MS2608 - FINANCIAL MANAGEMENT

UNIT I

Part-A
1. What do you mean by financial management? (R1PageNo.1)
Financial Management refers to rising of funds, their effective utilization
enabling to overall objectives of the firm. Simple financial management means,
manage the finance. Financial management gives special attention for the effective
management of funds.

2. Define Financial Management. (R1PageNo.1)

According to Joseph and Massie, “Financial Management is the operational
activity of a business that is responsible for obtaining and effectively utilizing the
funds necessary for efficient operations”.
3. List the objectives of financial Management. (R1PageNo.1)
1. Profit Maximization
2. Maximization of shareholders wealth
3. Wealth maximization

4. List the basic financial decisions. (R1PageNo.2)

The basic financial decisions are
 Fund requirement Decision
 Financing Decision
 Investment Decision
 Dividend Decision
 Liquidity Decision

5. What are the basic principles of Financial Management ?(R1PageNo.2)

1. Risk and Return
2. Time value of Money
3. Cash flow concept
4. Incremental cash flow analysis
5. Wealth Maximization
6. List the aspects of Time Value of Money. (R1PageNo.7)
1. Compensation for uncertainty
2. Preference for present consumption
3. The reinvestment opportunity

7. What do you mean by financial analysis? (R1PageNo.1)

 The term financial analysis refers to the process of examining the financial strength
and weakness of the firm by establishing relationship between the items from the balance
sheet, profit and loss account and other data. It is otherwise known as analysis and
interpretation of financial statements

8. List the tools of financial analysis. (R1PageNo.39)

Analysis and interpretation of financial statements reveals the financial position of
the concern in whole. The following tools are used for financial analysis
 Comparative Financial Statements
 Common Size Financial Statements
 Trend Analysis
 Fund Flow Analysis
 Cash Flow Analysis
 Ratio Analysis
 Cost Volume Profit Analysis

9. What do you mean by Cost Volume Profit Analysis? (R1PageNo.48)

Cost Volume Profit Analysis means planning of the average business in the
relationship between the volume of business cost and profits. It is otherwise called as CVP
Analysis. With help of the CVP Analysis the financial institution and financial agencies can
easily evaluate the profitable position, volume of business and cost.

10. Define Fund Flow Statement. (R1PageNo.50)

In the words of Foulke, “A Statement of sources and application of funds is a
technical device designed to analyse the changes in the financial conditions of a business
enterprise between two balance sheet dates”.

11. State the meaning of Current Assets. (R1PageNo.74)

Current assets are those assets which can be converted into cash quickly without any
delay. The components of current assets are cash in hand, cash at bank, Stock, bills
receivable, sundry debtors, marketable securities, accrued incomes, prepaid expenses, work in
process
12. Write the importance of Ratio Analysis (R1Page no.75)
1. Aid to measure general efficiency
2. Aid to measure financial solvency
3. Aid in forecasting and planning
4. Facilitate decision making
5. Evaluation of efficiency
13. List the uses of Cash Flow Statement. (R1PageNo.64)
1. Cash flow statement facilitates to prepare sound financial policies.
2. A projected cash flow statement can be prepared in order to know the future cash position
of a concern.
3. It helps the management in taking short term financial decisions.
4. The statement explains the causes for poor cash position in spite of substantial profits in a
firm by throwing light on various applications of cash made by the firm.
14. State the meaning of current Ratio.(R1PageNo.76)
 Current Ratio is the common ratio for measuring liquidity. It expresses relationship
between current assets and current liabilities
Current Ratio = Current Assets/ Current liabilities
15. What do you mean by Financial Planning? (R1PageNo.39)
It is the task of determining how a business will afford to achieve its strategic
goals and objectives. It s the process of estimating the capital required and
determining its completion.
16 MARKS

UNIT I

1. Explain the functions of financial management. (R1PageNo.2)

(a) Financing Decisions (2)
(b) Formulation of Borrowing Policy (2)
(c) Capital Budgeting Decisions (2)
(d) Finance Forecasting (2)
(e) Investigation of Financial Performance (2)
(f) Negotiation of various new outside financing (2)
(g) Dividend Decision (2)
(h) Acquisition and Mergers (2)
2. Describe the importance of financial management. (8 Marks) (R1PageNo.3)
(i) Acquiring financial resources (2)
(ii) Anticipation of financial needs (2)
(iii)Guide to decision making (2)
(iv) Allocating the funds in business (2)
(v) Analysing financial performance(2)
(vi) Finance for business promotion (3)
(vii) Accounting and reporting (3)
3. Elaborate the different methods used for the analysis and interpretation of
financial statements? (R1PageNo.41 and 42)
(i) Comparative financial statements (2)
(ii) Common size financial statements (2)
(iii)Trend analysis (2)
(iv) Fund flow analysis (3)
(v) Cash flow analysis (2)
(vi) Ratio analysis (3)
(vii) Cost volume profit analysis(2)

