INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, JUNE 2000

JUNE 2000 INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, JUNE 2000 SECTION-I 1. (a) Define any five of the following terms. (5) (i) Optimal Capital Structure: The structure at which the overall cost of capital is minimised and the firm s value is maximised. Therefore, every firm should try to achieve the optimal capital structure and then to maintain it. (ii) Linear Programming: Decision model concerned with how best to allocate scarce resources to attain a chosen objective. Linear programming helps the management to know whether the maximum profit strategy or the best production programmes will be useful under the given conditions. Linear programming is an important tool of Operations Research used in management problems. (iii) Selling Overheads: Overheads incurred in inducting customers to place orders. The expenses incurred in connection with sale and distribution of a commodity or product, are termed as Selling Overheads. Travelling expenses, salesmen s salaries and commission, discount, sample expenses, showroom expenses, packing expenses, carriage outwards, advertisement, bad debts, etc. are included under the selling overheads. (iv) Contribution: Excess of selling price over variable costs. It is also known as Gross Margin. Contribution is the sum total of fixed cost plus profit (or minus loss). (v) Past Due : As amount is to be treated as past due when it has not been paid for 30 days beyond the due date. This concept of past due is applicable to both interest and instalments due. (vi) Hire Purchase : Hire purchase is an agreement under which goods are let on hire and under which hires has an option to purchase them. (b) Fill the blanks with appropriate words / figures / phrase/s. (5) (i) Nationalised banks can raise funds by issuing shares to public upto 40% of their paid up capital. (ii) Eventually the overseas BUYER bears the cost of forfeiting. (iii) In case of companies engaged in the activity of equipment leasing & hire purchase no provision is required where lease rentals or hire charges are overdue upto 12 months. (iv) DICGC / ECGC guaranteed / covered advances carry 50% risk weight for computation of C A R of the banks. (v) Lease rental attracts SALES Tax. (vi) Debentures issued at a discount are called ZERO COUPON BONDS. (vii) Leasing across national frontier is called CROSS BRODER leasing. (viii) Cash flow is equal to not income plus DEPRECIATION. (ix) Direct labour plus factory overhead is equal to CONVERSION COST. 5

JUNE 2000 (x) Fixed assets are those held not for SALE in usual course of business. (c) State with reason/s in brief whether the following statements are true or false. (5) (i) Forfeiting frees the export banker from debt collection. TRUE: Relieves burden of collection - exporter is freed from cumbersome credit administration and problem of collecting the receivables. He can concentrate on quality in production, packaging and delivery. After forfeiting, he has no further involvement. (ii) The purchase of book debts or receivables is central to factoring. TRUE: Factoring is a financial service covering the financing and collection of book debts and receivables arising from credit sale of goods and services, both in domestic as well as international market. It aims at exonerating the supplier from the burden of complicated administrative and financial tasks involved in receivables management. (iii) Banks can lend to LHP companies by way of cash credit and bridge loans only against their capital / debenture issues. FALSE: As bank credit to LHP companies would primarily be against leave rentals / hire purchase instalment receivables, the credit facility should appropriately be granted by way of cash credit. However, vide its circular dated 13.8.93, RBI clarified that banks could discount bills arising out of lease rental receivables. Thus both cash credit and bill discounting facility could be extended by Banks Financial Institutions to LHP Companies. (iv) A hirer can return the goods before the payment of last instalment. TRUE: On payment of all the instalments and other dues specified in the agreement the hirer has the option to purchase the goods but is under no obligation to do so. The hirer can return the goods before the payment of the last instalment. Thus hire purchase is usually a cancellable contract. This feature of hire purchase distinguishes it from a conditional sale or credit sale. (v) Escrow account is a mechanism to pay the contractors / suppliers of an infrastructure project. FALSE: Escrow A/c - Accounts for which a bank acts as an uninterested third arty (custodian / depository) to ensure compliance with the terms of the deed between two parties only upon the fulfilment of same stated conditions. A bank holds such an account in which funds accumulate to pay taxes, insurance, instalments, other dues etc. SECTION-II 2. Answer any four questions explaining in short reason/s for your choice in not more than fifty words. (i) Term Loans are always secured by (3) (a) Primary Security (b) Collateral Security (c) Personal Guarantee (d) All of the above Ans: (A) Term Loans always secured by Primary Security. 6

JUNE 2000 (ii) In a branch of a bank a borrower s account has following characteristics as at the end of 31.3.2000. (3) Dr. Balance Rs.3,50,00,000 Interest held in Memo book Rs.1,50,00,000 Account is doubtful for more then 3 years Value of Security is Rs.2,00,00,000 Provision required for this account would be... (a) Rs. 3,50,00,000/-. (b) Rs. 1,50,00,000/-. (c) Rs. 2,50,00,000/-. (d) Rs. 2,00,00,000/-. Ans: (C). Debit balance 3,50,000 Less: Value of Security 2,00,000 Unsecured Balance 1,50,000 As the account is doubtful for more than 3 years, provision required will be: On unsecured part @ 100% on Rs.1,50,000 Rs.1,50,00,000 On secured part @ 50% on Rs.2,00,00,000 Rs.1,00,00,000 Total Provision required Rs.2,50,00,000 (iii) A project is more acceptable for finance if its... (3) (a) Break even point is high (b) IRR is higher than the cost of capital (c) neither (a) nor (b) (d) both (a) and (b) Ans: (B) A Project is more acceptable for finance if its IRR is higher than the cost of capital (iv) A Company has purchased on June 23, 1996 a machinery costing Rs.1,15,000/- and installation charges of Rs.17,000/- were incurred. Machinery had a service life of 3 years and depreciation on W.D.V. basis is allowed @ 15%. (3) Book Salvage Value of the Machinery would be... (a) Rs.81,065/- (b) Rs.72,600/- (c) Rs.80,250/- 7

JUNE 2000 Ans: (A) Total Cost of the Machinery: Purchase Price 1,15,000 + Installation Charges 17,000 Total Cost 1,32,000 Less: Dep. in 1 st Year @ 15% on Rs.1,32,000 19,800 1,12,200 Less: Dep. in 2 nd year @ 15% on Rs.1,12,200 16,830 95,370 Less: Dep. in 3 rd year @ 15% on Rs.95,370 14,305.50 81,064.50 Book Salvage Value of the Machinery or Say 81,065 (approx.) (v) ROI - Return on investment is equal to... (3) (a) Rs.Net Profit after Tax / Tangible Net Worth (b) Net Profit after Tax / Net Tangible Assets (c) Net Profit after Tax / Paid up Capital (d) Gross Profit / Gross Assets Ans: (B). ROI i.e., Return on Investment = Net Profit after Tax / Net Tangible Assets. 3. Answer question No.(i) and any three of the rest in 2-4 lines. (i) What is an Escrow account? (4) Account for which a bank acts as an uninterested third party (Custodian / Depository) to ensure compliance with the terms and conditions of the deed between two parties only upon the fulfilment of some stated conditions. (ii) How the future interest on an account treated as N.P.A. is treated? (3) Once a credit facility is classified as NPA future ;interest of the same borrower would not be reckoned if realised. However, interest could be charged and taken to income account to the extent of actual collection. (iii) What is Debt Turn Around and its significance? (3) Debt Turn Around: It indicates the period within which the customers are making payment invoices of the clients. Lower D.T.A. may ensure higher turn over which increases the income of the factor. (iv) What is Big Ticket Lease? (3) Lease of the assets of bigger value running into several crores is called big-ticket lease. Leasing aircraft s, satellite etc. are typical examples. 8

JUNE 2000 (v) What is Cash Flow Budget? (3) Cash Flow budget accounts for all items of cash flows; in and out like payment to creditors / cash purchases, payments of salaries and wages payment of rent, rates, taxes and other expenses. It also takes into account all cash inflows like realisation from debtors, cash sales and other cash receipts. SECTION-III 4. (a) Write Short Notes on (i) Impact of inflation on working capital (3) The impact of inflation on working capital is direct. For the same quantity of sales the value of sundry debtors, closing stock etc., increases as a result of inflation. The valuation of closing stock progressively on higher amounts would result in the company not being able to maintain its operations unless it finds extra funds to maintain the same stock level. The higher valuation results in acute shortage of funds as it triggers profit related cash outflows in respect of income tax, dividends and bonus. Unless proper planning is done, the business is likely to face a condition known as technical insolvency. (ii) Flexible Budget (4) This budget is designed to change with the changes in level of activities attained budget shows how costs vary with changes in activity level. The segregation of costs into fixed, variable and semivariable is necessary to construct a flexible budget. It is assumed that fixed costs will remain fixed only upto certain level of activity and after a certain level, they may tend to vary though not like variable costs. (b) Flexible budgets are desirable in the following cases: 1. Where sales are unpredictable e.g. Luxury and semi-luxury trade. 2. Increase of new venture it is not possible to foresee precisely public demand e.g. Fashions and novelty trades. 3. Where business is seasonal 4. Where progress depends on adequate supply of labour and labour is the key factor in that area. The following statement gives the sources and application of funds of ABC Ltd. for the year ended 31.03.2000. (8) SOURCES APPLICATION Rs. in Lacs Rs. in Lacs Equity 100.00 Increase in Working Capital 300.00 Loans @ 12% 500.00 Increase in Fixed Assets 300.00 Reduction in Investments 50.00 Loss as per P& L A/c 200.00 Sale of Assets 50.00 Depreciation for the year 100.00 800.0 800.00 9

JUNE 2000 The company s current ratio as at the beginning of the year was 2. The current liabilities of the company as at 1 st April, 1999 stood at Rs.600 lacs. It was disclosed that during the year ended 31.3.2000 the turnover to capital employed ratio declined from 1.5 to 1.25. You are required to give critical appraisal of the financial operations of the company during the year ended 31.3.2000. CRITICAL APPRAISAL: 1. It is known that long term or permanent sources of capital should be used for only creation of long term assets. In this case 50% permanent source (Equity Rs.0.50 lakhs) and long term loan @ 12% has been used for increasing working capital. This is not prudent practice. 2. Current ratio is an efficient organisation should not exceed 1:1 or the most 1.5:1. In this particular case though the Current ratio was 2:1 it has further has increased to 2.5:1 since net current assets increased by Rs.1.50 lakhs. This is not fair position. It appears that either stock of Raw Material and Finished goods are slow moving or unnecessary long amount is invested in work in progress because of time overrun or the collection of debtor is very poor. These areas need proper monitoring and control. 3. The decline in turnover to capital employed indicates that the turnover or sales has reduced though the capital employed has increased. It may be because the additional production expected out of new machinery has not been available either because the machineries are not commissioned or trail commercial production has not commenced. 4. Since original Debt / Equity ratio is not known, the addition to equity by Rs.0.50 lakhs and loan by Rs.2.50 lakhs cannot be commented upon. However, since the total cash loss of Rs.0.50 lakhs (Rs.1.00 - Rs.0.50 lakhs being depreciation) is contributed substantially by interest on loan @12% (Rs.0.30 lakhs), the decision on how the choice of the sources between Debt / Equity has been determined is questionable. 5. Following data on a capital project is being evaluated by the management of a manufacturing firm. (15) Project M Annual cost saving Rs.40,000/- Useful Life 4 years I.R.R. 15% Profitability Index (P) 1.064 NPV? Cost of Project? Pay Back Period? Salvage Value 0 10

JUNE 2000 Table of discount factor is given below. Discount Factor 15% 14% 13% 12% 1 st Year 0.869 0.877 0.885 0.893 2 nd Year 0.756 0.769 0.783 0.797 3 rd Year 0.658 0.675 0.693 0.712 4 th Year 0.572 0.675 0.693 0.636 2.855 2.913 2.974 3.038 Using the data and discount factor table given above, you are required to find out the missing value i.e., a. N.P.V. b. Cost of Project c. Pay Back Period Please show your working. Ans: Cost of Project : At 15% I.R.R. the sum total of cash inflows are equals to cost of the project i.e., initial cash outlay. Given factors are: Annual cost Saving Rs.40,000 Useful Life 4 Years I.R.R. 15% Now considering discount factor table @ 15% cumulative present value of cash inflows for 4 years is 2.855 Therefore Total cash inflows: For four years for the project is Rs. (40,000 x 2.855) = Rs.1,14,200 Hence the cost of Project is Rs.1,14,200. N.P.V. N.P.V = Total present values of cash inflows - cost of project. For working out NPV it is necessary to work out discounted cash inflows. In this case (PI) profitability index is 1.064. That means cash inflows would be more by 0.64 then outflow. Hence discounted cash inflows would be = PI x Cost of Project i.e., 1.064 x 114200 = Rs.1,21,509. NPV = Total present value of cash inflows minus cost of project i.e., Rs.1,21,509 - Rs.1,14,200 = Rs.7,309. Pay Back Period : Cost of the project / Annual Cost Savings i.e., Rs.1,14,200 / Rs.40,000 = 2.855 or 2 years 11 months (Approx.) Therefore pay back period is 2 years and 11 months. 11

JUNE 2000 SECTION-IV 6. (a) Explain with sufficient details the functions of Finance Manager. (8) Ans: Functions of Finance Manager: The Finance Manager s main objective is to manage funds in such a way so as to ensure their optimum utilisation and their procurement in a manner that the risk, cost and control considerations are properly balanced in a given situation. The main functions of Finance Manager are: 1. Estimating the requirement of funds : Both for long-term purpose i.e., investment in fixed assets and for short term i.e., for working capital. Forecasting the requirements of funds involves the use of techniques of budgetary control and long-range planning. 2. Decision regarding capital structure: Once the requirement of funds has been estimated, a decision regarding various sources from which these funds would be raised has to be taken. A proper balance has to be made between the loan funds and own funds. He has to ensure that he raises sufficient long-term funds to finance fixed assets and other long-term investments and to provide for the needs of working capital. 3. Investment decisions: The investment of funds, in a project has to be made after careful assessment of the various projects through capital budgeting. Assets management policies are to be laid down regarding various items of current assets. For e.g. receivable in co-ordination with sales manager, inventory in co-ordination with production manager. 4. Dividend decisions: The finance manager is concerned with the decision as to how much to retain and what portion to pay as dividend depending on the company s policy. Trend of earnings, trend of share market prices, requirement of funds for future growth, cash flow situation etc., are also to be considered. 5. Evaluating financial performance: A finance manager has to constantly review the financial performance of the various units of organisation generally in terms of R.O.I. Such a review helps the management in seeing how the funds have been utilised in various divisions and what can be done to improve it. 6. Finance negotiations: The finance manager plays a very important role in carrying out negotiations with the financial institutions, banks and public depositors for raising of funds on favourable terms. 7. Cash Management: The finance manager lays down the cash management and cash disbursement policies with a view to supply adequate funds to all units of organisation and to ensure that there is no excessive cash. 8. Keeping touch with stock exchange: Finance manager is required to analyse major trends in stock market and their impact on the price of the company share. (b) Elaborate seven rules for conserving cash. (7) Seven rules for conserving cash: 1. Keep the amount of money tied up in stock, whether it is raw materials, work in progress or finished stock at the minimum amount consistent with maintaining schedule of production and delivery. 2. Ensure that an effective and efficient credit control policy is always maintained 3. Always seek the best credit terms from suppliers 12

JUNE 2000 4. Keep ideal cash balance to the minimum for making day to day payments. Any funds not presently needed should be placed on deposit where they will earn interest. 5. There may be occasions when it is better to lease or enter Hire Purchase Contract when acquiring fixed assets. This saves working capital since the whole sum does not have to be raised immediately. 6. Keep overheads and administrative costs to their budgeted levels. 7. Always audit the effectiveness of promotional and advertising companies. OR Explain in details six different types of factoring. (15). Depending on the arrangement between the Factor and the Client, factoring can be of six different types: 1. Full Factoring: This is also called without recourse factoring or old-line factoring. This classical form of factoring is most comprehensive and includes services such as maintenance of sales ledger, collection of receivables, credit control, credit protection and financing of receivables. Here the Factor approves the customers for credit risks based on his credit worthiness. Factor assumes the debt risk (within the approved limit). The client is totally absolved of his responsibilities as the invoice representing the receivables / trade debts are assigned to the factor on a without resource basis upto a specified limits only. Client is free to exceed limit at his risk. But this non-recourse aspect is only towards financial inability of the debtors. Because, if payment is withheld for reasons of dispute regarding quality, quantity, counter-claim etc., recourse will be available to the Factor against the client. Corresponding to the types of services provided the Factor s charges include the following: a) Charge for rendering sales ledger administration and debt collection b) Premium for taking risk of debt-default c) Interest on funds provided to client from date of drawing to maturity date of the invoice 2. Recourse Factoring: Under this factoring, all the facilities of full factoring except that of credit protection are available to the client. Thus the factor assumes no credit risks. Hence, it may not approve customers of fix credit limits. It acts merely as a collection agent of the supplier besides providing finance and maintaining sales ledger. Accordingly, Factor s charges are limited to charges for sales ledger administration and debt collection and interest on finance provided. If the trade-debts are not realised within the agreed period, the corresponding invoice is assigned back to the client. A concept in resource factoring is Re-factoring Charges. It is akin to the original factoring charges levied on all trade debts, outstanding beyond 60-90 days after due date. This situation arises when the client requests the Factor not to reassign the invoices and to continue recovery efforts, including legal proceedings. Of course, the entire cost of such recovery measures is borne by the Client. 3. Maturity Factoring: This is also called Collecting factoring. Under this, the factor administers clients sales ledger and renders debt collection service. In this also, the factor undertakes no client risk. Maturity factoring can be without recourse or with recourse. The factor s fee includes charges for debt administration, premium for risk of default and interest on funds outlay. Amount of each invoice is made out to the client at the end of credit term or on agreed maturity date, after recovering factory charges. The maturity date is decided in the beginning of the factoring agreement with reference to the average time taken by the client to collect a date. The maturity date so decided 13

