 60%; and(c) 100% respectively, determine the
effect of different dividend pay-outs on the share price of Essar Co. Ltd. for each of the above
mentioned 3 alternatives levels of return using Gordons Model.
3. A company belongs to a risk class for which the appropriate capitalisation rate I s10%. It
currently has outstanding 25,000 shares selling at Rs.100 each. The firm is contemplating the
declaration of dividend of Rs.5 per share at the end of current financial year. The company
expects to have a new income of Rs.2.5 lakhs and has proposal for making new investment
of Rs.5 lakh.
Answer the following questions based on M-M model (assume there is no tax):
a) What will be the price per share at the end of the year if dividend is paid ?
b) What will be the price per share at the end of the year if dividend is not paid?
c) How many new shares are to be issued?
d) Determine the value of the firm considering (a) and (b) as stated above.
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