Taxmann' Financial Management & Economics for Finance (FM & ECO) | CRACKER

Contents

PAGE Chapter-wise Marks Distribution

I-5

Previous Exams Trend Analysis (New Syllabus)

I-7

SECTION A FINANCIAL MANAGEMENT (60 Marks) Chapter 1

SCOPE AND OBJECTIVES OF FINANCIAL MANAGEMENT

1.3

Chapter 2

2.1

TYPES OF FINANCING

Chapter 3

FINANCIAL ANALYSIS AND PLANNING - RATIO ANALYSIS

3.1

Chapter 4

4.1

COST OF CAPITAL

Chapter 5

FINANCIAL DECISIONS - CAPITAL STRUCTURE

5.1

Chapter 6

FINANCIAL DECISIONS - LEVERAGES

6.1

Chapter 7

INVESTMENT DECISIONS/CAPITAL BUDGETING

7.1

Chapter 8

RISK ANALYSIS IN CAPITAL BUDGETING

I-15

8.1

3 4 . % 4 . / #

I-16

PAGE Chapter 9

9.1

DIVIDEND DECISIONS

Chapter 10

MANAGEMENT OF WORKING CAPITAL

10.1

SECTION B ECONOMICS FOR FINANCE (40 Marks) Chapter 11

DETERMINATION OF NATIONAL INCOME

11.3

Chapter 12

PUBLIC FINANCE

12.1

Chapter 13

MONEY MARKET

13.1

Chapter 14

INTERNATIONAL TRADE

14.1

MODEL TEST PAPER-1

P.1

MODEL TEST PAPER-2

P.23

SOLVED PAPER: JULY 2021 (SUGGESTED ANSWERS)

P.43

SOLVED PAPER: DECEMBER 2021 (SUGGESTED ANSWERS)

P.67

SOLVED PAPER: MAY 2022 (SUGGESTED ANSWERS)

P.90

M O R F S L A T I P A C F O N O I T A N I B M O C E H T S I E R U T C U R T S L A

T E I P C AN #A N I F F O S E C R U O S T N E R E F F I D 3 % ) 2 / % ( 4 % 2 5 4 # 5 2 4 3 , !

4 ) 0 ! #

CHAPTER

E R Y UR T O C UE RH T 4 3 R LE A T IH T P A/ #

GRY NE R I DO K CRE E/H 0 4

5.1

Y ER DO AE R H 44 EF HF 4/

T B E $ F O E S U F O P L E H E T H B T E H $ T I F W O E E S S A U E F R O C T N N P I L A E L T L S H I N E W O H C T M R N H I I T & A I M W D N E E A R S L A Y L E I T I R W C U E Q + E % D L F D L O N I A W 6 D O + + -

I H N C ARA L EOG L LR I DI P O-P - !

G H NEC I A) MO T TA / E OR RC .E P. PNP /)!

LH A NC OA I O T I R D P AP R 4!

H EC A) TMO E OR. .C P NP ) !

H C A O R P P ! ) .

R E P S !

Y ER R O UE T H C U4 RE T C 3 N LA A V TE I P L E AR #R )

Y ER R O UE T H C U4 RE T 3 C N L AA T V I E P L AE #2

LE EEA R R GT A UA IH P T R C AS E UV CY RL EFR T A S LON A LI TI A S D C T OR I NC P O AA F CNEO G I F A H R E C CNE I AIV R OE P RSAT A D PE E E PR K T AC R H NG A SI I I H NEM T WS !

O A EL T M H L GR E T NF IN W I I D RE S OHEA N CTI M CFL R !OCI EEF UDE L O H A T T VD F EAO HL EE T U LL OL IA T TWV N E A H VNT O EI TE L L R E I E O R H S PW SO A I E R NR C O0#N I T#I S B I !L L C E E$ 7I D W

FINANCIAL DECISIONS CAPITAL STRUCTURE

5

SUMMARY 1. Capital Structure:

2. Capital Structure Theories:

3. Net Income Approach (NI):

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.2

T S O #

OD KK

D K

T B E $

D

7 D + 7 E +

$ 3

6

M R I & F O E U L A 6

E

LM A I R C I NF AF NO I F E FU O L A TV L U

SDE E NG R R AAE SNM W A E TOS A D D HSN T E SET R R M UOE OC S

R E V E M ALV A F T A H E I S R P C AT E A R N OCI A RFO M POP R PTT A I S A F SOH D I T E HCD 4 R TN E N V I O O E Y L PE N U EB MR F O E OV O SE + OW D T O N P ( A U E S + EE GA S AE R R E C VN EI L

O

+

Y T I U Q % F O T S O #

EBIT(1 t) V

+

L A T I P A # F O T S O #

EBIT(1 t) Ko

Or

E

$ 6

T B E $ F O E U L A 6 E C A &

$

T B E $ F O E U L A 6

3

E R A H 3 F O E U L A 6

H C A O R P P !

