B Com (H) III Year. Paper 3.4HA

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1 B Com (H) III Year Paper 3.4HA FINANCIAL MANAGEMENT Module 1 UNIT 1 : INTRODUCTION 1. Give an idea about the Wealth Maximisation objective of Financial Management. 2. Discuss the various functions of Financial Management. 3. Distinguish between profit maximization and wealth maximization objectives of the firm. 4. The financial goal of a firm should be to maximize value or wealth explain. 5. Explain the interrelationship between financing, investment and dividend decisions of a firm. 6. Why is it inappropriate to seek profit maximization as the goal of financial decision making. 7. State briefly the role of Chief Financial Officer. 8. Wealth Maximisation is dependent on Profit Maximisation discuss. 9. The operative objective of financial management is to maximize wealth or net present worth. Explain the statement and examine the finance function performed by a financial manager to achieve this goal. UNIT 2 : BASIC CONCEPTS 1. Explain with example the compounding technique and the discounting technique in relation to time value of money. 2. Write short notes on : a) Time Value of Money b) True and Fair View. 3. Explain the concept of risk-return relationship. 4. What is time value of money? What is its importance in long term financial decision making? 5. Give a brief idea regarding financial environment of a business. 6. In which techniques time is adjusted with the value of time? 7. Explain the mechanics of calculating the present value of cash flows. 8. Calculate the present value of Rs 6000 (a) received one year from now, (b) received at the end of five years, (c) received at the end of 15 years. Assume a 5% time preference rate. Year 1 Year 5 Year 15

2 PVIF A is offered either to receive Rs 5000 one year from now or Rs 7000 five years from now. Which one should be accepted and why if the discount rate is 10% Given present value of Re 1 at 10% is 0.909mand for first and fifth year respectively. 10. Use the tables to determine the present value of Rs each paid at the end of each of the next six years. Assume 10% compound annual growth rate. 11.At the age of 25, how much should one invest each year in order to have Rs at the age of 40? Assume 10% compound annual growth rate. 12.Your wife has promised to give you Rs in cash on your 30th birthday. Today is your 21st birthday. She wants to know two two things a) if she decides to make annual payments into a fund, how much will the annual amount be if the fund pays 8%? b) if she decides to invest a lump sum amount in the account now and let it compound annually, how much will the lumpsum be? 13.You want to make a gift of Rs to one of your friends after four years. What amount you need to invest every year starting from the beginning of the first year so that you can get the required amount after four years? The normal return is 10%. 14. If the loan amount is Rs 10 lacs, tenure is for three years and rate of interest is 12%, find out equated annual instalment. 15. State Bank of India pays 6% compound interest half yearly. If Rs is deposited initially, how much shall it grow into at the end of five years? 16.Mr A invested Rs at an interest of 12% p.a. for 3 years. Compute future value of investments assuming interest is compounded quarterly. 17. A sum of Rs 5000 is invested for 2 years at 10% interest rate compounded biannually. Find the maturity value. 18.Mr B has Rs at his disposal. He wants to get his money doubled. a) If interest is p.a. annually, then how long he has to wait to fulfill his desire?

3 b) If he is not ready to wait for more than 4 years, then what should be the approximate rate of compound interest? UNIT 3 : SOURCES OF FINANCE AND COST OF CAPITAL 1.State the role of lease financing. 2. Write the merits and demerits of convertible debentures. 3. Write a note on the popularity of trade credit as a source of short term finance. 4.What do you mean by term financing? Write down its features briefly. 5. Discuss the advantages and disadvantages of ploughing back of profits. 6.Explain the various sources of finance available to an enterprise in India. 7. Discuss the various foreign sources of raising finance for a large-sized industrial concern. 8. What are the recommendations of the Tandon Committee in regard to bank lending for working capital purposes? 9.What are the objectives of control on capital issue? Under what circumstances consent of the Controller of Capital Issues is required? 10. Write short notes on : a) Cash Credit b) Public Deposit c) Commercial Paper d) Trade Credit e) Factoring f) Bills of Exchange g) Bank Loan h) Preference Shares i) Debenture j) Institutional Finances Cost of capital

