Test Series: March, 2018

MOCK TEST PAPER

INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Total Time Allowed – 3 Hours (For both the part of paper 8) Maximum Marks – 60

1. Answer the following:

(a) A company had paid dividend of ` 2 per share last year. The estimated growth of the dividends
from the company is estimated to be 5% p.a. DETERMINE the estimated market price of the equity
share if the estimated growth rate of dividends (i) rises to 8%, and (ii) falls to 3%. Also COMPUTE
the present market price of the share, given that the required rate of return of the equity investors
is 15.5%.
(b) Based on the following particulars, PREPARE a balance sheet showing various assets and
liabilities of T Ltd.
Fixed assets turnover ratio 8 times
Capital turnover ratio 2 times
Inventory Turnover 8 times
Receivable turnover 4 times
Payable turnover 6 times
GP Ratio 25%
Gross profit during the year amounts to ` 8,00,000. There is no long-term loan or overdraft.
Reserve and surplus amount to ` 2,00,000. Ending inventory of the year is ` 20,000 above the
beginning inventory.
(c) The following information is related to YZ Company Ltd. for the year ended 31 st March, 20X8:
Equity share capital (of ` 10 each) ` 50 lakhs
12% Bonds of ` 1,000 each ` 37 lakhs
Sales ` 84 lakhs
Fixed cost (excluding interest) ` 6.96 lakhs
Financial leverage 1.49
Profit-volume Ratio 27.55%
Income Tax Applicable 40%
You are required to CALCULATE:
(i) Operating Leverage;
(ii) Combined leverage; and
(iii) Earnings per share.
(Show calculations upto two decimal points.)
1

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 (d) Sundaram Ltd. discounts its cash flows at 16% and is in the tax bracket of 35%. For the acquisition
of a machinery worth `10,00,000, it has two options – either to acquire the asset by taking a bank
loan @ 15% p.a. repayable in 5 yearly instalments of ` 2,00,000 each plus interest or to lease the
asset at yearly rentals of ` 3,34,000 for five (5) years. In both the cases, the instalment is payable
at the end of the year. Depreciation is to be applied at the rate of 15% using ‘written down value’
(WDV) method. You are required to STATE with reason which of the financing options is to be
exercised.
Year 1 2 3 4 5
P.V factor @16% 0.862 0.743 0.641 0.552 0.476
(4 × 5 = 20 Marks)
2. XYZ Ltd. is considering three financial plans for which the key information is as below:
(i) Total investment to be raised `4,00,000.
(ii) Plans of Financing Proportion
Plans Equity Debt Preference shares
A 100% - -
B 50% 50% -
C 50% - 50%
(iii) Cost of debt 8%
Cost of preference shares 8%
(iv) Tax Rate is 50%
(v) Equity shares of the face value of `10 each will be issued at a premium of `10 per share.
(vi) Expected EBIT is `1,60,000
DETERMINE for each plan:
(i) Earnings per share (EPS)
(ii) Financial break-even point.
(iii) COMPUTE the EBIT range among the plans A and C for point of indifference . (10 Marks)
3. 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: 1,04,000 completed units of production plus 4,000 units of work -in-progress.
Based on the above activity, estimated cost per unit is:
Raw material `80 per unit
Direct wages `30 per unit
Overheads (exclusive of depreciation) `60 per unit
Total cost `170 per unit
Selling price `200 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 8,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors/receivables Average 8 weeks

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 Lag in payment of wages 1
Average 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.
CALCULATE Net Working Capital. (10 Marks)
4. G Limited has the following capital structure, which it considers to be optimal:
Capital Structure Weightage (in %)
Debt 25
Preference Shares 15
Equity Shares 60
100
G Limited’s expected net income this year is ` 34,285.72, its established dividend payout ratio is 30 per
cent, its tax rate is 40 per cent, and investors expect earnings and dividends to grow at a constant rate
of 9 per cent in the future. It paid a dividend of ` 3.60 per share last year, and its shares currently sells
at a price of ` 54 per share.
G Limited requires additional funds which it can obtain in the following ways:
 Preference Shares: New preference shares with a dividend of ` 11 can be sold to the public at a
price of `95 per share.
 Debt: Debt can be sold at an interest rate of 12 per cent.
You are required to:
(i) DETERMINE the cost of each capital structure component; and
(ii) COMPUTE the weighted average cost of capital (WACC) of G Limited. (10 Marks)
5. You are a financial analyst of B Limited. The director of finance has asked you to analyse two capital
investments proposals, Projects X and Y. Each project has a cost of `10,000 and the cost of capital for
each project is 12 per cent. The project’s expected net cash flows are as follows:
Year Expected net cash flows
Project X (`) Project Y (`)
0 (10,000) (10,000)
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500
(i) CALCULATE each project’s payback period, net present value (NPV) and internal rate of return
(IRR).
(ii) DETERMINE, which project or projects should be accepted if they are independent? (10 Marks)
6. (a) DISCUSS Various Sources of Risk.
(b) EXPLAIN Financial Distress and explain its relationship with Insolvency.
(c) STATE Modified Internal Rate of Return method. (4+4+2 = 10 Marks)

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 Test Series: March, 2018
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER – 8B: ECONOMICS FOR FINANCE

Time Allowed - ……………… Maximum Marks - 40

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .

Question 1 is compulsory question.

Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above the
required number, then only the requisite number of questions first answered will be the evaluated the rest
answer shall be ignored
Working Notes should form part of the answer.
1. (a) Distinguish between Personal Income and Disposable Income.
(b) What will be the total credit created by the commercial banking system for an initial deposit of
` 1000 for required reserve ratio 0.02, 0.05 and 0.10 per cent respectively? Compute credit
multiplier.
(c) The table below shows the number of labour hours required to produce wheat and cloth in two
countries X and Y.
Commodity Country X Country Y
1 unit of cloth 4 1.0
I unit of wheat 2 2.5
(i) Compare the productivity of labour in both countries in respect of both commodities
(ii) Which country has advantage in the production of wheat?
(iii) Which country has absolute advantage in the production cloth?
(d) Define Externalities? Given example of each type of externalities. (2 + 2 + 3 + 3 = 10 Marks)
2. (a) You are the Finance Minister of India. You find that the country is passing through recession. As
Finance Minister what suggestions will you make to the Government of India to bring the country
out of recession. Justify your answer. (5 Marks)
(b) (i) Find GDPMP and GNPMP from the following data (in Crores of `) using Income method. Show
that it is the same as that obtained by Expenditure method.
Personal Consumption 7314
Depreciation 800
Wages 6508
Indirect Business Taxes 1000
Interest 1060
1

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 Domestic Investment 1442
Government Expenditures 2196
Rental Income 34
Corporate Profits 682
Exports 1346
Net Factor Income from Abroad 40
Mixed Income 806
Imports 1408
(ii) What would be the effect of automatic stabilizers on multiplier? (3 + 2 Marks)
3. (a) (i) Define public good. Why do you consider national defence as a public good?
(ii) Define ‘moral hazard’. (3 + 2 Marks)
(b) (i) Suppose that the consumption function is C = 200 + 0.6Y and the income level is 2000 billion.
Calculate what consumers intend to consume and save at this income level.
(ii) An increase of investment by ` 600 Crores resulted in an increase in national income by 2400
Crores. Find MPC and MPS. (2 + 3 Marks)
4. (a) (i) Define Money multiplier? What is the nature of relationship between money multiplier and
money supply?
(ii) How do changes in Statutory Liquidity Ratio impact the economy?
(3 + 2 Marks)
(b) (i) What’s meant by Foreign Portfolio investment?
(ii) Explain the Real Exchange Rate. (3 + 2 Marks)
5. (a) Enumerate six important effects of depreciation in exchange rate on domestic economy?
(5 Marks)
(b) (i) Account for cash reserve ratio as a monetary policy instrument
(ii) Explain how higher of interest rate affect the demand for money. (3+2 Marks)

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 Test Series: March, 2018
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
SECTION A: FINANICAL MANAGEMENT
Suggested Answers/ Hints

1. (a) In this case the company has paid dividend of `2 per share during the last year. The growth rate
(g) is 5%. Then, the current year dividend (D 1) with the expected growth rate of 5% will be ` 2.10
D1
The share price is = P o =
Ke - g

` 2.10
=
0.155  0.05
= ` 20
(i) In case the growth rate rises to 8% then the dividend for the current year (D1) would be ` 2.16
and market price would be-
` 2.16
=
0.155  0.08
= ` 28.80
(ii) In case growth rate falls to 3% then the dividend for the current year (D 1) would be `2.06 and
market price would be-
` 2.06
=
0.155  0.03
= `16.48
So, the market price of the share is expected to vary in response to change in expected growth
rate is dividends.
Gross Profit
(b) (a) G.P. ratio = = 25%
Sales
Gross Profit `8,00,000
Sales = × 100 = × 100 = `32,00,000
25 25
(b) Cost of Sales = Sales – Gross profit
= ` 32,00,000 - ` 8,00,000
= ` 24,00,000
Sales
(c) Receivable turnover = =4
Receivables
Sales
= Receivables =
4

= `32,00,000 = ` 8,00,000
4

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 Cost of Sales
(d) Fixed assets turnover = =8
Fixed Assets
Cost of Sales `24,00,000
Fixed assets = = = ` 3,00,000
8 8
Cost of Sales
(e) Inventory turnover = = 8
Average Stock
Cost of Sales ` 24,00,000
Average Stock = = = ` 3,00,000
8 8
Opening Stock + Closing Stock
Average Stock =
2
Opening Stock + Opening Stock + 20,000
Average Stock =
2
Average Stock = Opening Stock + ` 10,000
Opening Stock = Average Stock - ` 10,000
= ` 3,00,000 - `10,000
= ` 2,90,000
Closing Stock = Opening Stock + ` 20,000
= ` 2,90,000 + ` 20,000 = ` 3,10,000
Purchase
(f) Payable turnover = =6
Payables
Purchases = Cost of Sales + Increase in Stock
= ` 24,00,000 + ` 20,000 = ` 24,20,000
Purchase `24,20,000
Payables = = = ` 4,03,333
6 6
Cost of Sales
(g) Capital turnover = =2
Capital Employed
Cost of Sales ` 24,00,000
Capital Employed = = = ` 12,00,000
2 2
(h) Capital = Capital Employed – Reserves & Surplus
= `12,00,000 – `2,00,000 = `10,00,000
Balance Sheet of T Ltd as on……
Liabilities Amount (`) Assets Amount (`)
Capital 10,00,000 Fixed Assets 3,00,000
Reserve & Surplus 2,00,000 Inventories 3,10,000
Payables 4,03,333 Receivables 8,00,000
Other Current Assets 1,93,333
16,03,333 16,03,333

