CA Inter Financial and Strategic Management Important Question
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Financial Management
Strategic Management
Other Important Questions Blog :
Question 1.
EXPLAIN “Wealth maximisation” and “Profit maximisation” objectives of financial management.
Answer:
Efficient financial management requires existence of some objectives or goals. Although various objectives are possible, but we assume two objectives of financial management for elaborate discussion. These are:
1. PROFIT MAXIMISATION :
a) It is generally argued that profit maximisation is the Primary objective of a business enterprise.
b) This implies that finance manager has to make his decisions in a manner so that profits of the concern are maximised.
c) Profit Maximisation is viewed as a limited objective i.e. essential but not sufficient.
2. WEALTH OR VALUE MAXIMISATION :
a) Primary goal of a firm is to maximize its market value and implies that business decisions should try to increase the net present value of the economic profits of the firm.
b) It is the duty of finance manager to see that, the value of the share should increase in the share market.
c) This value depends upon (i) Cash flow approach not Accounting profit (ii) Cost benefit analysis (iii) Application of time value of money.
Hence, Wealth Maximisation is a better objective for a business since it represents both return and risk.
d) Profit maximisation can be considered as a part of maximisation strategy.
Question 2.
POINT OUT the difference between Financial Management & Financial Accounting?
Answer:
Question 3.
Explain in brief the phases of the evolution of financial management.
Answer:
Question 1.
Explain in brief following Financial Instruments:
(i) Euro Bonds
(ii) Floating Rate Notes
(iii) Euro Commercial paper
(iv) Fully Hedged Bond
Answer:
(i) Euro bonds : Euro bonds are debt instruments which are not denominated in the currency of the country in which they are issued. E.g. a Yen note floated in Germany.
(ii) Floating Rate Notes : Floating Rate Notes: are issued up to seven years maturity. Interest rates are adjusted to reflect the prevailing exchange rates. They provide cheaper money than foreign loans.
(iii) Euro Commercial Paper(ECP) : ECPs are short term money market instruments. They are for maturities less than one year. They are usually designated in US Dollars.
(iv) Fully Hedged Bond : In foreign bonds, the risk of currency fluctuations exists. Fully hedged bonds eliminate the risk by selling in forward markets the entire stream of principal and interest payments.
Question 2.
STATE in brief four features of Samurai Bond
Answer:
Question 3.
BRIEF out any four types of Preference shares along with its feature.
Answer:
Question 1.
The accountant of Moon Ltd. has reported the following data:
| Gross profit | ₹ 60,000 |
| Gross Profit Margin | 20 per cent |
| Total Assets Turnover | 0.30 : 1 |
| Net worth to total assets | 0.90 : 1 |
| Current Ratio | 1.5 : 1 |
| Liquid Assets to Current Liability | 1 : 1 |
| Credit Sales to Total Sales | 0.80 : 1 |
| Average Collection Period | 60 days |
Assume 360 days in a year
You are required to complete the following:
Balance Sheet of Moon Ltd.
| Liabilities | (₹) | Assets | (₹) |
| Net Worth | Fixed Assets | ||
| Current Liabilities | Stock | ||
| Debtors | |||
| Cash | |||
| Total Liabilities | Total Assets |
Answer:
Preparation of Balance Sheet
Working Notes:
Sales = Gross Profit / Gross Profit Margin
= 60,000 / 0.2 = ₹ 3,00,000
Total Assets = Sales / Total Asset Turnover
= 3,00,000 / 0.3 = ₹ 10,00,000
Net Worth = 0.9 x Total Assets
= 0.9 x ₹ 10,00,000 = ₹ 9,00,000
Current Liability = Total Assets – Net Worth
= ₹ 10,00,000 – ₹ 9,00,000
= ₹ 1,00,000
Current Assets = 1.5 x Current Liability
= 1.5 x ₹ 1,00,000 = ₹ 1,50,000
Stock = Current Assets – Liquid Assets
= Current Assets – (Liquid Assets / Current Liabilities =1)
= 1,50,000 – (LA / 1,00,000 = 1) = ₹ 50,000
Debtors = Average Collection Period x Credit Sales / 360
= 60 x 0.8 x 3,00,000 / 360 = ₹ 40,000
Cash = Current Assets – Debtors – Stock
= ₹ 1,50,000 – ₹ 40,000 – ₹ 50,000
= ₹ 60,000
Fixed Assets = Total Assets – Current Assets
= ₹ 10,00,000 – ₹ 1,50,000
= ₹ 8,50,000
Balance Sheet
| Liabilities | (₹) | Assets | (₹) |
| Net Worth | 9,00,000 | Fixed Assets | 8,50,000 |
| Current Liabilities | 1,00,000 | Stock | 50,000 |
| Debtors | 40,000 | ||
| Cash | 60,000 | ||
| Total liabilities | 10,00,000 | Total Assets | 10,00,000 |
Question 2.
