Super 30

CA Amit Sharma

Q.1 Prepare B/S RTP Nov 22

The following information of ASD Ltd. relate to the year ended 31st March, 2022:

Net profit 8% of sales

Raw materials consumed 20% of Cost of Goods Sold
Direct wages 10% of Cost of Goods Sold
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of Cost of Goods Sold
Gross Profit 15% of Sales
Debt collection period 2 Months
(All sales are on credit)
Current ratio 2:1
Fixed assets to Current assets 13 : 11
Fixed assets to sales 1:3
Long-term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4
You are required to PREPARE-
(a) Profit & Loss Statement of ASD Limited for the year ended 31st March, 2022 in the following format.
Particulars (`) Particulars (`)
To Direct Materials consumed ? By Sales ?
To Direct Wages ?
To Works (Overhead) ?
To Gross Profit c/d ?
? ?
To Selling and Distribution Expenses ? By Gross Profit b/d ?
To Net Profit ?
? ?
(b) Balance Sheet as on 31st March, 2022 in the following format.
Liabilities (`) Assets (`)
Share Capital ? Fixed Assets 1,30,00,000
Reserves and Surplus ? Current Assets:
Long term loans ? Stock of Raw Material ?
Current liabilities ? Stock of Finished Goods ?
Debtors ?
Cash ?
? ?

Ans. Working Notes:

(i) Calculation of Sales
Fixed Assets 1
=
Sales 3

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1,30,00,00 0 1
= ⇒ Sales = ` 3,90,00,000
Sales 3

(ii) Calculation of Current Assets

Fixed Assets 13
=
Current Assets 11
1,30,00,00 0 13
= ⇒ Current Assets = ` 1,10,00,000
Current Assets 11

(iii) Calculation of Raw Material Consumption and Direct Wages

`
Sales 3,90,00,000
Less: Gross Profit (15 % of Sales) 58,50,000
Cost of Goods sold 3,31,50,000
Raw Material Consumption (20% of Cost of Goods Sold) ` 66,30,000
Direct Wages (10% of Cost of Goods Sold)` 33,15,000

(iv) Calculation of Stock of Raw Materials (= 3 months usage)

3
= 66,30,000 x = ` 16,57,500
12

(v) Calculation of Stock of Finished Goods (= 6% of Cost of Goods Sold)

6
= 3,31,50,000 x = ` 19,89,000
100

(vi) Calculation of Current Liabilities

Current Assets
= 2
Current Liabilities
1,10,00,00 0
=2 ⇒ Current Liabilities = ` 55,00,000
Current Liabilities

(vii) Calculation of Debtors

Debtors
Average collection period = × 12 months
Credit Sales
Debtors
× 12 = 2 ⇒Debtors = ` 65,00,000
3,90,00,00 0

(viii) Calculation of Long-term Loan

Long term Loan 2
=
Current Liabilitie s 1
Long term Loan 2
= ⇒Long term loan = ` 1,10,00,000
55,00,000 1

(ix) Calculation of Cash Balance

`
Current assets 1,10,00,000

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Less: Debtors 65,00,000

Raw materials stock 16,57,500
Finished goods stock 19,89,000 1,01,46,500
Cash balance 8,53,500

(x) Calculation of Net worth

Fixed Assets 1,30,00,000
Current Assets 1,10,00,000
Total Assets 2,40,00,000
Less: Long term Loan 1,10,00,000
Current Liabilities 55,00,000 1,65,00,000
Net worth 75,00,000

Net worth = Share capital + Reserves = ` 75,00,000

Capital 1 1
= ⇒Share Capital = ` 75,00,000 × = ` 15,00,000
Reserves and Surplus 4 5
Reserves and Surplus = ` 75,00,000 × 5 = ` 60,00,000

Profit and Loss Statement of ASD Ltd.

for the year ended 31st March, 2022
Particulars (`) Particulars (`)
To Direct Materials 66,30,000 By Sales 3,90,00,000
consumed
To Direct Wages 33,15,000
To Works (Overhead) 2,32,05,000
(Bal. fig.)
To Gross Profit c/d 58,50,000
(15% of Sales)
3,90,00,000 3,90,00,000
To Selling and Distribution 27,30,000 By Gross Profit b/d 58,50,000
Expenses (Bal. fig.)

To Net Profit (8% of Sales) 31,20,000

58,50,000 58,50,000

Balance Sheet of ASD Ltd.

as at 31st March, 2022
Liabilities (`) Assets (`)
Share Capital 15,00,000 Fixed Assets 1,30,00,000
Reserves and Surplus 60,00,000 Current Assets:
Long term loans 1,10,00,000 Stock of Raw Material 16,57,500
Current liabilities 55,00,000 Stock of Finished Goods 19,89,000
Debtors 65,00,000
Cash 8,53,500
2,40,00,000 2,40,00,000

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Q.2 All Ratios ICAI MAT

Following is the abridged Balance Sheet of Alpha Ltd.:

Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Profit and Loss Account 17,000 Plant and Machineries 50,000
Current Liabilities 40,000 Less: Depreciation 15,000 35,000
1,15,000
Stock 21,000
Receivables 20,000
Bank 1,000 42,000
Total 1,57,000 Total 1,57,000

With the help of the additional information furnished below, you are required to

PREPARE Trading and Profit & Loss Account and Balance Sheet as at 31st March, 2023:

(i) The company went in for re-organisation of capital structure, with share capital remaining the same
as follows:
Share capital 50%
Other Shareholders’ funds 15%
5% Debentures 10%
Current Liabilities 25%
Debentures were issued on 1st April, interest being paid annually on 31 st March.
(ii) Land and Buildings remained unchanged. Additional plant and machinery has been bought and a further `
5,000 depreciation was written off.
(The total fixed assets then constituted 60% of total fixed and current assets.)
(iii) Working capital ratio was 8 : 5.
(iv) Quick assets ratio was 1 : 1.
(v) The receivables (four-fifth of the quick assets) to sales ratio revealed a credit period of 2 months. There
were no cash sales.
(vi) Return on net worth was 10%.
(vii) Gross profit was at the rate of 15% of selling price. (viii) Stock turnover was eight times for the year.
Ignore Taxation.
Ans.

Particulars % (` )
Share capital (given to be same) 50% 1,00,000
Other shareholders funds 15% 30,000
5% Debentures 10% 20,000
Current Liabilities 25% 50,000
Total (1,00,000 / 50%) 100% 2,00,000

Calculation of Assets
Total liabilities = Total Assets
` 2,00,000 = Total Assets

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Fixed Assets = 60% of total fixed assets and current assets

= ` ` 1,20,000
Current Assets = Total Assets – Fixed Assets
= ` 2,00,000 – ` 1,20,000 = ` 80,000

Calculation of additions to Plant & Machinery

`
Total fixed assets 1,20,000
Less: Land & Buildings 80,000
Plant and Machinery (after providing depreciation) 40,000
Less: Existing Plant & Machinery (after extra 30,000
depreciation of ₹ 5,000) i.e. 50,000 – 20,000
Addition to the Plant & Machinery 10,000

Calculation of stock
Currentassets  stock
Quick ratio: = =1
Current liabilities

`80, 000  stock

= =1
50, 000
` 50,000 = ` 80,000 – Stock
Stock = ` 80,000 - ` 50,000
= ` 30,000

Receivables = 4/5th of quick assets

= (` 80,000 – ` 30,000) x 4/5
= ` 40,000
Receivables
Receivables turnover = × 12Months = 2 months
Credit Sales
40, 000  12
= = 2 months
Credit Sales
2×credit sales = 4,80,000
Credit sales = 4,80,000/2
= ` 2,40,000 = Total Sales (As there were no cash sales)
Gross profit = 15% of sales = ` 2,40,000 x 15/100 = ` 36,000

Return on net worth (net profit)

Net worth = ` 1,00,000 + ` 30,000
= ` 1,30,000
Net profit = ` 1,30,000 x 10/100 = ` 13,000
Debenture interest = ` 20,000 x 5/100 = ` 1,000

Projected profit and loss account for the year ended 31st March, 2023
Particulars ` Particulars `
To cost of goods sold 2,04,000 By sales 2,40,000
To gross profit 36,000

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2,40,000 2,40,000
To debenture interest 1,000 By gross profit 36,000
To administration 22,000
and other expenses
(bal. fig.)
To net profit 13,000
36,000 36,000

Projected Balance Sheet as at 31st March, 2023

Liabilities ` Assets `
Share capital 1,00,000 Fixed assets:
Profit and loss A/c 30,000 Land & buildings 80,000
(17,000+13,000) Plant & machinery 60,000
5% Debentures 20,000 Less: Depreciation 20,000 40,000
Current liabilities 50,000 Current assets
Stock 30,000
Receivables 40,000
Bank 10,000
80,000
2,00,000 2,00,000

Q.3
% change in EPS / PL / FL / CL PY Dec 21
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 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%.

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CA Amit Sharma

Ans. (i) Working Notes

Earning after tax (EAT) is 5% of sales
Income tax is 50%
So, EBT is 10% of Sales
Since Interest Expenses is ` 30,000
EBIT = 10% of Sales + `30,000 ……………………………. (Equation i)
Now Degree of operating leverage = 4
Contribution
So, =4
EBIT
Or, Contribution = 4 EBIT
Or, Sales – Variable Cost = 4 EBIT
Or, Sales – ` 6,00,000 = 4 EBIT ……………………………… (Equation ii)
Replacing the value of EBIT of equation (i) in Equation (ii)
We get, Sales – ` 6,00,000 = 4 (10% of Sales + ` 30,000)
Or, Sales – ` 6,00,000 = 40% of Sales + ` 1,20,000
Or, 60% of Sales = ` 7,20,000
7,20,000
So, Sales = =` 12,00,000
60%
Contribution = Sales – Variable Cost = ` 12,00,000 – ` 6,00,000 =` 6,00,000
6, 00, 000
EBIT = = ` 1,50,000
4
Fixed Cost = Contribution – EBIT = ` 6,00,000 – ` 1,50,000 = ` 4,50,000
EBT = EBIT – Interest = ` 1,50,000 – ` 30,000 = ` 1,20,000
EAT = 50% of ` 1,20,000 = ` 60,000

Income Statement
Particulars (`)
Sales 12,00,000
Less: Variable cost 6,00,000
Contribution 6,00,000
Less: Fixed cost 4,50,000
EBIT 1,50,000
Less: Interest 30,000
EBT 1,20,000
Less: Tax (50%) 60,000
EAT 60,000

EBIT 1, 50, 000

(ii) Financial Leverage = = = 1.25 times
EBT 1,20, 000
Combined Leverage = Operating Leverage × Financial Leverage
= 4 x 1.25 = 5 times
Or,
Contribution EBIT
Combined Leverage = x
EBIT EBT

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Contribution 6, 00, 000

Combined Leverage = = = 5 times
EBIT 1,20, 000
(iii) Percentage Change in Earnings per share
% Change in EPS % Change in EPS
Combined Leverage = =
% change in Sales 5%
% Change in EPS = 25%
Hence, if sales increased by 5 %, EPS will be increased by 25 %.

