Revisionary Test Paper_June2018

Intermediate
Group II
Paper 10: Cost & Management Accounting and
Financial Management
(SYLLABUS – 2016)

SECTION - A
COST & MANAGEMENT ACCOUNTING

PART-I – Objective Question

I. Multiple Choice Questions (MCQ)

1. Cost Price is not fixed in case of:

A. Cost plus contracts
B. Escalation clause
C. De escalation clause
D. All of the above.

2. Continuous stock taking is a part of:

A. ABC analysis
B. Annual stock taking
C. Perpetual Inventory
D. None of these.

3. In Reconciliation Statements expenses shown only in financial accounts are:

A. Added to financial profit

B. Deducted from financial profit
C. Ignored
D. Added to costing profit.

4. Operating costing is applicable to:

A. Hospitals
B. Cinemas
C. Transport undertaking
D. All the above.

5. Flexible budget requires a careful study of:

A. Fixed, semi-fixed and variable expenses

B. Past and current expenses
C. Overheads, selling and administrative expenses
D. None of the above.

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6. Which of the following items is not excluded while preparing a cost sheet?
A. Goodwill written off
B. Provision for taxation
C. Property tax on factory building
D. Interest paid.

7. The most important element of cost is:

A. Material
B. Labour
C. Overheads
D. All the above.

8. Continuous stock taking is a part of:

A. ABC analysis
B. Annual stock taking
C. Perpetual inventory
D. None of the above.

9. Depreciation is an example of:

A. Fixed cost
B. Variable cost
C. Semi variable cost
D. None of the above.

10. Joint cost is suitable for:

A. Infrastructure industry
B. Ornament industry
C. Oil industry
D. Fertilizer industry.

Answer:

1-A 2-C 3-A 4-D 5-A 6-C 7-A

8-C 9-A 10-C

II. True / False

1. Multiple costing is suitable for banking industry.

2. Cost ledger control account makes the cost ledger self balancing.
3. Production cost includes only direct costs related to the production.
4. CAS 9 is for direct expenses as issued by the Cost Accounting Standards Board
(CASB) of the Institute of Cost Accountants of India.
5. ABC analysis is based on the principle of management by exception.
6. Slow moving materials have a high turnover ratio.

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7. Cost of indirect material is apportioned to various departments.
8. Departments that assist producing Department indirectly, are called service
departments.
9. Waste and scrap of material have small realisation value.
10. Bin card are not the part of accounting records.

Answer:
1. False
2. True
3. False
4. False
5. True
6. False
7. False
8. True
9. False
10. True.

III. Matching:

Column A Column B
1 Research and Development Cost A CAS 2
2 Depreciation on computer purchased B Forms part of selling expenses
for office
3 Abnormal loss is transferred to C Costing Profit and Loss Account
4 In electricity companies, the cost unit D Kilowatt
is
5 The summary of all functional budgets E CAS 18
6 Cost of free samples of products F Forms part of office administration
distributed expenses
7 In contract costing, cost unit is G Per contract
8 Capacity Determination H Not shown in the cost sheet but
debited to profit & loss account
9 Scrap value of abnormal loss of I Not shown in the cost sheet but
finished output credited to profit & loss account
10 Cash discount allowed J Master budget

Answer:

1-E 2-F 3-C 4-D 5-J 6-B 7-G

8-A 9-I 10-H

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PART-II

Marginal Costing:

2. EON Ltd. sold 275,000 units of its product at ₹ 37.50 per unit (Manufacturing Costs of ₹ 14
and Selling costs of ₹3.50 per unit). Fixed Costs are incurred uniformly throughout the year
and amount to ₹ 35,00,000 (including Depreciation of ₹15,00,000). There are no beginning
or ending inventories.
Required-
i. Estimated Break-Even Sales Quantity and Cash Break Even Sales Level Quantity
ii. Estimate the PV Ratio
iii. Estimate the number of units that must be sldo to earn an Income (EBIT) of ₹ 2,50,000.
iv. Estimate the Sales Level to achieve an After Tax Income (PAT) of ₹ 2,50,000. Assume
40% Corporate Income Tax Rate.

Answer:
i. Contribution per unit=Sales Price –Variable Costs = ₹37.50 - ₹17.50
= ₹ 20 per unit
ii. Break Even Quantity =Total Fixed = ₹ 35,00,000/₹ 20
Costs/Contribution per unit = 175,000 units
iii. Cash Break Even Quantity=Cash Fixed Costs/ = ₹ 20,00,000/₹ 20
Contribution per unit = 100,000 units
iv. PV Ratio=Contribution per unit/Sales Price per unit = ₹20.00/₹ 37.50 x100
x 100 = 53.33%
v. Required Profit(EBIT)= ₹ 250,000, Contribution = ₹ 35,00,000+ ₹ 250,000
required=FC+EBIT = ₹37,50,000
vi. Quantity required to earn above profit of ₹ = ₹ 37,50,000/₹ 20
250,000 = ₹ 187,500 units
vii. Since Tax Rate is 40%, PAT constitutes 60% of EBIT. = ₹ 250,000/60%
Hence, if required PBT is ₹ 250,000, required EBIT= = ₹ 4,16,667

viii. If Required Profit (EBIT)=₹ 4,16,667, Contribution = ₹ 35,00,000+₹ 4,16,667

required-FC +EBIT = ₹ 39,16,667
ix. Quantity required to earn above PAT of ₹ 250,000 = 39,16,667/ ₹ 20
= 1,95,833 units.

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3. Product B is one of a number of products produced and sold by Foxpro Ltd. The following
information relates to Product B:
(a). Production / Sales per period is 2000 units
(b). Selling Price / Unit is ₹ 10.00
(c). Variable Costs / Unit is ₹ 6.30
(d) Fixed Costs of ₹ 5400 per period which are avoidable if production of Product B
should not cease.
(e). ₹ 12,000 share of general company costs which will remain if the product is
discontinued.

You are required to find out, by showing all appropriate calculations, the following:
(a) Discuss a claim by one management member that production and sale of Product B
should be discontinued.
(b) At what production / sales level will Product B breakeven?
(c) Product B can be replaced by Product Y on the basis of one unit of Y for two units of B.
Product Y has a selling price of ₹ 16 and a Contribution / Sales ratio of 0.3. Should the
substation be implemented.
(i). If 500 units of B are to be replaced?
(ii). If all units of B are to be replaced?

Answer:

(a). Product-B

Sales revenue ₹ 20,000

Less-Variable costs 12,600
Contribution 7,400
Less- Avoidable fixed cost 5,400
Net margin 2,000
Less- General fixed cost 12,000
Net loss (10,000)
Product B is making a net loss, hence, the reason for management’s decision to
discontinue the product. It is however, making a contribution of ₹ 2,000 to company net
cash inflows represented by its net margin. In the absence of any more profitable use of
the capacity, its production should be continued.

(b). Contribution / Sales ratio-₹ 3.70 / ₹ 10 =0.37

Total fixed cost = ₹ 17,400

Sales at break-even point = Fixed cost/CS ratio

= ₹ 17,400/0.37

=₹ 47,027

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(c) (i) If 500 units of B are replaced, fixed cost of ₹ 5,400 will remain

Contribution lost from B =₹ 3.70 x 500

=₹ 1,850

Contribution gained from Y =₹ 16 x 0.3 x 250

=₹1,200

Net loss to the company ₹ 650

It is better therefore, not to substitute.

(ii). If all of B is replaced, ₹ 5,400of fixed cost is avoided

Net loss from B (its net margin) =₹2,000

Contribution gain from Y =₹ 16x0.3x1,000 =₹ 4,800

Net gain to the company ₹ 2,800

It is better in this situation to carry out the substitution.

Note: ₹ 12,000 share of general company costs should be ignored since they are
unavoidable whatever decision is taken.

4. The following extracts are taken from sales budget of a Vesuvious Ltd. for current year

(₹ ‘000)

Sales-40,000units@₹ 25 per unit 1,000

Selling costs:
Advertising 100
Salary of Salesman’s 80
Travelling expenses 50
Rent of sales office 10
Others 10 250

The management of the organization is considering a proposal to establish a new market

in the eastern region in the next year. It is proposed to increase the advertising
expenditure by 25% and appoint an additional sales supervisor at a salary of ₹ 30,000 per
year to establish a market. This will involve additional travelling , hence, additional
travelling expense shall increase by 10%. Target annual sales volume at the existing
selling price for the new market is 10,000 units. The estimated variable cost of production
is ₹ 12 per unit. Should the company try to establish the new market?

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Answer:

Statement showing Different Cost and Revenues

Sales (Units) Present-40,000 Budget-50,000 Incremental-10,000

Sales (a) 1,000 1,250 250
Selling Costs: (b)
Advertising 100 125 25
Salary of sales persons 80 110 30
Travelling expenses 50 55 5
Rent 10 10 --
Others 10 10 --
Cost of goods sold(a)- 750 940 190
(b)
Less- Variable cost of 480 600 120
production
PROFIT 270 340 70

Incremental Return on Incremental Sales = ₹ 70,000/₹250,000 x100

=28%.
Analysis- The incremental return is higher than the current return, hence, it is suggested to
implement the proposal.

5. Hi-tech Manufacturing Co. is presently evaluating two possible processes for the
manufacture of a toy. The following information is available:

Particulars Process A Process B

Variable cost per unit ₹ 12 ₹ 14
Sales price per unit ₹20 ₹ 20
Total fixed costs per year ₹ 30,00,000 ₹ 21,00,000
Capacity (in units) 430,000 500,000
Anticipated sales (Next year, in units) 400,000 400,000

Suggest:
(i) Which process should be chosen?
(ii) Would you change your answer as given above, if you were informed that the
capacities of the two processes are as-A 600,000 units & B 500,000 units?

Answer:

Particulars Process A Process B

Sale price p.u. ₹ 20 ₹20
Variable cost p.u. ₹12 ₹14
Contribution p.u. ₹8 ₹6
Fixed costs p.a. ₹ 30,00,000 ₹ 21,00,000
BEQ=[4/3] 375,000 units 350,000 units
Anticipated sales quantity 400,000 units 400,000 units
MOS Quantity (6-5) 25,000 units 50,000 units
Anticipated Profit(7x3) ₹ 2,00,000 ₹ 300,000

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Analysis & calculation:

1. Indifference point = Change in fixed costs / Change in contribution p.u.

= 30,00,000-21,00,000/8-6
= 900,000/2
=450,000 units
2. Since anticipated sales (400,000 units) is below the Indifference point (450,000 units),
the option with the lower fixed cost is preferable. Hence, Process B is preferable (as
reflected by higher anticipated profit)
3. No change in answer even if capacity of Process A increases, since anticipated
sales is only 400,000 units.