Given below are the estimations for the next year by Niti Ltd.:
| Particulars | (₹ in crores) |
| Fixed Assets | 5.20 |
| Current Liabilities | 4.68 |
| Current Assets | 7.80 |
| Sales | 23.00 |
| EBIT | 2.30 |
The company will issue equity funds of ₹5 crores in the next year. It is also considering the debt alternatives of ₹ 3.32 crores for financing the assets. The company wants to adopt one of the policies given below:
| (₹ in crores) | |||
| Financing Policy | Short term debt @ 12% | Long term debt @ 16% | Total |
| Conservative | 1.08 | 2.24 | 3.32 |
| Moderate | 2.00 | 1.32 | 3.32 |
| Aggressive | 3.00 | 0.32 | 3.32 |
Assuming corporate tax rate at 30%, Calculate the following for each of the financing policy:
(i) Return on total assets
(ii) Return on owner's equity
(iii) Net Working capital
Also advise which Financing policy should be adopted if the company wants high returns.
Answer:
Question 3.
Assuming the current ratio of a Company is 2, State in each of the following cases whether the ratio will improve or decline or will have no change:
(i) Payment of current liability
(ii) Purchase of fixed assets by cash
(iii) Cash collected from Customers
(iv) Bills receivable dishonoured
(v) Issue of new shares
Answer:
Question 1.
The Capital structure of PQR Ltd. is as follows:
| (₹) | |
| 10% Debenture | 3,00,000 |
| 12% Preference Shares | 2,50,000 |
| Equity Share (face value ₹ 10 per share) | 5,00,000 |
| 10,50,000 |
Additional Information:
(i) ₹ 100 per debenture redeemable at par has 2% floatation cost & 10 years of maturity. The market price per debenture is ₹ 110.
(ii) ₹ 100 per preference share redeemable at par has 3% floatation cost & 10 years of maturity. The market price per preference share is ₹ 108.
(iii) Equity share has ₹ 4 floatation cost and market price per share of ₹ 25. The next year expected dividend is ₹ 2 per share with annual growth of 5%. The firm has a practice of paying all earnings in the form of dividends.
(iv) Corporate Income Tax rate is 30%.
Required:
Calculate Weighted Average Cost of Capital (WACC) using market value weights.
Answer:
Workings:
1. Cost of Equity (ke) = (D1 / (P0 - F)) + g = (₹2 / (₹25-₹4)) + 0.05 = 0.145 (approx.)
2. Cost of Debt (Kd) =
= = (7+0.2) / 99 = 0.073 (approx.)
3. Cost of Preference Shares (Kp) =
= = (12+0.36) / 98.5 = 0.125 (approx.)
Calculation of WACC using market value weights
| Source of capital | Market Value | Weights | After tax cost of capital | WACC (Ko) |
| (₹) | (a) | (b) | (c)=(a)x(b) | |
| 10% Debentures (₹ 110 x 3,000) | 3,30,000 | 0.178 | 0.073 | 0.013 |
| 12% Preference shares (₹ 108 x 2,500) | 2,70,000 | 0.146 | 0.125 | 0.018 |
| Equity shares (₹ 25 x 50,000) | 12,50,000 | 0.676 | 0.145 | 0.098 |
| 18,50,000 | 1.00 | 0.129 |
WACC (Ko) = 0.129 or 12.9% (approx.)
Question 2.
PK Ltd. has the following book-value capital structure as on March 31, 2020.
| (₹) | |
| Equity share capital (10,00,000 shares) | 2,00,00,000 |
| 11.5% Preference shares | 60,00,000 |
| 10% Debentures | 1,00,00,000 |
| 3,60,00,000 |
The equity shares of the company are sold for ₹ 200. It is expected that the company will pay next year a dividend of ₹ 10 per equity share, which is expected to grow by 5% p.a. forever. Assume a 35% corporate tax rate.
Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital structure.
(ii) COMPUTE the new WACC, if the company raises an additional ₹ 50 lakhs debt by issuing 12% debentures. This would result in increasing the expected equity dividend to ₹12.40 and leave the growth rate unchanged, but the price of equity share will fall to ₹ 160 per share.
Answer:
Question 3.
MR Ltd. is having the following capital structure, which is considered to be optimum as on 31.03.2022.
| Equity share capital (50,000 shares) | ₹ 8,00,000 |
| 12% Pref. share capital | ₹ 50,000 |
| 15% Debentures | ₹ 1,50,000 |
| ₹ 10,00,000 |
The earnings per share (EPS) of the company were ₹ 2.50 in 2021 and the expected growth in equity dividend is 10% per year. The next year's dividend per share (DPS) is 50% of EPS of the year 202I. The current market price per share (MPS) is ₹ 25.00. The 15% new debentures can be issued by the company. The company's debentures are currently selling at ₹ 96 per debenture. The new 12% Pref. share can be sold at a net price of ₹ 91.50 (face value ₹ 100 each). The applicable tax rate is 30%.
You are required to calculate :
Answer:
Question 1.
Xylo Ltd. is considering two alternative financing plans as follows:
| Particulars | Plan – A (₹) | Plan – B (₹) |
| Equity shares of ₹ 10 each | 8,00,000 | 8,00,000 |
| Preference Shares of ₹ 100 each | - | 4,00,000 |
| 12% Debentures | 4,00,000 | - |
| 12,00,000 | 12,00,000 |
The indifference point between the plans is ₹ 4,80,000. Corporate tax rate is 30%. CALCULATE the rate of dividend on preference shares.