4. From the following profit and loss account for the year ended 31st Dec 2000
and 2001 prepare comparative income statement and comparative balance
sheet. (R1PageNo.45)
Profit & Loss Account
Particulars 2000 2001 Particulars 2000 2001
To cost of sales 600 750 By net sales 800 1000
To administrative 20 20
expenses
To selling expenses 30 40
To net profit 150 190
800 1000 800 1000
st
Balance sheet as on 31 December
Liabilities 2000 2001 Assets 2000 2001
Bills payable 50 75 cash 100 140
Sundry creditors 150 200 Debtors 200 300
Tax payable 100 150 Stock 200 300
6% Debentures 100 150 Land 100 100
10% Preference share 300 300 Building 300 270
capital
Equity capital 400 400 Plant 300 270
Reserves 200 245 Furniture 100 140
Total 1300 1520 Total 1300 1520
Comparative Income Statement(8m)
Particulars 2000 2001 Increase Percentage (%)
or
decrease
Net sales 800 1000 +200 25%
Less: 600 750 +150 25%
Cost of goods sold
Gross profit 200 250 50 25%
Less : 20 20
Operating expenses
Administrative 30 40 10 33.33%
selling
Total opening 50 60 10 26.66%
expenses
Operating profit 150 190 40 26.66%
Comparitive Balance Sheet
Current asset statement
Particulars 2000 2001 Increase Percentage (%)
or
decrease
Cash 100 140 40 40/100×100 40%
Debtors 200 300 100 100/200×100 50%
Stock 200 300 100 100/200×100 50%
Total current asset 500 740 240 240/500×100 48%
10% Preference 300 300
share
Equity capital 400 400
Reserves 200 245 45 45/200×100 5%
Total shareholders 900 945 45 45/900×100 5%
fund
Total liabilities and 1300 1520 220 220/1300×100 16.92%
capital
 5. The profit and Loss account and balance sheet of N ltd as on 31st march
2007 are as follows. Calculate common size income statement and balance
sheet. (R1PageNo.47)
Profit and Loss Account
Particulars 2006 2007
Sales: 2900000 3400000
Non operating income 150000 100000
3050000 3500000
Expenses:
Cost of production 1640000 1885000
Administrative expenses 540000 620000
Selling expenses 210000 275000
Interest 370000 390000
Total expenses 2760000 3170000
Net profit 290000 330000

Balance Sheet
Particulars 2006 2007
Assets
Cash 75000 95000
Sundry debtors 70000 77000
Stock 79000 85000
Outstanding Income 26000 23000
Prepaid expenses 20000 10000
Fixed asset 1020000 1210000
Total asset 1290000 1500000

Liabilities
Creditors 45000 32000
Bills ;payable 25000 13000
Long term loan 400000 555000
Capital 820000 900000
Total liabilities 1290000 1500000

Common size income statement(8m)

Particulars 2006 2007

Amt % Amt %
Sales 2900000 100 3400000 100
Less: 1640000 56.55 1885000 55.44
Cost of Production
Gross profit 1260000 43.45 1515000 44.56
Operating expenses: 540000 18.62 620000 18.24
Administrative expenses
Selling Expenses 210000 7.24 275000 8.08
Total operating expenses 750000 23.86 895000 26.32

Particulars 2006 2007

Operating profit Amt % Amt %
Operating expenses 510000 17.59 620000 18.23

Non operating income 150000 5.17 100000 2.94

Total income 660000 22.76 720000 21.17
Less: 370000 12.76 390000 11.47
Interest
Net profit 290000 10 330000 9.70

Common size balance sheet (8m)

Particulars 2006 2007
Amt % Amt %
Current assets
Cash 75000 5.81 95000 6.33
Sundry debtors 70000 5.42 77000 5.13
Stock 79000 6.12 85000 5.66
Outstanding Income 26000 2.01 23000 1.53
Prepaid expenses 20000 1.5 10000 0.66
Total current asset 270000 20.93 290000 19.33
Fixed asset 1020000 79.07 1210000 80.67
Total asset 1290000 100 1500000 100

Particulars N ltd M ltd

Current liabilities Amt % Amt %
Sundry creditors 45000 3.48 32000 2.13
Bills payable 25000 1.93 13000 0.86
Total current liabilities 70000 5.42 45000 3

Long term liabilities

Long term loan 400000 31.0 555000 37
Capital 8200000 63.57 900000 60
Total liabilities 1290000 100 1500000 100

a) Elaborate the uses of preparing cash flow statements? (8 marks)

(R1PageNo.66)
 Meaning (2)
Cash flow statement is a statement which is reveal the
movement of funds and is a report of the financial operations of
the business undertaking.
 Uses (6)
 Clearly explains the reasons for changes in the assets
and liabilities
 Helps the management for detailed analysis
 Guides the organisation to formulate financial policies
 Helps the management to identify strong and weak
financial areas
 Gives the solution for various difficult financial
questions
 Helps to evaluate the credit worthiness and repaying
capacity of the company
b) How does cash flow statement differ from fund flow statement? (8 marks)
 F.F – wider concept
C.F – narrower concept
 F.F – accrual basis of accounting
C.F – cash basis of accounting
 F.F – prepare the statement of changes in working capital
C.F – need not prepare the statement of changes in working
capital
 F.F – prepared by the sources and application of funds
C.F – prepared by cash inflows and cash outflows
 F.F – find out fund from operation
C.F – find out cash from operation
 F.F – guide to management for long term planning
C.F – guide to management for short term analysis

UNIT – II

1. Define Cost of Capital. (R1PageNo.161)

James C. Van Horne Defines cost of capital as, “a cut-off rate for the
allocation of capital to investments of projects. It is the rate of return on a project that
will leave unchanged the market price of the stock”.

2. What do you mean by the minimum rate of return or cut-off rate?

(R1PageNo.161)
Cost of Capital is otherwise known as the minimum rate of return or cut-off
rate. The cost of capital is the minimum rate of return a firm can earn on its
investment. The source of capital of a firm must be in the form of preference shares,
equity shares, debt and retained earnings.

