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Problems

Unit 1: Introduction to Financial Management

1) Find out from the following:

a) P.V. Ratio

b) Fixed cost

c) Sales volume to earn a profit of Rs.40,000

Sales

Profit

Variable Cost

Rs.1,00,000

Rs.10,000

70%

2) The sales turnover and profit during two years were as follows:

Year

Sales (Rs.)

2002

1,40,000

2003

1,60,000

You are required to calculate:

Profit (Rs.)

15,000

20,000

a) P/V Ratio

b) Sales required to earn a profit of Rs. 40,000

c) Profit when sales are Rs.1,20,000

3) From the following information, calculate the break-even point in units and in sales value:

Output

Selling price per unit

Variable Cost per unit

Total fixed cost

3,000 units

Rs.30

Rs.20

Rs.20,000

a) Break-even point in terms of sales value and in units.

b) Number of units that must be sold to earn a profit of Rs.90,000

Fixed factory overheads cost

Rs.60,000

Fixed selling overheads cost

Rs.12,000

Variable manufacturing cost per unit

Rs.12

Variable selling cost per unit

Rs.3

Selling price per unit

Rs.24

a) P/V Ratio

b) Break-even sales with the help of P/V Ratio

c) Sales required to earn a profit of Rs.4,50,000

Fixed expenses

Variable cost per unit: Direct material

Direct labour

Direct overheads

Selling price per unit

6) From the following information calculate:

Rs.90,000

Rs.5

Rs.2

100% of Direct labour

Rs.12

a) P/V Ratio

b) Break-even point

c) Margin of safety

Total Sales

Selling price per unit

Variable Cost per unit

Fixed cost

Rs.3,60,000

Rs.100

Rs. 50

Rs.1,00,000

7) If you deposit Rs. 5,000 today at 6% rate of interest, in how many years will this amount

double?

8) Calculate the compound value of Rs. 10,000 at the end of 3 years at 12% rate of interest,

when interest is calculated on (a) yearly basis and (b) quarterly basis.

9) A company offers 12% rate of interest on deposits. What is the effective rate of interest if

the compounding is done (a) half yearly (b) quarterly and (c) monthly?

10) Mr. A deposits Rs. 1,000 at the end of every year for 4 years and the deposit earns a

compound interest @ 10% p.a. Determine how much money he will have at the end of 4

years?

11) Mr. X is to receive Rs. 5,000 after 5 years from now. His time preference from money (rate

of interest) is 10% p.a. Calculate its present value by using discount factor tables.

12) Calculate present value of the following cash flows assuming a discount rate of 10%.

Year

5,000

10,000

10,000

3,000

2,000

Q.1. Determine the payback period for a project which requires a cash outlay of Rs. 10,000 and

generates cash inflows of Rs. 2,000, Rs. 4,000, Rs. 3,000 and Rs. 2,000, in the first, second, third and

fourth year respectively

Q.2. A project cost Rs. 5,00,000 and yields annually a profit of Rs. 80,000 after depreciation @ 12%

p.a. but before tax of 50%. Calculate the payback period.

Q.3. Calculate discounted payback period from the information given below:

Cost of project

Rs. 6,00,000

5 years

Cut off rate

10%

Q.4. From the following information calculate the net present value of the two projects and

suggest which of the two projects should be accepted assuming a discount rate of 10%.

Particulars

Initial investment

Estimated life

Scrap value

Project X

Rs. 20,000

5 years

Rs. 1,000

Project Y

Rs. 30,000

5 years

Rs. 2,000

The profits before depreciation and after taxes (cash flows) are as follows:

Projects

Project X

Project Y

Year 1 (Rs.)

5,000

20,000

Year 2 (Rs.)

10,000

10,000

Year 3 (Rs.)

10,000

5,000

Year 4 (Rs.)

3,000

3,000

Year 5 (Rs.)

2,000

2,000

Q.5. No project is acceptable unless the yield is 10%. Cash inflows of a certain project alongwith

cash outflows are given below:

Years

Outflows (Rs.) Inflows (Rs.)

0

1,50,000

1

30,000

20,000

2

30,000

3

60,000

4

80,000

5

30,000

The salvage value at the end of the 5th year is Rs. 40,000.

Calculate Net Present Value.

Initial investment

Life of the asset

Estimated net annual cash flows:

1st year

2nd year

3rd year

4th year

Rs. 60,000

4 years

15,000

20,000

30,000

20,000

Q.7. The initial cash outlay of a project is Rs. 50,000 and it generates cash inflows of Rs. 20,000,

Rs.15,000, Rs. 25,000 and Rs. 10,000 in four years.

Using present value index method, appraise profitability of the proposed investment assuming

10% rate of discount.