JUNE 2000 has no relation to the date on which the debt is actually due for payment as it is merely on estimated date of collection. 4. Credit Factoring: It is also known as Invoice Discounting. Under the credit factoring, the factor purchases the invoices of the clients at a discount, and thus provides finance to the clients. Under this arrangement, the factor neither maintains the sales ledger not undertakes debt collection. This is a type of undisclosed or confidential factoring as under this, the debtor/customer is not aware that the seller / client has availed factoring facility because there is no notice of assignment to him. 5. Bulk Factoring: This also is a type of Invoice Discounting. Under this factoring, the factor provides finance to the client only after notification to the debtors / customers to make payment to the factor. This factoring is with-recourse basis and the client himself is required to maintain sales ledger, credit control and collection of debts. 6. Agency Factoring: Under this, the factor acts as an Agent of the Client. The Factor provides repayment facility and protection against bad debts. But, here also the client maintains sales ledger, carries collection of debts and manages credit control. Agency factoring also provides additional facility of insurance against credit risk. 7. A limited company operates a lodging house with a restaurant, shops and recreational facilities attached. Its Chairman has entrusted you with the planning of the coming year s operations, more particularly on the level of profits the company was likely to earn. The lodging house has 100 double-bed rooms, which are likely to be rented at Rs.150 per day. The Chairman expects an occupancy ratio of 75% for a period of 250 days during the tourist season. It is also anticipated that both the beds in a room will be occupied during the period. Each person staying in the lodging house is expected to spend, on the basis of past statistics, Rs.30 per day in the shops attached to the lodge and Rs.60 per day in the restaurant. The recreational facilities are not charged to the customer. Some other relevant data available to you is as under: (i) Variable cost to volume ratio Shops Restaurant a. Cost of goods sold 40% 30% b. Supplies 5% 15% c. Others 5% 10% (ii) For the lodging house, the variable costs are Rs.25 per day per occupied room for clearing, laundry etc. (iii) Annual fixed costs for the entire complex are Rs.19,50,000 Further the Chairman of the company suggests that if the room rent is reduced to Rs.125 per day occupancy can go upto 90%. From the above you are required to prepare. (a) an income statement for the coming year, and (b) an analysis to indicate whether the Chairman s suggestion of reducing rent to Rs.125 per day to enhance the occupancy ratio to 90% should be accepted. (15) 14

JUNE 2000 Ans: (A) Income Statement for the coming year A Revenue Hotel Room Receipts (100 rooms x 250 days x Rs. 150 x 75% ) Shops (100 Rooms x 2 Persons x 250 days x Rs.30 x 75%) Restaurant (100 Rooms x 2 persons x 250 days x 60 x 75% ) Rs.28,12,500 Rs.11,25,000 Rs.22,50,000 Rs.61,87,500 B Variable Costs: Hotel Rooms (100 Rooms x 250 days x 25 x 75%) Rs. 4,68,750 Shops (Rs.11,25,000 x 50%) Rs. 5,62,500 Restaurant (22,50,000 x 55%) Rs. 12,37,500 Rs.22,68,750 Revenue Rs.61,87,500 - Variable Cost Rs.22,68,750 = Contribution Rs.39,18,750 Contribution Rs. 39,18,750 Less: Fixed Costs Rs. 19,50,000 (B) Income Statement based on Chairman s suggestions. Revenue Hotel Room Receipts (100 Rooms x 250 days) x Rs.125 x 90% Rs.28,12,500 Shops (100 Rooms x 2 persons x 250 days) x Rs.60 x 90% Rs.13,50,000 Restaurant (100 Rooms x 2 persons x 250 days x 60 x 90%) Rs.27,00,000 Rs.68,62,500 B Variable Cost Hotel Rooms (100 Rooms x 250 days x Rs.25) x 90% 5,62,500 Shops (Rs.13,50,000 x 50%) 6,75,000 Restaurant (Rs.27,00,000 x 55%) 14,85,000 27,22,500 Revenue Rs.68,62,500 - Variable Costs Rs.27,22,500 = Contribution Rs.41,40,000 Contribution 41,40,000 Less: Fixed Costs 19,50,000 Profits 21,90,000 The Profit based on Chairman s suggestion Rs.21,19,000 is higher than the expected profit Rs.19,68,750, therefore it is advisable that the chairman s suggestion of reducing the room rent to Rs.125/- per day to enhance the occupancy rate to 90% should be accepted. 15

JUNE 2000 OR Q: The following figures are made available to you of a limited company. Net profits for the year 18,00,000 Loss: Interest on secured Debentures @ 15% p.a. (Debentures were issued 3 months after the commencement of the year) 1,12,500 16,87,500 Less: Income Tax at 35% and dividend distribution Tax 8,43,750 Profit after Tax 8,43,750 No. of Equity Shares (Rs.10 Each) 1.00.000 Market quotation of equity share Rs.109.70 The company has accumulated revenue reserves of RS.12 lacs. The company is examining a project calling for an investment obligation of Rs.10 lakhs. This investment is expected to earn the same rate of return as funds already employed. You are informed that a debt equity ratio (Debt divided by Debt Plus Equity) higher than 60% will cause the price earning ratio to come down by 25% and the interest rate on additional borrowings will cost company 300 basis points more than on their current borrowals on secured debentures. You are required to advise the company on the probable price of the equity share, if... (a) the additional investment were to be raised by way of loans; or (b) the additional investment was to be raised by way of equity. (15) Ans: (A) Probable price / share, if additional investment were to be raised. Present Capital Employed Rs. Equity 10,00,000 Debentures (Long Term) 10,00,000 Revenue Reserves 12,00,000 32,00,000 Pre-interest Profit before tax Rs.18 lacs. Rate of Return EBIT = Rs.18 lacs x 100 / Rs.32 lacs = 56.25% Debt equity ratio, if Rs.10 lacs (additional investment) were to be borrowed (Debt Rs.20 lacs and equity Rs.22 lacs) will be = Rs. 20 lacs x 100 / Rs.42 lacs = 47.60% 16

JUNE 2000 Since the debt equity ratio will not exceed 60% P/E will remain the same. If Rs.10 lacs are to be borrowed, the earnings will be as under: Rs. Return 56.25% on Rs.42 lacs 23,62,500 Less: Interest @ 15% on existing Rs.10 lacs debentures 1,50,000 Interest on fresh borrowed funds of Rs.10 lacs @ 18% 1,80,000 3,30,000 Profit after interest but before tax 20,32,500 Less Tax @ 35% 7,11,375 Profit Post Tax 13,21,125 No. of Equity Shares 1,00,000 E.P.S. = Rs.13,21,125 / 1,00,000 = Rs.13.21 Probable price of share = Rs.13.21 x 10 = Rs.132.10 (B) Probable price / share, if an additional investment were to be raised by way of equity. If Rs.10 lacs were to be raised by way of equity shares to be raised at Market Rates. The existing market price of Rs.109.70 may come down a little and may possibly settle at Rs.100. Hence new equity share to be raised will be Rs.10,00,000 / Rs.100-10,000 shares Rs. Profit before interest & tax 23,62,500 Less: Interest on debentures 1,50,000 22,12,500 Less: Tax @ 35% 7,74,375 Profit after Tax 14,38,125 No. of Equity Shares 1,10,000 E.P.S. = 14,38,125 / 1,10,000 = rs.13.07 Probable price of equity share 13.07 x 10 = Rs.130.70 It will be advisable to issue fresh debentures to finance expansion. 17

JUNE 2000 Working Note: Present earnings / Shares Profit before Tax 16,87,500 Less: Taxes 35% 5,90,625 Profit after Tax 10,96,875 No. of Equity Shares 1,00,000 E.P.S. = Rs.10,96,875 / 1,00,000 E.P.S. = Rs.10.97 Market Price Rs.109.70 Hence P/E = Rs.109.70 / 10.97 = 10 18

DECEMBER 2000 INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, DECEMBER 2000 SECTION-I 1. (a) Define any five of the following terms. (5) (i) Cash Flow Discounting: Evaluation of cash flows both inflow and outflow to a base point to enable comparison of projects. Discounted Cash flow or time adjusted methods are: (a) Net Present Value Method (NPV); (b) Present Value Index Method (PVI); and (c) Internal Rate of Return Method (IRR) (ii) BETA: An index of systematic risk. It measures the sensitivity of a share s return to the changes in ratios on the market portfolio. Beta is an index of systematic risk. The riskiness of the individual stock is measured by the share s Beta Factor, which is simply a measure of the volatility of the share relative to the market. (iii) Conversion Cost: It is the cost of converting or transforming raw materials into finished products. Conversion cost is the total of direct labour, direct expenses and chargeable factory overheads - Conversion Cost = Direct Labour + Direct Overheads + Chargeable Factory Overheads. (iv) Price Earning Ratio: Market Price Per Share / Earnings Per Share. It is the ratio between market price per equity share and earnings per share. This ratio is calculated to make an estimate of appreciation in the value of a share of a company. (v) Preference share : A share which bears a stated dividend and has priority of claim over equity shares in the matter of dividend and assets in the event of liquidation of the Company. (vi) Capital Adequacy Ratio : This is the ratio of unimpaired capital funds to risk weighted assets and exposures. RBI allotted risk weights to different categories of on and off balance sheet assets and exposure of banks, both for their domestic and overseas operation. The amount of each fund-based asset is multiplied by the relevant risk weight to produce risk-weighted assets. (b) Fill the blanks with appropriate words / figures / phrase/s. (5) (i) All costs that cannot be identified with the object of costing but are necessary adjuncts are called INDIRECT COST. (ii) In sale of goods income is recognised when the properly in goods passes from BUYER to SELLER. (iii) Spread is the difference between AVERAGE rate of interest earned on advances and paid on deposits. (iv) Higher Burden Coverage Ratio IMPROVES branch s profitability. (v) Debtors + Cash and Bank Balance = LIQUID RATIO. Current Liabilities (vi) Profit is a SOURCE of funds. 19

DECEMBER 2000 (vii) The amount of provision to be made for the loss asset is 100% of the outstanding. (viii) Capital which is not subrogated or earmarked for any other purpose is called UNIMPAIRED. (ix) All facilities of full factoring except CREDIT PROTECTION are available in recourse factoring. (x) Seed Capital assistance / margin money assistance, subsidy from centre / state government etc., called QUASI CAPITAL. (c) State with reason/s in brief whether the following statements are true or false. (5) (i) Prime cost is equal to direct materials plus factory overheads. (ii) (iii) FALSE: In fact, prime cost is the total of Raw Material Consumed + Direct Labour + Direct or Chargeable Overheads. Flexible Budgeting is suitable for seasonal industries. TRUE: A flexible budget is useful where the level of activity changes from time to time. R and D allocation is determined after consideration of economic and competitive conditions of the business. TRUE: R & D (Research and Development) allocation is determined in view of the economic and competitive business in order to capture a big part of the market. (iv) Cash is a productive asset and hence should be maintained as high as possible. FALSE: If cash is maintained at a very high level, it will create a hurdle in the day to day working and thus will reduce the efficiency of the concern. (v) The forfeiter does not take over burden of receivable collection. FALSE: In fact, the forfeiter relives the exporter from the burden of collecting money from the importer. SECTION-II 2. Answer any four questions explaining in short reason/s for your choice in not more than 50 words. (i) Balance Sheet of a company indicates that its current ratio is 1.5. Company s net working capital is Rs. one crore. The Current Assets would amount to (3) (a) Rs. 3 crore (b) Rs.1.5 crore (c) Rs.4 crore Ans: (A) Current Ratio is 1.5 which means the current assets are 1.5 times of the current liabilities. Thus, if working capital is.5 crore, current assets will be Rs.1.5 crore and current liabilities Rs.1 crore. Therefore, if working capital becomes double i.e., Rs.1 crore, the current assets and current liabilities will also be double i.e., Rs.3 crore and Rs. 2 crore, respectively. (ii) Long term sources of funds can be had from (3) (a) Bridge Loan. (b) Trade Credit. 20

DECEMBER 2000 (c) Working Capital assistance from the bank. (d) Retained earnings. Ans: (D) Retained earnings or the ploughed - back profits are the major source of long-term finance. Retained earnings are the effect of surplus earned by way of operating the business and retained in the business by transforming the same in the reserves and surplus accounts. Bridge Loan, Trade Credit and Working Capital assistance from the bank are the sources for short-term or medium-term finances. (iii) Cost of project does not include (3) (a) Cost of Public Issue (b) Raw materials cost (c) Margin on working capital (d) Interest on borrowed funds before commercial production Ans: (B) Capital cost of a project includes all expenses needed to bring the project into the stage of commercial production. Thus, it includes the cost of fixed assets like land and site development, buildings, plant & machinery, etc. and also technical know-how fees, preliminary expenses, preoperative expenses (like salary, interest on loan, etc. before commencement of production), provision for contingencies and margin money for working capital. Therefore, raw material cost is not included in the project cost, as the raw material cost is the element for production cost. (iv) Under Cash Budget System method the working capital limit is determined by (3) (a) Ascertaining level of current assets (b) Ascertaining level of current liabilities (c) Finding cash gap after taking into account projected cash inflows and outflows. (d) All of above Ans: (C) Under cash budget system, the working capital limit is determined by finding cash gap after taking into accounts projected cash inflows and outflows. (v) Capital Adequacy of a bank can be improved by (3) (a) Fresh public issue of capital (b) Better recovery (c) Revaluation of assets (d) All of the above Ans: (D) Capital adequacy of a bank can be improved by all the methods given viz., fresh public issue of capital, better recovery of non-performing assets (NPAs) and revaluation of assets. 3. Answer question No.(i) and any three of the rest in 2-4 lines. (i) How is cost of preference capital calculated? (4) The cost of preference capital calculated as follows: Kp = D / P 21

DECEMBER 2000 Where Kp = Cost of Preference Shares D = Dividend in Rupees P = Price of Preference Shares (ii) How is Cash Break-Even point determined? (3) Cash Break-Even Point enables the management to determine the level of activity below which the liquidity position of the firm would be adversely affected. The formulae is as under: Fixed Operating Cost - Non Cash Expenditure = Price per Unit - Variable Operating Cost per Unit (iii) What is a budget? (3) A budget is quantitative expression of management objective and a means of monitoring progress towards achievement of those objectives. In the words of Crown and Howard, A budget is a predetermined statement of management policy during a given period which provides a standard for comparison with the results actually achieved. (iv) Name the common statements used for financial forecasting. (3) Forecasting is an well-educated guess or inference as to what the future may be. Forecasting is generally done on the opinions of executives, workers, foremen, etc., Besides some statistical techniques are also used for forecasting. These include Projected Cash Flow Statement Projected Profit & Loss Statement Projected Balance Sheet Fund Flow Statement (v) What is permanent working capital? (3) Permanent working capital represent the current assets required on a continuing basis over the entire years and relates to cash, receivable and inventory required to be maintained at a minimum level to carry out operations at any time as a safety measure. SECTION-III 4. (a) Write Short Notes on (i) Out of order borrowal account and past due (4) OUT OF ORDER: A Cash credit or overdraft account is out of order if: i) the outstanding balance remains continuously in excess of the sanctioned limit / drawing power. or ii) the outstanding balance is less than the sanctioned limit / drawing power, but there is no credit continuously for 6 months as on the date of balance sheet / classification. or 22

DECEMBER 2000 iii) credits, if any, are not sufficient to cover interest debited to the account during the above-mentioned period of 6 months. PAST DUE: An amount is to be treated as past due when it has not been paid for 30 days beyond the due date. This concept of past due is applicable to both interest and instalments due. For example - if interest is charged on an account for the quarter ending 30-09-97 and is not paid by 30-10-97, then it is past due. Similarly, if an instalment is due on 31 st October, 97 but it remained unpaid till 30 th November, 97 it is past due. (ii) Multiple Transfer Pricing System followed in banks (3) Banks follow with some modifications the Multiple Transfer Pricing System evolved by IBA. Under this system, branches receive subsidy from Head Office on their interest expenses on deposits and pay recovery to Head Office on their interest income on advances. With increased emphasis of late on Assets and Liabilities management branches also receive subsidy on their net reduction of Non- Performing Assets (NPAs). In some banks, their HOs effect recovery on the outstanding NPA of branches. Branches also are penalised by way of paying recovery to Head Office if they hold idle funds (cash at hand and balance with other commercial Banks). In some banks, branches pay recovery on the idle funds in excess of the limits fixed by their controlling offices. Similarly they receive subsidy from Head Office if they hold lower idle funds. However the weights assigned to each of the above variables differ from Bank to Bank. In some banks to encourage lending to eligible borrowers under Differential Rate of Interest (DRI) scheme, branches are paid subsidy for the interest earned on DRI loan. (b) The following figures relate to two companies. (8) A Ltd. B Ltd. (Rs. in lac) (Rs. in lac) Sales 500 1000 Variable Costs 200 300 Contribution 300 700 Fixed Costs 150 400 150 300 Interest 50 100 Profit before Tax 50 200 You are required to : i) Calculate the operating and leverages and ii) Comment on the relative risk position of the two companies Ans: CALCULATION OF LEVERAGES: A Ltd., B Ltd., Operating Leverage = Contribution / EBIT Rs.300 lakhs / Rs.150 lakhs Rs.700 lakhs / Rs.300 lakhs = 2 = 2.33 23