L A N O I T I D A R 4 R E P S !

6 T S E H G I H R E OO L B + A T I R S A E V W E O R L A H T M I R W I & E R F U O T C 6 U - R T D S L N A A T I Y P T A I U C Q T % C E F L O E S 6 O - T S D A N H A Y O + NM A EP R I + M& DO F + #O

E K

O K E K

E A L U M R O &

Or

EBIT(1 t) Ko

Or (EBIT I)(1 t) Ke

Note:

4. Traditional Approach:

KE

# # !

7 K

L A T I E P R AU CT LC A U MT R IS T P /

E G A R E V E L L A I C N A N I &

LL LFE

A IOG T W A I E P CR EI AG E RV CA HRPE CETL AVEF OEKO RLRE PEAE R PHMG ATEE NHD SI I H ETE T D G H ON NT T F GAAO NHMT C I RN D I RYF E ON D C!EN H CT T E !N P FE AO V D EEN U L I E L S A R I R V I L L A EA T R I T P A O A MTC REF H I O T F T ENS HIO T EC FGL O NA L SAR NHE OCV I YO S I NE C EAH DOT S ETA R D UA S T EE C L R UT A RO H T NS S

H C A O R P P ! ) / .

R E P S !

C U R T S X A T T U O H T I W F O E S A C N I T N A T S N O C N I A M E R L L I W M R I & F O 6 D N A O

+E R D U +T

E S A E R C N I E H T H T I W E S EA R E UR T C C UE RD T L S L XI A WO T H+ T D I N WA FE O S EA S E A R CC N NI I L TI L N AW T S M NR OF I CF NO I A 6 M ER T LB L I E W$ D N +I

-

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! # 3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

L A T I P A C F O T S O #

+

E

# # !

7

L A T I P A C F O T S O #

+

D

O I T A R Y T I U Q E O T T B E $

E G A R E V E L L A I C N A N I &

H C A O R P P ! ) / .

R E P S A S M R I & F O E U L A 6

M R I & D E R E V E L N 5 F O E U L A 6 E T A L U C L A #

P E T 3

6

M R I & D E R E V E L N 5 F O E U L A 6

5

EBIT(1 t) Ko

5.3

5. Net Operating Income Approach (NOI):

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.4

M R I & D E R E V E , F O E U L A 6 E T A L U C L A #

P E T 3

L RRA OET L I L LI P A A N-C OIF I N T O I A I T N L S I G F O I E C D DO L L S-R A I E H V CRO E AV T OE N 4 R A $ PWT P OS A( N O 5) C 6 /E R .CO NF EA N HI CO 4I FT I

N A GC I I F S M I T R LS , I A 6 UF R J

E OL H I AT M V R ARF I HUO & O E I E V D BA U E L R SHA E KEV V CBL E AS A L , T EO F DDT I O NV E E AO R U RO LP L F A A E HR UC 6 T E P AH EOT CR NPD OPN CAA 6. Modiglani-Miller Approach (MM):

H C A O R P P !

F O S N O I T P M U S S !

T C E F R E P E R A S T E K R A M L A T I P A #

Note:

S E H C A O R P P !

D N A ) / .

R E D N U E M A S E R A S M E L B O R P L A C I T C A R P F O N O I T U L O 3

S E X A T E T A R O P R O C F O E C N E T S I X E N O .

S E S S A L C K S I R T N E L A V I U Q % @ O T N I D E P U O R G E B N A C S M R I &

L A N O I T A R E R A S R O T S E V N I L L !

S T S O C N O I T C A S N A R T O N E R A E R E H 4

E L B A L I A V A Y L E E R F S I N O I T A M R O F N I L L !

7. The Trade Off Theory:

Trade Off Theory

Debt

Dispute between Shareholder and Board

Harsh terms of suppliers etc.