(Hint: First calculate Net present value and then calculate Profitability index)

Q.8. Using the information given below, compute the payback period under:

(a) Traditional payback method

(b) Discounted pay-back method

Initial outlay

Rs. 80,000

Estimated Life

5 years

Profit after tax:

End of 1st year

6,000

nd

End of 2 year

14,000

End of 3rd year

24,000

th

End of 4 year

16,000

th

End of 5 year

nil

Depreciation has been calculated under straight line method.

The cost of capital may be taken at 20% p.a. and the P.V. of Rupee 1 at 20% is given below:

Year

P.V. Factor

1

0.83

2

0.69

3

0.58

4

0.48

5

0.40

Q.9. X ltd. is considering the purchase of a machine. Two machines are available E and F. The cost

of each machine is Rs. 60,000. Each machine has an expected life of 5 years.

Net profits before tax and after depreciation during the expected life of the machines are given

below:

Year

Machine E (Rs.) Machine F (Rs.)

1

15,000

5,000

2

20,000

15,000

3

25,000

20,000

4

15,000

30,000

5

10,000

20,000

Total

85,000

90,000

Following the method of Average Return on Average Investment ascertain which of the

alternatives will be more profitable. The average rate of tax may be taken at 50%.

Q.1. (a) X Ltd. issues Rs. 50,000 8%debentures at par. The tax rate applicable to the company is

50%.compute the cost of debt capital.

(b) Y Ltd. issues Rs.50,000 8% debentures at a premium of 10%. The tax rate applicable to The

company is 60%. Compute cost of debt capital.

(c) A Ltd. Issues Rs. 50,000 08% debentures at a discount of 5%. The tax rate is 50%, compute the

cost of debt capital.

(d) B Ltd. Issues Rs. 1,00,000 9% debentures at a premium of 10%. The costs of floatation are 2%.

The tax rate applicable is 60%. Compute cost of debt-capital.

Q.2. A company issues Rs.10,00,000 10% redeemable debentures at a discount of 5 years. Calculate

before-tax and after-tax cost of debt assuming a tax rate of 50%.

Q.3. A 5-years Rs.100 debenture of a firm can be sold for a net price of Rs. 96.50. The coupon rate

of interest is 14 per cent per annum, and the debenture will be redeemed at 5 per cent premium on

maturity. The firms tax rate is 40%.compute the after-tax cost of debenture.

Q.4. A company issues 10,000 10% preference shares of Rs.100 each. Cost of issues is Rs.2 per

share. Calculate cost of preference capital if these shares are issued(a) at per,(b) at a premium of

10%,and (c) at a discount of 5%.

Q.5. A company issues 10,000 10% preference shares of Rs.100 each redeemable after 10 years at a

premium of 5%. The cost of issue is Rs. 2 per share. Calculate the cost of preference capital.

Q.6. A company issues 1,000 7% preference shares of Rs.100 each at premium of 10% redeemable

after 5 years at par. Compute the cost of preference capital.

Q.7. A company issues 1000 equity shares of Rs.100 each at a premium of 10%. The company has

been paying 20 % dividend to equity shareholders for the five years and expects to maintain the

same in the future also .Compute the cost of equity capital. Will it make any difference if the

market price of equity share is Rs.160 ?s

Q.8. (a) A company plan to issue 1000 new shares of Rs.100 each at par. The floatation costs are

expected to be 5% of the share price. The company pays a dividend of Rs.10 per share initially and

the growth in dividends is expected to be 5%. Compute the cost of new issue of equity shares.

(b)If the current market price of an equity share is Rs.150, calculate the cost of existing equity

share capital.

Q.9. The shares of a company are selling at Rs.40 per share and it had paid a dividend of Rs. 4 per

share last year. The investors market expects a growth rate of 5 per cent per year.

(a) Compute the companys equity cost of capital;

(b) If the anticipated growth rate is 7 per cent per annum, calculate the indicated market price per

share.

Q.10. A firm is considering an expenditure of Rs. 60 Lakhs for expanding its operations. The

relevant information is as follows:

Number of existing equity shares

10 Lakhs

Market value of existing shares

Rs.60

Net earnings

90 Lakhs

Compute the cost of existing equity share capital and of new equity capital assuming that new

shares will be issued at a price of Rs. 52 per share and the costs of new issue will be Rs.2 per share.

Q.11. You are given the following facts about a firm:

(i) Risk-free rate of return is 11%.

(ii) Beta co-efficient, i, of the firm is 1.25.

Compute the cost of equity capital using Capital Asset pricing Model (CAPM) assuming a

market return of 15 per cent next year. What would be the cost of equity if i rises to 1.75.

Q.12. A firm has the following capital structure and after tax costs for the different sources of

funds used:

Sources of funds

Amount (Rs.)