Answer:
Computation of Rate of Preference Dividend
(EBIT - Interest) × (1 - t) / No. of equity shares (N1) = (EBIT - Interest) × (1 - t) - Pref. Dividend / No. of equity shares (N2)
(4,80,000 - 48,000) × (1 - 0.30) / 80,00,000 shares = 4,80,000 (1 - 0.30) - Preference Dividend / 80,00,000 shares
₹3,02,400 / 80,00,000 shares = (₹3,36,000 - Preference Dividend) / 80,00,000 shares
₹3,02,400 = ₹3,36,000 - Preference Dividend
Preference Dividend = ₹3,36,000 - ₹3,02,400 = ₹33,600
Rate of Dividend = (Preference Dividend / Preference share capital) x 100
= (₹33,600 / 4,00,000) x 100 = 8.4%
Memory Tip
When EBIT is below the break-even point, companies often choose equity financing to avoid immediate financial obligations like interest payments. This approach helps manage cash flow during periods of lower profitability.
On the other hand, when EBIT exceeds the break-even point, companies may opt for debt financing because it offers lower interest costs and allows them to leverage their profitability more effectively.
Mnemonic phrase: EBIT Rules: Equity Below, Debt Above!
Question 2.
Y Limited requires ₹ 50,00,000 for a new project. This project is expected to yield earnings before interest and taxes of ₹ 10,00,000. While deciding about the financial plan, the company considers the objective of maximizing earnings per' share. It has two alternatives to finance the project - by raising debt ₹ 5,00,000 or ₹ 20,00,000 and the balance, in each case, by issuing Equity Shares. The company's share is currently selling at ₹ 300, but is expected to decline to ₹ 250 in case the funds are borrowed in excess of ₹ 20,00,000. The funds can be borrowed at the rate of 12 percent upto ₹ 5,00,000 and at 10 percent over ₹ 5,00,000. The tax rate applicable to the company is 25 percent.
Which form of financing should the company choose?
Answer:
Question 3.
XL Limited provides you with following figures:
| (₹) | |
| Profit | 2,60,000 |
| Less: Interest on Debentures @ 12% | 60,000 |
| 2,00,000 | |
| Income tax @ 50% | 1,00,000 |
| Profit after tax | 1,00,000 |
| Number of Equity shares (of ₹10 each) | 40,000 |
| EPS (Earning per share) | 2.50 |
| Ruling price in market | 25 |
| PE Ratio (i.e. Price/EPS) | 10 |
The Company has undistributed reserves of ₹6,00,000. The company needs ₹ 2,00,000 for expansion. This amount will earn at the same rate as funds already employed. You are informed that a debt equity ratio Debt/ (Debt+ Equity) more than 35% will push the P/E Ratio down to 8 and raise the interest rate on additional amount borrowed to 14%. You are required to ascertain the probable price of the share.
(i) If the additional funds are raised as debt; and
(ii) If the amount is raised by issuing equity shares.
Answer:
Question1.
A firm has sales of ₹ 75,00,000 variable cost is 56% and fixed cost is ₹ 6,00,000. It has a debt of ₹ 45,00,000 at 9% and equity of ₹ 55,00,000. You are required to Interpret:
(i) The firm’s ROI?
(ii) Does it have favourable financial leverage?
(iii) If the firm belongs to an industry whose capital turnover is 3, does it have a high or low capital turnover?
(iv) The operating, financial and combined leverages of the firm?
(v) If the sale is increased by 10% by what percentage EBIT will increase?
(vi) At what level of sales the EBT of the firm will be equal to zero?
(vii) If EBIT increases by 20%, by what percentage EBT will increase?
Answer:
Income Statement
| Particulars | Amount (₹) |
| Sales | 75,00,000 |
| Less: Variable cost (56% of 75,00,000) | (42,00,000) |
| Contribution | 33,00,000 |
| Less: Fixed costs | (6,00,000) |
| Earnings before interest and tax (EBIT) | 27,00,000 |
| Less: Interest on debt (@ 9% on ₹ 45 lakhs) | (4,05,000) |
| Earnings before tax (EBT) | 22,95,000 |
(i) ROI = (EBIT/Capital employed) x100 = (EBIT/Equity+Debt) x 100
= (27,00,000/55,00,000+45,00,000) x 100 = 27%
(ROI is calculated on Capital Employed)
(ii) ROI = 27% and Interest on debt is 9%, hence, it has a favourable financial leverage.
(iii) Capital Turnover = Net Sales/Capital
Or = Net Sales/Capital = ₹75,00,000/₹1,00,00,000 = 0.75
Which is very low as compared to industry average of 3.
(iv) Calculation of Operating, Financial and Combined leverages
(a) Operating Leverage = Contribution/EBIT = ₹33,00,000/₹27,00,000 = 1.22 (approx)
(b) Financial Leverage = EBIT/EBT = ₹27,00,000/₹22,95,000 = 1.18 (approx)
(c) Combined Leverage = Contribution/EBT = ₹33,00,000/₹22,95,000 = 1.44 (approx)
Or = Operating Leverage x Financial Leverage = 1.22 x 1.18 = 1.44 (approx)
(v) Operating leverage is 1.22. So if sales is increased by 10%. EBIT will be increased by 1.22 x 10 i.e. 12.20% (approx)
(vi) Since the combined Leverage is 1.44, sales have to drop by 100/1.44 i.e. 69.44% to bring EBT to Zero
Accordingly, New Sales = ₹ 75,00,000 x (1-0.6944)
= ₹ 75,00,000 x 0.3056
= ₹ 22,92,000 (approx)
Hence at ₹ 22,92,000 sales level EBT of the firm will be equal to Zero.