Cheap source of finance

Tax benefit on payment of interest Agency cost

Other Cost Financial distress

Dispute between Shareholder and Debt

Loss due to sale of asset at very lower price

Leaving off staff

Legal expenses

Non Bankruptcy Cost Bankruptcy Cost

Benefits Cost

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! # 3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

Debt Equity

Fresh Issue 1st Preference

3rd Preference

YTGNSH BENIIC A K E I A DRY R E E EAUMH R S BE R UMS H4O T YGI T GNE4I U I R F

ET O E O S T M I R L H A RP X E R I ETF C T S N EY AA D G AH E E E C K T T OF UA T A T L N R A SOT I VMO R ESR E OP GSE F I AH E VTE Y T R O T M C ENNFN O GA) V O E S

AD I S T C R S T A A I T I E I F F L F R B EO L I E A RKR W N A H A P I ETESG E R YK L C L NN UEA E I T HM C S E C I T R R UE DP E O RR N F T T F ES AEI S HD LHE A WISTG T T M F I I N LR O P R I A U I C AU E CFS I #D R EDU P IS V LEEE I L U D A KH L A AT NSV I T S DORMA NREOHM ACDTTU A N N S I S UI O G R E I N B I FET I I N A V L O C I I AI PU T I PR EC C Q ET I MPRJ E S A OIHBNT OAA CMS S E L A 3

T S O # E L B A I R A 6

S S E ,

N O I T U B I R T N O #

T S O # D E X I &

S S E ,

4 ) " % R O T l O R 0 G N I T A R E P /

T B E D M R E T G N O L N O T S E R E T N )

S S E ,

4 " %

8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8

` Particulars

2nd Preference Retained Earning

5.5 8. Pecking Order Theory:

PECKING ORDER THEORY Sources of Fund

9. Arbitrage Process:

10. Proforma Statement Showing EBIT, EPS & MPS:

4 ! %

D N E D I V I $ E C N E R E F E R 0

S S E ,

S R E D L O H E R A H 3 Y T I U Q % R O F E L B A L I A V A S G N I N R A %

S E R A H S Y T I U Q % F O

O .

3 0 %

O I T A 2 % 0

3 0 -

8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8

X A 4

S S E ,

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.6

S E S N E P X % E U S S ) E C I R 0 E U S S )

E R A H 3 M O R F S D E E C O R 0 T E .

E C I R 0 E U S S ) E B O T D E M U S S A S I 3 0 N O I T S E U Q E H T N I D E I F I C E P S S I G N I H T O N F ) Note:

Additional Funds Raised through Equity Net Proceeds from One Equity Share

8 8 8

8 8 8

T S E R E T N )

S S E ,

Y T I U Q % R O & G N I N R A %

O I T A 2 % S 3 0 E

0 R % A 3 H 0 S % Y

T I 3 U 0 Q % F O

O .

8 8 8 8 8 8 8 8 8 8 8

8 8 8 8 8 8 8 8 8 8 8

8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8

D N E 4 4 I D ! V " % I % $ E

C

N

E R E F E R 0

S S E , X A 4

S S E ,

8 8 8 8 8 8 8 8 8

8 8 8 8 8 8 8 8 8 8 8 8 8 8 8

Preference Debt Equity 4 ) " %

Alternatives

8 8 8

8 8 8 8 8 8 8 8 8 8 8 8

8 8 8 8 8 8 8 8 8

8 8 8

8 8 8

8 8 8

4 ! %

8 8 8 8 8 8 8 8 8

4 " %

X A 4

S S E ,

8 8 8

8 8 8

4 ) " %

W E .

Preference

G N I T S I X %

Debt

T S E R E T N )

S S E ,

Equity

Particulars

Alternatives Particulars

S E R A H 3 W E .

S E R A H 3 Y T I U Q % W E .

S E R A H 3 G N I T S I X %

S E R A H 3 Y T I U Q % F O R E B M U .

O I T A 2 % 0

3 0 %

3 0 Note:

11. Selection of plan on the basis of EPS or MPS (New company): Statement of EPS & MPS

12. Selection of plan on the basis of EPS or MPS (Existing company):

Statement of EPS & MPS

N O I T P O R E D N U 3 0 %

N O I T P O R E D N U 3 0 %

T B E $

Y T I U Q %

`

8 8 8

, ) 8 8 . 8 8 8 8 8 8 8

8 8 8 8

, ) 8 8 . 8 8 8 8 8 8 8

8 8 8 8

8 8 8

8 8 8 8 8 8 8 8 8 8 8

8 8 8 8

8 8 8

8 8 8

G N W I T E S I .

X %

O I T A W 2 E . % 3 0 G 0 N % 3 I T 0 S % I X

% 3

0 -

T N I O P E C N E R E F F I D N )

4 ) " %

/

T N I O 0 E C N E R E F F I D N )

4 ) " % D E T C E P X E F )

L A I C N A N I & D E X I & R E W O L G N I V A H N O I T P ON TE C D ER L U E 3"

T N I O 0 E C N E R E F F I D N )

4 ) " % D E T C E P X E F )

N O I T P O Y N A T C E L E 3

T N I O 0 E C N E R E F F I D N )

4 ) " % D E T C E P X E F )

L A I C N A N I & D E X I & R E H G I H G N I V A H N O I T P ON TE C D ER L U E 3"

O R E Z E B L L I W 3 0 % H C I H W T A 4 ) " % F O L E V E L E H T S I T )

T S E R E T N )

4 ) " %

Preference Dividend (1 t)

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! # 3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

Y T I U Q % R O & G N I N R A %

H C I H W T A 4 ) " % F O L E V E L E H T S R E F E R

TE N I M O A PS EE CR NA ES R N E O F F I IP T D NO ) T N E R E F F I D O W T R E D N U 3 0 %

14. Financial Break Even Point:

Action

Situations

Preference

S E R A H S Y T I U Q % F O

O .