4 Short Essay Type Questions 1) What do you mean by cost of capital? Mention any two significances of cost of capital. 2) Retained Earnings have no cost Is the statement justified? 3) What is the rationale behind the use of weighted average cost of capital over specific cost of capital in evaluating a project? 4) What are the uses of cost of capital? 5) Neither over capitalisation nor under capitalisation is desirable - evaluate the statement. 6) How will you determine the cost of equity share capital in a growth company? 7) Mention the causes of over capitalisation in a company. 8) Write short notes on: a) Marginal Cost of Capital. b) Capital Asset Pricing Model. 9) Cost of Capital is essentially a time cost Discuss. 1. X Ltd. Considering the issue of new equity shares of the face value. Of Rs. 100 each at Rs. 125 each. The cost of flotation cost per share is estimated to be Rs dividends paid per share by the company of the existing Equity shares for the last 5 years are: Rs , Rs , Rs , and Rs the company has a fixed D/P ratio. The expected dividend on the new shares at the end of the 1 st year is Rs Find out a) cost of existing equity shares. b) cost of new shares of the co. 2. Compute cost of equity share using CAPM approach. Risk free rate of between 10% Biota risk factor of the co. Is.50 Initial price of Investment in equity share of the company is Rs expected dividend at the year end is Rs Expected market price of equity share at the year end is Rs X Ltd. Is considering and expenditure of Rs. 50 lakhs for expanding it s operation. The necessary information is as follows: No. Of existing equity shares After tax profit (PAT) available to equity share holder for the year Rs MPS Rs. 120 Compute the cost of existing equity share capital and of new equity capital assuming that new share will be issued at a price of Rs. 105 per share and the floatation costs of new issue will be Rs. 3 per share. 4. X Ltd. Is earning a net profit of Rs p.a. the share holders required rate of between is 12%. The shareholders of the co are assumed to be in 30% personal tax bracket. It is expected that the share holders will have to incur 2% as brokerage on the after tax dividends received by them assuming that the entre earnings are distributed to the shareholders. Calculate cost of retained carring of the Co. 5. The following are the extracts from the financial statements of ABC Ltd. (Rs. In Lakh) (Rs. In Lakh) Operating Profit 105 Equity share Capital (Rs. 10 each 200 Less- int. on Debenture 33 Reserve and Surplus % non convertible Debt 220 EBT 72 Less- Tax 50% Net Profit 36 MPS of equity is Rs. 12 and per

5 debenture is Rs Compute a) what is the earning per share. b) what is the % of cost Capital to the co. From the Debt Capital and equity capital. 6. Compute cost of equity capital. For both existing as well as new equity shares current market price per share of Rs. 220 underwriting commission 5% expected dividend per share Rs. 12 tax on dividend 10% the company past dividends per share for last 6 years were as follows: year DPS year DPS X s share is quoted in the market at Rs. 20 currently. The co. Pays dividend of Rs per share and expected growth rate will be 5% per share compute. (a) cost of Equity share capital. (b) If the anticipated growth rate is 6% pa. Calculate the indicated market price per share. (c) If the co s cost of capital 1.59%, and the anticipated growth rate is 9% pa, calculate the indicated market price if the dividend of Rs is to be maintained. 8. compute cost of capital Risk free rate of return 10% Beta wejhcient (B) of the co. Is 1.20 Market risk premium 12% 9.Capital structure of X Ltd. Rs. (000) Equity capital: shares of Rs. 10 each fully paid 100 Reserve (General) 50 Long term debt a) Market price per share of X ltd. Is Rs. 60 and EPS is Rs expected growth rate in earnings is 5% pa. b) Cost of debt (before tax): 12% pa. c) Applicable corporate tax : 40% Compute weighted average cost of capital (WACC) urning market value as weight. 1. The B/S if X Ltd shows the following items as at 31 st December, (Rs.) Paid up capital: Equity share of Rs. 10 each Reserve and Surplus % non convertible Bonds % institutional loans Other information about the co. As relevant is given below. Year ended 31 st March DPS (Rs.) EPS (Rs.) MPS (Rs.) Compute WACC urning book value on weight and E/p ratio as the basis of cost of equity. Assume tax rate of 40%. 2. Compute WACC taking market values as weights. Capital structure Rs. In lakhs

