Sei sulla pagina 1di 200

I SEM

II SEM

TVM

III SEM

Chapter 2: Concepts of Value and Return


Problem 1
Time preference (discount) rate
(i) A. Investment
B. Period (years)
C. Compound value factor at 9% for 4 years
D.
Compound value at the end of 4 years: [A x C]
: 15,000 (1.09)4 = 15,000 x 1.4116

9%
15,000
4
1.4116
21,173.72
Now

(ii) A. Investment
B. Period (end of year)
C. Compounding periods
D. Compound value factor (lump sum)
E. Compound value [A x D]
: 6,000 (1.09)5 = 6,000 x 1.5386
: 6,000 (1.09)4 = 6,000 x 1.4116
(iii) A. Annual investment (end of year)
B. Period (years)
C. Compound value factor (annuity)
D. Compound value at the end of 8 years [A x C]
: 18,000 [(1.09)8 - 1]/0.09 = 18,000 x 11.0285
(iv) A. Annual investment (beginning of year)
B. Periods (years)
C. Compound value factor (annuity due)
D. Compound value at the end of 8 years [A x C]
: 18,000 [{(1.09)8 - 1}/0.09] (1.09) = 18,000 x 12.0210

6,000
5
5
1.5386

After 1 year
6,000
5
4
1

9,231.74
8,469
18,000
8
11.0285
198,512.53
18,000
8
12.0210
216,378.66
Withdrawal

(v) A. Annual investment for 4 years


B. Compound value at the end of 4 years:
: 18,000 x [{(1.09)4-1}/0.09]
C. Compound value at the end of 5 years:
: (82,316.32 x 1.09) - 12,000
C. Compound value at the end of 6 years:
: (77,724.79 x 1.09) - 12,000
D. Compound value at the end of 7 years:
: (72,720.02 x 1.09) -12,000
E. Compound value at the end of 8 years:
: (67,264.82 x 1.09) - 0

18,000.00
82,316.32
89,724.79

12,000

77,724.79

84,720.02

12,000

72,720.02

79,264.82

12,000

67,264.82

73,318.66

73,318.66

Problem 2
Discount rate
(i) A. Cash flow
B. Period
C. Present value factor
D. Present value (Rs): 2,000/(1.13)0
(ii) A. Cash flow
B. Period
C. Present value factor: 1/(1.13)1

Balance

13%
2,000
0
1
2,000
2,000
1
0.8850

D. Present value (Rs): [A x C]: 2,000/(1.13)1

1,769.91

(iii) A. Cash flow


B. Period
C. Present value factor
D. Present value (Rs) [A x C]

2,000
2
0.7831
1,566.29

(iv) A. Cash flow


B. Period
C. Present value factor: 1/(1.13)3
D. Present value (Rs): [A x C]: 4,000/(1.13)3

4,000
3
0.6931
2,772.20

(v) A. Cash flow


B. Period
C. Present value factor: 1/(1.13)3
D. Present value (Rs) [A x C]: 7,000/(1.13)3

7,000
3
0.6931
4,851.35

(vi) A. Cash flow


B. Period
C. Present value factor: 1/(1.13)4

3,000
4
0.6133

D. Present value (Rs): [A x C]: 3,000/(1.13)4

1,839.96

(vii) A. Cash flow (annuity)


B. Period
C. Present value annuity factor:
[{(1.13)5-1}/{0.13(1.13)5}]
D. Present value (Rs):[A x C]:

4,000
5
3.5172

PV

41,.000
13

t
t

4,000 3.5172

14068.93

t 1

(viii) A. Cash flow


B. Period
C. Present value factor (annuity due)
[{(1.13)5-1}/{0.13(1.13)5}](1.13)
D. Present value (Rs):

4,000
5
3.9745
15,897.89

Problem 3
Discount rate
Year
A. Cash flows
B. PVF at 14%
C. Present value [A x B]

14%
0

12832.30
4

PV

1.14
t 1

3,000
t

7,000

1.14 5

1
3,000.00
1
2,632

2
3,000.00
0.7695
2308.40

1,000

1.14 6

3,000 2.9138 7,000 0.5194 1,000 0.4556


Rs12,832.30

Problem 4
A. Rate of interest

15%

B. Sum received now (Rs)


C. Period (years)
D. Present value factor (annuity) at 15%
E. Capital recovery factor (annuity) at 15%
: [1/D]: 1/5.0188
F. Annual instalment (end of period) [B x E]
10

100

A
t 1

100
10
5.0188
0.1993
19.93

1.15

100 5.0188 A
A 100 / 5.0188 Rs 19 .93
G. Present value factor (annuity due) at 15%:
: 5.0188 x 1.15
H. Capital recovery factor (annuity due) at 15% [1/G]
I. Annual instalment (beginning of period) [B x H]

5.7716
0.1733
17.33

Problem 5
A. Interest rate
B. Debt payable now (Rs)
C. Period of instalments (years)
D. Present value factor (annuity) at 10%
E. Capital recovery factor (annuity) at 10%
F. Annual instalment (end of period): [B x E]
5

1,000

t 1

10%
1,000
5
3.7908
0.2638
263.80

t
1.10

1,000 A / 3.7908
A 1,000 (1 / 3.7908 ) Rs 263 .80
Problem 6
A. Time value of money
B. Payment now (Rs)
C. Period of instalments (years)
D. Present value factor (annuity) at 12%
E. Capital recovery factor (annuity) at 12%: [1/D]
F. Annual instalment (end of period): [B x E], 13,000 x 0.2774
G. Present value factor (annuity due) at 12%: [D x 1.12]
H. Capital recovery factor (annuity due) at 12% [1/G]
I. Annual instalment (beginning of period) (Rs): [B x H], 13,000 x 0.2477

12%
13,000
5
3.6048
0.2774
3606.33
4.0373
0.2477
3219.93

Problem 7
A. Discount rate
B. Outlay now
C. Period of instalments (years)
D. Present value factor (annuity) at 11%
E. Capital recovery factor (annuity) at 11% [1/D]
F. Annual instalment (end of period) [B x E or B/D]
G. Present value factor (annuity due) at 11%
H. Capital recovery factor (annuity due) at 11% [1/G]
I. Annual instalment (beginning of period) [B x H]
Problem 8

11%
10,000
5
3.6959
0.27057
2705.70
4.1024
0.24376
2437.57

A. Discount rate
B. Annual interest payment
C. Period (years)
D. Present value factor (annuity), 30 periods, 8%
E. Present value of annual interest [B x D]
F. Maturity value at the end of 30 years
G. Present value factor, end of 30 years
H. Present value of maturity value [F x G]
I. Present value of bond [E + H]:
30

PV

1.08
150 t

8%
150
30
11.25778
1688.67
1,000
0.09938
99.38
1788.04

t 1

1,000

1.08 3 0

150 11.2578 1,000 0.0994 Rs1,788.04

Problem 9
A. Discount rate
B. Annual pension
C. Periods of pension
D. Present value factor, 20 years, 15%
E. Present value of pension at the end of 20 years
F. Present value factor, end of 20 years
G. Present value of pension now [E x F]

15%
10,000
20
6.25933
62593.31
0.06110
3824.47

Problem 10
A. Interest rate
B. Year
C. Cash flow
D. Present value factor
E. Present value (Rs) [C x D]
F. Net present value (Rs)

10%
0
-10,000.00
1.0000
-10,000.00
2,384.11

1-6
2,000
4
8,711

7
-1,500.00
0.5132
-769.74

0
-100
100
1,000

1
114
-112
0

Problem 11
IRR
( i ) Deposit and receive
( ii ) Borrow and pay
( iii ) Borrow and pay

14.0%
12.0%
13.0%

The following formula is used to compute IRR:

NPV

1 IRR
NCFt

C0 0

t 1

Problem 12
Year
Bank deposit

13%

Problem 13
We can use the following formula in calculating the time period, n, in this problem:

1 r n 2
n ln 1 + r ln 2
n = ln 2/ln 1 + r

0
-100

1
0

A. Investment
B. Interest rate (annual)
C. Expected amount after n years:
6000(1+r)n = 12,000
D. Compound value factor:(1.06)n
= 12,000/6,000
E. ln (1+r)
F. ln 2
G. n = ln 2/ln (1+r)
H. Interest rate (semi-annual)
I. ln (1+r/2)
J. n (half-years)= ln 2/ln (1+r/2)

6,000
6%

6,000
10%

6,000
20%

12,000

12,000

12,000

2
0.0583
0.6931
11.90
3%
0.0296
23.45

2
0
1
7
0
0
14

2
0.1823
0.6931
3.80
10%
0.0953
7.27

Problem 14
A. Annual earnings in 19X1
B. Period (years)
C. Annual earnings in 19X8
D. 45,000 (1 + g)7 = 67,550 = (1 + g)7 = 67,550/45,000
E. 7 ln (1+g)
F. ln (1+g)
G. (1+g)
H. g (growth): 1.06 - 1

1 / 7

6 7,5 5 0

4 5,0 0 0

45000
7
67,550
1.5011
0.4062
0.0580
1.060
6%

1 1.5 0 1 1
1 / 7 16% 1.0 6 1 0.6 6%

Problem 15
A. Land price
B. Instalments
C. Annual instalment
D. Present value annuity factor required:40000/8213
E. From present value of annuity table, r equals 20%. We can write the formula
for IRR ( r ) as follows. The Excel in-built formula can be used to calculate r.

40,000
20
8,213
4.8703
20%

20

40 ,000

81,213
r

t
t

t 1

Problem 16
A. Needed future sum after 15 years
B. Period (years)
C. Interest rate
D. Future value factor of an annuity, 15 years, 12%
E. Annuity value [A/D]:

1.12 15

0.12

30 ,000

37 .28 A = 30,000
A = 30,000/37. 28 = Rs 8,047.27

Problem 17

300,000
15
12%
37.2797
8047.27

A. Needed future sum at the age of 50


B. Period (years)
C. Interest rate
D. Future value factor of an annuity, 30 years, 10%
E. ( a ) Annuity value [A/D]
F. Future value factor of a lump sum, 30 years, 10%
G. ( b ) Lump sum deposited now [A/F]

1,000,000
30
10%
16.4494
60,792.48
17.4494
57,308.55

Problem 18
A. Savings today
B. Period (years)
C. Interest rate
D. Future value factor, 10 years, 10%
E. Future value [A x D]
F. Future value of an annuity factor, 10 years, 10%
G. Annual withdrawal [E/F]
H. Present value of annuity factor, 10 years, 10%
I. Annual withdrawal [A / H]

80,000
10
10%
2.5937
207499.40
15.9374
13,019.63
6.1446
13,019.63

Problem 19
A. Price of house
B. Cash payment
C. Balance
D. Instalment period
E. Interest rate
F. Present value of an annuity factor, 20 years, 12%
G. Annual instalment: 400,000/7.4694

500,000
100,000
400,000
20
12%
7.4694
53,551.51

The interest paid and principal repaid each year are as follows:
12%
Years
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Balance
400,000.00
394,448.49
388,230.80
381,266.98
373,467.51
364,732.10
354,948.45
343,990.75
331,718.13
317,972.80
302,578.02
285,335.87
266,024.67
244,396.12
220,172.14
193,041.29
162,654.74
128,621.79
90,504.90
47,813.98
0.15

Instalment
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51

Interest
48,000.00
47,333.82
46,587.70
45,752.04
44,816.10
43,767.85
42,593.81
41,278.89
39,806.18
38,156.74
36,309.36
34,240.30
31,922.96
29,327.53
26,420.66
23,164.95
19,518.57
15,434.62
10,860.59
5,737.68

Problem 20
A. Price of flat
B. Down payment
C. Loan processing fee
D. Net amount of loan
E. Period of mortgage loan (years)
F. Loan instalment
G. Required factor [D/F]
H. Present value of an annuity factor at trial rate 14%, 12 years
I. Present value of an annuity factor at trial rate 16%, 12 years
J. Rate of return:

14% 1%

200,000
40,000
5,000
155,000
12
28,593
5.4209
5.6603
5.1971
15%
14.52%
5.421

5.660

5.660 5.197

14.52%

Problem 21
Required rate
Year
0
1
2
3
4
5
6
7

13%
End
Cash flow
0
2000
2000
2000
1000
1000
1000
1000

Problem 22
A. Payment now
B. Annuity
C. Expected period for annuity (years)
D. Interest rate
E. Annuity factor
F. Present value of annuity
Sundaram should prefer Rs 200,000 now.

200,000
25,000
20
12%
7.4694
186,736

Problem 23
A. Time value of money
B. 30-year annuity
C. PVAF, 10%, 30 year
D. Present value of 30-year annuity
E. 20-year annuity
F. PVAF, 10%, 20 year
G. Present value of 20-year annuity
H. Cash right now
You should choose 20-year annuity of Rs 6,600 as it has highest PV.
Problem 24

10%
5,000
9.4269
47,134.57
6,600
8.5136
56,189.52
50,000.00

PVF
1.000
0.885
0.783
0.693
0.613
0.543
0.480
0.425

PV
0
1769.9
1566.3
1386.1
613.3
542.8
480.3
425.1
6783.8

Interest rate
( i ) Amount now or
10-year annuity
PVAF, 8%, 10 year
Present value of 10-year annuity [14,000 x 6.7101]
Ms Punam should choose 10-year annuity

8%
80,000
14,000
6.7101
93,941

( ii ) Amount now or
20-year annuity
PVAF, 8%, 20 year
Present value of 20-year annuity [14,000 x 9.8181]
Ms Punam should choose to have Rs 150,000

150,000
14,000
9.8181
137,454

(iii) Amount now or


15-year annuity
PVAF, 8%, 15 year
Present value of 15-year annuity [14,000 x 8.5595]
Both alternatives are almost the same.

120,000
14,000
8.5595
119,833

Problem 25
Required rate of return

14%
End
Cash flow
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
PV

PVF
0
2,000
2,000
2,000
2,000
2,000
3,000
3,000
3000
3,000
6,000
6,000
6,000
6,000
6,000
6,000

PV
1.0000
0.8772
0.7695
0.6750
0.5921
0.5194
0.4556
0.3996
0.3506
0.3075
0.2697
0.2366
0.2076
0.1821
0.1597
0.1401

0
1754
1539
1350
1184
1039
1367
1199
1052
923
1618
1420
1245
1092
958
841
18581

Problem 26
Borrowing
Interest rate
Annuity factor, 10%, 5 year
Annual payment: 50,000/3.7908

50,000
10%
3.7908
13,190
Year Outstanding
Instalment
Interest
0
50,000
0
1
41,810
13,190
2
32,801
13,190
3
22,891
13,190
4
11,990
13,190
5
0
13,190

0
5,000
4,181
3,280
2,289
1,199

Problem 27
Nominal rate of interest
Period
Effective interest rate: annual compounding
Half-yearly compounding:
Compounding period
Half-yearly rate [12%/2]
Effective (annual) interest rate [(1.06)2-1]
Quarterly compounding:
Compounding period
Quarterly rate [12%/4]
Effective (annual) interest rate [(1.03)4-1]
Monthly compounding:
Compounding period
Monthly rate [12%/12]
Effective (annual) interest rate [(1.01)12-1]

12%
1
12%
2
6%
12.36%
4
3%
12.55%
12
1%
12.68%

Problem 28
A. Face value of debenture
B. Current yield (annual)
C. Half-yearly yield [18%/2]
D. Period (years)
E. Compounding periods [10 x 2]
F. Half-yearly interest amount

1,000
18%
9%
10
20
75
9.1285
684.64
0.17843
178.43

G. PVAF, 9%, 20 periods


H. Present value of 20-period annuity of Rs 75 [F x G]
I. PVF of a lump sum, 9%, 20 periods
J. PV of maturity value of Rs 1000 [1,000 x 0.1784]
K. Present value of the debenture [H + J]
20

Value of

bond

75
1.09

863.07 t

t 1

Problem 29
A. Initial deposit
B. Interest rate (annual)
C. Compounding period in a year
D. Quarterly rate [12%/4]
E. Period
F. Total compounding periods [C x E]
G. FVF, 3%, 30 periods
H. Future value [A x G]: [(1.03)30 x 1,000]

1,000
12%
4
3%
7.5
30
2.42726
2427.26

Problem 30
A. Half-yearly interest
B. Maturity (years)
C. Maturity value (at par)

50
7
1,000

1,000

1.09 20

D. Maturity value (at premium)


E. Required rate of return
F. Present value annuity factor, 6%, 14 periods
G. Present value factor, 6%, 14 periods
H. Value of the bond (redeemed at par):
(a) Value of interest [A x F]
(b) Present value of maturity value [C x G]
I. Value of bond (redeemed at premium):
(a) Value of interest [A x F]
(b) Present value of maturity value [D x G]

1,100
12%
9.2950
0.4423
907.05
464.75
442.30
951.28
464.75
486.53

Problem 31
Current deposit (Rs)
Montly withdrawal
Annual interest rate
Quarterly rate
Monthly interest rate
The present value of your deposit is Rs 10,000 and you want to withdraw Rs 100 every month. Thus

1
1

12n
0
.
00667
0.00667 1.00667

1
150
12n
0.00667 1.00667

10,000 100

100

1.00667 12n

150 100 0.00667 0.333

1.0066712n 3.0
12n ln 1.00667 ln 3 12n 0.00665 1.0986
1.0986
n
13.8
12 0.00665

You will be able to completely withdraw your deposit in about 14 years.


Problem 32
A. Preference share capital
B. Maturity period (years)
C. Required return
D. Compound value annuity factor, 12%, 8 years
E. Sinking fund factor, 12%, 8 years [1/D]
F. Annual contribution in SF (end of the year) [A x E]
G. Compound value annuity factor (annuity due), 12%, 8 years
H. Sinking fund factor (annuity due), 12%, 8 years [1/G]
I. Annual contribution in SF(beg. of the year) [A x H]

800,000
8
12%
12.2997
0.0813
65,042.27
13.7757
0.0726
58073.46

Problem 33
A. Face (and maturity) value of bond
B. Interest rate (half yearly)
C. Half yearly interest
D. Remaining life of bond (half years)
E. Required rate of return (half yearly)
F. Present value annuity factor, 6%, 8 years
G. Present value factor, 6%, 8 years

1,000
7%
70
8
6%
6.2098
0.62741

10000
100
8%
2%
0.006667

H. Value of bond:
(a) Present value of interest [C x F]
(b) Present value of maturity value [A x G]

1062.10
434.69
627.41

Problem 34
A. Annual payments
B. Period (years)
C. Principal
D. Internal rate of return:

3,800
4
10,000
19.14%
4

NPV

13,800r

10 ,000 0

19.14%

t 1

By trial & error IRR is approx. 19%


Problem 35
A. Loan amount
B. Period (years)
C. Interest rate
D. Annual repayment
E. Internal rate of return:

10,000
8
12%
2,013
12%
12%

NPV

12,013r

10 ,000 0

t 1

Interest rate charged by the bank and the internal rate of return are the same. 12% is the true rate of interest.
Loan amortisation schedule
Year
0
1
2
3
4
5
6
7
8

Beg.
balance
10,000
9,187
8,276
7,256
6,114
4,835
3,402
1,797
0

Problem 36
A. Amount deposited
B. Interest rate for years 1-5 (5 years)
C. Interest rate for years 6-13 (8 years)
D. Compound value for 13-year period:
[1,000(1.10)5 x (1.13)8]
E. Compound rate of interest:
[(4,281.45/1,000)1/13 - 1]

1,000
10%
13%
4,281.45
11.84%

Instalment
2,013
2,013
2,013
2,013
2,013
2,013
2,013
2,013

Repayment
Interest
1,200
1,102
993
871
734
580
408
216

3
3,000.00
0.6750
2024.91

00 0.4556

4
3,000.00
0.5921
1776.24

5
7,000.00
0.5194
3635.58

6
1,000.00
0.4556
455.59

s1,788.04

8
1,600.00
0.4665
746.41

9-12
2,500.00
1.4788
3,696.91

5 6 7 8

10

0 0 0 0

-3,395

2
0

3
0

4
0

5 6 7 8
0 0 0 0

9
300

6,000
30%
12,000
2
0.2624
0.6931
2.64
15%
0.1398
4.96

1 0.6 6%

Principal
repaid
5,551.51
6,217.69
6,963.81
7,799.47
8,735.41
9,783.66
10,957.70
12,272.62
13,745.33
15,394.77
17,242.15
19,311.21
21,628.55
24,223.98
27,130.85
30,386.56
34,032.94
38,116.89
42,690.92
47,813.83

14.52%

Beginning
Cash flow
2000
2000
2000
1000
1000
1000
1000

PV
2000.0
1,769.9
1,566.3
693.1
613.3
542.8
480.3
0.0
7665.7

Beginning
Cash flow
2,000
2,000
2,000
2,000
2,000
3,000
3,000
3,000
3,000
6,000
6,000
6,000
6,000
6,000
6000
0

Repayment
8,190
9,009
9,910
10,901
11,991

PV
2,000
1,754
1,539
1,350
1,184
1,558
1,367
1,199
1,052
1,845
1,618
1,420
1,245
1,092
958
0
21,182

1,000

1.09 20

Principal
813
911
1,020
1,142
1,279
1,433
1,605
1,797

End
balance
9,187
8,276
7,256
6,114
4,835
3,402
1,797
0

Chapter 8: Capital Budgeting Decisions


Problem 1
Year

Cash
flow

PFV
0%

PV

PVF
10%
1.0000
0.9091
0.8264

PV

0
1
2

-5,400
3,600
14,400

1.000
1.000
1.000

-5,400
3,600
14,400
12,600

0
1
2
3
4
5
6

Cash flow
-100,000
30,000
30,000
30,000
30,000
30,000
30,000

PVF, 15%
1.0000
0.8696
0.7561
0.6575
0.5718
0.4972
0.4323

PV
-100,000
26,087
22,684
19,725
17,153
14,915
12,970
13,534

PVF, 19%
1.0000
0.8403
0.7062
0.5934
0.4987
0.4190
0.3521

PV
-81,000
35,714
27,902
21,353
3,969

PVF, 18%
1.0000
0.8475
0.7182
0.6086

PV
-81,000
33,898
25,136
18,259
-3,706

2
800
0.7972
638

3
600
0.7118
427

4
400
0.6355
254

NPV

-5,400
3,273
11,901
9,774

PVF
40%
1.0000
0.7143
0.5102

Problem 2
Year

NPV
19.9%
IRR
IRR lies between 19% and 20%. It is approximated as follows: 19% + 1% [2,293/(2,293 +
235)] = 19.9%

PV
-100,000
25,210
21,185
17,802
14,960
12,571
10,564
2,293

PVF, 20%
1.0000
0.8333
0.6944
0.5787
0.4823
0.4019
0.3349

Problem 3
Year
0
1
2
3

Cash flow
-81,000
40,000
35,000
30,000

PVF, 12%
1.0000
0.8929
0.7972
0.7118

NPV
IRR
15.0%
IRR is about 15%: 12% + 6% x [3,969/(3,969+3,706)] = 15.0%
Problem 4
Year
Cash flows
PVF, 12%
PV

2,325

1
1,000
0.8929
893

5
200
0.5674
113

Problem 5

Year
0
1
2
NPV

PVF, 12%
1.0000
0.8929
0.7972

Project X
Cash flow
PV
-2,500
-2,500
0
0
3,305
2,635
135

Project Y
Cash flow
-2,500
1,540
1,540

PV
-2,500
1,375
1,228
103

Project Z
Cash flow
-2,500
2,875
0

IRR

15%

15%

Problem 6
Year
Cash flow
PVF, 14%
PV
NPV
IRR

0
-10,000
1.0000
-10,000
781
18%

1
3,700
0.8772
3,246

2
3,700
0.7695
2,847

3
3,700
0.6750
2,497

4
3,700
0.5921
2,191

IRR:18%:[10,000/3,700=2.7027 implies approx. 18% IRR]


Problem 7

Year
0
1
2
3
IRR

Project X
Cash flow
-20,000
8,326
8,326
8,326
12.0%

Project Q
Cash flow
-20,000
0
0
24,045
6.3%

Problem 8
Year

PVF
12%
0
1
2
3

1.0000
0.8929
0.7972
0.7118

NPV
IRR

Project A
Cash flow
PV
-25,000
-25,000
5,000
4,464
5,000
3,986
25,640
18,250
1,700
15%

Project B
Cash flow
-28,000
12,672
12,672
12,672

PV
-28,000
11,314
10,102
9,020
2,436
17%

Problem 9
Year
0
1
Cash flow
50,000
-56,000
Yes, NPV is positive or borrowing rate is less than OCC.