DECEMBER 2000 Financial Leverage = EBIT / Profit before Tax Rs.150 lakhs / Rs.100 lakhs Rs.300 lakhs / Rs.200 lakhs = 1.5 = 1.5 Combined Leverage = Contribution / PBT Rs,300 lakhs / Rs.100 lakhs Rs.700 lakhs / Rs.200 lakhs = 3 = 3.5 (a) Operating Leverage: It is higher for B Ltd., than for A Ltd. Hence, B Ltd., has greater degree of business risk. In other words the tendency of net income (Operating Profit or earnings before interest and tax to vary disproportionately with sales is greater in case of B Ltd., than A Ltd., (b) Financial Leverage: Both the companies have the same degree of Financial risk. It means that the tendency of residual net income (profit before tax) to vary disproportionately with net income (earnings before interest and tax) is the same in case of both the companies. (c) Combined Leverage: A Ltd., has less overall risk as compared to that of B Ltd., 5. XYZ Ltd. specialises in the manufacture of a computer component. The component is currently sold at Rs.1,000 and its variable cost is Rs.800. For the year ended 31.3.2000 the company sold on an average 400 components per month. At present the company grants one-month credit to its customers. The company is contemplating of extending the same to two months on account of which the following is expected. Increase in Sales 25% Increase in Stocks Rs.2,00,000 Increase in Creditors Rs.1,00,000 You are required To advise the company on whether or not to extend the credit terms if: a) all customers avail the extended credit period of two months and b) existing customers do not avail the extended credit terms but only the new customers avail the same. Assume in this case that the entire increase in sales is attributable to the new customers. The company expects a minimum return of 40% on the investment. (15) Ans: Statement showing analysis to advise the company on whether or not to extend the credit terms if: All customers avail the Only the new customers extended credit period avail the extended credit Rs. Rs. Profitability of additional sales Present annual turnover 400 x 12 x Rs.1,000 48,00,000 48,00,000 Increase in turnover 25% 12,00,000 12,00,000 Revised Sales 60,00,000 60,00,000 24

DECEMBER 2000 P/V Ratio = (Rs.1,000 - Rs.800 / Rs.1,000) x 1,000 20% 20% Profitability of additional sales (increase in contribution): (20/100) x Rs.12,00,000 (A) 2,40,000 2,40,000 Cost of carrying additional debtors and stock Proposed / Additional Debtors 10,00,000 2,00,000 (Rs.60,00,000 x 2 / 12) (Rs.12,00,000 x 2/12) Less: Existing debtors 4,00,000 (Rs.48,00,000 x 1/12) Additional (increase in) debtors 6,00,000 2,00,000 Investment in additional debtors (Variable cost being 80% of sales value) 4,80,000 1,60,000 Increase in Stock 2,00,000 2,00,000 6,80,000 3,60,000 Less: Increase in Creditors 1,00,000 1,00,000 Net additional investment in Working Capital 5,80,000 2,60,000 Minimum Return @ 40% (B) 2,32,000 1,04,000 Excess of profits over cost of carrying additional working capital @ (A-B) 8,000 1,36,000 ADVICE: The above statement shows that it is profitable to extend credit period in both cases. Hence the company may extend credit terms. However, in view of higher profits when only new customers avail the extended credit period, the second option (b) should be adopted. SECTION-IV 6. A) It is traditionally argued that the objective of a company is to earn profit; hence the objective of Financial Management is also profit maximisation. Comment. (8) Ans: The statement implies that the finance manager has to make his decision in a manner that the profits are maximised. Each alternative, therefore, is viewed by him as to whether or not it gives maximum profit. Profit maximisation can not be the sole objective of a company. It is at best a limited objective. If profit is accorded an undue importance, a number of problems can arise. Some of them have been discussed as follows: 25

DECEMBER 2000 (i) The sole objective of profit maximisation generally ignores the risk. Profit maximisation has to be attempted with a realisation of risk involved. There is a direct relationship between risk and profit. Many risky proposition yield high profit. Higher the risk, higher is the possibility of profits. If profit maximisation is the only goal. Then risk factor, is altogether ignored. This implies that finance manager will accept highly risky proposals also, if they give high profits. In practice, however, risk is a very important consideration and also to be balanced with the profit objective. (ii) Profit maximisation as an objective does not take into account the time pattern of returns. For example, proposal A may give a higher amount of profits compared to proposal B yet, if the returns begin to flow 10 years later, proposal B may be preferred which may have lower over all profits but the returns flow is more quick. (iii) Profit maximisation as an objective is too narrow. It fails to take into account the social considerations as also the obligations to various interests of workers, consumers, society, as well as ethical trade practices. If these factors are ignored, a company can not survive for long profit maximisation at the cost of social and moral obligations is a shortsighted policy. Hence, a company, which follows profit as its sole objective, may adopt policies yielding exorbitant profits in the short run which are unhealthy to the growth, survival and overall interests of the business. Thus, a company may not undertake planned and prescribed shut down of the plant simply to maximise its profits in the short run. If this reduces the life of a plant by five years, the company is ignoring maintenance only at its peril although it may have greater profits in the short run. Hence, it is commonly agreed that the objective of a firm is to maximise its wealth and the value of shares. The above statement is therefore incorrect. B) Explain various steps involved in financial planning. (7) Ans: Briefly speaking, the first step involved in financial planning is to lay down both long term and short term objectives. The short-term objective may be that of liquidity, while the long-term objective may be in optimise the shareholders wealth. The second step in the financial planning is formulation of policies, which will guide to all actions for procuring and disbursing funds to business firms. The third step is collection of facts and forecasting the future. This step is closely related to formulation of policies. Fourth step involved is formulation of procedures. Each procedure should be detailed enough to ensure consistency in action. Each person involved in the process should know what he is supposed to do. The next step is to provide flexibility. The situation changes often and the planning should provide room to revise the policies or completely change the same to take advantage of changing conditions. (In other words, financial planning covers the following aspects): i) Determination of financial objectives: As stated above, the financial objectives of an organisation may be divided into short-term and long-term objectives. The short-term objectives may be in respect of maintaining the liquidity, proper maintenance of sale etc. whereas the long term objectives of financial planning may be to secure and employ resources in the requisite amount and in the desired proportion to increase the efficiency of other factors of production. ii) Formulation of financial policies: Policies are guides to decision making for achieving the firm s primary objectives. Some of the important policies may be regarding capitalisation, capital structure, trading on equity, fixed assets management, dividend distribution and working capital management. These policies cover the areas of procuring, administering and distributing the funds of the business enterprise, and may specifically be spell out to govern the capitalisation, debt-equity ration, sources 26

DECEMBER 2000 of funds, administration and distribution of funds collection of debts and extending credit etc. and extent of control to be exercised by the suppliers of funds. iii) Designing financial procedures: A procedure helps in the practical implementation of decision taken by the finance manager. During the course of financial planning it is also necessary to design and develop procedures involving funds which are helpful in the achievement of the firm s objectives. In developing financial procedures, the finance manager will decide about the control system, develop standards of performance, evaluate the performance and then compare the activities with the standards. Since evaluation is continuous process the finance manager has to very vigilant. To ensure the best possible use of funds the finance manager may employ the techniques of capital budgeting, financial forecasting, and financial analysis like ratios and budgetary control, etc. OR Discuss elaborately any five factors, which need to be considered in the choice of INVESTMENT. (15). Ans: The following are the important factors, which are required to be considered in the choice of investment. i) Security: Whenever a person invests his funds, he would require that his investments are safe. This means that the principal amount and the return thereon would be redeemed when due. Safety of funds is the primary objective of portfolio management. Therefore, it is a must for the investors or portfolio managers to ensure that their investments are safe and will return with appreciation in value. ii) Liquidity: An investor would like that his investments should remain as liquid as possible so that in case of need, he can encash them without loss of time and value. Therefore, an investor has to consider the liquidity aspect while making investments. He has to match the maturity schedule of investments with his needs. iii) Return: Every investor with a view to get good / reasonable return on his investments. This is one of the prime considerations in taking an investment decision. Certain investments carry fixed rate of return, namely, bank deposits, debentures, public deposits etc., and there are other investments, namely, shares of a company, which do not carry fixed rate of return. An investor has to decide whether he would like to have fixed and regular return or he is prepared to have fluctuating return on his investments. Accordingly, he will decide about the investments. iv) Risk: Risk is inherent in all the investments. Risk and return have direct relationship. Higher the risk, higher the return. If one wishes to have higher return from his investments, he should be prepared to carry higher risk also. For example, if one wishes to double his investment in one year, he can do so by purchasing high risk shares, in which case, there is a great amount of risk that he may loose even his initial investments. Every investor has to consider this aspect while deciding about investment portfolio. By proper judgement and intelligence one can reduce the element of risk to the extent possible. Proper planning and periodical review of market situation can help in minimising the risk. v) Growth: This is very crucial to decide what type of securities an investor would like to have in his investment portfolio. The investor is very much concerned with appreciation in the value of his investment. This also determines the ultimate profitability of his investments. There are a wide variety of investments available, i.e., debentures, convertible bonds, preference shares, equity shares, Government Securities, Mutual funds, etc. Some of these are fixed return bearing securities. These ensure a definite return and thus have a lower risk and return. However, if investments are made in shares or convertible debentures of a good company, sufficient appreciation (growth) may be caused in the value of investments after the lapse of a reasonable time. 27

DECEMBER 2000 7. The following balance sheet of XYZ Co. Ltd. as of the year ended 31.3.1999 and 31.3.200 are available. You are required to prepare (15) (a) Statement of funds generated from operations (b) Change in Working Capital (c) Funds Flow Statement LIABILITIES 31.3.1999 31.3.2000 ASSETS 31.3.1999 31.3.2000 Rs. Rs. Rs. Rs. Share Capital 1,50,000 2,25,000 Land 1,50,000 1,50,000 Share Premium 7,500 Plant 1,50,000 1,50,000 General Reserve 75,000 90,000 Furniture 10,500 13,500 P and L A/c 15,000 25,500 Investment 90,000 1,20,000 Debenture 6% 1,05,000 75,000 Debtors 45,000 1,05,000 Provision for Depreciation on Plant 75,000 84,000 Stock 90,000 97,500 Depreciation of furniture 7,500 9,000 Cash 45,000 67,500 Tax 30,000 45,000 Sundry Creditors 1,29,000 1,42,500 TOTAL 5,86,500 7,03,500 TOTAL 5,86,500 7,03,500 Additional Information: 1. Plant purchased for Rs.6,000 (Depreciated value Rs.3,000) was sold for cash Rs.1,200 on 30 th Sept. 2. On 29 th June furniture was purchased for Rs.3,000. 3. Depreciation on plant 8%. Depreciation on furniture 12 1/2 % on average cost. 4. Dividend 22% on original share capital. Ans: Funds from operation (Profit & Loss A/c) Rs. Rs. To Depreciation on Plant 12,000 By Opening Balance of P & L A/c 15,000 To Depreciation on Furniture 1,500 By Net Profit 74,550 To General Reserves 15,000 To Dividend 33,750 To Loss on Sale 1,800 Closing Balance of P & L A/c 25,500 TOTAL 89,550 TOTAL 89,550 28

DECEMBER 2000 Changes in Working Capital: Rs. Increase in Current Assets: Debtors 60,000 Stock 7,500 Cash 22,500 90,000 Less: Increase in Current Liabilities: Sundry creditors 13,500 Tax 15,000 28,500 Net increase in working capital = Rs.61,500 Funds Flow Statement: SOURCES Rs. USES Rs. Funds from operation (P & L A/c) 74,500 Investment 30,000 Premium 7,500 Payment of debt 30,000 Issue of shares 75,000 Furniture 3,000 Sale of plant 1,200 Capital 61,500 Payment of dividend 33,750 1,58,250 1,58,250 OR Q: TIME watch Co. Ltd. manufactures and sells four types of watches under the brand names of classic. Legend, Vogue and Ultra. The total sales for the month of June 2000 is 1000 watches and the sales mix comprises of (15) Classic 150 watches Legend 240 watches Vouge 400 watches Ultra 100 watches The watches are sold at a fixed selling price of Rs.400 per watch. The operating costs are as follows. 29

DECEMBER 2000 Fixed cost per month Rs.1,00,000 Variable costs for the 4 brands are Classic Rs.200 per watch Legend Rs.240 per watch Vouge Rs.320 per watch Ultra Rs.160 per watch Keeping the total sales at 1000 watches per month Time Watch Co. Ltd. proposes to charge the sales mix as under: Classic 200 watches Legend 300 watches Vouge 350 watches Ultra 150 watches You are required to calculate (i) PV Ratio (ii) Break-Even Point and (iii) Profit for the watches sold on overall basis for the month of June 2000. Assuming that the proposal of the new sales mix is implemented, calculate P/V Ratio, Break-Even Point and Profit. Ans: CLASSIC LEGEND VOUGE ULTRA TOTAL (i) ii) June 2000-at the original sales mix Selling Price Rs. 400 400 400 400 No. of watches sold 150 350 400 100 1,000 Sales Rs. 60,000 1,40,000 1,60,000 40,000 4,00,000 Variable Costs per Watch Rs. 200 240 320 160 Total Rs. 30,000 84,000 1,28,000 16,000 2,58,000 Contribution 30,000 56,000 32,000 24,000 1,42,000 Fixed Costs 1,00,000 Profit 42,000 P/V Ration (C / S x 100) 50 40 20 60 35.5 Break-Even Point FC / (P/V Ratio) Rs. 2,81,690 When the new sales mix is implemented Selling Price Rs. 400 400 400 400 No. of Watches sold 200 300 350 150 1,000 30

DECEMBER 2000 Sales Rs. 80,000 1,20,000 1,40,000 60,000 4,00,000 Variable Costs per watch Rs. 200 240 320 160 Total Rs. 40,000 72,000 1,12,000 24,000 2,48,000 Contribution 40,000 48,000 28,000 36,000 1,52,000 Fixed Costs 1,00,000 Profit 52,000 P/V Ratio (C/S x 100) 50 40 20 60 38 Break Even Point FC / (P/V Ratio) Rs. 2,63,158 31

JUNE 2001 INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, JUNE 2001 SECTION-I 1. (a) Define any five of the following terms. (5) (i) Euro Bond: A debt security issued outside of its country to be marketed internationally. A major source of borrowing at Euro markets is through the issue of international bonds known as Euro bonds or offshore bonds. Euro bonds are those sold for international borrowers in several markets simultaneously by international group of banks. Euro bonds are sold in various countries other than the country of the currency in which the issue is denominated. (ii) Cash Flow Discounting: Evaluation of cash flows both inflow and out flow to a base point to enable comparison of projects. While appraising new or existing projects future cash flows are considered and analysed first besides other quantitative and qualitative parameters. Future cash flows are just estimates and based on the forecasted values. (iii) I.R.R: The Internal Rate of Return (IRR) is calculated as being the rate at which the Net Present Value of a project is Zero. Internal Rate of Return is percentage discount rate used in capital investment appraisals which brings the cost of a project and its future cash inflows into equality. It is the rate of return, which equates the present value of anticipated net cash flows with the initial outlay. (iv) Earning Per Share: Earning after tax divided by number of common shares. EPS = Profit After Tax (PAT) / No. of equity shares This is one of the most important profitability ratios for measuring the net profit earned on per share basis. (v) Opportunity Cost: The value of the benefit sacrificed in favour of choosing a particular alternative or action. It is the maximum amount that could be obtained at any given point of time if a resource was sold or put to the most valuable alternative use that would be practicable. The opportunity cost of a good or service; is measured in terms of revenue, which could have been earned by employing, that good or service in some other alternative uses. (vi) Capital Asset Pricing Model: A model that links together with risk and return for all assets. It provides a mechanism whereby the required return on asset can be estimated as a function of risk free rate, its BETA co-efficient and required return on market portfolio. (b) Fill the blanks with appropriate words / figures / phrase/s. (5) (i) Optimal capitalisation is when COST OF CAPITAL IS LOWEST. (ii) Standard Asset is a performing asset carrying not more than NORMAL credit RISK inherent in lending. (iii) Inventories are valued at COST or SELLING PRICE whichever is LOWER. (iv) The minimum value of export contract eligible for forfeiting is US $ 2,50,000. (v) Under D.P.G., a bank issues guarantee in favour of SUPPLIER. (vi) DICGC / ECGC guaranteed covered credit carries 50% risk weight. 32

JUNE 2001 (vii) The LESSOR bears the risk of obsolescence under operating lease. (viii) Bills negotiated under LCs are not taken as CURRENT ASSET for assessment of working capital. (ix) Under a Hire Purchase Agreement, the HIRES enjoy the salvage value of an asset. (x) A corporate bond very speculative, may be in default is rated as Ca by MOODY. (c) State with reason/s in brief whether the following statements are true or false. (5) (i) Revaluation reserve is part of Tier I Capital of banks. (ii) (iii) FALSE: The true version of this statement is that a revaluation reserve arises from the revaluation of assets that are under-valued in the books of a bank. This reserve is less permanent in nature and cannot be considered core capital. According to the directives of the RBI, revaluation reserve is to be included in Tier-II capital of the bank and that too at a discount of 25%. Contribution comes from Deposits alone. FALSE: Contribution comes from deposits (Savings, Term Deposits, Current Deposits) as well as Non- DRI advances, DRI advances, and reduction in NPA and float funds. Stock on hire is considered at full value by a lending banker while computing the receivables of a hire purchase company. FALSE: Stock on hire is considered at full values less amounts received for lending by a bank to the hire-purchase company. (iv) G.D.R. proceeds can be freely repatriated. TRUE: G.D.R. is freely repatriable at any time after cancellation. (v) Annual Sales / Net Fixed Assets = Total Assets Turnover FALSE: The correct formula is - Annual Sales / Total Assets (excluding fictitious assets) = Total Assets Turnover While computing Total Assets Turnover, Total Assets (excluding fictitious assets) are taken into account, and not Net Fixed Assets. SECTION-II 2. Answer any four questions explaining in short reason/s for your choice in not more than fifty words. (i) For arriving at book value of equity shares, which of the following factors you would consider and why? (3) (a) Increase in market share (b) Net Worth (c) Increase in share capital Ans: (B) For arriving at book value of the equity share net worth has to be considered. Net Worth includes paid up share capital plus un-encumbered reverses. Accumulated losses if any, have to be deducted from the capital. Net worth represents stake of equity holders and dividing net worth can arrive at book value of share by number of shares. 33