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 (c) Computation of Profits after Tax (PAT)
Particulars Amount (`)
Sales 84,00,000
Contribution (Sales × P/V ratio) 23,14,200
Less: Fixed cost (excluding Interest) (6,96,000)
EBIT (Earnings before interest and tax) 16,18,200
Less: Interest on debentures (12%  `37 lakhs) (4,44,000)
Less: Other fixed Interest (balancing figure) (88,160)*
EBT (Earnings before tax) 10,86,040
Less: Tax @ 40% 4,34,416
PAT (Profit after tax) 6,51,624
(i) Operating Leverage:
Contribution ` 23,14,200
= = = 1.43
EBIT `16,18,200
(ii) Combined Leverage:
= Operating Leverage × Financial Leverage
= 1.43  1.49 = 2.13
Or,
Contribution EBIT
Combined Leverage = ×
EBIT EBT
Contribution ` 23,14,200
Or, Combined Leverage = = = 2.13
EBT `10,86,040

EBIT `16,18,200
* Financial Leverage = = = 1.49
EBT EBT
` 16,18,200
So, EBT = = `10,86,040
1.49
Accordingly, other fixed interest
= `16,18,200 - ` 10,86,040 - ` 4,44,000 = ` 88,160
(iii) Earnings per share (EPS):

PAT ` 6,51,624
= = = `1.30
No.of sharesoutstanding 5,00,000 equity shares

(d) Alternative I: Acquiring the asset by taking bank loan:

Years 1 2 3 4 5
(a) Interest (@15% p.a. on 1,50,000 1,20,000 90,000 60,000 30,000
opening balance)
Depreciation (@15%WDV) 1,50,000 1,27,500 1,08,375 92,119 78,301

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 3,00,000 2,47,500 1,98,375 1,52,119 1,08,301
(b) Tax shield (@35%) 1,05,000 86,625 69,431 53,242 37,905
Interest less Tax shield (a)-(b) 45,000 33,375 20,569 6,758 (7,905)
Principal Repayment 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Total cash outflow 2,45,000 2,33,375 2,20,569 2,06,758 1,92,095
Discounting Factor @ 16% 0.862 0.743 0.641 0.552 0.476
Present Value 2,11,190 1,73,398 1,41,385 1,14,130 91,437
Total P.V of cash outflow = `7,31,540
Alternative II: Acquire the asset on lease basis
Year Lease Rentals Tax Shield Net Cash Discount Present
(`) @35% Outflow Factor Value
1 3,34,000 1,16,900 2,17,100 0.862 1,87,140
2 3,34,000 1,16,900 2,17,100 0.743 1,61,305
3 3,34,000 1,16,900 2,17,100 0.641 1,39,161
4 3,34,000 1,16,900 2,17,100 0.552 1,19,839
5 3,34,000 1,16,900 2,17,100 0.476 1,03,340
Present value of Total Cash out flow 7,10,785
By making analysis of both the alternatives, it is observed that the present value of the cash outflow
is lower in alternative II by ` 20,755 (i.e. ` 731,540 – ` 7,10,785) Hence, it is suggested to acquire
the asset on lease basis.
2. (i) Computation of Earnings per Share (EPS) for each Plan
Particulars Plan A Plan B Plan C
` ` `
Earnings Before Interest Tax (EBIT) 1,60,000 1,60,000 1,60,000
Less: Interest on debt at 8% --- (16,000) ---
Earnings Before Tax 1,60,000 1,44,000 1,60,000
Less: Tax at 50% 80,000 72,000 80,000
Earnings After Tax 80,000 72,000 80,000
Less: Preference Dividend at 8% --- --- 16,000
Earnings available for equity shareholders 80,000 72,000 64,000
Number of Equity Shares 20,000 10,000 10,000
Earnings per share (EPs) `4.00 `7.20 `6.40
(ii) Financial Break-even Point for Each Plan
Plan A : There is no fixed financial charges, hence the financial break-even point for Plan A is
zero.
Plan B : Fixed interest charges is `16,000, hence the financial break-even point for Plan B is
`16,000
Plan C : Fixed charge for preference dividend is `16,000, hence, the financial break-even point for
Plan C is `16,000

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 (iii) Indifference point between Plan A and C
(X - 0) (1- 0.5) - 0 (X - 0)(1- 0.5) - 16,000
=
20,000 10,000
0.5X 0.5X - 16,000
or =
20,000 10,000
or, 0.5X - X= -32,000
or, 0.5X = 32,000
or, X = ` 64,000
Thus point of indifference between plan A and C is `64,000.
3. 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)
Finished goods stock 13,60,000
(Refer to Working note 4)
Receivables 25,10,769
(Refer to Working note 5)
Cash and Bank balance 25,000 50,60,384
B. Current Liabilities:
Payables for raw materials 7,15,740
(Refer to Working note 6)
Payables for wages 91,731 (8,07,471)
(Refer to Working note 7) ________
Net Working Capital (A - B) 42,52,913
Working Notes:
1. Annual cost of production
`
Raw material requirements (1,04,000 units  ` 80) 83,20,000
Direct wages (1,04,000 units  ` 30) 31,20,000
Overheads (exclusive of depreciation)(1,04,000  ` 60) 62,40,000
1,76,80,000
2. Work in progress stock
`
Raw material requirements (4,000 units  ` 80) 3,20,000
Direct wages (50%  4,000 units  ` 30) 60,000
Overheads (50%  4,000 units  ` 60) 1,20,000
5,00,000

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 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
` 86, 40,000
Raw material stock = × 4 weeks i.e. ` 6,64,615
52 weeks
4. Finished goods stock
8,000 units @ ` 170 per unit = `13,60,000
5. Receivables for sale
Credit allowed to debtors Average 8 weeks
Credit sales for year (52 weeks) i.e. (1,04,000 units - 8,000 units) 96,000 units
Cost per unit ` 170
Credit sales for the year (96,000 units  `170) ` 1,63,20,000
Receivables = `1,63,20,000
× 8 weeks i.e. ` 25,10,769
52 weeks
6. Payables 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)
Payables for raw materials = `93,04,615
× 4 weeks i.e. ` 7,15,740
52 weeks
7. Payables 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)
Payables for wages = `31,80,000 1
× 1 weeks i.e. ` 91,731
52 weeks 2

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4. (i) Computation of Costs of Different Components of Capital:
(a) Equity Shares:
D1 D (1+ g)
Ke = + g= 0 +g
P0 P0

` 3.60 (1.09)
= + 0.09 = 0.0727 + 0.09 = 16.27%.
`54
(b) Preference Shares:
Preference Share Dividend ` 11
Kp = = = 11.58%.
P0 ` 95

(c) Debt at 12%

Kd (1 – t) = 12% (1 – 0.4) = 12% × 0.6 = 7.20%.
(ii) Weighted Average Cost of Capital (WACC)
WACC = WdKd + WpKp + WeKe
WACC = 0.25 (7.2%) + 0.15 (11.58%) + 0.60 (16.27%)
= 1.8 + 1.737 + 9.762 = 13.30%.
5. (i) Payback Period Method
The cumulative cash flows for each project are as follows:
Cumulative Cash Flows
Year
Project X (`) Project Y (`)
0 (10,000) (10,000)
1 (3,500) (6,500)
2 (500) (3,000)
3 2,500 500
4 3,500 4,000

` 500
Payback  2   2.17 years.
x ` 3,000
` 3,000
Payback  2   2.86 years.
y ` 3,500

Net Present Value (NPV)

` 6,500 ` 3,000 ` 3,000 ` 1,000
NPV  ` 10,000  1
 2
 3
 4
x (1.12) (1.12) (1.12) (1.12)
= ` 966.01
` 3,500 ` 3,500 ` 3,500 ` 3,500
NPV  ` 10,000  1
  
y (1.12) (1.12)2 (1.12)3 (1.12)4
= ` 630.72.

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 Internal Rate of Return (IRR)
To solve for each project’s IRR, find the discount rates that equate each NPV to zero:
IRRx = 18.0%.
IRRy = 15.0%.
(ii) The following table summarizes the project rankings by each method:
Project that ranks higher
Payback X
NPV X
IRR X
Analysis: All methods rank Project X over Project Y. In addition, both projects are acceptable
under the NPV and IRR criteria. Thus, both projects should be accepted if they are independent.
6. (a) Various Sources of Risk are:
Risk arises from different sources, depending on the type of investment being considered, as well
as the circumstances and the industry in which the organisation is operating. Some of the sources
of risk are as follows
1. Project-specific risk-Risks which are related to a particular project and affects the project’s
cash flows, it includes completion of the project in scheduled time, error of estimation in
resources and allocation, estimation of cash flows etc. For example, a nuclear power project
of a power generation company has different risks than hydel projects.
2. Company specific risk- Risk which arise due to company specific factors like downgrading
of credit rating, changes in key managerial persons, cases for violation of Intellectual Property
Rights (IPR) and other laws and regulations, dispute with workers etc. All these factors affect
the cash flows of an entity and access to funds for capital investments. For example, two
banks have different exposure to default risk.
3. Industry-specific risk- These are the risks which effects the whole industry in which the
company operates. The risks include regulatory restrictions on industry, changes in
technologies etc. For example, regulatory restriction imposed on leather and breweries
industries.
4. Market risk – The risk which arise due to market related conditions like entry of substitute,
changes in demand conditions, availability and access to resources etc. For example, a
thermal power project gets affected if the coal mines are unable to supply coal requirements
of a thermal power company etc.
5. Competition risk- These are risks related with competition in the market in which a company
operates. These risks are risk of entry of rival, product dynamism and change in taste and
preference of consumers etc.
6. Risk due to Economic conditions – These are the risks which are related with macro-
economic conditions like changes monetary policies by central banks, changes in fiscal
policies like introduction of new taxes and cess, inflation, changes in GDP, changes in savings
and net disposable income etc.
7. International risk – These are risks which are related with conditions which are caused by
global economic conditions like restriction on free trade, restrictions on market access,
recessions, bilateral agreements, political and geographical conditions etc. For example,
restriction on outsourcing of jobs to overseas market.