Q.4 PL Statement RTP May 22

Company P and Q are having same earnings before tax. However, t he margin of safety of Company P is 0.20 and,
for Company Q, is 1.25 times than that of Company P. The interest expense of Company P is ` 1,50,000 and, for
Company Q, is 1/3rd less than that of Company P. Further, the financial leverage of Company P is 4 and, for
Company Q, is 75% of Company P.

Other information is given as below:

Particulars Company P Company Q

Profit volume ratio 25% 33.33%
Tax rate 45% 45%

You are required to PREPARE Income Statement for both the companies.

Ans. Income Statement

Particulars Company P (`) Company Q (`)
Sales 40,00,000 18,00,000
Less: Variable Cost 30,00,000 12,00,000
Contribution 10,00,000 6,00,000
Less: Fixed Cost 8,00,000 4,50,000
EBIT 2,00,000 1,50,000
Less: Interest 1,50,000 1,00,000
EBT 50,000 50,000
Tax (45%) 22,500 22,500
EAT 27,500 27,500

Workings:
(i) Margin of Safety
For Company P = 0.20
For Company Q = 0.20 x 1.25 = 0.25
(ii) Interest Expenses
For Company P = ` 1,50,000
For Company Q = ` 1,50,000 (1-1/3) = ` 1,00,000
(iii) Financial Leverage
For Company P = 4
For Company Q = 4 x 75% = 3
(iv) EBIT
For Company A
Financial Leverage = EBIT/(EBIT- Interest)
4 = EBIT/(EBIT- ` 1,50,000)

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4EBIT – ` 6,00,000 = EBIT

3EBIT = ` 6,00,000
EBIT = ` 2,00,000
For Company B
Financial Leverage = EBIT/(EBIT - Interest)
3 = EBIT/(EBIT – ` 1,00,000)
3EBIT – ` 3,00,000 = EBIT
2EBIT EBIT = ` 3,00,000
Contribution = ` 1,50,000

(v) For Company A

Operating Leverage
= 1/Margin of Safety
Operating Leverage = 1/0.20 = 5
5 = Contribution/EBIT
Contribution = Contribution/` 2,00,000

For Company B = ` 10,00,000

Operating Leverage
= 1/Margin of Safety
Operating Leverage = 1/0.25 = 4
4 = Contribution/EBIT
Contribution = Contribution/` 1,50,000
Sales = ` 6,00,000

(vi) For Company A

Profit Volume Ratio = 25%
Profit Volume Ratio
25% = ` 10,00,000/Sales
Sales = ` 10,00,000/25%
Sales = ` 40,00,000
For Company B
Profit Volume Ratio = 33.33%
Therefore, Sales = ` 6,00,000/33.33%
Sales = ` 18,00,000

Q.5 ROI / EPS / OL / FL / CL RTP Nov 18

The following summarises the percentage changes in operating income, percentage changes in revenues, and
betas for four listed firms.
Firm Change in revenue Change in operating income Beta
A Ltd. 35% 22% 1.00
B Ltd. 24% 35% 1.65
C Ltd. 29% 26% 1.15
D Ltd. 32% 30% 1.20

Required:
(i) CALCULATE the degree of operating leverage for each of these firms. Comment also.
(ii) Use the operating leverage to EXPLAIN why these firms have different beta.

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%Change in Operating income

Ans. (i) Degree of operating leverage =
%Change in Revenues
A Ltd. = 0.22 / 0.35 = 0.63
B Ltd. = 0.35 / 0.24 = 1.46
C Ltd. = 0.26 / 0.29 = 0.90
D Ltd. = 0.30 / 0.32 = 0.94
It is level specific.
(ii) High operating leverage leads to high beta. So when operating leverage is lowest i.e.
0.63, Beta is minimum (1) and when operating leverage is maximum i.e. 1.46, beta is highest i.e. 1.65

Q.6 ROI / EPS / OL / FL / CL RTP Nov 18

A firm has sales of ` 75,00,000 variable cost is 56% and fixed cost is` 6,00,000. It has a debt of ` 45,00,000
at 9% and equity of ` 55,00,000. You are required to INTERPRET:
(i) The firm’s ROI?
(ii) Does it have favourable financial leverage?
(iii) If the firm belongs to an industry whose capital turnover is 3, does it have a high or low capital turnover?
(iv) The operating, financial and combined leverages of the firm?
(v) If the sales is increased by 10% by what percentage EBIT will increase?
(vi) At what level of sales the EBT of the firm will be equal to zero?
(vii) If EBIT increases by 20%, by what percentage EBT will increase?

Ans. Income Statement

Particulars Amount (`)
Sales 75,00,000
Less: Variable cost (56% of 75,00,000) (42,00,000)
Contribution 33,00,000
Less: Fixed costs (6,00,000)
Earnings before interest and tax (EBIT) 27,00,000
Less: Interest on debt (@ 9% on ` 45 lakhs) (4,05,000)
Earnings before tax (EBT) 22,95,000

EBIT EBIT
(i) ROI = ×100 = ×100
Capital employed Equity  Debt
27, 00, 000
= ×100 = 27%
55, 00, 000  45, 00, 000
(ROI is calculated on Capital Employed)

(ii) ROI = 27% and Interest on debt is 9%, hence, it has a favourable financial leverage.
NetSales
(iii) Capital Turnover =
Capital
NetSales 75, 00, 000
Or = = = 0.75
Capital 1, 00, 00, 000
Which is very low as compared to industry average of 3.

(iv) Calculation of Operating, Financial and Combined leverages

Contribution 33, 00, 000
(a) Operating Leverage = = = 1.22 (approx)
EBIT 27, 00, 000

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EBIT 27, 00, 000

(b) Financial Leverage = = = 1.18 (approx)
EBT 22, 95, 000

Contribution 33, 00, 000

(c) Combined Leverage = = = 1.44 (approx)
EBT 22, 95, 000
Or = Operating Leverage × Financial Leverage = 1.22 × 1.18 = 1.44 (approx)

(v) Operating leverage is 1.22. So if sales is increased by 10%. EBIT will be increased by 1.22 × 10 i.e. 12.20%
(approx)
(vi) Since the combined Leverage is 1.44, sales have to drop by 100/1.44 i.e. 69.44% to bring EBT to Zero
Accordingly, New Sales = ` 75,00,000 × (1-0.6944)
= ` 75,00,000 × 0.3056
= ` 22,92,000 (approx)
Hence at `22,92,000 sales level EBT of the firm will be equal to Zero.
(vii) Financial leverage is 1.18. So, if EBIT increases by 20% then EBT will increase by 1.18 × 20 = 23.6%
(approx)

Q.7 Q.1 Additional Capital & EPS max PY May 22

. 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

The capital structure of the company as on 31st March, 2022 is as follows:

Particulars Amount in `
Equity share capital (1,00,000 shares of ` 10 each) 10,00,000
Reserves 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 increased by ` 5,00,000 and variable cost
per unit will be decreased by 15%. The additional output can be sold at the 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%

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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%?

Ans.
Alternative 1 = Raising Debt of ` 5 lakh + Equity of ` 15 lakh
Alternative 2 = Raising Debt of ` 10 lakh + Equity of ` 10 lakh
Alternative 3 = Raising Debt of ` 14 lakh + Equity of ` 6 lakh

Calculation of Earnings per share (EPS)

FINANCIAL ALTERNATIVES
Particulars Alternative 1 Alternative 2 Alternative 3
(`) (`) (`)
Expected EBIT [W. N. (a)] 19,50,000 19,50,000 19,50,000
Less: Interest [W. N. (b)] (50,000) (1,25,000) (2,05,000)
Earnings before taxes (EBT) 19,00,000 18,25,000 17,45,000
Less: Taxes @ 40% 7,60,000 7,30,000 6,98,000
Earnings after taxes (EAT) 11,40,000 10,95,000 10,47,000
Number of shares [W. N. (d)] 1,07,500 1,05,000 1,03,000
Earnings per share (EPS) 10.60 10.43 10.17

Conclusion: Alternative 1 (i.e. Raising Debt of ` 5 lakh and Equity of ` 15 lakh) is recommended which
maximises the earnings per share.

Working Notes (W.N.):

(a) Calculation of Earnings before Interest and Tax (EBIT)

Particulars

Output (1,00,000 + 50%) (A) 1,50,000

Selling price per unit ` 40
Less: Variable cost per unit (` 20 – 15%) ` 17
Contribution per unit (B) ` 23
Total contribution (A x B) ` 34,50,000
Less: Fixed Cost (` 10,00,000 + ` 5,00,000) ` 15,00,000
EBIT ` 19,50,000

(b) Calculation of interest on Debt

Alternative (`) Total (`)

1 (` 5,00,000 x 10%) 50,000
2 (` 5,00,000 x 10%) 50,000
(` 5,00,000 x 15%) 75,000 1,25,000
3 (` 5,00,000 x 10%) 50,000

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(` 5,00,000 x 15%) 75,000

(` 4,00,000 x 20%) 80,000
2,05,000

(c) Number of equity shares to be issued

20, 00, 000  5, 00, 000  15, 00, 000

Alternative 1 = = = 7,500 shares
200  Market price of share  200

20, 00, 000  10, 00, 000  10, 00, 000

Alternative 2 = = = 5,000 shares
200  Market price of share  200

Alternative 3 =
20, 00, 000  14, 00, 000  =
6, 00, 000
= 3,000 shares
200  Market price of share  200

(d) Calculation of total equity shares after expansion program

Alternative 1 Alternative 2 Alternative 3
Existing no. of shares 1,00,000 1,00,000 1,00,000
Add: issued under 7,500 5,000 3,000
expansion program
Total no. of equity shares 1,07,500 1,05,000 1,03,000

Q.1
Q.8 Calculate new EPS PY Dec 21

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 expansi on 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 Eq uity shares at par. Tax rate is 40%.