3. State the meaning of Historical Cost.(R1PageNo.162)

Historical costs are the costs which are incurred for the procurement of
funds based upon the existing capital structure of the firm. Simply it is the book cost.
4. What do you mean by Future Cost? (R1PageNo.162)
 Future Cost is the cost which is relate to estimated for the future. Simply it is
the cost to be incurred for raising new funds.

5. Write the meaning of Explicit cost . (R1PageNo.163)

An explicit cost refers to the discount rate at which equalize the total present
value of cash inflows with the present value of cash outflows. It is otherwise known
as cut-off rate or internal rate of return
6. What do you mean by Implicit cost ? (R1PageNo.163)
An implicit cost is defined as the rate of return related to the best investment
opportunity of the firm and its shareholders that will be forgone in order to take up a
particular project. It is otherwise known as opportunity cost.
7. List the factors involved in operating Leverage.
1. The Quantum of sales
2. The amount of fixed costs
3. The contribution Margin

8. State the types of Leverage. (R1PageNo.192)

 Operating Leverage
 Financial Leverage
 Composite or Combined Leverage

9. Define Leverage. (R1PageNo.192)

James C. Van Horne has defined leverage as, “the employment of an asset
or sources of funds for which the firm has to pay a fixed cost or fixed return. The
fixed cost indicate the fixed operating cost, fixed return indicate financial cost it
should remain constant irrespective of changes in the volume of output or sales”.

10. What do you mean by trading on equity? (R1PageNo.162)

The use of long term fixed interest bearing securities, that means debt and
preference capital along with equity share capital is called financial leverage or
trading on equity

11. Write down the meaning of degree of operating leverage. (R1PageNo.193)

The term degree of operating leverage refers to the percentage changes in the
profits resulting from percentage change in sales

12. What do you mean by composite leverage? (R1PageNo.192)

Composite leverage is otherwise known as combined leverage. Composite
leverage is express the relationship between revenue on account of sales and taxable
income
Composite Leverage = Operating Leverage x Financial Leverage
13. State the types of capital. (R1PageNo.221)
Generally capital requirement of the business organization can be classified
under two main classifications
(i) Fixed Capital – Capital required for the purchase of land, plant & machinery,
office equipment, furniture and construction of building is called fixed
capital
(ii) Working Capital – Working Capital represent the amount of capital required
for the day-to-day activities

14. What do you mean by operating cycle? (R1PageNo.223)

In a manufacturing organization the operating cycle starts from the purchase
of raw material and ends with the conversion of cash. It indicates, the time required to
convert the cash into raw material, raw materials to work in progress, work in
progress to finished goods, finished goods to debtors and debtors back to cash. This
continuous process is called Operating cycle

15. List the procedures of estimation of Working capital. (R1PageNo.221)

1. Estimation of total current assets
2. Estimation of total current liabilities
3. Ascertainment of networking capital requirement
16 Marks
1. Explain the factors which determine the working capital needs of the
organization. (R1PageNo.221 and222)
(i) Nature of the business (1)
(ii) Production policies (1)
(iii)Length of the manufacturing cycle (2)
(iv) Growth and expansion (2)
(v) Capital structure of the company (1)
(vi) Policies of RBI (1)
(vii) Terms of purchases and sales(1)
(viii) Profitability (2)
(ix) Dividend policy (1)
(x) Seasonal variation (1)
(xi) Irregularities of supplies (1)
(xii) Sales volume (1)
(xiii) Market condition (1)
2. Describe the importance of Cost of capital and also the classification of cost of
capital. (R1PageNo.163 and 164)
Importance of Cost of capital
1. Determination of capital budgeting decisions (2)
2. To assist capital structure decisions(2)
3. To assist project expansion(2)
4. To evaluate the financial performance(2)
 5. Basis for taking other financial decisions(1)

Classification of cost of capital

1. Historical cost and future cost(2)

2. Specific cost and composite cost(2)
3. Average cost and Marginal cost(1)
4. Explicit cost and Implicit cost(1)
5. Normalized cost(1)

3. Describe the term Leverage and the types of Leverage(R1PageNo.192

and193)
Leverage
The employment of an asset or sources of funds for which the firm has to pay a
fixed cost or fixed return. The fixed cost indicates fixed operating cost, and fixed
return indicate financial cost it should remain constant irrespective of changes in
the volume of output or sales.(2)
Types
1. Operating Leverage(4)
2. Financial leverage(4)
3. Composite Leverage(4)
4. Describe the Techniques of working capital(R1PageNo.223 and 224)
1. Conventional Method (3)
2. Operating cycle(3)
3. Percentage of sales approach(3)
4. Balance sheet method(3)
5. Regression Analysis method(4)
5. MBC Ltd is considering the financial plan with a view to examining their
impact on Earnings Per Share (EPS). The Total funds required for
investment in assets are Rs.700000(R1PageNo.181 and 182)
Financial Plants:
Plan I (Rs) Plan II (Rs)
Debt (Interest @ 10% p.a.) 400000 100000
Equity shares (Rs.10 each) 300000 600000
Total finance required 700000 700000
No. of equity shares 30000 60000
The earnings before interest and tax are assumed as Rs. 50000, Rs. 75000 and
Rs. 125000. Tax rate may be taken at 50%
Solution
1. When EBIT are Rs 50000
Plan I Plan II
EBIT 50000 50000
Less interest on debt 40000 10000
Earnings before tax 10000 40000
Less Tax 50% 5000 20000
 PAT 5000 20000
No. Of Equity shares 30000 60000
Earnings per share 5000 20000
0.60 0.30P
2. When EBIT are Rs 75000
Plan I Plan II
EBIT 75000 75000
Less interest on debt 40000 10000
Earnings before tax 35000 65000
Less Tax 50% 17500 32500
PAT 17500 32500
No. Of Equity shares 30000 60000
Earnings per share 0.58 0.54