NPV, 15%
1,304

IRR
12%

Problem 10
Year
Cash flow
PVF, 10%
PV
NPV
IRR
No
Problem 11

0
100,000
1.0000
100,000
-6,587
13.0%

1
-33,625
0.9091
-30,568

2
-33,625
0.8264
-27,789

3
-33,625
0.7513
-25,263

4
-33,625
0.6830
-22,966

Year
0
1
2
3
IRR

Project A
Cash flow
-10,000
2,000
4,000
11,784
26%

Project B
Cash flow
-10,000
10,000
3,000
2,830
37%

Discount
rate
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40

Project A
NPV
7,784
5,712
3,977
2,512
1,264
193
-731
-1,534
-2,236

Project B
NPV
5,830
4,690
3,696
2,825
2,054
1,369
756
204
-295

Project Y-X

Discount

Project X

Project Y

Cash flows

rate

NPV

NPV

10,000
8,000
6,000
4,000
2,000
0
-2,0000.00
-4,000

Year
0
1
2
3
IRR

Project Y

Cash flows
-750
350
350
159
8.0%

Cash flows
-750
250
250
460
12.0%

PVF, 10%
1.0000
0.9091
0.8264
0.7513
0.6830

Project I
Cash flows
-25,000
30,000
0
0
0

0
-100
-100
301
30.6%

0.00
0.05
0.08
0.10
0.12
0.15
0.20
0.25
0.30
0.35
0.40

109
38
0
-23
-45
-76
-123
-165
-201
-234
-263

210
112
61
29
0
-41
-102
-154
-200
-241
-276

Problem 13

Year
0
1
2
3
4
NPV
IRR

PV
-25,000
27,273
0
0
0
2,273
20.0%

Project II
Cash flows
-25,000
0
0
0
43,750

PV
-25,000
0
0
0
29,882
4,882
15.0%

Problem 14

Year

PVF, 10%
0
1
2
3
4

NPV

Project A
Project B
Cash flow
PV
Cash flow
1.0000
-1,000
-1,000
-1,000
0.9091
600
545
200
0.8264
200
165
200
0.7513
200
150
600
0.6830
1,000
683
1,000
544

Project C
PV

Cash flow
-1,000
182
165
451
683
481

0.10

Pr

Problem 12
Project X

0.05

-300
100
100
100
600

IRR
Payback
Discounted PB

31.2%
3
3.2

25.2%
3
3.3

Problem 15
Year
Cost
SL dep.
BV
Profit before dep.
Less: dep.
PBT
Less: tax.
PAT
ARR:
Before-tax
After-tax

1
10,000
10,000

2
10,000
2,500
7,500
3,000
2,500
500
175
325

3
7,500
2,500
5,000
3,000
2,500
500
175
325

4
5,000
2,500
2,500
4,000
2,500
1,500
525
975

Average
2,500
2,500
0
4,000
2,500
1,500
525
975

20.00%
13.00%

Problem 16
Year
(a) ARR:
Cost
Depreciation
BV
Revenue
Expenses
Gross profit
Depreciation
Net profit
ARR
(b) ARR (modified cash flows):
Cost
Dep.
BV
Revenue
Expenses
Gross profit
Depreciation
Net profit
ARR
Cash flow
PVF, 9%
PV
NPV
IRR

Problem 17

5,000
3,500
2,500
1,000
350
650

12,000

12,000
4,000
8,000

8,000
4,000
4,000

4,000
4,000
0

16,000
8,000
8,000
4,000
4,000

14,000
7,000
7,000
4,000
3,000

12,000
6,000
6,000
4,000
2,000

9,000
3,000
6,000

6,000
3,000
3,000

3,000
3,000
0

16,000
9,000
7,000
3,000
4,000

14,000
8,000
6,000
3,000
3,000

12,000
7,000
5,000
3,000
2,000

7,000
0.9174
6,422

6,000
0.8417
5,050

5,000
0.7722
3,861

12,000

9,000
9,000

-9,000
1.0000
-9,000

3 Average

6,000
14,000
7,000
7,000
4,000
3,000
50.00%

4,500
14,000
8,000
6,000
3,000
3,000
66.67%

6,333
48%

Year
Cash flow

0
-150

150

1
450

2
-300

IRR
100%
0%

NPV @10%
11.16

450
300

0
(1 r )
(1 r ) 2

ax 2 bx c 0
300x 2 450 x 150 0
x
x

b 2 4ac
2a

b
1
(1 r )

a = -300; b = 450; c =-150; b2 = 202,500; ac = 45000; (b2 - 4ac) = 22,500; (b2-4ac)1/2 = 150; 2a = - 600

450

202 ,500 4 45,000


2 300

x = 0.50; x = 1.00
r = (1-x)/x = 100%
r = (1-x)/x = 0%
Problem 18
Year
Cash flow
PVF, 10%
PV
Discount rate
PVF
PV

1
-50,000
1.0000
-50,000
0.10
1.0000
-50,000

11,300
0.9091
10,273
0.10
0.9091
10,273

12,769
0.8264
10,553
0.10
0.8264
10,553

14,429
0.7513
10,841
0.12
0.7118
10,270

16,305
0.6830
11,137
0.12
0.6355
10,362

1
1,200

2
-400

IRR
0%
-50%

NPV @25%
-96

Problem 19
PI
Investment
Life (years)
Required rate
PV of inflows
=500,000 x 1.12
PVAF, 8%, 5
Annual inflows
= 560,000/3.9927

1.12
500,000
5
0.08
560000
3.9927
140,256

Problem 20

Year
Cash flow

0
-800

18,421
0.6209
11,438
0.13
0.5428
9,998

800

1,200
400

0
(1 r )
(1 r ) 2

ax 2 bx c 0
400 x 2 1,200 x 800 0
x
x

b 2 4ac
2a

1
(1 r )

a = -400; b = 1,200; c=-800; b2 = 1440,000; ac = 320000; (b2-4ac) = 160,000; (b2-4ac)1/2 = 400; 2a = -800
x = 1.00; x = 2.00
r = (1-x)/x = (1 - 1)/1 = 0%
0%
r = (1-x)/x = (1- 2)/2 = -50%
-50.0%

PV
-5,400
2,571
7,347
4,518

PV
-100,000
25,000
20,833
17,361
14,468
12,056
10,047
-235

Project Z
PV
-2,500
2,567
0
67

PVF
50%
1.0000
0.6667
0.4444

PV
-5400
2400
6400
3,400

PVF
100%
1.0000
0.5000
0.2500

PV
-5400
1800
3600
0

15%

10,000
8,000
6,000
4,000
2,000
0
-2,0000.00
-4,000

0.05

0.10

0.15

0.20

0.25

Project A NPV

0.30

0.35

0.40

0.45

Project B NPV

(Y - X)
300

NPV
101
74
61
53
45
35
21
10
1
-7
-13

200
100
0
0.00
-100

0.05

0.10

0.25

0.30

0.35

0.40

-300
-400
Project X NPV

Project D
Cash flow
-300
91
83
75
410
358

0.20

-200

Project C
PV

0.15

PV
-300
0
0
300
600

-300
0
0
225
410
335

Project Y NPV

(Y - X) NPV

0.45

42.4%
3
3.12

35.3%
3
3.18

NPV

IRR

4,241

1,456

13.00%

Chapter 9: The Cost of Capital


Problem 1
Face value (Rs)
Before-tax Interest (Rs)
Period (years)
Discount
Underwriting
Premium (Rs)
Tax
After-tax interest (Rs)
Cash inflow (face value less discount & underwriting commission)

14%
3%
3%

1000
140
7
30
30
30

35%
91
940

Cash inflow (face value plus premium less underwriting comm.)

1000

Yearly discount write-off


Tax saved on discount write-off
Yearly underwriting comm. write-off
Tax saved on underwriting comm. write-off
Yearly premium income
Tax on premium

4.29
1.50
4.29
1.50
4.29
1.5

Year

ATINT

Tax saved

Tax saved

outflow

discount

on under-writing
comm.

0
1
-91
1.5
2
-91
1.5
3
-91
1.5
4
-91
1.5
5
-91
1.5
6
-91
1.5
7
-91
1.5
7 Year 7 cash flows include repayment
After-tax cost of debenture
Debenture issued at discount
7

940

1 k

88 t

t 1

1,000

1 k d 7

k d 10.03%
Debenture issued at premium
7

940

1 k
t 1

91t
d

1,000

1 kd 7

k d 9.10%
Problem 2
Rs million
Face (and maturity) value

1.5
1.5
1.5
1.5
1.5
1.5
1.5

Net proceeds
Interest
Period (years)
Tax rate
Market value after 4 years
After-tax interest: 0.27 (1 - 0.52)
After-tax interest cost
After-tax yield after 4th year

13.50%
7
52%

1.8
0.27

2.2
0.130
8.43%
2.95%

After-tax cost of debenture:


7

1. 8

1 k
0.13t
t

t 1

2. 0

1 k d 7

After tax cost = 8.43%


After-tax yield at the end of 4th year:
3

2.2

1 k
t 1

0.13t
t

2.0

1 k d 3

After tax cost = 2.95%


Problem 3
Face value
Dividend, DIV
Current market price, P
Cost of preference capital, DIV/P = 9.75/80

9.75%

100
9.75
80
12.19%

Problem 4
Current market price, P0
Book value, B0
EPS0
DIV0
Retention ratio: (EPS0 - DIV0 )/EPS0
ROE: EPS0/B0
Growth, Retention ratio x ROE
Expected dividend: DIV1
Cost of equity:

DIV1
1.61
g
0.12
P0
25

25
18
3.6
1.44
60%
20%
12%
1.61
18.45%

Problem 5
Current market price, P0
Book value, B0
EPS0
DIV0
Net issue price, I0
ROE, EPS0/B0
Retention ratio: (EPS0-DIV0)/EPS0
Growth: Retention ratio x ROE
DIV1
Cost of new issue:

96
65
10
7
80
15.4%
30%
4.62%
7.32

13.8%

Cost of new issue:

DIV1
7.32
g
0.046
I0
80

13.8%

Problem 6
DIV
Current market price, P0
Cost of equity: DIV/P0: 3/33
It is a no-growth share.

3
33
9.09%

Problem 7
Year
1
2
3
4
5
6
Growth in dividend
Current market price, P0
Expected dividend next year, DIV1
Issue price, I0
Flotation cost per share
Cost of equity (including flotation cost):
DIV1
3.55
g
0.10
(I 0 f )
140 10

DIV
2.00
2.20
2.42
2.66
2.93
3.22

Growth
0.1
0.1
0.1
0.1
0.1

10%
150
3.55
140
10

12.7%

Cost of equity (ignoring flotation cost):


DIV1
3.55
g
0.10
I0
140

12.5%

Theoretically, it is appropriate not to adjust floating cost in the calculation of the cost of equity. Rather,
this cost should be adjusted to the initial cost of the investment project.
Problem 8
BV
(Rs mn.)
Ordinary shares
Reserves
Preference share
Debt
Total capital

Tax rate
Face value of debenture, F
Underwriting commission, c
Net proceeds from debenture issues, I = 1,000 - 20
Interest rate
Interest on debenture, INT = 1,000 x 16%
Period (years), N
Before-tax cost

30
10
20
40
100

35%
1000
20
980
16%
160
20

Weight
(wb)
0.3
0.1
0.2
0.4
1.0

MV
(Rs mn.)
60
24
36
120

F I
1 F I
2

INT

20

16.26%

1,000 980
1 1,000 980
2

160

20

After-tax cost, 0.1626(1-0.35)


Face value of preference share, F
Issue price , I
Underwriting commission, c
Net proceeds from preference issues, I
Preference dividend rate
Preference dividend, PDIV
Cost of pref. Share =
PDIV
11

I
112.75

10.57%
100
120
7.25
112.75
11%
11
9.76%

Current price of ordinary share, P0


DIV1
Growth
Issue price, I0
Flotation cost, f
Net proceeds, 145 - 5
Cost of retained earnings:

150
12
7.00%
145
5
140
15.00%

DIV1
12
g
0.07
P0
150

Cost of new issue of share:


DIV1
12
g
0.07
(I 0 f )
(145 5)

15.57%

Problem 9
(a)

Cost of debenture:

Tax rate
Current market price of debenture
Face value of debenture
Interest on debenture
Remaining period (years)

950

100

1 k d

35.00%

10.00%
5

100

1 k d

100

1 k d

100

1 k d

950
1,000
100

1,100

1 k d 5

k d 0.114 or 11.4%

7.4%

After - tax cost of debenture = 0.114(1 - 0.35) = 0.074 or 7.4%


(b)

Cost of preference share

Current market price of preference. P 0


Preference dividend, PDIV
Cost of preference, kp =PDIV/P0

60
6
10.00%

( c ) Cost of equity
Growth in dividend, g:

Year
1
2
3

DIV
2.00
2.16
2.37

Annual
Growth
0.080
0.097

4
5
6
7
8

2.60
2.80
3.08
3.38
3.70

Average

0.097
0.077
0.100
0.097
0.095
0.092

Alternatively, dividend growth can be calculated as a geometric average follows:

3.70

2.00

1/ 7

1 0.092

Current market price of equity, P0


Current dividend, DIV0
Dividend growth
Expected dividend, DIV1 = 3.7(1.092)
Cost of equity:
4.04
0.092
50

0.092
50
3.7
9.2%
4.04
17.3%

(d) Weighted average cost of capital:


(Rs 000)
Debenture
Preference
Ordinary share
Total
WACC

Weight (w)

500
400
600
1500

Problem 10
Investor's opportunity cost
Expected return
Tax rate
Brokerage
Funds available after brokerage, (1 - 0.03)
After-tax return from reinvestment, 0.18 0.97 (1 - 0.30)
Firm's opportunity cost

0.18
0.30
0.03
0.97
0.122
0.12

Since the investors opportunity cost is higher, dividends maybe distributed.


Problem 11
Market price of ordinary share (Rs)
Expected DIV (Rs)
Growth
Cost of internal equity (retained earnings):

150
.
0.10
25
Issue price of ordinary equity (Rs)
Cost of equity (new issue):

150
.
010
.
22

Issue price of preference share (Rs)


Flotation cost (Rs)

25
1.5
0.1
0.16
22
0.168
23
3

0.333
0.267
0.400
1.000

Cost (c)
0.074
0.100
0.173

Net proceeds from pref. share issue (Rs), [23 - 3]


Preference dividend (Rs)
Cost of preference: 2/20
Cost of debt
Tax rate
After-tax cost of debt: 0.17(1 - 0.5)
Retained earnings (Rs 000)
Equity weight
Investment before new equity (Rs 000), [700/0.75]
Investment planned (Rs 000)

20
2
0.1
0.17
0.5
0.085
700
0.75
933.33
1,000

Source of capital

Amount

Weights (w)

Retained earnings
Cost ( c )

14% Debt (Rs mn.)


93.75
0.1875
10% Preference (Rs mn.)
31.25
0.0625
Ordinary equity (Rs mn.)
375.00
0.7500
Total capital (Rs mn.)
500
1.000 WACC
The firm will have to issue new equity share to finance its funds requirement in excess of Rs 933,333.

0.085
0.100
0.160

Problem 12
Current equity share price (Rs)
Expected dividend, DIV1 (Rs)
Growth, g
Cost of equity:

36
3.6
0.08

3.60
0.08
36

0.18

Preference dividend (Rs)


Market price of irredeemable preference share (Rs)
Cost of irredeemable preference share: 10/81.81
Market price of redeemable preference share (Rs)
Remaining maturity of redeemable preference share
Cost of redeemable preference share:

93

10

10

10

10

10
81.81
0.122
93
7

10

10

110

1 k 1 k 1 k 1 k 1 k 1 k 1 k
1

11.51%

k f 0.1151 or 11.51%
Before-tax cost of term loan
Tax rate
After-tax cost of term loan: 0.14(1 - 0.35)

0.14
0.35
0.091

Weighted average cost of capital (WACC):


Source of capital
Equity capital
Reserve & surplus
10% Irredeemable pref. share
10% Redeemable pref. share
12% Term loan
Total capital

Problem 13
Growth in dividends:

(Rs mn)
563.50
485.66
56.00
28.18
377.71
1511.05

Weight (w)
0.3729
0.3214
0.0371
0.0186
0.2500
1.0000

Cost (c)
0.1800
0.1800
0.1222
0.1151
0.0910

Year

y = (Y-5.5)

EPS

1
2
3
4
5
6
7
8
9
10
Avg.

1
2
3
4
5
6
7
8
9
10
5.5

-4.5
-3.5
-2.5
-1.5
-0.5
0.5
1.5
2.5
3.5
4.5

2.24
3.00
4.21
3.96
4.80
4.40
5.15
5.05
6.00
6.80

ln (1+g) = 8.228/82.85 = 0.09974


(1+g) = 1.10488
g, (growth) = 1.10488 - 1 = 0.10488 or (approx.) 10.5%

0.09974
1.105
0.105

Market value per equity share (Rs)


Equity dividend (Rs)
Expected equity dividend (Rs), DIV1
Cost of equity: (4.42/50) + 0.105
Face value of preference (Rs)
Market value per preference share (Rs)
Pref. dividend rate
Pref. dividend (Rs)
Cost of preference share: 10/77.5
Long-term debt interest rate
Tax rate (assumed)
After-tax cost of long-term debt: 0.14(1 - 0.35)
Debenture interest
After-tax cost of debenture: 0.13(1 - 0.35)

50
4
4.42
0.193
100
77.5
0.1
10
0.129
0.14
0.35
0.091
0.13
0.085

Weighted average cost of capital:


Amount
(Rs 000)

Source of capital
Equity (Rs 25 par)
Reserves
Preference (Rs 100)
Debentures
Long-term debt
Total capital

66412
65258
3000
30000
5360
170030

Weight (w)

Cost (c)

0.3906
0.3838
0.0176
0.1764
0.0315
1.0000 WACC

0.193
0.193
0.129
0.085
0.091

Problem 14
Year
1
1
2
3
4
5

EPS
2
21.55
22.14
26.40
20.16
20.40

DPS
3
5.28
5.76
5.76
6.53
7.68

AMP
4
143.04
187.52
312.32
587.52
366.72

6
7
Average

23.09
22.00
22.25

11.53
7.68
7.17

416.64
355.20
338.42

Calculating growth rate:


(1) Internal growth: The average growth in dividend is 8%: g = ROE x Retention = 0.116 x 0.675 = 0.08 or 8%.
(2) The regression approach: This approach applied to dividend per share (DPS), gives a growth of 10.5%.

Y (year)
(Y - 4) = y
DPS
ln DPS
y x ln DPS
y2
ln (1+g) = 2.8/28 = 0.09999
(1+g)
g = 1.10516 - 1

1
-3
5.28
1.664
-4.992
9
0.09999
1.10516
10.52%

2
-2
5.76
1.751
-3.502
4

3
-1
5.76
1.751
-1.751
1

Similar approach gives a negative growth for EPS (- 4%).


(3) Geometric (average) growth:
7.68

5.28

1/ 6

1 0.064 or 6.4%

0.064
Different methods give different growth rates. Since the regression approach provides objective estimates, we use 10.5% as the growth rate.
Cost of equity:

ke

DIV1
7.68(1105
. )
g
0.105
P0
355.20

k e 0.129 12.9%

12.9%

Cost of debt:

After-tax cost of debt

Interest rate
Tax rate
0.15(1 - 0.5) = 0.075 or 7.5

0.11
0.5
5.5%

Weighted average cost of capital:


BV
(Rs million)
Share capital
Reserve
Net worth
Long-term loans
Total capital

6,808
34,857
41,665
538,220
579,885

Share capital
EPS in 2003
Number of shares: 6,808/22
Average market price of share in 2003
Market value of equity (Rs million)

6,808
22
309
338.42
104726

Problem 15

BV
weights
0.012
0.060
0.072
0.928
1.000

Cost

12.9%
5.5%

Year
1
1
2
3
4
5
6
Average

EPS
2
6.21
10.91
11.57
11.47
10.44
11.23
10.31

DPS
3
2.00
2.50
2.50
2.70
3.00
3.20
2.65

BV
4
26.03
34.44
43.52
37.98
45.42
53.45
40.14

Cost of equity:
g
Average Growth (retention x ROE)
Growth =[( DPS91/DPS85)1/5 -1]
Growth =[( EPS91/EPS85)1/5 -1]

Avg. yield
0.193
0.099
0.126

0.017
0.017
0.017

ke
0.210
0.116
0.143

Tax on

Discount

Premium

NCF

-1.5
-1.5
-1.5
-1.5
-1.5
-1.5
-1.5

940
-88
-88
-88
-88
-88
-88
-1,088
-1,000
10.03%

Premium
NCF

1000
-91
-91
-91
-91
-91
-91
-1,091
-1,000
9.10%

Weight
(wm)

Cost of
capital
0.5
0.2
0.3
1.0

15.57%
15.00%
9.76%
10.57%
WACC

Weighted cost
Book-value
Market-value
0.047
0.015
0.020
0.042
0.124
12.4%

0.078
0.000
0.020
0.032
0.129
12.91%

wxc
0.025
0.027
0.069
0.120
12.0%

Retained earnings
wxc

New Issue
Cost ( c )
0.016
0.006
0.120
0.142

WACC
0.0671
0.0579
0.0045
0.0021
0.0227
0.1544
15.44%

wxc
0.085
0.100
0.168

0.016
0.006
0.126
0.148

ln EPS

y x ln EPS

y2

0.80648
1.09861
1.43746
1.37624
1.56862
1.48160
1.63900
1.61939
1.79176
1.91692

-3.6291
-3.8451
-3.5937
-2.0644
-0.7843
0.7408
2.4585
4.0485
6.2712
8.6262
8.2285

20.25
12.25
6.25
2.25
0.25
0.25
2.25
6.25
12.25
20.25
82.5000

Retention
(6)=[(2-3)/2]
0.755
0.740
0.782
0.676
0.624

Growth
(7)=(5 x 7)
0.158
0.138
0.091
0.074
0.059

wxc
0.075
0.074
0.002
0.015
0.003
0.170
17.0%

ROE
5
0.209
0.186
0.117
0.110
0.095

Div. yield
(8)=(3/5)
0.0369
0.0307
0.0184
0.0111
0.0209

BV
(9)=(2/ 5)
103.11
119.03
225.64
183.27
214.74

0.103
0.084
0.1291

0.501
0.651
0.6754

0.052
0.055
0.0895

0.0277
0.0216
0.0239

4
0
6.53
1.876
0.000
0

5
1
7.68
2.039
2.039
1

6
2
11.53
2.445
4.890
4

7
3
7.68
2.039
6.116
9

224.17
261.90
190.27

r 8%.
.
Avg./Sum
4

2.800
28.00

we use 10.5% as the growth rate.