JUNE 2001 (ii) A borrowal account having outstanding of Rs. one crore has remained non-performing for 3 years. The realisable value of security is Rs. 50 lac. The worth of the guarantor is Rs. 2 crores. The provision required for this borrowal account would be... (3) (a) Rs. 20 lac. (b) Rs.30 lac. (c) Rs.50 lac. (d) None of these. Ans: (D) None of these. Provision required would be Rs.60 lacs. (iii) The perusal of the balance sheet reveals that the Current Ration is 3:1. Net working capital is Rs.80,000/-. The Current Assets will amount to... (3) (a) Rs.2,40,000 (b) Rs.1,20,000 (c) Rs.40,000 (d) None of these Ans: (B) The current assets will amount to Rs.1,20,000. Current Ration of 3:1 suggests that the current assets are three times more than current liabilities. Net working capital means current assets minus current liabilities. With the ratio, current assets will be 50% more than the net working capital. Hence, current assets would be 50% more than Rs.80,000 i.e., N.W.C. and hence equal to Rs.1,20,000. (iv) A company manufacturing washing machines has annual capacity for producing 5000 units. The variable cost per unit comes to Rs.1,600/- and each machine is sold for Rs.2,000/-. Fixed cost amounts to Rs.5,00,000/-. Break Even Point in terms of UNITS would be... (3) (a) 1000 units (b) 1250 units (c) 1200 units Ans: (B) 1,250 unit BEP (Units) = Fixed Cost / Sales Price - Variable Cost = Rs.50,000 / Rs.2,000 - Rs.1,600 = 1,250 units (v) Net Profit of a firm is Rs.1,50,000/-. Expenses other than those resulting in outflow of cash is Rs.40,000/-. The funds generated by the company from its operations would be... (3) (a) Rs.1,10,000 (b) Rs.1,30,000 (c) Rs.1,90,000 (d) None of these Ans: (C) Rs.1,90,000. Funds generated by the company are Rs.1,90,000. Expenses other than those resulting in cash outflow refers to depreciation, which is non-cash expenditure and is added to the net profit to arrive at funds/cash generated. 34

JUNE 2001 3. Answer question No.(i) and any three of the rest in 2-4 lines. (i) What is marginal cost of capital? (4) Marginal cost of capital is the cost of raising an additional rupee of capital. It is derived when the average cost of capital is computed with marginal weights. The weights represents one proportion of funds, the firm intends to employ. The marginal cost of capital is calculated with the intended financing portion of weights. (ii) What is substandard asset? (3) A sub-standard asset is one, which has been classified as NPA for the period not exceeding two years. (iii) What is operating cycle? (3) The Operating cycle is the length of time that elapses between the company s outlay on raw materials, wages and other expenditures and the inflow of cash from the sales of goods. (iv) What is Net Present Value? (3) A selection method using the difference between the present value of the cash inflows of one project and the investment outlay. This method evaluates differential cash flows between the proposals. (v) What is Economic Order Quantity? (3) This is the quantity of materials that should be ordered so that the cost of ordering together with the cost of stockholding is minimised. Alternatively, candidates may answer by giving one formula. The economic order quantity can be calculated by using the following formula: EOQ = 2 A C H A = Stock C = Cost of Ordering H = Stockholding cost per unit of stock. SECTION-III 4. (a) Write Short Notes on (i) Forward as hedge instrument (4) International transactions both trade and financial give rise to currency exposures. A currency exposure is left unmanaged leaves a corporate open to profit or losses arising on account of fluctuations in currency ratio. One way in which corporate can protect itself from the adverse effect of fluctuation in currency rates is through buying or selling in forward markets. A forward transaction is a transaction requiring delivery at a future date of a specified amount of 35

JUNE 2001 another currency. The exchange rate is determined at the time of entering into the contract but the payment and delivery takes place on maturity. Corporates use forward to hedge themselves against fluctuations in currency price that would have a significant impact on their financial position. Banks use forward to offset the forward contracts entered into with non-bank customers. (ii) Debt Servicing Coverage Ratio (3) This ratio indicates the ability of a project to service the debt i.e., payment of interest and repayment of principal within the stipulated time. In order to assess the ability of the project to service the debt it is necessary in the first place to find out the gross cash accruals and then co-relate the same with the liability in respect of payment of interest and repayment of the instalments of the principal amount. The financial institutions are very keen to ensure that the project has sufficient strength to service the debt. The Institutions would normal be satisfied with an average DSCR in the range of 1.6 to 2 times. Net Profit (Before Interest and Taxes) DSCR = Fixed Interest Charges (b) Find the operating leverage from the following data. (4) (i) Sales Rs.1,00,000 (ii) Variable Costs 60% (iii) Fixed Cost Rs.24,000 Ans: Calculation of Operating Leverage: Sales Rs.1,00,000 Less: Variable Cost 60% Rs. 60,000 Contribution Rs. 40,000 Less: Fixed Cost Rs. 24,000 Operating Profit Rs. 16,000 Operating Leverage = Contribution / Operating Profit = 40,000 / 16,000 = 2.5 (c) Find out Financial Leverage from the following data. (4) (i) Net Worth Rs.50,00,000 (ii) Debt / Equity 3:1 (iii) Interest - 12% (iv) Operating profit Rs.40,00,000 Ans: Calculation of Financial Leverage: Debt = 50 lacs x 3 Rs.150 lacs 36

JUNE 2001 Operating Profits Rs.40 lacs Less: Interest 1,50,000 x 12 / 100 Rs.18 lacs Profit before tax Rs. 22 lacs Financial leverage = Operating Profit / P.B.T. = Rs.40 lacs / Rs.22 lacs = 1.818 5. Given below is abridged Balance Sheet of a Corporate. (15) As at 31.3.2000 As at 31.3.2001 (Rs. in Million) Fixed Assets at cost 124 140 Additions During the year 16 34 140 174 Depreciation 50 90 72 102 CURRENT ASSETS: Investments 20 30 Stocks at cost 363 380 Trade Debtors 263 277 646 687 Less: CURRENT LIABILITIES: Bank Overdraft 232 110 Trade Creditors 200 238 Proposed Dividend 32 48 464 182 396 291 272 393 Represented by: Equity Share Capital 150 200 General Reserves 52 76 Profit & Loss A/c 70 97 8% Debentures 20 272 393 37

JUNE 2001 You are required to prepare Fund Flow Statement for the year ended 31.3.2001, highlighting areas of major achievements of the corporate and comment upon areas, management should re-examine from the viewpoint of the financing pattern. Ans: Changes in Working Capital a) Increase in current assets 31 (Excluding investment) Increase in trade creditors 38 Decrease in working 7 b) Funds from operations Profit & Loss A/c (97-70) 27 Add General Reserve (76-52) 24 Depreciation (72-50) 22 Proposed dividend 48 Funds from operation before Dividend 121 FUNDS FLOW STATEMENT FOR THE YEAR 31.03.2001 SOURCES Rs. APPLICATION Rs. IN MILLIONS IN MILLIONS Funds from operation 121 Purchase of fixed assets 34 Before dividend Issue of Share Capital 50 Repayment of bank overdraft 122 Issue of debentures 20 Dividend payment 32 Decrease in working capital 7 Purchase of investment 10 198 198 COMMENTS: Repayment of bank overdraft may be considered as an achievement of the management. However, the pattern of funding is subject to criticism. Creation of fixed assets has been done out of share issue. This is acceptable since one is long term asset and other is a permanent source. But such funding could be done by debenture issue entirely since debt/equity ratio was non-existent in 2000. Even in 2001, it is only 1:10. Besides, repayment of overdraft has been done from equity issue, partly from debenture issue and retained earnings. These funds are generally from long term sources. The repayment should have been done from short-term sources. SECTION - IV 6. With reference to infrastructure financing, elaborate upon. (a) Risks involved. (b) Concept of financing those have emerged (c) Funding structure 38

JUNE 2001 (d) (e) Mechanism of Escrow account Steps required to be taken by the banks in processing infrastructure financing a. Risks involved The specific risks involved with infrastructure are: k Commercial Risk - Costs of production and uncertainties in demand for services. k Construction Risk- Technical designs, cost over-run etc. k Operating Risk - Cost and availability of operating inputs, bottlenecks etc. k Regulatory Risk- As most of the infrastructure projects come under the category of public utilities; they are highly susceptible to sector specific regulatory policy decisions. k Funding Risk- Mismatch with regard to liability sources and investment deployment of the promoter, adverse interest movements (floating or fixed) and even high exchange risk. k Political Risk- Foreign investment does not come forth to developing countries mainly because of political risk etc. may result in funding risk. b. Concepts of financing The following concepts have emerged in management of infrastructure projects. v BOT (Build, Operate and Transfer) - It refers to construction by a private party/consortium, which finances, operates and maintains an infrastructure for a specified period. Thereafter, it transfers the project to an identified public agency or back to the Government itself. BOT may have a period of transfer between 10 and 25 years. v BOOT (Build, Own, Operate and Transfer) - It is like BOT but the period of transfer could be upto 50 years. v BOO (Build, Own and Operate) - Under this the right to construct, operate and own remains with the private party. The infrastructure does not get transferred to the public sector. v BOLT (Build, Own, Lease and Transfer) - Public agency / Government invites private sector to build / manufacture and lease the constructed asset to the Public agency / Government. The later will pay lease charges (rentals) during lease period. On expiry of lease period, the asset is transferred to the Public agency / Government. c. Funding structure The funding structure may take an equity route and / or mezzanine form i.e., a maximum of financing instruments including equity, bonds, subordinate debt, senior debt and bridge loan etc. Equity may be offered through special purpose funds by multilateral agencies like International Finance Corporation, Asian Development Bank, construction contractors, and suppliers of capital equipment or through local equity markets. Another suggested method of financing is that initial borrowing may be for ten years, which may be refinanced by another round of borrowing. d. Mechanism of Escrow account The work involved in infrastructure financing has 3 phases - Pre construction, Post construction and 39

JUNE 2001 Operational phase. In the pre-construction stage, financing banks manage the risk by having full recourse to the promoters, contractors and the suppliers. In the post-construction stage, banks depend only on cash flows committed by lenders. To protect against adverse events, banks have devised Escrow Account mechanism through which the cash inflows are pooled and on which banks have first charge towards recovery of their loans. e. Steps involved in processing infrastructure finance proposal Banks financing infrastructure projects have to undertake the following: v Banks should ensure that they have the requisite expertise for appraisal of technical feasibility, financial viability and bankability of the project with particular reference to risk and sensitivity analysis. They can appraise the project with in house experts and / or external consultants. v Financing offer which involves the development and application of a financing concept to the borrower with a view to capturing lead mandate. v After the mandate is awarded the financial structure is fine-tuned in consultation with other lead banks. Any participation with the borrower should result in what is called a term sheet which set out the basic details of the financing and serves as a basis on which underwriting of the loan amount by lead banks is possible. v Documentation v Syndication v Funding according to draw down schedule and financial supervision and monitoring. OR Differentiate between Forfeiting and Factoring and enumerate advantages of Forfeiting to exporters and banks. Factoring is a financial package of Credit Protection Sales administration and receivables financing on with or without recourse to the seller. However, discounting of book debts or receivables is central to factoring. FORFAITING FACTORING 1. This is without recourse to the exporter. 1. This may be with recourse or without recourse to The risks are borne by the forfeiter. the supplier. 2. Trade receivables of medium to long term maturity 2. Factoring usually involves trade receivables of are the subject matter of forfeiting. short maturities. 3. Forfeiting involves avalising negotiable instruments 3. Factoring does not involve avalising negotiable like bill of exchange or promissory notes. instruments. 4. Eventually, the overseas buyer bears the cost of forfeiting. 4. The seller (client) bears the cost of factoring. 5. Forfeiting is generally transaction or project-based. 5. Factoring usually involves the purchase of all So the structuring and costing is on case to case basis. debts or all class of debts owing to the customer. 6. There exist a secondary market in forfeiting. 6. Factoring tends to be a One-Off sale of debt obligations to This adds depth and liquidity to forfeiting. the factor with no secondary market. 7. In forfeiting apart from improving cash flow, divesting the 7. In factoring the seller is looking to improve its cash flow and performance risk is the motive of the exporter. not necessarily to divest itself of the risk of non-payment, especially in with recourse factoring. 40

JUNE 2001 ADVANTAGES TO EXPORTERS: Forfeiting is beneficial both to the exporter and banker. The major advantages are discussed below: 1. Easy Liquidity: Forfeiting converts the deferred sale of an exporter into a cash sale. With inflow of funds from forfeiter, Exporters liquidity position improves. 2. Risk Avoidance: Forfeiting frees the exporter from cross - border / political or commercial risk associated with export receivables. The exporter washes its hands off the risk of the importer not meeting his obligations on the bills of exchange or promissory notes since forfeiting agency has no recourse to exporter. 3. Additional Source of Funds: Unlike in traditional post-shipment export finance, the exporter receives 100% of export receivables from the forfeiter (less, of course, the forfeiting cost). Forfeiting does not reduce the normal bank borrowing limits of the exports, which remain available to him. Thus, forfeiting is an additional source of funds - contributing to improved liquidity and cash flow. 4. Relieves Burden of Collection: Exporter is freed from cumbersome credit administration and problem of collecting the receivables. He can concentrate on quality in production, packaging and delivery. After forfeiting, he has no further involvement. 8. ABC Ltd. has just installed Machine X at a cost of Rs.2,00,000. The machine has a five-year life with no residual value. The annual volume of production is estimated at 150,000 units, which can be sold at Rs.6 per unit. Annual operating costs are estimated at Rs.2, 00,000 (excluding depreciation) at this output level. Fixed cost is estimated at Rs.3 per unit for the same level of production. ABC Ltd. has just come across another model called Machine Y capable of giving the same output at an annual operating cost of Rs.1,80,000/- (excluding depreciation). There will be no change in fixed costs. Capital cost of this machine is Rs.2,50,000 and the estimated life is for five years with NIL residual value. The company has an offer for sale of Machine X at Rs.1,00,000. But the cost of dismantling and removal will amount to Rs.30,000/-. As the company has not yet commenced operations, it wants to sell machine X and purchase Machine Y. ABC Ltd. will be a zero tax company for seven years in view of several incentives and allowances available The cost of capital may be assumed at 14%. P.V. factors for five years are 0.877, 0.769, 0.675, 0.592, 0.519, for first, second, third, fourth and fifth year respectively. (i) Advise whether the company should go for the replacement. (ii) Will there be any change in your views, if machine X has not been installed but the company is in the process of selecting one or the other machine? Support your views with necessary workings. Ans: (i) Replacement of machine X Increment Cash outflow (i) Cash outflow on machine Y 2,50,000 Less: Sale value of machine X 41

JUNE 2001 Less: Cost of dismantling & removal (Rs.1,00,000 - Rs.30,000) 70,000 Net Outflow 1,80,000 Incremental cash flow from machine Y Annual cash flow from machine Y 2,70,000 Annual cash flow from machine X 2,50,000 Net incremental cash inflow 20,000 Present value of incremental cash inflow = Rs.20,000 x (0.877 + 0.675 + 0.592 + 0.519) = Rs.20,000 x 3.432 = Rs.68,640 NPV of machine Y = Rs.68,640 - Rs.1,80,000 = (-) Rs.1,11,360 Rs.2,00,000 spent on machine X is a sunk cost and hence it is not relevant for deciding the replacement. DECISION: Since NPV of machine Y is negative replacement is not advised. If the company is in the process of selecting one of the two machines, the decision is to be made on the basis of independent evaluation of two machineries by comparing their Net Present Value. (ii) Independent Evaluation of Machine X and Machine Y Machine X Machine Y Units Produced 1,50,000 1,50,000 Selling Price Per Unit 6 6 Sale value 9,00,000 9,00,000 LESS: Operating Cost 2,00,000 1,80,000 Contribution 7,00,000 7,20,000 LESS: Fixed Cost 4,50,000 4,50,000 Annual cash flow 2,50,000 2,70,000 Present value of cash flow for 5 years 8,58,000 9,26,640 Cash outflow 2,00,000 2,50,000 Net Present Value 6,58,000 6,76,640 As the NPV of Machine Y is higher than that of machine X, Machine Y should be chosen. NOTE: As the company is a zero tax company for seven years (machine life in both cases is only 5 years). Depreciation and the tax effect on the same are not relevant for consideration. OR Q: A company makes a single product with sale price of Rs.30/- and a marginal cost of Rs.18/-. Fixed cost are Rs.1,80,000/- p.a. 42

JUNE 2001 Calculate: (i) Number of units requires to break-even (ii) Sales at break-even-point (iii) Number of units required to be sold to achieve a profit of Rs.60,000/- p.a. (iv) C/S ratio (v) What level of sales will achieve a profit of Rs.60,000/- p.a. (vi) Because of increase in cost, the marginal cost is expected to rise to Rs.19.50 per unit and fixed cost to Rs.2,10,000/- p.a. If the selling price cannot be increased what would be the numbered of units required to maintain a profit of Rs.60,000/-. Ans: Contribution = Selling Price - Marginal Cost = Rs.30 - Rs.18 = Rs.12 (i) No. of units required to break even = Rs.1,80,000 / 12 = Rs.1,50,000 (ii) Sales at break-even-point = 15,000 x 30 = Rs.4,50,000 (iii) No. of units required to be sold to achieve profit of Rs.60,000 p.a. 60,000 + 1,80,000 / 12 = 2,40,000 / 12 = 20,000 units (iv) CS Ratio = Per unit contribution x 100 / Per unit selling price = 12 x 100 / 30 = 40% (v) Level of sales to achieve profit of Rs.60,000 p.a. = 20,000 x 30 = Rs.6,00,000 (vi) No. of units required to maintain a profit of Rs.60,000 = 2,10,000 + 60,000 / 10.50 = 25714 43

