Answer – 1
Introduction
Every business requires funds to run smoothly and on a daily basis. Companies require funds
for long-term investments such as the launch of new products, the improvement of existing
products, aggressive product positioning and marketing, expansion, restructuring, acquisition,
modernisation, contingency requirements, and the replacement of long-term assets, in addition
to current business operations.
Companies are always looking for new ways to fund their expansion. The act of contributing
resources to finance a programme, project, or need is known as funding. Short-term or long-
term funding can be initiated.
Companies are constantly looking for new sources of funding to help them grow. The act of
contributing resources to finance a programme, project, or need is referred to as funding.
Funding can be started for either short-term or long-term goals. Among the various funding
sources are:
Retained earnings
Preference stock
Common stock
Bonds and debentures
I am using Reliance Industries Limited of Financial Year 2021-22. Its sources of funds
are as follows:
Reliance Industries Limited is an Indian multinational conglomerate based in Mumbai. Among
its diverse businesses are energy, petrochemicals, natural gas, retail, telecommunications, mass
media, and textiles. Reliance is one of India's most profitable companies, as well as its largest
publicly traded company by market capitalisation and revenue. It is also one of India's largest
employers, with over 236,000 employees globally. RIL's market capitalisation in 2022 is
US$270 billion (INR 23 trillion), its revenue is $99 billion, its net profit is $8.5 billion, and its
total assets are $229 billion. Reliance Industries expects to earn $150 billion in revenue, with
$27 billion in operating income and $15 billion in net profit. here are its some sources of funds:
1. Common stock
A common stock is a type of stock that most people invest in because it represents a portion
of a company's ownership. Common stock carries voting rights as well as the potential for
dividends and capital appreciation. In accounting, the balance sheet contains information
about a company's common stock.
Simply put, each share of common stock represents a portion of a company's ownership. If
a company performs well or the value of its assets rises, the value of its common stock may
rise. A common stock, on the other hand, can lose value if a company performs poorly.
Common stock allows investors to share in a company's long-term success, making it an
excellent long-term investment.
The amount of equity issued is Rs. 6,766 crores, of which Rs. 6,765 crore is paid.
2. Preferred stock
Preferred stock, also known as preference stock, are shares of a company's stock that
receive preference over, or are ranked higher than, common equity or ordinary shareholders
when it comes to dividend payments. Furthermore, if a company goes bankrupt, preferred
stockholders are paid before ordinary shareholders. In other words, preferred stock has
preferential rights over ordinary shareholders.
Preferred stock can have features similar to debt, such as fixed rate dividends and a
redemption date. The International Financial Reporting Standards (IFRS) require
companies to report preferred stock with debt characteristics as debt on the balance sheet
and to treat any associated dividends as interest on the income statement.
There are no preferential stocks in Reliance Industries Limited.
3. Bonds and Debentures
Every organisation requires funding for both its initial formation and ongoing survival.
These funds can be established by issuing debt or equity securities. Debt is preferred by
most organisations because it does not require the use of personal funds and can be used
for leverage. Debentures and bonds are two of the most common types of debt financing.
Bonds, though the terms are used interchangeably, are essentially loans secured by a
specific physical asset. A debenture is a corporate debt security that is not secured by assets
but rather by the organization's credit rating. This instrument is preferred by both
governments and private organizations.
Reliance Industries has Rs. 7,626 crores in non-convertible debt and Rs. 13,719 crores in
current maturity, totaling Rs. 21,345 crores.
4. Retained earnings
Retained earnings reveal information about a company's financial performance. Revenue
is an important part of the income statement. It reveals the company's "top line," or the
sales made during the period. Retained earnings are the total of a company's net income
and net losses over all of its years of operation. Retained earnings are a component of
stockholders' equity on the balance sheet.
Reliance Industries Limited's net profit for fiscal year 2021-22 is Rs. 2,47,951 crores.
The companies' retained earnings (Rs. 2,47,951 crore) are very high when compared to other
sources of funds, which total Rs. 28,111 crores. Bonds and debentures are worth Rs. 21,345
crores, while common stocks are worth Rs. 6,766 crores.