Course of Action:

Debt Equity

D N E D I V I $ E C N E R E F E R 0

S S E ,

E R A H S R E P G N I N R A %

EBIT I 1 t PD N2 EBIT I 1 t PD N1

Alternatives Particulars

5.7

13. Indifference Point:

`

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.8

15. Indifference Point in case of Equal Number of Share: Indifference Point in Case of Equal Number of Shares Situation 1

Situation 2

No EBIT will provide same EPS under both plans

There is no indifference point between two plans

Each and every EBIT will provide same EPS under both plans

Plan having lower financial fixed burden will dominate other plan

Each and every EBIT is indifference point between two plans

No plan will dominate

PLAN 1

PLAN 2

PLAN 1

PLAN 2 Single line for both plans

Parallel Lines LHS = RHS

LHS = RHS

THEORY

)E M /H T R .F I F OO E T E H GU T NL F I AO D RVE O R CDU CNC T !AU L A R T T I S P L AA CT I FP O A TC S OE CH T EF HO T T NN EE ED WN TE E P BE PD I N H I SS NI OM I TI R A F L E E R H OT F NO SE I EL U R A E HV T E HH CT A O R PM R PI AF

Q1. What is Net Operating income theory of capital structure? Explain the assumptions on which the NOI theory is based.

(4 Marks May 2012)

Ans. Net Operating Income NOI Theory of Capital Structure: i.e.

T S I X E T O N O D S E X A T E M O C N I E T A R O P R O C E H 4

Assumptions:

M R I F F O E U L A V T E K R A M F O N O I T A T U P M O C R O F T N A V E L E R R I S I X I M Y T I U Q % T B E $

F O S N O I T A T C E P X E D N A K S I R L A I C N A N I F N O I T R O P O R P T B E E DS NA I E R EC S A N EI R S C R NE I D L EO HH T E HR T A I H 7S

T B E D F O S E E R G E D L L A R O F T N A T S N O C S N I A M E R

O

+

L A T I P A C F O T S O C LX

L A I R M E VY OI T EU HQ 4E

:

T FEES O SCO I N C EAE CRR F R I UMEE F R E OI S R SF A APE RN R E D C PEN N AHA I E7T L L H I BW CX E AD ST 3 I 0 TRG% E N B I EPR L $SA A A EI T EB P S NTA ESC E PR E XE R ET A DNH EIS WDT Y EI OX L U LF IQ A O E SMH L R T A E I ST W I G T G S N E N OO R L E L T HA N G L I A U DO T I NR P AH A ETC C E NSR D AN A NU H I F FS

Ans.

E R A E R U T C U R T 3 L A T I P A # G N I N R E V O ' S E L P I C N I R 0 L A T N E M A D N U &

Q2. List the fundamental principles governing capital structure.

(4 Marks Nov. 2012, May 2016) Financial leverage or Trading on Equity:

3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! #

5.9

ST ET O A A DR N EN O L I L T AU A CHA T SR C I S TED ) HE MGE I RHN I S F T YII E BDR DNO EUE F NFR RDE E A H X EI 4 NF

RFY UO L T E T E S S R R

O E FC M VR O FDI E) AF T

A N KA R OR F I NT OO AA WE HU R T E T U I RS GT E C A WERU R OGET V A L S R E SE L L I A SVNI T DEEP H NLT A E UL C FB NE DARH ERUT XUTN E O I R F VF A FA L O FOP

T TNYE T E S B L C OAI MBE S N E D ID MCAET E ED L H INHT SA NF I SA NOGI SEC OLUW A O E L ECP L RO B S A I H W A G E C S T T D N T E SO I FSU I DN O H VR O P N N T YI ER UD T L IWVPDFU N L E O I AEO MR S B S L I TA RL EA AI H S T S S R & E B S E R AL N M E E T DR A AR T S S NU CF N I HNI AT T I MN Y C I HA HU RE WT T I PF REW H WT OSSOYST RLURL IEG L A AGSA N 'T A I C I T EEESA P H F ABT NO U C FA T T O H C B EE ECTU DD Y T W L I A EO F C EFRHR S DOETGI H T T FM T A ON T UYHOI R T E L ROR F T T OM A A N T Y L R C IER AM N AR F IMEA T E F TE3 A H O N GE T G A