DECEMBER 2001 INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, DECEMBER 2001 SECTION-I 1. (a) Define any five of the following terms. (5) (i) Aval : This is an endorsement on a bill of exchange or a promissory note by the guaranteeing bank by writing Per aval on such document under proper authentication. (ii) Master Lease : Master lease provides for a period longer than the assets life and holds the lessor responsible for providing equipments in good working condition during the Lease period. (iii) Bridge Loan : A Short-term loan given by commercial bank to a borrower to tide over temporary fund shortage due to delay in receipt of a sanctioned term loan or proceeds of a public issue. (iv) Working Capital Management : The Process of planning and controlling both the label and mix of the firm s current assets and liabilities. (v) Pay Back Method : A selection method in which a firm sets a maximum payback period during which cash inflow must be sufficient to recover the initial outlay. (vi) Mixed Cost : Costs that are fixing up to a certain level of output by will vary within certain range of output. (b) Fill the blanks with appropriate words / figures / phrase/s. (5) (i) Changes in financial position should show separately FUNDS provided from or USED in operation. (ii) Conversion Cost = Direct Labour + FACTORY OVERHEADS. (iii) Where the manager is responsible for both cost and revenue is called PROFIT Centre. (iv) Interest spread (%) = Total Interest & Discount Income / AVERAGE ADVANCES x 100. (v) A summary of the objectives of all functions of an organisation including sales, production, distribution and finance is called MASTER budget. (vi) Bank finance for bills drawn under L/C is considered as CONTINGENT liability for assessment of working capital finance. (vii) IDBI s Venture Fund 1986 provides assistance by way of UNSEDURED loans only. (viii) Forfeiting is a method of financing MEDIUM TERM export receivable. (ix) Purchase / discount of Export documents under confirmed orders / Export contracts is called POST SHIPMENT finance. (x) Borrowings by corporate / financial Institutions from International markets at commercial rate is called EXTERNAL COMMERCIAL BORROWINGS. (c) State with reason/s in brief whether the following statements are true or false. (5) (i) Marginal costing is applied on long term decisions. 44

DECEMBER 2001 FALSE: Marginal costing can be adapted to all costing system. More efficient pricing decisions can be made, since their impact on the contribution margin can be measured through Marginal Costing. (ii) (iii) Financial accounting is for the use of management only. FALSE: Financial accounting is prepared more for the consumption of owners and outsiders like creditors, regulatory authorities, taxing authorities, trade unions and investors. The focus therefore is the totality of transactions for the business as a whole. Long term owned funds of the company is called long-term debt. FALSE: Long Term debt financing may be undertaken by a company by way of Term Loan, Deferred Payment Guarantee (DPG), Debentures or Bonds, Leasing & Hire purchase, Public deposits, unsecured loans, forfeiting, external commercial borrowings (ECBs) etc. (iv) Net profit after tax / Net tangible asset = Return on equity. FALSE: Return of equity = Net Profit After Tax / Net tangible assets (v) Where the asset is unrealisable because of non-availability of credit cover or significant level of security is called doubtful asset. FALSE:A doubtful asset is one, which has remained NPA for a period exceeding two years. In the case of term loans, a doubtful asset is one where instalments of principal remained overdue for a period exceeding 1 1/2 years. Earlier, this overdue period was two years under the 4 quarter norms for NPA classification. SECTION-II 2. Answer any four questions explaining in short reason/s for your choice in not more than fifty words. (4 x 3 = 12) (i) A bank in India is having Export Credit outstandings covered by E.C.G.C. at Rs.3,000 crore. For determining the C.A.R. this item will be taken at... (a) Rs.3000 crore (b) Rs.1000 crore (c) Rs.1500 crore (d) None of these Ans: (C) Items which carry 50% risk weight DICGC / ECGC guaranteed covered credit only. In this case for determining the C.A.R. Rs.1,500 will be taken. (ii) For determining N.O.F. which of the following are deducted from the paid up capital? (a) Accumulated balance of loss. (b) Intangible assets. (c) Investments and deposits with subsidiaries. (d) All of these. Ans: (D) For determining Net Own Funds Accumulated balance of loss, Intangible assets and Investments and deposits with subsidiaries are to be deducted. 45

DECEMBER 2001 (iii) Earnings after Interest and Tax is Rs.20 crore, interest is Rs.4 crore, Income Tax is Rs.16 crore... Interest Coverage Ratio would be... (a) 09 (b) 10 (c) 05 (d) 07.50 Ans: (B) Interest Coverage Ratio = Earnings before Interest and Tax divided by Interest i.e., 20 Crores + Rs.4 Crores + Rs.16 Crores / Rs.4 Crores = 10 (iv) Sources of Financing project cost excludes... (a) Term Lending (b) Promoters contribution (c) Subsidy (d) Trade Credit Ans: (D) While calculating the sources of Financing Project Cost the Trade Credit is to be deducted. (v) A company has purchased on June 23, 1999 a machinery costing Rs.2,30,000/- and incurred installation charges of Rs.34,000. Machinery had a service life of 3 years and depreciation on W.D.V. basis is allowed @ 15%. Book salvage value of the machinery would be... (a) Rs.1,62,129 (b) Rs.1,45,200 (c) Rs.1,60,500 (d) None of these Ans: (A) The calculations are as follows: Rs.2,30,000 + Rs.34,000 = Rs.2,64,000 Less: 1 st Year Depreciation @ 15% Rs. 39,600 Rs.2,24,400 Less: 2 nd Year Depreciation @ 15% Rs. 33,660 Rs.1,90,740 Less: 3 rd Year Depreciation @ 15% Rs. 28,611 Book Salvage value of Machinery Rs.1,62,129 3. Answer question No.(i) and any three of the rest in 2-4 lines. (i) Which are the common statements used in financial forecasting? (4) Ans: The common statements used in financial forecasting are: (a) Projected cash flow statement (b) Projected income statement (c) Projected balance sheet (d) Funds Flow statement 46

DECEMBER 2001 (ii) What is output costing? (3) Ans: Output Costing is the form of unit costing used when the enterprise produces only on product or essentially one product, since it may be in two or three grades. Enterprises using output costing include dairies, quarries and cement works. (iii) How is excess working capital identified? (3) Ans: Excess working capital can be identified by making regular checks to ascertain excess current assets. This should be done by comparing ratios with previous periods and industry norms. (iv) What is venture capital? (3) Ans: It is an equity financing / participating scheme whereby a major share of the equity requirement of a company is contributed by a venture capital fund. (v) What is a leveraged lease? (3) Ans: It is a type of financial lease in which lessor (equity participant) obtains finance from outside financier (debt participant) by way of non-recourse to debt. SECTION-III 4. (a) Write Short Notes on - (i) Additional disclosures to be incorporated in the published accounts of the Indian Banks under R.B.I. guidelines. (4) Ans: Additional disclosures in published accounts: As per guidelines of RBI following eight disclosures are required to be made in the published accounts of the banks: 1. Percentage of shareholding of government of India. 2. Percentage of net NPA to net advances. 3. Details of provisions and contingencies. 4. Subordinated debts raised as tier II capital. 5. Business ratios at the year-end. 6. Movement of NPA. 7. Lending to sensitive sectors. 8. Maturity pattern of assets and liabilities. (ii) Requisites of a Performance Budget (3) The requisites of performance budget are: a. Presents the purposes and objects for which funds are sought and to bring out the programmes and accomplishments in financial and physical terms. b. The cost of activities proposes for achieving these objectives. c. Quantitative Data measuring the accomplishments. d. Work performance under each activity. 47

DECEMBER 2001 (b) e. To enhance the accountability of the management and the same time to provide an additional tool to management control of financial operation. ABC Ltd. operates at normal capacity. It produces 20,000 units of a product from Plant III. The unit cost of manufacturing at normal capacity is as follows:- (8) Rs. Direct Material 6.50 Direct Labour 2.60 Variable Overhead 3.30 Fixed Overhead 4.00 16.40 Each unit of the product is sold for Rs.20 with variable selling and administrative expenses of 60 paise per unit of product. The Company expects that during the next year only 2000 units can be sold. Management plans to shut down the plant, estimating that the fixed manufacturing overhead can be reduced to Rs.45,000 for the next year. When the plant is operating the fixed overhead costs are incurred at a uniform rate throughout the year. Additional costs of plant shut are estimated at Rs.15,000. Should the plant be shut down? Show computations. What is the shut down point? Ans: Irreducible Fixed Cost Rs.45,000 Additional shut down cost Rs.15,000 Total usher down cost Rs.60,000 If the company continues to operate it will incur Rs.80,000/- as fixed costs, but if it closes down, the shut down cost will amount to Rs.60,000/-. The Plant should continue to operate if the contribution from product sales is equal to or greater than Rs.20,000, the difference in the cost (Rs.80,000 - Rs.20,000). However, if the difference of cost cannot be recovered then the plant should be closed down. A case of the above mentioned a plant, the position is as follows: Sales (2,000 units @ Rs.20) Rs.40,000 LESS: Variable cost (2,000 @ Rs.13) Rs.26,000 Contribution Less: Fixed Costs Rs.14,000 Rs.80,000 Operation Loss Rs.(66,000) From the above it is clear that if the company continues to operate the plant, loss is Rs.66,000/- but if the plant is closed down, shut down costs are Rs.60,000, hence it is preferable to close down the plant. Shut down point will be calculated as follows: Fixed cost - Shut down cost / Contribution x S.P. 48

DECEMBER 2001 80,000-60,000 / 20-13 x 20 20,000 / 7 x 20 = Rs.57,143 5. A company has two Plants at locations I and II, operating at 100% and 75% of their capacities respectively. The company is considering a proposal to merge the two plants at one location to optimise available capacity. The following details are available in respect of the two plants, regarding their present performance / operations. (15) Location Location I II Rs. in Lacs Rs. in Lacs Sales 200 75 Variable Cost 140 54 Fixed Cost 30 14 For decision-making purpose you are required to work out the following: (a) The capacity at which the merged plant will break even. (b) The profit of the merged plant working at 80% capacity. (c) Sales required if the merged plant is required to earn an overall profit of Rs.22 lac. Ans: Profitability statement before and after merger: (Rs. in lakhs) Particulars Plant Plant Merged Location I Location II Plant Capacity Utilisation 100% 75% 100% 100% Sales 200 75 72 212 Less: Variable Cost 140 54 72 212 Contribution 60 21 28 88 Less: Fixed Cost 30 14 14 44 Profit 30 7 14 44 P/V Ratio 30% 28% 29.33% (Contribution/ Sales) * 100 Break-even point (sales) of merged plant = Fixed cost / P/V Ratio of merged plant = Rs.44,00,000 / 29.33% = Rs.150,00,000 Capacity of Break-even point: Sales at BEP / Total Sales x 100 = Rs.150,00,000 / Rs.300,00,000 x 100 = 50% 49

DECEMBER 2001 Computation of profitability of merger plant at 80% capacity: Rs. in lakhs Sales (300 x 80/100) 240.00 Less: Variable Cost (212 x 80/100) 169.60 Contribution 70.40 Less: Fixed Cost 44.00 Profit 26.40 Computation of sales required to earn the profit of Rs.22,00,000 in merged plant: Desired sales = Fixed Cost + Desired Profit / P/V Ratio = Rs.44 lakhs + Rs.22 lakhs / 29.33 % = Rs.66 lakhs / 0.2933 = Rs. 225 Lakhs SECTION-IV 6. Describe elaborately various ways and means by which the banks in India can improve their Capital Adequacy Ratio. Ans: Since Capital Adequacy Norm is expressed as a ratio of capital to risk weighted assets and exposures, the prescribed ratio can be achieved by lowering the denominator (risk-weighted assets & exposures) and / or by increasing the numerator (capital). DENOMINATOR SIDE: a) Asset-Management: To reduce the denominator, a bank has to reduce its size of assets - composition by having assets carrying NIL or LOWER risk weights. However, such a step will put a strain on the interest spread of the bank because low risk asset portfolios yield lower return. b) Recovery-Management: Banks can improve their capital adequacy ratios by better recovery of nonperforming assets (NPAs). Cash recovery is the most ideal way of reducing NPAs. In addition, banks can resort to compromise proposal or discount sale of their NPAs under the maxim a bird in hand is better than two in the bush. NUMBERATOR SIDE: c) Re-capitalisation of public sector banks (PSBs): PSBs are owned by Government. Moreover, these banks carry historical burden resulting from some of the governmental policies. Government has the responsibility to infuse capital to weak banks. Hence, Government undertook the re-capitalisation exercise and has pumped in Rs.13,346 crore till March, 1997. But, time and again, Government has made it clear that such re-capitalisation cannot be undertaken further in view of the budgetary constraints. d) Public Issue: Government has allowed dis-investment in banks upto 49% to enable them to approach the market. But, banks approaching the market with above-par pricing should have posted net profit in the preceding three years. Again, banks have to earn higher profits year after year to sustain a higher dividend pay out. Thus, in the long run, equity base is a function of profit. e) Revaluation Reserve : Fixed assets of the bank can be revalued at some interval say once in two/three 50

DECEMBER 2001 years. This will make available 45% of the increased valuation for Tier-II capital. But, this is only a technically permissible way of boosting Tier-II capital. It cannot be resorted to in a sustained way. Moreover, higher book value of fixed asset will entail higher depreciation expenditure and higher capital adequacy requirement. f) Merger: Weak, small / medium banks can be merged with strong and big banks to improve capital. The merger of Now Bank of India with Punjab National Bank in September, 1993, was an experiment in this direction. But, this option is fraught with complex industrial relations problem in Indian environment. g) Cross-holding: Cross-holding of capital by other cash-rich organisation such as banks, companies, public sector undertakings, mutual funds etc. as practised in countries like France, can also be permitted in India. But, it requires political will to initiate administrative and legislative actions. h) Equity participation by employees: This measure has a salutary effect in as much as ownership by employees propels them to improve their productivity. i) Innovative instruments: There is scope for innovation in capital instruments of the nature of hybrid debt as part of Tier-II capital. Subordinated debt instruments like Deep Discount Bond also improves Tier-II capital. However, raising Tier-II capital has a limitation, as it calls for equivalent rise in Tier-I capital OR Elaborate with adequate details any five Accounting Standards issued by the Institute of Chartered Accountants of India indicating its numbers. Ans: The Institute of Chartered Accountants of India constituted the Accounting Standards Board in April 1977 recognising the need to harmonise diverse accounting policies and practices in India and keeping in view the international development. The Board was entrusted with the responsibility of formulating accounting standards; propagate accounting standards, issue guidelines and to periodically review the accounting standards. The accounting standards are mandatory and in case any company does not follow these standards the auditor will have to qualify in his report otherwise disciplinary action against the auditor on the ground of professional misconduct will be taken. The Board has so far issued fifteen standards. They are: DISCLOSURE OF ACCOUNTING POLICIES : AS-1 This standard deals with significant disclosures with regard to accounting policies. Essentially these standard states that all significant accounting adopted in preparation and presentation of financial statements must be disclosed. It also states that if there is a material change in the policy as affecting the current period or later periods or if GAAP is not followed they should be disclosed. VALUATION OF INVENTORIES: AS-2 Inventories should be valued at the lower of the cost or realisable value. The cost to be incurred for disposal should be deducted from the realisable value before applying the value. The concern may adopt any of the normal methods like FIFO, LIFO or AVERAGE COST for the valuation of Inventory. But whatever method is followed, it should be followed consistently. CHANGES IN FINANCIAL POSITION: AS 3 Along with annual accounts as STATEMENT OF CHANGES IN FINANCIAL POSITION should also be published showing separately funds provided by and used in operation. 51

DECEMBER 2001 CONTINGENCIES AND EVENTS OCCURING AFTER THE BALANCE SHEET DATE: AS 4 This standard says if any of the events occurring after the balance-sheet date indicate the impairing of an asset or existence of a liability such events must be considered in identifying the contingency and in determining the amount. Contingent loss is pointed out by impairing of an asset or incurring of a liability subsequent to the balancesheet date and a reasonable estimate of the loss or liability could be made then such amounts should be provided for in the accounts. PRIOR PERIOD AND EXTRAORDINARY ITEMS AND CHANGES IN ACCOUNTING POLICIES : AS 5 If prior period and extraordinary items are included in the income statement of an accounting period, this item should be separately disclosed in the current statement of profit and loss accounting indicating the nature and amount. Extraordinary items are also known as unusual items. Some examples are sale of significant part of business, sale of an investment not acquired with an intention of resale, liability arising out of legislative changes or judicial pronouncements. DEPRECIATION ACCOUNTING: AS6 The amount of depreciation should be based on the historical cost; expected useful life of the asset and estimated residual value of the asset. The standard permits the use of straight-line method or diminishing balance method of provision of depreciation. ACCOUNTING FOR CONSTRUCTION CONTRACTS : AS 7 In accounting for construction contracts the percentage completion method or the completed method may be used. The concern should use the same type of accounting for similar other contracts. This however does not preclude the contracts from using one method of accounting for some contracts and another for some dissimilar contracts. ACCOUNTING FOR RESEARCH & DEVELOPMENT : AS 8 These costs if cannot be related to future revenue or too much uncertainty exists must be written off to profit & loss account. When those costs are deferred they should be systematically amortised. REVENUE RECOGNITION: AS 9 This standard states that revenue from sales transactions should be recognised when the property in the goods has passed to the buyer and the amount of sale consideration is definite. In case of rendering of services contract they should be treated on line with construction contracts either on percentage completion method or on completed contract method but under both the methods the realisation of revenue should be reasonable to expect; otherwise the revenue should be postponed. ACCOUNTING FOR FIXED ASSETS: AS 10 Fixed assets are those assets held in business for the purpose of running the business and not for resale. Any expenditure, which results in acquisition of fixed assets, must be capitalised. The cost of an asset comprises the purchase price, import duties and other levies direct attributable to the fixed assets to bring it to working condition. The price should be net of any rebates offered by the supplier. CHANGES IN FOREIGN EXCHANGE RATES: AS 11 This standard is concerned with FOREX transactions. All foreign exchange transactions should be entered in rupees applying the rate at the time of transaction or at standard rate. Gain or loss of FOREX transactions should be recognised in the profit or loss of the period with in same accounting period. Exchange differences with respect to acquisition of fixed asset must be capitalised. 52