Standard Costing:

6. Zeda Company has a normal capacity of 120 machines, working 8 hours per day of 25 days in a
month. The Fixed Overheads are budgeted at ₹1,44,000 per month. The standard time required
to manufacture one unit of product is 4 hours. In April, the Company worked 24 days of 840
machine hours per day and produced 5,305 units of output. The Actual Fixed Overheads were ₹
1,42,000. From the above, compute all FOH related variances.

Answer:
1. Basic Calculations

(a) Budgeted Hours = 120 machines × 8 hours × 25 days = 24,000 machine hours.
24,000 hours
(b) Budgeted output = = 6,000 units
4 hours per unit
Budgeted FOH `1,44,000
(c) FOH Standard Rate per hour = = = `6 per hours
Budgeted Hours 24,000 hours
Budgeted FOH `1,44,000
(d) FOH Standard Rate per unit = = = ` 24 pear unit
Budgeted Output 6,000 hours

2. Variance Computation Chart

Col (1): COL (2) : (3): PFOH = COL (4) : COL (5) :
AO × SR AH ×SR AD BFOH AFOM
BFOH ×
BD
5,305 units × ₹24 (24 × 840) hrs × ₹6 24 ₹1,44,000 ₹1,42,000
₹1,44,000 ×
pu ph 25 (Given) (Given)
=₹ 1,27,320 = ₹ 1,20,960 = ₹1,38,240

Efficiency variance + Capacity variance + Calendar variance + Expenditure variance

= ₹1,27,320 = ₹1,20,960 = ₹1,38,240 = ₹1,44,000
– ₹1,20,960 - ₹1,38,240 - ₹1,44,000 - ₹1,42,000
= ₹6,360 F = ₹17,280 A = ₹5,760 A =₹2,000 F

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FOH Volume Variance + FOH Expenditure Variance b/fd as above ₹
= ₹1,27,320 – ₹1,44,000 = ₹16,680 A =₹ 2,000 F

Total FOH Cost Variance

=₹1,27,320 – ₹1,42,000 =₹ 14,680 A

7. Nandana Ltd manufactures a commercial product for which the Standard Cost per unit is as
follows:

Particulars ₹
Material: 5 kg @ ₹4 per kg 20.00
Labour: 3 hours @ ₹10 per hour 30.00
Overhead Variable: 3 hours @ ₹1 per hour 3.00
Fixed: 3 hours @ ₹0.50 per hour 1.50

Total 54.50

During January, 600 units of the product were manufactured at the cost shown below:

Particulars ₹
Material 5,000 kg @ ₹4.10 per kg (Material used: 3,500 kg) 20,500
Purchased
1,700 hours @ ₹9 15,300
Direct Labour
1,900
Variable
Overhead 900

Total 38,600

The Flexible Budget required 1,800 Direct Labour Hours for operation at the monthly
activity level used to set the Fixed OH Rate.

Calculate the following items. Also reconcile the Standard and Actual cost of Production.
(a) Material Price Variance. (f) Variable Overhead Efficiency Variance,
(b) Material Usage Variance. (g) Fixed Overhead Expenditure Variance,
(c) Labour Rate Variance. (h) Fixed Overhead Volume Variance,
(d) Labour Efficiency Variance. (i) Fixed Overhead Capacity Variance,
(e) Variable Overhead Expenditure Variance, (j) Fixed Overhead Efficiency Variance,

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Solution:
1. Computation of Material cost variances
Col. (1): SQ × SP Col. (2) : AQ × SP Col. (3) : AQ × AP
(600 units × ₹5 Kg) × ₹ 4 3,500 Kg × ₹4 Kg 3,500 Kg × ₹4.10
= ₹ 12,000 = ₹ 14,000 = ₹ 14,350

Usage Variance = ₹12,000 – ₹14,000 = ₹2,000 A + Price Variance

= ₹14,000 – ₹14,350 = ₹3500 A
Total Material Cost Variance = ₹12,000 – ₹14,350
= ₹ 2,350 A
Note: Material Purchase Price Variance = Purchase Qty × (Std Price - Actual Price)
= 5,000 × (₹ 4 – ₹ 4.10) = ₹500 Adv.

2. Computation of Labour Cost variance

Col. (1): SH × SR Col. (2) : AH × SR Col. (3) : AH × AR
(600 × ₹3 hours) × Rs 10 1,700 hours × ₹10 1,700 hours × ₹9
= ₹ 18,000 = ₹ 17,000 = ₹ 15,300

Efficiency Variance = ₹18,000 – ₹17,000 = ₹1,000 F + Rate Variance

= ₹ 17,000 – ₹ 15,300 = ₹1,700 F
Total Labour Cost Variance = ₹18,000 – ₹15,300
= ₹2,700 F

3. Computation of VOH Cost variance

Col. (1): SH × SR Col. (2) : AH × SR Col. (3) : AVOH
(600 × 3 hours) × ₹ 1 1,700 hours × Rs 1 Given = ₹ 1,900
= ₹ 1,800 = ₹1,700

VOH Efficiency Variance + VOH Efficiency Variance

= ₹1,800 –₹1,700 = ₹100 F = ₹1,700 – ₹1,900 = ₹ 200 A

Total VOH Cost Variance = ₹1,800 – ₹1,900 = ₹100 A

4. Computation of FOH Cost variance

Col. (1): AO × SR Col. (2) : Total AH × SR Col. (3) : BFOH Col. (4) : BFOH
(600 × 3 ) × Re 0.50 1,700 hours × Re 0.50 1,800 hours × Re 0.50 Given = ₹ 900
= ₹ 900 = ₹ 850 = ₹ 900

Efficiency Variance + Capacity Variance + Expenditure var.

= ₹900 –₹850 = ₹50 F = ₹ 850 – ₹ 900 = ₹50 A ₹900 –₹900 = Nil

FOH Volume Variance + FOH Expenditure Variance b/fd as above

= ₹50 – ₹50 = Nil = Nil

Total FOH cost variance = Nil

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5. Reconciliation of Standard and actual Costs

Particulars ₹ ₹ ₹
Standard Cost: 600 units at × ₹ 54.50 pu Fav. 32,700
Adjust: Effect of Variances: Adv.
Material Usage 2,000
Material Purchase Price (since RM Stock is valued at Std 500
Cost)
Labour Efficiency 1,000
Labour Rate 1,700
VOH Efficiency 100
VOH Expenditure 200
FOH Variances Nil Nil
Total of Variances 2,700 2,800 100 Fav.
Actual Cost: Given 38,600 less RM Stock at Std Cost: 1,500 kg 32,600
× ₹ 4/kg 6,000

8. The standard cost of a certain chemical mixture is as under:

40% of Material A at ₹ 20 per tonne. 60% of Material B at ₹ 30 per tonne.

A standard loss of 10% is expected in production. The following actual cost data is given for
the period.

180 tonnes material A at a cost of ₹ 18 per tonne.

220 tonnes material B at a cost of ₹ 34 per tonne.

The weight produced is 364 tonne.

Calculate and present:

(a) Material Price Variance.

(b) Material Mix Variance.
(c) Material Yield Variance.
(d) Material Cost Variance.
(e) Material Usage Variance.
Solution:
Calculation of variances
M1 — Actual cost of Material used:
Material A — 180 tonnes × ₹ 18 = 3,240
Material B — 220 tonnes × ₹ 34 = 7,480 ₹ 10,720

M2 — Standard cost material used

Material A —180 tonnes × ₹ 20 = 3,600
Material B —220 tonnes × ₹ 30 = 6,600 ₹10,200

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 Revisionary Test Paper_June2018
M3 — Standard cost of material, if it had been in standard proportions.

Standard Qty. of Material A in

Standard mix in kg. Weight in Standard rate
× ×
Weight of Std.mix actual mix of Mat. Aper kg.
Material A =
40 kg.
×400 kg × ` 20 or ` 3,200
100 kg.
= ………..…………..………(i)
Standard Qty. of Material B in
Standard mix in kg. Weight in Standard rate
× ×
Weight of Std.mix actual mix of Material
Material B =
60 kg.
×400 kg × ` 30 or `7,200
100 kg.
= …………………………..(ii)
Adding (i) and (ii) we get the value of M3
= ₹3,200 + ₹ 7,200 or ₹ 10,400.

M4 — Standard cost of output.

Let us find out the standard cost, when input is 100 kg.
Standard Mix Standard rate Standard cost
40 kg ₹20 ₹800
60 kg 30 1,800
100 kg 2,600
Loss 10% 10 -------
90 kg 2,600

It means for output of 90 kg. standard cost will be ₹ 2,600.

2,600
Standard cost of actual output of 364 kg. this will be: = × 364 or `10,516.
90
Variances
(a) Material Price Variance = M1- M2 = ₹ 10,720 - 10,200 or ₹ 520 (A)
(b) Material Mix Variance = M2 - M3 = 10,200 -10.400 or ₹200 (F)
(c) Material Yield Variance = M3 - M4 = ₹10,400 – ₹ 10,516 or ₹ 116 (F)
(d) Material Cost Variance = M1 - M4 = 10,720 - 10,516 or ₹ 204 (A)
Alternatively, it can be found out as follows:
(x)= Material Price Variance + Material Mix Variance + Material Yield Variance
(y)= ₹ 520 (A) + ₹ 200 (F) + ₹ 116 (F) = ₹ 204 (A)
(z) = Material Usage Variance = M2 - M4 = 10,200-10,516 or ₹ 316(F)

Alternatively, it can be found out as follows:

(z)= Mat. Mix Variance + Mat. Yield Variance
= 200 (F)+ 116(F) =₹ 316(F)

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9. From the following data, calculate:
(1) Sales Value Variance.
(2) Sales Price Variance.
(3) Sales Mix Variance.
(4) Sales Quantity Variance.
(5) Sales Value Volume Variance.