Required:
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.

Ans
Working Notes:
(1) Capital employed before expansion plan:
(`)
Equity shares (` 10 × 80,000 shares) 8,00,000
Debentures {(` 1,20,000/12) 100} 10,00,000
Retained earnings 12,00,000
Total capital employed 30,00,000

(2) Earnings before interest and tax (EBIT) = 4,50,000

(3) Return on Capital Employed (ROCE):
EBIT 4, 50, 000
ROCE = × 100 = ×100 = 15%
Capital employed 30, 00, 000

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(4) Earnings before interest and tax (EBIT) after expansion scheme:
After expansion, capital employed = ` 30,00,000 + ` 6,00,000 = ` 36,00,000
Desired EBIT = 15% x ` 36,00,000 = ` 5,40,000

(i) & (ii) Computation of Earnings Per Share (EPS) under the following options:
Present Expansion scheme
situation Additional funds raised as
Debt (i) Equity (ii)
(`) (`) (`)
Earnings before Interest 4,50,000 5,40,000 5,40,000
and Tax (EBIT)
Less: Interest - Old Debt 1,20,000 1,20,000 1,20,000
- New Debt -- 72,000 --
(` 6,00,000 x 12%)
Earnings before Tax (EBT) 3,30,000 3,48,000 4,20,000
Less: Tax (40% of EBT) 1,32,000 1,39,200 1,68,000
PAT/EAT 1,98,000 2,08,800 2,52,000
No. of shares outstanding 80,000 80,000 1,40,000
Earnings per Share (EPS) 2.475 2.610 1.800
 1, 98, 000   2, 08, 800   2, 52, 000 
     
 80, 000   80, 000   1, 40, 000 

Advise to the Company: When the expansion scheme is financed by additional debt, the EPS is higher.
Hence, the company should finance the expansion scheme by raising debt.

Q.1
Q.9 EPS / Fin. BEP / Indifference PY Nov 20

J Ltd. is considering three financing plans. The-key information is as follows:

(a) Total investment to be raised ` 4,00,000.
(b) Plans showing the Financing Proportion:

Plans Equity Debt Preference Shares

X 100% - -
Y 50% 50% -
Z 50% - 50%

(c) Cost of Debt 10% Cost of preference shares 10%

(d) Tax Rate 50%
(e) Equity shares of the face value of `10 each will be issued at a premium of ` 10 per share.
(f) Expected EBIT is ` 1,00,000.

You are required to compute the following for each plan :

(i) Earnings per share (EPS)
(ii) Financial break even point
(iii) Indifference Point between the plans and indicate if any of the plans dominate.(10 Marks)

Ans
(i) Computation of Earnings per Share (EPS)

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Plans X (`) Y (`) Z (`)

Earnings before interest & tax (EBIT) 1,00,000 1,00,000 1,00,000
Less: Interest charges (10% of ` 2,00,000) -- (20,000) --
Earnings before tax (EBT) 1,00,000 80,000 1,00,000
Less: Tax @ 50% (50,000) (40,000) (50,000)
Earnings after tax (EAT) 50,000 40,000 50,000
Less: Preference share dividend (10% of -- -- (20,000)
`2,00,000)
Earnings available for equity shareholders (A) 50,000 40,000 30,000
No. of equity shares (B) Plan X = ` 20,000 10,000 10,000
4,00,000/ ` 20
Plan Y = ` 2,00,000 / ` 20
Plan Z = ` 2,00,000 / ` 20
E.P.S (A B) 2.5 4 3

(ii) Computation of Financial Break-even Points

Financial Break-even point = Interest + Preference dividend/(1 - tax rate)
Proposal ‘X’ =0
Proposal ‘Y’ = ` 20,000 (Interest charges)
Proposal ‘Z’ = Earnings required for payment of preference share dividend
= ` 20,000 ÷ (1- 0.5 Tax Rate) = ` 40,000

(iii) Computation of Indifference Point between the plans

Combination of Proposals

(a) Indifference point where EBIT of proposal “X” and proposal ‘Y’ is equal
 EBIT 1  0.5  =
 EBIT  
`20, 000 1  0.5 
20, 000shares 10, 000shares
0.5 EBIT = EBIT – ` 20,000
EBIT = ` 40,000

(b) Indifference point where EBIT of proposal ‘X’ and proposal ‘Z’ is equal:
 EBIT 1  0.5  =  
EBIT 1  0.5  ` 2 0, 000
20, 000shares 10, 000shares
0.5 EBIT = EBIT- ` 40,000
0.5 EBIT = ` 40,000
40, 000
EBIT = = ` 80,000
0.5

(c) Indifference point where EBIT of proposal ‘Y’ and proposal ‘Z’ are equal
 EBIT ` 20, 000 1  0.5  = 
EBIT 1  0.5   ` 2 0, 000
10, 000shares 10, 000 shares
0.5 EBIT – ` 10,000 = 0.5 EBIT – ` 20,000

There is no indifference point between proposal ‘Y’ and proposal ‘Z’

Analysis: It can be seen that financial proposal ‘Y’ dominates proposal ‘Z’, since the financial break-even-
point of the former is only ` 20,000 but in case of latter, it is ` 40,000. EPS of plan ‘Y’ is also
higher.

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Q.1
Q.10 Interest / EPS MTP Nov 22(2)
Axar Ltd. has a Sales of ` 68, 00,000 with a Variable cost Ratio of 60%.
The company has fixed cost of `16,32,000. The capital of the company comprises of 12% long term debt,
`1,00,000 Preference Shares of ` 10 each carrying dividend rate of 10% and 1,50,000 equity shares.
The tax rate applicable for the company is 30%.
At current sales level, DETERMINE the Interest, EPS and amount of debt for the firm if a 25% decline in Sales
will wipe out all the EPS.

Ans. Break Even Sales = ` 6800000×0.75 = ` 51,00,000

Income Statement (Amount in `)
Original Calculation of Interest Now at present
at BEP (backward level
calculation)
Sales 68,00,000 51,00,000 68,00,000
Less: Variable Cost 40,80,000 30,60,000 40,80,000
Contribution 27,20,000 20,40,000 27,20,000
Less: Fixed Cost 16,32,000 16,32,000 16,32,000
EBIT 10,88,000 4,08,000 10,88,000
Less: Interest (EBIT-PBT) ? 3,93,714 3,93,714
PBT ? 14,286(10,000/70%) 6,94,286
Less: Tax @ 30%(or PBT-PAT) ? 4,286 2,08,286
PAT ? 10,000(Nil+10,000) 4,86,000
Less: Preference Dividend 10,000 10,000 10,000
Earnings for Equity share holders ? Nil (at BEP) 4,76,000
Number of Equity Shares 1,50,000 1,50,000 1,50,000
EPS ? - 3.1733

So Interest=`3,93,714, EPS=`3.1733, Amount of debt=3,93,714/12%=` 32,80,950

Q.11 FM May 24

Following data is available in respect of Levered and Unlevered companies having same business risk:
Capital employed = ` 2,00,000, EBIT = ` 25,000 and Ke = 12.5%

Sources Levered Company (f) Unlevered Company (`)

Debt (@8%) 75,000 Nil
1,25,000
Equity 2,00,000

An investor is holding 12% shares in levered company. Calculate the increase in annual earnings of investor if he
switches over his holding from Levered to Unlevered company.

Ans. 1. Valuation of firms

Particulars Levered Firm (`) Unlevered Firm (`)
EBIT 25,000 25,000
Less: Interest on debt (8% × ` 75,000) 6,000 Nil
Earnings available to Equity shareholders 19,000 25,000
Ke 12.5% 12.5%

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Value of Equity (S) 1,52,000 2,00,000

(Earnings available to Equity shareholders/ Ke)
Debt (D) 75,000 Nil
Value of Firm (V) = S + D 2,27,000 2,00,000

Value of Levered company is more than that of unlevered company. Therefore, investor will sell his shares
in levered company and buy shares in unlevered company. To maintain the level of risk he will borrow
proportionate amount and invest that amount also in shares of unlevered company.
2. Investment & Borrowings `
Sell shares in Levered company (` 1,52,000 x 12%) 18,240
Borrow money (` 75,000 x 12%) 9,000
Buy shares in Unlevered company 27,240
3. Change in Return `
Income from shares in Unlevered company
(` 27,240 x 12.5%) 3,405
Less: Interest on loan (` 9,000 x 8%) 720
Net Income from unlevered firm 2,685
Less: Income from Levered firm (` 18,240 x 12.5%) 2,280
Incremental Income due to arbitrage 405

Solution can also be done in the following way:

Valuation of firms

Particulars Levered Firm (`) Unlevered Firm (`)

EBIT 25,000 25,000
Less: Interest on debt (8% × ` 75,000) 6,000 Nil
Earnings available to Equity shareholders 19,000 25,000
Ke 12.5% 12.5%
Value of Equity (S) 1,52,000 2,00,000
(Earnings available to Equity shareholders/ Ke)
Debt (D) 75,000 Nil
Value of Firm (V) = S + D 2,27,000 2,00,000

Value of Levered company is more than that of unlevered company. Therefore, investor will sell his shares
in levered company and buy shares in unlevered company.
Arbitrage Process:
If investor have 12% shares of levered company, value of investment in equity shares is 12% of ` 1,52,000
i.e. ` 18,240 and return will be 12% of `19,000 = ` 2,280.
Alternate Strategy will be:
Sell 12% shares of levered firm for ` 18,240 and borrow 12% of levered firm's debt i.e. ` 9,000 (12% of
` 75,000) and invest the money i.e. 12% in unlevered firm's stock:
Total resources /Money investor have = ` 18,240 + ` 9,000 = ` 27,240 and investor invest 12% of `
2,00,000 = ` 24,000
Surplus cash available with investor is = ` 27,240 – ` 24,000 = ` 3,240
Investor return = 12% EBIT of unlevered firm – Interest to be paid on borrowed funds
i.e. = 12% of ` 25,000 – 8% of ` 9,000 = ` 3,000 – ` 720 = ` 2,280

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Now, return remains the same i.e. ` 2,280 which investor is getting from levered company before investing
in unlevered company but still have ` 3,240 excess money available with investor. Hence, investor is better
off by doing arbitrage.

