Mcqs On Financial Management.docx

1. XY Ltd. has an EBIT of Rs. 1 lakh. Its cost of debt is 10% and the outstanding debt amounts to Rs. 4 lakhs. The overall capitalisation rate is 12.5%. The company decides to raise a sum of Rs. 1 lakh through debt at 10% and uses the proceeds to pay off the equity shareholders. You are required to calculate the total value of the firm and also the equity capitalisation rate. 2. Two firms A and B are identical in all respects except that the firm A has 10% Rs. 50,000 debentures. Both the firms have the same earnings before interest and tax amounting to Rs. 10,000. The equity capitalisation rate of firm A is 16% while that of firm B is 12.5%. You are required to calculate the total market value of each of the firms and explain with an example the working of the ‘arbitrage process’. 3. Two firms A and B are identical in all respects except the degree of leverage. Firm A has 60% debt of Rs. 3.00 lacs, while firm B has no debt. Both the firms earning an EBT of Rs. 1,20,000 each. The equity capitalisation rate is 10% and the corporate tax is 60%. Compute the market value of the two firms. 4. In considering the most desirable capital structure for a company, the following estimates of the cost of debt and equity capital (after tax) has been made at various levels of debt-equity mix: Debt as percentage of total Cost of Debt (%) Cost of Equity (%) capital employed 0 5.0 12.0 10 5.0 12.0 20 5.0 12.5 30 5.5 13.0 40 6.0 14.0 50 6.5 16.0 60 7.0 20.0 You are required to determine the optimal debt-equity mix for the company by calculating composite cost of capital. 5. Determine the average rate of return from the following date of two machines A and B. Machine A Machine B Original Cost Rs. 56,125 Rs. 56,125 Addl. Investment in net working capital 5000 6000 Estimated life in years 5 5 Estimated salvage value 3000 3000 Average income tax rate 55% 55% Annual estimated income after depr. and tax: Ist year 3375 11375 2nd year 5375 9375 3rd year 7375 7375 4th year 9375 5375 5th year 11.375 3375 36875 36875 Depreciation has been charged on straight line basis. 6. A choice is to be made between two competing projects which require an equal investment of Rs. 50,000 and are expected to generate net cash flows as under: Project I Project II End of year 1 Rs. 25,000 Rs. 10,000 End of year 2 15,000 12,000 End of year 3 10,000 18,000 End of year 4 Nil 25,000 End of year 5 12,000 8,000 End of year 6 6,000 4,000 The cost of capital of the company is 10%. The following are the Present Value Factors @ 10% per annum: Year P.V. Factors@ 10% p.a. 1 0.909 2 0.826 3 0.751 4 0.683 5 0.621 6 0.524

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Which project proposal should be chosen and why? Evaluate the project proposals under: (a) pay-back Period, and (b) Discounted Cash Flow methods, pointing out their relative merits and demerits. The Alpha co. Ltd. is considering the purchase of a new machine. Two alternative machines (A and B) have been suggested, each having an initial cost of Rs. 4,00,000 and requiring Rs. 20,000 as additional working capital at the end of 1st year. Earnings after taxation are expected to be as follows: Year Cash Inflows Machine A Machine B 1 Rs. 40,000 Rs. 1,20,000 2 1,20,000 1,60,000 3 1,60,000 2,00,000 4 2,40,000 1,20,000 5 1,60,000 80,000 The company has target of return on capital of 10% and on this basis you are required to compare the profitability of the machines and state which alternative you consider financially preferable. Note: the following table gives the present value of Re. 1 due in ‘n’ number of years. Year present value at 10% 1 0.91 2 0.83 3 .075 4 0.68 5 0.62 A firm issues debentures of Rs. 1,00,000 and realises Rs. 98,000 after allowing 2% commission to brokers. The debentures carry an interest rate of 10%. The debentures are due for maturity at the end of the 10 th year. you are required to calculate the effective cost of debt before tax. From the following capital structure of a company, calculate the overall cost of capital, using (a) book value weights and (b) market value weight. Source Book Value Market Value Equity share capital (Rs. 10 Rs. 45,000 Rs. 90,000 shares) Retained earnings 15,000 Preference share capital 10,000 10,000 Debentures 30,000 30,000 The after tax cost of different sources of finance is as follows: Equity share capital: 14%; Retained earnings: 13%; Preference share capital: 10%; Debentures: 5%. The installed capacity of a factory is 600 units. Actual capacity used is 400 units. Selling price per unit is Rs. 10, Variable cost is Rs. 6 per unit. Calculate the operating leverage in each of the following three situations: (a) When fixed costs are Rs. 400 (b) When fixed costs are Rs. 1,000 (c) When fixed costs are Rs. 1,200 A company has a choice of the following three financial plans. You are required to calculate the financial leverage in each case and interpret it. Equity capital Rs. 2,000 Rs. 1,000 Rs. 3,000 Debt 2,000 3,000 1,000 Operating Profit (EBIT) 400 400 400 interest @ 10% on debt in all cases A company has sales of Rs. 1 lakh. The variable costs are 40% of the sales while the fixed operating costs amount to Rs. 30,000. The amount of interest on long-term debt is Rs. 10,000. You are required to calculate the composite leverage and illustrate its impact if sales increase by 5%. The present share capital of A Ltd. consists of 1,000 shares selling at Rs. 100 each. The company is contemplating a dividend of Rs. 10 per share at the end of the current financial year. The company belongs to a risk class for which appropriate capitalisation rate is 20%. The company expects to have a net income of Rs. 25,000. What will be the price of the share at the end of the year if (i) dividend is not declared and (ii) a dividend is declared? Presuming that the company pays the dividend and has to make new investment of Rs. 48,000 in the coming period. how many new shares be issued to finance the investment programme? You are required to use the MM model for this purpose. A chemical company belongs to a risk-class for which the appropriate P/E ratio is 10. It currently has 50,000 equity shares (outstanding) selling at Rs. 100 each. The firm is contemplating the declaration of dividend of Rs. 8

per share at the current fiscal year which has just started. Given the assumptions of Modigliani and Miller, answer the following questions: (i) What will be the price of the share at the end of the year (a) if dividend is not declared; and (b) if it is declared (ii) Assuming that the company pays the dividend, has as net income (Y) of Rs. 5,00,000 and makes new investment of Rs. 10,00,000 during the period, how many new shares must be issued? 15. Following are the details regarding three companies A Ltd., B Ltd. and C Ltd.: A Ltd. A Ltd. A Ltd. r=15% r=5% r=10% Ke= 10% Ke= 10% Ke= 10% E= Rs. 8 E= Rs. 8 E= Rs. 8 Calculate the value of an equity share of each of these companies applying Walter’s formula when dividend payment ratio (D/P ratio) is: (a) 50% (b) 75% (c) 25% What conclusions do you draw?