Standard Actual
Qty. (kgs) Sales price Total Qty. (kgs) Sales price Total
₹ (kg) ₹ (kg)
Product X 500 5.00 2,500 500 5.00 2,500
Product Y 400 6.00 2,400 600 6.25 3,750
Product Z 300 7.00 2,100 400 6.75 2,700
1,200 7,000 1,500 8,950

Answer:
1. SV1—Actual sales value realised = ₹ 8,950 (Given)
2. SV2—Standard Value of Actual Sales.
Product X 500 × 5 = ₹ 2,500
Product Y 600 × 6 = ₹ 3,600
Product Z 400 × 7 = ₹ 2,800
Total ₹ 8,900

3. SV3—Standard value of actual sales, if these sales had been effected according to the
ratio of standard mix.
Product X = (500 ÷ 1200) × 1,500 × 5 = ₹ 3125
Product y = (400 ÷ 1200) × 1,500 × 6= ₹ 3,000
Product Z = (300 ÷ 1200) × 1,500 × 7 = ₹ 2,625
Total 8,750
4. SK4—Standard value of sales as per standard or budget = ₹ 7,000 (Given).
Variance
1. Sales Value Price Variance = SV1 - SV2 = ₹ 8,950 - 8,900 or ₹ 50(F)
2. Sales Value Mix Variance = SV2 – SV3 = ₹ 8,900 – ₹ 8,750 or ₹ 150(F)
3. Sales Value Quantity Variance = SV3 – SV4 = ₹ 8,750 – ₹ 7,000 or ₹1,750(F)
4. Sales Value Variance = SV1 - SV4 = ₹ 8,950- ₹ 7,000 or ₹ 1,950 (F)
Alternatively, it can be worked out as under:
= Sales Value price Variance + Sales Value Mix Variance + Sales value Quantity Variance
= ₹ 50 (F) + ₹ 150 (F) + ₹ 1,750 (F)
= ₹ 1,950 (F)
5. Sales Value Volume Variance =SV2 -SV4 = ₹ 8,900 – ₹ 7,000 or ₹ 1,900(F)
Alternatively, it is the sum total of sales value mix variance and sales value
quantity variance.
= ₹ 150 (F) + ₹ 1,750 (F) or ₹ 1,900 (F).

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Transfer Pricing & Budgeting:

10. Telco Ltd. which has a system of assessment of divisional performance on the basis of
residual income, has two divisions Alfa and Beta. Alfa has annual capacity to
manufacture 15,00,000 numbers of a special component which it sells to outside
customers; but has idle capacity. The budgeted residual income of Beta is ₹ 120 lakhs
while that of Alfa is ₹ 100 lakhs. Other relevant details extracted from the budget of Alfa
for the year are:

Sale (to outside customers) 12 lakh units @ ₹ 180 per unit

Variable cost per unit ₹ 160
Divisional fixed cost ₹ 80 lakhs
Capital employed ₹ 750 lakhs
Cost of capital 12%

Beta has just received a special order for which it requires componens similar to the
ones made by Alfa. Fully aware of Alfa’s unutilized capacity, Beta has asked Alfa to
quote for manufacture and supply of 300,000 numbers of the components with a slight
modification during final processing. Alfa and Beta agree that this will involve an extra
variable cost of ₹ 5 per unit.

(i) Calculate the transfer price which Alfa should quote to Beta to achieve its budgeted
residual income
(ii) Indicate the circumstances in which the proposed transfer price may result in a
suboptimal decision for the Telco Ltd. as a whole.
Answer:
(i). Calculation of Transfer Price to be quoted by Alfa to Beta based on Residual Income:
(₹ lakhs)
Fixed costs 80
Return on capital employed (₹ 750 lakhs x 12/100) 90
Residual income desired 100
270
Desire contribution per unit:
Selling price per unit – Variable cost per unit
= ₹ 180 -160
= ₹ 20 per unit
Total desired contribution
12,00,000 units x ₹ 20 per unit
=₹ 240 lakhs.
Minimum contribution to be earned from sale of additional 3 lakh units
= ₹ 270 lakhs - ₹ 240 lakhs
=₹ 30 lakhs.
Contribution per unit on additional 300,000 units
=₹ 30,00,000/300,000 units
=₹ 10 per unit
Variable cost of modification per unit = ₹ 5

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 Revisionary Test Paper_June2018
Hence, the minimum transfer price per unit to be quoted will be
= ₹ 160 + ₹10+ ₹5
= ₹ 175.

(ii). Beta can buy from outside at less than the variable cost of manufacture, ₹ 165. Then
only the decision to transfer at the price of ₹ 175 will become suboptimal for the group
as a whole.

11 .The following details are made available by an autonomous division of Tetra Ltd. for the
month of April, 2018:
Particulars Budget Actuals
Sales 24,00,000 22,00,000
Direct materials 6,00,000 5,20,000
Direct labour 8,00,000 7,56,000
Variable overheads 5,00,000 4,72,000
Fixed overheads 3,00,000 3,00,000
Total 22,00,000 20,48,000
Profit 2,00,000 1,52,000
Production/ Sales (units) 20,000 18,000

(a) Prepare a flexible budget of the division for April, 2018

(b) Analyze the variation in profit between the budget and actual in as much detail as
possible.

Answer:

(a). Flexible Budget for April, 2018 along with the Budget and Actual:

Sales (units) Budget-20,000 Flexible budget- Actuals- Remarks-

18000 18,000 18,000
Sales value 24,00,000 21,60,000 22,00,000 @₹ 120 for
18,000 units
Direct 600,000 540,000 520,000 25% of sales
materials value
Direct labour 800,000 720,000 756,000 33 1/3% o of
sales value
Variable 500,000 450,000 472,000 20% of sales
overheads value
Fixed 300,000 300,000 300,000
overheads
22,00,000 20,10,000 20,48,000

PROFIT 200,000 150,000 152,000

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 Revisionary Test Paper_June2018
(b). Analysis of Variance:
The variance in profit between the budget and actual is ₹ 48,000(A) and this is analysed
as:
₹ ₹
(i) Sales price variance =21,60,000-22,00,000 40,000(F)
(ii) Direct material cost variance =5,40,000-5,20,000 20,000(F)
(iii) Direct labour cost variance =7,20,000-7,56,000 36,000(A)
(iv) Variable overhead cost variance =4,50,000-4,72,000 22,000(A)
(v) Sales margin volume variance (Budgeted Sales-Actual
Sales) x Standard profit per
unit 20,000(A)
=(20,000-18,000) x Rs 10
(vi) Fixed overhead cost variance (Standard fixed overhead of
actual production –Actual
fixed overhead) 30,000(A)
= (18,000 x Rs 15)-3,00,000
Net variance 48,000(A)

12. Jagruti Ltd. will pay a royalty @10% of selling price fixed by it for sale in local market less
landed cost of imported items of the kit less cost of standard items purchased locally.
Considering the above information, calculate the selling price that should be fixed for
local sales so as to set 20% profit on selling price.

Answer:

Landed cost of imported parts per kit ₹3640

Cost of indigenously manufactured parts per kit ₹4500
Assembly and other overhead ₹1000
Technical know-how ₹ 10
Total cost excluding Royalty ₹ 9150
Add-Royalty ₹ 685*
₹ 9835
Profit 20% on sales or 25% on cost ₹ 2459
Selling price for local market ₹12,294
Working Notes:
*Supposing Selling Price = x and Royalty=y

X=(₹9150+y) +25% (9150+y)

Or, x=₹ 9150 +y +₹ 2287.50 +0.25y
Or, x= ₹ 11437.50 +1.25y ............................(i)
We also know that
Y=0.10(x-₹ 3640-₹1800)
Or y=0.10x –₹544 ..................................(ii)
Multiplying (ii) by 1.25
1.25y=0.125x-₹680 .....................................(iii)
± 1.25y = ± x ± ₹11437.50 .......................................(iv)
Or 0.875x = ₹ 10757.50

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 Revisionary Test Paper_June2018
Or x=₹ 12,294 (appx)
Putting the value of x in (iv) above
1.25y= x-₹ 11437.50
1.25y= ₹ 12294-₹ 11437.50
Or y= 685(appx).

13. The Budget manager of Philips Electricals Ltd. is preparing a flexible budget for the
accounting year commencing from 1.4.2017. The company produces one product-
Kaypee. Direct material costs ₹ 7 per unit, Direct labour averages ₹ 2.50 per hour and
requires 1.60 hours to produce one unit of Kaypee. Salesman are paid a commission of
₹ 1 per unit sold. Fixed selling and administration expenses amount to Rs 85,000 per
year. Manufacturing overheads under specified conditions of volume have been
estimated as follows:

Volume of production (units) 1,20,000 1,50,000

Expenses: 264,000 330,000
Indirect material
Indirect labour 150,000 187,500
Inspection 90,000 112,500
Maintenance 84,000 102,000
Supervision 198,000 234,000
Depreciation-Plant & equipment 90,000 90,000
Engineering services 94,000 94,000
Total manufacturing overheads 9,70,000 11,50,000

Normal capacity of production of the company is 125,000 units. Prepare a budget of

total cost at 140,000 units of output.

Answer:

Working notes:

1. Variable costs per unit:

₹
Direct material 7.00
Direct labour (1.60 hours x ₹ 2.50) 4.00
Sales commission 1.00
Indirect material (₹ 264,000 / 120,000 units) 2.20*
(₹ 330,000 / 150,000 units)
Indirect labour (₹ 150,000/120,000 units) 1.25*
(₹ 187,500 / 150,000 units)
Inspection (₹ 90,000/120,000 units) 0.75*
(₹ 112,500/150,000 units)

*Indirect material, indirect labour and inspection costs directly vary with the number
of units produced.

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2. Fixed costs (No change in cost irrespective of level of production) ₹
Depreciation-Plant & equipment 90,000
Engineering services 94,000
Selling and administration expenses 85,000
3. Semi-variable expenses- Maintenance and supervision expenses are in the nature of
semi-variable expenses. The variable component of these expenses can be divided
by applying the following formula:
= Change in cost / Change in production level
(a) Maintenance expenses:
(i) Variable cost = ₹ 102,000 - ₹84,000/ 150,000 -120,000
= ₹ 0.60 per unit
(ii) Fixed cost = ₹ 84,000 -(120,000 x Re 0.60)
= ₹ 12,000
(b) Supervision expenses:
(i) Variable cost = ₹ 234,000 - ₹ 198,000/150,000-120,000
= ₹ 1.20 per unit
(ii) Fixed cost = ₹ 198,000 -(120,000 x ₹ 1.20)
= ₹ 54,000.