(vii) Financial leverage is 1.18. So, if EBIT increases by 20% then EBT will increase by 1.18 x 20 = 23.6% (approx)
Question 2.
The following data is available for Stone Ltd.
| (₹) | |
| Sales | 5,00,000 |
| (-) Variable cost @ 40% | 2,00,000 |
| Contribution | 3,00,000 |
| (-) Fixed cost | 2,00,000 |
| EBIT | 1,00,000 |
| (-) Interest | 25,000 |
| Profit before tax | 75,000 |
Using the concept of leverage, find out
(i) The percentage change in taxable income if EBIT increases by 10%.
(ii) The percentage change in EBIT if sales increases by 10%.
(iii) The percentage change in taxable income if sales increases by 10%.
Also verify the results in each of the above case.
Answer:
Question 3.
Debu Ltd. currently has an equity share capital of ₹ 1,30,00,000 consisting of 13,00,000 Equity shares. The company is going through a major expansion plan requiring to raise funds to the tune of ₹ 78,00,000. To finance the expansion the management has following plans:
Plan-I : Issue 7,80,000 Equity shares of ₹ 10 each.
Plan-II : Issue 5,20,000 Equity shares of ₹ 10 each and the balance through long-term borrowing at 12% interest p.a.
Plan-III : Issue 3,90,000 Equity shares of ₹ 10 each and 39,000, 9% Debentures of ₹ 100 each.
Plan-IV : Issue 3,90,000 Equity shares of ₹ 10 each and the balance through 6% preference shares.
EBIT of the company is expected to be ₹ 52,00,000 p.a.
Considering corporate tax rate @ 40%, you are required to-
(i) CALCULATE EPS in each of the above plans.
(ii) ASCERTAIN financial leverage in each plan and comment.
Answer:
Question 1.
Alpha Limited is a manufacturer of computers. It wants to introduce artificial intelligence while making computers. The estimated annual saving from introduction of the artificial intelligence (Al) is as follows :
The purchase price of the system for installation of artificial intelligence is ₹ 20,00,000 and installation cost is ₹ 1,00,000. 80% of the purchase price will be paid in the year of purchase and remaining will be paid in next year. The estimated life of the system is 5 years and it will be depreciated on a straight -line basis.
However, the operation of the new system requires two computer specialists with annual salaries of ₹ 5,00,000 per person.
In addition to above, annual maintenance and operating cost for five years are as below :
| Year | 1 | 2 | 3 | 4 | 5 |
| Maintenance & Operating Cost | 2,00,000 | 1,80,000 | 1,60,000 | 1,40,000 | 1,20,000 |
Maintenance and operating cost are payable in advance.
The company’s tax rate is 30% and its required rate of return is 15%.
| Year | 1 | 2 | 3 | 4 | 5 |
| PVIF 0.10,t | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 |
| PVIF 0.12,t | 0.893 | 0.797 | 0.712 | 0.636 | 0.567 |
| PVIF 0.15,t | 0.870 | 0.756 | 0.658 | 0.572 | 0.497 |
Evaluate the project by using Net Present Value and Profitability Index.
Answer:
| Computation of Annual Cash Flow after Tax | ||||||
| Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Savings in Salaries | 15,00,000 | 15,00,000 | 15,00,000 | 15,00,000 | 15,00,000 | |
| Reduction in Production Delays | 3,00,000 | 3,00,000 | 3,00,000 | 3,00,000 | 3,00,000 | |
| Reduction in Lost Sales | 2,50,000 | 2,50,000 | 2,50,000 | 2,50,000 | 2,50,000 | |
| Gain due to Timely Billing | 2,00,000 | 2,00,000 | 2,00,000 | 2,00,000 | 2,00,000 | |
| Salary to Computer Specialist | (10,00,000) | (10,00,000) | (10,00,000) | (10,00,000) | (10,00,000) | |
| Maintenance and Operating Cost (payable in advance) | (2,00,000) | (1,80,000) | (1,60,000) | (1,40,000) | (1,20,000) | |
| Depreciation (21 lakhs/5) | (4,20,000) | (4,20,000) | (4,20,000) | (4,20,000) | (4,20,000) | |
| Gain Before Tax | 6,30,000 | 6,50,000 | 6,70,000 | 6,90,000 | 7,10,000 | |
| Less: Tax (30%) | 1,89,000 | 1,95,000 | 2,01,000 | 2,07,000 | 2,13,000 | |
| Gain After Tax | 4,41,000 | 4,55,000 | 4,69,000 | 4,83,000 | 4,97,000 | |
| Add: Depreciation | 4,20,000 | 4,20,000 | 4,20,000 | 4,20,000 | 4,20,000 | |
| Add: Maintenance and Operating Cost (payable in advance) | 2,00,000 | 1,80,000 | 1,60,000 | 1,40,000 | 1,20,000 | |
| less: Maintenance and Operating Cost (payable in advance) | (2,00,000) | (1,80,000) | (1,60,000) | (1,40,000) | (1,20,000) | - |
| Net CFAT | (2,00,000) | 8,81,000 | 8,95,000 | 9,09,000 | 9,23,000 | 10,37,000 |
Note: Annual cash flows can also be calculated Considering tax shield on depreciation & maintenance and operating cost. There will be no change in the final cash flows after tax.