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 (b) There are various factors like price of the product/ service, demand, price of inputs e.g. raw
material, labour etc., which is to be managed by an organisation on a continuous basis. Proportion
of debt also needs to be managed by an organisation very delicately. Higher debt requires higher
interest and if the cash inflow is not sufficient then it will put lot of pressure to the organisation.
Both short term and long term creditors will put stress to the firm. If all the above factors are not
well managed by the firm, it can create situation known as distress, so financial distress is a position
where Cash inflows of a firm are inadequate to meet all its current obligations.
Now if distress continues for a long period of time, firm may have to sell its asset, even many times
at a lower price. Further when revenue is inadequate to revive the situation, firm will not be able to
meet its obligations and become insolvent. So, insolvency basically means inability of a firm to
repay various debts and is a result of continuous financial distress.
(c) Modified Internal Rate of Return (MIRR): There are several limitations attached with the concept
of the conventional Internal Rate of Return. The MIRR addresses some of these deficiencies. For
example, it eliminates multiple IRR rates; it addresses the reinvestment rate issue and produces
results, which are consistent with the Net Present Value method.
Under this method, all cash flows, apart from the initial investment, are brought to the terminal
value using an appropriate discount rate (usually the cost of capital). This results in a single stream
of cash inflow in the terminal year. The MIRR is obtained by assuming a single outflow in the zeroth
year and the terminal cash inflow as mentioned above. The discount rate which equates the present
value of the terminal cash in flow to the zeroth year outflow is called the MIRR.

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 Test Series: March, 2018
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER – 8B: ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/HINTS
1. (a) Personal income is a measure of actual current income receipts of persons from all sources which
may or may not be earned from productive activities during a given period of time. It is the income
‘actually paid out’ to the household sector, but not necessarily earned. Some people obtain income
for which no goods and services are provided in return. Examples of this include transfer payments
such as social security benefits, unemployment compensation, welfare payments etc. Individuals
also earn income which they do not actually receive; for example, undistributed corporate profits
and the contribution of employers to social security. Personal income forms the basis for
consumption expenditures and is derived from national income as follows:
PI = NI + income received but not earned - income earned but not received.
Disposable personal income is a measure of amount of the money in the hands of the individuals
that is available for their consumption or savings. Disposable personal income is derived from
personal income by subtracting the direct taxes paid by individuals and other compulsory payments
made to the government.
DI = PI - Personal Income Taxes
(b) Credit Multiplier = 1/ Required Reserve Ratio
1000×1/ 0.02 = 50,000
1000 ×1/ 0.05 = 20,000
1000 ×1/ 0.10= 10,000
(c) (i) In respect of both commodities
Productivity of Labour in Country X and Country Y
Productivity of Labour Country X Country Y
Units of cloth per hour 0.25 1.0
Units of wheat per hour 0.5 0.4
(ii) Country X has absolute advantage in the production of wheat because productivity of wheat
is higher in country X, or conversely, the number of labour hours required to produce wheat
in country X is less compared to country Y.
(iii) Country Y has absolute advantage in the production of cloth because productivity of cloth is
higher in country Y, or conversely, the number of labour hours required to produce wheat in
country Y is less compared to country X.
(d) Externalities, also referred to as 'spillover effects', 'neighbourhood effects' 'third -party effects' or
'side-effects', occur when the actions of either consumers or producers result in costs or benefits
that do not reflect as part of the market price. Externalities cause market inefficiencies because
they hinder the ability of market prices to convey accurate information about how much to produce
and how much to buy. Since externalities are not reflected in market prices, they can be a source
of economic inefficiency. Externalities can be positive or negative. Negative externalities occur
when the action of one party imposes costs on another party. Positive externalities occur when the
action of one party confers benefits on another party. The four possible types of externalities are
1

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 negative externality initiated in production which imposes an external cost on others, positive
production externality, example A firm which offers training to its employees for increasing their
skills. The firm generates positive benefits on other firms when they hire such workers as they
change their jobs. Another example is the case of a beekeeper who locates beehives in an orange
growing area enhancing the chances of greater production of oranges through increased pollinati on
less commonly seen, initiated in production that confers external benefits on others. Negative
Production Externality example when a factory which produces aluminum discharges untreated
waste water into a nearby river and pollutes the water causing health hazards for people who use
the water for drinking and bathing. Pollution of river also affects fish output as there will be less
catch for fishermen due to loss of fish resources. Negative consumption externalities initiated in
consumption which produce external costs on others for example Smoking cigarettes in public
place causing passive smoking by others, creating litter and diminishing the aesthetic value of the
room and playing the radio loudly obstructing one from enjoying a concert. Positive consumption
externality initiated in consumption that confers external benefits on others for example,
consumption of the services of a health club by the employees of a firm would result in an external
benefit to the firm in the form of increased efficiency and productivity.
2. (a) A recession is said to occur when overall economic activity declines or in other words, when the
economy contracts. As a Finance Minister it is my responsibility to frame / suggest fiscal policy for
the country at the time of recession or inflation so as to take the country out of it.
Fiscal policy involves the use of government spending, taxation and borrowing to infl uence both
the pattern of economic activity and level of growth of aggregate demand, output and employment.
Fiscal measures could be discretionary and non-discretionary.
During recession, the government has to use discretionary fiscal policies. Discretionary fiscal policy
refers to deliberate policy actions on the part of the government to change the levels of expenditure
and taxes to influence the level of national output, employment and prices. Since GDP = C + I +
G + NX, governments can influence economic activity (GDP), by controlling G (Government
Expenditure) directly and influencing C(Private Consumption), I(Private Investment), and NX (Net
Exports) indirectly, through changes in taxes, transfer payments and expenditure.
During a recession as a part of government I may initiate a fresh wave of public works. These will
involve employment of labour as well as purchase of multitude of goods and services. These
expenditures directly generate incomes to labour and suppliers of material and services. Apart from
this, there is also indirect effect in the form of working of multiplier.
Besides this, as a finance minister, I may reduce corporate and personal income tax to overcome
contractionarily tendencies in the economy. A tax cut increases disposable income of households.
Their inclination to spend a portion of additional disposable income determined by their marginal
propensity to consumer and multiplier effect of spending would set out a chain reaction of spending,
increased income and consequent increases output. Moreover, these can provide firms and
households incentives to engage in investment.
(b) (i) Income Method
GDPMP = Employee compensation (wages and salaries + employers'
contribution towards social security schemes) + profits + rent + interest +
mixed income + depreciation + net indirect taxes (Indirect taxes - subsidies)
GDPMP = 6,508+ 34 + 1060 + 806+ 682 + 1,000 + 800 = 10,890
GNPMP = GDPMP + NFIA =10,890+ 40 = 10,930
Expenditure Method
Y = C + I + G + (X – M)
Y = 7314 + 1442 + 2196+ (1346 –1408)
2

© The Institute of Chartered Accountants of India

 Y = (7314 + 1442 + 2196) – 62
Y = 10890
GNPMP = GDPMP + NFIA =10,890+ 40 =10,930
(ii) An automatic stabilizer is any feature of an economy that automatically reduces the changes
in spending during the multiplier process, making the multiplier smaller. As GDP increases,
an automatic stabilizer would reduce the increases in spending in each round of the multiplier
making the final increase in GDP less than what would otherwise be. Therefore, automatic
stabilizers reduce the size of the multiplier, and consequently reduce fluctuations in GDP and
employment, making the economy more stable in the short run. Briefly put, automatic
stabilizers diminish the impact of spending changes on real GDP.
3. (a) A public good (also referred to as a collective consumption good or a social good) is defined as
one which all individuals enjoy in common in the sense that each individual’s consumption of such
a good leads to no subtraction from any other individual’s consumption of that good.
National defence has all characteristics of a public good. It yields utility to people; its consumption
is essentially non-rival, non-excludable and collective in nature and is characterized by indivisibility.
National defence is available for all individuals whether they pay taxes or not and it is impossible
to exclude anyone within the country from consuming and benefiting from it. No direct payment by
the consumer is involved in the case of defence. Once it is provided, the additional resource cost
of another person consuming it is zero. Defence also has the unique feature of public good i.e. it
does not conform to the settings of market exchange. Though defence is extremely valuable for
the well being of the society, left to market, it will not be produced at all or will be under produced.
(b) Moral hazard is associated with information failure and refers to a situation that increases the
probability of occurrence of a loss or a larger than normal loss, because of a change in the
unobservable or hard to observe behaviour of one of the parties in the transaction after the
transaction has been made. Moral hazard is opportunism characterized by an informed person’s
taking advantage of a less-informed person through an unobserved action. It arises from lack of
information about someone’s future behaviour. Moral hazard occurs due to asymmetric information
i.e., an individual knows more about his or her own actions than other people do. This leads to a
distortion of incentives to take care or to exert effort when someone else bears the costs of the
lack of care or effort. For example, in the insurance market, the expected loss from an adverse
event increases as insurance coverage increases.
(b) (i) C = 200 + .6Y; Y= 2000 billion.
C= 200+.6(2000) = 1400 billion.
S = Y-C = 2000-14000= 600 billion.
Consumers intend to consume 1,400 billion and save 600 billion.
(ii) The ratio of ∆Y to ∆I is called the investment multiplier, k.
Change inIncome ∆Y
k= =
Change in Investment ∆I
2400 𝟏 𝟏
Here =4 4= 𝟏−𝑴𝑷𝑪 =
600 𝑴𝑷𝑺