DECEMBER 2001 ACCOUNTING FOR GOVERNMENT GRANTS: AS 12 Until there is safe assurance that the enterprise will comply with all the conditions governing the grant and the grant will be received the grant should not be recognised. Grants relating to specific fixed assets should be reduced in the gross value of the asset. Where the grant covers the entire value of the asset, the asset should be carried at a nominal value. ACCOUNTING FOR INVESTMENTS: AS 13 Investments as per the standard assets held by an enterprise for earning income by way of dividends interest and rentals for capital appreciation or other benefits to the investing enterprise. The enterprise should disclose current investments and long-term investments separately in the financial statements. ACCOUNTING FOR AMALGAMATIONS: AS 14 An amalgamation can be either by way of merger or purchase. It is merger where all the assets & liabilities of the transferor company ( a company which is amalgamated into another company) become the assets & liabilities of the transferee company (the company into which the transferor company is amalgamated) and 90% of shareholding of the transferor company become the equity shareholding of the transferee company by virtue of amalgamation and the transferee company issue equity shares fully except to the extent of any fractional shares to be paid in cash and the business of the transferor company is intended to be carried on by the transferee company and no adjustment in the values of the assets & the liabilities is intended to be made when they are incorporated in the books of the transferee company except to ensure uniformity of accounting policies. It is treated as purchased when one or more of the conditions stated above is not satisfied. ACCOUNTING FOR RETIREMENT BENEFITS : AS 15 Retirement benefits usually consists of the following: a) Provident fund b) Superannuation - pension c) Gratuity 7. Prepare a cash budget for the three months ended 30 th September 2001 based on the following information. Rs. Cash at Bank on 1 st July 2001 25,000 Monthly estimated Salaries and Wages 10,000 Interest payable in August 2001 5,000 Estimated June July August September (Actual) Cash Sales 1,20,000 1,40,000 1,52,000 1,21,000 Credit Sales 1,00,000 80,000 1,40,000 1,20,000 Purchases 1,60,000 1,70,000 2,40,000 1,80,000 Other Expenses 18,000 20,000 22,000 21,000 53

DECEMBER 2001 Credit sales are collected 50% in the month of sale and 50% in the month following. Collections from credit sales are subject to 10% discount if received in the month of sale and to 5% if received in the month following. 10% of the purchases are in cash and balance is paid in next month. Particulars July August September Opening Balance 25,000 57,500 96,500 Receipts: Sales : Cash 1,40,000 1,52,000 1.21.000 Credits: Current Month 36,000 63,000 54,000 Credits: Previous Month 47,500 38,000 66,500 TOTAL RECEIPTS 2,23,500 2,53,000 2,41,500 TOTAL CASH... (i) 2,48,500 3,10,500 3,38,000 Payments: Purchases : Cash 17,000 24,000 18,000 Purchases: Credit(Previous Month) 1,44,000 1,53,000 2,16,000 Other expenses 20,000 22,000 21,000 Interest 5,000 Salaries and wages 10,000 10,000 10,000 TOTAL PAYMENTS... (ii) 1,91,500 2,14,000 2,65,000 CLOSING BALANCE (I) - (II) 57,500 96,500 73,000 OR A firm wishes to let on lease a machine costing Rs.1 lac, financed 75% through debt and the balance through equity. Pre-tax explicit cost of debt is 18% and that of Equity is 15% per annum. (15) The firm has an effective tax rate of 45% and can claim 25% depreciation on W.D.V. method. The residual value of the machine is Rs.15,000 at the end of 5 th year. The lessor has to spend Rs.2,000/- per year towards maintenance of machine and administration. The Lessee agrees to pay annual year-end rent of Rs.35,000/- for five years; security deposit of Rs.1,000/- and one-time management fees of Rs.1,000/- at the beginning of the lease. You are called upon to advise the lessor whether the above plan is beneficial to him. 54

DECEMBER 2001 Ans: The Lessor s cash flow profile: i) Cash outflow at year 0 Rs. Cost of Machine 1,00,000.00 LESS: Security Deposit 1,000.00 Management Fee 1,000.00 2,000.00 Net Cash Out Flow 98,000.00 ii) Annual Net Cash-Inflow YEARS (Rs.) A) Inflow I II III IV V Lease Rentals 35000 35000 35000 35000 35000 Residual Value of Machine 15000 35000 35000 35000 35000 50000 B) Outflow Maintenance / Admn. cost 2000 2000 2000 2000 2000 Tax (see working below) 3600 6413 8522 10104 11290 5600 8413 10522 12104 13290 C) Net Cash Inflow 29400 26587 24478 22896 36710 (A-B) Working: Computation of Annual Tax I II III IV V a) Income Lease Rentals 35000 35000 35000 35000 35000 b) Expenditure Maintenance & Admn. 2000 2000 2000 2000 2000 Depreciation 25000 18750 14063 10547 7910 27000 20750 16063 12547 9910 55

DECEMBER 2001 c) Taxable Income 8000 14250 18937 22453 25090 (a-b) d) Tax @ 45% 3600 6413 8522 10104 11290 Post-tax Profit 4400 7837 10415 12349 13800 iii) Computation of Internal Rate of Return (IRR) Year Cash Cash Discount Present Discount Present Outflow Inflow Factor at 12% Value Factor at 14% Value 0 98000 1 29400 0.8928 26248 0.8771 25787 2 26587 0.7971 21192 0.7694 20456 3 24478 0.7117 17421 0.6749 16520 4 22896 0.6355 14550 0.5920 13554 5 36710 0.5674 20829 0.5193 19063 100240 95380 NPV +2240-2620 IRR = 12 + (2240/2240 + 2620) x 2 = 12 + 0.92 = 12.02% iv) Weighted Average Cost of Capital : Ko = Kd (1-T) x D/D+S + S/D+S = {18 (1-45/100) x 75000 / 100000} + {15 x 25,000 / 100000} = 7.425 + 3.75 = 11.175% Since the tax-adjusted weighted average cost of capital works out to 11.1175% which is less than the IRR of 12.92%, the lessor can take up this beneficial lease Plan. 56

JUNE 2002 INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, JUNE 2002 SECTION-I 1. (a) Define any five of the following terms. (5) (i) Management Accounting: A system of accounting and other data for one purpose of decision making by management for planning and control activities. Management Accounting may be defined as the presentation of accounting records in such a classified, tabulated and analytical manner that the management may use them for controlling, planning and decision-making purposes. (ii) Capital rationing: A situation where a constraint is placed on the total size of capital expenditure and allocation has to be on a group competing projects. Rationing means a fixed or optimum quantity. Hence, capital rationing means the optimum use of capital. (iii) Margin of Safety: The maximum percentage by which expected sales can decline and profit can still be realised. Margin of safety represents the difference between actual sale and break even point sale in a concern. Margin of Safety = Actual Sales - BEP Sales (iv) Goal congruence: Harmony of goals at different levels of organisation. Goal means objective and Congruence means agreement, adjustment or harmony. Therefore, Goal Congruence means agreement, adjustment or harmony of goals/objectives at different levels of organisation. (v) Capital budget: The schedule of investment project selected to be undertaken over some interval of time. Capital Budget or Capital budgeting is the planned and pre-determined allocation of funds to long-term assets so as to achieve the maximum profitability of the resources. (vi) Withholding tax: A tax deducted in certain countries on interest payable to non-resident. Withholding Tax means Keeping back the tax or refusing to pay the tax. In such situation, assessee is deemed to be in default. On withholding of the tax by the assessee, the assessing officer may impose on him a penalty after giving a reasonable opportunity of being heard. (b) Fill the blanks with appropriate words / figures / phrase/s. (5) (i) Average business per employee = Average deposits + AVERAGE ADVANCES. NO. OF STAFF (ii) Optimum Capitalisation is when COST OF CAPITAL IS LOWEST. (iii) Under D.P.G., a bank issues guarantee in favour of SUPPLIER OF CAPITAL GOODS. (iv) The LESSOR bears the risk of obsolescence under operating lease. (v) Forfeiters link their discount rate to LIBOR. (vi) Securities which are eligible for fulfilling S.L.R. obligation are APPROVED SECURITIES. (vii) Direct Material, direct labour, direct expenses is equal to PRIMARY COST. (viii) Loans and advances guaranteed by bank carry 20% risk weight. 57

JUNE 2002 (ix) Change in cost due to change in the volume of activity is called INCREMENTAL COST. (x) Net profit after tax divided by net tangible assets represents return on INVESTMENT. (c) State with reason/s in brief whether the following statements are true or false. (5) (i) Revaluation reserve is part of Tier I Capital of banks. FALSE: The true version of this statement is that a revaluation reserve arises from the revaluation of assets that are under-valued in the books of a bank. This reserve is less permanent in nature and cannot be considered core capital. According to the directives of the RBI, revaluation reserve is to be included in Tier-II capital of the bank and that too at a discount of 25%. (ii) Annual Sales / Net Fixed Assets = Total Assets Turnover. FALSE: The formula is = Annual Sales / Total Assets (Excluding fictitious Assets) While computing Total Assets Turnover, Total Assets (excluding fictitious assets) are taken into account, and not Net Fixed Assets. (iii) Decrease in value of stock is application of funds. FALSE: In fact, decrease in the value of stock is not an application of fund, but it is a source of fund, because by selling the stock, cash would have come to the business thereby raising the fund. If the stock is sold on credit, there will be no change in the fund. (iv) Factoring is beneficial to those clients who operate in sellers market. FALSE: In fact, factoring is beneficial to both kinds of clients who operate in sellers market as well as in the buyers market. (v) Contribution = Selling Price - Fixed Cost. FALSE: Contribution = Selling Price - Marginal / Variable Cost OR Contribution = Fixed Cost + Profit SECTION-II 2. Answer any four questions explaining in short reason/s for your choice in not more than fifty words / by showing the working ( 4 x 3 = 12). (i) (ii) The production unit of a company has a capacity ration of 0.80 and an Activity ratio of 1.20. The Efficiency ration would be 1.50. (a) 2.00 (b) 1.50 (c) 0.66 A machine is purchased at Rs.5,00,000 and its economic life is 8 years, with a residual value of Rs.40,000. Depreciation per annum on S.L.M. would be 57,500. (a) 62,500 (b) 50,000 (c) 57,500 58

JUNE 2002 (iii) A credit facility of Rs.5,00,00,000 guaranteed by the Central Government has become overdue for more than six months but less than one year. The guarantee stands invoked but has not been repudiated. The provision required in such account would be NONE OF THESE (a) Rs.50,00,000 (b) Rs.1,00,00,000 (c) None of these (iv) A company has acquired a Machinery as per the costs mentioned below:- Purchase price Rs.10,50,000. Import duty Rs.3,15,000. Transport and other directly attributable costs Rs.1,35,000. Interest paid on deferred credit till the asset becomes ready for use Rs.1,05,000. Rebate allowed by the vendor Rs.52,500. Amount to be capitalised as per A.S-10 of the Institute s of Chartered Accountants of India would be 15,52,500 (a) 9,97,000 (b) 15,00,000 (c) 15,52,500 (d) None of these (v) Capital adequacy of banks can be improved by BETTER RECOVERY PERFORMANCE (a) Additional lending to corporate at P.L.R. (b) Additional resources mobilisation even at higher rate (c) Better recovery performance 3. Answer question No.(i) and any three of the rest in 2-4 lines. (i) What is usual asset related covenants in a Term Loan Agreement? (4) The borrower is required to maintain a minimum asset base, hence there may be requirement of maintaining desired current ratio, not deposing any fixed asset without the consent of the lender not creating additional charge on assets etc. (ii) Which kind of security is classified by the banks as securities Held for trading. (3) The securities required by the bank with the intention to trade by taking advantage of the short-term price / interest rate movements are classified under Held for Trading category. (iii) What is credit conversion factor? (3) This is a factor which is multiplied to the off balance sheet exposure to convert them to on Balance Sheet items. (iv) Why Full Factoring is so named? (3) Because under full factoring whole range of services generally provided by a factor viz., sales ledger administration, receivables collection, credit control, credit protection and advisory services are available to a client. 59

JUNE 2002 (v) What is the significance of Inventory turnover Ratio? (3) Other things being equal, the higher the turnover, better the control the management has over inventory and indicates brisk selling. SECTION-III 4. (a) Write Short Notes on - (i) Asset Liability Management in banks. (4) The Traditional approach by the banks for managing various risks is no longer viable. The banks were feeling the need to find out a system which will tell the management the various risks, the banks are undertaking and finally to evolve a method or policy to tackle or manage the risks associated with banking business. Reserve Bank of India, in view of emerging need of risk management, has framed the guidelines for Asset-Liability Management during the first quarter of year 1999. Asset Liability Management would mean: Identifying risks related to asset liability mismatches, Quantifying the risks, Deciding the acceptable level of risks, Monitoring and controlling such risks. ALM Process involves management of various risks viz., Liquidity Risk, Market Risk, Trading Risk, etc., and funding and capital planning and finally, profit planning and growth projections. In simple words, the ALM process can be defined as identifying, measuring and projecting the various risks and funding, planning and controlling such risks. (ii) Significant differences between Management and Financial accounting. (3) Accounting can be broadly classified into FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING: Financial accounting according to American Institute of Certified Public Accountants is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character and interpreting the results thereof. Management accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of information that assist executives in fulfilling organisation objectives. FINANCIAL ACCOUNTING Financial accounting is prepared more for the consumption of owners and outsiders like creditors, regulatory authorities, taxing authorities, trade unions and investors. The focus therefore is the totality of transactions for the business as a whole. MANAGEMENT ACCOUNTING Management accounting on the other hand is meant for the use of the managers who run the organisation. Management requires information more detailed, product-wise, division-wise, territory-wise for cost assembly and decision making. Management 60

JUNE 2002 FINANCIAL ACCOUNTING Financial accounting records data after the happening and therefore is post facto. The reports are also prepared and submitted late for the information has to be audited before presentation. The only time limit is the statutory time limit. In short financial accounting is historical whereas management accounting is prospective. Financial accounting is subject to audit and therefore has to be accurate. Transactions are recorded to the last paise. Financial accounting has also to follow double entry methods of recording and observe various accounting conventions and statutory regulations. MANAGEMENT ACCOUNTING accounting has therefore to be much in detail related to the objectives. Management accounting on the other hand has to be prepared fast before the event keeping in view the future happenings since if the management were to wait for the event to happen their competitors may take over. In Short financial accounting is historical where as management accounting is prospective. Management Accounting has no such constraints. For decision making the manger requires different type of information. Since the decision concerns the future it cannot be accurate but will only be a probability. There is no fixed pattern of preparation of these reports and each concern will tailor the reports to suit its requirements: The reports are also not subject to audit and accounting conventions. They are quite flexible. (b) Following information relating to a type of raw material is available: (8) Annual demand 2,400 Units Unit Price Rs.2.40 Ordering cost per order Rs.4.00 Storage cost 2% per annum Interest rate 10% per annum Lead Time Half-month Calculate Economic Order Quantity and total annual inventory cost in respect of the particular raw material. ANS: Economic order Quantity = 2 A B * Inventory carrying cost CS = 2 x 2400 x 4 = Storage cost + Interest Rate = 2% + 10% = 12% 2.4 x 0.12 61

JUNE 2002 = 19,200 0.288 = 258 Units Calculation of total cost of inventory: Rs. Cost of Inventory 2,400 units @ Rs.2.40 5,760.00 Ordering cost 2400 units / 258 units = 9.3 order or say 10 orders (10 orders x Rs.4 per order) 40.00 Carrying Cost ( 1/2 x 258 x 12/100) 37.15 Total Cost of Inventory 5,837.15 5. The variable cost structure of a product manufactured by a company during the current year is as under: (15) (Rs. per unit) Material 120 Labour 30 Overheads 12 The selling price per unit is Rs.270 and the fixed costs and sales during the current year are Rs.14 lac and Rs.40.5 lac respectively. During the forthcoming year direct workers will be entitled to a wage increase of 10% from the beginning of the year and the material cost, variable overheads and fixed overhead are expected to increase by 7.5%, 5% and 3% respectively. You are required to compute the following: (a) New sale price in the forthcoming year in the current P/V ratio is to be maintained. (b) Number of units that would be required to be sold during the forthcoming year so as to yield the same amount of profit in the current year, assuming that selling price per unit will not be increased. Ans: Profitability Statement of current year sales (Units) - 15000 Units per unit Rs. Selling price 270 Less: Variable cost Materials 120 Labour 30 Overheads 12 162 62

JUNE 2002 Contribution per unit 108 Total contribution (15000 units x Rs.108) 16,20,000 Less: Fixed Cost 14,00,000 Profit 2,20,000 P/V Ratio = Contribution / Sales x 100 = 108/270 x 100 = 40% Computation ofnew Sale Price in the forthcoming year if the current P/V Ratio is to be maintained. Rs. Selling Price = Rs.174.60 / 0.60 291.00 LESS: Variable cost Materials (Rs. 120 x 1.075) 129.00 Labour (Rs.30 x 1.10) 33.00 Overheads (Rs.12 x 1.05) 12.60 174.60 Contribution per unit 116.40 P/V Ratio 40% Fixed cost = Rs.14,00,000 x 1.03 = Rs.14,42,000 Computation of number of units to be sold in the next year to earn the same amount of profit of current year. Desired Sales (Rs.) = Fixed Cost + Desired Profit / P/V Ratio = Rs.14,42,000 + Rs.2,20,000 / (270-174.60) = Rs. 16,62,000 / 95.40 = 17421.38 units Desired sales (Units) = 17421 units SECTION-IV 6. Explain at length Concepts and methods of Transfer Pricing. (15) Ans: In decentralised organisation, individual sub-units act as separate units. In such settings, the management control system often uses transfer pricing to measure the profit of a profit centre. Transfer price is the price one sub-unit (branch or division or department etc.,) of organisation charges for a product or service supplied to another sub-unit of the same organisation. The transfer price creates revenue for the selling sub-unit and cost for the buying sub-unit. Thus it affects the operating incomes for both sub-units. The operating income can be used to evaluate the performance of each sub-unit and to motivate managers. Thus transfer price is essentially an accounting concept generally used in manufacturing industries to fix prices for transfer of intermediate goods / services among different units in the same organisation. But it is widely used by banks mainly for ascertaining the number of loss making branches. Broadly there are three methods for determining transfer prices. They are: (i) Market-based 63