Proportion (%)

After tax cost (%)

Debt

15,00,000

25

5

Preference shares

12,00,000

20

10

Equity shares

18,00,000

30

12

Retained earnings

15,00,000

25

11

Total

60,00,000

100

You are required to compute the weighted average cost of capital.

Q.13. Continuing the above question, if the firm has 18,000 equity shares of Rs. 100 each

outstanding and the current market price is Rs. 300 per share, calculate the market value weighted

average cost of capital assuming that the market values and book values of the debt and

preference capital are the same.

Q.14. In considering the most desirable capital structure for a company, the following estimates of

the debt and equity capital (after tax) have been made at various levels of debt-equity mix:

Debt as a percentage of total

Cost of debt Cost of

capital employed

(%)

equity (%)

0

5.00

12.00

10

5.00

12.00

20

5.00

12.50

30

5.50

13.00

40

6.00

14.00

50

6.50

16.00

60

7.00

20.00

You are required to determine the optimal debt equity mix for the company by calculating

composite cost of capital.

Q.15. The following is the capital structure of Saras Ltd. as on 31st December, 2003:

Particulars

Equity shares- 20,000 shares of Rs. 100 each

10% Preference shares of Rs. 100 each

12% Debentures

Rs.

20,00,000

8,00,000

12,00,000

40,00,000

The market price of the companys share is Rs. 110 and it is expected that a dividend of Rs.10 per

share would be declared after 1 year. The dividend growth rate is 6%.

(i) If the company is in the 50% tax bracket, compute the weighted average cost of capital

(ii) Assuming that in order to finance an expansion plan, the company intends to borrow a fund of

Rs. 20 lakhs bearing 14% rate of interest, what will be the companys revised weighted average

cost of capital? This financing decision is expected to increase dividend from Rs. 10 to Rs. 12 per

share. However, the market price of equity share is expected to decline from Rs. 110 to Rs. 105 per

share.

Q.1. A ltd. Company has equity share capital of Rs. 5,00,000 divided into shares of Rs. 100 each. It

wishes to raise further Rs. 3,00,000 for expansion cum modernization plans. The company plans

the following financing schemes:

a) All Equity stock

b) Rs. 1,00,000 in equity shares and Rs. 2,00,000 in 10% debentures

c) All debt at 10% per annum

d) Rs. 1,00,000 in equity shares and Rs. 2,00,000 in preference capital with the rate of dividend

at 8%

The companys existing earnings before interest and tax (EBIT) is Rs. 1,50,000. The corporate rate

of tax is 50%.

You are required to determine the earnings per share (EPS) in each plan and comment on the

implications of financial leverage.

Q.2. XYZ company has currently an equity share capital of Rs.40,00,000 consisting of 40,000 equity

shares of Rs.100 each. The management is planning to raise another Rs.30,00,000 to finance a

major programme of expansion through one of the four possible financing plans.

The options are:

a) Entirely through equity shares

b) Rs. 15,00,000 in equity shares of Rs.100 each and the balance in 8% debentures

c) Rs. 10,00,000 in equity shares of Rs.100 each and the balance through long-term borrowing

at 9% interest p.a.

d) Rs. 15,00,000 in equity shares of Rs.100 each and the balance through preference shares

with 5% dividend

The companys expected earnings before interest and taxes (EBIT) will be Rs.15,00,000. Assuming

corporate tax rate of 50%, you are required to determine the earnings per share (EPS) and

comment on the financial leverage that will be authorized under each of the above scheme of

financing.

Q.3. A company has sales of Rs.5,00,000, variable costs of Rs.3,00,000, fixed costs of Rs.1,00,000

and long term loans of Rs.4,00,000 at 10% rate of interest. Calculate the composite leverage.

Q.4. The following figures relate to two companies:

Particulars

Sales

Variable costs

Contribution

Fixed costs

Interest

Profit before Tax

500

200

300

150

150

50

100

1,000

300

700

400

300

100

200

a) Calculate the operating, financial and combined leverages for the two companies; and

b) Comment on the relative risk position of them

Q.5. A firm has sales of Rs.20,00,000, variable cost of Rs.14,00,000 and fixed costs of Rs.4,00,000

and debt of Rs.10,00,000 at 10% rate of interest. What are the operating, financial and combined

leverages? If the firm wants to double its earnings before interest ans tax (EBIT), how much of a

rise in sales would be needed on a percentage basis?

Particulars

Financial Leverage

Interest

Operating Leverage

Variable cost as a %age of sales

Income-tax rate

Company A

3:1

Rs.200

4:1

66 2/3 %

45%

Company B

4:1

Rs.300

5:1

75%

45%

Company C

2:1

Rs.1,000

3:1

50%

45%

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