| Computation of NPV |
||||
| Particulars | Year | Cash Flows (₹) | PVF | PV (₹) |
| Initial Investment (80% of 20 Lacs) | 0 | 16,00,000 | 1 | 16,00,000 |
| Installation Expenses | 0 | 1,00,000 | 1 | 1,00,000 |
| Instalment of Purchase Price | 1 | 4,00,000 | 0.870 | 3,48,000 |
| PV of Outflows (A) | 20,48,000 | |||
| CFAT | 0 | (2,00,000) | 1 | (2,00,000) |
| CFAT | 1 | 8,81,000 | 0.870 | 7,66,470 |
| CFAT | 2 | 8,95,000 | 0.756 | 6,76,620 |
| CFAT | 3 | 9,09,000 | 0.658 | 5,98,122 |
| CFAT | 4 | 9,23,000 | 0.572 | 5,27,956 |
| CFAT | 5 | 10,37,000 | 0.497 | 5,15,389 |
| PV of Inflows (B) | 28,84,557 | |||
| NPV (B-A) | 8,36,557 | |||
| Profitability Index (B/A) | 1.408 or 1.41 | |||
Evaluation: Since the NPV is positive (i.e. ₹ 8,36,557) and Profitability Index is also greater than 1 (i.e. 1.41), Alpha Ltd. may introduce artificial intelligence (AI) while making computers.
Question 2.
Xavly Ltd. has a machine which has been in operation for 3 years. The machine has a remaining estimated useful life of 5 years with no salvage value in the end. Its current market value is ₹ 2,00,000. The company is considering a proposal to purchase a new model of machine to replace the existing machine. The relevant information is as follows:
| Existing Machine | New Machine | |
| Cost of machine | ₹ 3,30,000 | ₹ 10,00,000 |
| Estimated life | 8 years | 5 years |
| Salvage value | Nil | ₹ 40,000 |
| Annual output | 30,000 units | 75,000 units |
| Selling price per unit | ₹ 15 | ₹ 15 |
| Annual operating hours | 3,000 | 3,000 |
| Material cost per unit | ₹ 4 | ₹ 4 |
| Labour cost per hour | ₹ 40 | ₹ 70 |
| Indirect cash cost per annum | ₹ 50,000 | ₹ 65,000 |
The company uses written down value of depreciation @ 20% and it has several other machines in the block of assets. The Income tax rate is 30 per cent and Xavly Ltd. does not make any investment, if it yields less than 12 per cent.
ADVISE Xavly Ltd. whether the existing machine should be replaced or not.
PV factors @12%:
| Year | 1 | 2 | 3 | 4 | 5 |
| PVF | 0.893 | 0.797 | 0.712 | 0.636 | 0.567 |
Answer:
Question 3.
A company wants to buy a machine, and two different models namely A and B are available.
Following further particulars are available:
| Particulars | Machine-A | Machine-B |
| Original Cost (₹) | 8,00,000 | 6,00,000 |
| Estimated Life in years | 4 | 4 |
| Salvage Value (₹) | 0 | 0 |
The company provides depreciation under Straight Line Method. Income tax rate applicable is 30%.
The present value of ₹ 1 at 12% discounting factor and net profit before depreciation and tax are as under:
| Year | Net Profit Before Depreciation and tax | PV Factor | |
| Machine-A (₹) | Machine-B (₹) | ||
| 1 | 2,30,000 | 1,75,000 | 0.893 |
| 2 | 2,40,000 | 2,60,000 | 0.797 |
| 3 | 2,20,000 | 3,20,000 | 0.712 |
| 4 | 5,60,000 | 1,50,000 | 0.636 |
Calculate:
1. NPV (Net Present Value)
2. Discounted pay-back period
3. PI (Profitability Index)
Suggest: Purchase of which machine is more beneficial under Discounted pay-back period method, NPV method and PI method.
Answer:
Question 1.
Following information relating to Jee Ltd. are given:
Particulars
| Particulars | |
| Profit after tax | ₹ 10,00,000 |
| Dividend payout ratio | 50% |
| Number of Equity Shares | 50,000 |
| Cost of Equity | 10% |
| Rate of Return on Investment | 12% |
(i) What would be the market value per share as per Walter's Model?
(ii) What is the optimum dividend payout ratio according to Walter's Model and Market value of equity share at that payout ratio?
Answer:
(i) Walter’s model is given by –
P =
Where,
P = Market price per share,
E = Earnings per share = ₹ 10,00,000 ÷ 50,000 = ₹ 20
D = Dividend per share = 50% of 20 = ₹ 10
r = Return earned on investment = 12%
Ke = Cost of equity capital = 10%
∴ P = 22/10% = ₹ 220
(ii) According to Walter’s model when the return on investment is more than the cost of equity capital, the price per share increases as the dividend pay-out ratio decreases. Hence, the optimum dividend pay-out ratio in this case is Nil. So, at a payout ratio of zero, the market value of the company’s share will be:-
P = 24/10% = ₹ 240
Question 2.
(A) The following information regarding the equity shares of M ltd. is given:
| Market price | ₹58.33 |
| Dividend per share | ₹5 |
| Multiplier | 7 |
According to the Graham & Dodd approach to the dividend policy, compute the EPS.
(B) Given the last year’s dividend is ₹ 9.80, speed of adjustment = 45%, target payout ratio 60% and EPS for current year ₹ 20. COMPUTE current year’s dividend using Linter’s model.