4 – 4MPC = 1
4 MPC = 4-1 = 3
3
MPC= 4
=0.75
MPS= 1-MPC = 0.25

© The Institute of Chartered Accountants of India

4. (a) (i) Money multiplier m is defined as a ratio that relates the change in the money supply to a given
change in the monetary base.
Money supply
Money multiplier (m) =
Monetary base

The multiplier indicates what multiple of the monetary base is transformed into money supply.
The link from reserve money to money supply is through the money multiplier. The multiplier
process operates as long as banks have excess reserves. If some portion of the increase in
high-powered money finds its way into currency, this portion does not undergo multiple
deposit expansion.
(ii) Changes in SLR chiefly influence the availability of resources in the banking system for
lending. A rise in SLR -during periods of high liquidity - to lock up a rising fraction of a bank’s
assets in the form of eligible instruments - reduces the credit creation capacity of banks. A
reduction in SLR during periods of economic downturn has the opposite effect.
(b) (i) Foreign Portfolio Investment: Foreign portfolio investment is the flow of ‘financial capital’
rather than ‘real capital’ and does not involve ownership or control on the part of the investor.
Examples of foreign portfolio investment are the deposit of funds in an Indian or a British bank
by an Italian company or the purchase of a bond (a certificate of indebtedness) of a Swiss
company or of the Swiss government by a citizen or company based in France. Unlike FDI,
portfolio capital, in general, moves to investment in financial stocks, bonds and other financial
instruments and is effected largely by individuals and institutions through the mechanism of
capital market. These flows of financial capital have their immediate effects on balance of
payments or exchange rates rather than on production or income generation.
(ii) Real Exchange Rate: The ‘real exchange rate' describes ‘how many’ of a good or service in
one country can be traded for ‘one’ of that good or service in a foreign country. It is calculated
as :
Domestic price Index
Real exchange rate = Nominal exchange rate X
Foreign price Index

Real Exchange Rate (RER) incorporates changes in prices.

5. (a) Fluctuations in the exchange rate affect the economy by changing the relative prices of
domestically-produced and foreign-produced goods and services. Following are the major effects
of depreciation of domestic currency.
(1) All else equal, depreciation lowers the relative price of a country’s exports and raises the
relative price of its imports. When a country’s currency depreciates, foreigners find that its
exports are cheaper and domestic residents find that imports from abroad are more
expensive. Exporters will be benefitted as goods exported abroad will fetch forex which can
now be converted to more rupees. By lowering export prices, currency depreciation helps
increase the international competitiveness of domestic industries, increases the volume of
exports and promotes trade balance. When a country’s currency depreciates, production for
exports and of import substitutes become more profitable. Therefore, factors of production
will be induced to move into the tradable goods sectors and out of the non tradable goods
sectors. Such resource movements involve economic wastes.
(2) Depreciation increases the price of foreign goods relative to goods produced i n the home
country and help divert spending from foreign goods to domestic goods. Increased demand,
both for domestic import-competing goods and for exports encourages economic activity and
creates output expansion.

© The Institute of Chartered Accountants of India

 (3) For an economy where exports are significantly high, a depreciated currency would mean a
lot of gain. In addition, if exports originate from labour-intensive industries, increased export
prices will have spiraling effects on wages, employment and income.
(4) In an under developed or semi industrialized country, where inputs and components for
manufacturing are mostly imported and cannot be domestically produced, increased import
prices will increase firms’ cost of production, push domestic prices up and decrease real
output.
(5) Depreciation is also likely to fuel consumer price inflation, directly through its effect on prices
of imported consumer goods and also due to increased demand for domestic goods. The
impact will be greater if the composition of domestic consumption baskets consists more of
imported goods. Indirectly, cost push inflation may result through possible escalation in the
cost of imported components and intermediaries used in production.
(6) The fiscal health of a country whose currency depreciates is likely to be affected with rising
import payments and consequent rising current account deficit (CAD). In case of foreign
currency denominated government debts, currency depreciation will increase the interest
burden and cause strain to the exchequer for repaying and servicing foreign debt.
(b) (i) Cash Reserve Ratio (CRR) refers to the fraction of the total net demand and time liabilities
(NDTL) of a scheduled commercial bank in India which it should maintain as cash deposit
with the Reserve Bank. CRR has, in recent years, assumed significance as one of the
important quantitative tools aiding in liquidity management. The RBI may set the ratio in
keeping with the broad objective of maintaining monetary stability in the economy.
Higher the CRR with the RBI, lower will be the liquidity in the system and vice versa. During
deflation, the RBI reduces the CRR in order to enable the banks to expand credit and increase
the supply of money available in the economy. During periods of inflation, the RBI increases
the CRR in order to contain credit expansion.
(ii) The demand for money is a decision about how much of one’s given stock of wealth should
be held in the form of money rather than as other assets such as bonds. Demand for money
is actually demand for liquidity and a demand to store value.
Demand for money is in the nature of derived demand; it is demanded for it purchasing power.
Basically people demand money because they wish to have command over real goods and
services with the use of money.
Demand for money has an important role in the determination of interest, prices and income
in an economy. Higher the interest rate, higher would be opportunity cost of holding cash and
lower the demand for money. Similarly, lower the interest rate, lower will be the opportunity
cost of holding cash and higher the demand for money.

© The Institute of Chartered Accountants of India

 Test Series: August, 2018
MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
Time Allowed – 3 Hours Maximum Marks – 100

PAPER 8A : FINANICAL MANAGEMENT (60 Marks)

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
1. Answer the following:
(a) From the following information, PREPARE a summarised Balance Sheet as at 31 st March, 20X6:
Working Capital Rs.2,40,000
Bank overdraft Rs.40,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus Rs.1,60,000
Current ratio 2.5
Liquid ratio 1.5
(b) An enterprise is investing Rs.100 lakhs in a project. The risk-free rate of return is 7%. Risk premium
expected by the management is 7%. The life of the project is 5 years. Following are the cash flows
that are estimated over the life of the project.
Year Cash flows (Rs.)
1 25,00,000
2 60,00,000
3 75,00,000
4 80,00,000
5 65,00,000
CALCULATE Net Present Value of the project based on Risk free rate and also on the basis of
Risks adjusted discount rate.
(c) 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 Rs. 100. It expects a net profit of Rs. 2,50,000 for the year
and the Board is considering dividend of Rs. 5 per share.
M Ltd. requires to raise Rs. 5,00,000 for an approved investment expenditure. ANALYSE, how the
MM approach affects the value of M Ltd. if dividends are paid or not paid.
(d) PQR Ltd. has the following capital structure on October 31, 20X8:
Sources of capital (Rs.)
Equity Share Capital (2,00,000 Shares of Rs. 10 each) 20,00,000
Reserves & Surplus 20,00,000

© The Institute of Chartered Accountants of India

 12% Preference Shares 10,00,000
9% Debentures 30,00,000
80,00,000
The market price of equity share is Rs. 30. It is expected that the company will pay next year a
dividend of Rs. 3 per share, which will grow at 7% forever. Assume 40% income tax rate.
You are required to COMPUTE weighted average cost of capital using market value weights.
(4 × 5 = 20 Marks)
2. 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: 1,04,000 completed units of production plus 4,000 units of work-in progress.
Based on the above activity, estimated cost per unit is:
Raw material Rs. 80 per unit
Direct wages Rs. 30 per unit
Overheads (exclusive of depreciation) Rs. 60 per unit
Total cost Rs. 170 per unit
Selling price Rs. 200 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 8,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors/receivables Average 8 weeks
Lag in payment of wages 1
Average 1 weeks
2
Cash at banks (for smooth operation) is expected to be Rs.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.
CALCULATE
(i) Net Working Capital required;
(ii) Maximum Permissible Bank finance under first and second methods of financing as per Tandon
Committee Norms. (10 Marks)
3. A company has to make a choice between two projects namely A and B. The initial capital outlay of two
Projects are Rs.1,35,00,000 and Rs.2,40,00,000 respectively for A and B. There will be no scrap value
at the end of the life of both the projects. The opportunity cost of capital of the company is 16%. The
annual incomes are as under:
Year Project A Project B Discounting factor @ 16%
1 -- 60,00,000 0.862
2 30,00,000 84,00,000 0.743
3 1,32,00,000 96,00,000 0.641
4 84,00,000 1,02,00,000 0.552
5 84,00,000 90,00,000 0.476

© The Institute of Chartered Accountants of India

 You are required to CALCULATE for each project:
(i) Discounted payback period
(ii) Profitability index
(iii) Net present value (10 Marks)
4. The Modern Chemicals Ltd. requires Rs.25,00,000 for a new plant. This plant is expected to yield
earnings before interest and taxes of Rs. 5,00,000. While deciding about the financial plan, the company
considers the objective of maximising earnings per share. It has three alternatives to finance the project-
by raising debt of Rs.2,50,000 or Rs.10,00,000 or Rs.15,00,000 and the balance, in each case, by
issuing equity shares. The company’s share is currently selling at Rs. 150, but is expected to decline to
Rs.125 in case the funds are borrowed in excess of Rs.10,00,000. The funds can be borrowed at the
rate of 10% upto Rs. 2,50,000, at 15% over Rs.2,50,000 and upto Rs.10,00,000 and at 20% over
Rs.10,00,000. The tax rate applicable to the company is 50%.
DETERMINE, which form of financing should the company choose? (10 Marks)
5. From the following, PREPARE Income Statement of Company A and B.
Company A B
Financial leverage 3:1 4:1
Interest Rs.20,000 Rs.30,000
Operating leverage 4:1 5:1
Variable Cost as a Percentage to Sales 2
66 % 75%
3
Income tax Rate 45% 45%
(10 Marks)
6. (a) STATE Agency Cost. DISCUSS the ways to reduce the effect of it.
(b) EXPLAIN the importance of trade credit and accruals as source of short-term finance. DISCUSS
the cost of these sources?
(c) STATE two advantages of Walter Model of Dividend Decision. (4 + 4 + 2 =10 Marks)

© The Institute of Chartered Accountants of India

 PAPER – 8B: ECONOMICS FOR FINANCE

Question No.7 is compulsory. Answer any three from rest.