BV
WACC

MV
(Rs million)

0.009
0.051
0.060

104,726
538,220
642946

MV
weights

0.163
0.837

Cost

12.9%
5.5%

MV
WACC

0.021
0.046
0.067

AMV
5
100.00
205.00
209.38
164.00
138.88
155.00
162.04

ROE
(6)=(2/4)
0.239
0.317
0.266
0.302
0.230
0.210
0.261

Payout
(7)=(3/2)
0.322
0.229
0.216
0.235
0.287
0.285
0.262

Retention
(8)=(1-7)
0.678
0.771
0.784
0.765
0.713
0.715
0.738

Growth
(9)=(6 x 8)
0.162
0.244
0.208
0.231
0.164
0.150
0.193

Div. yield
(10) = (3/5)
0.020
0.012
0.012
0.016
0.022
0.021
0.017

Earn. yield
(11) = (2/5)
0.062
0.053
0.055
0.070
0.075
0.072
0.065

Chapter 10: Determining Cash Flows for Investment Analysis


Problem 1
Assumption: (1) It is assumed that the given annual cash inflows are after-tax. (2) ARR is calculated as average cash profit divided
by original investment. Alternatively, average investment (original investment/2) can be used for calculation.

Required rate
Tax rate
Projects
Outlay
Annual inflows
Life
PVAF @10%
PV of NCF
NPV
IRR
PB (years)
ARR

10%
35%
A
-500,000
125,000
8
5.3349
666,865.8
166,865.8
18.6%
4
25.0%

B
-120,000
12,000
15
7.6061
91,273.0
-28,727.0
5.6%
10
10.0%

C
-92,000
15,000
20
8.5136
127,703.5
35,703.5
15.4%
6.13
16.3%

PB

ARR

D
-5,750
2,000
5
3.7908
7,581.6
1,831.6
21.8%
2.88
34.8%

E
-40,000
6,000
10
6.1446
36,867.4
-3,132.6
8.1%
6.67
15.0%

Rank
Project
A
B
C
D
E

NPV

IRR
1
5
2
3
4

2
5
3
1
4

2
5
3
1
4

2
5
3
1
4

1
4,200

2
4,800

3
7,000

4
8,000

5
2,000

2,730

3,120

4,550

5,200

1,300

1,400
4,130
0.909
3,755

1,400
4,520
0.826
3,736

1,400
5,950
0.751
4,470

1,400
6,600
0.683
4,508

1,400
2,700
0.621
1,676

-15870

-11350

-5400

1200
4

3900

Problem 2
Cost of capital
Tax rate
Cost of project X
Life of project X
Straight line depreciation
Cost of project Y
Life of project Y
Straight line depreciation

10%
35%
20,000
5
4,000
15,000
5
3,000

PROJECT X
Year
BT cash flows
AT cash flows (T = 35%)

0
-20,000

Add: DTS (Dep. T = 4,000 .35


)
NCF
PVF
PV (Rs)
NPV (Rs)
PI
IRR
Accumulated cash flows
Payback (years)
PROJECT Y

-20,000
1.000
-20,000
-1,855
0.91
6.29%
-20000

Year
BT cash flows
AT cash flows (T = 35%)

0
-15,000

1
4,200

2
4,500

3
4,000

4
5,000

5
1,000

2,730
1,050

2,925
1,050

2,600
1,050

3,250
1,050

650
1,050

NCF
-15,000
3,780
3,975
3,650
PVF
1.000
0.909
0.826
0.751
PV (Rs)
-15,000
3,436
3,285
2,742
NPV (Rs)
-1,544
PI
0.90
IRR
5.59%
Cumulative cash flows
-15000
-11220
-7245
-3595
Payback (years)
Both projects have negative NPV and IRR less than the cost of capital. They should be rejected.

4,300
0.683
2,937

1,700
0.621
1,056

705
4

2405

Add: DTS (Dep. T = 3,000 .35


)

Problem 3
Required rate of return
Tax rate
Outlay M:
Life (years)
S L depreciation: 100,000/5

10%
35%
100,000
5
20,000

Salvage value (SV)


Outlay N:
Life (years)
SV
S L depreciation: 140,000/5

0
140,000
5
20,000
28,000

PROJECT M
Year
Book value (BV)
SL depreciation
Earnings before depreciation &
tax
Less: dep.
Earnings before tax
Tax at 35%
Earnings after tax (EAT)
Plus: dep.
Plus: SV
NCF
PVF
PV (Rs)
NPV (Rs)
IRR
Cumulative NCF
Payback (years)
Project N
Year
Book value
S L depreciation
Earnings before depreciation &
taxes

0
100,000

-100,000
1.000
-100,000
-11,864
5.24%
-100,000
4 1/2

0
140,000

1
80,000
20,000
25,000

2
60,000
20,000
25,000

3
40,000
20,000
25,000

4
20,000
20,000
25,000

5
0
20,000
25,000

20,000
5,000
1750
3,250
20,000

20,000
5,000
1750
3,250
20,000

20,000
5,000
1750
3,250
20,000

20,000
5,000
1750
3,250
20,000

23,250
0.909
21,136

23,250
0.826
19,215

23,250
0.751
17,468

23,250
0.683
15,880

20,000
5,000
1750
3,250
20,000
0
23,250
0.621
14,436

-76,750

-53,500

-30,250

-7,000

16,250

1
112,000
28,000
40,000

2
84,000
28,000
40,000

3
56,000
28,000
40,000

4
28,000
28,000
40,000

5
0
28,000
40,000

Less: dep.
28,000
Earnings before taxes
12,000
Tax
4,200
Earnings after tax
7,800
Plus: dep.
28,000
After-tax salvage
NCF
-140,000
35,800
PVF
1.000
0.909
PV (Rs)
-140,000
32,545
NPV (Rs)
3,782
IRR
11.0%
Cum. NCF
-140,000
-104,200
Payback
4
* After-tax salvage: 20,000 - .35(20,000 0) = Rs 13,000.

28,000
12,000
4,200
7,800
28,000

28,000
12,000
4,200
7,800
28,000

28,000
12,000
4,200
7,800
28,000

35,800
0.826
29,587

35,800
0.751
26,897

35,800
0.683
24,452

28,000
12,000
4,200
7,800
28,000
13,000
48,800
0.621
30,301

-68,400

-32,600

3,200

52,000

25,270
5,000
12,670
-7,670

3
25,270
25,570
12,670
12,900

24%
15%
17%

NPV, 12%
10,694.3
1,650.5
2,431.2
-780.7

Problem 4
Year
O
P
Q
(P - Q)

0
-50,000
-25,000
-28,000
3,000

2
25,270
5,000
12,670
-7,670

IRR

Project O has the highest NPV; hence it should be preferred over other projects. Between projects P and Q, Q is better with higher
NPV. The incremental cash flow analysis also shows that P losses NPV when compared with Q.
Problem 5
Year
0
1
2
A
-6,000
8,000
2,000
B
-8,000
12,000
(A - B)
-6,000
16,000
-10,000
Both absolute and incremental analyses reveal that B is a better project than A.

3
2,000
4,000
-2,000

NPV, 10%
4,428.2
6,214.9
-1,221.6

IRR
65.6%
78.1%

7,000

4
-25,000

NPV, 10%
6,666.0

Problem 6
Year
Cash flow

1
7,000

2
7,000

Problem 7
Required rate of return
Tax rate
Purchase price
Installation
Total cost
Plus: WC
Less: SV, old
Initial outlay
SV, new (4 yrs)
SV, old (4 yrs)
Differential SV after 4 years

10%
40%
40,000
8,000
48,000
10,000
20,000 no tax assumed
38,000
14,000
4,000
10,000 no tax assumed

BV, old
Life (years), new
Life (years), old
SL dep., new
SL dep., old

16,000
4
4
12,000
4,000

3
7,000

Differential dep.
Diff. DTS (depreciation tax
shield): 8,000 0.40
Year
Initial outlay
BT cash flows
AT cash flows: 16,000 (1-.4)
DTS
Differential SV
NCF
NPV
IRR

8,000
3,200

0
-38,000

-38,000
9,404.41
20%

16,000
9,600

16,000
9,600

16,000
9,600

16,000
9,600

3,200

3,200

3,200

12,800

12,800

12,800

3,200
10,000
22,800

Problem 8
Investment
Required rate
Tax rate
Investment period
Building
Merchandise
Working capital
Total investment

300,000
15%
30%
13
140,000
100,000
60,000
300,000

Annual receipts
Less: Costs
Less: SL dep. on build.
(140,000/13)

390,000
300,000
10,769

Pre-tax savings
Tax @ 30%
Post-tax savings
Add: Dep.
Less: Loss of salary (no tax on salary assumed)
NCF (annuity)
Post-tax SV: 50,000 (1 0.3)
Release of WC and merchandise
Year-end CF
PVAF, 15%, 13
PVF, 15%, 13
PV of annuity
PV of year-end CF
NPV

79,231
23,769
55,462
10,769
36,000
30,231
35,000
160,000
195,000
5.5831
0.1625
168,781
31,688
-99,531

Problem 9
BV, old
Life, old (years)
Cost, new
Life, new (years)
SV, new
Savings, new
WDV dep. rate
Tax rate
Required rate

64,000
6
80,000
6
0
16,000
25%
35%
10%

Situation I
SV, old (now)
0
SV, (after 6 years)
0
BV, old
64,000
Dep. base, new
80,000
Diff. dep. base (80,000-64,000)
16,000
Year
0
1
2
3
4
16,000
12,000
9,000
6,750
5,063
Depreciated value
WDV dep.
4,000
3,000
2,250
1,688
Investment
-80,000
Savings
16,000
16,000
16,000
16,000
Less: depreciation*
4,000
3,000
2,250
1,688
Taxable savings
12,000
13,000
13,750
14,313
Less: Tax @ 35%
4,200
4,550
4,813
5,009
Post-tax savings
7,800
8,450
8,938
9,303
Add: depreciation*
4,000
3,000
2,250
1,688
After-tax SV (old) lost
NCF
-80,000
11,800
11,450
11,188
10,991
PVF
1.000
0.909
0.826
0.751
0.683
PV
-80,000
10,727
9,463
8,405
7,507
NPV
-30,545
* New machine has zero salvage value. Its book value of Rs 2,848 at the end of 6th year will be treated as loss and will save taxes. This amount has be
sixth year's depreciation.

Situation II
SV, old (now)
16000
BV, old
64,000
After-tax SV, old: 16,000 - .35(16,000-64,000)
32,800 Assumption given in the problem
SV, old (after 6 years)
0
Cost of new
80,000
Less: After-tax SV, old
32,800
Net cost of new
47,200
Diff. dep. base (80,000-64,000)
16,000
Year
0
1
2
3
4
16,000
12,000
9,000
6,750
5,063
Depreciated value
WDV depreciation
4,000
3,000
2,250
1,688
Investment
-47,200
Savings
16,000
16,000
16,000
16,000
Less: depreciation*
4,000
3,000
2,250
1,688
Taxable savings
12,000
13,000
13,750
14,313
Less: Tax
4,200
4,550
4,813
5,009
Post-tax savings
7,800
8,450
8,938
9,303
Add: depreciation*
4,000
3,000
2,250
1,688
After-tax SV (old) lost
NCF
-47,200
11,800
11,450
11,188
10,991
PVF
1.000
0.909
0.826
0.751
0.683
PV
-47,200
10,727
9,463
8,405
7,507
NPV
2,255
* New machine has zero salvage value. Its book value of Rs 2,848 at the end of 6th year will be treated as loss and will save taxes. This amount has be
sixth year's depreciation.
Situation III
SV, old (now)
BV, old
After-tax SV, old: 16,000 - .35(16,000-64,000)
SV, (after 6 years)

16000
64,000
32,800 Assumption given in the problem
2,000

BV, old (after six years): 64,000 (1-0.25)6


11391
After-tax SV, old: 2,000 - .35(2,000-11,391)
5,287
Cost of new
80,000
Less: After-tax SV, old
32,800
Net cost of new
47,200
Diff. dep. base (80,000-64,000)
16,000
Year
0
1
2
3
4
16,000
12,000
9,000
6,750
5,063
Depreciated value
WDV depreciation
4,000
3,000
2,250
1,688
Investment
-47,200
Savings
16,000
16,000
16,000
16,000
Less: depreciation*
4,000
3,000
2,250
1,688
Taxable savings
12,000
13,000
13,750
14,313
Less: Tax
4,200
4,550
4,813
5,009
Post-tax savings
7,800
8,450
8,938
9,303
Add: depreciation*
4,000
3,000
2,250
1,688
After-tax SV (old) lost
NCF
-47,200
11,800
11,450
11,188
10,991
PVF
1.000
0.909
0.826
0.751
0.683
PV
-47,200
10,727
9,463
8,405
7,507
NPV
-729
* New machine has zero salvage value. Its book value of Rs 2,848 at the end of 6th year will be treated as loss and will save taxes. This amount has be
sixth year's depreciation.
Problem 10
Old Machine:
BV
Current MV
After-tax SV: 20,000-.35(20,000-0)
SV after 8 years
Remaining life (years)

0
20,000
13,000
0
8

New Machines (Vs Old):


Cost
SV after 8 years
BV after 8 years
After-tax SV: SV-.35(SV-BV)
Life (years)
Dep. rate (WDV)
Tax rate
Cost of capital
Increase in sales
Cost savings
Gross savings
After-tax savings (T = 35%)
Diff. dep. base: Cost, new BV, old
New investment: cost After-tax SV, old (Rs 13,000)

I
102,500
12,500
10,262
11,717
8
0.25
0.35
0.11
12,500
12,500
25,000
16,250
102,500
89,500

II
175,000
25,000
17,520
22,382
8
0.25
0.35
0.11
12,500
30,000
42,500
27,625
175,000
162,000

2
57,656
19,219
6,727
16,250

3
43,242
14,414
5,045
16,250

New machine I (Vs Old):


Years
Diff. dep. Base
Depreciation
Dep. Tax shield
After-tax savings

0
102,500

1
76,875
25,625
8,969
16,250

4
32,432
10,811
3,784
16,250

5
24,324
8,108
2,838
16,250

SV
NCF
PVF
PV (Rs)
NPV (Rs)
IRR

-89,500
1.000
-89,500
23,040
18.07%

25,219
0.901
22,720

22,977
0.812
18,648

21,295
0.731
15,571

20,034
0.659
13,197

19,088
0.593
11,328

New machine II (Vs Old) :


Years
0
1
2
3
4
5
Diff. dep. Base
175,000
131,250
98,438
73,828
55,371
41,528
Depreciation
43,750
32,813
24,609
18,457
13,843
Dep. Tax shield
15,313
11,484
8,613
6,460
4,845
After-tax savings
27,625
27,625
27,625
27,625
27,625
SV
NCF
-162,000
42,938
39,109
36,238
34,085
32,470
PVF
1.000
0.901
0.812
0.731
0.659
0.593
PV (Rs)
-162,000
38,682
31,742
26,497
22,453
19,269
NPV (Rs)
30,561
IRR
16.20%
The company should go for the new machine costing Rs 175,000 since it has higher NPV. NPV is consistent with shareholdr wealth maximisation.
Problem 11
The block of assets method of depreciation in India requires adjustment of salvage value in the depreciable base. Thus, if an asset has
no salvage value, it can be depreciated for ever (infinity) if the firm keeps the positive balance in the block of assets. If it has a
salvage value, the balance of the block will be reduced for the amount of salvage value less depreciation tax shield lost on this
amount.
Old Machine:
Depreciated BV
0
Exchange value
40,000
Current MV
30,000
SV after 10 years
6,000
Remaining life (years)
10
New Machine:
Cost
360,000
SV after 10 years.
40,000
Life (years)
10
WDV dep. rate
25%
Required rate
12%
Tax rate
50%
Tax rate is inferred from given data.

Profit before tax


Add: dep.
Add: allocated
overhead
PBDT
Tax @ 50%
PBDAT
Years
New block
Dep.
DTS
PBDAT
CFO

Old
373,000
2,000

New
449,000
36,000

Difference
76,000
34,000

120,000
495,000
247,500
247,500

130,000
615,000
307,500
307,500

10,000
120,000
60,000
60,000

0
320,000

1
240,000
80,000
40,000
60,000
100,000

2
180,000
60,000
30,000
60,000
90,000

3
135,000
45,000
22,500
60,000
82,500

4
101,250
33,750
16,875
60,000
76,875

5
75,938
25,313
12,656
60,000
72,656

Investment
-320,000
SV
Lost DTS on SV
NCF
-320,000
100,000
90,000
82,500
76,875
72,656
PVF
1.000
0.893
0.797
0.712
0.636
0.567
PV (Rs)
-320,000
89,286
71,747
58,722
48,855
41,227
NPV (Rs)
135,649
IRR
22.45%
* Last year DTS includes DTS (for infinity) on the remaining book value: BV (d T)/(k + d) = 18.020 (0.25 0.50)/(0.12 + 0.25) = Rs .6,088.
Note: Exchange value is higher than the current market value. Hence, the relevant salvage value of the old machine is Rs 40,000.
Problem 12
Old Machine:
Original cost (Rs)
Original life (yrs)
Remaining life (yrs)
Depreciation rate
BV after 5 years
BV after 12 years
Current MV
New Machine:
Cost
Installation
Total cost
Working capital
Gross outlay
Life (years)
Depreciation rate
SV (Rs)
BV after 7 years
Cost of capital
Tax rate
Increase in sales
After-tax revenue: 70,000(1-.35)
Gross outlay
Less: SV, old
Net outlay
Diff. Dep. Base: 200,000 - 40,000

129,000
12
7
25%
30,612 (1-0.25)^5*129,000
4,086 (1-0.25)^12*129,000
40,000
175,000
25,000
200,000
25,000
225,000
7
0.25
18,000
23,360 (1-0.25)^7*175,000
12%
35%
70,000
45,500
225,000
40,000
185,000
160,000

Year
0
1
2
3
Diff. dep. base
160,000
120,000
90,000
67,500
Differential dep.
40,000
30,000
22,500
DTS*
14,000
10,500
7,875
After-tax revenue
45,500
45,500
45,500
SV
DTS lost on SV**
WC released
Net outlay
-185,000
NCF
-185,000
59,500
56,000
53,375
PVF
1.000
0.893
0.797
0.712
PV (Rs)
-185,000
53,125
44,643
37,991
NPV
78,014
IRR
24.0%
* Last year DTS includes DTS on remaining book value: 21,357 (.25 .35)/(.12 + .25) = Rs 5,051.

4
50,625
16,875
5,906
45,500

5
37,969
12,656
4,430
45,500

51,406
0.636
32,670

49,930
0.567
28,331

** DTS lost on SV: 18,000 (.25 .35)/(.25 + .12) = -4,257.


Problem 13
Purchase price
Life (years)
SV (Rs)
Maintenance cost
SL dep.
Tax rate
Cost of capital

175,000
5
21,000
3,500
35,000
50%
10%

0
Outlay
-175,000
Tax saved on depreciation
After-tax SV
NCF
-175,000
PVF
1.0000
PV (Rs)
-175,000
NPV (Rs)
-102,142
* Tax payable on book profit. After-tax SV = 21,000 0.50(21,000 0)

17,500

17,500

17,500

17,500

17,500
0.9091
15,909

17,500
0.8264
14,463

17,500
0.7513
13,148

17,500
0.6830
11,953

Hiring option:
0
1
Hire charges (Rs)
0
-42,000
After-tax hire charges (Rs)
0
-21,000
PVF
1.0000
0.9091
PV (Rs)
0
-19,091
NPV (Rs)
-79,607
Maintenance cost being common in both options is ignored in calculating cash flows.
Hiring option is cheaper.