(C) X Ltd. is a no growth company, pays a dividend of ₹5 per share. If the cost of capital is 10%, COMPUTE the current market price of the share?
Answer:
Question 3.
The following figures are collected from the annual report of XYZ Ltd.:
| Net Profit | ₹ 30 lakhs |
| Outstanding 12% preference shares | ₹ 100 lakhs |
| No. of equity shares | 3 lakhs |
| Return on Investment | 20% |
| Cost of capital i.e. (Ke) | 16% |
COMPUTE the approximate dividend pay-out ratio so as to keep the share price at ₹ 42 by using Walter’s model?
Answer:
Question 1.
Mosaic Limited has current sales of ₹ 15 lakhs per year. Cost of sales is 75 per cent of sales and bad debts are one per cent of sales. Cost of sales comprises 80 per cent variable costs and 20 per cent fixed costs, while the company’s required rate of return is 12 per cent. Mosaic Limited currently allows customers 30 days’ credit, but is considering increasing this to 60 days’ credit in order to increase sales.
It has been estimated that this change in policy will increase sales by 15 per cent, while bad debts will increase from one per cent to four per cent. It is not expected that the policy change will result in an increase in fixed costs and creditors and stock will be unchanged.
Should Mosaic Limited introduce the proposed policy? ANALYSE (Assume a 360 days year)
Answer:
New level of sales will be 15,00,000 x 1.15 = ₹ 17,25,000
Variable costs are 80% x 75% = 60% of sales
Contribution from sales is therefore 40% of sales
Fixed Cost are 20 % x 75% = 15% of sales
* Fixed Cost is taken at existing level in case of proposed investment as well
Advise: Mosaic Limited should introduce the proposed policy.
| Particulars | ₹ | ₹ |
| Proposed investment in debtors = Variable Cost + Fixed Cost* | 2,10,000 | |
| = (17,25,000 x 60%) + (15,00,000 x 15%) = (10,35,000 + 2,25,000) x (60/360) | ||
| Current investment in debtors | 93,750 | |
| = [(15,00,000 x 60%) + (15,00,000 x 15%)] x (30/360) | ||
| Increase in investment in debtors | 1,16,250 | |
| Increase in contribution = 15% x 15,00,000 x 40% | 90,000 | |
| New level of bad debts = (17,25,000 x 4%) | 69,000 | |
| Current level of bad debts (15,00,000 x 1%) | 15,000 | |
| Increase in bad debts | (54,000) | |
| Additional financing costs = 1,16,250 x 12% = | (13,950) | |
| Savings by introducing change in policy | 22,050 |
* Fixed Cost is taken at existing level in case of proposed investment as well
Advise: Mosaic Limited should introduce the proposed policy.
Question 2.
A company wants to follow a more prudent policy to improve its sales for the region which is ₹ 9 lakhs per annum at present, having an average collection period of 45 days. After certain researches, the management consultant of the company reveals the following information:
| Credit policy | Increase in collection period | Increase in sales | Present default anticipated |
| W | 15 Days | ₹ 60,000 | 1.5% |
| X | 30 Days | ₹ 90,000 | 2% |
| Y | 45 Days | ₹ 1,50,000 | 3% |
| Z | 70 Days | ₹ 2,10,000 | 4% |
The selling price per unit is ₹ 3. Average cost per unit is ₹ 2.25 and variable costs per unit are ₹ 2. The current bad debt loss is 1%. Required return on additional investment is 20%. (Assume 360 days year)
ANALYSE which of the above policies would you recommend for adoption?
Answer:
Question 3.
PD Ltd. an existing company, is planning to introduce a new product with projected life of 8 years. Project cost will be ₹2,40,00,000. At the end of 8 years no residual value will be realized. Working capital of ₹30,00,000 will be needed. The 100% capacity of the project is 2,00,000 units p.a. but the Production and Sales Volume is expected are as under :
| Year | Number of units |
| 1 | 60,000 units |
| 2 | 80,000 units |
| 3-5 | 1,40,000 units |
| 6-8 | 1,20,000 units |
Other Information:
(i) Selling price per unit ₹ 200
(ii) Variable cost is 40% of sales.
(iii) Fixed cost p.a. ₹ 30,00,000.
(iv) In addition to these advertisement expenditure will have to be incurred as under:
| Year | 1 | 2 | 3-5 | 6-8 |
| Expenditure (₹) | 50,00,000 | 25,00,000 | 10,00,000 | 5,00,000 |
(v) Income Tax is 25%.
(vi) Straight-line method of depreciation is permissible for tax purpose.
(vii) Cost of capital is 10%.
(viii) Assume that loss cannot be carried forward.
Present Value Table
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
| PVF @10 | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 | 0.564 | 0.513 | 0.467 |
Advise about the project acceptability.
Answer:
Question 1.
Mr. Mehta sharing with his friend in an informal discussion that he has to move very cautiously in his organization as the decisions taken by him has organisation wide impact and involves large commitments of resources. He also said that his decisions decide the future of his organisation. Where will you place Mr. Mehta in the organizational hierarchy and explain his role in the organization.
Answer:
Mr. Mehta works in an organization at top level. He participates in strategic decision making within the organization.
The role of corporate-level managers is - to oversee the development of strategies for the whole organization. This role includes defining the mission and goals of the organization, determining what businesses it should be in, allocating resources among the different businesses, formulating and implementing strategies that span individual businesses, and providing leadership for the organization.