6 Equity shares (Rs. 100 each) 200 Reserves and Surplus % bonds (Rs each) Current market price: Equity Rs. 300 per share, Bond Rs unit corporate tax 40%. Expected dividend per share: Rs. 20. Tax on dividend is 10%. Future growth rate in dividend may be taken as a proxy of the average of the annual growth rates. The past DPS were as follows: Year: Dividend (Rs.) The co s earning and dividends are declining at a rate of 8% per year. If the previous year s dividend was Rs. 10 and the required rate of return 15.15%, what would be the current market price of the equity share of the company? UNIT 4 : Leverages and Capital Structure Theories 1> Explain the relation among Fixed Cost, Risk and Leverage. 2>What do you mean by operating leverage? How can it be measured? 3> Write a short note on EBIT EPS analysis. 4>What is indifference point? Explain it in relation to EBIT EPS analysis. 5> Write short notes on : a) Break-Even analysis b) Working capital leverage c) Relationship between margin of safety and degree of operating leverage. 6> Define Trading on Equity. Give an example. 7>What factors contribute to the operating risk and financial risk of a firm? 8> Calculate the degree of operating leverage, degree of financial leverage and degree of combined leverage from the following data: Sales Rs 20 per unit Rs Variable cost per unit Rs 7.00 Fixed cost Rs Interest charges Rs > Compute operating, financial and combined leverages under situations when fixed costs are

7 (a) Rs 5000 and (b) Rs under financial plans 1 and 2 respectively from the following information pertaining to the operation and capital structure of a textile company : Total Assets Rs Total Assets turnover ratio 2 Variable cost as a %age of sales 60 Financial Plan 1 Financial Plan 2 Equity Rs Rs % Debenture Rs Rs > X Ltd has estimated that for a new product the break- even point is 2000 units if the item is sold for Rs 14 per unit, the cost accounting department has currently identified variable cost of Rs 9 per unit. Calculate the degree of operating leverage for sales value of 2500 units and 3000 units. What do you infer from the degree of operating leverage at the sales volumes of 2500 units and 3000 units and their difference if any? 11> A firm has sales of Rs , variable cost of Rs and fixed cost of Rs and debt of Rs at 10% rate of interest. What is the combined leverage? If the firm wants to double its EBIT, how much percentage rise in sales would be needed? 12> The following information have been taken from the income statement of X Ltd : Fixed operating expenses Rs 1200 Fixed financial charges Rs 600 Earning before tax Rs 400 Calculate percentage of change in EPS, if sales increase by 10%. 13> A multi-product firm has the following costs and output data for the year : Product Total X Y Z Sales Mix 40% 35% 25% Unit Selling Price (Rs)

8 Variable cost per unit (Rs) Fixed Cost (Rs) Sales (Rs) >Which of the following financial plans would you recommend and why? Particulars Equity Plan Equity Preference Share Plan Equity Debt Plan Earning per share (Rs) Price Earning Ratio > The following is the Balance Sheet of a company : Balance Sheet as at Equity and Liabilities: Amount(Rs) Share Capital Equity Share Capital(Rs 10 each) Retained Earning Non Current Liabilities Current Liabilities Total Assets Non Current Assets: Fixed Assets Current Assets Total The company s total assets turnover ratio is 3, its fixed operating cost is Rs and its variable operating cost ratio is 40%. The income tax rate is 50%. a) Calculate all the three types of leverages for the company. b) Determine the likely level of EBIT if EPS is (a) Re 1.00, (b)rs 3.00, (c) zero. 16> The capital structure of X Ltd consists of an ordinary share capital of Rs ( shares of Rs