Q.12 Cost of Debt / Equity / Marginal RTP Jul 21

Indel Ltd. has the following capital structure, which is considered to be optimum as on 31st March, 2021:
Particulars (`)
14% Debentures 60,000
11% Preference shares 20,000
Equity Shares (10,000 shares) 3,20,000
4,00,00

The company share has a market price of ` 47.20. Next year dividend per share is 50% of year 2020 EPS. The
0 which is expected to continue in future.
following is the uniform trend of EPS for the preceding 10 years
Year EPS (`) Year EPS (`)
2011 2.00 2016 3.22
2012 2.20 2017 3.54
2013 2.42 2018 3.90
2014 2.66 2019 4.29
2015 2.93 2020 4.72

The company issued new debentures carrying 16% rate of interest and the current market price of debenture is
` 96. Preference shares of ` 18.50 (with annual dividend of ` 2.22 per share) were also issued. The company is in
30% tax bracket.

The company is in 30% tax bracket.

(A) CALCULATE after tax:

(i) Cost of new debt
(ii) Cost of new preference shares
(iii) New equity share (assuming new equity from retained earnings)
(B) CALCULATE marginal cost of capital when no new shares are issued.
(C) DETERMINE the amount that can be spent for capital investment before new ordinary shares must be
sold, assuming that the retained earnings for next year’s investment is 50 percent of earnings of 2020.
(D) COMPUTE marginal cost of capital when the fund exceeds the amount calculated in assuming new equity
is issued at ` 40 per share?

Ans. (A) (i) Cost of new debt

I (1  t ) 16(1  0.3)
Kd= =  0.11667
P0 96

(ii) Cost of new preference shares

2.22
Kp =  0.12
18.5

(iii) Cost of new equity shares

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D1 2.36
Ke = g =  0.10
P0 47.20

Ke = 0.05 + 0.10 = 0.15

Calculation of g when there is a uniform trend (on the basis of EPS)
EPS (2012)  EPS (2011) 2.20  2.00
  0.10 or 10%
EPS (2011) 2.00
Calculation of D1
D1 = 50% of 2020 EPS = 50% of ` 4.72 = ` 2.36

(B) Calculation of marginal cost of capital

Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debentures 0.15 0.11667 0.0175
Preference Share 0.05 0.1200 0.0060
Equity Share 0.80 0.1500 0.1200

Marginal cost of capital 0.1435

(C) The company can spend the following amount without increasing marginal cost of capital and without
selling the new shares:
Retained earnings = 50% of EPS of 2020 × outstanding equity shares
= 50% of ` 4.72 × 10,000 shares = ` 23,600
The ordinary equity (Retained earnings in this case) is 80% of total capital
So, ` 23,600 = 80% of Total Capital

(D) If the company spends in excess of ` 29,500, it will have to issue new equity shares at ` 40 per share.
 The cost of new issue of equity shares will be:
D1 `2.36
Ke= g  0.10  0.159
P0 `40
The marginal cost of capital will be:

Type of Capital Proportion Specific Cost Product

(1) (2) (3) (2) × (3) =
Debentures 0.15 0.11667 (4) 0.0175

Preference Shares 0.05 0.1200 0.0060

Equity Shares (New) 0.80 0.1590 0.1272

Marginal cost of 0.1507

capital
Q.13 Cost of Debt / Preference PY May 22

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

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share. Five year 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%.

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

Year 1 2 3 4 5 6 7 8 9 10
PVIF 0.03, 0.97 0.94 0.91 0.88 0.86 0.83 0.81 0.78 0.76 0.74
t
PVIF 0.05, 1
0.95 3
0.90 5
0.86 8
0.82 3
0.78 7
0.74 3
0.711 9
0.67 6
0.64 4
0.61
t
PVIFA 2
0.97 7
1.913 4
2.82 3
3.71 4
4.58 6
5.41 6.23 7
7.02 5
7.78 4
8.53
0.03, t
PVIFA 1
0.95 1.85 9
2.72 7
3.54 0
4.32 7
5.07 0
5.78 0
6.46 6
7.10 0
7.72
0.05, t 2 9 3 6 9 6 6 3 8 2
Interest rate 1% 2% 3% 4% 5% 6% 7% 8% 9%
FVIF i, 5 1.051 1.104 1.159 1.217 1.27 1.33 1.40 1.46 1.53
FVIF i, 6 1.06 1.126 1.194 1.26 6
1.34 8
1.419 3
1.501 9
1.58 9
1.67
FVIF i, 7 2
1.07 1.149 1.23 5
1.316 0
1.40 1.50 1.60 7
1.714 7
1.82
2 0 7 4 6 8
Ans. (i) Calculation of Cost of Convertible Debentures:

Given that,

RF = 10% Rm-Rt = 18%

B= 1.25% D0 = 12.76

D-5 = 10 Flotation Cost = 5%

Using CAPM,

Ke = Rt+ β(Rm-Rf) = 10%+1.25(18%)

= 32.50%

Calculation of growth rate in dividend

12.76 = 10 (1+g)5

1.276 = (1+g)5

(1+5%) = 1.276……… from FV Table

g = 5%

D7 12.76(1.05) 7
Price of share after 6 years = 
ke  g 0.325  0.5 7

12.75 x 1.407
P6 = = 65.28
0.275

Redemption Value of Debenture (RV) = 65.28 × 2 = 130.56 (RV)

NP = 95 n=6

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(RV  NP ) 9  5.93
INT (1  t )  X 100
Kd = n X 100 = 112.78
[RV  NP ]
2
Kd = 13.24%

(ii) Calculation of Cost of Preference Shares:

Net Proceeds = 100(1.1)-6% of 100 (1.1)

= 110-6.60

= 103.40
Redemption Value = 100

Year Cash Flows (`) PVF @ 3% PV (`) PVF @ 5% PV (`)

0 103.40 1 103.40 1 103.40
1-10 -5 8.530 -42.65 7.722 -38.61
10 -100 0.744 -74.40 0.614 -61.40
- 3.39
13.65
5%  3%
Kp= 3%+ x 13.65 = 4.6%
[3.39  ( 13.65)]
Q.14 WACC PY Jan 21
The Capital structure of PQR Ltd. is as follows:
`
10% Debenture 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% floatation cost & 10 years of maturity. The market price
per debenture is ` 110.
(ii) ` 100 per preference share redeemable at par has 3% floatation cost & 10 years of maturity. The market
price per preference share is ` 108.
(iii) Equity share has ` 4 floatation 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.

Ans Workings:
D1 2
1. Cost of Equity (Ke) = +g= + 0.05 = 0.145 (approx.)
P0 F 25  4

RV-NP 
I(1-t) +
n
2. Cost of Debt (Kd) =
RV-NP 
2

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100-98 
10(1-0.3) +
10 7  0 .2
= = =0.073 (approx.)
100-98  99
2

RV-NP 
PD +
n
3. Cost of Preference Shares (Kp) =
RV-NP 
2
100-97 
12 +
10 12  0 .3
= = = 0.125 (approx.)
100-97  98 .5
2

Calculation of WACC using market value weights

Source of capital Market Weights After tax cost WACC (Ko)

Value of capital
(`) (a) (b) (c) = (a)×(b)
10% Debentures (` 110 × 3,000) 3,30,000 0.178 0.073 0.013
12% Preference shares (` 108 × 2,70,000 0.146 0.125 0.018
2,500)
Equity shares (` 25 × 50,000) 12,50,000 0.676 0.145 0.098
18,50,000 1.00 0.129
WACC (Ko) = 0.129 or 12.9% (approx.)

Q.15 WACC MTP May 21(1)

CALCULATE the WACC by using Market value weights.

The capital structure of the company is as under:

(`)
Debentures (Rs.100 per debenture) 10,00,000
Preference shares (Rs.100 per share) 10,00,000
Equity shares (Rs.10 per share) 20,00,000
40,00,000
The market prices of these securities are:
Debentures Rs. 115 per debenture
Preference shares Rs. 120 per preference share
Equity shares Rs. 265 each.
Additional information:
(1) Rs.100 per debenture redeemable at par, 10% coupon rate, 2% floatation cost, 10-year maturity.
(2) Rs.100 per preference share redeemable at par, 5% coupon rate, 2% floatation cost and 10 - year maturity.
(3) Equity shares have a floatation cost of Rs. 1 per share.
The next year expected dividend is Rs. 5 with an annual growth of 15%. The firm has the practice of paying
all earnings in the form of dividend.
Corporate tax rate is 30%. Use YTM method to calculate cost of debentures and preference shares.

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Ans (i) Cost of Equity (Ke)

D1 Rs. 5
= +g= + 0.15 = 0.1689 or 16.89%
P0 -F Rs.265  Re.1
(ii) Cost of Debt (Kd)
Calculation of NPV at discount rate of 5% and 7%
Year Cash flows Discount Present Discount Present Value
(Rs.) factor @ 5% Value factor @ 7% (Rs.)