2
-42,000
-21,000
0.8264
-17,355

3
-42,000
-21,000
0.7513
-15,778

4
-42,000
-21,000
0.6830
-14,343

Problem 14
Cost of capital
Tax rate
Dep. Rate
Project P
Investment
Depreciation
Additional investment
Depreciation
Total depreciation
Before-tax cash flows
After-tax cash flows
DTS*
Investment
Working capital
Salvage value
Lost DTS on SV**
WC released
NCF
PVF
PV
NPV

0.18
0.5
0.25
0

250,000

187,500
62,500

140,625
46,875

105,469
35,156

79,102
26,367

59,326
19,775
45,000

62,500

46,875

35,156

26,367

19,775

90,000
45,000
31,250

90,000
45,000
23,438

90,000
45,000
17,578

90,000
45,000
13,184

90,000
45,000
9,888
-45,000

76,250
0.847
64,619

68,438
0.718
49,151

62,578
0.609
38,087

58,184
0.516
30,010

9,888
0.437
4,322

-250,000
-50,000

-300,000
1.000
-300,000
-25,425

IRR
15.54%
* Includes DTS on the remaining book value: (14,078 + 10,679) (.25 .50)/(.25 + .18) = Rs 7,197.
# Lost DTS on VS: Rs 30,000 (.25 .50)/(.25 + .18) = Rs 8,721.
Problem 15
Cost
Life (years)
Straight line dep. (Rs)
Savage value
Savings
Tax rate
Cost of capital
Year
Investment
After-tax savings
Tax saved on dep.
Salvage value
NCF
PVF
PV (Rs)
NPV (Rs)
IRR

100,000
5
20,000
0
40,000
0.5
0.18
0
-100,000

-100,000
1.0000
-100,000
-6,185
15.20%

20,000
10,000

20,000
10,000

20,000
10,000

20,000
10,000

30,000
0.8475
25,424
-6,185

30,000
0.7182
21,546

30,000
0.6086
18,259

30,000
0.5158
15,474

Here we ignore the effect of specific financing. The cost of capital, which assumes a target capital structure, is used as the discount rate.
Problem 16
Project cost (Rs)
Cost savings (Rs)
Period (years)
Tax rate
Required rate
Straight line dep. (Rs)
Salvage value
Year
Investment (Rs)
After-tax cost savings (Rs)
Tax saved on dep. (Rs)
Salvage value (Rs)
NCF (Rs)
PVF
PV (Rs)
NPV (Rs)
IRR

50,000
30,000
5
0.5
0.12
10,000
0
0
-50,000

-50,000
1.0000
-50,000
22,096
28.65%

15,000
5,000

15,000
5,000

15,000
5,000

15,000
5,000

20,000
0.8929
17,857
22,096

20,000
0.7972
15,944

20,000
0.7118
14,236

20,000
0.6355
12,710

Here we ignore the effect of specific financing. The cost of capital, which assumes a target capital structure, is used as the discount rate.
Problem 17
Old
Capacity (units)
Selling price
Revenue
Cost of production:

(Rs 000)
New - Old

New
3
200
600

4
180
720

1
-20
120

Materials
Labour
Variable overheads
Fixed overheads
Per unit production cost
Total production cost
Profit
Original cost of machine (Rs)
Current book value
Exchange (salvage) value
After-tax salvage value: 100,000-.5(100,000 200,000)
Tax saved on book loss
Net outlay (Rs): 500,000 - 150,000
Salvage value after 10 years
After-tax salvage value: 50,000 - .5(50,000 0)
Remaining life (years)
Straight line dep.
Working capital
Tax rate
Required rate of return

Year
Cost of machine
Working capital
Tax saved on SV
Revenue
Cost savings
Increase in profits
After-tax profits
Dep. tax shield
After-tax SV
Release of WC
NCF
PVF
PV (Rs)
NPV (Rs)
IRR

40
60
30

38
40
15
2
95
380
340
500

130
390
210
300
200
100
150
50

0
-200
-25
50

-175
1.000
-175
65
20.2%

10
20

350
50
25
10
50
25
0.5
0.15

2
20
15
-2
35
10
110

30

1
-200

120
10
130
65
15

120
10
130
65
15

120
10
130
65
15

120
10
130
65
15

120
10
130
65
15

-120
0.870
-104
65

80
0.756
60

80
0.658
53

80
0.572
46

80
0.497
40

Problem 18
Initial cost (Rs)
Life (years)
Cash inflow (Rs)
Cost of capital (real)
Inflation
Nominal cost of capital: [(1.10)(1.05) - 1]

200,000
5
70,000
10.00%
5.00%
15.50%

Assumptions: (1) It is assumed that both cash flows and the cost of capital are in real terms. (2) Nominal cash flows are calculated as
follows: Real cash flows (1 + inflation rate)n.
Year
Cash flows (real)
Nominal cash flows

0
-200,000
-200,000

2
70,000
73,500

70,000
77,175

3
70,000
81,034

5
70,000
85,085

70,000
89,340

It may be noticed that NPV is the same in both situations. The real cash flows are discounted at the nominal cost of capital, and real cash flows at the r
capital.
Problem 19

Discount rate
Tax rate
General inflation rate

20%
35%
10%

Year
Cost
Volume
Price
Cost per unit
Revenue
Total cost
Profit
Less: dep.
PBT
Tax
PAT
Add: dep.
NCF
PVF at 20%
PV at 20%
NPV
IRR

0
-500,000
20%
10%
15%

-500,000
1.000
-500,000
-99,155
11.6%

1
10,000
20
10
200,000
100,000
100,000
100,000
0
0
0
100,000
100,000
0.833
83,333
-99155

12,000
22
11.50
264,000
138,000
126,000
100,000
26,000
9100
16,900
100,000
116,900
0.694
81,181

14,400
24.2
13.23
348,480
190,440
158,040
100,000
58,040
20314
37,726
100,000
137,726
0.579
79,703

17,280
26.62
15.21
459,994
262,807
197,186
100,000
97,186
34015
63,171
100,000
163,171
0.482
78,690

Price increases at general inflation rate while cost increases by a higher rate of inflation. It is assumed that the cost of capital is market determined;
hence, it is in nominal terms.
Problem 20
Cash outlay
Life of project (years)
Sales growth: 2-7 years
Increase in expenses
Initial working capital
WC to sales
WDV dep. rate
Tax rate
Opportunity cost of capital
Salvage value: 0.20 6,000,000 (1.10)7
Nominal Cash Flows
Year
Cash outlay
Sales
Op. expenses
PBDIT
Depreciation
Profit/loss
Loss carried forward
Unrecovered loss
Taxable profit
Tax
PAT
Add: depreciation
Funds from operation
Initial working capital
Change in WC
Release of WC

6,000,000
7
10%
10%
500,000
25%
25%
35%
21%
2,338,461

0
-6,000,000

1,200,000
600,000
600,000
1,500,000
-900,000
-900,000
0
0
0
1,500,000
1,500,000

2,000,000
660,000
1,340,000
1,125,000
215,000
-900,000
-685,000
0
0
215,000
1,125,000
1,340,000

2,200,000
726,000
1,474,000
843,750
630,250
-685,000
-54,750
0
0
630,250
843,750
1,474,000

2,420,000
798,600
1,621,400
632,813
988,588
-54,750
0
933,838
326,843
661,744
632,813
1,294,557

2,662,000
878,460
1,783,540
474,609
1,308,931
0
0
1,308,931
458,126
850,805
474,609
1,325,414

-300,000

-200,000

-50,000

-55,000

-60,500

-500,000

Salvage value
NCF
PVF, 21%
PV
NPV
IRR

-6,500,000
1.000
-6,500,000
-1,100,836
15.7%

1,200,000
0.826
991,736
-1,100,836

1,140,000
0.683
778,635

1,424,000
0.564
803,811

1,239,557
0.467
578,262

1,264,914
0.386
487,679

Theoretically, the answer should not change if the analysis is made in terms of real terms. The real cash flows would be discounted at the real cost of c
since flows like deprecation tax shields are always in nominal terms, it is difficult to use real cash flow analysis.

IRR
-4.5%

5
3,797
1,266

6
2,848
949

16,000
1,266
14,734
5,157
9,577
1,266

16,000
3,797
12,203
4,271
7,932
3,797
0
11,729
0.564
6,621

10,843
0.621
6,733

save taxes. This amount has been added to the

n in the problem

5
3,797
1,266

6
2,848
949

16,000
1,266
14,734
5,157
9,577
1,266

16,000
3,797
12,203
4,271
7,932
3,797
0
11,729
0.564
6,621

10,843
0.621
6,733

save taxes. This amount has been added to the

n in the problem

5
3,797
1,266

6
2,848
949

16,000
1,266
14,734
5,157
9,577
1,266

16,000
3,797
12,203
4,271
7,932
3,797
-5,287
6,442
0.564
3,636

10,843
0.621
6,733

save taxes. This amount has been added to the

6
18,243
6,081
2,128
16,250

7
13,682
4,561
1,596
16,250

8
10,262
3,421
1,197
16,250

11,717
29,164
0.434
12,655

18,378
0.535
9,826

17,846
0.482
8,596

6
31,146
10,382
3,634
27,625

7
23,360
7,787
2,725
27,625

31,259
0.535
16,712

30,350
0.482
14,618

8
17,520
5,840
2,044
27,625
22,382
52,051
0.434
22,586

7
42,715
14,238
7,119
60,000
67,119

8
32,036
10,679
5,339
60,000
65,339

holdr wealth maximisation.

6
56,953
18,984
9,492
60,000
69,492

9
24,027
8,009
4,005
60,000
64,005

10
18,020
6,007
9,091
60,000
69,091

69,492
0.507
35,207

67,119
0.452
30,361

)/(0.12 + 0.25) = Rs .6,088.


Rs 40,000.

6
28,477
9,492
3,322
45,500

7
21,357
7,119
7,542
45,500
18,000
-4,257
25,000

48,822
0.507
24,735

91,786
0.452
41,519

65,339
0.404
26,389

64,005
0.361
23,081

40,000
-13,514
95,578
0.322
30,774

5
17,500
10,500
28,000
0.6209
17,386

5
-42,000
-21,000
0.6209
-13,039

10

44,495
14,832
33,750
11,250
26,082

33,371
11,124
25,313
8,438
19,561

25,028
8,343
18,984
6,328
14,671

18,771
6,257
14,238
4,746
11,003

14,078
4,693
10,679
3,560
8,252

90,000
45,000
13,041

90,000
45,000
9,781

90,000
45,000
7,335

90,000
45,000
5,502

90,000
45,000
11,323

50,502
0.225
11,386

30,000
-8721
50,000
127,602
0.191
24,380

58,041
0.370
21,500

54,781
0.314
17,197

52,335
0.266
13,923

5
20,000
10,000
0
30,000
0.4371
13,113

he discount rate.

he discount rate.

5
15,000
5,000
0
20,000
0.5674
11,349

120
10
130
65
15

120
10
130
65
15

120
10
130
65
15

120
10
130
65
15

80
0.432
35

80
0.376
30

80
0.327
26

80
0.284
23

Dis. rate
10.00%
15.50%

NPV
65,355
65,355

ital, and real cash flows at the real cost of

(Rs 000)
10

120
10
130
65
15
25
25
130
0.247
32

5
20,736
29.28
17.49
607,192
362,674
244,518
100,000
144,518
50581
93,936
100,000
193,936
0.402
77,939

apital is market determined;

2,928,200
966,306
1,961,894
355,957
1,605,937
0
0
1,605,937
562,078
1,043,859
355,957
1,399,816

3,221,020
1,062,937
2,158,083
266,968
1,891,116
0
0
1,891,116
661,890
1,229,225
266,968
1,496,193

-66,550

-73,205
1,305,255

1,333,266
0.319
424,820

2,338,461
5,066,703
0.263
1,334,221

discounted at the real cost of capital. However,

Chapter 14: Financial and Operating Leverage


Problem 1
Assets (Rs)
No. of shares
BV per share (Rs)
Equity (Rs)
Debt (Rs)
PBIT (Rs)
Tax rate
PBIT (1 - T) (Rs)
ROI
Expansion:
Investment (Rs)
No. of shares
Price (Rs)
New equity (Rs)
Debt (Rs)
Interest at 14%
Pref. capital (Rs)
Dividend at 14%

1,000,000
100,000
10
1,000,000
0
250,000
35%
162,500
0.1625
Plan I
500,000
50,000
10
500,000

Plan II
Plan III
500,000
500,000

500,000
70,000
500,000
70,000

Analysis of alternative financing plan:


Plan I
Expected:
PBIT
PBIT(1-T)
Assets
ROI: [PBIT(1-T)/Assets]

PBIT
Less: Interest at 14%
PBT
Less: Tax @ 35%
PAT (before pref. div.)
Less: Pref. dividend
PAT available to equity
shareholders
No. of equity shares (N)
Equity capital (E)
EPS:[ PAT (after pref. div.)/N]
ROE: [PAT (after pref. div.)/E]

Plan II

(Rs)
Plan III

375,000
243,750
1,500,000
0.1625
16.25%

375,000
243,750
1,500,000
0.1625
16.25%

375,000
243,750
1,500,000
0.1625
16.25%

375,000
0
375,000
131,250
243,750
0
243,750

375,000
70,000
305,000
106,750
198,250
0
198,250

375,000
0
375,000
131,250
243,750
70,000
173,750

150,000
1,500,000
1.625
0.1625
16.30%

100,000
1,000,000
1.983
0.1983
19.80%

100,000
1,000,000
1.738
0.1738
17.40%

The second plan (14% Rs 500,000 debt) plan has maximum shareholder's
return (EPS/ROE). Hence, other things remaining the same, it is better than
other two plans.
Problem 2
Funds needed (Rs)
Tax rate
Plan I

200,000
35%
Equity

No. of shares
Price (Rs)
Equity capital (Rs)
PBIT
Less: Interest
PBT
Less: Tax
PAT
EPS (T = 0.35)
EPS (T = 0)

5,000
0
5,000
1,750
3,250
0.16
0.25

Plan II

12,000
0
12,000
4,200
7,800
0.39
0.60
Equity

No.
Price
Total (Rs)
Interest rate
Interest

10,000
10
100,000

PBIT
Interest
PBT
Tax
PAT
EPS (T=0.35)
EPS (T=0)

5,000
14,000
-9,000
0
-9,000
-0.90
-0.90

Plan III

12,000
14,000
-2,000
0
-2,000
-0.20
-0.20
Equity

No.
Price
Total (Rs)
Interest rate
Interest

5,000
10
50,000

PBIT
Less: Interest
PBT
Less: Tax
PAT
EPS (T = 0.35)
EPS (T = 0)

5,000
21,000
-16,000
0
-16,000
-3.20
-3.20

12,000
21,000
-9,000
0
-9,000
-1.80
-1.80

20,000
10
200,000
(Rs)
25,000
0
25,000
8,750
16,250
0.81
1.25
Debenture
1,000
100
100,000
14%
14000
(Rs)
25,000
14,000
11,000
3,850
7,150
0.72
1.10
Debenture
1,500
100
150,000
14%
21,000
(Rs)
25,000
21,000
4,000
1,400
2,600
0.52
0.80

Problem 3
Preference dividend
Debenture interest
Tax
Funds needed (Rs lakh)

11%
15%
35%
400

Share price (Rs)


Plan I
Proportion
Amount (Rs lakh)

25
Equity
100%
400

Pref.

Debenture

No of shares
Interest (Rs)
Pref. dividend (Rs)

16

EBIT
Interest
PBT
PAT
Pref. div.
Equity earnings
EPS
Plan II
Proportion
Amount (Rs lakh)
No of shares
Interest (Rs lakh)
Pref. dividend (Rs lakh)

10
0
10
6.5
0
6.5
0.41
Equity

Proportion
Amount (Rs lakh)
No of shares
Interest (Rs lakh)
Pref. dividend (Rs lakh)

Proportion
Amount (Rs lakh)
No of shares
Interest (Rs lakh)
Pref. dividend (Rs lakh)

40
15
25
16.25
0
16.25
1.35

50
15
35
22.75
0
22.75
1.90

60
15
45
29.25
0
29.25
2.44

40
0
40
26
11
15
1.25

50
0
50
32.5
11
21.5
1.79

60
0
60
39
11
28
2.33

15

30
15
15
9.75
0
9.75
0.81
Debenture

11

0%
-

20
0
20
13
11
2
0.17
Pref.

50%
200
8

60
0
60
39
0
39
2.44

25%
100

10
0
10
6.5
11
-4.5
-0.38

50
0
50
32.5
0
32.5
2.03

Pref.

40
0
40
26
0
26
1.63

25%
100

20
15
5
3.25
0
3.25
0.27

75%
300
12

Equity

30
0
30
19.5
0
19.5
1.22
Debenture

10
15
-5
-5
0
-5
-0.42

EBIT
Interest
PBT
PAT
Pref. div.
Equity earnings
EPS (Rs)
Plan IV

Pref.

Equity

20
0
20
13
0
13
0.81

75%
300
12

EBIT
Interest
PBT
PAT
Pref. div.
Equity earnings
EPS (Rs)
Plan III

30
0
30
19.5
11
8.5
0.71
Debenture

20%
80
-

30%
120
18

8.8

EBIT
10
20
30
40
Interest
18
18
18
18
PBT
-8
2
12
22
PAT
-8
1.3
7.8
14.3
Pref. div.
8.8
8.8
8.8
8.8
Equity earnings
-8
0
0
5.5
EPS (Rs)
-1.00
0.00
0.00
0.69
* It is assumed that PAT, if positive, will be used to first pay dividend to preference shareholders.

50
18
32
20.8
8.8
12
1.50

60
18
42
27.3
8.8
18.5
2.31

40
30
10
6.5
0
6.5
0.81

50
30
20
13
0
13
1.63

60
30
30
19.5
0
19.5
2.44

EBIT
10
20
30
40
Interest
30
30
30
30
PBT
-20
-10
0
10
PAT
-20
-10
0
6.5
Pref. dividend
8.8
8.8
8.8
8.8
Equity earnings
-20
-10
0
0
EPS
-4.17
-2.08
0.00
0.00
* It is assumed that PAT, if positive, will be used to first pay dividend to preference shareholders.

50
30
20
13
8.8
4.2
0.88

60
30
30
19.5
8.8
10.7
2.23

Plan V

Equity

Proportion
Amount (Rs lakh)
No of shares
Interest (Rs lakh)
Pref. dividend (Rs lakh)

50%
200
8
-

EBIT
Interest
PBT
PAT
Pref. div.
Equity earnings
EPS (Rs)
Plan VI
Proportion
Amount (Rs lakh)
No of shares
Interest (Rs lakh)
Pref. dividend (Rs lakh)

Pref.

Debenture
0%
-

10
30
-20
-20
0
-20
-2.50
Equity
30%
120
4.8
-

50%
200
30
-

20
30
-10
-10
0
-10
-1.25
Pref.

30
30
0
0
0
0
0.00
Debenture

20%
80
-

50%
200
30

8.8

Problem 4
Funds needed (Rs '000)
EBIT (Rs '000)
Tax rate

1,000
150
35%

Amount

Equity
Share price
(Rs)

Debt
Amount

Share price
(Rs)
Proportion
Plan I
Plan II

75%
50%

(Rs '000)

No. of shares

750
500

50
40

15
12.5

(Rs 000)
Plan I
Plan II
150
150
35
80
115
70
40.25
24.5
74.75
45.5
15
12.5
4.98
3.64

EBIT
Interest
PBT
Tax
PAT
Number of shares
EPS
Problem 5

Plan I
Equity
Debt
Total capital
Share issue price
Number of shares
Tax rate

300,000
0
300,000
20
15,000
35%

Plan II
180,000
120,000
300,000
20
9,000
35%

EBIT
Interest
PBT
Tax
PAT
Number of shares
EPS

45,000
0
45,000
15,750
29,250
15,000
1.95

45,000
18,000
27,000
9,450
17,550
9,000
1.95

(Rs)
Plan III
120,000
180,000
300,000
20
6,000
35%
45,000
28,200
16,800
5,880
10,920
6,000
1.82

Interest calculation:
Interest (%)

Debt
14%
16%
18%

Plan I
Interest amt.

Debt

Plan II
Interest amt.

60,000
60,000
0
120,000

8400
9600
0
18,000

60,000
90,000
30,000
180,000

1,000,000
I

1,000,000
II

1,000,000
III

1,000,000
20
50,000

500,000
20
25,000

250,000
20
12,500

0
0
0
35%

500,000
14%
70,000
35%

750,000
14%
105,000
35%

Problem 6
Fund needed (Rs)
Alternatives
Equity
Amount (Rs)
Per share (Rs)
No. shares
Debt
Amount (Rs)
Interest rate
Interest amount (Rs)
Tax rate

8,400
14,400
5,400
28,200

Proportion
25%
50%

(Rs '000)
250
500

Probability
EBIT
EPS
Alternative I
Alternative II
Alternative III
DFL
Alternative I
Alternative II
Alternative III
Indifference point
Alternatives I & II
Alternative I & III
Alternative II & III

0.10 Expected
320,000
168,000

0.10
80,000

0.20
120,000

0.40
160,000

0.20
200,000

1.04
0.26
-1.30

1.56
1.30
0.78

2.08
2.34
2.86

2.60
3.38
4.94

4.16
6.50
11.18

2.18
2.55
3.28

1.00
8.00
-3.20
B/E EBIT
140,000
140,000
140,000

1.00
2.40
8.00

1.00
1.78
2.91

1.00
1.54
2.11

1.00
1.28
1.49

1.00
2.43
3.01

Problem 7
EBIT
Contribution
Interest (INT)
Decline in sales

200
400
100
-5%

Fixed cost (FC): contribution minus EBIT


PBT: EBIT - interest (Int.)
Degree of combined leverage: [1+(Int.+FC)/PBT]
Percentage change in EPS: % change in sales DCL

200
100
4
-20%

Problem 8
A
Expected EBIT
Standard deviation of expected EBIT
Coefficient of variation of expected EBIT (business risk)
Interest
Expected PBT
Standard deviation of expected PBT
Coefficient of variation of expected PBT (financial risk)
B, with fixed interest charges, is more risky.

120,000
30,000
25%
0
120,000
30,000
25%

Problem 9

Funds needed
Tax
Existing shares
Plan I:
Debt
Plan II:
Equity
Total shares

(Rs)
1,000,000
35%
100,000
15%
No.
100,000
200,000

EBITi
100,000
150,000

1,000,000
(Rs)
1,000,000

Probability
(pi)
0.05
0.10

EBITpi
5,000
15,000

[{EBITi E(EBIT)}2]pi
845,000,000
640,000,000

B
120,000
30,000
25%
30,000
90,000
30,000
33%

200,000
250,000
300,000
400,000

0.30
0.40
0.10
0.05

Interest
150,000
150,000
150,000
150,000
150,000
150,000

PAT
-32,500
0
32,500
65,000
97,500
162,500

EPSi

Interest

PAT
65,000
97,500
130,000
162,500
195,000
260,000

EPSi

Variance
Standard dev.
Coeff. Variation

60,000
100,000
30,000
20,000
230,000

270,000,000
160,000,000
490,000,000
1,445,000,000
3,850,000,000
62,048
27%

Plan I
EBITi
100,000
150,000
200,000
250,000
300,000
400,000

{[EPS E(EPS)}2]pi

EPSipi
-0.33
0.00
0.33
0.65
0.98
1.63

Variance
Standard dev.
Coeff. Variation

-0.0163
0.0000
0.0975
0.2600
0.0975
0.0813
0.5200

0.0357
0.0270
0.0114
0.0068
0.0207
0.0611
0.1627
0.4033
77.56%

Plan II

EBITi
100,000
150,000
200,000
250,000
300,000
400,000

0
0
0
0
0
0

{[EPS E(EPS)}2]pi

EPSipi
0.33
0.49
0.65
0.81
0.98
1.30

Variance
Standard dev.
Coeff. Variation
Plan I is more risky as it has higher standard deviation.