3. When EBIT are Rs 125000

Plan I Plan II
EBIT 125000 125000
Less interest on debt 40000 10000
Earnings before tax 85000 115000
Less Tax 50% 42500 57500
PAT 42500 57500
No. Of Equity shares 30000 60000
Earnings per share 1.41 0.95

6. Godrej Company sells goods in the home market and earns a gross profit of
20% on sales. Its annual figures are as follows: (R1PageNo.188 and189)
Rs.
Sales 300000
Materials used 108000
Wages 96000
Manufacturing expenses 30000
Administrative expenses 120000
Depreciation 12000
Selling expenses 18000
Income tax payable in two instalments
of which one falls in the next year 30000
Additional Information:
(a) Credit given by suppliers-2 months
(b) Credit allowed to customers-1 month
(c) Lag in payment of wages-1/2 month
 (d) Lag in payment of manufacturing expenses-1 month
(e) Selling expenses are paid quarterly in advance
(f) Raw materials and finished goods are in stock for 1 month
(g) Cash balance estimated to be maintained at Rs. 30000
You are required to prepare a statement of working capital requirements.

Solution (16Marks)

Stock of rawmaterials 9000

Stock of finished goods 20000

Prepaid selling expenses 4500

Debtors 20000

Cash balance 30000

Total current Assets 83500

Less Creditors 18000

Lag in payment of wages 4000

Lag in payment of manufacturing expenses 10000

Total current liabilities 32000

Working capital Required 51500

Sales 300000

Less Gross profit 60000

Cost of sales 240000

UNIT – III
1. What do you mean by capital structure? (R1PageNo.132)
The term capital structure refers to the mix of long-term sources of funds
such as equity share capital, reserves and surpluses, debenture, long-term debt
from outside sources and preference share capital. In other words, capital
structure refers to total assets less current liabilities

2. Define capital structure. (R1PageNo.132)

According to Weston and Brigham, “capital structure is the permanent
financing of the firm represented by long-term debt, preferred stock and net
worth”
3. Write down the meaning of medium term capital. (R1PageNo.133)
According to state Industrial Corporation in West Bengal, a medium term
capital refers to capital that varies for periods from one to ten years. The sources
of medium term capital are hire purchase, equipment leasing and public deposits.

4. What do you mean by point of indifference? (R1PageNo.134)

The term point of indifference refers to that earnings before interest and
tax at which earnings per share or return on share capital is equal for various
combinations of debt and equity.

5. State the meaning of capital gearing. (R1PageNo.133)

Capital gearing or leverage refers to the relationship between equity capital
and long term debt. In other words it is the proportion between fixed interest or
dividend bearing securities and non-fixed interest or non-bearing securities in the
capital structure of the company.

6. What do you mean by capital structure planning? (R1PageNo.132)

The term capital structure means proportion of various sources of equity
share capital, preference share capital, retained earnings, term loan and debentures
in the total capital of the firm. Capital structure planning means the estimation of
total capital requirements for current and future needs is almost essential for a
firm. Simply a capital structure planning helps to ensure effective utilization of
funds and maximize the return to equity shareholders.

7. What are the essentials of a sound capital mix? (R1PageNo.135)

A sound capital should have the following essential features,
(i) The capital structure should be flexible
(ii) It involves minimum possible risk of loss of control
(iii)To avoid undue restrictions in agreement of debt
(iv) To avoid undue financial risk with the increase of debt

8. Write down the meaning of optimum capital structure. (R1PageNo.133)

The term balanced or optimum capital structure is that capital structure at
that level of debt-equity proportion where the market value per share is maximum
and the cost of capital is minimum.

9. Define marginal cost and marginal costing. (R1PageNo.142)

The Chartered Institute of Management Accountants, England, defines the
term marginal cost as,” Marginal cost is the amount at any given volume of output
by which aggregate costs are changed if the volume of output is increased or
decreased by one unit”
The Institute of Cost and Management Accounts London has defined
Marginal Costing as,” the ascertainment of marginal costs and of the effect of
 profit of changes in volume or type output by differentiating between fixed costs
and variable costs”.

10. Write the meaning of Contribution. (R1PageNo.143)

Contribution is the difference between sales and variable cost. It may be
defined as the excess selling price over variable cost per unit. Contribution is also
known as Contribution margin or Gross margin.
Contribution can be arrived by,
Contribution = Sales – Variable Cost
OR
Contribution = Fixed cost + Profit

11. What do you mean by Absorption costing? (R1PageNo.144)

Absorption costing is a technique whereby fixed as well as variable costs
are considered as to find out the cost of production and also used to determining
the cost of goods manufactured and inventories. It is also called as total or full
cost method.
12. State the meaning of Break Even chart. (R1PageNo.145)
Break even chart is a chart which is showing the graphical representation of the
break even point with help of the mathematical formula. It reveals the
interrelationship between the profit volume and cost.