Flexible Budget of Philips Electricals Ltd. for the year 2017-18 (Budgeted output-140,000
units)

₹
Variable cost:
Direct material (@₹ 7) 980,000
Direct labour (@₹ 4) 560,000
Indirect material (@₹ 2.20) 308,000
Indirect labour (@ ₹ 1.25) 175,000
Inspection (@ ₹ 0.75) 105,000
Maintenance (@₹ 0.60) 84,000
Supervision (@ ₹1.20) 168,000
Sales commission (@₹ 1.00) 140,000
(a) 25,20,000
Fixed cost:
Maintenance 12,000
Supervision 54,000
Depreciation-Plant and equipment 90,000
Engineering services 94,000
Selling and administrative expenses 85,000
(b) 3,35,000
Total cost (a) + (b) 28,55,000

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14. Delta Ltd. fixes the interdivisional transfer prices for its product on the basis of cost plus a
return on investment in the division. The budget for Division A for 2017-18 is as under:

Fixed assets ₹ 250,000

Current assets ₹ 150,000
Debtors ₹ 100,000
Annual fixed cost of the division ₹ 400,000
Variable cost per unit of the product ₹ 10.00

Budgeted volume 200,000 units per year

Desired ROI 28%
Determine the transfer price for Division A.
If the volume (in units) can be increased by 10%, what will be the impact on transfer
price?

Answer:

Calculation of desired Return on Investment:

Fixed Assets ₹ 250,000
Current Assets ₹ 150,000
Stock ₹ 100,000
Total investment in business ₹ 500,000
Desired return (₹ 500,000 x 28/100) ₹ 140,000

Calculation of Transfer Price:

Variable cost (200,000 units x ₹ 10) ₹ 20,00,000
Fixed cost of Division A p.a. ₹ 400,000
Total cost ₹ 24,00,000
Add desired Return ₹ 140,000
Total amount to be charged ₹ 25,40,000
Inter divisional transfer price p.u. ₹ 12.70
(₹ 25,40,000 /200,000 units)

Impact on Transfer price if the volume is increased by 10%:

Variable cost (220,000 units x ₹ 10) ₹22,00,000
Fixed cost ₹400,000
Total cost ₹ 26,00,000
Add- desired return on investment ₹ 140,000
Total amount to be charged ₹ 27,40,000

Interdivisional transfer price = ₹ 27,40,000 / 220,000 units

= ₹ 12.45 per unit

Due to increase in sales volume the transfer price will be reduced by Re 0.25 (i.e. ₹ 12.70 -
₹12.45) per unit.

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15. (a) Sunk Cost

Sunk costs are historical costs which are already incurred i.e. sunk in the past and are not
relevant to the particular decision making problem being considered. Sunk costs are
those that have been incurred for a project and which will not be recovered if the
project is terminated. While considering the replacement of a plant, the depreciated
book value of the old asset is irrelevant as the amount is sunk cost which is to written-off
at the time of replacement.

(b). Uniform Costing

Answer: Uniform costing is not a particular method of costing. It is adoption of common

accounting principles and in some cases common methods by member companies in
the same industry so that their cost figures may be comparable. Uniform costing can be
defined as the ̳use by several undertakings of the same costing principle and
practices‘.
In other words, it is a technique or method of costing by which different firms of a field
or industry apply similar costing system so as to produce cost data which have
maximum comparability.
Standard costs may be developed and cost-control is secured in firm through mutual
comparison. Relative efficiency and inefficiencies in production may be identified and
suitable steps may be suggested to control and reduce the cost. The objectives of
uniform costing are to standardize accounting methods and to assist in determining
suitable prices of products of firms which adopt this method.
Uniform costing can be adopted if certain pre-conditions exists. The success of a
uniform costing system depends primarily on the cooperation extended by different
units or firm towards the working of the system. Every unit should agree to supply
required accounting and costing information without reservation to a central body
formed by them for implementation of the uniform costing scheme. This body has to
correlate, analyze and consolidate the information received from the different units.

(c). What do you mean about ‘Responsibility Accounting’

One of the recent developments in the field of management accounting is the

responsibility accounting, which is helpful in exercising cost control. Responsibility
Accounting is a system of accounting that recognizes various responsibility centers
throughout the organization and reflects the plans and actions of each of these centers

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by assigning particular revenues and costs to the one having the pertinent
responsibility. It is also called profitability accounting and activity accounting. It is a
system in which the person holding the supervisory posts as president, function head,
foreman, etc are given a report showing the performance of the company or
department or section as the case may be. The report will show the data relating to
operational results of the area and the items of which he is responsible for control.
Responsibility accounting follows the basic principles of any system of cost control like
budgetary control and standard costing. It differs only in the sense that it lays emphasis
on human beings and fixes responsibilities for individuals. It is based on the belief that
control can be exercised by human beings, so responsibilities should be fixed for
individuals.

Principles of responsibility accounting are as follows:

(a) A target is fixed for each department or responsibility center.
(b) Actual performance is compared with the target.
(c) The variances from plan are analysed so as to fix the responsibility.
(d) Corrective action is taken by higher management and is communicated.

(d). Discuss the process of installation of Cost Accounting System.

Cost Accounting System has to be specially designed for an undertaking to meet its
specific needs. Before installing a cost system proper care should be taken to study
and taken into account all the aspects involved as otherwise the system will be a misfit
and full advantages will not be realized from it. The following points should be looked
into and the prerequisites satisfied before installing a cost system:
(i)The nature, method and stages of production, the number of varieties and the
quantity of each product and such other technical aspects should be examined. It is
to be seen how complex or how simple the production methods are and what is the
degree of control exercised over them.
(ii) The size, layout and organisation of the factory should be studied.
(iii) The methods of purchase, receipt, storage and issue of materials should be
examined and modified wherever considered necessary.
(iv) The wage payment methods should be studied.
(v) The requirements of the management and the policy adopted by them towards
cost control should be kept in view.

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(vi) The cost of the system to be installed should be considered. It is needless to
emphasize that the installation and operation of system should be economic.
(vii) The system should be simple and easy to operate.
(viii) The system can be effectively run if it is appropriate and properly suited to the
organisation.
(ix) Forms and records of original entry should be so designed and to involve minimum
clerical work and expenditure.
(x) The system should be so designed that cost control can be effectively exercised.
(xi) The system should incorporate suitable procedure for reporting to the various levels
of management. This should be based on the principles of exception.

(e). State the significance of ‘Management Accounting’.

The various advantages that accrue out of management accounting are

enumerated below:
(1) Delegation of Authority: Now a day the function of management is no longer
personal, management accounting helps the organisation in proper delegation
of authority for the attainment of the vision and mission of the business.
(2) Need of the Management : Management Accounting plays the role in meeting
the need of the management.
(3) Qualitative Information: Management Accounting accumulates the qualitative
information so that management would concentrate on the actual issue to
deliberate and attain the specific conclusion even for the complex problem.
(4) Objective of the Business: Management Accounting provides measure and
reports to the management thereby facilitating in attainment of the objective of
the business.

(f). State the advantages of Budgetary Control:

(i) Budgetary control aims at maximisation of profits through optimum utilisation of

resources.
(ii) It is a technique for continuous monitoring of policies and objectives of the
organisation.
(iii) It helps in reducing the costs, thereby helps in better utilisation of funds of the
organisation.

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 Revisionary Test Paper_June2018
(iv) All the departments of the organisation are closely coordinated through
establishment of plans resulting in smooth functioning of the organisation.
(v) Since budgets fix the responsibilities of the executives, they act as a plan of action
for them there by reducing some of their work.
(vi) It facilitates analysis of variances, thereby identifying the areas where deficiencies
occur and proper remedial action can be taken.
(vii) It facilitates the management by exception.
(viii) Budgets act as a motivating force to achieve the desired objective of the
organisation.
(ix) It assists delegation of authority and is a powerful tool of responsibility accounting.
(x) It helps in stabilizing the conditions in industries which face seasonal fluctuations.
(xi) It helps as a basis for internal audit.
(xii) It provides a suitable basis for introducing the payment by results system.
(xiii) It ensures adequacy of working capital to the organisation.
(xiv) It aids in performance analysis and performance reporting system.
(xv)It aids in obtaining bank credit.
(xvi) Budgets are forerunners of standard costs in the sense that they create necessary
conditions to suit setting up of standard costs.

(g). State the Objectives and Advantages of Production budget:

• Optimum utilisation of the productive resources of the organisation;
• Maintaining low inventory which results in risk of deterioration and fall in prices;
• Focus on the factors that are necessary to frame policies and plan sequence of
operations;
• Projection of policies framed, on the basis of past performance, into the future to get
the desired results;
• To see that right materials are provided at right place and at right time;
• Helps in scheduling of production so that delivery dates are met and customer
satisfaction is gained;
• Helpful in preparation of projected profit and loss statement, which is useful in
evaluation of performance and profitability.

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(h). What do you mean by Performance Budgeting:

Performance Budgeting is synonymous with Responsibility Accounting which means thus

the responsibility of various levels of management is predetermined in terms of output or
result keeping in view the authority vested with them. The main concepts of such a
system are enumerated below:
(a) It is based on a classification of managerial level for the purpose of establishing a
budget for each level. The individual in charge of that level should be made
responsible and held accountable for its performance over a given period of time.
(b) The starting point of the performance budgeting system rests with the organisation
chart in which the spheres of jurisdiction have been determined. Authority leads to
the responsibility for certain costs and expenses which are forecast or present in the
budget with the knowledge of the manager concerned.
(c) The costs in each individual or department‘s budget should be limited to the cost
controllable by him.
(d) The person concerned should have the authority to bear the responsibility.