AI B E NRSC T G H E E R L N OEDAHA A PI S YMTS N AOIFI MA F IRPT7)

Growth and stability of sales:

TO F A HE T U SL I A EV R T UE T K C R UA RM T S LD A N T I A P T AS CE W MO UL S MI IL T A P T OI P EA L C P I F C O NT I S R PO TC S H OC CI H RW E PT SA !X

IT ME S YH T G I I U H QS EI TM B R EI DF

Cost Principle:

YF KO SN I R O I T AR SO I P TO B R EP DR TE H N D GE EI D M(N YE E AC M PR DUM EOO XSC I E YR F KT FS O IO TRN N NS E I O MNK S TSI I R MIR Y T E MI H OUG CQI E ODH T Y L ENG A UE N I $C D NR O AC NC I F A FD O N EA CT R UB OE SD

Risk Principle:

H YD T T I EI U T W U QL D EI E D FE B O R U EBT L L UI S SW I S D I SN HRU E GD S UL N OOI RHA HEM T RE SAR DHP NSI G UN H FI S R TE LS A IN NX OEW I FO T I O D D DYN ANA A L EPO S MT R I A ON R CO ERC ET WV N FOE ) LM O RE T G N OA CNE C NAN EMA HGN T NF I SI E TT R S B I A HXE S%D

Control Principle:

RO E T NG NN AD I MR O TC N C EA I C I E F S F A E B ND AN NU I F SS D NY UN FA EP GM NO AC R E R S A A DE L R U C OE HD SR MO E RS I & A E R C N I N AT CN EE WM E TR A I HU T Q OE SR

Flexibility Principle:

TSD E E KER RIE C I A L D O MP I S N STO S NC E NEE I MB S UNO RS BE L FV A O OD EGL R U UOO T H I A R S NA

C SNT E A E T HCE CSK T UE R SK A SR M R A OM N T I C AEN F O R I RU T I E TT HU E T FP /DM NO AC D GN NA I T E S I U X S ES I F NO OG I T N A I UM T I I S T

Other Considerations:

R D ONN A HA LT A T D SN I S P E E AL D CH I V TI SR S OD E C Y XWA EEP R SA O A S T HT T E N MSE S RA I I C F I NF AOF I U T EA S R E UO T HT IN WS SE NIR H OT A I T S NG A ) UT N T I I NN S ER A A M SR EE I D IN TU ) QA EL R A T NI AP HA T C RE E R HA GH I H S ED R

ET A S U E SS R DS I E NS T UT N FI I

Q3. What is Over capitalisation? State its causes and consequences.

(4 Marks Nov. 2013)

Ans. Over capitalization:

N A H T S E R U T N E B E D R O S E R A H S F O E U S S I H G U O R H T T N U O M A S RD E E HE GN I H Y N GA NP I S M I A O 2C

Causes of Over Capitalization:

Y N A P M O C H C I H W T A E T A R N A H T E T A R R E H G I H T A T B E D F O T N U O M A R E H G I

H N R GA NE I S I N A A 2C

T N E M Y A P H G I H E K I L S T E S S A S U O I T I T C I F F O

NC OT I E T I L S L I I U W QD CO AO EG HE T S RA OH F C TR N U EP MO YT AE PD E GA UM S (I

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.10

Y L R E P O R P E D A M T O N S I N O I T A I C E R P E D R O F N O I S I V O R 0

E T A R H G I H H T I W D N E D I V I D F O T N E M Y A 0

G N O R W S A W N O I T A Z I L A T I P A C D N A S G N I N R A E F O N O I T A M I T S %

S T N E M Y A P T S E R E T N I D N A D N E D I V I D F O E T A R E H T N I E S A E R C E $

Consequences of Over-Capitalisation

S E R A H S F O E C I R P T E K R A M E H T N I E S A E R C E $

M R I F F O E U L A V T E K R A M N I E S A E R C E $

G N I S S E R D W O D N I W E S U Y A M M R I &

Y N A P M O C F O N O I T A S I N A G R O E 2

O I R A N E C S T S R O W N I N O I T A D I U Q I ,

SY S DT T I B NU E UQ D FE F M H O GR E NUT OOG I R T H N A T O NS L I D B D MNN A OUL CFA E T EGI N P HA T A R C OR T E AR SNA R AH E C S F E YE R N C EAN P R E U E R M T C F O E U#R R P T E S CS LN G A AN T I I N P N I F AF R A #O E SD E E CN R I UA OT SE TR N L ET A R I E P F F A I C D E MR A OH RS F Q4. What do you mean by capital structure? State its significance in financing decision.