0.0163
0.0488
0.1950
0.3250
0.0975
0.0650
0.7475

0.0089
0.0068
0.0029
0.0017
0.0052
0.0153
0.0407
0.2017
27%

Problem 10

Current sales

Company 1
10% fall in
sales

10% rise in
sales

Company 2
10% fall in
sales
Current sales

10% rise in
sales

Sales
Less: variable cost
Contribution
Less: fixed cost
EBIT
Less: interest
PBT
Less: tax at 35%
PAT*
Total assets
Equity
Debt

108.65
43.46
65.19
52.69
12.50
9.27
3.23
1.13
2.10
92.70
30.90
61.80

97.79
39.12
58.67
52.69
5.98
9.27
-3.29
-1.15
-2.14
92.70
30.90
61.80

119.52
47.81
71.71
52.69
19.02
9.27
9.75
3.41
6.34
92.70
30.90
61.80

108.65
35.85
72.80
61.40
11.40
6.95
4.45
1.56
2.89
92.70
46.35
46.35

97.79
32.27
65.52
61.40
4.12
6.95
-2.83
-0.99
-1.84
92.70
46.35
46.35

119.52
39.44
80.08
61.40
18.68
6.95
11.73
4.11
7.62
92.70
46.35
46.35

Variable cost ratio


Contribution ratio

40.00%
60.00%

40.00%
60.00%

40.00%
60.00%

33.00%
67.00%

33.00%
67.00%

33.00%
67.00%

Before-tax ROI: EBIT/TA

13.48%

6.46%

20.52%

12.30%

4.44%

20.15%

After-tax ROI: EBIT(1-T)/TA

8.76%

4.20%

13.34%

7.99%

2.89%

13.10%

ROE: PAT/Equity
Debt-equity ratio
DOL: %EBIT/%Sales
DFL: %PAT/%EBIT
DCL: %PAT/%Sales

6.79%
2.0

-6.91%
2.0
5.22
3.87
20.18

20.51%
2.0
5.22
3.87
20.18

6.24%
1.0

-3.97%
1.0
6.39
2.56
16.36

16.45%
1.0
6.39
2.56
16.36

* On loss tax credit is assumed.


Problem 11
(Rs crore)
Existing situation:
Sales
PAT
Tax rate
PBIT: PAT/(1 - T)
Fixed assets
Net worth
Number of shares
EPS

Expansion:
137.5 Expansion in capacity
7.15 Additional fixed assets
35% Additional sales
11 New sales
100 PBIT/sales ratio
135 Additional PBIT
4 New PBIT
1.79 Total cost: sales - PBIT
Fixed cost/total cost
Fixed cost
Variable cost

Proposed financing:

(Rs crore)
Equity

Debt
Debt
Interest rate
Tax rate
Number of shares (Nd)
Analysis:
Sales
Less: variable cost
Contribution
Less: fixed cost
PBIT
Less: interest
PBT
Tax
PAT
Number of shares
EPS (Rs): PAT/N
Break-even PBIT: [Ne/(Ne - Nd)]
x INT
Break-even EPS (Rs)
Contribution ratio
Break-even point
Margin of safety
DOL: Contribution/PBIT
DFL: PBIT/PBT

30%
30
55
192.5
18%
9.9
20.9
171.6
70%
120.12
51.48

30 Equity
15% Per share issue price
35% Additional shares
4 Number of shares (Ne)

30
10
3
7

192.5
51.48
141.02
120.12
20.9
4.5
16.4
5.74
10.66

192.5
51.48
141.02
120.12
20.9
0
20.9
7.32
13.59

4
2.67

7
1.94

10.5
0.98
73.26%
163.97
17.40%
6.75

10.5
0.98
73.26%
163.97
17.40%
6.75

1.27

1.00

DCL

8.60

6.75

Problem 12
Volga
Net worth
Borrowing
EBIT
Interest (INT)
Fixed cost (FC)
1. Debt-equity ratio
2. Interest coverage
3. DOL = [1 + FC/EBIT]
4. DFL = [EBIT/(EBIT - INT)]
5. DCL = DOL x DFL

152.31
165.47
43.17
34.39
118.23
1.09
1.26
3.74
4.92
18.38

70
0
70
45.5
0
45.5
2.84

(Rs lakh)
80
0
80
52
0
52
3.25

70
15
55
35.75
0
35.75
2.98

(Rs lakh)
80
15
65
42.25
0
42.25
3.52

70
0
70
45.5
11
34.5
2.88

(Rs lakh)
80
0
80
52
11
41
3.42

70
18
52
33.8
8.8
25
3.13

(Rs lakh)
80
18
62
40.3
8.8
31.5
3.94

(Rs lakh)
70
30
40
26
0
26
3.25

80
30
50
32.5
0
32.5
4.06

(Rs lakh)
70
80
30
30
40
50
26
32.5
8.8
8.8
17.2
23.7
3.58
4.94

Debt
Interest

Amount

(%)
14%
16%

(Rs '000)
35
80

Chapter 15: Capital Structure Theory and Policy


Problem 1
NI approach:
Investment
Debt
Interest rate
Equity-capitalisation rate, ke

No debt
1,000,000
0
16%
18%

300,000 debt
1,000,000
300,000
16%
18%

600,000 debt
1,000,000
600,000
16%
18%

NOI
Interest (16%)
NI
Market value of equity, E =NI/ke
Market value of debt, D
Value of the firm, V +E + D
WACC, NOI/V

200,000
0
200,000
1,111,111
0
1,111,111
18.0%

200,000
48,000
152,000
844,444
300,000
1,144,444
17.5%

200,000
96,000
104,000
577,778
600,000
1,177,778
17.0%

NOI approach:
Investment
Debt
Interest rate
Over-all capitalisation rate, ko

No debt
1,000,000
0
16.00%
12.00%

300,000 debt
1,000,000
300,000
16.00%
12.00%

600,000 debt
1,000,000
600,000
16.00%
12.00%

NOI
Interest
NI
Value of the firm, V = NOI/ko
Market value of debt, D
Market value of equity, E = V - D
Cost of equity, ke = NI/E

200,000
0
200,000
1,666,667
0
1,666,667
12.0%

200,000
48,000
152,000
1,666,667
300,000
1,366,667
11.1%

200,000
96,000
104,000
1,666,667
600,000
1,066,667
9.8%

Problem 2
Assets
Debentures
ROI
Cost of debt
Corporate tax rate
Pure equity-capitalisation rate
NOI approach:
NOI
Tax
After-tax NOI
Value of the firm, V
WACC, After-tax NOI/V
NI approach:
NOI
Interest
PBT
Tax
NI
Interest tax shield
Value of equity, E = V - D
Value of debt, D
Value of the firm, V
Arbitrage:
Investment in L's shares
Investment value: 5% x 320,000
Return from the investment: 5% x 48,000
Sell shares in L (cash inflow)
Borrow equal to 5% of U's debt:
5% x (1-0.50) x 400,000
Total available cash
Buy 5% of U's shares: 5% x 480,000
Remaining cash

U
800,000
0
18%
0%
50%
15%

L
800,000
400,000
18%
12%
50%
15%

144,000
72,000
72,000
480,000
15.0%

144,000
72,000
72,000
480,000
15.0%

144,000
0
144,000
72,000
72,000
0
480,000
0
480,000

144,000
48,000
96,000
48,000
48,000
24,000
320,000
400,000
720,000

5%
16,000
2,400
16,000
10,000
26,000
24,000
2,000

Return:
Return from U's shares: 5% x 72,000
Less: cost of borrowed funds: 10,000 x 12%
Net return

3,600
1,200
2,400

Problem 3

NOI
Interest
Net income
Value of equity, E
Value of Debt, D
Value of firm, V
Cost of equity, ke
Cost of debt, kd
Cost of capital, k0
Corporate leverage: D/E

X
200,000
0
200,000
1,800,000
0
1,800,000
11.10%
0.00%
11.10%
0.00%

Y
200,000
36,000
164,000
1,312,000
600,000
1,912,000
12.50%
6.00%
10.50%
45.73%

Percentage shares held in Y: (20/1312)


Value of investment in Y
Return: (20/1312) x 164,000

1.52%
20,000.00
2,500.00

Sell shares in the levered firm Y


Borrow on personal account:(600/1312)x20,000
Total cash available

20,000.00
9,146.34
29,146.34

Buy share of unlevered firm X: (20/1312) x 1,800,000

27,439.02

Return: (20/1312) x 200,000


Less: interest on personal debt: 9,146.34 x 6%
Net return
Surplus cash available: 29,146.34 - 27,439.02

3,048.78
548.78
2,500.00
1,707.32

Problem 4

NOI
Interest
NI

A
150,000
0
150,000

B
150,000
30,000
120,000

Equity-capitalisation rate, ke
Value of shares, E
Value of debt, D
Value of the firm, V
Overall capitalisation rate

10%
1,500,000
0
1,500,000
10.0%

15%
800,000
500,000
1,300,000
11.5%

Investment in A's shares


Investment value
Return

10%
150,000
15,000

Sell share in A

150,000

Buy shares in B
Lend at 6% in firm B
Investment
Surplus cash

80,000
50,000
130,000
20,000

Return
12,000
3,000
15,000

Problem 5

Value of shares, E
Value of debt, D
Value of the firm, V
Cost of debt, kd
NOI
Interest
NI
Cost of equity, ke = NI/E
WACC, k0 = NOI/V

Unlevered (U)
500,000
0
500,000
0%

Levered (L)
280,000
250,000
530,000
6%

50,000
0
50,000
10.0%
10.0%

50,000
15,000
35,000
12.5%
9.4%

Investment in L's shares


Investment value: 5% x 280,000
Return: 5% x 35,000

5.00%
14,000
1,750

Sell shares in the levered firm


Borrow equal to L's debt: 5% x 250,000
Total cash available

14,000
12,500
26,500

Invest in U's shares (5%)


Return: 5% x 50,000

25,000
2,500

Less: interest on debt: 6% x 12,500


Net return
Surplus cash

750
1,750
1,500

Problem 6
Traditional approach
Debt ratio
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
M-M approach:
Debt ratio
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%

kd

ke
0.0%
5.0%
5.0%
6.0%
7.0%
8.0%
10.0%

kd

Cost of capital, ko - MM thesis (given)

X
50,000
0
50,000
10.0%
500,000
0
500,000
10.0%
0.0%
12.5%

12.5%
13.0%
13.6%
14.3%
16.0%
18.0%
20.0%
ke

0.0%
5.0%
5.0%
6.0%
7.0%
8.0%
10.0%

Problem 7

Expected NOI
Cost of debt, INT = kd x D
Net income, NI
Cost of equity, ke
Value of shares, E
Value of debt, D
Value of the firm, V = E + D
Average cost of capital, ko = NOI/V
D/E ratio

k0

Y
50,000
10,000
40,000
11.1%
360,000
200,000
560,000
8.9%
55.6%
12.5%

12.5%
12.2%
11.9%
11.8%
12.4%
13.0%
14.0%
k0

12.5%
13.3%
14.4%
15.3%
16.2%
17.0%
16.3%

12.5%
12.5%
12.5%
12.5%
12.5%
12.5%
12.5%

Value of the firm, V - MM thesis: NOI/ko


Value of debt, D
Value of shares, E = V - D

400,000
0
400,000

400,000
200,000
200,000

Problem 8

NOI
Interest, INT
NI
Overall capitalisation rate, ko
Value of the firm, V = NOI/ko
Value of debt, D
Value of shares, E = V - D
Cost of debt, kd = INT/D
Cost of equity, ke = NI/S
Traditional view:
Cost of equity, ke
Value of shares, E = NI/ke
Value of debt, D = INT/kd
Value of the firm, V = E + D
Overall capitalisation rate,
ko = ke x (S/V) + kd x (D/V)

M
12,000
0
12,000
8%
150,000
0
150,000
0.0%
8.0%

N
12,000
2,000
10,000
8%
150,000
40,000
110,000
5.0%
9.1%

10.0%
120,000.0
0
120,000.0

10.5%
95,238.1
40,000.00
135,238.1

10.0%

8.9%

Problem 9
I
Corporate tax
Personal tax- dividend
Personal tax- interest
Equity
Debt
Cost of debt
NOI
Interest
Taxable income
Corporate tax
Net income

0%
0%
0%
U
100,000
0
0%
25,000
0
25,000
0
25,000

II
50%
0%
0%

0%
0%
0%
L

50%
0%
0%
L

III
50%
30%
30%

50%
30%
30%

IV
50%
20%
40%

50,000
50,000
15%

100,000
0
0%

50,000
50,000
15%

U
100,000
0
0%

L
50,000
50,000
15%

U
100,000
0
0%

25,000
7,500
17,500
0
17,500

25,000
0
25,000
12,500
12,500

25,000
7,500
17,500
8,750
8,750

25,000
0
25,000
12,500
12,500

25,000
7,500
17,500
8,750
8,750

25,000
0
25,000
12,500
12,500

Invesors' net income:


Dividend income
Tax on dividend
After-tax dividend income
Interest income
Tax on interest income
After-tax interest income
After-tax total income
Interest tax shield
Cost of debt (after personal tax)
Value of interest tax shield

25,000
0
25,000
0
0
0
25,000

17,500
0
17,500
7,500
0
7,500
25,000
0
15.0%
0

12,500
0
12,500
0
0
0
12,500

8,750
0
8,750
7,500
0
7,500
16,250
3,750
15.0%
25,000

12,500
3,750
8,750
0
0
0
8,750

8,750
2,625
6,125
7,500
2,250
5,250
11,375
2,625
10.5%
25,000

12,500
2,500
10,000
0
0
0
10,000

Problem 10
Target debt-equity ratio
Target payout ratio
Growth rate
Before -tax ROI
Interest rate
Sales-to-assets ratio
Tax rate
Sustainable growth
.4[{.21 + (.21 - .12)1}(1-.35)]

1.0
40%
20%
21%
12%
1.8
35%
7.8%

Problem 11
Hindustan Lever Ltd. (HLL)
Year

GFA
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

Year

Debt ratio
1992
1993
1994
1995
1996

NCA
323.1
285.8
299.7
193.0
168.9
567.2
895.3
1151.8
1087.1
1349.7
1639.0

INVST
12.3
51.0
191.5
122.8
328.8
544.6
729.5
1068.1
1832.2
1668.9
2397.7

Capital structure analysis


D/E
37.5%
0.60
23.0%
0.30
21.4%
0.27
20.1%
0.25
21.7%
0.28

Coverage
6.1
9.0
11.1
19.1
11.5

330.5
365.6
491.8
563.8
953.6
1035.2
1273.4
1349.7
1539.4
1778.3
1836.9

NW
333.3
385.7
538.3
638.3
937.5
1260.8
1712.4
2102.6
2487.6
3043.0
3658.2

Debt
200.3
115.2
146.5
160.2
260.1
186.6
264.3
177.3
111.6
83.7
58.3

NS
1221.1
1505.0
1721.3
2039.4
2798.8
3337.8
6560.7
7736.8
9426.1
10116.5
10588.2

Capex
35.1
126.2
72.0
389.8

Invstments anf Financing


INVST
NCA
38.7
-37.3
140.5
13.9
-68.7
-106.7
206.0
-24.1

1997
1998
1999
2000
2001
2002

12.9%
13.4%
7.8%
4.3%
2.7%
1.6%

0.15
0.15
0.08
0.04
0.03
0.02

25.8
38.6
63.4
126.4
242.3
234.2

81.6
238.2
76.3
189.7
238.9
58.6

215.8
184.9
338.6
764.1
-163.3
728.8

398.3
328.1
256.5
-64.7
262.6
289.3

Profitability analysi
Year
NS/CE
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

PBIT/NS
2.3
3.0
2.5
2.6
2.3
2.3
3.3
3.4
3.6
3.2
2.8

16.1%
16.3%
19.0%
18.9%
23.4%
26.2%
17.2%
18.4%
17.7%
18.4%
20.3%

PAT/PBIT
PBIT/CE
CE/NW
36.9%
30.5%
48.9%
32.6%
47.8%
29.7%
48.2%
31.7%
54.6%
28.3%
60.4%
26.5%
57.2%
35.8%
62.3%
40.2%
64.2%
48.4%
59.7%
57.9%
58.0%
60.4%

ROE
1.60
1.30
1.27
1.25
1.28
1.15
1.15
1.08
1.04
1.03
1.02

18.0%
20.7%
18.1%
19.1%
19.8%
18.4%
23.6%
27.1%
32.5%
35.5%
35.5%

116.5
101.8
114.6
69.3
62.5
169.7
186.9
168.3
195.7
159.9
127.3
66.1
48.0

STBB
12.1
16.0
31.1
6.4
12.8
91.3
71.5
47.6
44.8
35.4
25.8
45.9
5.5

Problem 12
Philips India Ltd.
Year

GFA
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

Year

NCA
154.7
162.1
181.8
232.1
253.1
319.2
376.1
386.0
414.8
330.4
363.3
334.7
605.4

NS/CE
1990
1991

INVST
82.1
97.1
122.9
112.8
141.3
223.4
194.3
175.8
217.8
213.1
134.1
40.0
67.6

PAT/NS
2.48
3.16

ROE
-2.1%
5.1%

NW

2.1
7.6
12.2
13.8
13.2
14.7
19.6
16.7
15.5
14.0
14.0
17.3
1.9

TD
-19.9%
42.0%

TD
41.3
63.6
76.5
129.3
175.9
187.4
190.9
171.7
176.2
191.6
167.8
147.3
306.4

Percentage of Capital Employed


STBB
LTB
73.8%
7.7%
66.2%
61.5%
9.7%
51.9%

1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

3.61
3.38
4.58
4.07
3.81
4.44
4.36
4.73
4.89
6.84
4.21

3.1%
1.3%
3.1%
1.5%
0.8%
3.0%
2.4%
2.5%
-0.2%
2.8%
5.7%

28.1%
7.0%
19.2%
11.8%
6.2%
26.0%
22.2%
21.6%
-1.8%
27.4%
27.9%

60.0%
34.9%
26.2%
47.5%
49.5%
49.5%
52.6%
45.5%
43.1%
31.0%
13.5%

16.3%
3.2%
5.4%
25.6%
18.9%
14.0%
12.0%
10.1%
8.7%
21.5%
1.6%

43.7%
26.6%
16.6%
17.8%
26.5%
23.7%
29.8%
29.7%
29.3%
9.5%
12.0%

IV
50%
20%
40%
L
50,000
50,000
15%
25,000
7,500
17,500
8,750
8,750

8,750
1,750
7,000
7,500
3,000
4,500
11,500
1,500
9.0%
16,667

PBIT
197.0
244.9
327.4
385.2
654.2
874.2
1130.5
1420.1
1668.4
1865.6
2154.4

INT
32.2
27.2
29.5
20.2
57.0
33.9
29.3
22.4
13.2
7.7
9.2

NW
52.4
152.6
100.0
299.2

Debt
-85.1
31.3
13.7
99.9

nts anf Financing

(Rs crore)
PAT
60.0
79.8
97.3
122.1
185.2
232.0
404.7
570.3
808.2
1079.8
1300.3

323.3
451.6
390.2
385.0
555.4
615.2

-73.5
77.7
-87.0
-65.7
-27.9
-25.4

LTB
104.4
85.8
83.6
52.9
39.6
63.4
100.3
80.7
110.9
104.5
86.5
20.2
42.5

ital Employed
DEBN
35.9%
29.2%

DEBN
56.7
48.3
41.2
22.8
3.2
3.0
32.7
32.7
72.2
50.0
53.8
0.0
8.3

NS
391.2
523.1
689.5
672.0
1092.7
1454.4
1438.8
1509.4
1620.1
1662.9
1444.4
1459.5
1492.8

(Rs crore)
PAT
-8.2
26.7
21.5
9.0
33.7
22.1
11.8
44.6
39.2
41.4
-3.1
40.4
85.5

21.6%
11.5%
1.3%
0.8%
8.7%
9.6%
19.4%
14.2%
18.2%
0.0%
2.3%

Chapter 18: Dividend Policy


Problem 3

Year
2000
2001
2002
2003
2004
Average

EPS
3.6
3.9
3.7
3.2
3.8
3.64

Year
2000
2001
2002
2003
2004
Average

EPS
3.5
3
2.5
6
5
4

DPS
2
2
2
2
2
2.00

DPS
1.75
1.5
1.25
3
2.5
2

MP

MP

Brown Ltd.
MP

High
48
53
51
59
60
54.20

Low
32
34
30
31
35
32.40

Avg.
40.00
43.50
40.50
45.00
47.50
43.30

MP

MP

Crown Ltd.
MP

High
38
42
42
50
48
44

Low
34
32
28
30
27
30.2

Avg.
36
37
35
40
37.5
37.1

BV
30.5
32.5
33.75
36.5
38.5
34.35

(Rs)
5.3
5.9
6.5
7.4
8.3
9.4
10.5
11.5
13.0
14.2
15.1
15.9
17.2
19.1
21.6
23.5
80.5
28.2

Change in
DPS(%)
11.7
11.7
10.5
14.3
11.7
13.4
11.8
9.4
12.9
9.5
6.1
5.7
7.7
11.5
12.9
8.6
243.1
-65.0

Payout (%)
37.9
37.0
39.7
40.2
41.8
39.7
42.4
44.4
46.6
46.3
50.1
51.1
50.7
54.9
26.4
52.3
150.1
77.2

Change in EPS
(%)
+
+
+
+
+
+
+
+
+
+
+
+
+
+
-

BV
37.2
38.8
40.6
42.3
43.2
40.42

Problem 4

Year
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

EPS

(Rs)
13.9
15.9
16.4
18.4
19.8
23.6
24.7
25.9
27.8
30.7
30.1
31.2
33.9
34.9
81.8
44.9
53.6
36.5

Change in EPS
(%)
DPS
-7.2
14.2
3.1
12.8
7.4
19.3
4.7
4.5
7.6
10.2
-2.0
3.7
8.7
2.9
134.5
-45.1
19.5
-32.0

300.0
250.0
200.0
% Change in EPS & DPS
150.0
100.0
50.0
0.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-50.0
-100.0

250.0
200.0
% Change in EPS & DPS
150.0
100.0
50.0
0.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-50.0
-100.0
-150.0
Year
Change in DPS(%)

Change in EPS (%)

Problem 5
Ashoka Ltd.
Current structure
No of shares
(crore)
Equity
Pref.
Share pre.
R&S
Total

After bonus

Capital
(Rs crore)

5
0.5

No of shares
(crore)

50
50
50
80
230

6
0.5

After split

Capital
(Rs crore)
60
50
120
0
230

No of shares
Capital (Rs
(crore)
crore)
25
50
0.5
50
50
80
230

Problem 6
Current structure
No of shares
Capital
Equity
Share pre.
R&S
Total

EPS
DPS

No of shares

200
100
190
490

2.1

17
6.5

After bonus
Capital
210
104
176
490
16.2
6.2

Problem 7
(Rs crore)
Paid up capital
Reserves
Previous years' pre-tax profit
Year 1
Year 2
Year 3
Average

12
16
8
8.6
8.3
8.3

Conditions:
(1) Residual reserve criterion:
Pre-bonus reserve - (Pre-bonus paid-up capital Bonus ratio) 0.40 (1 + bonus ratio) pre-bonus paid-up capital
16 - (12 B) 0.40 (1 + B) 12
16 - 12B = 4.8 + 4.8B
16.8B = 11.2
B = 11.2/16.8
0.67

No of shares
4

(2) Profitability criterion:


0.3 3-year avg. PBT 0.1 (1 + B) pre-bonus paid-up capital
0. 3 8.3 = 0.1 (1 + B) 12
2.49 = 1.2 + 1.2B
1.2B = 1.29
B = 1.29/1.2

1.075

Payout Dividend Yield Earnings Yield


55.60%
5.00%
9.00%
51.30%
4.60%
9.00%
54.10%
4.90%
9.10%
62.50%
4.40%
7.10%
52.60%
4.20%
8.00%
55.22%
4.62%
8.44%

P/E
11.11
11.15
10.95
14.06
12.5
11.95

Payout Dividend Yield Earnings Yield


50.00%
4.90%
9.70%
50.00%
4.10%
8.10%
50.00%
3.60%
7.10%
50.00%
7.50%
15.00%
50.00%
6.70%
13.30%
50.00%
5.36%
10.64%

P/E
10.29
12.33
14
6.67
7.5
10.158

Lintner's Model
Change in
DPS(%)
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
-

DPSt

EPSt
5.9
6.5
7.4
8.3
9.4
10.5
11.5
13.0
14.2
15.1
15.9
17.2
19.1
21.6
23.5
80.5
28.2

Intercept
EPSt
DPSt-1

DPSt-1
15.9
16.4
18.4
19.8
23.6
24.7
25.9
27.8
30.7
30.1
31.2
33.9
34.9
81.8
44.9
53.6
36.5

5.3
5.9
6.5
7.4
8.3
9.4
10.5
11.5
13.0
14.2
15.1
15.9
17.2
19.1
21.6
23.5
80.5

Coeff.
-2.459
0.522

t Stat
-0.294
2.155

P-value
0.773
0.049

0.219

0.973

0.347

Target payout: Coeff. EPSt/Coeff.