In case, any candidate answers extra question(s) / Sub -question(s) over and above the required number,
then only the requisite number of questions first answered in the answer book shall be valued and subsequent
extra question(s) answered shall be ignored.
Working Notes should from part of the respective questions.
7. (a) The equilibrium level of real GDP is Rs 1,000 billion, the full employment level of real GDP is
Rs 1,250 billion, and the marginal propensity to consume (MPC) is 0.60. How much government
spending (∆G) would be needed to raise income to full-employment level? (2 Marks)
(b) Explain how Reserve Bank of India acts as a ‘lender of last resort ‘to commercial banks? Or Explain
the operation of Marginal Standing Facility? (3 Marks)
(c) Classify each of the following goods based on their characteristics. Mention the rationale.
(i) Open-access Wi-Fi networks
(ii) Roads with toll booths
(iii) Parks (3 Marks)
(d) Define Real Effective Exchange Rate (REER)? (2 Marks)
8. (a) (i) Explain the Cambridge Version of Cash Balance Approach
Md = k P Y (3 Marks)
(ii) Distinguish between ‘pump priming’ and ‘compensatory spending’ (3 Marks)
(b) (i) If an economy has a flat aggregate expenditure function, what would be the nature of the
multiplier? (2 Marks)
(ii) Distinguish between private cost and social cost (2 Marks)
9. (a) (i) What is meant by Liquidity Adjustment Facility (LAF)? How does it help commercial banks?
(3 Marks)
(ii) Define ‘Moral Hazard’ (2 Marks)
(b) You are given the following data on an economy (Rs. in Cores):
Investment expenditure (I): 250
Government expenditure on goods and services (G): 800
Exports (X): 600
All tax revenues are derived from a uniform rate of income tax of 30% of income.
Consumption expenditure is given by: C = 0.75 Y d; Where: Yd is disposable national income (i.e.
income less taxes) and C is consumption expenditure
Import expenditure is given by: M = 0.15 Y Where: Y is national income and M is import expenditure
(i) Calculate the equilibrium value of National Income.
(ii) Calculate the Current Account Balance at the equilibrium value of National Income.
(ii) Calculate the Fiscal Surplus (+) or Deficit (-) at the equilibrium value of National Income.
(5 Marks)

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10. (a) (i) What is meant by ‘monetary policy instruments’ (3 Marks)
(ii) Estimate national Income by (a) Expenditure Method (b) Income Method From Following data
(3 Marks)
Rs. in Crores
Private Final Consumption Expenditure 210
Govt. Final Consumption Expenditure 50
Net domestic capital Formation 40
Net Exports (-) 5
Wages and Salaries 170
Employers Contribution 10
Profit 45
Interest 20
Indirect Taxes 30
Subsidies 05
Rent 10
Factor Income from abroad 03
Consumption of Fixed capital 25
Royalty 15
(b) (i) What do you understand by the term ‘Most-Favored-Nation’ (MFN)? (2 Marks)
(ii) What’s meant by free trade area? (2 Marks)
11. (a) (i) What is the rationale behind resource seeking foreign direct investments (3 Marks)
(ii) What is meant by ‘safeguard measures’ under WTO? (2 Marks)
(b) (i) What is the major determinant of the economic functions of a government (3 Marks)
(ii) What ‘s Arbitrage? What is the outcome of Arbitrage? (2 Marks)
Or
Define Money Multiplier (2 Marks)

© The Institute of Chartered Accountants of India

 Test Series: August, 2018
MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Working notes:
(i) Current assets and Current liabilities computation:
Current assets 2.5
=
Current liabilities 1

Current Assets Current Liabilities

Or, = = k (say)
2.5 1
Or, Current Assets = 2.5 k and Current Liabilities = k
Or, Working capital = (Current Assets  Current Liabilities)
Or, Rs.2,40,000 = k (2.5  1) = 1.5 k
Or, k = Rs.1,60,000
 Current Liabilities = Rs. 1,60,000
Current Assets = Rs.1,60,000  2.5 = Rs.4,00,000
(ii) Computation of stock
Liquid assets
Liquid ratio =
Current liabilities
Current Assets - Stock
Or,1.5 =
Rs.1,60,000
Or, 1.5  Rs.1,60,000 = Rs.4,00,000  Stock
Or, Stock = Rs.1,60,000
(iii) Computation of Proprietary fund; Fixed assets; Capital and Sundry payables (creditors)
Fixed assets
Proprietary ratio = = 0.75
Proprietary fund
 Fixed assets = 0.75 Proprietary fund
and Net working capital = 0.25 Proprietary fund
Or, Rs.2,40,000/0.25 = Proprietary fund
Or, Proprietary fund = Rs.9,60,000
and Fixed assets = 0.75 proprietary fund
= 0.75  Rs.9,60,000
= Rs.7,20,000
Equity Capital = Proprietary fund  Reserves & Surplus
= Rs.9,60,000  Rs.1,60,000
1

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 = Rs.8,00,000
Sundry payables (creditors) = (Current liabilities  Bank overdraft)
= (Rs.1,60,000  Rs.40,000) = Rs.1,20,000
Balance Sheet
Liabilities (Rs.) Assets (Rs.)
Equity Capital 8,00,000 Fixed assets 7,20,000
Reserves & Surplus 1,60,000 Stock 1,60,000
Bank overdraft 40,000 Current assets 2,40,000
Sundry payables 1,20,000
11,20,000 11,20,000

(b) The Present Value of the Cash Flows for all the years by discounting the cash flow at 7% is
calculated as below:
Year Cash flows Discounting factor @ Present value of cash
Rs. in lakhs 7% flows Rs. in lakhs
1 25,00,000 0.935 23,37,500
2 60,00,000 0.873 52,38,000
3 75,00,000 0.816 61,20,000
4 80,00,000 0.763 61,04,000
5 65,00,000 0.713 46,34,500
Total of present value of Cash flow 2,44,34,000
Less: Initial investment 1,00,00,000
Net Present Value (NPV) 1,44,34,000
When the risk-free rate is 7% and the risk premium expected by the management is 7 %. So the
risk adjusted discount rate is 7% + 7% =14%.
Discounting the above cash flows using the Risk Adjusted Discount Rate would be as below:
Year Cash flows Discounting factor @14% Present Value of cash flows
Rs. in lakhs Rs. in lakhs
1 25,00,000 0.877 21,92,500
2 60,00,000 0.769 46,14,000
3 75,00,000 0.675 50,62,500
4 80,00,000 0.592 47,36,000
5 65,00,000 0.519 33,73,500
Total of present value of Cash flow 1,99,78,500
Initial investment 1,00,00,000
Net present value (NPV) 99,78,500
(c)
A When dividend is paid
(a) Price per share at the end of year 1

© The Institute of Chartered Accountants of India

 1
100 = (Rs. 5+ P 1)
1.10
110 = Rs. 5 + P1
P1 = 105
(b) Amount required to be raised from issue of new shares
Rs.5,00,000 – (Rs.2,50,000 – Rs.1,25,000)
Rs.5,00,000 – Rs.1,25,000 = Rs.3,75,000
(c) Number of additional shares to be issued
3,75,000 75,000
 shares or say 3,572 shares
105 21
(d) Value of M Ltd.
(Number of shares × Expected Price per share)
i.e., (25,000 + 3,572) × Rs.105 = Rs.30,00,060
B When dividend is not paid
(a) Price per share at the end of year 1
P1
100=
1.10
P1 = 110
(b) Amount required to be raised from issue of new shares
Rs.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 2,273 shares.
110 11
(d) Value of M Ltd.,
(25,000 + 2273) × Rs.110
= Rs.30,00,030
Whether dividend is paid or not, the value remains the same.
(d) Workings:
D1 `3
(i) Cost of Equity (K e) = g=  0.07  0.1  0.07 = 0.17 = 17%
P0 ` 30
(ii) Cost of Debentures (K d) = I (1 - t) = 0.09 (1 - 0.4) = 0.054 or 5.4%
Computation of Weighted Average Cost of Capital (WACC using market value weights)
Source of capital Market Value Weight Cost of capital (%) WACC (%)
of capital (Rs.)
9% Debentures 30,00,000 0.30 5.40 1.62
12% Preference Shares 10,00,000 0.10 12.00 1.20
Equity Share Capital 60,00,000 0.60 17.00 10.20
(Rs.30 × 2,00,000 shares)
Total 1,00,00,000 1.00 13.02

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2. (i) Estimate of the Requirement of Working Capital
(Rs.) (Rs.)
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)
Finished goods stock 13,60,000
(Refer to Working note 4)
Debtors/ Receivables 29,53,846
(Refer to Working note 5)
Cash and Bank balance 25,000 55,03,461
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) 46,95,990
(ii) The maximum permissible bank finance as per Tandon Committee Norms
First Method:
75% of the net working capital financed by bank i.e. 75% of Rs.46,95,990
(Refer to (i) above)
= Rs. 35,21,993
Second Method:
(75% of Current Assets) - Current liabilities
= 75% of Rs. 55,03,461 - Rs. 8,07,471
(Refer to (i) above)
= Rs. 41,27,596 – Rs. 8,07,471
= Rs. 33,20,125
Working Notes:
1. Annual cost of production
Rs.
Raw material requirements (1,04,000 units  Rs. 80) 83,20,000
Direct wages (1,04,000 units  Rs. 30) 31,20,000
Overheads (exclusive of depreciation) (1,04,000  Rs. 60) 62,40,000
1,76,80,000
2. Work in progress stock
Rs.
Raw material requirements (4,000 units  Rs. 80) 3,20,000
4