(4 Marks Nov. 2013) Ans. Capital structure

LDY EFSA UODT NN L I A A A TE A P S LAME 6O G C L #A RN N I A O TMFR I S I P UER G T A H A N A M T C S I IF I R N T OO MRFP O A IE OET X TT UN AXS OALE A MA M CTV HT S TN

F G S E R T O E L N E W O A I V T I E Z O EF S N I T L I I WAA C SMY SRI E I ST

I RLXND I A A A E MF E T I M ER W RO P I U CT O F N ,ANNC I C YO A TN U NT FN R N AI O I T A O AFS FS T V I O I O S L E LT 4 O A A L EAS T CE

VT I II L R L I P P A DS T A A T A C T N I I I C ECP AEP J E A R A B Y M CK U OBCR T A FT C FF I YDO R UOO E T A FT RS T T E O A ML SO S T A IU ELCA R A U L PCRL T LH L I S A A M EA P R HCAVAE R I 4SDTCV F E I E OOE K3 S R MU G E

NP RSAE I I M U I F R Z R UI LRT YA E E ML NT C I HU AI G N P G N RII FAH T MS O CIS Significance:

PRACTICAL PROBLEMS

M. M. Approach:

Q1. RES Ltd. is an all equity financed company with a market value of ` 25,00,000 and cost of equity Ke 21%.The company wants to buyback equity shares worth ` 5,00,000 by issuing and raising 15% perpetual amount (Debt).

Rate of tax may be taken as 30%. After the capital restructuring and applying MM model with taxes.

You are required to calculate:

(a) Market value of RES Ltd.

(b) Cost of Equity Ke.

(c) Weighted average cost of capital and comment on it.

(4 Marks May 2012)

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! # 3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

, 5

+

O

O

D

+

E

+

D(1 t) E

+

T B E D F O T S O C X A T E R O F E B

M M R R l l Y D D T E E I R R U E E V V Q E E % L L F N N U U O E F F U O O L O EA + + 6

7

D D

+

E

7

E

+

# # !

7

E R E (

(iii) EBIT is ` 2,50,000 and

(iv) The equity capitalization rate of ‘A’ Ltd. is 20%.

T B E $ F O E U L

A 6

M R l F O

E U L A

6

L A T I P A C F O T S O C E G A R E V A D E T H G I E 7

M R l D OD E % % + + R E V E L N U F O O +

E C N E (

G N I R U T C U R T S E R E R O F E B N

A H

T R E W O T L S I M G

R N I ) I F E RH U T T C E UR RU T S T E C R U RR E T T S F E DA R + #D L #U !O 7H S Y N A P M O C

(ii) Income tax rate is 30%;

5, 00, 000 (1 .30) 21,50, 000 E R E (

(i) All assumptions of MM model are met;

5, 00, 000 26,50, 000 21,50, 000 26,50, 000

,

X A 4

T B

E $

, 5 6

6

G N I R U T C U R T S E R R E T F A 6

c

6

G N I R U T C U R T S E R E R O F E B 6 a

Cost of Equity: b

D T , 3 % 2 F O 6

E U L A 6 T E K R A

Ans.

5.11

Comment:

Q2. ‘A’ Ltd. and ‘B’ Ltd. are identical in every respect except capital structure.

‘A’ Ltd. does not use any debt in its capital structure whereas ‘B’ Ltd. employs 12% debentures amounting to ` 10,00,000. Assuming that:

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.12

D T ,

! @ F O E UX L A A V4 T E KT RB A E -$

"D @E R FE OV E , E U LD A T 6,

EBIT (1 t) Ke

Y T I U Q E L L !

F =E O+ E S A O C+ Y NN )A ; P M O C

D T ,

! @ F O

+

D T ,

! @ F O E +

Calculation of WACC of ‘A’ Ltd and ‘B’ Ltd:

D T ,

" @ F O

+

EBIT (1 t) V

2,50,000 (1 .30) .20

D T , D !

E @ R F E O V EE L UN L A 5 6

Ans.

D T ,

" @ D N A D T ,

! @ F O E U L A V F O N O I T A L U C L A #

Calculate the value of both the companies and also find out Weighted Average Cost of Capital for both the companies.

(5 Marks Nov. 2014)

2,50, 000 (1 .30) 11,75, 000

Q3. PNR Limited and PXR Limited are identical in every respect except capital structure. PNR limited does not employ debts in its capital structure whereas PXR Limited employs 12% Debentures amounting to ` 20,00,000.

The following additional information are given to you: (i) Income tax rate is 30% (ii) EBIT is ` 5,00,000 (iii) The equity capitalization rate of PNR Limited is 20% and (iv) All assumptions of Modigliani - Miller Approach are met.