DPSt-1

2005 2006 2007 2008 2009

67%

2005 2006 2007 2008 2009

Regression Statistics
Multiple R
R Square

capital

After split
No of shares
4

Capital
200
100
190
490
8.5
3.25

0.5954
0.3545

Standard Error
Observations

14.8224
17

Chapter 20: Long-term Finance


Problem 1
A. Funds needed (Rs)
B. Existing shares
C. Current market price (Rs)
D. Subscription price (Rs)
E. Ex-right price (Rs)
[(B C + i x D)/(B + i)]

50,000,000
500,000
170
125
150

(i) New shares [A/D]


(ii) No of rights [B/i]
(iii) Value of rights [(E-D)/ii]

400,000
1.25
20

Problem 2
A. Funds needed (Rs)
B. Flotation cost (Rs) [10% of C]
C. Gross funds needed (Rs)
D. Existing shares
E. Current market price (Rs)
F. Subscription price (Rs)
G. Ex-right price (Rs)
[(D E +i x F)/(D + i)]
(i) New shares [A/D]
(ii) No of rights [B/i]
(iii) Value of rights [(G-F)/ii]
(iv) Impact on shareholder's wealth
Existing wealth [2 100]
Buys share [(3xG)-F]
Sells right [2 x G+2 x iii]
Does not exercise right [2 G]

45,000,000
5,000,000
50,000,000
2,000,000
100
50
83.33

1,000,000
2
16.67
200
200
200
166.67

Problem 3

Revenues
Pre-tax profit
Net profit
EPS
Equity dividend
Interest
Borrowing
NAV
Market price
Pre-tax margin
Net margin
ROE = EPS/NVA
MP/NAV
P/E ratio

Actual
1991-92
250
10.7

20%
7
57

4.3%

1992-93
285
12
7.2
23%
12
74
44.8
102.5

1993-94
360

Projected
1994-95
420

17.1
11.78

18.1
7.38

62.96

71.87

4.8%
18.7%

4.3%
10.3%

4.2%
16.1%
2.3
14.2

Rights ratio
Subscription price
New shares (crore)
Funds needed (Rs crore)
Ex-right price

1:1
80
1.44
115.21
91.25

Greaves, which was so far basically a trading company, has decided to diversify into manufacturing and marketing. It has plans for large capital expe
long-term finance to meet its need for funds. The company is expecting its sales to grow at a compound rate of about 23% and reach to Rs 563 cro
higher net profits and increased EPS. The company has proposed to raise Rs 115.20 crore through rights issue in the ratio of 1:1. The subscription pr
that the proportionate ownership of existing shareholders will be maintained. As a result, they shall be able to participate in the prosperity of the
companys expected strong sales growth and higher profitability is likely to improve the companys P/E ratio which currently is 14 times. The higher E
and the companys cost of raising equity capital will also reduce.

Projected
1995-96
563
25.3
9

78.86

4.5%
11.4%

ting. It has plans for large capital expenditures of Rs 219.70 crore in the next five years. The company will have to use various sources of
of about 23% and reach to Rs 563 crore in 1995-96. The companys net margin is expected to be maintained at 4.5% which will result in
in the ratio of 1:1. The subscription price is Rs 80 that will cause ex-rights price to be Rs 91.25. The advantage of Greaves rights issue is
to participate in the prosperity of the company. If Greaves maintains the dividend rate of 23%, shareholders dividend will double. The
hich currently is 14 times. The higher EPS and P/E ratio will result into a higher share price. Thus, the wealth of shareholders will increase

Chapter 21: Convertible Debentures and Warrants


Problem 1
Fully convertible debenture:
Interest rate
Number of debentures (lakh)
Par value (Rs)
Conversion period (years)
Conversion ratio: shares/per debenture
Conversion price (Rs)
Current share price (Rs)
Conversion value (now): conversion ratio share price
Partly convertible debenture:
Convertible:
Interest rate
Number of debentures (lakh)
Par value (Rs)
Convertble portion - par value
Conversion period (years)
Conversion ratio: shares/per debenture
Conversion price (Rs)
Current share price (Rs)
Conversion value (now): conversion ratio share price
Non-convertible:
Non-convertible portion - par value
Maturity of non-convertible portion (years)
Annual interest (Rs)
Maturity value (Rs)
Discount rate (assumed)
Value of NCD (Rs)
Discount rate (assumed)
Value of NCD (Rs)

10%
50
1000
2
5
200
120
600

10%
50
2000
1000
2
5
200
120
600
1000
10
100
1000
12%
887
10%
###

Problem 2
Equity market value (25 crore shares), (Rs crore)
Share price (Rs): 800/25
Debt (Rs crore)
Total assets (market value) (Rs crore)
Debenture issue (Rs 100 each), (Rs crore)
Number of debentures (crore)
Number of warrants (one debenture/one warrant/one share)
Warrant price (Rs)
Warrant money (Rs crore)
Exercise price (Rs)
Expiry period (years)
Share price variability (before debenture issue)
Risk-free rate

800
32
400
1200
400
4
4
10
40
15
2
4.5
10%

Equity/Assets (before warrant issue): 800/1200


Debt/Assets (before warrant issue): 400/1200
Asset variability (stdev.) (assuming risk free debt)

0.667
0.333
3

Share value after warrant issue (Rs): 32 + 10


Equity value after warrants issue (Rs crore): 800 + 40
Assets after debenture issue (Rs crore): 1200+400+40
Equity/Assets (after warrant issue)

42
840
1640
0.512

Debt/Assets (after warrant issue)


Revised variability of equity
Value of Warrant by Black-Scholes formula:
Revised share price after warrant issue (Rs)
Exercise price (Rs)
Expiry period (years)
Revised variability of equity
Risk-free rate
d1
d2
N(d1)
N(d2)
Call value
New shares after warrants are exercised (crore)
New shares/existing shares (w)
Total shares after warrants are exercised
Dilution factor
Warrant value (Rs): (1/(1 + w) call value

0.488
5.86

42
15
2
5.86
10%
4.2901
-3.9932
1.0000
0.0000
42.00
4
0.16
29
0.862
36.21

Chapter 22: Asset-Based Fiancing: Lease, Hire Purchase and Project Financing
Problem 1
Tax rate
Cost of borrowing
After-tax cost of borrowing
WDV depreciation rate

35%
15%
9.75%
25%

Year
Purchase price avoided
Lease rental
After-tax lease rentals
Depreciation (Dep.)
Dep. tax-shield lost
Operating cost
After-tax operating cost
Salvage value
NCF
PVF at 9.75%
PV
Net present value at 9.75%
IRR

0
10

10
1.000
10.00
1.48
5.2%

-1.75
-1.14
2.50
-0.88
0
0
0
-2.01
0.911
-1.83
1.48

-1.75
-1.14
1.88
-0.66
0
0
0
-1.79
0.830
-1.49

-1.75
-1.14
1.41
-0.49
0
0
0
-1.63
0.756
-1.23

Equivalent loan (start backwards to make calculations)


Year
0
1
2
3
NCF
2.01
1.79
1.63
Before-tax interest
1.28
1.10
0.94
After-tax interest
0.83
0.72
0.61
Principal repaid
1.18
1.08
1.02
Loan outstanding
8.52
7.34
6.26
5.24
Assumption: The equipment will have unrecovered book value of Rs1 lakh after eight years. This has been ignored in the above calculations.
Problem 2
Equipment purchase price (lakh)
Tax rate
WDV depreciation rate
Before-tax borrowing rate
After-tax borrowing rate
Salvage value
Book value at the end of 5th year

Year
Purchase price avoided
Lease rental
After-tax lease rentals
Depreciation
Dep. tax-shield lost
Net cash flows
PVF at 10.4%
PV
Net present value at 10.4%
IRR
Equivalent loan

75
35%
25%
16%
10.4%
0
17.80

0
75
-20
-13

62
1.000
62.00
2.61
8.5%

-20
-13
18.75
-6.56
-19.56
0.906
-17.72

-20
-13
14.06
-4.92
-17.92
0.820
-14.70

-20
-13
10.55
-3.69
-16.69
0.743
-12.40

Year
0
1
2
3
NCF
19.56
17.92
16.69
Before-tax interest
9.50
7.36
5.26
After-tax interest
6.18
4.78
3.42
Principal repaid
13.39
13.14
13.27
Loan outstanding
59.39
46.01
32.87
19.60
As per the current tax rules, a company can claim depreciation on asset (even if sold) provided the block of assets exists with positive balance. We assu
going concern. This, therefore, implies that DTS on the asset is available for ever. The fifth year DTS includes DTS after 5th year. This has been calcul
book value at the end of fifth year (Tax rate Depreciation rate)/(Depreciation rate + Discount rate). The salvage value is assumed to be z

Problem 3
Tax rate
Cost of borrowing
After-tax cost of borrowing
WDV depreciation rate

Year
Purchase price avoided
Lease rental
After-tax lease rentals
Depreciation
Dep. Tax-shield lost
Operating cost
After-tax operating cost
Salvage value lost
DTS on lost SV
NCF
PVF at 9.1%

35%
14%
9.10%
25%

0
30

-8.4
-5.46
7.50
-2.63
0
0
0

-8.4
-5.46
5.63
-1.97
0
0
0

-8.4
-5.46
4.22
-1.48
0
0
0

30
-8.09
-7.43
-6.94
1.000
0.917
0.840
0.770
30.00
-7.41
-6.24
-5.34
Net present value 9.1%
0.18
0.18
IRR
8.9%
As per the current tax rules, a company can claim depreciation on asset (even if sold) provided the block of assets exists with positive balance. We assu
going concern. This, therefore, implies that DTS on the asset is available for ever. The fifth year DTS includes DTS after 5th year. This has been calcul
book value at the end of fifth year (Tax rate Depreciation rate)/(Depreciation rate + Discount rate). The lessee also loses salvage value. Since salva
is deducted from gross block, DTS on salvage value will be reversed. Salvage value is riskier, and hence, it should be discounted at the cost of capital.
case we do not have information about the cost of capital. Therefore, we have used after-tax borrowing cost as the discount rate.

Problem 4

In solving this problem, the lessees borrowing rate is assumed to be 14%. Thus 14% is considered as the after-tax required rate of return of the lessor.
Lessee's tax rate
0%
Lessee's cost of borrowing
14%
After-tax cost of borrowing
14%
Lessor's cost of capital
14%
Lessor's tax rate
35%
WDV depreciation rate
25%
Lessee's lease evaluation
Year
Purchase price avoided

0
20

Lease rental
After-tax lease rentals (T=0)
Depreciation
Dep. tax-shield lost
Operating cost
After-tax operating cost
Salvage value
NCF
PVF at 14%
PV
Net present value at 14%
IRR
Since lessee pays no tax, depreciation is worthless for him.
Break-even lease rentals of the lessee:

-5
-5
5.00
0
0
0
0
-5
0.877
-4.39
2.83

20
1.000
20.00
2.83
7.93%

-5
-5
3.75
0
0
0
0
-5
0.769
-3.85

-5
-5
2.81
0
0
0
0
-5
0.675
-3.37

NPV 20 - PV of After - tax lease rentals (ATLR) - PV of dep. tax shield = 0


NPV = 20 - 3.4331 ATLR - 0 = 0
ATLR = 20/3.4331 = 5.83

Since lessees tax rate is zero, the before- and after-tax lease rentals are same.
Lessor's lease evaluation
Year
Purchase price avoided
Lease rental
After-tax lease rentals (T=35%)
Depreciation
Dep. tax-shield lost
Operating cost
After-tax operating cost
Salvage value
NCF
PVF at 14%
PV
Net present value at 14%
IRR
Break-even lease rentals of the lessor:

0
-20

-20
1.000
-20.00
-4.36
4.36%

5
3.25
5.00
1.75
0
0
0
5.00
0.877
4.39
-4.36

5
3.25
3.75
1.31
0
0
0
4.56
0.769
3.51

5
3.25
2.81
0.98
0
0
0
4.23
0.675
2.86

NPV 20 PV( ATLR ) PV( DTS ) 0


NPV 20 3.433(1 0.35) BTLR 4.49 0
BTLR 15.51 / 2.23 6.95
Problem 5
Rs '000
Purchase price
Monthly lease rental
Tax rate
After-tax lease rentals
No of years
No of months
Dep rate

150
2.5
0
2.5
8
96
0
Annual

Before-tax borrowing rate


After-tax borrowing rate
PVAF (annuity due), 0.833%, 96
PV of lease payments : [(2.5 x 66.45)
NPV of lease payments : [(2.5 x 66.45) - 150]

Monthly
10%
10%

0.00833
0.00833
66.4507
166.13
16.13

IRR
Borrowing and buying is cheaper.

13.1%

1.1%

Problem 6
Tax rate
Cost of borrowing
After-tax cost of borrowing
Cost of capital
WDV depreciation rate

35%
14%
9.1%
16%
25%

(a)
Year
0
1
2
3
Purchase price avoided
80
Lease rental
-20
-20
-20
-20
After-tax lease rentals (T = 35%)
-13
-13
-13
-13
Depreciation
20.00
15.00
11.25
Dep. tax-shield lost
-7.00
-5.25
-3.94
Operating cost
0
0
0
After-tax operating cost
0
0
0
Salvage value
0
0
0
NCF
67
-20.00
-18.25
-16.94
Net present value
4.45
IRR
6.2%
As per the current tax rules, a company can claim depreciation on asset (even if sold) provided the block of assets exists with positive balance. We assu
that DTS on the asset is available for ever. The fifth year DTS includes DTS after 5th year. This has been calculated as: book value at the end of fifth y
(Depreciation rate + Discount rate).

(b)
Year
0
1
2
3
Purchase price avoided
80
Lease rental
-20
-20
-20
-20
After-tax lease rentals
-13
-13
-13
-13
Depreciation
20.00
15.00
11.25
Dep. tax-shield lost
-7.00
-5.25
-3.94
Operating cost saved
1.00
1.00
1.00
After-tax operating cost
0.65
0.65
0.65
Salvage value
DTS lost on SV
NCF
67
-19.35
-17.60
-16.29
Net present value
3.0
IRR
4.4%
As per the current tax rules, a company can claim depreciation on asset (even if sold) provided the block of assets exists with positive balance. We assu
that DTS on the asset is available for ever. The fifth year DTS includes DTS after 5th year. This has been calculated as: book value at the end of fifth y
(Depreciation rate + Discount rate). The lessee also loses salvage value. Since salvage value is deducted from gross block, DTS on salvage value will b
operating costs are riskier, hence, they will be discounted at the cost of capital.

Hire purchase instalment: The above calculations reveal that after-tax lease cash flows can service net borrowing of Rs 70 lakh (67 + 3). Given the co
determine the maximum up-fronted hire purchase instalment. However, under hire purchase, the hiree will avail DTS and salvage value. Therefore, his

Amount (Rs lakh)


PVAF14%,5 (annuity due)
Before-tax instalment (Rs lakh)

70
3.9137
17.89

Rs lakh
4

-1.75
-1.14
1.05
-0.37
0
0
0
-1.51
0.689
-1.04

-1.75
-1.14
0.79
-0.28
0
0
0
-1.41
0.628
-0.89

-1.75
-1.14
0.59
-0.21
0
0
0
-1.35
0.572
-0.77

-1.75
-1.14
0.44
-0.16
0
0
0
-1.29
0.521
-0.67

-1.75
-1.14
0.33
-0.12
0
0
0
-1.25
0.475
-0.60

4
1.51
0.79
0.51
1.00
4.25
nored in the above calculations.

5
1.41
0.64
0.41
1.00
3.25

6
1.35
0.49
0.32
1.03
2.22

7
1.29
0.33
0.22
1.08
1.14

8
1.25
0.17
0.11
1.14
0

-20
-13
7.91
-2.77
-15.77
0.673
-10.61

0
0
5.93
-6.48
-6.48
0.610
-3.95

4
5
15.77
6.48
3.14
0.94
2.04
0.61
13.73
5.87
5.87
0
sets exists with positive balance. We assume a
DTS after 5th year. This has been calculated as:
he salvage value is assumed to be zero.

Rs lakh
4

-8.4
-5.46
3.16
-1.11
0
0
0

-8.4
-5.46
4.20
-1.47
0
0
-3.56
0.91
-9.58
0.647
-6.20

-6.57
0.706
-4.64

sets exists with positive balance. We assume a


DTS after 5th year. This has been calculated as:
see also loses salvage value. Since salvage value
ould be discounted at the cost of capital. In this
the discount rate.

-tax required rate of return of the lessor.

(Rs lakh)
5

-5
-5
2.11
0
0
0
0
-5
0.592
-2.96

-5
-5
1.58
0
0
0
0
-5
0.519
-2.60

5.83

Rs lakh
4

5
3.25
2.11
0.74
0
0
0
3.99
0.592
2.36

5
3.25
1.58
1.62
0
0
0
4.87
0.519
2.53

6.95

5 Dis. Rate

PV
80.00

-20
-13
8.44
-2.95
0
0
0
-15.95

6.33
-7.09
0
0
0
-7.09

9.1%

-55.02

9.1%

-20.53

16%
16%
4.45

sets exists with positive balance. We assume a going concern. This, therefore, implies
ulated as: book value at the end of fifth year (Tax rate Depreciation rate)/

5 Dis. Rate

PV
80.00

-20
-13
8.44
-2.95
1.00
0.65

-15.30

6.33
-7.09
1.00
0.65
-10.00
2.57
-6.44

9.1%

-55.02

9.1%

-20.53

16%
16%
16%

2.13
-4.76
1.22
3.0

sets exists with positive balance. We assume a going concern. This, therefore, implies
ulated as: book value at the end of fifth year (Tax rate Depreciation rate)/
gross block, DTS on salvage value will be reversed. Salvage value, DTS on it and

wing of Rs 70 lakh (67 + 3). Given the cost of borrowing of 14 per cent, we can
il DTS and salvage value. Therefore, his net cash outflow will be much less.

