Q1.

The following data is available in respect of a company :

Equity Rs.10lakhs,cost of capital 18% Debt Rs.5lakhs,cost of debt 13% Calculate the weighted average cost of funds taking market values as weights assuming tax rate as 40% Answer:

Use the equation WACC = We Ke + Wp Kp +Wr Kr + Wd Kd + Wt Kt ANS = 14.57

Q. 2 ABC Ltd. provides the information as shown in table 6.21 regarding the cost, sales, interests and selling prices. Calculate the DFL. Details of ABC Ltd. Output 20,000 units Fixed costs Rs.3,500 Variable cost Rs.0.05 per unit Interest on borrowed funds Nil Selling price per unit 0.20 Answer:

calculate DFL =

Q. 3

Two companies are identical in all respects except in the debt equity profile. Company X has 14%

debentures worth Rs. 25,00,000 whereas company Y does not have any debt. Both companies earn 20% before interest and taxes on their total assets of Rs. 50,00,000. Assuming a tax rate of 40%, and cost of equity capital to be 22%, find out the value of the companies X and Y using NOI approach?

Answer:

use the formula K0 = [B/(B+S)]Kd + [S/(B+S)]Ke

Q .4

Examine the importance of capital budgeting.

Answer: Importance of Capital budgeting Capital budgeting decisions are the most important decisions in Corporate financial management. These decisions make or mar a business organization. These decisions commit a firm to invest its current funds in the operating assets (i,e long-term assets) with the hope of employing them most efficiently to generate a series of cash flows in future. These decisions could be grouped into 1. Replacement decisions: These decisions may be decision to replace the equipments for maintenance of current level of business or decisions aiming at cost reductions. 2. Decisions on expenditure for increasing the present operating level or expansion through improved network of distribution. 3. Decisions for products of new goods or rendering of new services. 4. Decisions on penetrating into new geographical area. 5. Decisions to comply with the regulatory structure affecting the operations of the company. Investments in assets to comply with the conditions imposed by Environmental Protection Act come under this category. 6. Decisions on investment to build township for providing residential accommodation to employees working in a manufacturing plant.

Q. 5 Briefly explain the process of capital rationing. Answer: CAPITAL RATIONING Generally, firms fix up maximum amount that can be invested in capital projects, during a given period of time, say a year. The firm then attempts to select a combination of investment proposals that will be within the specific limits

providing maximum profitability and ranks them in descending order according to their rate of return; such a situation is of capital rationing.

There are basically two types of capital rationing Hard capital rationing Soft capital rationing

Hard capital rationing Hard capital rationing is defined as the capital rationing that under no circumstances can be violated. Hard capital rationing also refers to the companies acting external to the firms, which will not supply enough amount of investment capital, though having positive NPV projects. Hard capital rationing does not occur under perfect market. Soft capital rationing Soft capital rationing is defined as the circumstances under which the constraints on spending can be violated. Soft capital rationing refers to or arises with the internal, management-imposed limits on investment expenditure.

Q. 6 Explain the concepts of working capital. Answer: Concepts of Working Capital

The four most important concepts of working capital are Gross working capital, Net working capital, Temporary working capital and Permanent working capital.

Gross working capital Gross Working Capital refers to the amounts invested in various components of current assets. This concept has the following practical relevance. Management of current assets is the crucial aspect of working capital management Gross working capital helps in the fixation of various areas of financial responsibility Gross working capital is an important component of operating capital. Therefore, for improving the profitability on its investment a finance manager of a company must give top priority to efficient management of current assets The need to plan and monitor the utilisation of funds of a firm demands working capital management, as applied to current assets Net working capital Net working capital is the excess of current assets over current liabilities and provisions. Net working capital is positive when current assets exceed current liabilities and negative when current liabilities exceed current assets. This concept has the following practical relevance. Net working capital indicates the ability of the firm to effectively use the spontaneous finance in managing the firms working capital requirements A firms short term solvency is measured through the net working capital position it commands Permanent Working Capital Permanent working capital is the minimum amount of investment required to be made in current assets at all times to carry on the day to day operation of firms business. This minimum level of current assets has been given the name of core current assets by the Tandon Committee. Permanent working capital is also known as fixed working capital. Temporary Working Capital Temporary working capital is also known as variable working capital or fluctuating working capital. The firms working capital requirements vary depending upon the seasonal and cyclical changes in demand for a firms products. The extra working capital required as per the changing production and sales levels of a firm is known as temporary working capital.