Question 2.
CDE Holdings operates in various sectors, including manufacturing fitness equipment, organic foods, eco-friendly products and children’s educational tools. The organization is currently in the process of recruiting a Chief Executive Officer. In this scenario imagine yourself as a HR consultant for CDE Holdings.
Identify the stategic level the encompasses this role within CDE Holdings.
provide an overview of the key duties and responsibilties falling under the Chief Executive Officer’s scope.
Answer:
Question 3.
Swati is the marketing manager at a software company. She is responsible for developing and implementing marketing strategies for the company’s products. Swati leads a team of marketing professionals and works closely with the product development and sales teams to ensure that the company's products are effectively promoted in the market. She also analyzes market trends and customer feedback tore fine the marketing strategies. Which level is she working at, discuss the roles and responsibilities of this level in organization?
Answer:
Question 1.
ABC Corp, a multinational consumer electronics company, is planning to expand its operations into a new country. The company's senior management is evaluating the potential risks and opportunities of entering this new market. As part of their analysis, they decide to use the PESTLE framework to assess the external factors that could impact their decision. How can the PESTLE framework help ABC Corp assess the external factors affecting its decision to expand into a new country?
Answer:
The PESTLE framework can help ABC Corp assess the external factorsaffecting its decision to expand into a new country by considering thefollowing aspects:
• Political Factors: These include the stability of the government,government policies on foreign investment, trade agreements, andregulatory frameworks. By analyzing these factors, ABC Corp canassess the political risks associated with entering the new market.
• Economic Factors: Economic factors such as GDP growth rate,inflation rate, exchange rates, and economic stability can impact ABC Corp's decision. By analyzing these factors, the company can understand the economic environment of the new market and its potential impact on business operations.
• Social Factors: Social factors such as cultural norms,demographics, and lifestyle trends can influence consumer behavior and demand for ABC Corp's products. Understanding these factors can help the company tailor its marketing strategies to the new market.
• Technological Factors: Technological factors such as infrastructure, technological advancements, and the level of technology adoption in the new market can impact ABC Corp's operations. By assessing these factors, the company can determinethe technological requirements for entering the new market.
• Legal Factors: Legal factors such as laws and regulations related to foreign investment, intellectual property rights, and labor laws can impact ABC Corp's decision. By analyzing these factors, the company can ensure compliance with legal requirements in the new market.
• Environmental Factors: Environmental factors such as climate change, environmental regulations, and sustainability practices can impact ABC Corp's operations and reputation. By considering these factors, the company can assess the environmental risks and opportunities in the new market.
Overall, the PESTLE framework can provide ABC Corp with a comprehensive analysis of the external factors that could impact its decision to expand into a new country, helping the company make informed and strategic decisions.
Question 2.
Pulkit was very confident about cloud kitchen business model, and he bought three real estate spaces in very hideous localities. Later due to government and court orders the cloud kitchens had to be only operated in a well- ventilated space, which made his investment redundant. What aspect of industry competition is Pulkit currently faced as a result of this situation?
Answer:
Question 3.
Suresh Singhania is the owner of an agri-based private company in Sangrur, Punjab. His unit is producing puree, ketchup, and sauces. While its products have significant market share in the northern part of country, the sales are on decline in last couple of years. He seeks help of a management expert who advises him to first understand the competitive landscape.
Explain the steps to be followed by Suresh Singhania to understand competitive landscape.
Answer:
Question 1.
Inspite of high commodity inflation, shortage of components and the threat of a third wave of COVID-19 pandemic in India, Manufactures of packaged goods, home appliances and consumer electronics are expecting the business to grow by 12 to 25 percent in the coming months. After one-and-a-half years of disruption, manufacturers are now confident about managing their inventories better, keeping their supply channels well-stocked and preparing themselves to minimalize the impact of any COVID related restrictions even as they gear up for the festive season, which usually accounts for 25 to 35 percent of their yearly sales.
The home appliances sectors could be an example. After a dismal April-June quarter in the year 2021; producers of air conditioners, refrigerators and washing machines are expecting their business to grow by 15-20 percent in the months to come. All the companies operating in the sector have geared up to grad the opportunities available in the market.
A leading company in the house appliances domain, XXP India, is planning to launch various innovative product designs and offer loyalty programmers to lure consumers.
With reference to Michael Porter’s generic, identify which strategy XXP India has planned for? Explain how this strategy will be advantageous to the company to remain profitable?
Answer:
According to Michael Porter, strategies allow organizations to gain competitive advantage from three different bases: cost leadership, differentiation, and focus. Porter called these base generic strategies.
XXP India Ltd. has planned for Differentiation Strategy. The company is planning to launch various innovative product designs and offer loyalty programmes to lure customers.
Differentiation strategy should be pursued only after a careful study of buyers’ needs and preferences to determine the feasibility of incorporating one or more differentiating features into a unique product that features the desired attributes. A successful differentiation strategy allows a firm to charge a higher price for its product and to gain customer loyalty, because consumers may become strongly attached to the differentiated features.
Advantages of Differentiation Strategy
A differentiation strategy may help an organisation to remain profitable even with rivalry, new entrants, suppliers’ power, substitute products, and buyers’ power.
1. Rivalry - Brand loyalty acts as a safeguard against competitors. It means that customers will be less sensitive to price increases, as long as the firm can satisfy the needs of its customers.