9 100 par value and Rs of 10% debentures. Sales increased by 20% from units to units, the selling price is Rs 10 per unit, Variable cost amount to Rs 6 per unit and fixed expenses amount to Rs The income tax rate is assumed to be 50%. (a) You are required to calculate the following i) the %age increase in earning per share ii) the degree of financial leverage at units and units iii) the degree of operating leverage at units and units. (b) Comment on the behavior of operating and financial leverages in relation to increase of production from units to units. 17> The Capital Structure of X Ltd is given below : Equity Share Capital (Rs 10 each per share)rs 10 lacs Retained EarningRs 6 lacs 10% Preference Share Capital Nil The firm has planned to undertake an expansion scheme of Rs which can be financed (i) entirely by issue of equity shares of Rs 10 each or (ii) by issue of 12% debentures of Rs 100 each at par. As a result of expansion, sales and operating fixed cost will increase by 60% and 75% respectively. The other relevant information is given below: Sales Rs Variable Cost 60% Operating Fixed Cost Rs Corporate Tax 40% Calculate leverages and EPS before and after expansion and give your opinion for taking appropriate decision with respect to financing. 18> XYZ Ltd provides you the following information: Capital Gearing Ratio 3 Fixed Cost : 1/3 rd of total operating cost

10 Dividend yield 6% Operating Ratio 75% Ratio of 18% Preference Share to 15% Debenture 125% Dividend payment ratio 30% Accumulated reserve Rs Capital Employed Rs Market price of an Equity Shares of Rs 10 Rs 135 Tax Rate 40% Prepare an income statement and calculate the degree of operating leverage, financial leverage and combined leverage. Unit 5 : Working Capital Management Theoritical question 1) What is working capital? what is working capital cycle? 2) What is positive working capital? and what is negative working capital? 3) State the factors to be considered to forecast working capital requirement? 4) State the factors on which the duration of the working capital cycle depends? 5) What is liquidity profitability tangle? 6) What is gross working capital and net working capital? 7) State the differences between permanent working capital and fluctuating working capital? 8) Distinguish between fixed and variable working capital of a firm? 9) Write a short note on the recommendations of chore committee? 10) Distinguish between conservative and aggressive strategies of financing current assets? Practical Problems 1) A company has prepared it s annual budget, relevant details of which are reproduced below: i) Sales Rs lacks : units (25% cash sales and Balance on credit) ii) Raw material cost : 60% of sale value iii) Labour cost : Rs. 6 per unit iv) Variable overheads : Rs. 1 per unit v) Fixed overheads :Rs. 5 lacks (including Rs As depreciation) vi) Budgeted stock level

11 Raw materials Work in progress Finished goods vii) Debtors are allowed credit For 4 weeks viii) Creditors allow 4 week credit ix) Wages are paid by monthly x) Log in payment of overhead : 2 weeks xi) Cash in hand required : Rs : 3 weeks : 1 weeks ( material 100% labour and Overhead 50 %) : 2 weeks Prepare the working capital budget for the year of the company, making whatever assumptions that you may find necessary. 2) Cost sheet of a company provides the following data Cost per unit (Rs) Raw material Direct labour Overheads (including depreciation of Rs. 10) Total cost Profit Selling price Additional information Average raw material in stock is for one month Average material in progress is for half month Credit allowed by supplies : one month Credit allowed to debtors : one month Average time log in payment of wages : 10 days Average time log in payment of overheads : 30 days 25% of the sales are on cash basis Cash balance expected to be Rs Finished goods lie in the warehouse for one month you are required to prepare a statement showing the working capital needs to finance a level of the activity of units of output. Production is carried on evenly trough out the year and wages and overheads accrue similarly. 3) Calculate the operating cycle from the following figures : Rs. In lacks Annual sales 1000 Manufacturing expenses 200 Distribution and other expenses 40 Purchase of materials 400 Opening Stock: Raw material 80 Work in progress 20 Finished goods 60 Closing stock: Raw materials 120 Work in progress 60 Finished goods 20