(i). Zero Base Budgeting:

It differs from the conventional system of budgeting mainly it starts from scratch or zero
and not on the basis of trends or historical levels of expenditure. In the customary
budgeting system, the last year‘s figures are accepted as they are, or cut back or
increases are granted. Zero based budgeting on the other hand, starts with the premise
that the budget for next period is zero so long the demand for a function, process,
project or activity is not justified for each rupee from the first rupee spent. The
assumptions are that without such a justification no spending will be allowed. The
burden of proof thus shifts to each manager to justify why the money should be spent
at all and to indicate what would happen if the proposed activity is not carried out and
no money is spent.
The first step in the process of zero base budgeting is to develop an operational plan or
decision package. A decision package identifies and describes a particular activity
with a view to:
(i) Evaluate and allotted ranking the activity against other activities competing
for the same scarce resources, and
(ii) Decide whether to accept or reject or amend the activity.

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For this purpose, each package should give details of costs, returns, purpose, expected
results, the alternatives available and a statement of the consequences if the activity is
reduced or not performed at all.
The advantages of Zero based budgeting are:
(a) Out of date and inefficient operations are identified.
(b) Allows managers to promptly respond to changes in the business
environment.
(c) Instead of accepting the current practice, it creates a challenging and
questioning attitude.
(d) Allocation of resources is made according to needs and the benefits
derived.
(e) It has a psychological impact on all levels of management which makes
each manager to ̳pay his way.

(j). State distinctive features of Learning Curve Theory:

.
(i) Learning curve is not a cost reduction technique. It is a naturally occurring human
phenomenon.
(iii) It is a human characteristic that a person engaged in repetitive task will improve his
performance over time.
(iv) In the initial stage of production, generally the workers do not have the confidence
of completing the job successfully. When they produce a few units, they gain
confidence. People learn from errors.
(v) When the workers produce more and more units, they come to know the problems
and their reasons. Now they are able to avoid the problems.
(vi) The workers are able to find the new methods of doing the job; they are able to
complete task in less time.
(vii) Better equipments and tools are developed.
(viii)Better product designs lead to increased efficiency.

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SECTION - B
Financial Management

PART-I – Objective Question

1. (a) Multiple Choice Questions (MCQ)

(i) Which of the following is not a characteristic of GDR?
(A) Is a negotiable instrument
(B) Carry voting rights
(C ) Freely tradable in International Market
(D) Denominated in US Dollars.
(ii)Which of the following is a feature of Factoring?
(A)Tool of short term borrowing
(B)Purchase of export bill only.
(C)Used in Export business only.
(D)Done without recourse to the client.
(iii)Which of the following is a Profitability Ratio?
(A)Proprietary Ratio
(B)Debt –equity Ratio
(C )Price Earnings Ratio
(D)Fixed Asset Ratio.
(iv) GP Margin=20%, GP=₹54000, Sales=
(A) ₹300000
(B) ₹270000
(C) ₹280000
(D) ₹290000
(v) EBIT=₹1120000, PBT=₹320000, Fixed Costs=₹700000, Operating Leverage=
(A) 1.625
(B) 2.625
(C) 6.625
(B) 3.625
(vi) Which of the following is not a Source of Fund?
(A) Issue of Capital
(B) Issue of Debenture
(C)Decrease in working capital
(D)Increase in working capital.

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(vii)Determinants of credit policy relates to:
(A) Credit standards
(B)Credit terms
( C)Collection Procedures
(D)All of the above
(viii)The following is not a Discounted Cash Flow Technique:
(A) NPV
(B) PI
(C)Accounting of Average rate of return
(D) IRR
(ix) β(Beta ) of a security measures its:
(A)Diversifiable risk
(B) Financial risk
(C) Market risk
(D) None of above.
(x)Following method is also known as ‘Benefit Cost Ratio.’
(A) NPV
(B)IRR
(C)ARR
(D) PI
(b)Match the following:

Column 1 Column 2
(A) Capital Budgeting (i) Money Market Instrument
(B) Commercial Paper (ii) NOPAT/Sales*Sales/Average Capital
Employed
(C) Debtors Turnover Ratio (iii)Capital structure theory
(D) ROI (iv)Change in working capital between
two Balance Sheet dates
(E)Fund Flow Statement (v) Initial Investment/Annual Cash
Inflows
(F) NPV (vi)Functional area of Financial
Management
(G) Payback Period (vii) Credit Sales/Average collection
period
(H) Net Income Approach (viii)EBIT/EBT
(I) ADR (ix)Negotiable Instrument
(J) Financial Leverage (x)Cost of Capital

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 Revisionary Test Paper_June2018
(c) State whether the following statement are True/False.
(i) Cost of capital is highest in Equity share Financing.
(ii) Bill Financing is least liquid from Banker’s point of view
(iii) Payout Ratio=Earning per Equity share/Dividend per equity share
(iv) Liquid Assets=Current Assets-Inventory
(v) Under cash credit/overdraft arrangement , a predetermined limit for borrowing
is specified by the bank.
(vi) As per TANDON Committee norms under method 1 the proprietor should
contribute 75% of Working Capital Gap.
(vii) Value of right=Cum right share price minus Ex right share price
(viii)Combined leverage=Contribution/EBT
(ix) DPP=Discounted Annual Cash Flow/Investment
(x) Project can be accepted when NPV is positive or at least zero

Ans:

1(a)
(i)-(B) (ii)-(A) (iii)-(C) (iv)-(B) (v)-(A) (vi)-(D)
(vii)-(D) (viii)-(C) (ix)-(C) (x)-(D)

1(b)
(A)-(vi) (B)-(i) (C)-(vii) (D)-(ii) (E)-(iv) (F)-(x)
(G)-(v) (H)-(iii) (I)-(ix) (J)-(viii)

1(c)
(i)True (ii)False (iii)False (iv)True (v)True (vi)False
(vii)True (viii)True (ix)False (x) True

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 Revisionary Test Paper_June2018
Part II: Subjective Questions

Financial Ratio Analysis

2) The following accounting information and financial ratios of PQR Ltd. relate to the year
ended 31st March, 2018:
Gross Profit 15% of Sales; Net Profit 8% of Sales; Raw Materials consumed 20% of works
cost, Direct wages 10% of works cost, Stock of Raw materials equals to 3 months usage;
stock of finished goods is 6% of works Cost, debt collection period 60 days. All sales are
on credit.
Fixed Assets to Sales 1:3 ; Fixed Assets to Current Assets 13:11 ; Current ratio 2:1 ; Long
term loans to current liabilities 2:1 ; Capital to Reserves & Surplus 1:4.
If value of fixed assets as on 31st March, 2017 amounted to ₹26 lakhs, prepare a
summarised Profit and Loss Account of the company for the year ended 31st March, 2018
and also the Balance Sheet as on 31st March, 2018.

Ans: (2)
(a) Working Notes:
(i) Calculation of Sales

Fixed Assets 1
=
Sales 3
26 ,00 ,000 1
∴ = ⇒ Sales = ` 78,00 ,000
Sales 3

(ii) Calculation of Current Assets

Fixed Assets 13
=
Current Assets 11

26,00,000 = 13 ⇒ Current Assets =` 22,00,000

Current Assets 11

(iii) Calculation of Raw Material Consumption and Direct Wages

₹
Sales 78,00,000
Less: Gross Profit 11,70,000
Works Cost 66,30,000
Raw Material Consumption (20% of Works Cost) ₹13,26,000
Direct Wages (10% of Works Cost) ₹ 6,63,000

(iv) Calculation of Stock of Raw Materials (= 3 months usage)

= 13,26,000 × 3 =` 3,31,500
12
(v) Calculation of Stock of Finished Goods (= 6% of Works Cost)
= 66,30,000 × 6 =` 3,97,800
100

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 Revisionary Test Paper_June2018
(vii) Calculation of Current Liabilities

Current Assets
=2
Current Liabilities

22,00,000
= 2 ⇒ Current Liabilities = ` 11,00,000
Current Liabilities

(vii) Calculation of Debtors

Debtors
Average collection period = × 365
Credit Sales
Debtors
× 365 = 60 ⇒ Debtors = ` 12,82,191.78 or ` 12,82,192
78,00,000

(viii) Calculation of Long term Loan

Long term Loan 2

=
Current Liabilities 1
Long term loan 2
= ⇒ Long term loan = ` 22,00,000.
11,00,000 1
(ix) Calculation of Cash Balance
`
Current assets 22,00,000
Less: Debtors 12,82,192
Raw materials stock 3,31,500
Finished goods stock 3,97,800 20,11,492
Cash balance 1,88,508
(x) Calculation of Net worth
Fixed Assets 26,00,000
Current Assets 22,00,000
Total Assets 48,00,000
Less: Long term Loan 22,00,000
Current Liabilities 11,00,000 33,00,000
Net worth 15,00,000

Net worth = Share capital + Reserves = 15,00,000

Capital 1 1
= ⇒ Share Capital = 15,00,000 × = ` 3,00,000
Reserves and Surplus 4 5
4
Reserves and Surplus = 15,00,000 × = ` 12,00,000
5

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 Revisionary Test Paper_June2018
Profit and Loss Account of PQR Ltd for the year ended 31st March, 2018

Particulars ₹ Particulars ₹
To Direct Materials 13,26,000 By Sales 78,00,000
To Direct Wages 6,63,000
To Works (Overhead) 46,41,000
Balancing figure

To Gross Profit c/d

(15% of Sales) 11,70,000 ________
78,00,000 78,00,000
To Selling and Distribution 5,46,000 By Gross Profit 11,70,000
Expenses (Balancing b/d
figure)
To Net Profit (8% of Sales) 6,24,000 ________
11,70,000 11,70,000

Balance Sheet of PQR Ltd.as at 31st March, 2018

Liabilities ₹ Assets ₹
Share Capital 3,00,000 Fixed Assets 26,00,000
Reserves and Surplus 12,00,000 Current Assets:
Long term loans 22,00,000 Stock of Raw 3,31,500
Material
Current liabilities 11,00,000 Stock of Finished 3,97,800
Goods
Debtors 12,82,192
________ Cash 1,88,508
48,00,000 48,00,000

3) A company has a profit margin of 20% and asset turnover of 3 times. What is the
company’s return on investment? How will this return on investment vary if?
Profit margin is increased by 5%?
Asset turnover is decreased to 2 times?
Profit margin is decreased by 5% and asset turnover is increase to 4 times?
Ans:
Net profit ratio = 20% (given)
Assets turnover ratio = 3 times (given)
Return on Investment (ROI) = Net Profit ratio x Assets turnover ratio
= 20% x 3 times = 60%