Chapter 24: Financial Statements and Cash Flow Analysis


Problem 1
Sources
Internal funds
Net profit
Add: Depreciation (90,000 - 67,500)
15% Debenture
Total
Uses
Investment
Land
Machinery
Dividend

(Rs)
157,500
22,500

180,000
240,000
420,000

45,000
48,000
112,500
87,000
292,500
Increase in working capital
127,500
Total
420,000
Note: Share capital has increased due to bonus issue which does not affect funds. Bonus issue causes a notional transfer from
reserve and surplus to share capital.
Problem 2

Total

19X2
(Rs)
82,000
104,000
112,000
22,000
380,000
36,000
736,000

19X1
(Rs)
22,000
24,000
60,000
14,000
360,000
40,000
520,000

Change
(Rs)
60,000
80,000
52,000
8,000
20,000
-4,000
216,000

Total

30,000
100,000
102,000
12,000
190,000
30,000
272,000
736,000

14,000
60,000
102,000
18,000
90,000
0
236,000
520,000

16,000
40,000
0
-6,000
100,000
30,000
36,000
216,000

Assets
Cash
Debtors
Stock
Prepaid expenses
Plant and machinery
Goodwill
Equities
Creditors
Provision for depreciation
Debentures
Premium on debentures issue
Share capital
Share premium
Reserves and surplus

Statement of Changes in Financial Position: Working Capital Basis


Sources
Profit
Add: Depreciation
Add: Goodwill written off
Less: Debenture premium written off
Funds from operations
Share capital
Share premium
Total
Uses
Plant & Machinery

(Rs)
66,000
40,000
4,000
-6,000
104,000
100,000
30,000
234,000
20,000

Dividend (66,000 - 36,000)

30,000
50,000
184,000
234,000

Increase in working capital


Total

Schedule for Changes in Working Capital


19X2
(Rs)
82,000
104,000
112,000
22,000
320,000
30,000
290,000

Cash
Debtors
Stock
Prepaid expenses
Total
Less: creditors
Increase in Working Capital

Statement of Changes in Financial Position: Cash Basis


Sources
Profit
Add: Depreciation
Add: Goodwill written off
Less: Debenture premium written off
Funds from operation
Less: Increase in current assets
Add: Increase in current liabilities
Cash from operation
Share capital
Share premium
Total
Uses
Plant & Machinery
Dividend
Increase in cash
Total

19X1
(Rs)
22,000
24,000
60,000
14,000
120,000
14,000
106,000

(Rs)
66,000
40,000
4,000
-6,000
104,000
140,000
16,000
-20,000
100,000
30,000
110,000
20,000
30,000
50,000
60,000
110,000

Problem 3
Statement of Changes in Financial Position
Sources
Net profit
Add: Depreciation
Add: Provision for doubtful debts
Less: Gain on sale of machine
Less: Gain on sale of investment
Long-term investment
Sale of machine
Total
Uses
Purchase of machine
Purchase of Building
Cash dividend
Loan adjustment

(Rs)
27,500
5,750
500
-1,000
-2,500
30,250
12,500
3,000
45,750
10,000
7,500
13,250
2,500

33,250
12,500
45,750

Increase in working capital


Total

Problem 4
M COMPANY
Statement of changes in working capital
Sources
Profit before tax
Less: Tax provision
Add: Depreciation
Internal funds
Share capital
Sale of other non-current assets
Long-term debt

(Rs)
42,000
21,000
15,000
36,000
18,000
9,000
45,000
108,000

Total
Uses
Purchase of fixed assets [165,000 - (150,000 - 15,000)]
Cash dividend
Increase in working capital
Total

30,000
9,000
69,000
108,000

Statement of Changes in Cash Flow


Sources
Profit before tax
Less: Tax paid (9,000 + 21,000 - 15,000)
Add: Depreciation

(Rs)
42,000
15,000
15,000
42,000
9,000

Add:
Increase in bills payable
Decrease in marketable securities
Less:
Increase in debtors
Increase in stocks
Decrease in creditors
Decrease in cash used from operation
Sale of other non-current assets
Share capital
Long-term debt

6,000

Total

15,000
9,000
60,000
-27,000
9,000
18,000
45,000
45,000

Total

30,000
9,000
39,000
6,000
45,000

Uses
Purchase of fixed assets
Cash dividend
Decrease in Cash

Schedule for Changes in Working Capital


19X1
(Rs)
Current Assets
Cash

15,000

19X2
(Rs)

Change

9,000

-6,000

Marketable securities
Debtors
Stock
Total
Current liabilities
Creditors
Bills payable
Accrued expenses
Tax payable
Total
NWC

15,000
30,000
36,000
96,000

21,000
45,000
45,000
120,000

6,000
15,000
9,000
24,000

60,000
15,000
6,000
9,000
90,000
6,000

0
24,000
6,000
15,000
45,000
75,000

-60,000
9,000
0
6,000
-45,000
69,000

Problem 5
J B SONS COMPANY
Statement of Sources & Uses of Funds
Sources
Net earnings
Add: Depreciation

(Rs)

Total

5,000
10,000
15,000

Total

10,000
15,000
3,000
28,000
-13,000
15,000

Uses
Payment of loan
Fixed assets [65,000 - (60,000 - 10,000)]
Cash dividend
Decrease in working capital

Working Capital Changes


Current assets
Less: Current liabilities
Working capital

19X1
40,000
30,000
10,000

19X2
35,000
38,000
-3,000

Change
-5,000
8,000
-13,000

Problem 8
Changes in Cash flow
(Rs)
Sources
Profit before depreciation & taxes
Less:
Tax
Increase in stock
Increase in bills receivable
Add:
Decrease in debtors
Decrease in creditors
Cash from operation
Share capital: 5,000 x Rs 15
Plus: Bank balance
Total cash inflow
Bank overdraft

240,000
-137,500
-140,000
-7,500
45,000
80,000
80,000
75,000
180,000
335,000
67,500

Total

402,500

Total

370,000
32,500
402,500

Uses
Purchase of fixed assets
Cash dividend

Note: Cash dividend includes tax on dividend which is also an outflow from the companys point of view.
Problem 7
PANDIT SONS LIMITED
Statement of Sources & Uses of Funds
Sources
Net income
Add: Depreciation
Add: Loss on sale of machine
Less: Gain on sale of investment
Internal funds
Share capital (150 + 60)
Debenture
Sale of investment
Sale of machinery
Total

(Rs)
40
130
5
-12
163
210
250
52
15
690

Total

175
400
29
604
86
690

Uses
Purchase of machine
Purchase of building
Cash dividend
Increase in working capital

Change in Working Capital


19X2
(Rs)
Current assets
Current liabilities
Total

19X1
(Rs)
666
150
516

Change
(Rs)
530
100
430

136
50
86

Notes:
1.
Retained earnings have increased by Rs 11,000 while net earnings are Rs 40,000. It is implied that cash dividend of Rs
29,000 is paid.
2.
The total depreciation charged during the year is Rs 130,000 (income statement). The change in accumulated depreciation
is Rs 125,000. Thus the difference, Rs 5,000, is the accumulated depreciation on the machinery that was sold during the year.
The proceeds from the machine were Rs 15,000 and a loss of Rs 5,000 was incurred. Thus the book value of the machine was Rs
20,000, and its original cost was Rs 25,000.

3.
The balance of machinery at the end of 19X2 is Rs 500,000. The balance at the beginning was Rs 350,000. After the sale
of machinery which had original cost of Rs 25,000, the balance at the end should have been Rs 325,000. Thus new machinery
worth Rs 175,000 (Rs 500,000 - Rs 325,000) was acquired during the year.

Problem 8
ALPHA CO.

Funds Flow Statement


(Rs)
Sources
Funds from operation
Sale of land
Sale of machine
Equity share capital
Total

86,000
50,000
10,000
100,000
246,000

Total

11,000
142,000
50,000
20,000
223,000
23,000
246,000

Uses
Purchase of investment
Purchase of machinery
Pref. share capital
Interim dividend
Increase in working capital

Funds from operations:


General reserve
Pre-acquisition profit
P&L
Depreciation
Loss on sale of machine
Goodwill written off
Preliminary exp. written off
Interim dividend

10,000
1,000
18,000
10,000
2,000
20,000
5,000
20,000
86,000

Statement of Changes in Working Capital


Current assets
Sundry debtors
Stock
Bills receivable
Cash in hand
Cash at bank
Total
Current liabilities
Proposed dividend
Sundry creditors
Bills payable
Liabilities for expenses
Provision for taxation
Total
Working capital

19X1
(Rs)
140,000
77,000
20,000
15,000
10,000
262,000

19X2
(Rs)
170,000
109,000
30,000
10,000
8,000
327,000

Change
(Rs)
30,000
32,000
10,000
-5,000
-2,000
65,000

42,000
25,000
20,000
30,000
40,000
157,000
105,000
262,000

50,000
47,000
16,000
36,000
50,000
199,000
128,000
327,000

8,000
22,000
-4,000
6,000
10,000
42,000
23,000
65,000

Problem 9
C VICTORY LTD
Statement of Sources & Application of Funds
Sources
Net profit
Add: Depreciation

(Rs)
65,530
24,600

Less: Tax
Funds from operation
Uses
Purchase of machine
Interim dividend
Final dividend

-25,000
65,130
5,600
26,000
13,000
44,600
20,530
65,130

Increase in working capital


Total

Schedule of Changes in Working Capital


19X1
(Rs)
Current assets
Cash at bank
Sundry debtors
Stock
Acquired stock
Total (A)
Current liabilities
Sundry creditors
Bills payable
Bank overdraft
Provision for taxation
Total (B)
Working capital (A - B)

19X2
(Rs)

Change
(Rs)

2,500
87,490
111,040

2,700
73,360
97,370

201,030

173,430

200
-14,130
-13,670
-22,000
-49,600

39,500
33,780
59,510
40,000
172,790
28,240
201,030

41,135
11,525
0
50,000
102,660
70,770
173,430

1,635
-22,255
-59,510
10,000
-70,130
20,530
-49,600

Problem 10
BOMBAY INDUSTRIES
Statement of Sources & Application of Funds
Sources
Income
Add: Depreciation
Funds from operations
Share capital
Profit from sale of land
Total

57.8
8.4
66.2
40.0
15.6
121.8

Uses
Plant etc.
Loan repaid
Dividend paid
Loss on marketable securities

84.6
1.0
25.6
2.8
114.0
7.8
121.8

Increase in working capital


Total

Schedule of Changes in Working Capital


19X1
Cash at bank
Debtors
Stock-in-trade

19X2
44.6
10.8
44.0

Change
47.8
17.0
67.2

3.2
6.2
23.2

Miscellaneous
Total current assets

30.2
129.6

8.0
140.0

-22.2
10.4

Sundry creditors
Provision for taxation
Liabilities for expenses
Total
Working capital

40.4
10.8
2.6
53.8
75.8
129.6

43.2
12.2
1.0
56.4
83.6
140.0

2.8
1.4
-1.6
2.6
7.8
10.4

Notes:
1.
The total proceeds from the purchase and sale of land are not known. Therefore, only profit made on these deals is taken
as source of funds.
2.

Loss on sale of marketable securities has been taken as use of funds since the proceeds from the sale are not known.

Problem 11
PQ LMITED
Statement of Sources & Uses of Cash
Sources
Net profit
Add: Depreciation
Debenture interest
Increase in creditors
Increase in doubtful debts
Less: Gain on sale of machine
Increase in debtors
Increase in stock
Cash from operations
Sale of machine
Profit on sale of property
Debenture (net realisation)
Increase in bank borrowings
Total

Uses
Dividend
Purchase of plant
Trade investment
Debenture interest

(Rs)
76,500
27,900
7,000
11,800
3,300
-2,500
-50,000
-38,500
35,500
7,000
6,200
49,000
97,700
64,300
162,000

30,000
78,000
47,000
7,000
162,000

Notes:
1.
The difference between the freehold property at cost and at valuation is: 165,000 - 122,000 = Rs 43,000; it is a non-cash item. This amount is
balance: 49,200 - 43,000 = Rs 6,200 represent profit on sale of property. The total proceeds from the sale of property are not known. The profit, R
source of cash.
2.
The accumulated depreciation after the sale of plant with accumulated depreciation of Rs 13,500 should have been: 107,600 - 13,500 = Rs
depreciation during the year is: 122,000 - 94,100 = Rs 27,900.

3.
The value (gross) of plant after the sale of plant costing Rs 18,000 should have been: 223,000 - 18,000= Rs 205,000. Since it is Rs 283,000, pla
been bought during the year.
Problem 12
CD LIMITED

Statement of Source & Disposition of Funds


Sources
Profit
Add:
Depreciation
Loss on sale of fixture
Debenture redemption premium
Less:
Profit on sale of machine tool

(Rs)
42,000
19,000
1,000
1,000
-1,000
62,000
70,000
3,000
2,000
137,000

Share capital
Sale of machine tool
Sale of fixture
Uses
Debenture redemption
Freehold property
Plant & machinery
Fixtures

42,000
20,000
39,000
10,000
111,000
26,000
137,000

Increase in working capital

19X1
(Rs)
37,000
43,000

Current assets
Stocks
Debtors
Bank balance
Total
Current liabilities
Bank overdraft
Creditors
Proposed dividends
Total
Working capital

80,000

19X2
(Rs)
51,000
44,000
16,000
111,000

Change
(Rs)
14,000
1,000
16,000
31,000

14,000
34,000
15,000
63,000
17,000
80,000

0
48,000
20,000
68,000
43,000
111,000

-14,000
14,000
5,000
5,000
26,000
31,000

Change
(Rs)
60,000
80,000
52,000
8,000
200,000
16,000
184,000

t is a non-cash item. This amount is included in capital reserve. The


operty are not known. The profit, Rs 6,200 has been shown as the
have been: 107,600 - 13,500 = Rs 94,100. Since it is Rs 122,000,

s 205,000. Since it is Rs 283,000, plant worth Rs 78,000 would have

Chapter 25: Financial Statement Analysis


Problem 8
Table 25.36: Jagan Ltd.
Balance Sheet
Liabilities and equity
Creditors
Debentures
Share capital
Reserves
Total
Assets
Cash
Debtors
Stock
Fixed assets, net
Total
Table 25.37: Jagan Ltd.
Profit & Loss Account
Sales
Cost of goods sold
Gross profit
Operating expenses
EBIT
Interest
Profit before tax
Tax
Net profit
No. of shares
P/E ratio

25
250
1,000
225
1,500

25
1,000
1,000
225
2,250

25
1,750
1,000
225
3,000

25
2,500
1,000
225
3,750

25
3,250
1,000
225
4,500

50
50
400
1,000
1,500

50
50
650
1,500
2,250

50
50
900
2,000
3,000

50
50
1,150
2,500
3,750

50
50
1,400
3,000
4,500

300
100
200
25
175
15
160
67.55
92.45
100

450
150
300
50
250
67.5
182.5
75.35
107.15
100

600
200
400
100
300
127.5
172.5
73.55
98.95
100

750
250
500
150
350
195
155
65.15
89.85
100

900
300
600
200
400
270
130
53.1
76.9
100
3.5

3.5

Problem 12

ASEETS
Gross fixed assets
Less: Cumulative depreciation
Net fixed assets
Investments
Current Assets
Inventories
Receivables
Marketable investment
Cash and bank balance
Misc. expenses not written off
Total Assets
CAPITAL & LIABILITIES
Net worth
Share capital

Table 25.42: Tata Iron & Steel Co. Ltd.


Summarised Balance Sheet as on 31 March
1995
1996
1997
1998

1999

2000

6,962.89
1,749.41
5,213.48
220.65

7,408.46
2,014.90
5,393.56
410.94

7,850.82
2,324.42
5,526.40
664.9

8,948.52
2,648.48
6,300.04
626.08

10,032.17
2,973.59
7,058.58
588.84

10,668.33
3,241.95
7,426.38
818.89

865.34
1,341.87
175.51
162.44
2,545.16
31.33
7,835.11
8,010.62
2,688.04
336.87

1,076.57
1,723.63
365.75
437.09
3,603.04
167.99
9,209.78
9,575.53
3,742.40
367.23

1,021.11
2,178.76
479.77
251.38
3,931.02
278.32
9,920.87
10,400.64
3,974.02
367.38

1,039.70
1,948.40
453.03
462.96
3,904.09
896.98
11,274.16
11,727.19
4,064.88
367.55

1,016.51
1,874.18
399.51
336.19
3,626.39
1,118.53
11,992.83
12,392.34
4,164.42
367.77

944.85
1,868.77
342.35
232.87
3,388.84
828.12
12,119.88
12,462.23
4,558.40
517.77

Equity capital
Preference capital
Reserves & surplus
Total borrowings
Current liabilities & provisions
Current liabilities
Sundry creditors
Others
Provisions
Tax provision
Dividend provision
Other provisions
Total Liabilities

336.87
0
2,351.17
3,582.73
1,564.34
1,421.51
1,256.72
164.79
142.83
21.24
118.24
3.35
7,835.11

367.23
0
3,375.17
3,842.07
1,625.31
1,326.82
1,203.97
122.85
298.49
18.96
156.97
122.56
9,209.78

367.38
0
3,606.64
4,082.49
1,864.36
1,385.47
1,251.00
134.47
478.89
111.4
165.66
201.83
9,920.87

367.55
0
3,697.33
5,212.44
1,996.84
1,414.66
1,296.61
118.05
582.18
150.58
147.25
284.35
11,274.16

367.77
0
3,796.65
5,503.26
2,325.15
1,463.35
1,340.17
123.18
861.8
185.53
147.11
529.16
11,992.83

367.77
150
4,040.63
4,946.52
2,614.96
1,492.55
1,345.65
146.9
1122.41
167.04
147.11
808.26
12,119.88

Table 25.43 Tata Iron & Steel Company Limited


Summarised Profit & Loss Account for the Year ending on 31 March
(Rs crore)
1995

1996

1997

1998

1999

2000

4,993.39
440.77
4,552.62
44.58
-17.35
16.03
4,595.88

6,349.35
592.61
5,756.74
76.18
66.24
0.35
5,899.51

6,919.40
696.49
6,222.91
150.52
42.12
11.20
6,426.75

7,012.35
724.34
6,288.01
117.16
4.80
27.59
6,437.56

6,885.12
710.09
6,175.03
96.73
46.18
139.84
6,457.78

7,015.16
796.86
6,218.30
68.51
-33.19
152.44
6,406.06

PBDIT
Less: Depreciation
PBIT
Less: Interest
PBT
Less: Tax provision
PAT

808.10
262.26
545.84
281.40
264.44
0.25
264.19

1,212.74
297.61
915.13
348.91
566.22
0.43
565.79

1,260.45
326.83
933.62
390.66
542.96
73.75
469.21

1,030.38
343.23
687.15
323.42
363.73
41.65
322.08

1,058.26
382.18
676.08
360.35
315.73
33.50
282.23

1,291.98
426.54
865.44
388.35
477.09
54.50
422.59

Appropriation of Profit
Equity Dividends
Dividend Tax
Retained earnings

118.24
0.00
145.95

156.97
0.00
408.82

165.66
16.57
286.98

147.25
14.73
160.10

147.11
16.18
118.94

154.86
17.04
250.69

530.35
681.14
4,504.29
1,501.19
1,238.93

867.30
638.86
5,795.26
2,174.54
1,876.93

801.69
881.30
6,238.20
2,205.36
1,878.53

665.31
880.44
6,257.51
2,055.30
1,712.07

664.41
1,007.98
6,189.62
1,998.68
1,616.50

849.13
1,323.94
6,154.84
2,273.55
1,847.01

Income
Sales
Less: Excise
Net sales
Other income
Change in stocks
Non-recurring income
Total Income

Other Financial Items


Cash profit
Cash flow from business activities
Value of output
Gross value added
Net value added

Problem 13
Table 25.44: Agro-Chemicals & Pesticides Companies

Sales
PBDIT
Dep.
PBIT
Int.
PBT
Tax
PAT
EPS
DPS
Book value
Market value

Financial Data for the Year ending 31 March 19X2


CynaKhaMonMonBuyer
mide
Excel
itau
santo
tari
218.43
100.46
175.31
26.85
14.32
59.69
33.69
15.15
39.83
5.12
1.72
7.61
5.33
1.91
4.12
1.30
0.04
1.22
28.36
13.24
35.71
3.82
1.68
6.39
11.29
2.07
7.59
2.64
0.36
4.44
17.07
11.17
28.12
1.18
1.32
1.95
8.25
5.09
9.50
0.00
0.70
0.00
8.82
6.08
18.62
1.18
0.62
1.95
54.38
11.56
26.87
2.34
6.20
3.18
24.00
3.50
10.10
2.50
2.30
2.20
268.50
52.23
62.37
19.21
25.40
14.67
2,100.00
280.00
630.00
47.50
250.00
120.00

Problem 14
Alembic

Sales
PBIT
Interest
Tax
PAT
Per share data
EPS
DPS
BV
MV

19X1
19X2
19X1
19X2
19X1
19X2
19X1
19X2
19X1
19X2
19X1
19X2
19X1
19X2
19X1
19X2
19X2

19.8
28.2
1.6
2.7
1.3
1.7
0.0
0.0
0.3
1.0
11.3
38.5
0.0
0.0
93.8
129.6
575.0

Ashi

Borosil

Excel

Fgp

19.3
26.4
1.9
4.2
1.5
2.1
0.1
0.0
0.3
2.1

24.7
31.1
3.8
5.9
1.9
2.1
0.7
1.8
1.2
2.0

9.7
13.5
0.7
1.2
8.4
0.6
0.1
0.1
0.2
0.5

29.4
30.8
4.7
4.0
1.4
1.6
1.2
0.4
2.1
2.0

1.7
11.2
1.0
1.5
12.3
22.5
227.5

3.1
5.6
2.5
0.3
45.4
48.6

1.5
3.7
1.4
1.8
20.4
22.2

3.5
3.1
2.2
2.2
31.4
32.3

85.0

75.0

85.0

2001
11,258.17
3,720.08
7,538.09
850.83
921.77
2,060.70
381.38
239.78
3,603.63
920.29
12,531.46
12,912.84
4,888.43
507.77

ies

367.77
140
4,380.66
4,672.56
2,970.47
1,696.38
1,574.35
122.03
1274.09
180.2
183.89
910
12,531.46

2001
7,822.58
920.83
6,901.75
86.53
-56.74
13.15
6,944.69
1,507.68
492.25
1,015.43
412.39
603.04
49.60
553.44

196.09
21.52
335.83

1,045.69
1,718.70
6,812.71
2,732.10
2,239.85

2
PauUP
shak
Searle
straw
United
12.30
74.36
160.00
101.17
1.50
9.71
1.77
22.75
0.20
1.14
0.50
1.34
1.30
8.57
1.27
21.41
0.69
2.58
0.31
18.21
0.61
5.99
0.96
18.21
0.08
1.80
0.00
4.00
0.53
4.19
0.96
14.21
6.24
8.03
3.54
20.01
1.70
2.50
0.00
5.00
27.18
57.85
15.72
33.72
130.00
280.00
58.00
590.00

Hind

Indo

66.2
76.7
6.3
8.2
3.0
3.0
0.0
0.0
3.3
4.4
22.8
30.5
1.0
1.0
96.5
126.9
35.0

Maha

54.3
83.0
12.3
12.6
1.6
1.3
1.7
6.0
9.0
5.3

9.7
12.4
1.0
1.5
0.5
0.6
0.0
0.4
0.5
0.5

27.8
8.2
4.0
3.0
63.0
45.6
145.0

3.7
3.7
1.4
1.4
17.7
20.0

Tri

Vic

31.5
48.2
6.2
14.9
0.8
0.7
2.0
6.3
3.4
7.9

6.0

29.2
67.7
3.0
3.6
115.0
180.3
675.0

Industry

7.8
8.2
1.0
1.4
0.6
0.0
0.0
0.0
0.4
0.6

271.5
338.5
39.6
56.5
13.0
15.3
5.7
15.1
20.9
26.1

3.5
4.9
1.5
2.0
17.1
20.0
45.0

Chapter 25: Financial Statement Analysis

Problem 1
(a)
Ratios
(i) NP/NA
(ii) NP/Sales
(iii) GP/Sales
(iv) CA/CL (times)
(v) Liquid ratio (times)
(vi) Stock turnover (times)

S Ltd.
8,000/100,000 =
8,000/160,000 =
64,000/160,000 =
90,000/30,000 =
(90,000 - 57,000)/30,000 =
96,000/57,000 =

T Ltd.
8% 6,000/50,000 =
5% 6,000/120,000 =
40% 45,000/120,000 =
3.0 60,000/30,000 =
1.10 (60,000 - 30,000)/30,000 =
1.68 75,000/30,000 =

12.0%
5.0%
37.5%
2
1
2.5

(b) S Ltd. has higher gross profit margin than T Ltd. But the two firms have equal net margin and T Ltd. has a higher net profit to
net assets ratio. This implies that S Ltd. has higher operating expenses as well as lower assets turnover as compared to T Ltd. T
Ltd. is more efficient in turning over its stock, but it has lower liquidity as reflected by current and liquid ratios.