13. What do you mean by P/V ratio? (R1PageNo.146)

Profit Volume ratio is one of the most important ratio for studying the
profitability position of the business and also establishes the relationship between
contribution and sales. It is otherwise called contribution ratio or marginal ratio
P/V ratio. It can computed the following,
P/V ratio = contribution / sales x 100
14. State the meaning o Break Even Analysis. (R1PageNo.145)
The term Break Even Analysis is applied in two sense one is narrow sense
and another one is broad sense. In the broad sense point of view, break even
analysis refers to the study of relationship between costs, volume and profits at
different levels of production or sales. In the narrow sense point of view, break
even analysis refers to a technique of determining that level of operation where
total incomes equal to its total expenses i.e., no profit no loss point.

15. What do you mean by angle of incidence? (R1PageNo.146)

The angle of incidence is formed at the breakeven point at which the sales
line cuts the total cost line. It indicates the profit earning capacity of the
organization. Large angle of incidence is an indication of higher rate of profit. On
the other hand small angle of incidence indicates the low rate of profit.
16 Marks
1. Describe the various theories of capital structure
 Net Income Approach (4) (R1PageNo.132)
  Net Operating Income Approach (4)
 Traditional Position (4)
 Modigliani and Miller Position (4)

2. Briefly explain the factors which determine the capital structure of a

firm(R1PageNo.133)
(i) Flexibility (1)
(ii) Size of the company (2)
(iii)Control (2)
(iv) Tax planning (1)
(v) Capital market conditions (2)
(vi) Legal requirements (1)
(vii) Ability of cash flow (2)
(viii) Purpose of financing (1)
(ix) Management philosophy (1)
(x) Stability of sales (1)
(xi) Financial leverage (2)
3. Explain the break even chart and the managerial uses and limitations of break
even chart. (R1PageNo.145 and 146)
 Break Even Chart- meaning (2)
Break even chart is a chart which is showing the graphical
representation of the breakeven point, with the help of the mathematical
formula. It reveals the inter-relationship between profit, volume and cost.
 Managerial uses (8)
 Provides detailed information
 Assists the management for taking managerial decisions
 Helps to knowing and analysing the profitability position
 Useful for forecasting, planning and growth of the business
 Assists to formulation of pricing policies
 Helps to know the total, fixed and variable cost
 Helps to product planning
 Assists the management for make or buy decisions
 Provides necessary guidance to management
 Assists to preparation of flexible budget
 Limitations (6)
 Based on number of assumptions
 Limited quantum of information
 Fixed cost do not always remains constant
 Variable costs do not always vary proportionately
 Sales revenue does not always change proportionately
 Provides information only on sales mix
4. From the following details you are required to determine the breakeven point.
(R1PageNo.148 and 149)
 Direct Labour Rs.100 per unit
Direct Material Rs.40 per unit
Variable overhead 100% of direct labour
Fixed overheads Rs. 60000
Selling price Rs.400 per unit
In order to increase the efficiency in production, the concern installs improved
machinery, which results in fixed overhead Rs.20000, but the variable over head
is reduced by 40%
 BEP= Fixed cost / (Selling price per unit-variable cost per unit)(2)
 BEP in units = 375 units(4)
 BEP in value = Rs. 150000(4)
 Inorder to increase production (3)
Fixed overhead = Rs 60000
(+) Additional = Rs20000
Total fixed cost= 80000
Variable overhead is reduced by 40%
Variable cost
Direct material= 40
Direct labour= RS100
Variable overhead 100x60/100=RS60
Total variable cost = RS200
 To increase the production BEP in units = 400 units, BEP in value = Rs.
160000 (3)

5. An analysis of digital manufacturing Co. Ltd., submits the following

information: (R1PageNo.235 and 236)
Cost element Variable cost(% sales) Fixed cost
Direct material 32.8 -
Direct labour 28.4 -
Factory overheads 12.6 189900
Distribution overheads 4.1 58400
General administration
overheads 1.1 66700
Budgeted sales are Rs. 1850000. You are required to determine
(a) The break even sales volume
(b) Profit at the budgeted sales value
(c) The profit if the sales
(i) Drop by 10%
(ii) Increase by 5% from budgeted sales

 (a) Break even sales volume = Rs. 1500000(4)

 (b) Profit at the budgeted sales volume of Rs.1850000
 Profit= Rs. 73500(4)
 (c) The profit if actual sales
(i) Drop by 10%, profit = Rs. 34,650 (4)
(ii) Increase by 5%, profit = Rs. 92,925(4)
6. The following is the capital structure of a company(R1PageNo.136 and 137)
Rs.
Equity shares of Rs.100 each 2000000
Reserves and surplus 800000
9% preference shares 1200000
7% debentures 1000000
Total capital 5000000
The company earns 12% on its total capital. The company proposes to invest Rs.
25 lakhs in an expansion programme. The following alternatives are available
Plan A Issue of 20000 equity shares at a premium of Rs.25
Plan B Issue of 10% preference shares
Plan C Issue of 8% debentures
The price earning ratios are estimated as follows: Plan A-13, Plan B-12, Plan C-1
Evaluate the financing plans and make your recommendation, assuming a
corporate tax rate of 50%
Plan A Plan B Plan C
 EPS 7.68 2.85 10.35 (10)
 Market price 99.84 34.2 103.5 (4)
 As market price is the maximum in plan C, it is recommended (2)
7.

UNIT IV
1. What do you mean by budget? (R1PageNo.119)
A budget is the entire plan of business operation for some definite future
period. It is a predetermined plan of operation. It is a statement which showing a
financial and or quantitative aspect of the business plans and policies to be pursued
in the specified future period.