0 112.7 1.000 (112.7) 1.000 (112.7)

1 to 10 7 7.722 54.05 7.024 49.17
10 100 0.614 61.40 0.508 50.80
NPV +2.75 -12.73
Calculation of IRR
2.75 2.75
IRR = 5% + (7% - 5%) = 5% + (7% - 5%) = 5.36%
2.75   12.73  15.48
Cost of Debt (Kd) = 5.36%
(i) Cost of Preference shares (Kp)
Calculation of NPV at discount rate of 2% and 5%
Year Cashflow Discount Present Discount Present Value
(Rs.) factor@ 2% Value factor @ 5% (Rs.)
0 117.6 1.000 (117.6) 1.000 (117.6)
1 to 10 5 8.983 44.92 7.722 38.61
10 100 0.820 82.00 0.614 61.40
NPV +9.32 -17.59

Calculation of IRR 2%

9.32 9.32
(5%-2%) = 2% + = (5%-2%) = 3.04%
9.32-(-17.59) 26.91

9.32
Cost of Preference S hares (Kp) = 3.04%
9.32-(-17.59)
Calculation of WACC using market value weights

Source of capital Market Value Weights After tax WACC (Ko)

cost of
capital
(Rs.) (a) (b) (c) =(a)×(b)
10% Debentures (Rs.115× 11,50,000 0.021 0.0536 0.00113
10,000)
5% Preference shares (Rs.120× 12,00,000 0.022 0.0304 0.00067
10,000)
Equity shares (Rs.265 × 5,30,00,000 0.957 0.1689 0.16164
2,00,000)
5,53,50,000 1.000 0.16344

WACC (Ko) = 0.16344 or 16.344%

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Q.16 Dividend Payout PY May 23

Following information are given for a company:
Earnings per share ` 10
P/E ratio 12.5
Rate of return on investment 12%
Market price per share as per Walter’s Model ` 130

You are required to calculate: (i)

Dividend payout ratio.

(ii) Market price of share at optimum dividend payout ratio.

(iii) P/E ratio, at which the dividend policy will have no effect on the price of share.

(iv) Market price of share at this P/E ratio.

(v) Market price of share using Dividend growth model.

Ans (i) The EPS of the firm is ` 10, r =12%. The P/E Ratio is given at 12.5 and the cost of capital (Ke) may be taken
as the inverse of P/E ratio. Therefore, Ke is 8% (i.e., 1/12.5). The value of the share is ` 130 which may be
equated with Walter Model as follows:
r 12%
D (E  D ) D (10%  D )
ke 8%
P= or p=
Ke 8%
or [D+1.5(10-D)]/0.08=130 or
D+15-1.5D=10.4
or -0.5D=-4.6
So, D = ` 9.2
The firm has a dividend pay-out of 92% (i.e., 9.2/10).
(ii) Since the rate of return of the firm (r) is 12% and it is more than the Ke of 8%,
therefore, by distributing 92% of earnings, the firm is not following an optimal dividend
policy. The optimal dividend policy for the firm would be to pay zero dividend and in
such a situation, the market price would be:
12%
D (10%  0)
P = 8%
8%
P = ` 187.5
So, theoretically the market price of the share can be increased by adopting a zero pay-out.

(iii) The P/E ratio at which the dividend policy will have no effect on the value of the share is such at which the
Ke would be equal to the rate of return (r) of the firm. The Ke would be 12% (= r) at the P/E ratio of
1/12%=8.33. Therefore, at the P/E ratio of 8.33, the dividend policy would have no effect on the value of the
share.
(iv) If the P/E is 8.33 instead of 12.5, then the Ke which is the inverse of P/E ratio, would be 12% and in such a
situation ke= r and the market price, as per Walter’s model would be:
r 12%
D (E  D ) 9.2  (10%  9.2)
ke 0.12
P = = = ` 83.33
ke 0.12
Dividend Growth Model applying growth on dividend
Ke = 8%, r = 12%, D0 = 9.2, b = 0.08
g = b.r

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g = 0.08 x 0.12=0.96%
D1 = D0 (1+g) = 9.2 (1+0.0096) = ` 9.2883
D1
P= = 9.2883/(0.08 – 0.0096) = 9.2883/0.0704 = ` 131.936
Ke  g 

Alternative
Alternatively, without applying growth on dividend
E(1  b) 10(1  0.08)
P = = = ` 130.68
Ke  br 0.08  (0.08´ 0.12)

Q.17 MM Approach RTP May 23

Rambo Limited Has 1,00,000 equity shares outstanding for the year 2022. The current market price of the shares
is ` 100 each. Company is planning to pay dividend of ` 10 per share. Required rate of return is 15%. Based on
Modigliani-Miller approach, calculate the market price of the share of the company when the recommended
dividend is 1) declared and 2) not declared.

How many new shares are to be issued by the company at the end of the year on the assumption that net income
for the year is ` 40 Lac and the investment budget is
` 50,00,000 when dividend is declared, or dividend is not declared.

PROOF that the market value of the company at the end of the accounting year will remain same whether
dividends are distributed or not distributed.

Ans CASE 1: Value of the firm when dividends are not paid.
Step 1: Calculate price at the end of the period
Ke = 15%, P₀ = `100, D₁ = 0
P1  D1
Pₒ =
1  Ke
P1  0
`100 =
1  0.15
P₁ = `115

Step 2: Calculation of funds required for investment

Earning ` 40,00,000
Dividend distributed Nil
Fund available for investment ` 40,00,000
Total Investment ` 50,00,000
Balance Funds required ` 50,00,000 - ` 40,00,000 = ` 10,00,000

Step 3: Calculation of No. of shares required to be issued for balance funds

No. of shares = Funds required/P1
∆n = `10,00,000/`115
Step 4: Calculation of value of firm nPₒ = [(n+∆n)P1-I+E]/(1+Ke)
nP₀ = [(100000+1000000/`115) `115 - `5000000 + `4000000]/(1.15)
= `1,00,00,000

CASE 2: Value of the firm when dividends are paid.

Step 1: Calculate price at the end of the period
Ke= 15%, P₀= `100, D₁= `10

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P1  D1
Pₒ =
1  Ke
P1  10
`100 =
1  0.15
P₁ = `105
Step 2: Calculation of funds required for investment

Dividend distributed 10,00,000

Fund available for investment ` 30,00,000
Total Investment ` 50,00,000
Balance Funds required ` 50,00,000 - ` 30,00,000 = ` 20,00,000

Step 3: Calculation of No. of shares required to be issued for balance fund

No. of shares = Funds Required/P1

∆n = `2000000/`105
Step 4: Calculation of value of firm
nPₒ = [(n+∆n)P1 – I+E]/(1+Ke)
nP₀ = [(100000 + 2000000/`105) `105 – `5000000 + `4000000]/(1.15)= `1,00,00,000
Thus, it can be seen from the above calculations that the value of the firm remains
the same in either case.

Q.18 MPS Using Gordon’s Model PY Dec 21

X Ltd. is a multinational company. Current market price per share is ` 2,185. During the F.Y. 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 under priced.
Year 1 2 3 4 5
Discounting Factor @ 18% 0.847 0.718 0.608 0.515 0.436

Ans As per Dividend discount model, the price of share is calculated as follows:
D1 D2 D3 D4 D4 (1+g) 1
P= +    x
(1  Ke)1 (1  Ke)2 (1  Ke)3 (1  Ke) 4 (Ke-g) (1  Ke) 4
Where,

P = Price per share

Ke = Required rate of return on equity

g = Growth rate

140x 1.12 156.80 x 1.12 175.62 x1.12 196x1.12 220.29(1  0.05) 1

P =     x
1 2 3 4
(0.18  0.05) 4
(1  0.18) (1  0.18) (1  0.18) (1  0.18) 1  0.18
P= 132.81 + 126.10 + 119.59 + 113.45 + 916.34 = ` 1,408.29

Intrinsic value of share is ` 1,408.29 as compared to latest market price of

`2,185. Market price of share is over-priced by ` 776.71.

26 By CA Amit Sharma

Fast Cost FM by AB
 Super 30
CA Amit Sharma

Q.19 FM Nov 23
Paarath Limited had recently repurchased 20,000 equity shares at a premium of 10% to its prevailing market
price. The book value per share (after repurchasing) is ` 193.20.
Other Details of the company are as follows:
Earnings of the company (before buyback) = ` 18,00,000 Current MPS is ` 270 with a P/E Ratio of 18.
CALCULATE the Book Value per share of the company before the re- purchase.

Ans. i. No of Eq. Shares (before buyback) = Total Earnings (before buy back)/EPS
= 18,00,000/(270/18)
= 1,20,000 shares
ii. Buyback price = 270 + 10% premium = 297
iii. No of Eq. shares (after buyback) = 1,20,000 (-) 20,000 = 1,00,000 shares
iv. Total Book Value of Equity (after buyback) = 1,00,000 X 193.20
= 1,93,20,000
Now,
Total BV of Eq. (after buyback) = Total BV of Eq.(before buyback) (-)
Amt of buyback
1,93,20,000 = x (-) (20,000 X 297)
Therefore x = Total BV (before buyback)
= 2,52,60,000
BV per share (before buyback) = 2,52,60,000 / 1,20,000
= 210.50 per share

Q.20 Monthly Cash Budget MTP May 21(1)

PREPARE monthly cash budget for the first six months of 2021 on the basis of the following information:
(i) Actual and estimated monthly sales are as follows:
Actual (Rs.) Estimated (Rs.)
October 2020 2,00,000 January 2021 60,000
November 2020 2,20,000 February 2021 80,000
December 2020 2,40,000 March 2021 1,00,000
April 2021 1,20,000
May 2021 80,000
June 2021 60,000
July 2021 1,20,000

(ii) Operating Expenses (including salary & wages) are estimated to be payable as follows:

Month (Rs.) Month (Rs.)

January 2021 22,000 April 2021 30,000
February 2021 25,000 May 2021 25,000
March 2021 30,000 June 2021 24,000
(iii) Of the sales, 75% is on credit and 25% for cash. 60% of the credit sales are collected after one month,
30% after two months and 10% after three months.
(iv) Purchases amount to 80% of sales and are made on credit and paid for in the month preceding the sales.
(v) The firm has 12% debentures of Rs.1,00,000. Interest on these has to be paid quarterly in
January, April and so on.
(vi) The firm is to make an advance payment of tax of Rs. 5,000 in April.

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CA Amit Sharma

(vii) The firm had a cash balance of Rs. 40,000 at 31st Dec. 2020, which is the minimum desired level of cash
balance. Any cash surplus/deficit above/below this level is made up by temporary investments/liquidation
of temporary investments or temporary borrowings at the end of each month (interest on these to be
ignored).