Retailed Earnings > Bonds and Debentures > Common stock > Preference Stock
Conclusion
Each of these funding sources comes at a cost. Each capital component's cost can be calculated.
Determining the cost of a specific source of capital is critical for all businesses because it allows
them to identify low-cost funding sources. Because each fund source has a different risk and
time period, each fund source will have a different cost.
Because different sources of funds carry different risks, investors demand different rates of
return on different securities, resulting in a different cost of capital for the firm.
Answer – 2
Introduction
Capital budgeting is defined as the process of determining whether or not to invest in capital
assets. Capital assets make up a small percentage of a company's total assets, but they are
typically long-term investments such as new equipment, facilities, and software upgrades.
Companies can more effectively determine and prioritise which projects, programmes, and
other investment assets will be most financially beneficial in the long run by incorporating
strategically planned capital budgeting into their financial processes. Because these assets
frequently only generate tangible returns in the long run, it is critical that practising finance
professionals understand the five primary methods of capital budgeting and how they can be
used to determine the best course of action when firms are planning their next significant capital
investment.
Methods of Capital Budgeting
Payback Period
The payback period is the amount of time it takes to recover the initial investment in an
investment. It is the number of years required to recoup a project's initial investment. As a
result, the payback period would be used as a tool in capital budgeting to compare projects and
calculate the time in years required to recoup the initial investment. The project is usually
chosen with the fewest number of years.
Formula for payback period:
Payback Period = Initial Payment / Cash flow Per Year
Net Present Value (NPV)
An investment's Net Present Value (NPV) is the sum of all future cash flows (positive and
negative) discounted to the present. The net present value (NPV) analysis is a type of intrinsic
valuation that is commonly used in finance and accounting to determine the value of a company,
investment security, capital project, new venture, cost-cutting programme, or anything else that
involves cash flow.
The net present value (NPV) analysis is used to determine the value of an investment, project,
or series of cash flows. It is a comprehensive metric because it includes in its Free Cash Flow
all revenues, expenses, and capital costs associated with an investment (FCF).
It takes into account not only all revenues and costs, but also the timing of each cash flow,
which can have a significant impact on an investment's present value. It is preferable, for
example, to see cash inflows earlier and cash outflows later than the opposite.
Formula for NPV
NPV = {CI1 /(1+K)1 + CI2 /(1+K)2 + …. + CIt /(1+K) t} – C0
Where,
CIt is the cash flow at a time t,
C0 is the initial investment and k is the cost of capital/rate of interest.
Internal Rate of Return (IRR)
The Internal Rate of Return (IRR) is the discount rate that causes a project's net present value
(NPV) to be zero. In other words, it is the anticipated compound annual rate of return on a
project or investment.
The expected cash flows for a project or investment are given when calculating IRR, and the
NPV is zero. In other words, the initial cash investment for the initial period will be equal to
the present value of the investment's future cash flows. (Because the cost paid equals the
present value of future cash flows, the net present value equals zero.
Once calculated, the internal rate of return is typically compared to a company's hurdle rate or
cost of capital. If the IRR exceeds or equals the cost of capital, the company will consider the
project a good investment. (Of course, this assumes that this is the only basis for the decision.)
Formula for IRR
C0 = {CI1 /(1+r)1 + CI2 /(1+r)2 + ….. + CIt /(1+r) t +}
Here, IRR = r (required rate of return or the discount rate)
Given details
Rate of Interest 5%
Year A B
0 -40,000 -50,000
1 5,000 8,500
2 12,000 15,000
3 10,000 12,000
4 12,500 12,300
5 10,500 10,500
PB Method
Option A
Initial Payment: 40,000
Cash flow of 4 years: 5000 + 12000 + 10000 + 12500 = 39500
Remaining balance = 500 which accounts to 0.05 years
Hence, Payback period for option A is 4.05 years.
Option B
Initial Payment = 50,000
Cash flow of 4 years: 8500 + 15000 + 12000 + 12300 = 47800
Remaining balance = 2200 which accounts to 0.21 years
Hence, Payback period for option B is 4.21 years.