12 Opening balance of sundry debtors 40 Closing balance of sundry debtors 40 The company obtains a credit for 60 day from its supplier. All goods are sold for credit. Take 360 days in a year. 4) X Ltd supplies you the following information: i) Sales (at 2 months credit) Rs ii) Materials consumed (suppliers extend 2 months Rs Credit) iii) Wages paid (log in payment one month) Rs iv) Manufacturing expenses outstanding at the end Of the year (log in payment 1 month) Rs v) Total administrative expenses, paid as above Rs vi) Sales promotion expenses, paid quarterly in advance Rs The company sells its products on a gross profit of 25% counting depreciation as part of the cost of production. It keeps one month s sock of each raw material and finished goods and a cash balance of Rs Assuming a 20% safety margin, work out the working capital requirement of the company on cash cost basis. Ignore WIP. 5) From the following data compute the money block period working capital. (1 year 360 days) (Rs. In 000) Stock: Raw material 20 WIP 14 Finished goods 21 Purchases 96 Cost of goods sold 140 Sales 160 Creditors 16 6) You are a responsible officer in the finance department of X co. The given below are estimates relating to the year ending 31 st December. Rs. In lacks i) Opening balances 410 Raw materials WIP 100 Finished goods (F.G0 450 Receivable 600 Payables 450 ii) Estimated closing balances Raw materials 450 WIP 120 F.G 500 Receivables 740 Payables 420 iii) Raw material purchased 1600 Manufacturing expenses 1100 Selling, administration and financing 480 Sales cost 4000 You are required to compute the operating cycle period and prepare a statement showing the cash working capital of the co. Assume 360 day in the year.

13 UNIT 6: Working Capital Management (2) Short Essay Type Questions Module II 1) Define EOQ. How is it computed? 2) Why should inventory be held? 3) Explain the objective of credit policy. 4) Explain three principal motives for holding cash. 5) What are the advantages of cash planning? 6) What are the objectives of the collection policy? How should it be established? 7) What is inventory turnover ratio? 8) Write a short note on the recommendations of Tandon Committee regarding bank financing. 9) What are the factors in determining the size of debtors? Unit 7 & 8 :Capital expenditure decision 1) X Ltd. Are thinking of investing in a project costing Rs. 20 lakhs. The life of the project is five years and the estimated salvage value of the project is zero. Straight line method of charging depreciation is followed. The tax rate is 50%. the expected cash flows before tax are as follows: Year Estimated cash Flow before Depreciation And tax (Rs. Lakhs) You are required to determine the: i) Pay back period for the investment ii) Average rate of return on the investment iii) Net present value at 10% cost of capital iv) Benefit cost ratio. v) Internal rate of return. vi) Discounted pay-back period. For the investment. 2) In the January 2005, a multi-product firm proposes to replace one of its plants installed in January 2000 at a cost of Rs The plant stands in the books of accounts at the written down value of Rs , depreciation having been charged on straight line basis assumption there is realisable scrap value at the end of the life. Current exit value of the plant, however, is Rs The proposed replacement will not affect the quality and quantity of output produced and sold. But the new plant, if installed will reduce operating expenses by Rs per annum. The new plant will cost Rs and is expected to have economic life of five years with no scrap value at the end. It will be entitled to accepted depreciation of 40% in the first year and 30% in cash of the subsequently two years. Any loss on disposal of the old plant is also allowed to be written off over a period of two years in equal instalments. The marginal tax rate is 40% end cost of capital is 10%.

14 You are required to evaluate the replacement proposal and give your recommendations as to its acceptance or rejection make your suitable assumption you may find necessary for the purpose. The relevant P.V. factor at 10% are 0.909,0.826,0.751,0.683 and ) A firm is considering the question of installing a plant for producing a new product having estimated product life of sin years. It has two alternative models to choose from model a requires an initial outlay of Rs and has economic. Life of three years with scrap value of Rs at the end. Its operating costs are likely to be Rs p.a. model B. On the other hand, requires an initial outlay of Rs and has no realisable scrap value at the end of its 6 years life. Its operating costs are likely to be Rs p.a. the firm is allowed to charge depreciation on straight line basis and its cost of capital has been estimated to be 10% marginal tax rate is 40%. Which of the two models should the firm choose? 4) The total available budget for a company is Rs. 20 corers and total cost of the projects is Rs. 25 corers. The projects listed below have been remarked in order of profitability. There is a possibility of submitting project X where cost is assumed to be Rs. 13 corers and it has the profitability index of 140. Project cost profitability index Rs. In corers A B C D E 5 _ _ Which project, including project x should be acquired by the company? 5) Compute pay back period for the project Year Book value Of assets Profit after AX (Rs ) Compute pay back period. Initial outlay Rs Estimated life 5 year Profit after tax (Rs.)