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If net profit ratio is increased by 5 %:
Then Revised Net Profit Ratio = 20 + 5 = 25%
Asset Turnover Ratio (as before) = 3 times
∴ROI = 25 % x 3 times = 75%
If assets turnover ratio is decreased to 2 times:
NP Ratio (as before) = 20%
Revised Asset Turnover Ratio = 2 times
∴ROI = 20% x 2 times = 40 %
If net profit ratio falls by 5% and assets turnover ratio raises to 4 times:
Then Revised NP Ratio = 20 – 5 = 15%
Revised Asset Turnover Ratio = 4 times
∴ ROI = 15% x 4 = 60%

Cash Flow Analysis

4) From the information contained in Income Statement and Balance Sheet of ‘A’ Ltd.,
prepare Cash Flow Statement:
Income Statement for the year ended March 31, 2018
₹
Net Sales (A) 2,52,00,000
Less:
Cash Cost of Sales 1,98,00,000
Depreciation 6,00,000
Salaries and Wages 24,00,000
Operating Expenses 8,00,000
Provision for Taxation 8,80,000
(B) 2,44,80,000
Net Operating Profit (A – B) 7,20,000
Non-recurring Income – Profits on sale of 1,20,000
equipment
8,40,000
Retained earnings and profits brought forward 15,18,000
23,58,000
Dividends declared and paid during the year 7,20,000
Profit and Loss Account balance as on March 31, 16,38,000
2018

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Balance Sheet as on
Assets: March 31, 2017 March 31, 2018
(₹) (₹)
Fixed Assets:
Land 4,80,000 9,60,000
Buildings and Equipment 36,00,000 57,60,000
Current Assets:
Cash 6,00,000 7,20,000
Debtors 16,80,000 18,60,000
Stock 26,40,000 9,60,000
Advances 78,000 90,000
90,78,000 1,03,50,000
Liabilities and Equity: March 31, 2017 March 31, 2018
(₹) (₹)
Share Capital 36,00,000 44,40,000
Surplus in Profit and Loss 15,18,000 16,38,000
Account
Sundry Creditors 24,00,000 23,40,000
Outstanding Expenses 2,40,000 4,80,000
Income-tax payable 1,20,000 1,32,000
Accumulated Depreciation
on Buildings and 12,00,000 13,20,000
Equipment
90,78,000 1,03,50,000

The original cost of equipment sold during the year 2017-18 was ₹ 7,20,000.

Ans:
Cash Flow Statement of Company A Ltd. for the year ending March 31, 2018
Cash flows from Operating Activities
`
Net Profits before Tax and Extra-ordinary Item 16,00,000
Add: Depreciation 6,00,000
Operating Profits before Working Capital Changes 22,00,000
Increase in Debtors (1,80,000)
Decrease in Stock 16,80,000
Increase in Advances (12,000)
Decrease in Sundry Creditors (60,000)
Increase in Outstanding Expenses 2,40,000
Cash Generated from Operations 38,68,000
Income tax Paid 8,68,000
Net Cash from Operations 30,00,000

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Cash flows from Investment Activities
₹
Purchase of Land (4,80,000)
Purchase of Buildings and Equipment (28,80,000)
Sale of Equipment 3,60,000
Net Cash used in Investment Activities (30,00,000)

Cash flows from Financing Activities

₹
Issue of Share Capital 8,40,000
Dividends Paid (7,20,000)
Net Cash from Financing Activities 1,20,000

Net increase in Cash and Cash Equivalents 1,20,000

Cash and Cash Equivalents at the beginning 6,00,000
Cash and Cash Equivalents at the end 7,20,000

Buildings and Equipment Account

₹ ₹
Balance b/d 36,00,000 Sale of Asset 7,20,000
Cash/Bank Balance c/d 57,60,000
(purchase) 28,80,000 ________
(Balancing figure)
64,80,000 64,80,000

Accumulated Depreciation on
Buildings and Equipment Account
₹ ₹
Sale of Asset Balance b/d 12,00,000
(Accumulated 4,80,000 Profit and Loss 6,00,000
depreciation) (Provisional)
Balance c/d 13,20,000 ________
18,00,000 18,00,000

Statement showing Sale of Asset

₹
Original Cost 7,20,000
Less: Accumulated Depreciation 4,80,000
Net Cost 2,40,000
Profit on Sale of Asset 1,20,000
Sale Proceeds from Asset Sales 3,60,000

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Funds Flow Analysis

5) Following are the financial statements of Z Ltd.:

Balance Sheet as on
March 31, March 31,
2017 2016
₹ ₹
Capital and Liabilities:
Share capital, ₹ 10 par value 1,67,500 1,50,000
Share premium 3,35,000 2,37,500
Reserves and Surplus 1,74,300 1,23,250
Debentures 2,40,000
−
Long-term loans 40,000 50,000
Creditors 28,800 27,100
Bank Overdraft 7,500 6,250
Accrued expenses 4,350 4,600
Income-tax payable 48,250 16,850
10,45,700 6,15,550

March 31, March 31,

2017 2016
₹ ₹
Assets:
Land 3,600 3,600
Building, net of depreciation 6,01,800 1,78,400
Machinery, net of depreciation 1,10,850 1,07,050
Investment in ‘A’ Ltd. 75,000
−
Stock 58,800 46,150
Prepaid expenses 1,900 2,300
Debtors 76,350 77,150
Trade Investments 40,000 1,05,000
Cash 77,400 95,900
10,45,700 6,15,550

Income Statement
for the year ended March 31, 2017

₹
Net Sales 13,50,000
Less: Cost of goods sold and operating expenses (including
depreciation on buildings of ₹ 6,600 and depreciation on 12,58,950
machinery of ₹ 11,400)
Net operating profit 91,050
Gain on sale of trade investments 6,400

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 Revisionary Test Paper_June2018
Gain on sale of machinery 1,850
Profits before tax 99,300
Income-tax 48,250
Profits after tax 51,050

Additional information:
(i) Machinery with a net book value of ₹ 9,150 was sold during the year.
(ii) The shares of ‘A’ Ltd. were acquired by issue of debentures.
Required:
Prepare a Funds Flow Statement (Statement of changes in Financial position on Working
capital basis) for the year ended March 31, 2017.

Ans:

Schedule of Changes in Working Capital

March 31, March 31, Impact on Working
2017 2016 Capital
Increase Decrease
Current Assets

Stock 58,800 46,150 12,650 −

Prepaid expenses 1,900 2,300 − 400

Debtors 76,350 77,150 − 800
Trade Investments 40,000 1,05,000 − 65,000

Cash 77,400 95,900 − 18,500

2,54,450 3,26,500 12,650 84,700
Current Liabilities
Creditors 28,800 27,100 − 1,700
Bank overdraft 7,500 6,250 − 1,250
Accrued expenses 4,350 4,600 250 −
Income tax payable 48,250 16,850 − 31,400
88,900 54,800 250 34,350

Net Working Capital 1,65,550 2,71,700 12,900 1,19,050

Decrease in net working
capital 1,06,150 − 1,06,150 −
2,71,700 2,71,700 1,19,050 1,19,050

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Machinery Account
₹ ₹
Balance b/d 1,07,050 Sale of machinery 9,150
(given)
Purchase of machinery (plug) 24,350 Depreciation (given) 11,400
________ Balance c/d 1,10,850
1,31,400 1,31,400
Trade Investments Account
₹ ₹
Balance b/d 1,05,000 Cash (sale of trade 65,000
investments)
_______ Balance c/d 40,000
1,05,000 1,05,000

Estimation of Funds flow from Operations

₹
Profits after tax 51,050
Add: Depreciation on Buildings 6,600
Depreciation on Machinery 11,400 18,000
69,050
Less: Gain on sale of machinery 1,850
Funds from Operations 67,200

Gain on sale of trade investments has been considered as an operating income.

Trade investments have been considered as part of current assets.

Statement of Changes in Financial Position (Working Capital basis)

for the year ended March 31, 2017
Sources: ₹
Funds from operations 67,200
Sale of machinery on gain (9,150 + 1,850) 11,000
Debentures issued (₹ 2,40,000 – 75,000) 1,65,000
Investment in ‘A’ Ltd. financial transaction and hence not affecting
working capital
Issue of share capital (including share premium) 1,15,000
Financial Resources Provided 3,58,200
Uses:
Purchase of building (6,01,800 + 6,600 − 1,78,400) 4,30,000
Purchase of machinery 24,350
Payment of long-term loan 10,000
Financial Resources Applied 4,64,350
Net Decrease in Working Capital 1,06,150

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Working Capital Management

6) Hello Limited is launching a new project for the manufacture of a unique component.
At full capacity of 48,000 units, the cost will be as follows:
Cost per unit ₹
Material 40
Labour and Variable Expenses 20
Fixed Manufacturing and Administrative Expenses 10
Depreciation 5
75
The selling price per unit is expected at ₹100 and the selling expenses per unit will be
₹ 5, 80% of which is variable.
In the first two years production and sales are expected to be as follows:
Year Production Sales
1 30,000 units 28,000 units
2 40,000 units 36,000 units
To assess working capital requirement, the following additional information is given:
(a) Stock of raw material -3 months’ average consumption.
(b) Work-in-progress-Nil.
(c) Debtors-1 month average sales.
(d) Creditors for supply of materials- 2 months average purchases of the year.
(e) Creditors for expenses- 1 month average of all expenses during the year.
(f) Cash balance-₹ 20,000
Stock of finished goods is taken at average cost.
You are required to prepare for the two years:
(1) A projected statement of profit/loss
(2) A projected statement of working capital requirements.
Ans:
Hello Ltd.
(1) Projected Statement of Profit/Loss
Year I Year II
₹ ₹
Production in units 15,000 20,000
Sales in units 14,000 18,000
Sales Revenue @ ` 100 per unit (A) 28,00,000 36,00,000
Cost of Production
Material @ ₹ 40 per unit 12,00,000 16,00,000
Direct labour & variable expenses @₹ 20 per 6,00,000 8,00,000
unit
Fixed manufacturing & Administrative expenses 4,80,000 4,80,000
@ ₹10 on 48,000 units
Depreciation @ ₹ 5 for 48,000 units 2,40,000 2,40,000
Total Cost of Production 25,20,000 31,20,000
Add: Opening stock of finished goods at - 1,68,000