JUNE 2002 (ii) Cost-based and (iii) Negotiated Transfer Prices (i) Market-based Transfer Prices: Under this approach top management uses the price of similar product or service available in the market for computing the transfer price. These may be published or bid prices. Alternatively the external price that a sub-unit charges to outside customers may be the basis for transfer or inter-unit price. Of course, the prevalent market or bid price may be adjusted for discounts, certain selling costs etc. that are not needed for inter-unit exchanges. This way it is ensured that the transfer prices are neither arbitrary nor discouraging. Both the selling and buying units become subject to market dynamics. In fact both units also stand to benefit. Because the selling unit incurs no risk of bad debts and no selling cost on the sale of goods/services to another unit in the organisation. Likewise, the buying unit is assured of quality service and timely delivery of goods and services. The problem arises where there is no expressed or implied market prices. (ii) Cost-based Transfer Prices: Sometimes, a product or service supplied by the selling unit to other intra-organisational units may be tailor-made or unique in terms of specification, quality and service. In such cases it market prices are un-available or inappropriate or too costly to obtain, cost-based transfer prices are useful. Such cost-based transfer prices may further be classified into three sub-categories (a) Full Cost (b) Cost Plus (c) Incremental cost. (iii) Negotiated Transfer Prices: Negotiated transfer prices arise when the buying and selling units of an organisation mutually settle the prices through negotiations. This approach pre-supposes that the internal units have alternatives and enjoy autonomy for bargaining. It means they are operationally and economically independent. OR Elaborate with sufficient details benefits and limitations of FACTORING. (15) Ans: There are certain intrinsic benefits accruing under factoring, which have increased its popularity. BENEFITS: 1. Improvement in Liquidity: Factoring provides additional source of funding the receivables which eliminates the uncertainty in realising receivables. The immediate availability of cash reduces the operating cycle and increases the turnover. This improves client s performance greatly. 2. Technical advantage: Apart from the financial aspects, the technical advantage of the factoring is that the client gets guidance on credit decision, examination of credit worthiness of the customers, selection of accounts receivables; feed-back data on registered developments, turnover of the client, information regarding product design / mix, prices, market conditions, general economic prospect etc. 3. Savings in cost and time: Factoring has a cost and time saving effect on the operation of the client as it relieves him of the responsibility of maintaining a credit department, book-keeping, servicing the receivables, demand and collection of the same etc. All these activities are taken over by the Factor at about 2% higher than bank charges. This additional cost is more than compensated by the reduction in expenditure effected in sales administration and debt collection. The client can concentrate more on planning, production and sales. 64

JUNE 2002 4. Improves Profitability: Factoring improves profitability of the client by avoiding the risk of bad debts. It ensures perfect debt turn around which is very rate in business. 5. Better Purchase / Sale Terms: With the availability of advance against receivables, the client can make cash purchase of his inputs. He can negotiate better prices for such inputs. The client can offer finer terms to his customers. His customers may avail credit facility. So he need not offer trade discount for early payment. Thus, factoring facilitates flow of inputs one side and the market prospect improves on the other. 6. Flexibility: Factoring provides, flexibility to the client as he can draw continuously against receivables, overdraws during peak period, receive interest on un-drawn balance etc. 7. Improves Leverage: With the release of funds under operating assets, the client can invest more in fixed assets. This increases his degree of operating leverage. Factoring is beneficial especially for those companies facing liquidity problems due to expansion, diversification, necessity of offering longer credit, rising input prices etc., It is most suitable for small scale enterprises. 8. Encourages Bill Culture: Factoring helps in systemising trade credit. Though RBI has been trying to encourage bill market in India, it has not been very popular. Factoring encourages clients and customers to transact their business through invoicing. 9. A useful alternative method of finance: Factoring is useful for the client to ascertain the payment performance of the customers. This helps in cash management for the clients. It also helps in ascertaining percentage share of each customer in the client s total turnover. Factoring also is useful in ascertaining location-wise concentration of debts. It is also useful for ascertaining labour cost of business. 10. Operationally easy: The client need not register his debt under Section 125 of the Companies Act, 1956. Thus it is operationally easy-compared to traditional borrowing from banks. LIMITATIONS: 1. May not be attractive: Companies with established credit procedures and continuing contracts with their bankers, may not find factoring so attractive to switch over from the transitional method of assigning the receivables to selling the receivables. 2. Restricted Coverage: Sound corporate bodies operating in a sellers market, where credit for payment of receivables is ruled out, will not need factoring. On the other hand, in a buyers market, where sellers have to offer long credit, it may be difficult for factors to enforce financial discipline. Thus the coverage of factoring may be restricted. 3. Sign of financial weakness: Resorting to factoring is, sometimes, viewed as a sign of weakness of the client indicating at his liquidity problems. For this reason, some companies prefer undisclosed factoring. 4. Too Costly: Companies may find factoring too costly when compared to other methods of receivablefinancing. Though it is theoretically said that factoring cost companies well with the cost of bad debts, collection and credit costs, interest charged on finance availed etc., 65

JUNE 2002 7. The data below relates to a Company which makes and sells computers / computers parts. (15). March April (Units) (Units) Sales 5000 10000 Production 10000 5000 Rs. Rs. Selling price per Unit 100 100 Variable production cost per unit 50 50 Fixed production overhead incurred 100000 100000 Fixed production overheads cost, per unit, being the pre-determined overhead absorption rate 10 10 Selling, distribution and administration cost (all fixed) 50000 50000 You are required to present comparative profit statement for each month using: (i) absorption costing. (ii) marginal cost. Ans: STATEMENT OF PROFIT UNDER ABSORPTION COSTING Rs. Rs. PARTICULARS MARCH APRIL Sales (5,000 x 100) : (10,000 x 100) (A) 5,00,000 10,00,000 Cost of goods sold: Opening Stock NIL 3,00,000 ADD: Variable production cost (10,000 x 50) : (5,000 x 50) 5,00,000 2,50,000 Fixed Production overhead (10,000 x 10) : (5,000 x 10) 1,00,000 5,00,000 Under Absorbed production overhead 50,000 6,00,000 6,50,000 LESS: Closing Stock (5,000 x 60) 3,00,000 NIL TOTAL (B) 3,00,000 6,50,000 Gross Profit (A) - (B) 2,00,000 3,50,000 LESS: Selling, Distribution & Administrative overheads 50,000 50,000 NET PROFIT 1,50,000 3,00,000 66

JUNE 2002 STATEMENT OF PROFIT UNDER MARGINAL COSTING Rs. Rs. Particulars March April Sales (5,000 x 100) : (10,000 x 100) (A) 5,00,000 10,00,000 Cost of goods sold: Opening stock (5,000 x 50) NIL 2,50,000 ADD: Variable production cost 5,00,000 2,50,000 5,00,000 5,00,000 LESS: Closing Stock 2,50,000 NIL Cost of goods sold (B) 2,50,000 5,00,000 Contribution (A) - (B) = (C) 2,50,000 5,00,000 LESS: Fixed Cost Production overhead 1,00,000 1,00,000 Selling distribution & Administrative overheads 50,000 50,000 Total (D) 1,50,000 1,50,000 Profit: (C)-(D) 1,00,000 3,50,000 NOTES: 1. When production exceeds sales during the period, a higher profit is shown under absorption costing. Since, the fixed overhead is absorbed over more number of units produced. 2. When sales are in excess of production, a higher profit is reported under marginal costing, as fixed production overhead is not recovered in valuation of closing stock. OR 7. Efficient Chemicals Company Ltd. has just completed the first year of operation on 31 st March 2002 and the summarised result of the operation is given below: Installed capacity - 20,000 kgs. Production and sales - 14,000 kgs. Income & Expenditure details Rs. Income 28,00,000 Expenditure Variable Cost: Material 3,50,000 Labour 4,20,000 67

JUNE 2002 Overheads Factory 2,80,000 Marketing 2,10,000 12,60,000 Contribution 15,40,000 Fixed Cost 10,00,000 Profit 5,40,000 The Managing Director wishes to expand the operation for the next year and has asked you to prepare flexible budgets (showing profit at different capacity level) on capacity utilisation levels of 80%, 90% and 100% based on the following estimate: Rs. per Kg. (a) Price at 80% level 220 at 90% level 210 at 100% level 200 Whatever produced during the year is expected to be sold within the year. (b) (c) Increase in variable cost components. Materials @ 12% Labour @ 10% Overheads Factory @ 15% Marketing @ 20% Inflation rate applicable to fixed cost is 15%. Additionally, if the capacity utilisation exceeds 80% level, fixed cost is expected to increase by 10% upto 100% capacity utilisation level. To avoid the incidence of increase in the fixed cost for production levels beyond 80% capacity utilisation, the Production Manager has submitted a plan to sub-contract the additional production of 4,000 Kgs. to a party at a cost of Rs.105 per kg. including marketing cost. You are requested to comment on this plan of sub-contracting with a view to maximising the profit of the company. Show workings. Ans: (i) Statement showing profit at different capacity level: CAPACITY LEVEL 70% 80% 90% 100% UNITS 14,000 16,000 18,000 20,000 68

JUNE 2002 Rs. Rs. Rs. Rs. Selling price per unit 200 220 210 200 Material 25 28 28 28 Labour 30 33 33 33 Factory overheads 20 23 23 23 Marketing overheads 15 18 18 18 Marginal Cost per Unit 90 102 102 102 Contribution per unit 110 118 108 98 Total Contribution 15,40,000 18,88,000 19,44,000 19,60,000 LESS: Fixed Cost 10,00,000 11,50,000 12,65,000 12,65,000 PROFIT 5,40,000 7,38,000 6,79,000 6,95,000 ii) If the company wishes to sub-contract the additional 4,000 Kgs. selling price of 20,000 kgs. (16,000 Kgs. + 4,000 Kgs.) willbe Rs.200 per kg. at 80% capacity level. Total contribution per kg. will be Rs.98 i.e., Rs.200 - Rs.102. Rs. Total Contribution (16,000 x Rs.98) 15,68,000 LESS: Fixed Cost 11,50,000 Cost of purchasing 4,000 Kgs. Selling price Rs.105 per kg. Rs.200 per kg. 4,18,000 Contribution Rs. 95 per kg. Total contribution (4,000 kgs. x Rs.95) 3,80,000 Total profit from 20,000 kgs. 7,98,000 Hence the company should procure 4,000 kgs by sub-contract instead of producing themselves. 69

DECEMBER 2002 INDIAN INSTITUTE OF BANKERS ASSOCIATE EXAMINATION, DECEMBER 2002 SECTION-I 1. (A) Define any five of the following terms. (5) i) Forfeiter An international agency who offers quotes for forfeiting. ii) iii) iv) Tangible Net Worth Paid up capital (Equity & Preference) plus free reserves and surplus minus accumulated losses and all intangible assets. Primary Lease Period It is the part of the lease period during which the cost of the asset and reasonable profit are realised by the lessor by way of lease rentals. This period may generally be about 5 years. Internal Rate of Return method A selection method using the compound rate of return on the cash flow of a project. This method is insensitive to the differential cash flows between proposals. v) Imputed Cost These are hypothetical costs, which do not involve cash outlay but are important for management control. For example interest on owners capital is ignored in cost accounting, though it is considered in financial accounting. vi) Optimal Capital Structure The structure at which the overall cost of capital is minimised and the firm s value are maximised. (B) Fill in the blanks with appropriate words / figures / phrase/s: (5) i) Standard asset is a performing asset carrying not more than NORMAL credit RISK inherent in lending. ii) iii) Fixed assets are those held not for SALE in the usual course of business. The LESSOR bears the risk of obsolescence under operating lease. iv) In sale of goods income is recognised when the property in goods pass from SELLER to BUYER. v) Spread is the difference between AVERAGE rate of interest paid on deposits and earned on advances. vi) Higher burden coverage ration IMPROVES branch s profitability. vii) Profit is a SOURCE of funds. viii) Capital which is not surrogated or encumbered for any other purpose is called UNIMPAIRED. 70

DECEMBER 2002 ix) Under H.P. agreement HIRER enjoys the salvage value of an asset. x) Leasing across national frontier is called CROSS BORDER leasing. (C) State with reason/s in brief whether the following statements are true or false: (5) i) Prime cost is equal to direct materials plus factory overheads. FALSE: Prime Costs are direct materials, direct labour and direct expenses. ii) A hirer can return the goods before the payment of last instalment. TRUE: The goods are regarded as the property of the financier /seller until the final instalment is paid. iii) The purchase of book debts or receivable is central to factoring. TRUE: Factoring is a financial service covering the financing and collection of book debts and receivables arising from the credit sale of goods and services, both in domestic as well as international market. iv) Cash is a productive asset and hence should be maintained as high as possible. FALSE: The amount of cash, which any business needs to hold, will depend upon its payment cycle. v) The lessee is the legal owner of the leased asset. FALSE: In a lease transactions, the lessee (user) acquires only the usage or custody of the asset and it not the owner thereof. Legal ownership vests with the lessor. SECTION-II 2. Answer any four questions explaining in short reason/s for your choice in not more than fifty words by showing the working. (4 x 3 = 12) (i) Current ratio can be improved by - (a) More bank borrowing for working capital (b) Increase in credit sales (c) Long term borrowing for investment in current assets (d) Reduction of stock in process (C) REASON: Long term borrowings is an inflow of cash to the Company and if this amount is being invested in investments (i.e., Temporary Investments) then Current Ratio of the Company can be improved. (ii) For arriving at book value of equity shares which of the following factor you would consider - (a) Increase in market price of the share (b) Increase in share capital (c) Dividend paid (d) Net worth (D) 71

DECEMBER 2002 REASON: Book value per share is an indication of the amount of Shareholders equity embedded in each share. The formulae for calculating Book Value of Equity Shares is: Tangible Net Worth Book Value of Share = - Number of Shares (iii) In order to work out Cash Forecast which of the following items not to be added to the cash and bank balance at the beginning of the year - (a) Profit before tax expected to be earned (b) Depreciation (c) Increase in working capital (d) Sale proceeds of fixed assets (C) REASON: Cash Budget means expected cash receipts and disbursements during the budget period adjusted for opening and closing cash balances. Hence Increase in Working Capital item not to be added to the cash and bank balance at the beginning of the year. (iv) Return on investment is equal to - (a) Net Profit after tax / Tangible net worth (b) Net Profit after tax / Net tangible assets (c) Net Profit after tax / Paid up capital (d) Gross Profit / Gross Assets (B) REASON:The Return on Investment also known as return on total assets, this profitability measures looks at the amount of resources used by the firm to support the current level of operations; a key measures in assessing the overall effectiveness of management in generating profits from available resources, shows payoff from investment and assets, and reveals overall liquidity and profitability of resource allocation of investment decision. (v) A borrower s account in a bank reveals following information as on 31.3.2002. a. Debit balance Rs.5,00,00,000 b. Interest not charged to the account kept in memorandum book. Rs.2,25,00,000 c. Value of Security Rs.2,00,00,000 d. Account is doubtful for over three years. Provision required would be (a) Rs.5,00,00,000 (b) Rs.3,00,00,000 (c) Rs.4,00,00,000 (d) Rs.2,50,00,000 (C) REASON: For Doubtful assets, the provision should be made for 100% of the unsecured / uncovered portion in addition to 50% of the secured portion. (Doubtful Assets more than 3 years). In this case Rs.1,00,000 (50% of Secured Portion) + Rs.3,00,000 (unsecured portion i.e., Rs.5,00,000 - Rs.2,00,000). 72

DECEMBER 2002 3. Answer question No.(i) and any three of the rest in 2-4 lines. (i) What is net present value? (4) A selection method using the difference between the present value of the cash inflows of one project and the investment outlay. This method evaluates differential cash flows between the proposals. (ii) What is a revaluation reserve in the bank s balance sheet? (3) Fixed assets of the bank can be re-valued at some intervals say ones in two/three years. This will make available 45% of the increased valuation for tier II capital. Higher book value of fixed assets entail higher depreciation and higher capital adequacy requirement. (iii) What is cash flow budget? (3) Cash flow budget accounts for all items of cash flows in and out like payment to creditors, cash purchases, payments of salaries, wages, rent, rates, taxes and other expenses. It also takes into account all cash inflows like cash sales, realisation of debtors and other cash receipts. (iv) What is forfeiting? (3) Under arrangement of forfeiting an exporter surrenders his right to the future receivables from importer and the forfeiter usually loses his right of recourse to the exporter in the event of non-payment by the importers. (v) How is the future interest on account classified as N.P.A. treated? (3) Once a credit facility is classified as N.P.A. future interest of the same borrower cannot be recognised if not realised. However, interest could be charged and taken to income account to the extent of actual collection / realisation. SECTION-III 4. Answer in 10 / 15 lines. (A) Write short notes on (i) Essential features of commercial appraisal of term loan. (4) Commercial appraisal aims at evaluating the profitability and marketing of what is produced in quantity and price as projected, Commercial prudence is to produce that which can be sold. To ensure reasonability of the projected cash flow the lender has to examine the following aspects: v The present and future trend of demand for the product. v Reliability of demand forecasting technique. v The level of competition and availability and the price of substitute products. v Strategy to gain and retain comfortable market share. v The present stage of the life cycle of the product. v Price elasticity of demand. v Market conditions and channels of distributions. v Govt. policy regarding the product 73

DECEMBER 2002 (ii) Call and put option with reference to debentures. (3) A debenture is an instrument for a fixed period time, mostly at fixed rate of interest. Now-a-days interest rates vary significantly with inflow of foreign funds this has assumed greater significance. A call option gives a liberty to the issuer of the debentures to pay back the amount earlier to redemption date at a pre-determined price within the specified period. In case the option is not exercised the debentures continues. On the other hand, a put option means a right to investor to demand back the money earlier to the redemption date at a pre-determined price within the specified period. The debenture holder can get back the money and invest it elsewhere. The kinds of options are necessary to make the instrument investor friendly and to ensure liquidity in debt market. (B) (i) Find out the Operating Leverage from the following data. (4) a. Sales Rs.1,00,00,000 b. Variable Cost 60% c. Fixed Cost Rs. 24,00,000 Ans. Calculation of Operating Leverage: Sales Rs. 1,00,00,000 Less Variable Cost 60% Rs. 60,00,000 Contribution Rs. 40,00,000 Less Fixed Costs Rs. 24,00,000 Operating Profit Rs. 16,00,000 Contribution 40,00,000 Operating Leverage = = = 2.5 Operating Profit 16,00,000 (ii) Find out the Financial Leverage from the following. (4) Net worth Rs.50,00,000 Debt/Equity 3:1 Interest 12% Operating profit Rs.40,00,000 Ans. Calculation of Financial Leverage Debt = 50,00,000 x 3 = 1,50,00,000 Operating Profit 40,00,000 Less Interest 1,50,00,000 x 12 18,00,000 100 74