Ans. Monthly Cash Budget for first six months of 2021

(Amount in Rs.)
Particulars Jan. Feb. Mar. April May June
Opening balance 40,000 40,000 40,000 40,000 40,000 40,000
Receipts:
Cash sales 15,000 20,000 25,000 30,000 20,000 15,000
Collection from debtors 1,72,500 97,500 67,500 67,500 82,500 70,500
Total cash available (A) 2,27,500 1,57,500 1,32,500 1,37,500 1,42,500 1,25,500
Payments:
Purchases 64,000 80,000 96,000 64,000 48,000 96,000
Operating Expenses 22,000 25,000 30,000 30,000 25,000 24,000
Interest on debentures 3,000 - - 3,000 - -
Tax payment - - - 5,000 - -
Total payments (B) 89,000 1,05,000 1,26,000 1,02,000 73,000 1,20,000
Minimum cash balance 40,000 40,000 40,000 40,000 40,000 40,000
desired
Total cash needed (C) 1,29,000 1,45,000 1,66,000 1,42,000 1,13,000 1,60,000
Surplus/(deficit) (A - C) 98,500 12,500 (33,500) (4,500) 29,500 (34,500)
Investment/financing
Temporary Investments (98,500) (12,500) - - (29,500) -
Liquidation of temporary 33,500 4,500
investments or temporary - 34,500
borrowings
Total effect of 4,500 (29,500) 34,500
investment/financing(D) (98,500) (12,500) 33,500
Closing cash balance (A +
D - B) 40,000 40,000 40,000 40,000 40,000 40,000

Workings:
1. Collection from debtors: (Amount in Rs.)
Year 2020 Year 2021
Oct. Nov. Dec. Jan. Feb. Mar. April May June
Total sales 2,00,000 2,20,000 2,40,000 60,000 80,000 1,00,000 1,20,000 80,000 60,000
Credit sales
(75% of total
sales) 1,50,000 1,65,000 1,80,000 45,000 60,000 75,000 90,000 60,000 45,000

Collections:
One month 90,000 99,000 1,08,000 27,000 36,000 45,000 54,000 36,000
Two months 45,000 49,500 54,000 13,500 18,000 22,500 27,000
Three months 15,000 16,500 18,000 4,500 6,000 7,500
Total
collections 1,72,50 97,500 67,500 67,500 82,500 70,500
0

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CA Amit Sharma

2. Payment to Creditors: (Amount in Rs.)

Year 2021
Jan Feb Mar Apr May Jun Jul
Total sales 60,000 80,000 1,00,000 1,20,000 80,000 60,000 1,20,000
Purchases 96,000
(80% of total sales) 48,000 64,000 80,000 96,000 64,000 48,000
Payment:
One month prior 64,000 80,000 96,000 64,000 48,000 96,000

Q.21 Credit Policy RTP Nov 20

A company wants to follow a more prudent policy to improve its sales for the region which is ` 9 lakhs per
annum at present, having an average collection period of 45 days. After certain researches, the management
consultant of the company reveals the following information:
Credit Policy Increase in Increase in sales Present default
collection period anticipated
W 15 days ` 60,000 1.5%
X 30 days ` 90,000 2%
Y 45 days ` 1,50,000 3%
Z 70 days ` 2,10,000 4%

The selling price per unit is ` 3. Average cost per unit is ` 2.25 and variable costs per unit are ` 2. The current
bad debt loss is 1%. Required return on additional investment is 20%. (Assume 360 days year)
ANALYSE which of the above policies would you recommend for adoption?

Ans A. Statement showing the Evaluation of Debtors Policies (Total Approach)

(Amount in `)
Particulars Present Proposed Proposed Proposed Proposed
Policy 45 Policy Policy Policy Policy Z
days W X Y 115 days
I. Expected Profit: 60 days 75 days 90 days
Z
(a) Credit Sales 9,00,000 9,60,000 9,90,000 10,50,000 11,10,000
(b) Total Cost other
than Bad Debts
(i) Variable Costs 6,00,000 6,40,000 6,60,000 7,00,000 7,40,000
[Sales × 2/ 3]
(ii) Fixed Costs 75,000 75,000 75,000 75,000 75,000
6,75,000 7,15,000 7,35,000 7,75,000 8,15,000
(c) Bad Debts 9,000 14,400 19,800 31,500 44,400
(d) Expected Profit 2,16,000 2,30,600 2,35,200 2,43,500 2,50,600
[(a) – (b) – (c)]
II. Opportunity Cost of 16,875 23,833 30,625 38,750 52,069
Investments in
Receivables
III. Net Benefits (I – II) 1,99,125 2,06,767 2,04,575 2,04,750 1,98,531

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CA Amit Sharma

Recommendation: The Proposed Policy W (i.e. increase in collection period by 15 days or total 60 days)
should be adopted since the net benefits under this policy are higher as compared to other policies.

Working Notes:
(i) Calculation of Fixed Cost = [Average Cost per unit – Variable Cost per unit] × No. of Units sold
= [` 2.25 - ` 2.00] × (` 9,00,000/3)
= ` 0.25 × 3,00,000 = ` 75,000
(ii) Calculation of Opportunity Cost of Average Investments

C o lle c ti o n p er i o d R ate of R etu r n

Opportunity Cost = Total Cost x x
360 100

45 20
Present Policy = 6,75,000 × x =16,875
360 100

60 20
Policy W = 7,15,000 × x =23,833
360 100

75 20
Policy X = 7,35,000 × x = 30,625
360 100

90 20
Policy Y = 7,75,000 × x = 38,750
360 100

115 20
Policy Z = 8,15,000 × × = 52,069
360 100

B. Another method of solving the problem is Incremental Approach. Here we assume that sales are all
credit sales. (Amount in `)
Particulars Present Proposed Proposed Proposed Proposed
Policy 45 Policy W Policy X Policy Y Policy Z
days 60 days 75 days days
90 115 days
I. Incremental Expected
Profit:
(a) Incremental Credit 0 60,000 90,000 1,50,000 2,10,000
Sales
(b) Incremental Costs
(i) Variable Costs 6,00,000 40,000 60,000 1,00,000 1,40,000
(ii) Fixed Costs 75,000 - - - -
(c) Incremental Bad Debt 9,000 5,400 10,800 22,500 35,400
Losses
(d) Incremental Expected 14,600 19,200 27,500 34,600
Profit (a – b –c)]
II. Required Return on
Incremental Investments:
(a) Cost of Credit 6,75,000 7,15,000 7,35,000 7,75,000 8,15,000

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Sales
(b) Collection period 45 60 75 90 115
(c) Investment in 84,375 1,19,167 1,53,125 1,93,750 2,60,347
Receivable (a × b/360)
(d) Incremental Investment in
Receivables - 34,792 68,750 1,09,375 1,75,972

(e) Required Rate of 20 20 20 20

Return (in %)
(f) Required Return
on Incremental Investments - 6,958 13,750 21,875 35,194
(d × e)
III. Net Benefits (I – II) - 7,642 5,450 5,625 (594)
-
Recommendation: The Proposed Policy W should be adopted since the net benefits under this policy are
higher than those under other policies.
C. Another method of solving the problem is by computing the Expected Rate of Return
In c r em en tal Exp ec ted Pr o f i t
Expected Rate of Return = x100
Incremental Investment in Receivables

14, 500
For Policy W = x 100 = 41.96%
34, 792

19, 200
For Policy X = x 100 = 27.93%
68, 750

27, 500
For Policy Y = x 100 = 25.14%
109, 375

34, 600
For Policy Z = x 100 = 19.66%
1, 75, 972

Recommendation: The Proposed Policy W should be adopted since the Expected Rate of Return (41.96%)
is more than the Required Rate of Return (20%) and is highest among the given policies compared.

Q.22 Credit Policy RTP Nov 19

A regular customer of your company has approached to you for extension of credit facility for purchasing of
goods. On analysis of past performance and on the basis of information supplied, the following pattern of
payment schedule emerges:

Pattern of Payment Schedule

At the end of 30 days 20% of the bill
At the end of 60 days 30% of the bill.
At the end of 90 days 30% of the bill.
At the end of 100 days 18% of the bill.
Non-recovery 2% of the bill.

The customer wants to enter into a firm commitment for purchase of goods of `30 lakhs in 2019, deliveries
to be made in equal quantities on the first day of each quarter in the calendar year. The price per unit of
commodity is `300 on which a profit of `10 per unit is expected to be made. It is anticipated that taking up

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CA Amit Sharma

of this contract would mean an extra recurring expenditure of `10,000 per annum. If the opportunity cost
is 18% per annum, would you as the finance manager of the companyRECOMMEND the grant of credit to the
customer? Assume 1 year = 360 days.

Ans Statement showing the Evaluation of credit Policies

Particulars Proposed Policy`
A. Expected Profit:
(a) Credit Sales 30,00,000
(b) Total Cost
(i) Variable Costs 29,00,000
(ii) Recurring Costs 10,000
29,10,000
(c) Ba d Debts 60,000
(d) Expected Profit [(a) – (b) – (c)] 30,000
B. Opportunity Cost of Investments in Receivables 1,00,395
C. Net Benefits (A – B) (70,395)
Recommendation: The Proposed Policy should not be adopted since the net benefits under this policyare
negative
Working Note: Calculation of Opportunity Cost of Average Investments

Collection Period Rate of Return

Opportunity Cost = Total Cost x x
360 100
Particulars 20% 30% 30% 18% Total
A. Total Cost 5,82,000 8,73,000 8,73,000 5,23,800 28,51,800
B. Collection period 30/360 60/360 90/360 100/360
C. Required Rate of Return 18% 18% 18% 18%
D. Opportunity Cost 8,730 26,190 39,285 26,190 1,00,395
(A × B × C)

Q.23 Payment to Debtor MTP May 19(1)

A bank is analysing the receivables of J Ltd. in order to identify acceptable collateral for a short-term loan. The
company’s credit policy is 2/10 net 30. The bank lends 80 percent on accounts where customers are not currently
overdue and where the average payment period does not exceed 10 days past the net period. A schedule
of J Ltd.’s receivables has been prepared. ANALYSE, how much will the bank lend on pledge of receivables, if
the bank uses a 10 per cent allowance for cash discount and returns?
Account Amount Rs. Days Outstanding in days Average Payment Period
historically
74 25,000 15 20
91 9,000 45 60
107 11,500 22 24
108 2,300 9 10
114 18,000 50 45
116 29,000 16 10
123 14,000 27 48

1,08,800

Ans Analysis of the receivables of J Ltd. by the bank in order to identify acceptable collateral for a short- term