NPV method
Option A
= {5000/1+0.051 + 12000/1+0.052 + 10000/1+0.053 + 12000/1+0.054 + 10500/1+0.055} -40000
= 2795.44
Option B
= {8500/1+0.051 + 15000/1+0.052 + 12000/1+0.053 + 12300/1+0.054 + 10500/1+0.055} -50000
= 413
IRR method
Option A
40000 = {5000/1+0.051 + 12000/1+0.052 + 10000/1+0.053 + 12000/1+0.054 + 10500/1+0.055}
= 7.291
Option B
50000 = {8500/1+0.051 + 15000/1+0.052 + 12000/1+0.053 + 12300/1+0.054 + 10500/1+0.055}
= 5.295
Conclusion
As the company's CFO, I would choose Option A because it has a higher NPV and IRR than
Option A. Option A is therefore more profitable and has a higher return on investment than
Option B. Option B has a slightly longer pay-back period than option A, but the difference is
insignificant, and pay-back period is not a reliable criterion for investment decisions.
Answer – 3 (a)
Introduction to Compound Interest
Compound interest is interest charged on a loan or deposit. It is the most commonly used
concept in our everyday lives. The compound interest for an amount is determined by both the
principal and the interest earned over time. This is the primary distinction between compound
and simple interest.
A) Invest Rs. 3 lacs for 5 years earn an interest of 8% compounded quarterly.
Given details are:
P = 3,00,000
R=8%
T = 5 years
A = P (1+R/400)4t
Where,
A = Fixed Amount
P = Principal Amount
R = Rate of Interest
n = No. of time interest is compounding
t = No. of years money is invested for
= 300000 (1 + 8/400)4x5
= 300000 (408/400)20i
= 300000 (1.02)20
A = 445784.21
CI = A-P
CI = 145784.21
B) Investment of Rs. 20,000 per year for 5 years @ 10% compounded quarterly.
For 1st year:
A1 = 20000 (1+10/400)4n
= 20000 (1.025)4
= 20000 * 1.10381289
A1 = 22076.25
For 2nd year: P = 20000 + A1 = 42076.25
A2 = 42076.25 * 1.10381289
A2 = 46,444.31
For 3rd Year: P = 20000 + A2 = 66444.31
A3 = 66444.31 * 1.10381289
A3 = 73342.09
For 4th Year: P = 20000 + A3 = 93342.09
A4 = 93342.09 * 1.10381289
A4 = 103032.20
For 5th Year: P = 20000 + A4 = 123032.20
A5 = 123032.20 * 1.10381289
A5 = 135804.53
CI = A-P
CI = 15804.53
Sunil should choose the initial investment for 3 lacs with 8% quarterly compounding
over the other option because the power of works better with an initial deposit rather
than installments.
Answer – 3 (b)
Introduction to yield
The term "yield" refers to the profits generated and realised on an investment over a specific
time period. It is expressed as a percentage of the invested amount, current market value, or
face value of the security.
The yield includes the interest or dividends received from holding a specific security. Yields
can be classified as known or anticipated based on the security's valuation (fixed vs.
fluctuating).
Yield is a measure of the cash flow received by an investor on the amount invested in a security.
It is mostly calculated on an annual basis, though quarterly and monthly yields are also used.
Total return, a more comprehensive measure of return on investment, should not be confused
with yield. It is calculated as:
Yield = Net Realised Return/Principal Amount
A) When market price is Rs. 98.20
Given Details are:
Debenture par value Rs. 100 @ 6%
Market price: 98.20
Debenture Yield = (6 / 98.20) *100
= 6.11%
B) When Market Price is Rs. 102
Given Details are:
Debenture par value Rs. 100 @ 6%
Market price: 98.20
Debenture Yield = (6 / 102) *100
= 5.88%
Depicts inverse relationship between Market price and yield. When Yield increases
price declines and vice versa.
i
Amount Rs. 408 comes after taking LCM
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