Calculate: (i) Value of both the companies,

5, 00, 000 (1 .30) .20

17,50,000

X A 4

T B E $

D T ,

2

.

0 @ F O

E U L A

V T E K R A

-

2 8D E 0R @ E FV O E , E U L D A T 6,

EBIT (1 t) Ke

2 D E .R 0E @ V E FL O N 5 E U L D A T 6,

Ans.

D T ,

2 8 0 @ D N A D T ,

2 .

0 @ F O E U L A V F O N O I T A L U C L A #

(ii) Weighted average cost of capital for both the companies.

(8 Marks May 2017)

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! #

3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

5.13

Y T I U Q E L L !

F =E O+ E S A O C+ Y NN )A ; P M O C

20%

D T ,

2 8 0 @ F O

+

EBIT (1 t) V

D T ,

2 .

0 @ F O E +

D T ,

2 .

0 @ F O

+

Calculation of WACC of ‘PNR’ Ltd and ‘PXR’ Ltd:

5, 00, 000 (1 .30) 23,50, 000

Q4. Stopgo Ltd. an all equity financed company is considering the repurchase of ` 200 Lakhs equity and to replace it with 15% debentures of the same amount. Current market value of the company is ` 1140 Lakhs and it’s cost of capital is 20%. It’s earning before interest and tax (EBIT) are expected to remain constant in future. It’s entire earnings are distributed as dividend.

Applicable tax rate is 30%.

You are required to calculate the impact on the following on account of the change in the capital structure as per MM Hypothesis: (1) The market value of the company.

(2) It’s cost of capital, and (5 Marks May 2018)

(3) It’s cost of equity.

Ans.

D T , O G P O T 3 F O 6

E U L A 6 T E K R A -

6

E S A H C R U P E R R E T F A 6 -

S H K A ,

,

,

X A 4 ,

S H T K B A E , $ ,

,

5

L 6 A T I P A C , F 5 , O T S O C E G A R E V A D E T H G I E 7

6

E S A H C R U P E R E R O F E B 6 M R l F O 6 N O T C A P M )

Increase by 60 Lakhs

D

7 D +

E

7 E

+

E S A H C R U P E R R E T F A # # !

7

E S A H C R U P E R E R O F E B # # !

7

200L 1, 200L

M R l F O 6 N O T C A P M )

T

)

E R E D ( +

Decrease by 1%

1, 000L 1, 000L 1, 200L 1, 200L

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.14

Y T I U Q % F O T S O #

+

+

O

O

D

+

E S E A S H A C H R C U R P U E P R E E R R R O E F T E F B A E E + +

D(1 t) E

E R E (

Increase by 0.70%

M R l F O 6 N O T C A P M )

200L(1 .30) 1, 000L

T B E D F O T S O C X A T E R O F E B

M M R R l l Y D D T E E I R R U E E Q V V % E L E L F N N U U O E F F U O O L O EA + + 6 T B E $ F O E U L A 6

M R l F O E U L A 6

,

,

,

M R l D D OE % % + + R E V E L N U F O O +

Q5. The following data relate to two companies belonging to the same risk class: A Ltd.

B Ltd.

Expected Net operating Income

` 18,00,000

` 18,00,000

12% Debt

` 54,00,000

-

-

18

Equity Capitalization Rate Required:

(a) Determine the total market value, Equity capitalization rate and weighted average cost of capital for each company assuming no taxes as per M.M. Approach. (b) Determine the total market value, Equity capitalization rate and weighted average cost of capital for each company assuming 40% taxes as per M.M. Approach.

(10 Marks Nov. 2018)

S M R l F O E U L A 6 T E K R A -

a

X A T T U O H T I W N O I T A L U C L A C S U O I R A 6

Ans.

+

4 ) " %

`

,E T A 2 N O I T A Z I L A T I P A # Y T I U Q %

`

D E R E V E L N U F O E U L A 6

E

, 5

6

D T , !

F O E U L A 6 T E K R A -

6

D T , " F O E U L A 6 T E K R A -

`

Y T I U Q % F O E U L A 6

%

) 4 ) " %

O

X A T H T I W N O I T A L U C L A C S U O I R A 6

S M R l F O E U L A 6 T E K R A -

D E R E V E L N U F O E U L A 6

X A 4

T B E $

O + R

O E +

T

4 ) " %

, 5

6

D T , !