2. Define the term budget. (R1PageNo.119)

In the words of Crown and Howard, “A budget is a pre-determined
statement of management policy during given period which provides a standard for
comparison with the results actually achieved”.

3. State the meaning of budgetary control. (R1PageNo.120)

According to Crown and Howard, “Budgetary control is a system of
controlling cost which includes the preparation of budgets, coordinating the
departments establishing responsibilities comparing actual performance with the
budgeted and acting upon results to achieve maximum profitability”.
4. What do you mean by budgeting? (R1PageNo.120)

The term budgeting is a technique for the implementation of budgets.

5. Write the meaning of budget period.(R1PageNo.120)
Budget period is the specified future period of time over which revenue and
expenses are estimated. The length of the period depends on the nature of business,
the production period, the control aspects, etc.,. Budget can be prepared by any
entity which earns and spends money.

6. What do you mean by cash budget? (R1PageNo.122)

Cash budget is just like a cash book. It is a budget which is prepared to
forecast the cash receipt and disbursements during a specified future period of time.
The cash budget should be coordinated with all other functional activities of the
business.

7. State the meaning of performance budgeting. (R1PageNo.122)

Performance budget simply says it is a budget which relate to measure and
appraisal of performance as well as follow up actions. According to National
Institute of Bank management Mumbai, performance budgeting technique is the
process of analysing, identifying and simplifying and crystallizing specific
performance objectives of a job to be achieved over a period in the frame work of
the organizational objectives. The technique is characterized by its specific direction
towards the business objective of the organization.

8. Define zero base budgeting(R1PageNo.123)

In the words of Peter A Pyher, “A planning and budgeting process which
requires each managers to justify his entire budget request in detail from scratch
(hence zero base) and shifts the burden of proof to each manager to justify why he
should spend money at all. The approach requires that all activities be analysed in
decision packages which are evaluated by systematic analysis and ranked in order of
importance”.

9. What do you mean by control? (R1PageNo.124)

The term control means, organization fix certain objectives, for some
specified time duration expiry of this time duration actual performance compared
with predetermined one. If any deviations are arising remedial actions are taken by
the organizations.

10. Write the meaning of master budget. (R1PageNo.122)

The master budget is the summary of all the functional budgets. In the words
of Rowland and William H. Harr the master budget is,” a summary of the budget
schedules in capsule from made for the purpose of presenting in one report the
highlights of the budget forecast”.

11. List the types of budget according to time. (R1PageNo.123)

The budgets are actually classified into four groups according to time
(i) Long term budgets
(ii) Short term budgets
(iii)Current budgets
(iv) Rolling budgets
 12. From the following figures prepare a raw material purchased budget for
January. (R1PageNo.124)
Materials
A(Units) B(Units)
st
Estimated stock on 1 Jan 16,000 6,000
Estimated stock on 31st Jan 20,000 8,000

Estimated Consumption 1, 20,000 44,000

Solution:

Raw materials Raw materials

A B
Estimated consumption (units) 1,20,000 44,000
Add: Estimated stock on 31st Jan 20,000 8,000
1,40,000 52,000
Less: Estimated stock on 1st Jan 16,000 6,000
Estimated Purchase (units) 1,24,000 46,000

13. What do you mean by production budget ? (R1PageNo.123)

Production budget is prepared for the purpose of finding out the
number of units to be produced for the budget period. It is based on sales budget.

14. State the meaning of cost of production budget. (R1PageNo.125)

Cost of production budget is based on the production budget. Production
budget determines the quantum of production during a budget period. The cost of
production budget indicates total cost incurred on the materials labour and
overheads, for the manufacturing of the product. These three cost taken together to
make it a cost of production budget.
‘
15. What do you mean by fixed budget? (R1PageNo.124 and 125)
A fixed budget is prepared for a given level activity or fixed level of
activity and also it is prepared before the beginning of the financial year. According
to ICWA London, “fixed budget is a budget which is designed to remain uncharged
irrespective of the level of activity actually attained”.
16 Marks
1. Explain the objectives and disadvantages of budgetary control(R1PageNo.119
and 120)
 Objectives (10)
 Assists to set-up budgets for determining future plan
 Coordinate the activities of different departments
 Determine the quantum of amount required for capital expenditure
 Guides effective and efficient operations
 Centralize the control system
 Fixation of responsibilities of each and every individual
 Assist to increase in profitability
 Provide detailed information about capital
  Enables to evaluate the performance
 Promote research and development in future
 Disadvantages (6)
 Based on future predictions
 More time consuming
 Not suitable for small scale organization
 Budget is a decision making tool
 Success depends upon the coordination among different
departments
 Allocation of funds to each and every department creates conflicts
among them
 Lack of support from the top management

2. Elaborate the classification of budgets according to function and

flexibility(R1PageNo.122,123,124)
(I) Classification on the basis of function (8)
(a) Operating Budgets
(i) Sales Budget
(ii) Production Budget
(iii)Purchase Budget
(iv) Raw material Budget
(v) Labour Budget
(vi) Plant utilization Budget
(vii) Factory overhead Budget
(viii) Manufacturing expenses Budget
(ix) Administrative and selling expenses Budget
(x) Selling and distribution overhead Budget
(b) Financial Budgets(4)
(i) Cash Budget
(ii) Working capital Budget
(iii)Capital expenditure Budget
(iv) Master Budget
(II) Classification according to flexibility(4)
(a) Fixed Budgets
(b) Flexible Budgets

