Examination Problems

Advanced Financial
Management
EBIT-EPS Analysis
1

Elite India Limited, a four year old company is growing rapidly. Presently it has
80,000 equity shares of Rs. 50 each and 10% debentures of Rs. 20,00,000. The
following is the summary of the Income Statement for the year ended December 31,
2010:
Sales..............................................................................50,00,000
Variable Expenses.......................................................(25,00,000)
Fixed Expenses.............................................................(9,00,000)
EBIT..............................................................................16,00,000
Interest..........................................................................(2,00,000)
Earnings Before Taxes...................................................14,00,000
Tax (35%).....................................................................(4,90,000)
Profit After Taxes............................................................9,10,000
EPS.......................................................................................11.38
The company further wants to expand its activities for which it is planning to make an
additional investment of Rs. 20,00,000. There are two financing options: (a) Issue 40,000
equity shares of Rs. 50 each; or (b) obtain a term loan of Rs. 20,00,000 at an interest rate of
20 per cent.
The ratio of variable expenses to sales will remain the same next year and fixed expenses will
be Rs. 13,00,000 if the sales are less than or equal to Rs. 70,00,000, or Rs. 26,00,000 if the
sales are 120,00,000 or more.
The PE ratio will be 2.5 in case the equity option is selected, and it will be 3 in case the debt
option is selected.
Required
Which financing option is optimal assuming the sales are:
(a) Rs. 70,00,000?
(b) Rs. 120,00,000...........................................................................................(MU Nov 2008)

Forecasting External Funding

1.........................The balance sheet of Deepak Limited on December 31, 2009 is given below:
Liabilities
Share Capital
Reserves & Surplus
Term Loans

Rs.
15
0
18
0
80

Assets
Fixed
Inventories
Receivables

Rs.
40
0
20
0
15

Bank Loan (Short Term)

Account Payables
Provisions
Total

20 Cash
0
14
0
50
80 Total
0

0
50

80
0

The sales of Deepak Limited for the year ended December 31, 2009 were Rs. 1000
lacs. Its profit margin on sales was 6% and its dividend payout ratio was 50%. The tax
rate was 60%.
The company expects its sales to increase by 30% in 2010. The ratio of assets to sales
and spontaneous current liabilities to sales would remain unchanged.
Required
(a)......................................Estimate the external funds requirements for the year 2010.
(b)
Prepare projected balance sheet and projected profit and loss account
assuming that the external funds requirement would be raised equally from
term loans and short term bank borrowings...............................(MU Dec 2010)
2

The balance for the current year for a company is given below (all figures are in Rs.
Lakhs):
Liabilities
Equity Capital
Retained Earnings
Term Loans
Short Term Borrowings
Creditors
Provisions
Total

Rs.
10
0
12
0
16
0
12
0
10
0
40

Assets
Land and Building
Machinery

Rs.
20
0
30

Furniture

30

Bills Receivable

10
0
60

Debtors
Stock

Bank
64 Total
0

18
0
40
64
0

During the year sales were Rs. 800; variable expenses were Rs. 560; and fixed
expenses were Rs. 160. The following projections are made for the next year:

The sales are expected to be Rs. 1000

Fixed expenses will increase by 25 per cent.
There would be no change in the ratio of variable expenses to sales.
There would be no change in the fixed assets (ignore depreciation).
Bank balance and other current assets will increase in proportion to sales.
Income tax rate would be 35 per cent.

Creditors will increase in proportion to sales.

In case the company is required to raise funds (that is, the liability side is less, they
will be raised in order of short term borrowings, term loans, and if required, equity
capital. It is the policy of the company to maintain a current ratio of minimum 1.25:1
and ensure that the long term loans do not exceed 40 per cent of the long term funds.
In case the asset side is less then the difference will be considered as cash balance
available.
Required Prepare the income statement of the company for the next year and a
balance sheet as on the end of the next year............................................ (MU Nov 2008)

Dividend Policy
1

Alpha Limited paid a dividend of Rs. 5 per share for 2009-10. The company follows a
fixed dividend payout ratio of 30 per cent and earns a return of 18 per cent per annum
on investments. Cost of capital of the company is 12 per cent per annum. What would
be the price of the companys share as per the Walter Model?................(MU Dec 2010)

The following information is available in respect of a company:

Capitalisation Rate (Ke)..................................................0.12
EPS .........................................................................Rs. 15
The company wishes to know the effect on the market price of its shares under two
possibilities: (a) r = 15%; and (b) r = 10%; both under two options: (i) no dividend;
and (ii) dividend is Rs. 15. Use Walters Model to explain your results. (MU Nov 2008)

ABC Co. Ltd has net present value of net assets of Rs. 100 lakhs which includes cash
balance of Rs. 10 lakhs. It has issued 100,000 equity shares; there are no preference
shares or debt. The company has to make the decision about declaring dividend. At
the same time it is also exploring the possibility of investing in a new project. The
present value of the future cash flows generated by this project is Rs. 20 lakhs The
company is considering three options:
(a)
(b)
(c)

Do not declare any dividend and invest the available cash in the new project;
or
Pay Rs. 10 per share as dividend; or
Pay Rs. 10 per share as dividend and also invest in the new project by making
an issue of 100,000 equity shares of Rs. 10 each at par.

Required: Recommend the option that should be selected by the company which
would help it maximise shareholder value.............................................(MU Nov 2008)

EVA
1......................The Income Statement and balance sheet of Five Star Limited is given below:
Income Statement
Sales ...................................................500
Interest on Investments..............................10
Profit on Sale of Old Assets........................5
Total Income...........................................515
Less: Manufacturing Costs..................180
Administration Costs.......60
Selling and Dist. Costs.....50
Depreciation....................30
Loss on Sale of Mach........5
Total Expenses........................(325)
EBIT ...................................................190
Less: Interest..........................................(20)
Less: Provision for Tax 30%..................(51)
EAT........................................................119
EPS.......................................................23.80

Balance Sheet
Liabilities
Equity Capital (FV Rs. 10)........................50
Retained Earnings......................................40
Long Term Loans......................................60
Creditors....................................................15
Provisions..................................................13
Total Liabilities.......................................178
Assets
Building.....................................................80
Machinery..................................................70
Stock .........................................................10
Debtors......................................................12
Bank............................................................6
Total Assets.............................................178

Additional Information
P/E Ratio....................................................2
Cost of Equity.......................................0.10
Cost of Debt...........................................0.12....................................................(MU Dec 2010)

Required Calculate the EVA and MVA of the company.

2

Acme Limited is considering a capital project for which the following information is
available:
Investment Outlay...........................Rs. 1000
Project Life.....................................10 Years
Salvage Value.............................................0
Annual Revenue..............................Rs. 2000
Cost of Equity (Ke).................................0.18

Debt-Equity Ratio.....................................1:1
Depreciation Method.............................SLM
Income Tax Rate....................................40%
Annual Cost*...................................Rs. 1400
Cost of Debt (post tax)............................0.10

*Annual cost does not include depreciation, interest and taxes.

Required: (a) Calculate EVA over project life; (b) Compute the NPV of the project.
..........................................................................................................................(MU Dec 2010)