Problem 2
Solvency ratios
(i) Current ratio: CA/CL
(ii) Liquidity ratio: (CA - stock)/CL

Year I
1.6
1.3

Year II
1.4
1.0

35
11.7

15
10

31

36

6.3%

6.0%

(iii) Stock turnover: sales/stock


(iv) Debtors turnover: sales/debtors
(v) Collection period: 360/debtors turnover
(vi) NWC/Sales

XYZ Ltd.s solvency position has deteriorated. Its current ratio, liquidity ratio, stock turnover and debtors turnover have declined
in year II. However, net working capital (current assets minus current liabilities) as a percentage of sales has almost remained at
the same level. The implication is that the company has incurred more current liabilities (creditors and bank overdraft) to finance
its higher current asset requirements.
Problem 3
Industry
average
Current ratio
Quick ratio
Debt-equity ratio
Times interest earned
Inventory turnover
Fixed-asset turnover
Total assets turnover
Net profit margin
Return on assets (PBIT/TA)
Return on equity

2.95
1.05
0.50
2.60
0.35
0.8
0.5
16.00%
15.00%
21.00%

ABC Ltd

Comments

2.68 Comparable with industry average


1.22 Comparable with industry average
0.23 Lower than industry average
4.38 Higher than industry average
0.23 Lower than industry average
0.66 Higher than industry average
0.20 Lower than industry average
15.65% Comparable with industry average
6.08% Lower than industry average
4.23% Lower than industry average

ABC Ltd.s short-term solvency (as shown by current ratio and quick ratio) is comparable with the industry average. It is
conservatively financed and has a strong long-term solvency (debt-equity ratio and times interest earned). But the company is
generally inefficient in utilising its assets and controlling its expenses. As a result, its profitability is much lower than the industry
average. The company must take measures to reduce its expenses, improve its working capital management and increase
productivity of its fixed assets.

Problem 4

A. Sales
B. Total assets
C. Net profit
1. Assets turnover [A/B]
2. Net margin [C/A]
3. ROI [1 x 2 or C/B]

N
(Rs)
800,000
4,000,000
750,000
20.00%
93.75%
18.75%

M
(Rs)
200,000
600,000
420,000
33.33%
210.00%
70.00%

M has much lower sales than N. But it is much more efficient. Its assets productivity is high as well as its margin is very high.
Thus, overall, it earns a higher return on assets than N.
Problem 5
JAGAN LTD.
Current ratios
Current ratio [CA/CL]
Quick ratio [(CA-Stock)/CL]
Activity ratios
Sales/net assets
Sales/fixed assets
Sales/net current assets
Sales/stock
Average inventory holding (days)
Sales/debtors
Average collection period (days)
Capital structure ratios
Debt-equity ratio
Debt/capital employed ratio
Times interest earned [EBIT/Int.]
Profitability ratios
Gross margin [GP/sales]
Net margin [NP/sales]
EBIT/sales
Operating expenses/sales
Interest/sales
ROI [EBIT/NA]
ROI [NP/NA]
ROE [NP/NW]
Notes:
Net current assets [NCA=CA-CL]
Net assets [NCA+NFA]

19X1

19X2

19X3

19X4

19X5

20
4

30
4

40
4

50
4

60
4

0.20
0.30
0.63
0.75
480
6
60

0.20
0.30
0.62
0.69
520
9
40

0.20
0.30
0.62
0.67
540
12
30

0.20
0.30
0.61
0.65
552
15
24

0.20
0.30
0.61
0.64
560
18
20

0.20
16.95%
11.67

0.82
44.94%
3.70

1.43
58.82%
2.35

2.04
67.11%
1.79

2.65
72.63%
1.48

66.67%
30.82%
58.33%
8.33%
5.00%
11.86%
6.27%
7.55%

66.67%
23.81%
55.56%
11.11%
15.00%
11.24%
4.82%
8.75%

66.67%
16.49%
50.00%
16.67%
21.25%
10.08%
3.33%
8.08%

66.67%
11.98%
46.67%
20.00%
26.00%
9.40%
2.41%
7.33%

66.67%
8.54%
44.44%
22.22%
30.00%
8.94%
1.72%
6.28%

Jagan Ltd.s gross margin and assets turnover have remained at the same level during last five years. However, all other measures
of profitability have shown significant decline. The firms debt-equity ratio has sharply increased, and as a consequence, interest
coverage and interest to sales ratio have shown deterioration. The reason for poor profitability is sharp increase in operating
expenses and interest charges (cost of gods sold to sales ratio has remained stable). The company is earning very low return for
the shareholders and perhaps, as result the price-earnings ratio is low and has been declining. Given poor profitability, high debtequity ratio and inefficient inventory management, the overall financial capability of the company is quite week.
Problem 6

Sales: 54,000/0.20
Credit sales: 270,000 x 0.80
Cost of goods sold: 0.80 x 270,000

(Rs)
270,000
216,000
216,000

Long-term debt: 0.40 x 600,000


Inventory: 216,000/4
Total assets: 270,000/0.3
Total liabilities
Shareholders' equity
Creditors: [900,000 - 600,000-240,000]

240,000
54,000
900,000
900,000
600,000
60,000

Debtors
Current assets [60,000 x 1.8]

12,000
108,000

Liabilities
Creditors
Long-term debt
Shareholders equity

Total liabilities

(Rs)
Assets
60,000 Cash
240,000 Debtors
600,000 Inventory

(Rs)
42,000
12,000
54,000

Current
assets

108,000

Fixed assets

792,000

900,000 Total assets

900,000

Problem 7
SUENDRA MOHAN & SONS
Ratios
Sales/total assets
Sales/fixed assets
Sales/current assets
Sales/debtors
Sales/stock
Gross margin
Net margin
Operating expenses/sales
Net profit/total assets (ROI)
Net profit/net worth (ROE)

19X3
1.7
4.8
2.8
5.5
7.8

19X2
1.9
4.7
3.3
7.4
7.2

19X1
1.8
4.1
3.4
9.9
5.9

35.40%
6.00%
29.40%
10.40%
13.90%

39.70%
9.60%
30.20%
17.80%
24.10%

42.40%
12.20%
30.20%
22.20%
29.90%

Current asset/current liability


Quick assets/current liabilities

2.5
1.6

2.2
1.2

2.1
0.9

Debt-equity
Surendra Mohan & Sons is not doing well. Its weak working capital management is reflected by declining stock turnover, debtors
turnover and current assets turnover. The rising current assets are reflected in the higher current ratio and quick ratio which is
good from the short-term lenders point of view. The profitability of the firm is declining; both ROI and ROE have become half
of the ratios three years ago. Gross and net margins have also squeezed. Operating expenses have remained almost stable. The
declining gross margin indicates that the firms cost of goods sold is rising. The firm does not employ any debt. Thus there is no
threat to its long-term solvency.

Problem 8
PLASTIC WORKS LTD.
Activity ratios
19X3
19X2
19X1
Sales/total assets
1.8
2.1
2
Sales/fixed assets
8.2
9
8.9
Sales/current assets
2.4
2.7
2.6
Sales/debtors
8.7
7.7
6.8
Sales/finished stock
7
9
8.2
Profitability ratios
Gross margin
52.10%
52.00%
52.20%
Net margin
3.90%
6.50%
7.50%
Operating expenses/sales
45.20%
40.00%
38.20%
Net profit/total assets (ROI)
7.20%
13.30%
15.00%
Net profit/net worth (ROE)
15.10%
20.80%
22.70%
Liquidity ratios
Current asset/current liability
1.7
2.1
2.3
Quick assets/current liabilities
0.7
0.9
1
Leverage ratio
Debt-equity
0.21
0.02
Plastic Works Limited is not doing well. Its efficiency in utilising its assets to generate sales is showing a weakness. The rising
current assets are reflected in the higher current ratio and quick ratio which is good from the short-term lenders point of view.
The profitability of the firm is declining; both ROI and ROE have decreased significantly. Gross margin has remained same but
net margin has squeezed due too increasing operating expenses. The firm was not using any debt so far but in the most recent
year, it has employed debt and its total debt-equity ratio is 0.21:1 which is not significant in absolute terms. But in view of the
firms poor financial performance, it may find it difficult even to sustain a low debt-equity ratio.

Problem 9

TATA IRON & STEL CO. LTD.


Current ratios
Current ratio [CA/CL]
Quick ratio [(CA-Stock)/CL]
Activity ratios
Net sales/net assets
Net sales/Net fixed assets
Net sales/Current assets

1995

1996

1997

1998

1999

2000

1.63
1.07

2.22
1.55

2.11
1.56

1.96
1.43

1.56
1.12

1.30
0.93

0.73
0.87
1.79

0.76
1.07
1.60

0.77
1.13
1.58

0.68
1.00
1.61

0.64
0.87
1.70

0.65
0.84
1.83

Net sales/Net current assets


Net sales/inventory
Average inventory holding (days)
Net sales/debtors
Average collection period (days)
Capital structure ratios
Debt-equity ratio
Net assets/net worth
Debt/capital employed ratio
Times interest earned [PBDIT/Interest]

4.64
5.26
68
3.39
106

2.91
5.35
67
3.34
108

3.01
6.09
59
2.86
126

3.30
6.05
60
3.23
112

4.75
6.07
59
3.29
109

8.04
6.58
55
3.33
108

1.33
2.33
0.57
2.87

1.03
2.03
0.51
3.48

1.03
2.03
0.51
3.23

1.28
2.28
0.56
3.19

1.32
2.32
0.57
2.94

1.09
2.09
0.52
3.33

17.75%
11.99%
5.80%
6.18%
8.70%
4.21%
9.83%

21.07%
15.90%
9.83%
6.06%
12.07%
7.46%
15.12%

20.25%
15.00%
7.54%
6.28%
11.59%
5.82%
11.81%

16.39%
10.93%
5.12%
5.14%
7.41%
3.47%
7.92%

17.14%
10.95%
4.57%
5.84%
6.99%
2.92%
6.78%

20.78%
13.92%
6.80%
6.25%
9.11%
4.45%
9.27%

44.76%
55.24%

27.74%
72.26%

35.31%
61.16%

45.72%
49.71%

52.12%
42.14%

36.65%
59.32%

0.73
11.99%
8.70%
48.40%
2.33
9.83%

0.76
15.90%
12.07%
61.83%
2.03
15.12%

0.77
15.00%
11.59%
50.26%
2.03
11.81%

0.68
10.93%
7.41%
46.87%
2.28
7.92%

0.64
10.95%
6.99%
41.75%
2.32
6.78%

0.65
13.92%
9.11%
48.83%
2.09
9.27%

2. Net current assets [CA-CL]


3. Net assets [NCA+NFA+ Inest.]

1995
980.82
6,270.77

1996
1,977.73
7,584.47

1997
2,066.66
8,056.51

1998
1,907.25
9,277.32

1999
1,301.24
9,667.68

2000
773.88
9,504.92

4. Capital employed [NW + Debt]

6,270.77

7,584.47

8,056.51

9,277.32

9,667.68

9,504.92

Profitability ratios
Gross margin [PBDIT/sales]
Gross margin [PBIT/sales]
Net margin [NP/sales]
Interest/sales
ROI [EBIT/NA]
ROI [NP/NA]
ROE [NP/NW]
Payout ratio
Retention ratio
Performance analysis
A. Turnover: Net sales/net assets
B. Margin: PBIT/Net sales
C. ROI: PBIT/Net assets [A x B]
D. Leverage (income): PAT/PBIT
E. Leverage (balance sheet) : Net assets/net wor
F. ROE: PAT/Net worth [C x D x E]

Comments:
There appears to be three phases in the performance of TISCO during 1990-1997. The period 1995-96 shows good profitability. The performance
company starts declining in 1997 and drops significantly in 19999, and then again starts improving. ROE is highest at 15% in 1996. The use of d
fluctuating, but debt-equity remains around 1.

Problem 10
AGRO-CHEMICALS & PESTICIDES COMPANIES

Market share
Margin: PBIT/sales
Net margin: PAT/sales
Interest/sales
Leverage factor: PAT/PBT
Interest coverage: PBDIT/interest
P/E ratio

Buyer
23.2%
13.0%
4.0%
5.2%
51.7%
3.0
38.6

Cynamide
10.7%
13.2%
6.1%
2.1%
54.4%
7.3
24.2

Excel
18.6%
20.4%
10.6%
4.3%
66.2%
5.2
23.4

Khatau
2.8%
14.2%
4.4%
9.8%
30.90%
1.9
20.3

Monsanto
1.5%
11.7%
4.3%
2.5%
36.90%
4.8
40.3

Montari
6.3%
10.7%
3.3%
7.4%
30.50%
1.7
37.7

ROE
Payout
Retention ratio
Growth: ROE x Retention ratio
MV/BV

20.3%
44.1%
55.9%
11.3%
7.8

22.1%
30.3%
69.7%
15.4%
5.4

43.1%
37.6%
62.4%
26.9%
10.1

12.2%
106.8%
-6.8%
-0.8%
2.5

24.4%
37.1%
62.9%
15.4%
9.8

21.7%
69.2%
30.8%
6.7%
8.2

Year
20X1
20X2
20X1
20X2
20X1
20X2
20X1
20X2
20X1
20X2
20X1
20X2

Alembic
8.1%
9.6%
1.5%
3.5%
18.8%
37.0%
12.0%
29.7%
0.0%
0.0%
14.9
4.4

Ashi
9.8%
15.9%
1.6%
8.0%
15.8%
50.0%
13.8%
49.8%
58.8%
13.4%
20.3
10.1

Borosil
15.4%
19.0%
4.9%
6.4%
31.6%
33.9%
6.8%
11.5%
80.6%
4.5%
15.2
1.7

Excel
7.2%
8.9%
2.1%
3.7%
28.6%
41.7%
7.4%
16.7%
93.3%
48.6%
20.3
3.4

Fgp.
16.0%
13.0%
7.1%
6.5%
44.7%
50.0%
11.1%
9.6%
62.9%
71.0%
27.4
2.6

Problem 11
GLASS MANUFACTURING COMPANIES

Margin: PBIT/sales
Net margin: PAT/sales
Leverage (income): PAT/PBIT
ROE: EPS/BV
Payout: DPS/EPS
P/E ratio: MV/EPS
MV/BV
Top performers:

20X1

20X2

Market share
Hind.
Indo
Triveni

24.38% Indo
20.00% Hind
11.60% Triveni

24.52%
22.66%
14.24%

Indo
Triveni
Hind.
Industry

44.13% Ashi
25.39% Triveni
23.63% Alembic
18.60% Industry

49.78%
37.55%
29.71%
24.00%

Ashi
Alembic
Triveni
Industry

10.1
4.4
3.7
3.2

ROE

MV/BV

2001

Average

1.21
0.90

1.71
1.23

0.72
0.92
1.92

0.71
0.96
1.72

10.90
7.49
48
3.35
107

5.36
6.13
59
3.26
111

0.96
1.96
0.49
3.66

1.15
2.15
0.53
3.24

21.84%
14.71%
8.02%
5.98%
10.62%
5.79%
11.32%

19.32%
13.34%
6.81%
5.96%
9.50%
4.87%
10.29%

35.43%
60.68%

39.7%
57.2%

0.72
14.71%
10.62%
54.50%
1.96
11.32%

0.71
13.34%
9.50%
50.35%
2.15
10.3%

2001
633.16
9,560.99

Average
1,377.25
8,560.38

9,560.99

8,560.38

ood profitability. The performance of the


ghest at 15% in 1996. The use of debt is

Paushak
1.3%
10.6%
4.3%
5.6%
40.80%
2.2
20.8

UP straw
Searle
7.9%
11.5%
5.6%
3.5%
48.90%
3.8
34.9

17.0%
0.8%
0.6%
0.2%
75.60%
5.7
16.4

United
10.7%
21.2%
14.0%
18.0%
66.40%
1.2
29.5

Ind.
Avg.
12.7%
5.7%
5.9%
50.2%
3.7
28.6

23.0%
27.2%
72.8%
16.7%
4.8

Hind.
9.5%
10.7%
5.0%
5.7%
52.4%
53.7%
23.6%
24.0%
4.4%
3.3%
1.1
0.3

13.9%
31.1%
68.9%
9.6%
4.8

Indo.
22.7%
15.2%
16.6%
6.4%
73.2%
42.1%
44.1%
18.0%
14.4%
36.6%
17.7
3.2

22.5%
0.0%
100.0%
22.5%
3.7

59.3%
25.0%
75.0%
44.5%
17.5

26.2%
40.8%
59.2%
16.8%
7.5

Maha
10.3%
12.1%
5.2%
4.0%
50.0%
33.3%
20.9%
18.5%
37.8%
37.8%
1.6
0.3

Triveni
19.7%
30.9%
10.8%
16.4%
54.8%
53.0%
25.4%
37.5%
10.3%
5.3%
10.0
3.7

Victory
12.8%
17.1%
5.1%
7.3%
40.0%
42.9%
20.5%
24.5%
42.9%
40.8%
9.2
2.3

Industry
14.6%
16.7%
7.7%
7.7%
52.8%
46.2%
18.6%
24.0%
40.5%
50.5%
8.9
3.2

Chapter 27: Working Capital Management Principles


Problem 1
19X1

19X2

(1) Raw material consumed


(2) Raw material inventory
(3) Raw material conversion period (days)
(4) Cost of production
(5) Work-in-process inventory
(6) Work-in-process conversion period (days)
(7) Cost of goods sold
(8) Finished goods inventory
(9) Finished goods conversion period (days)
(10) Cost of sales
(11) Debtors
(12) Debtors conversion period (days)
(13) Purchases
(14) Creditors
(15) Payment deferral period (days)

24
6.8
102
36.9
2
20
37.3
2.8
27
38.6
10.8
101
25.6
4.6
65

32.7
7.6
84
49.2
3.1
23
48.4
3.6
27
50.3
14.9
107
33.5
8
86

Gross operating cycle (days)


Net operating cycle (days)

249
185

240
154

Problem 2
Weeks
Current assets:
Stock of finished goods
Stock of stores, materials etc.
Debtors
Inland sales
Export sales
Advance payment for sundry exp.

Months

6
1.5
Quarterly
Total current assets

Current liabilities:
Wages
Stocks, materials, etc.
Rent, royalties etc.
Clerical staff
Manager
Misc.

1.5
1.5
6
0.5
0.5
1.5
Total current liabilities

Working capital

Problem 3
Per unit
Raw material

80

Total
8,320,000

Direct labour
Overheads
Total cost
Profit
Selling price
Units produced & sold
Cash sales
Credit sales
Raw material consumption
Cost of production

30
60
170
30
200
104,000
5,200,000
15,600,000
8,320,000
17,680,000

Current assets:
Raw material inventory
Materials in process
Finished goods
Debtors
Cash balance

Days

Amount
30
15
30
60

693,333
736,667
1,473,333
2,600,000
25,000
5,528,333

30
10
30

693,333
86,667
520,000
1,300,000
4,228,333
422,833
4,651,167

Total current assets


Current liabilities:
Creditors
Wages
Overheads

3,120,000
6,240,000
17,680,000
3,120,000
20,800,000

Total current liabilities


Add: 10% contingencies
Net working capital
Problem 4
Per unit
Raw material
Direct labour
Overheads
Total cost
Profit
Selling price
Units produced & sold
Sales
Raw material consumption
Cost of production

Current assets:
Raw material inventory
Materials in process
Finished goods
Debtors

42.4
15.9
31.8
90.1
15.9
106
100,000
10,600,000
4,240,000
9,010,000

Weeks

Total
4,240,000
1,590,000
3,180,000
9,010,000
1,590,000
10,600,000

Amount
4
2
4
8

326,154
346,538
693,077
1,630,769

Cash balance (given)

125,000
3,121,538

Total current assets


Current liabilities:
Creditors
Wages

4
1 1/2
Total current liabilities

Add: 10% contingencies


Net working capital

326,154
45,865
372,019
2,749,519
274,952
3,024,471

Problem 5

CA/FA Cost of liquidity Cost of illiquidity


0.10
0.25
0.40
0.70
1.00
1.50
2.50

138
275
550
1,100
2,200
4,140
6,890

2,200
1,650
1,100
830
690
550
276

Problem 6

Month
January
February
March
April
May
June
July
August
September
October
November
December

Cost of illiq

WC

LTD
72.65
58.13
29.06
24.22
33.90
43.60
58.12
72.66
82.30
87.19
92.02
87.17

92.02
92.02
92.02
92.02
92.02
92.02
92.02
92.02
92.02
92.02
92.02
92.02

The maximum amount of working capital is Rs 92.02 in November. This is assumed as long-term borrowing.
Long-term interest rate: annual
14.00%
Long-term interest rate: monthly
1.17%
Inter-corporate lending rate: annual
12.00%
Inter-corporate lending rate: monthly
1.00%

Month
January

Short-term
Borrowing

WC
72.65

72.65

February
March
April
May
June
July
August
September
October
November
December
Short-term interest rate: annual
Short-term interest rate: monthly

58.13
29.06
24.22
33.9
43.6
58.12
72.66
82.3
87.19
92.02
87.17

58.13
29.06
24.22
33.9
43.6
58.12
72.66
82.3
87.19
92.02
87.17

16.00%
1.33%

Net interest payment is lower when the company goes for long-term debt.
Problem 7
Aggressive
Current assets
Fixed assets
Total assets
Current liabilities
Short-term debt
Long-term debt
Total debt
Equity
Total capital
Projected sales
Expected EBIT
Interest on short-term debt
Interest on long-term debt
Profit before tax
(a) Before-tax ROE
(b) Current assets/Total assets
Current assets/Current liabilities
(d) Net working capital
Long-term interest rate
Short-term interest rate

252
180
432
150
216
43
259
23
432
531
53
35
8
11
46.5%
0.58
1.68
102
18%
16%

Moderate
270
180
450
150
162
108
270
30
450
540
54
26
19
9
28.8%
0.60
1.80
120

(Rs crore)
19X3
44
9.2
75
66.2
4.6
25
66.9
2.9
16
69
20.5
107
45.6
12
95
223
128

Annual
(Rs)
5,000
8,000

Average
(Rs)
5,000
8,000

312,000
78,000
8,000

36,000
2,250
2,000
53,250

260,000
48,000
10,000
62,000
4,800
48,000

7,500
1,385
5,000
2,583
200
6,000
22,668
30,582

Cost tradeoff
8,000

(Rs 000)
Total cost
2,338
1,925
1,650
1,930
2,890
4,690
7,166

Int. exp.
1.07
1.07
1.07
1.07
1.07
1.07
1.07
1.07
1.07
1.07
1.07
1.07
12.88

Interest
expense
0.97

C o s ts

7,000

Total cost

6,000
5,000
4,000

Cost of liq

3,000
2,000
1,000

Cost of illiq

0
0.10

0.25

0.40

0.70
CA/FA

Invst.
19.37
33.89
62.96
67.80
58.12
48.42
33.90
19.36
9.72
4.83
0.00
4.85

Net
int.

Int. inc.
0.19
0.34
0.63
0.68
0.58
0.48
0.34
0.19
0.10
0.05
0.00
0.05
3.63

0.88
0.73
0.44
0.40
0.49
0.59
0.73
0.88
0.98
1.03
1.07
1.03
9.25

1.00

1.50

2.50

0.78
0.39
0.32
0.45
0.58
0.77
0.97
1.10
1.16
1.23
1.16
9.88

Conservative
288
180
468
150
108
173
281
37
468
549
55
17
31
7
17.8%
0.62
1.92
138

of liq

2.50