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 Direct wages (50%  4,000 units  Rs. 30) 60,000
Overheads (50%  4,000 units  Rs.60) 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:
Rs.
For Finished goods 83,20,000
For Work in progress 3,20,000
86,40,000
Rs. 86, 40,000
Raw material stock × 4 weeks i.e. Rs. 6,64,615
52 weeks
4. Finished goods stock
8,000 units @ Rs. 170 per unit = Rs. 13,60,000
5. Debtors for sale
Credit allowed to debtors Average 8 weeks
Credit sales for year (52 weeks) i.e. (1,04,000 units-8,000 units) 96,000 units
Selling price per unit Rs.200
Credit sales for the year (96,000 units Rs. 200) Rs. 1,92,00,000
Debtors Rs. 1,92,00,000
× 8 weeks i.e. Rs. 29,53,846
52 weeks
(Debtor can also be calculated based on Cost of goods sold)
6. Creditors for raw material:
Credit allowed by suppliers Average 4 weeks
Purchases during the year (52 weeks) i.e. Rs. 93,04,615
(Rs. 83,20,000 + Rs. 3,20,000 + Rs. 6,64,615)
(Refer to Working notes 1,2 and 3 above)
Creditors Rs. 93,04,615
× 4 weeks i.e. Rs. 7,15,740
52 weeks
7. Creditors for wages
Lag in payment of wages 1
Average 1 weeks
2
Direct wages for the year (52 weeks) i.e. Rs. 31,80,000
(Rs. 31,20,000 + Rs. 60,000)
(Refer to Working notes 1 and 2 above)
Creditors Rs.31,80,000 1
× 1 weeks i.e. Rs. 91,731
52 weeks 2

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3. (1) Computation of Net Present Values of Projects (Amount in Rs. ‘000)
Year Cash flows Discount Discounted Cash flow
Project A Project B factor @ 16 % Project A Project B
(Rs.) (Rs.) (Rs.) (Rs.)
(1) (2) (3) (3)  (1) (3)  (2)
0 (13,500) (24,000) 1.000 (13,500) (24,000)
1 -- 6,000 0.862 -- 5,172
2 3,000 8,400 0.743 2,229 6,241.2
3 13,200 9,600 0.641 8,461.2 6,153.6
4 8,400 10,200 0.552 4,636.8 5,630.4
5 8,400 9,000 0.476 3,998.4 4,284
Net present value 5,825.4 3,481.2
(2) Computation of Cumulative Present Values of Projects Cash inflows
(Amount in Rs. ‘000)
Project A Project B
Year PV of Cumulative PV of Cumulative
cash inflows (Rs.) PV (Rs.) cash inflows (Rs.) PV (Rs.)
1 -- -- 5,172 51,72
2 2,229 22,29 6,241.2 11,413.2
3 8,461.2 10,690.2 6,153.6 17,566.8
4 4,636.8 15,327 5,630.4 23,197.2
5 3,998.4 19,325.4 4,284 27,481.2
(i) Discounted payback period: (Refer to Working note 2)
Cost of Project A = Rs.1,35,00,000
Cost of Project B = Rs.2,40,00,000
Cumulative PV of cash inflows of Project A after 4 years = Rs.1,53,27,000
Cumulative PV of cash inflows of Project B after 5 years = Rs.2,74,81,200
A comparison of projects cost with their cumulative PV clearly shows that the project A’s cost
will be recovered in less than 4 years and that of project B in less than 5 years. The exact
duration of discounted payback period can be computed as follows:
Project A Project B
Excess PV of cash 18,27,000 34,81,200
inflows over the project (Rs.1,53,27,000  Rs.1,35,00,000) (Rs. 2,74,81,200  Rs.2,40,00,000)
cost (Rs.)
Computation of period 0.39 year 0.81 years
required to recover (Rs. 18,27,000 ÷ Rs.46,36,800) (Rs.34,81,200 ÷ Rs. 42,84,000)
excess amount of
cumulative PV over
project cost (Refer to
Working note 2)
Discounted payback 3.61 year 4.19 years
period (4  0.39) years (5  0.81) years
6

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 Sum of discounted cash inflows
(ii) Profitability Index: =
Initian cash outlay
Rs.1,93,25,400
Profitability Index (for Project A) = = 1.43
Rs.1,35,00,000
Rs.2,74,81,200
Profitability Index (for Project B) = = 1.15
Rs.2,40,00,000
(iii) Net present value (for Project A) = Rs.58,25,400 (Refer to Working note 1)
Net present value (for Project B) = Rs.34,81,200
4. Calculation of Earnings per share for three alternatives to finance the project
Alternatives
I II III
Particulars To raise debt of Rs. To raise debt of To raise debt of
2,50,000 and equity Rs.10,00,000 and Rs.15,00,000 and
of Rs. 22,50,000 equity of Rs.15,00,000 equity of Rs. 10,00,000
(Rs.) (Rs.) (Rs.)
Earnings before interest and tax 5,00,000 5,00,000 5,00,000
Less: Interest on debt at the rate 25,000 1,37,500 2,37,500
of (10% on Rs.2,50,000) (10% on Rs.2,50,000) (10% on Rs. 2,50,000)
(15% on Rs. 7,50,000) (15% on Rs.7,50,000)
(20% on Rs.5,00,000)
Earnings before tax 4,75,000 3,62,500 2,62,500
Less: Tax @ 50% 2,37,500 1,81,250 1,31,250
Earnings after tax: (A) 2,37,500 1,81,250 1,31,250
Number of shares: (B) (Equity/ 15,000 10,000 8,000
Market price of Share) (Rs.22,50,000/Rs.150) (Rs.15,00,000/Rs.150) (Rs.10,00,000/Rs.125)
Earnings per share: [(A)/(B)] 15.833 18.125 16.406
The company should raise Rs.10,00,000 from debt and Rs.15,00,000 by issuing equity shares, as it
gives highest EPS.
5. Working Notes:
Company A
EBIT 3
Financial leverage= = = Or, EBIT = 3× EBT (1)
EBT 1
Again EBIT – Interest = EBT
Or, EBIT- 20,000 = EBT (2)
Taking (1) and (2) we get
3 EBT- 20,000 = EBT
Or, 2 EBT = 20,000 or EBT = Rs.10,000
Hence EBIT = 3EBT = Rs.30,000
Contribution 4
Again, we have operating leverage = =
EBIT 1

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 EBIT = Rs. 30,000, hence we get
Contribution = 4 × EBIT = Rs.1,20,000
2
Now variable cost = 66 % on sales
3
2 1
Contribution = 100 - 66 % i.e. 33 % on sales
3 3
1,20,000
Hence, sales = = Rs. 3,60,000
1
33 %
3
Same way EBIT, EBT, contribution and sales for company B can be worked out.
Company B
EBIT 4
Financial leverage = = or EBIT = 4 EBT (3)
EBT 1
Again EBIT – Interest = EBT or EBIT – 30,000 = EBT (4)
Taking (3) and (4) we get, 4EBT- 30,000 = EBT
Or, 3EBT = 30,000 Or, EBT=10,000
Hence, EBIT = 4 × EBT= 40,000
Contribution 5
Again, we have operating leverage = =
EBIT 1
EBIT= 40,000; Hence we get contribution = 5 × EBIT = 2,00,000
Now variable cost =75% on sales
Contribution = 100- 75% i.e. 25% on sales
2,00,000
Hence Sales = = Rs. 8,00,000
25%
Income Statement
A (Rs.) B (Rs.)
Sales 3,60,000 8,00,000
Less: Variable Cost 2,40,000 6,00,000
Contribution 1,20,000 2,00,000
Less: Fixed Cost (bal. Fig) 90,000 1,60,000
EBIT 30,000 40,000
Less: Interest 20,000 30,000
EBT 10,000 10,000
Less: Tax 45% 4,500 4,500
EAT 5,500 5,500
6. (a) Agency Cost: In a sole proprietorship firm, partnership etc., owners participate in management
but in corporate, owners are not active in management so, there is a separation between owner/
shareholders and managers. In theory managers should act in the best interest of shareholders
however in reality, managers may try to maximise their individual goal like salary, perks etc., so
there is a principal-agent relationship between managers and owners, which is known as Agency
8

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 Problem. In a nutshell, Agency Problem is the chances that managers may place personal goals
ahead of the goal of owners. Agency Problem leads to Agency Cost. Agency cost is the additional
cost borne by the shareholders to monitor the manager and control their behaviour so as to
maximise shareholders wealth. Generally, Agency Costs are of four types (i) monitoring (ii) bonding
(iii) opportunity (iv) structuring
However, following efforts can be made to address Agency Cost:
Managerial compensation to be linked to profit of the company to some extent with the long term
objectives of the company.
Employees’ Stock option plan (ESOP) is also designed to address the issue with the underlying
assumption that maximisation of the stock price is the objective of the investors.
Effective monitoring through corporate governance can be done.
(b) Trade credit and accruals as source of short-term finance like working capital refers to credit facility
given by suppliers of goods during the normal course of trade. It is a short term source of finance.
Micro small and medium enterprises (MSMEs) in particular are heavily dependent on this source
for financing their working capital needs. The major advantages of trade credit are  easy
availability, flexibility and informality.
There can be an argument that trade credit is a cost free source of finance. But it is not. It involves
implicit cost. The supplier extending trade credit incurs cost in the form of opportunity cost of funds
invested in trade receivables. Generally, the supplier passes on these costs to the buyer by
increasing the price of the goods or alternatively by not extending cash discount facility.
(c) Advantages of Walter Model
1. The formula is simple to understand and easy to compute.
2. It can envisage different possible market prices in different situations and considers internal
rate of return, market capitalisation rate and dividend payout ratio in the determination o f
market value of shares.