32 By CA Amit Sharma

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CA Amit Sharma

loan:
(i) The J Ltd.’s credit policy is 2/10 net 30.
The bank lends 80 per cent on accounts where customers are not currently overdue and where the average
payment period does not exceed 10 days past the net period i.e. thirty days. From the schedule of
receivables of J Ltd. Account No. 91 and Account No. 114 are currently overdue and for Account No. 123
the average payment period exceeds 40 days. Hence Account Nos. 91, 114 and 123 are eliminated.
Therefore, the selected Accounts are Account Nos. 74, 107, 108 and 116.
(ii) Statement showing the calculation of the amount which the bank will lend on a pledge of receivables if the
bank uses a 10 per cent allowances for cash discount and returns

Account No. Amount (Rs.) 90 per cent of amount (Rs.) 80% of amount (Rs.)
(a) (b) = 90% of (a) (c) = 80% of (b)
74 25,000 22,500 18,000
107 11,500 10,350 8280
108 2,300 2,070 1,656
116 29,000 26,100 20,880
Total loan amount 48,816

Q.24 FM May 24

Following is the sales information in respect of Bright Ltd:

Annual Sales (90 % on credit) ` 7,50,00,000
Credit period 45 days
Average Collection period 70 days
Bad debts 0.75%
Credit administration cost (out of which 2/5th is avoidable) ` 18,60,000
A factor firm has offered to manage the company's debtors on a non- recourse basis at a service charge of 2%.
Factor agrees to grant advance against debtors at in interest rate of 14% after withholding 20% as reserve.
Payment period guaranteed by factor is 45 days. The cost of capital of the company is 12.5%. One time redundancy
payment of ` 50,000 is required to be made to factor.
Calculate the effective cost of factoring to the company. (Assume 360 days in a year)

Ans. Evaluation of Factoring Proposal

Particulars ` `
A. Savings due to factoring
Bad Debts saved 0.75% x 7.5 crores ` 5,06,250
x 90%
Administration cost saved 18.6 lakhs x 2/5 ` 7,44,000
Interest saved due to reduction in average collection 7.5 crores x 90% ` 5,85,937.5
period x (70-45)/ 360 x 12.5%
Total ` 18,36,187.5
B. Costs of factoring:
Service charge 7.5 crores x 90% x 2% ` 13,50,000
Interest cost ` 1,15,171.875 ` 9,21,375
x 360/45
Redundancy Payment ` 50,000

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CA Amit Sharma

Total ` 23.21,375
C. Net Annual cost to the Firm: (A-B) ` 4,85,187.5
Rate of effective cost of factoring ` 4,85,187.5/ 7.504%
` 64,66,078.125 x 100

Advice: Since the rate of effective cost of factoring is less than the existing cost of capital, therefore, the
proposal is acceptable.

Credit Sales = ` 7.5 crores x 90% = ` 6,75,00,000

Average level of receivables = ` 6.75 crores x 45/360 = ` 84,37,500
Service charge = 2% of ` 84,37,500 ` 1,68,750
Reserve = 20% of ` 84,37,500 ` 16,87,500
Total (i) ` 18,56,250
Thus, the amount available for advance is
Average level of receivables ` 84,37,500
Less: Total (i) from above ` 18,56,250
(ii) ` 65,81,250
Less: Interest @ 14% p.a. for 45 days ` 1,15,171.875
Net Amount of Advance available. ` 64,66,078.125
Note: Alternatively, if redundancy cost is taken as irrelevant for decision making, then Net Annual cost to the
Firm will be ` 4,35,187.5 and Rate of effective cost of factoring will be ` 4,35,187.5/` 64,66,078.125 x 100 =
6.730%
If average level of receivables is considered for 70 days then the calculation can be done in following
way:
Evaluation of Factoring Proposal
Credit Sales = ` 7.5 crores X 90% = ` 6,75,00,000
Average level of receivables = ` 6.75 crores x 70/360 = ` 1,31,25,000
Service charge = 2% of ` 1,31,25,000 ` 2,62,500
Reserve = 20% of ` 1,31,25,000 ` 26,25,000
Total (i) ` 28,87,500
Thus, the amount available for advance is
Average level of receivables ` 1,31,25,000
Less: Total (i) from above ` 28,87,500
(ii) ` 1,02,37,500
Less: Interest @ 14% p.a. for 45 days ` 1,79,156.25
Net Amount of Advance available. ` 1,00,58,343.75
Note 1: Accordingly, interest cost will be ` 14,33,250 cost of factoring will be ` 28,33,250. Therefore, Rate of
effective cost of factoring is 9.913%
Note 2: Alternatively, if redundancy cost is taken as irrelevant for decision making, then Net Annual cost to
the Firm will be ` 9,47,062.5 and Rate of effective cost of factoring will be ` 9,47,062.5/ ` 1,00,58,343.75 x
100 = 9.416%.
Advice: Since the rate of effective cost of factoring is less than the existing cost of capital, therefore, the
proposal is acceptable.

Q.25 Accept Factoring or Not MTP May 19(2)

Navya Ltd has annual credit sales of Rs. 45 lakhs. Credit terms are 30 days, but its management of receivables
has been poor and the average collection period is 50 days, Bad debt is 0.4 per cent of sales. A factor has offered
to take over the task of debt administration and credit checking, at an annual fee of 1 per cent of credit sales.
Navya Ltd. estimates that it would save Rs. 35,000 per year in administration costs as a result. Due to the
efficiency of the factor, the average collection period would reduce to 30 days and bad debts would be zero. The

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CA Amit Sharma

factor would advance 80 per cent of invoiced debts at an annual interest rate of 11 per cent. Navya Ltd. is
currently financing receivables from an overdraft costing 10 per cent per year.
If occurrence of credit sales is throughout the year, COMPUTE whether the factor’s services should be accepted
or rejected. Assume 365 days in a year.

Ans
Rs.
Present level of receivables is 45 lakh× 50/365 6,16,438

In case of factor, receivables would reduce to 45 lakhs× 30/365 3,69,863

The costs of the existing policyare as follows:
Cost of financing existing receivables: 6,16,438×10% 61,644
Cost of bad debts: 45 lakhs × 0.4% 18,000
Cost of current policy 79,644
The cost under the factor are as follows:
Cost of financing new receivable through factor:
(Rs. 3,69,863 × 0.8 × 0.11) + (Rs. 3,69,863 × 0.2 × 0.10) 39,945
= (32,548 + 7,397)
Factor’s annual fee: 45 Lakhs × 0.01 45,000
Administration costs saved: (35,000)
Net cost under factor: 49,945
From the above analysis it is clear that the factor’s services are cheaper than Existing policy by Rs. 29,699
(Rs. 79,644 - Rs.49,945) per year. Hence, the services of the factor should be accepted.

Q.26 Net Working Capital PY May 18

Day Ltd., a newly formed company has applied to the Private Bank for the first time for financing it's Working
Capital Requirements. The following informations are available about the projections for the current year:

Estimated Level of Activity Completed Units of Production 31200 plus unit of work
in progress 12000
Raw Material Cost ` 40 per unit
Direct Wages Cost ` 15 per unit
Overhead ` 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 24000 Units
Credit Allowed by the supplier 30 days
Credit Allowed to Purchasers 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.

Ans Calculation of Net Working Capital requirement:

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CA Amit Sharma

(`) (`)
A. Current Assets:
Inventories:
Stock of Raw material 1,44,000
(Refer to Working note (iii)
Stock of Work in progress 7,50,000
(Refer to Working note (ii)
Stock of Finished goods 20,40,000
(Refer to Working note (iv)
Debtors for Sales 1,02,000
(Refer to Working note (v)
Cash 2,00,000
Gross Working Capital 32,36,000 32,36,000
B. Current Liabilities:
Creditors for Purchases 1,56,000
(Refer to Working note (vi)
Creditors for wages
(Refer to Working note (vii) 23,250
1,79,250 1,79,250
Net Working Capital (A - B) 30,56,750

Working Notes:
(i) Annual cost of production
(`)
Raw material requirements
{(31,200 × ` 40) + (12,000 x ` 40)}
17,28,000
Direct wages {(31,200 × ` 15) +(12,000 X ` 15 x 0.5)} 5,58,000
Overheads (exclusive of depreciation)
{(31,200 × ` 30) + (12,000 x ` 30 x 0.5)}
11,16,000
Gross Factory Cost 34,02,000
Less: Closing W.I.P [12,000 ( ` 40 + ` 7.5 + `15)] (7,50,000)
Cost of Goods Produced 26,52,000
Less: Closing Stock of Finished Goods
( ` 26,52,000 × 24,000/31,200)
(20,40,000)
Total Cash Cost of Sales 6,12,000

(ii) Work in progress stock

( `)
Raw material requirements (12,000 units × `40) 4,80,000
Direct wages (50% × 12,000 units × ` 15) 90,000
Overheads (50% × 12,000 units × ` 30) 1,80,000
7,50,000
(iii) Raw material stock

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CA Amit Sharma

It is given that raw material in stock is average 30 days consumption. Since, the company is newly
formed; the raw material requirement for production and work in progress will be issued and consumed
during the year. Hence, the raw material consumption for the year (360 days) is as follows:
( `)
For Finished goods (31,200 × ` 40) 12,48,000
For Work in progress (12,000 × ` 40) 4,80,000
17,28,000
17,28, 000
Raw material stock = × 30 days = `1,44,000
360days
(iv) Finished goods stock:

24,000 units @ ` (40+15+30) per unit = `20,40,000

60 days
(v) Debtors for sale: ` 6,12,000x 360days
= `1,02,000

(vi) Creditors for raw material Purchases [Working Note (iii)]:

Annual Material Consumed ( `12,48,000 + `4,80,000) `17,28,000
Add: Closing stock of raw material ` 1,44,000
`18,72,000
18, 72, 000
Credit allowed by suppliers = × 30days = ` 1,56,000
360days
(vii) Creditors for wages:
5,58, 000
Outstanding wage payment = ×15days = ` 23,250
360days

Q.27 Working Capital Requirement RTP Nov 22

Trading and Profit and Loss Account of Beat Ltd. for the year ended 31st March, 2022 is given below:
Particulars Amount (`) Amount (`) Particulars Amount(`) Amount(`)
To Opening Stock: By Sales (Credit) 1,60,00,000
- Raw Materials 14,40,000 By Closing Stock:
- Work-in- progress 4,80,000 - Raw Materials 16,00,000
- Finished Goods 20,80,000 40,00,000 - Work-inprogress 8,00,000
To Purchases (credit) 88,00,000 - Finished Goods 24,00,000 48,00,000
To Wages 24,00,000
To Production Exp. 16,00,000
To Gross Profit c/d 40,00,000
2,08,00,000 2,08,00,000
To Administration 14,00,000 By Gross Profitb/d 40,00,000
Exp.
To Selling Exp. 6,00,000
To Net Profit 20,00,000
40,00,000 40,00,000
The opening and closing payables for raw materials were ` 16,00,000 and ` 19,20,000 respectively whereas the
opening and closing balances of receivables were ` 12,00,000 and ` 16,00,000 respectively.
You are required to ASCERTAIN the working capital requirement by operating cycle method.