2. Buyers – They do not negotiate for price as they get special features, and they have fewer options in the market.
3. Suppliers – Because differentiators charge a premium price, they can afford to absorb higher costs of supplies as the customers are willing to pay extra too.
4. Entrants – Innovative features are an expensive offer. So, new entrants generally avoid these features because it is tough for them to provide the same product with special features at a comparable price.
5. Substitutes – Substitute products can’t replace differentiated products which have high brand value and enjoy customer loyalty.
Question 2.
Spacetek Pvt. Ltd. is an IT company. Although there is cut throat competition in the IT sector, Spacetek deals with distinctive niche clients and is generating high efficiencies for serving such niche market. Other rival firms are not attempting to specialize in the same target market. Identify the strategy adopted by Spacetek Pvt. Ltd. and also explain the advantages and disadvantages of that strategy.
Answer:
Question 3.
A century-old footwear company “Mota Shoes” had an image of being the footwear choice for formal occasions. In an attempt to reinvent its brand, it tied up with a foreign footwear giant “Buffrine” to manufacture and sell its Hideseek brand in the country. Putting its best foot forward, it launched extra soft, casual and relaxed footwear for young. Aiming at a brand and image makeover the “Mota Shoes” decided to price the Hide Seek products at premium. What kind of Michael Porter business level strategy is being used by “Mota Shoe company”? State its advantages.
Answer:
Question 1.
X Pvt. Ltd. had recently ventured into the business of co-working spaces when the global pandemic struck. This has resulted in the business line becoming unprofitable and unviable, and a failure of the existing strategy. However, the other businesses of X Pvt. Ltd. are relatively less affected by the pandemic as compared to the recent co-working spaces. Suggest a strategy for X Pvt. Ltd. with reasons to justify your answer.
Answer:
It is advisable that divestment strategy should be adopted by X Pvt. Ltd.
In the given situation where the business of co-working spaces became unprofitable and unviable due to Global pandemic, the best option for the company is to divest the loss-making business.
Retrenchment may be done either internally or externally. Turnaround strategy is adopted in case of internal retrenchment where emphasis is laid on improving internal efficiency of the organization, while divestment strategy is adopted when a business turns unprofitable and unviable due to some external factors. In view of the above, the company should go for divestment strategy.
Further, divestment helps address issues like:
1. Persistent cash flows from loss making segment could affect other profit-making segments, which is the case in the given scenario.
2. Inability to cope from the losses, which again is uncertain due to pandemic.
3. Better investment opportunity, which could be the case if X Pvt. Ltd. can invest the money it generates from divestment.
Question 2.
General public is discerning from buying air conditioning units based on the Health Ministry guidelines regarding emergence of a contagious viral pandemic. Consequently, Nebula Pvt. Ltd, a manufacturer of evaporation coils used in air conditioning units, has faced significant loss in working capital due to sharp fall in demand. The company conducted financial assessment and developed a workable action plan based on short and long term financial needs. But for immediate needs, an emergency plan has been implemented. It includes selling scrap, asset liquidation and overheads cost reduction. Further, to avoid any such untoward event in future, they plan to diversify into newer business areas along with its core business. Identify and explain the strategy opted by M/s. Nebula Pvt. Ltd.?
Answer:
Question 3.
An XYZ Company is facing continuous losses. There is decline in sales and product market share. The products of the company became uncompetitive and there is persistent negative cash flow. The physical facilities are deteriorating and employees have low morale. At the board meeting, the board members decided that they should continue the organization and adopt such measures that the company functions properly. The board has decided to hire young executive Shayamli for improving the functions of the organization. What corporate strategy should Shayamli adopt for this company, and what steps to be taken to implement the corporate strategy adopted by Shayamli?
Answer:
Question 1.
A Mumbai-based conglomerate, PQR Ltd., has announced a major restructuring of its business operations. The company has decided to split its business into four separate units: Manufacturing, Retail, Services, and Technology. Each unit will operate as a separate business, with delegated responsibility for day-to-day operations and strategy to the respective unit managers. Identify the organization structure that PQR Ltd. has planned to implement. Discuss any four attributes and the benefits the firm may derive by using this organization structure.
Answer:
PQR Ltd. has planned to implement the Strategic Business Unit (SBU) structure. Very large organisations, particularly those running into several products, or operating at distant geographical locations that are extremely diverse in terms of environmental factors, can be better managed by creating strategic business units.
SBU structure becomes imperative in an organisation with increase in number, size and diversity.The attributes of an SBU and the benefits a firm may derive by using the SBU Structure are as follows:
Question 2.
Due to reoccurrence of various variants of Corona virus, LMN Ltd. is facing unstable environment and it has started unbundling and disintegrating its activities. It also started relying on outside vendors for performing these activities. Identify the organisation structure LMN Ltd. is shifting to. Under what circumstances this structure becomes useful ?
Answer:
Question 3.
Bunch Pvt Ltd is dealing in multiproduct like electronics and FMCG and are having outlets in different cities and markets across India. Due to scale of operation, it is having technical difficulty in dealing with distinct product line and markets especially in coordination and control related problems. Identify and suggest an ideal organizational structure for Bunch Pvt Ltd in resolving the problem ?
Answer:
Ruchika Saboo
An All India Ranker (AIR 7 - CA Finals, AIR 43 - CA Inter), she is one of those teachers who just loved studying as a student. Aims to bring the same drive in her students.
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