15 7) The cost of plant is Rs The expected life of the plant is 3 years it is Rs.26000, Rs.30000,Rs Compute accounting rate of return assuming 30% tax. And straight line method of depreciation. 8) From the following cash flow streams, which cash flows stream would you recommend and why. End of year stream A (Rs.) B (Rs.) c (Rs.) It is given that P.V. of Rs. 1 at 10% to be received at the end of each year is given below. Year PV. Factor ) A machine costing is required in order to undertake a proposed project the effective life of the machine is expected to be year 5 with a residual value of Rs The company follows straight line method of charging depreciation. The estimated earnings before tax of the project are as follows. Year Earning before Tax If the tax rate is 40%, cost of capital 15%, calculate the NPV. And suggest whether the machine would be acquire or not. Given the P.V. factors at a discount rate of 15% rate are Year P.V. factors Theoretical question i) State the significance of capital budgeting decision. ii) Any pay back period method of project evaluation is considered to be conceptually un sound. iii) What is profitability index method in the context of capital expenditure decision? iv) Write a short note on internal rate of return. v) What do you meant by capital rationing? vi) What is the reinvestment rate and what are its assumption under the WPV and IRR method? vii) Write any 3 importance of capital budgeting. How will you take accept, reject decision under net present value method in case of evaluation of a proposed project? Unit 9 Dividend policy 1) Number of equity shares at the beginning of the year Market price per equity share (Po) = Rs. 150 Contemplated dividend (D) = Rs per share Contemplated rate (K) = 12% Find out the market price of equity share at the end of the year s where

16 a) Dividends are declared and b) Dividends are not declared. 2) The following figure are collected from the annual report of co. X ltd. Net profits Rs. 30 lakhs Outstanding 12% preference share Rs. 100 lakhs No. Of equity shares Rs. 3 lakhs Return on investment 20% What should be the approximate dividend pay out ratio. So as to keep the share price at Rs. 42 by using Walter s model? 3) From the following information relating to X ltd. Determine the market price of a share using Gordon s model. Total return in assets Rs No of shares Total earnings Rs Cost of capital 16% Pay out ratio 40% 4) A company has shares at present. The company requires Rs to finance its new investments. The company s total earning during the current year would be Rs The company is taking of two alternatives:- I) Retain the entire amount of earnings to finance its investment or II) Pay Rs by way of dividends and issue shares to cover the share fall by way of external financing. The market price of the company s share is at present Rs. 100 each. The cost of capital is 20%. Determine the market price of the company s share under each of the alternative situations using the MM model. Also ascertain the value of the firm at the end of the year. 5) From the following data, calculate the value form equity share of each of the following 3 companies according to Walter s model when dividend pay out ratio is a) Nil b) 25% and c) 75% Companies M.ltd. l. Ltd. W.ltd. Internal rate of return (M) 15% 12% 10% Cost of capital (K) 12% 12% 12% Earning per share (E) Rs. 10 Rs. 10 Rs. 10 What conclusion would you draw from your observation? UNIT 10: Financial Control Short Essay Type Questions 1) Return on Investment is an important tool of financial control Discuss.

17 2) State the advantages and disadvantages of Budgetary Control. 3) Evaluate the objectives of financial control. 4) How does ratio analysis help a firm in financial control? 5) What is Accounting Ratio Analysis? State the limitations of accounting ratio analysis as a tool of financial control. 6) Explain the steps in Financial Control. Describe the essential elements of an effective financial control system. 7) Explain in brief, Break Even Analysis and Return on Investment as tools of financial control. 8) Write short notes on : a) Budgetary Control b) Cash Flow Statement c) Break Even Analysis.

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