DECEMBER 2002 Profit before Tax 22,00,000 Financial Leverage = Operating Profit 40,00,000 = P.B.T. 22,00,000 = 1.818 5. XYZ Ltd. is engaged in manufacturing and selling two products A and B. The following information is available from the records of the company. (15) (1) Budgeted Data (Monthly) Product A B Capacity 40% 30% Production units 4,000 6,000 Rs. Rs. Rs. Rs. Cost per Unit: Direct Material 150 80 Conversion cost: Variable 360 300 Fixed 90 600 120 500 Selling price per unit 750 425 150 (75) (2) In the subsequent period, the following changes are envisaged. (a) Direct material cost of production of products A and B to increase by 20% (b) Selling price of product A to increase by 10% (c) Selling price of product B to increase by 30% (3) The management is contemplating to utilise 30% capacity presently lying idle and for this the following alternative proposals are to be considered. (a) Further sale of product A is possible, but additional output can be sold at Rs.600 per unit. Efficiency for this additional production will decrease by 10% (b) Product B is expected to have ready market at a price of Rs.510 per unit. The additional out is possible at the same efficiency level as budgeted. (4) The following additional information also needs to be considered. (a) Present allocation of capacity of 40% to product A and 30% to product B can not be altered. However the idle capacity can be utilised for any of the products A & B. (b) Fixed expenses are not to increase on account of utilisation of additional 30% capacity. You are required to prepare a comparative statement for providing information to the management giving your comments on the profitability of the two proposals as stated above. Ans: Alternative (A): Further sale of 3000 units of product A with selling price of Rs.600 on additional 75

DECEMBER 2002 output and decrease in efficiency for additional production by 10% Profitability Statement Products Total A B Production (Units) 4,000 6,000 13,000 Current Current 3,000 Additional Capacity utilisation 70% 30% 100% Sales Current (A @ Rs.825/-, B @ Rs.552.50) 33,00,000 33,15,000 66,15,000 Addll. (A @ Rs.600, B @ Rs.510) 18,00,000 18,00,000 TOTAL (I) 51,00,000 33,15,000 84,15,000 Variable cost Direct Material(A @ Rs.180, B @ Rs.96) 12,60,000 5,76,000 18,36,000 Conversion Cost (Variable) Current (A@ Rs.360, B @ Rs.300) 14,40,000 18,00,000 32,40,000 Additional (A @ Rs.400) 12,00,000 12,00,000 TOTAL (II) 39,00,000 23,76,000 62,76,000 Contribution (I) - (II) 12,00,000 9,39,000 21,39,000 Less Fixed Cost 3,60,000 7,20,000 10,80,000 PROFIT 8,40,000 2,19,000 10,59,000 Alternative (B): Additional output of product B at a market price of Rs.510/- at the same level of efficiency. Profitability Statement Products Total A B Production (Units) 4,000 6,000 16,000 Current Current 6,000 Additional Capacity utilisation 40% 60% 100% Sales Current (A @ Rs.825/-, B @ Rs.552.50) 33,00,000 33,15,000 66,15,000 76

DECEMBER 2002 Addll. (B @ Rs.510) 30,60,000 30,60,000 TOTAL (I) 33,00,000 63,75,000 96,75,000 Variable cost Direct Material(A @ Rs.180, B @ Rs.96) 7,20,000 11,52,000 18,72,000 Conversion Cost (Variable) Current (A@ Rs.360, B @ Rs.300) 14,40,000 36,00,000 50,40,000 TOTAL (II) 21,60,000 47,52,000 69,12,000 Contribution (I) - (II) 11,40,000 16,23,000 27,63,000 Less Fixed Cost 3,60,000 7,20,000 10,80,000 PROFIT 7,80,000 9,03,000 16,83,000 In option B profit at Rs.16,83,000 is higher than profit if Rs.10,59,000 in alternative A. Therefore it is advised to go for alternative (B). Working Notes: 1. Computation of Selling Price per unit Product A Current Output (Rs.750 + 10% of Rs.750) Rs.825-00 Additional Output Rs.600-00 Product B Current Output (Rs.425 + 30% of Rs.425) Rs.552-50 Additional Output Rs.510-00 2. Direct Material Cost Per Unit Product A (Rs.150 + 20% of Rs.150) Rs.180-00 Product B (Rs. 80 + 20% of Rs. 80) Rs. 96-00 3. Conversion cost (Variable) of Product A for additional output of 3,000 units Conversion cost per unit Rs.360-00 Add Decrease inefficiency by 10% (Rs.360 x 1/9) 40-00 Rs.400-00 Total conversion cost (3000 units x Rs.400) 12,00,000 SECTION-IV 6. Infrastructure Financing is the major driver for the growth of economy. With reference to infrastructure financing elaborate upon the following aspects. (15) a. Risks involved The specific risks involved with infrastructure are: k Commercial Risk - Costs of production and uncertainties in demand for services. 77

DECEMBER 2002 k k k k k Construction Risk- Technical designs, cost over-run etc. Operating Risk - Cost and availability of operating inputs, bottlenecks etc. Regulatory Risk- As most of the infrastructure projects come under the category of public utilities; they are highly susceptible to sector specific regulatory policy decisions. Funding Risk- Mismatch with regard to liability sources and investment deployment of the promoter, adverse interest movements (floating or fixed) and even high exchange risk. Political Risk- Foreign investment does not come forth to developing countries mainly because of political risk etc. may result in funding risk. b. Concepts of financing The following concepts have emerged in management of infrastructure projects. v BOT (Build, Operate and Transfer) - It refers to construction by a private party/consortium, which finances, operates and maintains an infrastructure for a specified period. Thereafter, it transfers the project to an identified public agency or back to the Government itself. BOT may have a period of transfer between 10 and 25 years. v BOOT (Build, Own, Operate and Transfer) - It is like BOT but the period of transfer could be upto 50 years. v BOO (Build, Own and Operate) - Under this the right to construct, operate and own remains with the private party. The infrastructure does not get transferred to the public sector. v BOLT (Build, Own, Lease and Transfer) - Public agency / Government invites private sector to build / manufacture and lease the constructed asset to the Public agency / Government. The later will pay lease charges (rentals) during lease period. On expiry of lease period, the asset is transferred to the Public agency / Government. c. Funding structure The funding structure may take an equity route and / or mezzanine form i.e., a maximum of financing instruments including equity, bonds, subordinate debt, senior debt and bridge loan etc. Equity may be offered through special purpose funds by multilateral agencies like International Finance Corporation, Asian Development Bank, construction contractors, and suppliers of capital equipment or through local equity markets. Another suggested method of financing is that initial borrowing may be for ten years, which may be refinanced by another round of borrowing. d. Mechanism of Escrow account The work involved in infrastructure financing has 3 phases - Pre construction, Post construction and Operational phase. In the pre-construction stage, financing banks manage the risk by having full recourse to the promoters, contractors and the suppliers. In the post-construction stage, banks depend only on cash flows committed by lenders. To protect against adverse events, banks have devised Escrow Account mechanism through which the cash inflows are pooled and on which banks have first charge towards recovery of their loans. e. Steps involved in processing infrastructure finance proposal Banks financing infrastructure projects have to undertake the following: 78

DECEMBER 2002 v v v Banks should ensure that they have the requisite expertise for appraisal of technical feasibility, financial viability and bankability of the project with particular reference to risk and sensitivity analysis. They can appraise the project with in house experts and / or external consultants. Financing offer which involves the development and application of a financing concept to the borrower with a view to capturing lead mandate. After the mandate is awarded the financial structure is fine-tuned in consultation with other lead banks. Any participation with the borrower should result in what is called a term sheet which set out the basic details of the financing and serves as a basis on which underwriting of the loan amount by lead banks is possible. v Documentation v Syndication v Funding according to draw down schedule and financial supervision and monitoring. OR 6. (a) Elaborate with sufficient details functions of a Finance Manager. (8) The Finance Manager s main objective is to manage funds in such a way so as to ensure their optimum utilisation and their procurement in a manner that the risk, cost and control considerations are properly balanced in a given situation. To achieve these objectives the Finance Manager perform the following functions: (1) Estimating the requirement of Funds: Both for long-term purpose i.e., investment in fixed assets and for short term i.e., for working capital. Forecasting the requirements of funds involves the use of techniques of budgetary control and long-range planning. (2) Decision regarding Capital Structure: Once the requirement of funds has been estimated, a decision regarding various sources from which these funds would be raised has to be taken. A proper balance has to be made between the loan funds and own funds. He has to ensure that he raises sufficient long-term funds to finance fixed assets and other long-term investments and to provide for the needs of working capital. (3) Investment Decision: The investment of funds, in a project has to be made after careful assessment of the various projects through capital budgeting. Assets management policies are to be laid down regarding various items of current assets. For e.g. receivable in co-ordination with sales manager, inventory in co-ordination with production manager. (4) Dividend Decision: The finance manager is concerned with the decision as to how much to retain and what portion to pay as dividend depending on the company s policy. Trend of earnings, trend of share market prices, requirement of funds for future growth, cash flow situation etc., are also to be considered. (5) Evaluating Financial Performance: A finance manager has to constantly review the financial performance of the various units of organisation generally in terms of R.O.I. Such a review helps the management in seeing how the funds have been utilised in various divisions and what can be done to improve it. (6) Financial negotiation: The finance manager plays a very important role in carrying out negotiations with the financial institutions, banks and public depositors for raising of funds on favourable terms. 79

DECEMBER 2002 (7) Cash management: The finance manager lays down the cash management and cash disbursement policies with a view to supply adequate funds to all units of organisation and to ensure that there is no excessive cash. (8) Keeping touch with Stock Exchange: Finance manager is required to analyse major trends in stock market and their impact on the price of the company share. 6. (b) Classify and explain the kinds of Capital Investment proposals. (7) Apart from the actual generation of ideas, the first step in the capital budgeting process is to assemble a list of proposed new investments, together with the data necessary to appraise them. Although practices vary from firm to firm, proposals dealing with asset acquisitions are frequently grouped according to the following four categories: 1. Replacements. 2. Expansion: Additional capacity in existing product lines. 3. Growth: New product lines 4. Other (for example, pollution control equipment) These groupings are somewhat arbitrary, and it is frequently difficult to decide the appropriate category for a particular investment. In spite of such problems, the scheme is used quite widely and with good reason. Ordinarily, replacement decisions are the simplest to make. Assets wear out or become obsolete, and they must be replaced if production efficiency is to be maintained. A firm has a very good idea of the cost savings to be obtained by replacing an old asset, and it knows the consequences of non-replacement. All in all the outcomes of most replacement decision can be predicted with a high degree of confidence. Examples of the second investment classification are proposals for adding more machines of the type already in use or the opening of new branches in a nation-wide chain of food stores. Expansion investments are frequently incorporated in replacement decision. To illustrate, an old, inefficient machine may be replaced by a large and more efficient one. A degree of uncertainty sometimes extremely high is clearly involved in expansion but the firm at least has the advantages of examining past production and sales experience with similar machines or stores. When it considers an investment of the third kind, growth into new product lines, little, if any, experience is available on which to base decision. The Others category is a catchall and includes intangible. An example is a proposal to boost employee morale and productivity by installing a music system. Mandatory pollution control devices, which must be undertaken even though they produce no revenues, are another example of the other category. Major strategic decision, such as plans for overseas expansion or mergers, might also be included here, but more frequently, they are treated separately from the regular capital budget. 7. A review made by the top management of ABC Ltd. which makes only one product, of the result of the first quarter of the year revealed the following: (15) Sales in Units 10,000 Loss Rs.10,000 Fixed Cost (For the year Rs.1,20,000) Rs.30,000 Variable cost per unit Rs.8.00 80

DECEMBER 2002 The finance manager who feels perturbed suggests that the company should at least break even in the second quarter with a drive for increased sales. Towards this end, the company should introduce better packing, which will increase the cost by 50 paise per unit. The Sales manager has an alternative proposal. For the second quarter additional sales promotion expenses can be incurred to the extent of Rs.5000 and a profit of Rs.5000 can be aimed at during the period with increased sales. The Production manager feels otherwise. To improve the demand, the selling price per unit has to be reduced by 3%. As a result the sales volume can be increased to attain a profit level of Rs.4000 for the quarter. The Managing Director asks you to evaluate the three proposals and calculate the additional sales volume that would be required to break even in each case, along with P/V ratio and recommend which of the three proposals should be accepted. Ans: (First alternative) EVALUATION OF ALTERNATIVE PROPOSALS: 1. Finance Manager s Proposal: Variable cost per unit = Rs. 8 + Rs. 0.50 = Rs.8.50 Contribution per unit = Rs.10 - Rs.8.50 = Rs.1.50 Fixed Cost Rs.30,000 Break-even point = = = 20,000 units Contribution Rs.1.50 Contribution P.U. Rs.1.50 P.V. Ratio = x 100 = x 100 = 15% Selling Price P.U. Rs.10 Additional sales volume required to achieve breakeven = 10,000 units 2. Production Manager s Proposal: Selling price per unit = Rs. 10 - Rs. 0.30 = Rs.9.70 Contribution per unit = Rs.9.70 - Rs.8 = Rs.1.70 Desired contribution = Rs.Fixed Cost + Revised Profit Desired contribution Rs.34,000 Desired Sales = = = 20,000 units Contribution per unit Rs.1.70 Contribution P.U. Rs.1.70 P.V. Ratio = x 100 = x 100 = 17.5% Selling Price P.U. Rs.9.70 Additional sales volume required to achieve breakeven = 10,000 units 81

DECEMBER 2002 3. Sales Managers Proposal: Rs. Current fixed cost 30,000 Add: Sales promotion expenses 5,000 Revised fixed cost 35,000 Add: Desired Profit 5,000 Desired contribution 40,000 Desired contribution Rs.40,000 Desired Sales = = = 20,000 units Contribution per unit Rs.2 Contribution P.U. Rs.2 P.V. Ratio = x 100 = x 100 = 20% Selling Price P.U. Rs.10 Additional Sale volume required to achieve breakeven = 10,000 units Analysis of three proposals: Particulars Finance Manager Production Manager Sales Manager Breakeven Units 20,000 20,000 20,000 P.V. Ratio 15% 17.5% 20% Net Profit NIL Rs.4,000 Rs.5,000 OPINION: From the above analysis it is observed that P.V. Ratio and Net Profit are highest as per Sales Manager s Proposal. Hence, Sales Manager s proposal can be accepted. WORKING NOTES: Calculation of selling price per unit: Fixed Cost 30,000 Less: Loss 10,000 Contribution 20,000 Rs.20,000 Contribution per unit = = Rs.2/- 10,000 units Selling price per unit = Variable cost per Unit + Contribution per unit Rs.8/- + Rs.2/- = Rs.10/- OR 82

DECEMBER 2002 7. ABC Ltd. is presently operating at 60% level, producing 36,000 units of a T.V. set component and proposes to increase capacity utilisation in the coming year by 33 1/3 % over the existing level of production. The following data has been supplied. (i) Unit cost structure of the product at current level. Rs. Raw Materials 4 Wages (Variable) 2 Overheads (Variable) 2 Fixed overhead 1 Profit 3 Selling Price 12 (ii) Raw materials will remain in stores for 1 month before being issued for production. Material will remain in process for further 1 month. Suppliers grant 3 months credit to the company. (iii) Finished goods remain in godown for one month. (iv) Debtors are allowed credit for 2 months. (v) Lag in wages and overhead payments is 1 month, and these expenses accrue evenly throughout the production cycle. (vi) No increase either in cost of inputs or selling price is envisaged. You are required to prepare a Projected Profitability statement and the Working Capital Requirement at the new level, assuming that a minimum cash balance of Rs.19,500 has to be maintained. Ans: (Second Alternative) ABC LTD. Projected Profitability statement at 80 per cent capacity units to be produced: (36,000 / 60 x 80) = 48,000 Units A. Cost of Sales: Rs. Raw Material Rs.4 x 48,000 1,92,000 Wages Rs.2 x 48,000 96,000 Overheads (Variable) Rs.2 x 48,000 96,000 Overheads (Fixed) Rs.1 x 36,000 36,000 4,20,000 B. Profit Rs.3.25 x 48,000 1,56,000 C. Sales Value Rs.12 x 48,000 5,76,000 83

DECEMBER 2002 Working Notes: Cost of Sales - Average per month Per annum Per month Rs. Rs. Raw Material 1,92,000 16,000 Wages 96,000 8,000 Overheads(variable) 96,000 8,000 Overheads (fixed) 36,000 3,000 4,20,000 35,000 Profit 1,56,000 13,000 5,76,000 48,000 Projected Statement of working capital at 80 percent capacity: Rs. Rs. Current Assets: Raw Material (48,000 / 12 x 4) 16,000 Work in progress: Materials (48,000 x 4 x 1/12) 16,000 Wages (48,000 x 2 x 1/24) 4,000 Variable overheads(48,000 x 2 x 1/24) 4,000 Fixed overheads (48,000 x 0.75 x 1/24) 1,500 25,500 Finished goods (48,000 x 8.75 x 1/12) 35,000 76,500 Sundry debtors 96,000 Cash balance 19,500 (A) 1,92,000 Less: Current Liabilities: Creditors for goods (48,000 x 4 x 3/12) 48,000 Creditors for expenses (48,000 x 4.75 x 1/12) 19,000 (B) 67,000 Net Working Capital (A) - (B) 1,25,000 Note: (i) Since wages and overheads payments accrue evenly, it is assumed that they will be in process for half a month in average. (ii) Fixed overheads per unit = Rs.36,000 / 48,000 = Re. 0.75 84