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 PAPER – 8B: ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/ HINTS
7. (a) k. ∆I =∆ Y; k = 1/0.4
= (1250 -1000) .0.4
= 100 billion
(b) The Marginal Standing Facility (MSF) is the last resort for banks to obtain funds once they exhaust
all borrowing options including the liquidity adjustment facility on which the rates are lower
compared to the MSF. Under this facility, the scheduled commercial banks can borrow additional
amount of overnight money from the central bank over and above what is available to them through
the LAF window by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit ( a fixed
per cent of their net demand and time liabilities deposits (NDTL) liable to change ) at a penal rate
of interest. The scheme has been introduced by RBI with the main aim of reducing volatility in the
overnight lending rates in the inter-bank market and to enable smooth monetary transmission in
the financial system. This provides a safety valve against unexpected liquidity shocks to the
banking system.
(c) All the goods mentioned above can be classified as impure public good. There are many hybrid
goods that possess some features of both public and private goods. These goods are called impure
public goods and are partially rivalrous or congestible. Because of the possibility of congestion, the
benefit that an individual gets from an impure public good depends on the number of use rs.
Consumption of these goods by another person reduces, but does not eliminate, the benefits that
other people receive from their consumption of the same good. Impure public goods also differ
from pure public goods in that they are often excludable.
Since free riding can be eliminated, the impure public good may be provided either by the market
or by the government at a price or fee. If the consumption of a good can be excluded, then the
market would provide a price mechanism for it. The provider of an impure public good may be able
to control the degree of congestion either by regulating the number of people who may use it, or
the frequency with which it may be used or both.
(d) The ‘real exchange rate' incorporates changes in prices and describes ‘how many’ of a good or
service in one country can be traded for ‘one’ of that good or service in a foreign country.
Domestic price Index
Real exchange rate = Nominal exchange rate X Foreign price Index

8. (a) (i) In the early 1900s, Cambridge Economists Alfred Marshall, A.C. Pigou, D.H. Robertson and
John Maynard Keynes (then associated with Cambridge) put forward a fundamentally different
approach to quantity theory, known neoclassical theory or cash balance approach. The
Cambridge version holds that money increases utility in the following two ways:
1. enabling the possibility of split-up of sale and purchase to two different points of time
rather than being simultaneous, and
2. being a hedge against uncertainty.
While the first above represents transaction motive, just as Fisher envisaged, the second
points to money’s role as a temporary store of wealth. Since sale and purchase of
commodities by individuals do not take place simultaneously, they need a ‘temporary abode’
of purchasing power as a hedge against uncertainty. As such, demand for money also
involves a precautionary motive in Cambridge approach. Since money gives utility in its store
of wealth and precautionary modes, one can say that money is demanded for itself.
Now, the question is how much money will be demanded? The answer is: it depends partly
on income and partly on other factors of which important ones are wealth and interest rates.
The former determinant of demand i.e. income, points to transactions demand such that
10

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 higher the income, the greater the quantity of purchases and as a consequence greater will
be the need for money as a temporary abode of value to overcome transactions costs. The
Cambridge equation is stated as:
Md = k PY, Where M d = is the demand for money
Y = real national income
P = average price level of currently produced goods and services
PY = nominal income
k = proportion of nominal income (PY) that people want to hold as cash balances
The term ‘k’ in the above equation is called ‘Cambridge k’. The equation above explains that
the demand for money (M) equals k proportion of the total money income.
Thus we see that the neoclassical theory changed the focus of the quantity theory of money
to money demand and hypothesized that demand for money is a function of money income.
Both these versions are chiefly concerned with money as a means of transactions or
exchange, and therefore, they present models of the transaction demand for money.
(ii) A distinction is made between the two concepts of public spending during depression, namely,
the concept of ‘pump priming’ and the concept of 'compensatory spending'. Pump priming
involves a one-shot injection of government expenditure into a depressed economy with the
aim of boosting business confidence and encouraging larger private investment. It is a
temporary fiscal stimulus in order to set off the multiplier process. The argument is that with
a temporary injection of purchasing power into the economy through a rise in government
spending financed by borrowing rather than taxes, it is possible for government to bring about
permanent recovery from a slump. Pump priming was widely used by governments in the
post-war era in order to maintain full employment; however, it became discredited later when
it failed to halt rising unemployment and was held responsible for inflation. Compensatory
spending is said to be resorted to when the government spending is deliberately carried out
with the obvious intention to compensate for the deficiency in private investment.
(b) (i) The marginal propensity to consume (MPC) is the determinant of the value of the multiplier
and that there exists a direct relationship between MPC and the value of multiplier. Higher
the MPC, more will be the value of the multiplier and vice-versa. A flat aggregate expenditure
function implies lower MPC and higher MPS for all levels of income. Therefore, the value of
multiplier will be small.
(ii) Private cost is the cost faced by the producer or consumer directly involved in a transaction.
If we take the case of a producer, his private cost includes direct cost of labour, materials,
energy and other indirect overheads. These are usually added up to determine market price.
The actions of consumers or producers result in costs or benefits to others and the relevant
costs and benefits are not reflected as part of market prices. In other words, market prices do
not incorporate externalities. Social costs refer to the total costs to the society on account of
a production or consumption activity. Social costs are private costs borne by individuals
directly involved in a transaction together with the external costs borne by third parties not
directly involved in the transaction. Social costs represent the true burdens carried by society
in monetary and non-monetary terms.
9. (a) (i) The Liquidity Adjustment Facility(LAF) is a facility extended by the Reserve Bank of India to
the scheduled commercial banks (excluding RRBs) and primary dealers to avail of liquidity in
case of requirement (or park excess funds with the RBI in case of excess liquidity) on an
overnight basis against the collateral of government securities including state government
securities. The objective is to provide liquidity to commercial banks to adjust their day to day
mismatches in liquidity. Under this facility, financial accommodation is provided through
repos/reverse repos.
11

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 (ii) Moral hazard is associated with information failure and refers to a situation that increases the
probability of occurrence of a loss or a larger than normal loss, because of a change in the
unobservable or hard to observe behaviour of one of the parties in the transaction after the
transaction has been made. Moral hazard is opportunism characterized by an informed
person’s taking advantage of a less-informed person through an unobserved action. It arises
from lack of information about someone’s future behavior. Moral hazard occurs due to
asymmetric information i.e., an individual knows more about his or her own actions than other
people do. This leads to a distortion of incentives to take care or to exert effort when someone
else bears the costs of the lack of care or effort. For example, in the insurance market, the
expected loss from an adverse event increases as insurance coverage increases.
(b) (i) Y=C + I+ G+ (X-M)
Y= 0.75 ×{(1-0.30)*Y} + 250 + 800 + 600 - 0. 15×Y
Y= 0.375Y+1650
0.625Y= 1650
1650
Y=
0.625
Hence Y = Rs.2640 Crores
(ii) Exports (X) = Rs.600 Crores
Imports = 0.15(2640) = Rs.396 Cores
Hence current account is in surplus of Rs. 204 Crores
(iii) Tax revenue = 0. 3 (2640) = Rs.792 Crores
Government expenditure = Rs.800 Crores
Hence budget is in deficit of Rs. 8 crores i.e. –8
10. (a) (i) The monetary policy instruments are the various direct and indirect instruments or tools that
a central bank can use to influence money market and credit conditions and pursue its
monetary policy objectives. In general, the direct instruments comprise of:
(a) the required cash reserve ratios and liquidity reserve ratios prescribed from time to time.
(b) directed credit which takes the form of prescribed targets for allocation of credit to preferred
sectors (for e.g. Credit to priority sectors), and
(c) administered interest rates wherein the deposit and lending rates are prescribed by the
central bank.
The indirect instruments mainly consist of:
(a) Repos
(b) Open market operations
(c) Standing facilities, and
(d) Market-based discount window.
(ii) National Income (NNPFC)
Expenditure Method:
= Private Final Consumption Expenditure + Govt. Final Consumption Expenditure +
Net domestic capital Formation + Net Exports = 210+50+40+(-5) = 295
NNP (FC) = NDP MP + Factor Income from abroad – Net Indirect Tax (Indirect Tax – Subsidy)
= 295 + 3 - (30-5)
12

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 = 295 + 3 - 25 = 273
= 298 - 25 = 273
NNP FC = 273 Crores
Income Method: Wages and Salaries+ Employers Contribution+ Profit + Interest + Rent +
Royalty
= 170 + 10 + 45 + 20 + 10 + 15 = 270 (NDPFC)
NNPFC = NDPFC + FIFA
270+3 = 273 Crores
(b) (i) When a country enjoys the best trade terms given by its trading partner it is said to enjoy the
Most Favoured Nation (MFN) status. Originally formulated as Article 1 of GATT, this principle
of non-discrimination states that any advantage, favour, privilege or immunity granted by any
contracting party to any product originating in or destined for any other country shall be
extended immediately and unconditionally to the like product originating or destined for the
territories of all other contracting parties. Under the WTO agreements, countries cannot
normally discriminate between their trading partners. If a country improves the benefits that it
gives to one trading partner, (such as a lower a trade barrier, or opens up a market), it has to
give the same best treatment to all the other WTO members too in respect of the same
goods or services so that they all remain ‘most-favoured’. As per the WTO agreements, each
member treats all the other members equally as “most-favoured” trading partners.
(ii) Free trade policy is based on the principle of non-interference by government in foreign trade.
The distinction between domestic trade and international trade disappears and goods and
services are freely imported from and exported to the rest of the world. Buyers and sellers
from separate economies voluntarily trade without the domestic government helping or
hindering movements of goods and services between countries by applying tariffs, quotas,
subsidies or prohibitions on their goods and services. The theoretical case for free trade is
based on Adam Smith’s argument that the division of labour among countries leads to
specialization, greater efficiency, and higher aggregate production.
11. (a) (i) The foreign-based multinational companies invest abroad to gain access to resources, that
are either unobtainable or available only at a much higher cost in the home country. The firm
may find it cheaper to produce in a foreign facility due to the availability of superior or less
costly access to the inputs of production than at home. The resources generally sought for
are:
(i) physical resources such as oil, minerals, raw materials, or agricultural products.
(ii) human resources such as skilled labor and low-cost unskilled labour, organizational skills,
management, consultancy or marketing expertise,
(iii) technological resources such as innovative, and other created assets (e.g., brand names)
(iv) physical infrastructure
(v) financial infrastructure such as safe efficient and integrated financial market, set of market
institutions, networks and financial intermediaries
(ii) A safeguard measures is an action taken to protect a specific domestic industry from an
unexpected build-up of imports. Safeguard measures are initiated by countries to restrict
imports of a product temporarily if its domestic industry is injured or threatened with serious
injury caused by a surge in imports.