F O E U L A 6 T E K R A -

,

6

D T , " F O E U L A 6 T E K R A -

E T A 2 N O I T A Z I L A T I P A # Y T I U Q %

E T A 2 N O I T A Z I L A T I P A #

YD T T I , U Q! %

Y T I U Q % F O E U L A 6

%

T

) 4 ) " %

N O I T S E U Q E H T N I N E V I G

E T A 2 N O I T A Z I L A T I P A #

YD T T I , U Q" %

T

B

E

$

M

R I

&

F O

E

U

L A

6

D T , !

F O %

Y T I U Q % F O E U L A 6

L A T I P A # F O T S O # E G A R E V !

D E T H G I E 7

O

M R I & F O E U L A 6

6

T

4 ) " %

F O T S O # E G A R

E D VT !, !

D EL T A H T GI I P E A 7#

+

E +

F O T S O # E G A R

E D VT !, " D EL T A H T GI I P E A 7#

`

` `

M R I & F O E U L A 6

6

4 ) " %

F O T S O # E G A R

E D VT !, !

D EL T A H T GI I P E A 7#

+

E +

F O T S O # E G A R

E D VT !, " D EL T A H T GI I P E A 7#

Weighted Average Cost of Capital:

M R I & F O E U L A 6

T B E $

D T , !

F O %

Y T I U Q % F O E U L A 6

`

`

`

`

`

`

` ` `

% 2 5 4 # 5 2 4 3 , !

4 ) 0 ! # 3 . / ) 3 ) # % $ , ! ) # . ! . ) &

( #

E T A 2 N O I T A Z I L A T I P A #

YD T T I , U Q! %

18% given in the question

E T A 2 N O I T A Z I L A T I P A #

YD T T I , U Q" %

b

`

` `

` ` `

`

` `

5.15

4 . % % ' ! . ! , ! ) # . ! . ) &

! . / ) 4 # % 3

5.16

Selection of Best Option (Ko based) Q6. RST Ltd. is expecting an EBIT of ` 4,00,000 for F.Y. 2015-16. Presently the company is financed by equity share capital ` 20,00,000 with equity capitalization rate of 16%. The company is contemplating to redeem part of the capital by introducing debt financing. The company has two options to raise debt to the extent of 30% or 50% of the total fund. It is expected that for debt financing upto 30%, the rate of interest will be 10% and equity capitalization rate will increase to 17%. If the company opts for 50% debt, then the interest rate will be 12% and equity capitalization rate will be 20%.

You are required to compute value of the company; its overall cost of capital under different options and also state which is the best option.

(8 Marks Nov. 2015) Ans. Statement of Value of Firm and Cost of Capital

R O

F O

T S E R E T N )

S S E ,

26,00,000

24,00,000

16%

15.38%

16.67%

F

Decision:

Ko EBIT ÷ V

25,00,000

F O E U L A 6 R E H G I H G N I V A H E C N A N I F T B E D

R O F T P

O = E + D L

U O 4 H " S 0 ; Y N O % A+ $ PR Y

T ME T I B U OW Q E O # % $ L F O F D O N E E A EU U

L L M A A R 6 6 I

Value of Firm V

+

Earning available for Equity

F O

`

`

50% Debt

All equity 30% Debt

X A T D N A T S E R E T N I E R O F E B S G N I N R A %

Particulars

Implied Return Q7. A Limited and B Limited are identical except for capital structures. A Ltd. has 60 per cent debt and 40 per cent equity, whereas B Ltd. has 20 per cent debt and 80 per cent equity. (All percentages are in market value terms).

The borrowing rate for both companies is 8 per cent in a no-tax world, and capital markets are assumed to be perfect. (a) (i) If X, own 3 per cent of the equity shares of A Ltd., determine his return if the Company has net operating income of ` 4,50,000 and the overall capitalisation rate of the company, Ko is 18 per cent. (ii) Calculate the implied required rate of return on equity of A Ltd.

Financial Management & Economics for Finance (FM & ECO) | CRACKER AUTHOR PUBLISHER DATE OF PUBLICATION EDITION ISBN NO NO. OF PAGES BINDING TYPE

: : : : : : :

Namit Arora TAXMANN June 2022 3rd Edition 9789356221529 578 PAPERBACK

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Description This book is prepared exclusively for the Intermediate Level of Chartered Accountancy Examination requirement. It covers the questions & detailed answers strictly as per the new syllabus of ICAI. The Present Publication is the 3rd Edition & updated till 30th April 2022 for CA-Inter | New Syllabus | Nov. 2022/May 2023 exams. This book is authored

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· Strictly as per the New Syllabus of ICAI · Coverage of this book includes: All Past Exam Question, including:

 

Solved Paper: July 2021 (Suggested Answers) Solved Paper: December 2021 (Suggested Answers)



Solved Paper: May 2022 (Suggested Answers)

Questions from RTPs and MTPs of ICAI Solved Model Test Papers on CA Exam Pattern

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