Ans Computation of Operating Cycle

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(1) Raw Material Storage Period (R)

Average Stock of Raw Material
Raw Material Storage Period (R) =
Daily Average Consumption of Raw material

= (14, 40, 000  16, 00, 000) / 2 = 64.21 Days

86, 40, 000 / 365
Raw Material Consumed = Opening Stock + Purchases – Closing Stock
= ` 14,40,000+ ` 88,00,000– ` 16,00,000 = ` 86,40,000
(2) Conversion/Work-in-Process Period (W)

AverageStock of WIP
Conversion/Processing Period =
Daily Average Pr oduction

= (4, 80, 000  8, 00, 000) / 2 = 18.96 days

1,23,20, 000 / 365
Production Cost: `
Opening Stock of WIP 4,80,000
Add: Raw Material Consumed 86,40,000
Add: Wages 24,00,000
Add: Production Expenses 16,00,000
1,31,20,000
Less: Closing Stock of WIP 8,00,000
Production Cost 1,23,20,000
(3) Finished Goods Storage Period (F)
Average Stock of Finished Goods
Finished Goods Storage Period =
Daily Average Cost of Good Sold

= (20, 80, 000  24, 00, 000) / 2 = 68.13 Days

1,20, 00, 000 / 365

Cost of Goods Sold `

Opening Stock of Finished Goods 20,80,000
Add: Production Cost 1,23,20,000
1,44,00,000
Less: Closing Stock of Finished Goods (24,00,000)
1,20,00,000
(4) Receivables Collection Period (D)
Average Receivables
Receivables Collection Period =
Daily averagecredit sales

= (12, 00, 000  16, 00, 000) / 2 = 31.94 Days

1, 60, 00, 000 / 365

(5) Payables Payment Period (C)

Average Payable
Payables Payment Period =
Daily averagecredit sales

= (16, 00, 000  19,20, 000) / 2 = 73 Days

88, 00, 000 / 365

(6) Duration of Operating Cycle (O)

O = R+W+F+D–C
= 64.21 + 18.96 + 68.13 + 31.94 – 73
= 110.24 days

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Computation of Working Capital

(i) Number of Operating Cycles per Year
= 365/Duration Operating Cycle = 365/110.24 = 3.311
(ii) Total Operating Expenses `
Total Cost of Goods sold 1,20,00,000
Add: Administration Expenses 14,00,000
Add: Selling Expenses 6,00,000
1,40,00,000
(iii) Working Capital Required
Total Operating Expenses
Working Capital Required =
Number of Operating Cycles per year

= 1, 40, 00, 000 = ` 42,28,329.81

3.311

Q.28 Working Capital Requirement RTP July 21

MT Ltd. has been operating its manufacturing facilities till 31.3.202 1 on a single shift working with the following
cost structure:
Per unit (`)
Cost of Materials 24
Wages (out of which 60% variable) 20
Overheads (out of which 20% variable) 20
64
Profit 8
Selling Price 72
As at 31.3.2021 with the sales of ` 17,28,000, the company held:
(`)
Stock of raw materials (at cost) 1,44,000
Work-in-progress (valued at prime cost) Finished 88,000
goods (valued at total cost) Sundry debtors 2,88,000
4,32,000
In view of increased market demand, it is proposed to double production by working an extra shift. It is
expected that a 10% discount will be available from suppliers of raw materials in view of increased volume of
business. Selling price will remain the same. The credit period allowed to customers will remain unaltered. Credit
availed from suppliers will continue to remain at the present level i.e. 2 months. Lag in payment of wages and
overheads will continue to remain at one month.
You are required to CALCULATE the additional working capital requirements, if the policy to increase output is
implemented, to assess the impact of double shift for long term as a matter of production policy.

Ans (1) Statement of cost at single shift and double shift working
24,000 units 48,000 Units
Per unit Total Per unit Total
(`) (`) (`) (`)
Raw materials 24 5,76,000 21.6 10,36,000
Wages:
Variable 12 2,88,000 12 5,76,000
Fixed 8 1,92,000 4 1,92,000
Overheads:

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Variable 4 96,000 4 1,92,000

Fixed 16 3,84,000 8 3,84,000
Total cost 64 15,36,000 49.6 23,80,800
Profit 8 1,92,000 22.4 10,75,200
Sales 72 17,28,000 72 34,56,000

Sales
(2) Sales in units 2020-21 = = 17,28, 000 = 24,000 units
Unit selling price 72

(3) Stock of Raw Materials in units on 31.3.2021

= Value of stock = 6,000 units

1, 44, 000

Cost per unit ` 24

(4) Stock of work-in-progress in units on 31.3.2021
Value of work  in  progress
= = 88, 000 =2,000units
PrimeCost per unit (24+20)

(5) Stock of finished goods in units 2020-213

Value of stock
= = 2, 88, 000 = 4,500 units.
TotalCost per unit 64

Comparative Statement of Working Capital Requirement

Single Shift (24,000 units) Double Shift (48,000 units)
Units Rate Amount Units Rate Amount
(`) (`) (`) (`)
Current Assets
Inventories:
Raw Materials 6,000 24 1,44,000 12,000 21.6 2,59,200
Work-in-Progress 2,000 44 88,000 2,000 37.6 75,200
Finished Goods 4,500 64 2,88,000 9,000 49.6 4,46,400
Sundry Debtors 6,000 64 3,84,000 12,000 49.6 5,95,200
Total Current Assets (A) 9,04,000 13,76,000
Current Liabilities
Creditors for Materials 4,000 24 96,000 8,000 21.6 1,72,800
Creditors for Wages 2,000 20 40,000 4,000 16 64,000
Creditors for Overheads 2,000 20 40,000 4,000 12 48,000
Total Current Liabilities (B) 1,76,000 2,84,800
Working Capital (A) – (B) 7,28,000 10,91,200
Analysis: Additional Working Capital requirement = ` 10,91,200 – ` 7,28,000 = `3,63,200, if the policy to
increase output is implemented.

Q.29 Cash Cost Basis RTP May 20

Day Ltd., a newly formed company has applied to the Private Bank for the first time for financing it's Working
Capital Requirements. The following information is available about the projections 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
Overhead ` 40 per unit (inclusive of Depreciation `10 per unit)

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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 Purchasers 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.

Ans Calculation of Net Working Capital requirement:

( `) ( `)
A. Current Assets:
Inventories:
Stock of Raw material (Refer to Working note (iii) 1,44,000
Stock of Work in progress (Refer to Working note (ii) 7,50,000
Stock of Finished goods (Refer to Working note (iv) 20,40,000
Debtors for Sales(Refer to Working note (v) 1,02,000
Cash 2,00,000
Gross Working Capital 32,36,000 32,36,000
B. Current Liabilities:
Creditors for Purchases (Refer to Working note (vi) 1,56,000
Creditors for wages (Refer to Working note (vii) 23,250
1,79,250 1,79,250
Net Working Capital (A - B) 30,56,750

Working Notes:
(i) Annual cost of production
(`)
Raw material requirements
{(31,200 × ` 40) + (12,000 x ` 40)}
17,28,000
Direct wages {(31,200 × ` 15) +(12,000 X ` 15 x 0.5)} 5,58,000
Overheads (exclusive of depreciation)
{(31,200 × ` 30) + (12,000 x ` 30 x 0.5)} 11,16,000
Gross Factory Cost 34,02,000
Less: Closing W.I.P [12,000 ( ` 40 + ` 7.5 + `15)] (7,50,000)
Cost of Goods Produced 26,52,000
Less: Closing Stock of Finished Goods
( ` 26,52,000 × 24,000/31,200) (20,40,000)
Total Cash Cost of Sales* 6,12,000

[*Note: Alternatively, Total Cash Cost of Sales = (31,200 units – 24,000 units) x ( ` 40+ ` 15 + ` 30) = `
6,12,000]
(ii) Work in progress stock

(`)
Raw material requirements (12,000 units × `40) 4,80,000
Direct wages (50% × 12,000 units × ` 15) 90,000
Overheads (50% × 12,000 units × ` 30) 1,80,000

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7,50,000

(iii) Raw material stock

It is given that raw material in stock is average 30 days consumption. Since, the company is newly formed;
the raw material requirement for production and work in progress will be issued and consumed during the
year. Hence, the raw materi al consumption for the year (360 days) is as follows:

(`)
For Finished goods (31,200 × ` 40) 12,48,000
For Work in progress (12,000 × ` 40) 4,80,000
17,28,000
17,28, 000
Raw material stock = × 30 days = `1,44,000
360days
(iv) Finished goods stock:
24,000 units @ ` (40+15+30) per unit = `20,40,000
60 days
(v) Debtors for sale: ` 6,12,000x = `1,02,000
360days
(vi) Creditors for raw material Purchases [Working Note (iii)]:
Annual Material Consumed ( `12,48,000 + `4,80,000) `17,28,000
Add: Closing stock of raw material [( `17,28,000 x 30 days) / 360 days] ` 1,44,000
`18,72,000
18, 72, 000
Credit allowed by suppliers = × 30days = ` 1,56,000
360days
(vii) Creditors for wages:
Outstanding wage payment = [(31,200 units x ` 15) + (12,000 units x ` 15 x .50)] x
15 days / 360 days
5,58, 000
= ×15days = ` 23,250
360days

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