3. Explain the steps involved in budgetary control system(R1PageNo.126)

 Steps (8x2=16 Marks)
(i) Well defined organisation chart
(ii) Clearly defined objectives
(iii)Establishment of budget centre
(iv) Appointment of budget officer
(v) Forming of budget committee
(vi) Preparation of budget manual
(vii) Determination of budget period
(viii) Determination of key factor

4. Explain the process of budgetary control and objectives of budgeting

Process(R1PageNo.123)
  Determine the objective (4)
 Compare actual with predetermined objectives (4)
 Determine the variance (4)
 Remedial actions if need (4)
Objectives
1. To define and determine organizational goals.
2. To minimize unnecessary wastage and control expenses.
3. To achieve higher profitability.
4. To establish effective centralized control system.
5. To fix the authorities and responsibilities of different departments or
heads.
6. To formulate long term and short term plans for achieving organizational
objectives.
7. To provide guidance for taking remedial action for the purpose of
correcting deviations

5. Draw materials procurement (Quantitative) Budget from the following

information. Estimated sales of product 40000 units. Each unit of the product
requires 3 units of materials A and 5 units of Materials B(R1PageNo.129)
Estimated opening balances at the commencement of the next year
Finished product 5000 units
Materials A 12000 units
Materials B 20000 units
Materials on order
Materials A 7000 units
Materials B 11000 units
The desirable closing balances at the end of the next year
Finished product 7000 units
Materials A 15000 units
Materials B 25000 units
Materials on order
Materials A 8000 units
Materials B 10000 units
Solution

Estimated sales 40000

Add desired closing stock 7000
47000
Less opening stock 5000
Estimated production 42000

Materials procurement Budget

Material A Material B
Estimated consumption 126000
Add 42000x5 21000
Desired closing stock 15000 25000
Material on order 8000 10000
149000 245000
20000
Less opening stock 12000 11000
 Material on order 7000
19000 31000
Estimated purchases 130000 214000
Total purchases 344000

6. You are required to prepare sales over head budget from the estimation given
below
(R1PageNo.128) Rs.
Advertisement 2500
Salaries of sales department 5000
Expenses of sales department 1500
Counter salesman’s salary and dearness allowance 6000
Commission to counter salesman’s at 1% on their sales
Travelling in salesman commission at 10% on their sales and expenses at
5% on their sales. The sales during the period were estimated as follows
Counter sales Travelling salesman’s
80000 10000
120000 15000
140000 20000

Fixed overheads Rs.90000 Rs. 135000 Rs. 160000((2)

Total fixed cost 15000 15000 15000 (6)
Total variable cost 2300 3450 4400 (6)
Total sales overheads 17300 18450 19400(2)

UNIT V
1. State the meaning of dividend. (R1PageNo.305)
The term dividend refers to that part of earnings of a company which is
distributed among its shareholders on the basis of their shareholding. It is the reward
to the shareholders for their investments made in the company. Generally dividend
may be paid as a fixed percentage but this percentage may be changed every year
according to the level of profit earned by the company.

2. What do you mean by dividend policy? (R1PageNo.305)

Dividend policy means it is the policy of the company with regard to
quantum of profits to be distributed as dividend. The basic concept of the dividend
policy is that the company desires and take any future action regarding the payment
of dividend with help of the company law board.

3. List the two main theories of dividend. (R1PageNo.305)

The dividend theories can be classified under two groups
 (i) Relevance concept of dividend (Theories of Relevance)
(ii) Irrelevance concept of dividend (Theories of Irrelevance)

4. State the forms of stable dividend. (R1PageNo.306)

The term stable dividend means when the company maintains more or less
stable rate of dividend. It may be in the following three forms.
 Constant Dividend per share
 Constant payout ratio
 Stable rupee dividend plus extra dividend

5. What do you mean by cash dividend? (R1PageNo.307)

Dividend is paid to the shareholders in the form of cash is called cash
dividend. The usual practice followed by the company is to pay dividend in cash. It
results in outflow of fund from the firm. Hence the firm should maintain and
adequate cash resources for payment of cash dividend.

6. Write the meaning of risk-adjusted discount rate. (R1PageNo.309)

It is a composite discount rate that takes into accounts both the time risk
factors. It is assumed on the basis of the investor’s expectation at a higher rate of
return on risky projects. The following types of rates are determined under this
method i.e., (i) risk free rate, (ii) risk premium rate

7. What do you mean by decision tree analysis? (R1PageNo.309)

It is one of the important techniques which are helpful in tackling in risky
investment project proposals. Number of decision needed to find the future
alternative decisions. The group of all these decisions present as well as future
viewed in relation to one another is called a decision tree.

8. State the meaning of inventory. (R1PageNo.289)

Inventories are the stocks of the product of a company manufacturing for
sale and the components that make up the product. The various forms in which
inventories exist in a manufacturing company are: (i) raw materials, (ii) work-in-
progress, (iii) finished goods and (iv) consumables and spares.

9. Write the meaning of ABC Analysis. (R1PageNo.291)

ABC analysis is otherwise known as ‘Always Better Control’. It is one of
the techniques used for exercising selective control over inventory items. Under this
approach the inventory items can be classified into three parts A,B,C. Category may
include more costly items, category B include less costly items and category C
include least costly items. This approach is also known as proportional value
analysis.