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average cost *

*25,20,000
× 2,000
30,000
Cost of goods available 25,20,000 32,88,000
Less: Closing stock of finished goods at average 1,68,000 4,69,714#
cost
#32,88,000
× 6,000
42,000
Cost of goods sold 23,52,000 28,18,286
Add: Selling expenses 1,12,000 1,44,000
(Variable at ₹4)
Selling expenses fixed at ₹ 1 48,000 48,000
Cost of Sales (B) 25,12,000 30,10,286
Profit A-B 2,88,000 5,89,714

Working Notes
Year I Year II
₹ ₹
(a) Creditors for supply of material
Materials consumed 12,00,000 16,00,000
Add: Closing stock of Average consumption 3,00,000 4,00,000
(3 months)
15,00,000 20,00,000
Less: Opening Stock - 3,00,000
Purchases 15,00,000 17,00,000
Average purchases per month (Creditors) 1,25,000 1,41,667
Creditors (2 months for goods) 2,50,000 2,83,334
(b) Creditors for expenses 1,03,334* 1,22,667*
Total of Current Liabilities (B) 3,53,334 4,06,001
*Labour, Manufacturing expenses & Selling
expenses
6,00,000 8,00,000
4,80,000 4,80,000
1,12,000 1,44,000
48,000 48,000
12,40,000 14,72,000
12 12
(2) Projected Statement of Working Capital Requirements
Year I Year II
₹ ₹
Current Assets: 3,00,000 4,00,000
Stock of materials
(3 months average consumption)
Finished Goods 1,68,000 4,69,714

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 Revisionary Test Paper_June2018
Debtors (one month) 2,33,334 3,00,000
Cash 20,000 20,000
Total Current Assets 7,21,334 11,89,714
(A)
Current Liabilities:
Creditors for supply of materials 2,50,000 2,83,334
Creditors for expenses 1,03,334 1,22,667
(See W.N. (b) above) _______ _______
Estimated Working Capital requirement 3,53,334 4,06,001
(B)
Estimated Working Capital 3,68,000 7,83,713

7) A newly formed company has applied to the commercial bank for the first time for
financing its working capital requirements. The following information is available
about the projections for the current year:
Estimated level of activity: 4,16,000 completed units of production plus 16,000 units
of work-in-progress. Based on the above activity, estimated cost per unit is:
Raw material ₹20 per unit
Direct wages ₹7.50 per unit
Overheads (exclusive of depreciation) ₹ 15 per unit
Total cost ₹ 75 per unit
Selling price ₹100 per unit
Raw materials in stock: Average 4 weeks consumption, work-in-progress (assume
50% completion stage in respect of conversion cost) (materials issued at the start of
the processing).
Finished goods in stock 32,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors/receivables Average 8 weeks
Lag in payment of wages
Average 1 1 weeks
2
Cash at banks (for smooth operation) is expected to be₹ 25,000
Assume that production is carried on evenly throughout the year (52 weeks) and
wages and overheads accrue similarly. All sales are on credit basis only.
Find out
(i) the net working capital required; ( on Cost Basis)
(ii) the maximum permissible bank finance under first and second methods of
financing as per Tandom Committee Norms.

Ans:
(i) Estimate of the Requirement of Working Capital
₹ ₹
A. Current Assets:
Raw material stock 6,64,615
(Refer to Working note 3)
Work in progress stock 5,00,000
(Refer to Working note 2)

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 Revisionary Test Paper_June2018
Finished goods stock 13,60,000
(Refer to Working note 4)
Debtors 25,10,769
(Refer to Working note 5)
Cash and Bank balance 25,000 50,60,384
B. Current Liabilities:
Creditors for raw materials 7,15,740
(Refer to Working note 6)
Creditors for wages 91,731 8,07,471
(Refer to Working note 7) ________
Net Working Capital (A-B) 42,52,913

(ii) The maximum permissible bank finance as per Tandom Committee Norms
First Method:
75% of the net working capital financed by bank i.e. 75% of ₹ 42,52,913
(Refer to (i) above)
= ₹ 31,89,685
Second Method:
(75% of Current Assets)- Current liabilities (i.e. 75% of ₹50,60,384) - ₹ 8,07,471
(Refer to (i) above)
= ₹37,95,288 – ₹ 8,07,471
= ₹ 28,87,817

Working Notes:
1. Annual cost of production
₹
Raw material requirements (4,16,000 units × ₹20) 83,20,000
Direct wages (4,16,000 units × ₹ 7.50) 31,20,000
Overheads (exclusive of depreciation)(4,16,000 ×₹15) 62,40,000
1,76,80,000
2. Work in progress stock
₹
Raw material requirements (16,000 units × ₹ 20) 3,20,000
Direct wages (50% × 16,000 units × ₹7.50) 60,000
Overheads (50% × 16,000 units × ₹15) 1,20,000
5,00,000
3. Raw material stock
It is given that raw material in stock is average 4 weeks consumption. Since, the
company is newly formed, the raw material requirement for production and
work in progress will be issued and consumed during the year.
Hence, the raw material consumption for the year (52 weeks) is as follows:
₹
For Finished goods 83,20,000
For Work in progress 3,20,000
86,40,000

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 Revisionary Test Paper_June2018

Raw material stock ` 86,40,000 × 4 weeks = ₹6,64,615

52 weeks
4. Finished goods stock
32,000 units @ ₹ 42.50 per unit = ₹ 13,60,000
5. Debtors for sale
Credit allowed to debtors Average 8
weeks
Credit sales for year (52 weeks) i.e. (4,16,000 units- 3,84,000 units
32,000 units)
Selling price per unit ₹ 100
Credit sales for the year (3,84,000 units × ₹ 42.50 ) ₹1,63,20,000

Debtors ` 1,63,20,000 × 8 weeks

52 weeks = ₹ 25,10,769
6. Creditors for raw material:
Credit allowed by suppliers Average 4 weeks
Purchases during the year (52 weeks) i.e. ₹93,04,615
(₹83,20,000 + ₹ 3,20,000 + ₹ 6,64,615)
(Refer to Working notes 1,2 and 3 above)

Creditors ` 93.04.615 × 4 weeks

52 weeks =₹7,15,740
7. Creditors for wages
Lag in payment of wages 1
Average 1 weeks
2
Direct wages for the year (52 weeks) i.e. =₹31,80,000
(₹31,20,000 + ₹60,000)
(Refer to Working notes 1 and 2 above)
Creditors ` 31,80,000 × 1 1 weeks
52 weeks 2
= ₹91,731

8) The following information has been extracted from the records of a Company:
Product Cost Sheet ₹/unit
Raw materials 45
Direct labour 20
Overheads 40
Total 105
Profit 15
Selling price 120

− Raw materials are in stock on an average of two months.

– The materials are in process on an average for 4 weeks. The degree of
completion is 50%.
− Finished goods stock on an average is for one month.
− Time lag in payment of wages and overheads is 1½ weeks.
− Time lag in receipt of proceeds from debtors is 2 months.
− Credit allowed by suppliers is one month.

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 Revisionary Test Paper_June2018
− 20% of the output is sold against cash.
− The company expects to keep a Cash balance of ₹2,00,000.
− Take 52 weeks per annum.

The Company is poised for a manufacture of 1,50,000 units in the year. You are
required to prepare a statement showing the Working Capital requirements of the
Company.

Ans:
Statement showing the Working Capital Requirement
Current Assets: ₹
Stock of raw materials 11,25,000
[₹67,50,000 / 12 months) × 2 months
Work-in-progress 6,05,769
[(₹1,57,50,000 × 4) / 52 months] × 50%
Finished goods 13,12,500
(₹1,57,50,000 / 12 months)
Debtors 24,00,000
(₹30,00,000 × 80%)
(Refer to Working note 2)
Cash balances 2,00,000
56,43,256
Current Liabilities:
Creditors of raw materials 5,62,500
(₹67,50,000 / 12 months)
Creditors for wages & overheads 2,59,615
 ` 90,00,000 
 × 1.5 weeks 
 52 weeks 
Net Working Capital (C.A− C.L) 48,21,154

Working Notes:
1, Annual raw materials requirements (₹) 67,50,000
1,50,000 units × ₹45
Annual direct labour cost (₹) 30,00,000
1,50,000 units × ₹20
Annual overhead costs (₹) 60,00,000
1,50,000 units × ₹40
Total Cost (₹) 1,57,50,000
2. Total Sales: 1,80,00,000
(1,50,000 units × ₹120)
Two months sales 30,00,000
(₹1,80,80,000 / 6 months)

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 Revisionary Test Paper_June2018
Leverage Analysis

9) Calculate the operating leverage and financial leverage under situation A, B and C and
financial plans I, II and III respectively from the following information relating to the
operational and capital structure of XYZ Co. Also find out the combinations of operating
and financial leverage which give the highest value.

Installed Capacity 1200

units
Actual production and
800 units
sales
Selling price per unit ₹15
Variable cost per unit ₹10
Fixed cost Situation A ₹1000
Situation B ₹2000
Situation C ₹3000

Capital Structure Financial Plan

Equity 5,000 7,500 2,500
Debt 5,000 2,500 7,500
Cost of debt 12%
Answer
Calculation of Leverages under various Situations and Financial Plans:
A B C
Sales 12000 12000 12000
(-) variable cost 8000 8000 8000
Contribution 4000 4000 4000
(-) fixed cost 1000 2000 3000

EBIT 3000 2000 1000

DOL (Degree of Operating Leverage) 1.33 2 4

(C / EBIT) 1 2 3

Situation A

EBIT 3000 3000 3000

(-) interest 600 300 900

EBT 2400 2700 2100

DFL (EBIT / EBT) 1.25 1.11 1.43

Situation B

EBIT 2000 2000 2000

(-) interest 600 300 900

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 Revisionary Test Paper_June2018
EBT 1400 1700 1100

DFL (EBIT / EBT) 1.43 1.18 1.82

Situation C

EBIT 1000 1000 1000

(-)Interest 600 300 900

EBT 400 700 100

DFL 2.5 1.43 10

Situation C in plan 3 is 40 times variation gives maximum value.