10. What do you mean by EOQ? (R1PageNo.293)

Economic Order Quantity refers to that size of the lot to be purchased which
is economically viable. In other words it is the quantity of material that should be
purchased by the organization at a minimum cost. Simply economic order quantity is
that inventory level or quantity of material to place an order at a point that
minimizes the total ordering cost and carrying cost.

11. State the meaning of inventory turnover ratio. (R1PageNo.293)

 The purpose of calculating inventory turnover ratio to find out whether
inventories have been used efficiently or not. The ultimate aim of this ratio is to
minimize the investment in inventories. From the outcome of this ratio the
organization must know its inventory conversion period and also find average time
taken for clearing the stock.
Formula for computing Inventory Turnover Ratio

Inventory Turnover Ratio= Cost of goods sold/ Net sales

Average inventory

12. What do you mean by inventory reports? (R1PageNo.295)

Inventory report is a statement prepared by the organisation to show the latest stock
position of different items. This report should contain all the relevant information for
managerial administrative action.

13. Write the methods of inventory valuation. (R1PageNo.296)

The following are the methods of Inventory valuation
(i) First in first out method(FIFO)
(ii) Last in first out method(LIFO)
(iii)Average price method
(iv) Base stock method
(v) Inflated price method
(vi) Specific price method
(vii) Highest in first out method
(viii) Current standard price method
(ix) Replacement price method

14. State the meaning of safety stock. (R1PageNo.297)

Safety stock is a stock which is maintained by an organisation in order to
meet out any of the unanticipated increase in the usage of materials. But one of the
basic problems for inventory management is to determine the level of quantity of
safety stocks to be maintained by the organisations at all the time.

15. From the following information, calculate a) Maximum stock level, b) Minimum
stock level, c) Re-order level(R1PageNo.298)
Minimum consumption 240 units per day
Normal consumption 300 units per day
Maximum consumption 420 units per day
Re-order level 3600 units
Re-order period 10 to 15 days
Normal order period 12 days
Answers:
Re-order level = 6300 units
Minimum level = 2700 units
Maximum level= 7500 units

16 MARKS
1. Determine the factors of the dividend policy of a company. (R1PageNo.306)
(i) Legal restrictions (2)
(ii) General state of economy (1)
(iii)Age of the company (2)
(iv) Nature of industry (2)
(v) Government policy (2)
(vi) State of capital market (1)
(vii)Past year dividend rate (1)
(viii) Stability of dividends (2)
(ix) Taxation policy (1)
(x) Liquid resources (1)
(xi) Restriction by lenders (1)
2. The earnings per share of ARP Ltd are Rs.8. the rate of capitalization rate is
10%. The productivity of retained earnings is 15%
Compute the market price per share if the payout is 0%, 25%, 50% and
100%. What inference can be drawn from the above exercise? (R1PageNo.310)
(a) Payout is 0% - Rs.120(4)
(b) Payout is 25% - Rs. 110(4)
(c) Payout is 50% - Rs. 100(3)
(d) Payout is 100% - Rs. 80(3)
The market price is the highest when the payout is 0%. As payout
increase, market price comes down. Hence, the ideal payout is 0% (2)

3. Describe the various methods used for incorporating risk factor in capital
budgeting decision(R1PageNo.311)
I. Modern methods
(i) Sensitivity analysis(2)
(ii) Probability analysis(1)
(iii)Certainty equivalent coefficient (2)
(iv) Standard deviation (2)
II. Modern quantitative techniques
(i) System analysis (1)
(ii) Marketing research (1)
(iii)Operations research (1)
(iv) Network analysis (1)
(v) Cost – volume profit analysis (1)
(vi) Ratio analysis(1)
III. Conservative methods
(i) Shorter payback period (1)
(ii) Risk adjusted discount rate (1)
(iii)Decision tree analysis (1)
4. Lux Ltd is considering the purchase of a new machine. Two alternative
investments are available M and N each costing Rs. 70000. The cash inflows
are expected to be as follows: (R1PageNo.321)
 Cash inflows
Year Investment M(Rs.) Investment N (Rs.)
1 30000 40000
2 30000 30000
3 20000 20000
4 10000 10000
The company has the expected return on capital of 10% risk premium rates of
2% and 7% respectively for investments M and N. Which investment should be
Preferred?
Investment M, NPV is 1290 (7)
Investment N, NPV is 3950 (7)
NPV for investment N is greater than M. Hence, N should be preferred (2)

5. Discuss the various tools of inventory management(R1PageNo.298and 299)

(i) Determination of economic order quantity(2)
(ii) ABC analysis(2)
(iii)VED analysis (2)
(iv) Determination of stock levels (2)
(v) Determination of safety stocks (2)
(vi) Inventory turnover ratio (2)
(vii) Just In Time inventory system(2)
(viii) Inventory reports (1)
(ix) Classification and codification (1)
6. Describe the objectives and types of Inventory Management (R1PageNo.289
and 290)
Objectives

1.To provide regular supply of materials and also meet out the customers demand.(2)

2.To minimize the investment in inventories and also maximize profitability .(1)

3. To employ suitable techniques to minimizes losses due to wastages and damages.(1)

4. to ensure the quality standards of the final output.(1)

5. Enable to provide data for formulating inventory planning and control techniques.(1)

6. Enable to minimize the cost of production and overall cost of the product.(2)

Types Of Inventory (4x2=8M)

1.Finished Goods

2.Rawmateral

3.Consmables and Spares

4.Work-In-Progress