10) M Ltd. belongs to a risk class for which the capitalization rate is 10%. It has 25,000
outstanding shares and the current market price is ₹ 100. It expects a net profit of
₹2,50,000 for the year and the Board is considering dividend of ₹ 5 per share. M Ltd.
requires to raise ₹5,00,000 for an approved investment expenditure. Show, how does the
M-M approach affect the value of M Ltd., if dividends are paid or not paid.

Ans:
(1) When dividend is paid
(a) Price per share at the end of year 1
100 = 1 (` 5 + P 1)
1.10
110 = ₹5 + P1
P1 = 105
(b) Amount required to be raised from issue of new shares
₹5,00,000 – (2,50,000 – 1,25,000)
₹5,00,000 – 1,25,000 = ₹3,75,000
(c) Number of additional shares to be issued
3,75,000 = 75,000 shares or say 3572 shares
105 21
(d) Value of M Ltd.
(Number of shares × Expected Price per share)
i.e., (25,000 + 3,572) × ₹105 = ₹30,00,060

(2) When dividend is not paid

(a) Price per share at the end of year 1
p
100 = 1 P1 = 110
1.10

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 Revisionary Test Paper_June2018
(b) Amount required to be raised from issue of new shares
₹5,00,000 – 2,50,000 = 2,50,000

(c) Number of additional shares to be issued

2,50,000 = 25,000 shares or say 2273 shares.
110 11

(d) Value of M Ltd.,

(25,000 + 2273) × ₹110
= ₹30,00,030
Whether dividend is paid or not, the value remains the same.

Cost of Capital

11) Determine the cost of capital for H P Ltd using the book (BV) and market value (MV)
weights from the following information:

Equity Shares: ₹ 1,20,00,000 (₹2,00,00,000, MV)

Retained earnings: ₹30,00,000
Preference Shares: ₹ 9,00,000 (₹10,40,000, MV)
Debentures: ₹ 36,00,000 (₹ 33,75,000, MV)

Additional information:
(i) Equity: Equity shares are quoted at ₹130 per share and a new issue priced at ₹125
will be fully subscribed; flotation costs will be ₹ 5 per share.
(ii) Dividend: During the previous 5 years, dividends have steadily grown from ₹10.60 to
₹ 14.19. Dividend at the current year-end is expected to be ₹15 per share.
(iii) Preference shares: 15% Irredeemable Preference shares with face value of ₹ 100
would realise ₹ 105 per share.
(iv) Debentures: The company proposes to issue 11 year 15% Debentures but the yield on
debentures of similar maturity and risk class is 16%; flotation cost is, 2 %.
(v) Tax: Corporate tax rate is 35%. Ignore dividend tax.

Ans: Specific cost of capital:

Where
[10.6 x (1 + g) 5 = 14.19, g = 6%]

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 Revisionary Test Paper_June2018

In order to earn 16% yield the company has to issue debentures at discount which is
calculated as follows:
(100 x 15) / 16 = ₹ 93.75  issue price

Calculation of KO (WACC)

Book value basis:

Rs Weight Cost of KO
Source capital
Equity 12000000 0.6154 18.50% 11.38
Reserves 3000000 0.1538 18.00% 2.76
Preference 900000 0.0462 14.29% 0.66
Debentures 3600000 0.1846 11.00% 2.03
19500000 16.84 %

Market value basis:

Source Rs Weight Cost of KO
capital
Equity 16000000 0.6553 18.50% 12.12
Reserves 4000000 0.1638 18.00% 2.95
Preference 1040000 0.0426 14.29% 0.61
Debentures 3375000 0.1383 11.00% 1.52
24415000 17.20%

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 Revisionary Test Paper_June2018
Capital Structure

12) In considering the most desirable capital structure of a company, the following
estimates of the cost of debt and equity capital (after tax) have been made at various
levels of Debt –equity Mix.
Debt as % of total capital Cost of Debt % Cost of equity %
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
Calculate the optimal Debt-Equity Mix for the company by calculating composite cost
of capital.
Ans:
Composite cost of capital is calculated as follows:

Debt as
0 10 20 30 40 50 60
%of capital

Cost of
5.0 5.0 5.0 5.5 6.0 6.5 7.0
Debt %
Cost of
12.0 12.0 12.5 13.0 14.0 16.0 20.0
Equity%

0%*5+ 20%*5 30%*5.5

Composite 10%*5 40%*6+ 50%*6.5 60%*7
100%*12. +80%*12 +
cost of +90%*12 60%*14 +50%*16 40%*20
00 .5= 70%*13
capital 11.30 =10.8 =11.25 =12.20
12 11 =10.75

13) Project A and B are analysed and you have determined the following parameters.
Advise the investor on the choice of a project.
Particulars Project A Project B
Investment ₹8cr ₹6cr
Project Life 8years 10 years
Construction period 4 years 4 years
Cost of Capital 15% 18%
NPV @12% ₹3700 ₹4566
NPV @18% ₹425 ₹425
IRR 45% 32%
Rate of Return 20% 27%
Payback 5 years 7 years
BEP 45% 35%
Profitability Index 1.70 1.30

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 Revisionary Test Paper_June2018
Ans:
Determination of priority of the project
A B
NPV at 12% II I
NPV at 18% Same Same
IRR I II
ARR II I
Payback I II
PI I II

Decision:
(i)As the outlays in the projects are different, NPV is not suitable for evaluation.
(ii)As there is a different life period, ARR is not appropriate for evaluation.
On basis of remaining evaluation methods (IRR, PBP, PI) project A is occupied first
priority. Hence, it is advised to choose Project A.

14) Company X is forced to choose between two machines A and B. The two machines
are designed differently, but have identical capacity and do exactly the same job.
Machine A costs ₹1,50,000 and will last for 3 years. It costs ₹40,000 per year to run.
Machine B is an ‘economy’ model costing only ₹ 1,00,000, but will last only for 2
years, and costs ₹ 60,000 per year to run. These are real cash flows. The costs are
forecasted in rupees of constant purchasing power. Ignore tax. Opportunity cost of
capital is 12 per cent. Which machine company X should buy?
Ans:
Statement showing the evaluation of two machines
Machines A B
Purchase cost (₹): (i) 1,50,000 1,00,000
Life of machines (years) 3 2
Running cost of machine per year (₹): (ii) 40,000 60,000
Cumulative present value factor for 1-3 years @ 12% (iii) 2.4018 −
Cumulative present value factor for 1-2 years @ 10% (iv) − 1.6901
Present value of running cost of machines (₹): (v) 96,072 1,01,406
[(ii) × (iii)] [(ii) × (iv)]
Cash outflow of machines (₹): (vi) = (i) + (v) 2,46,672 2,01,406
Equivalent present value of annual cash outflow 1,02,453 1,19,168
[(vi) ÷ (iii)] [(vi) ÷ (iv)]

Decision: Company X should buy machine A since its equivalent cash outflow is less
than machine B.

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 Revisionary Test Paper_June2018
Part III: Short Questions
15) Write short note on:
a) ADRs
b) Debt Service Coverage Ratio
c) Working Capital Cycle
d) Marginal Cost of Capital
e) Discounted Cash Flow Techniques

15 (a) American Depository Receipt (ADR)

The depository receipt in the US market is called ADR. ADRs are those which are
issued and listed in any of the stock exchanges of US. It is an investment in the
stock of non- US corporation trading in the US stock exchange.

Characteristics:

1. The ADRs may or may not have voting rights.

2. The ADRs are issued in accordance with the provisions laid by SEC, USA.

3. The ADRs are bearer negotiable instrument and the holder can sell it in the
market.

4. The ADRs once sold can be re- issued. The operation of ADR- similar to that
of GDR

Advantages

1. The ADRs are an easy cost effective way for individuals to hold and own
shares in a foreign country.

2. They save considerable money by reducing administration cost and

avoiding foreign taxes on each transaction.
15 (b)
Debt Service Coverage Ratio (DSCR)
This ratio indicates whether the business is earning sufficient profits to pay not only the
interest charged, but also whether due of the principal amount. The ratio is calculated
as follows:
Debt Service Coverage Ratio = [Profit after Taxes + Depreciation + Interest on Loan]/ [
Interest on Loan + Loan repayment in a year]
Significance: The ratio is the key indicator to the lender to assess the extent of ability of
the borrower to service the loan in regard to timely payment of interest and
repayment of loan installment. A ratio of 2 is considered satisfactory by the financial
institutions the greater debt service coverage ratio indicates the better debt servicing
capacity of the organization.

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 Revisionary Test Paper_June2018

15(c) Working Capital Cycle or Operating Cycle are synonymous terms in the context of
management of working capital. Any business concern, whether it is of financial
nature, trade organisation or a manufacturing organisation needs certain time to
net fruits of the efforts. That is, by investment of cash, producing or doing something
for some time will fetch profit. But soon after the investment of cash, it cannot get
that profit by way of cash again immediately. It takes time to do so. The time
required to take from investment of cash in some assets and conversion of it again
into cash termed as operating or working capital cycle. Here the cycle refers to the
time period. Chart for Operating Cycle or Working Capital Cycle.

15(d) Marginal Cost of Capital

The weighted average cost of capital can be worked out on the basis of marginal
cost of capital than the historical costs. The weighted average cost of new or
incremental capital is known as the marginal cost of capital. This concept is used in
capital budgeting decisions. The marginal cost of capital is derived, when we
calculate the weighted average cost of capital using the marginal weights. The
marginal cost of capital would rise whenever any component cost increases. The
marginal cost of capital should be used as the cut off rate. The average cost of
capital should be used to evaluate the impact of the acceptance or rejection of the
entire capital expenditure on the value of the firm.

15(e) Discounted Cash Flow Techniques:

The discounted cash flow methods provide a more objective basis for evaluating and
selecting an investment project. These methods consider the magnitude and timing of
cash flows in each period of a project‘s life. Discounted Cash Flows methods enable
us to isolate the differences in the timing of cash flows of the project by discounting
them to know the present value. The present value can be analyses to determine the
desirability of the project. These techniques adjust the cash flows over the life of a
project for the time value of money.
The popular discounted cash flows techniques are:
(a) Net Present Value
(b) Internal Rate of Return, and
(c) Profitability Index

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