13

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 (b) (i) The nature of the economic system determines the size and scope of the economic functions
of the government. In a centrally planned socialistic economy, the state owns all productive
resources and makes all important economic decisions. On the contrary , in a market
economy, all important economic decisions are made by individuals and firms who want to
maximise self-interest and there is only limited role for the government. In a mixed economic
system, both markets and government contribute towards resource allocation decisions.
(ii) Arbitrage refers to the practice of making risk-less profits by intelligently exploiting price
differences of an asset at different dealing places. On account of arbitrage, regardless of
physical location, at any given moment, all markets tend to have the same exchange rate for
a given currency
or
Money Supply
(ii) Money Multiplier( 𝑚) =
Monetary Base

Money multiplier m is defined as a ratio that relates the change in the money supply to a given
change in the monetary base. It denotes by how much the money supply will change for a
given change in high-powered money. The multiplier indicates what multiple of the monetary
base is transformed into money supply.

14

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 Test Series: October, 2018
MOCK TEST PAPER – 2
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
Time Allowed – 3 Hours Maximum Marks – 100

PAPER 8A : FINANICAL MANAGEMENT (60 Marks)

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
1. Answer the following:
(a) PQR Ltd. has the following capital structure on October 31, 20X8:
Sources of capital (Rs.)
Equity share capital (2,00,000 shares of Rs.10 each) 20,00,000
Reserves & surplus 20,00,000
12% Preference share capital 10,00,000
9% Debentures 30,00,000
80,00,000
The market price of equity share is Rs. 30. It is expected that the company will pay next year a
dividend of Rs. 3 per share, which will grow at 7% forever. Assume 40% income tax rate.
You are required to COMPUTE weighted average cost of capital using market value weights.
(b) NSG Ltd. has a sale of Rs.75,00,000, variable cost of Rs.42,00,000 and fixed cost of Rs.6,00,000.
The Present capital structure of NSG is as follows:
Equity Shares Rs. 55,00,000
Debt (12%) Rs. 45,00,000
Total Rs. 1,00,00,000
(i) DETERMINE the ROCE of NSG Ltd.
(ii) Does NSG have a favourable financial leverage? ANALYSE.
(iii) If the industry average of asset turnover is 3, does it have a high or low asset leverage?
DETERMINE
(iv) COMPUTE the leverages of NSG?
(v) DETERMINE, at what level of sales, will the EBT be zero?
(c) Following information relate to a concern:
Debtors Velocity 3 months
Credits Velocity 2 months
Stock Turnover Ratio 1.5
Gross Profit Ratio 25%

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 Bills Receivables Rs. 25,000
Bills Payables Rs. 10,000
Gross Profit Rs. 4,00,000
Fixed Assets to turnover Ratio 4
Closing stock of the period is Rs. 10,000 above the opening stock.
CALCULATE
(i) Sales and cost of goods sold
(ii) Sundry Debtors
(iii) Sundry Creditors
(iv) Closing Stock
(v) Fixed Assets
(d) RST Ltd. has a capital of Rs. 10,00,000 in equity shares of Rs. 100 each. The shares are currently
quoted at par. The company proposes to declare a dividend of Rs. 10 per share at the end of the
current financial year. The capitalization rate for the risk class of which the company belongs is
12%. COMPUTE the market price of the share at the end of the year, if
(i) a dividend is not declared?
(ii) a dividend is declared?
(iii) assuming that the company pays the dividend and has net profits of Rs.5,00,000 and makes
new investments of Rs.10,00,000 during the period, how many new shares must be issued?
Use the MM model. (4 × 5 Marks = 20 Marks)
2. JKL Ltd. has the following book-value capital structure as on March 31, 20X8.
(Rs.)
Equity share capital (2,00,000 shares) 40,00,000
11.5% Preference shares 10,00,000
10% Debentures 30,00,000
80,00,000
The equity shares of the company are sold at Rs. 20. It is expected that the company will pay next year
a dividend of Rs. 2 per equity share, which is expected to grow by 5% p.a. forever. Assume a 35%
corporate tax rate.
Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital
structure.
(ii) COMPUTE the new WACC, if the company raises an additional Rs. 20 lakhs debt by issuing 12%
debentures. This would result in increasing the expected equity dividend to Rs. 2.40 and leave the
growth rate unchanged, but the price of equity share will fall to Rs.16 per share. (10 Marks)
3. RST Limited is considering relaxing its present credit policy and is in the process of evaluating two
proposed polices. Currently, the firm has annual credit sales of Rs 225 lakhs and accounts receivable
turnover ratio of 5 times a year. The current level of loss due to bad debts is Rs.7,50,000. The firm is
required to give a return of 20% on the investment in new accounts receivables. The company’s variable
costs are 60% of the selling price. Given the following information, DETERMINE which is a better
option?

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 (Amount in lakhs)
Present Policy Policy Policy
Option I Option II
Annual credit sales (Rs) 225 275 350
Accounts receivable turnover ratio 5 4 3
Bad debt losses (Rs) 7.5 22.5 47.5
(10 Marks)
4. The management of Z Company Ltd. wants to raise its funds from market to meet out the financial
demands of its long-term projects. The company has various combinations of proposals to raise its
funds. You are given the following proposals of the company:
Proposal Equity shares (%) Debts (%) Preference shares (%)
P 100 - -
Q 50 50 -
R 50 - 50
(i) Cost of debt and preference shares is 10% each.
(ii) Tax rate – 50%
(iii) Equity shares of the face value of Rs. 10 each will be issued at a premium of Rs. 10 per share.
(iv) Total investment to be raised Rs. 40,00,000.
(iv) Expected earnings before interest and tax Rs. 18,00,000.
From the above proposals the management wants to take advice from you for appropriate plan
after computing the following:
• Earnings per share
• Financial break-even-point
COMPUTE the EBIT range among the plans for indifference. Also indicate if any of the plans dominate.
(10 Marks)
5. X Limited is considering to purchase of new plant worth Rs. 80,00,000. The expected net cash flows
after taxes and before depreciation are as follows:
Year Net Cash Flows (Rs.)
1 14,00,000
2 14,00,000
3 14,00,000
4 14,00,000
5 14,00,000
6 16,00,000
7 20,00,000
8 30,00,000
9 20,00,000
10 8,00,000

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 The rate of cost of capital is 10%.
You are required to CALCULATE
(i) Pay-back period
(ii) Net present value at 10 discount factor
(iii) Profitability index at 10 discount factor
(iv) Internal rate of return with the help of 10% and 15% discount factor
The following present value table is given for you:

Present value of Rs. 1 at Present value of Rs. 1 at

Year
10% discount rate 15% discount rate
1 .909 .870
2 .826 .756
3 .751 .658
4 .683 .572
5 .621 .497
6 .564 .432
7 .513 .376
8 .467 .327
9 .424 .284
10 .386 .247
(10 Marks)
6. (a) DISCUSS the three major decisions taken by a finance manager to maximize the wealth of
shareholders.
(b) STATE the disadvantages of the Certainty equivalent Method. EXPLAIN its differences with Risk
Adjusted discount rate.
(c) STATE the advantages of Stock-Splits. (4 + 4 + 2 =10 Marks)

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 PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
SECTION B: ECONOMICS FOR FINANCE
Question No.7 is compulsory. Answer any three from rest.
Marks: 40
In case, any candidate answers extra question(s) / Sub -question(s) over and above the required number, then
only the requisite number of questions first answered in the answer book shall be valued and subsequent extra
question(s) answered shall be ignored.
Working Notes should from part of the respective questions.
7 (a) An increase of investment by Rs. 600 Crores resulted in an increase in national income by
2400 Crores. Find MPC and MPS? (2 Marks)
(b) Explain the effects of monetary policy through the exchange rate channel? (3 Marks)
(c) Define information failure (3 Marks)
(d) What’ s meant by devaluation? (2 Marks)
8. (a) (i) Define CRR. How is CRR used as a policy instrument. (3 Marks)
(ii) What should the market price reflect for achieving economic efficiency? (3 Marks)
(b) (i) Explain the leakages and injections in the circular flow of income (2 Marks)
(ii) Define ‘moral hazard’ (2 Marks)
9. (a) (i) Explain the function of money as a unit of account? (3 Marks)
(ii) What is the rationale for government intervention in allocation of resources? (2 Marks)
(b) Suppose an economy:
Consumption Function (C) = 200+ 0.6 Yd, where Yd = Y-T
Autonomous Investment (I) = Rs. 600 crores
Government Expenditure G = Rs. 900 crores
Taxes (T) = Rs.100 crores
Exports (X) = Rs.200 crores
Import Function (M) = 50 + 0.3 Y
Where Y and Y d National Income and Personal Disposable Income respectively. All the figures are
in Rupees.
Find Out:
(i) Equilibrium level of GDP
(ii) Disposable Income
(iii) Net Exports at Equilibrium GDP (5 Marks)
10. (a) (i) Explain how Reserve Bank of India acts as a ‘lender of last resort ‘to commercial banks?
(3 Marks)

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 (ii) Calculate (a) GDP MP and (b) NNPFC from the following data:
Particulars (Rs.) In Crore
Net
(i) indirect tax 208
Consumption
(ii) of fixed capital 42
Net
(iii) factor income from abroad -40
Rent
(iv) 311
Profits
(v) 892
Interest
(vi) 81
Royalty
(vii) 6
Wages
(viii) and salary 489
Employer's
(ix) contribution to Social Security Scheme 50
(3 Marks)
(b) (i) What are the different routes for securing FDI? (2 Marks)
(ii) What is meant by ‘Voluntary Export Restraints’? (2 Marks)
11. (a) (i) What is meant by free trade policy? (3 Marks)
(ii) What is meant by ‘safeguard measures’ under WTO? (2 Marks)
(b) (i) Explain the concept of adverse selection. What are the possible consequences of adverse
selection? (3 Marks)
(ii) Mention the types of Transactions in the forex market? (2 Marks)
OR
What is the role of Liquidity Adjustment Facility? (2 Marks)

© The Institute of Chartered Accountants of India

 Test Series: October 2018
MOCK TEST PAPER – 2
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
ANSWERS
1. (a) Workings:
D1 `3
(i) Cost of Equity (K e) = g =  0.07  0.1  0.07 = 0.17 = 17%
P0 ` 30

(ii) Cost of Debentures (K d) = I (1 - t) = 0.09 (1 - 0.4) = 0.054 or 5.4%

Computation of Weighted Average Cost of Capital (WACC using market value weights)
Source of capital Market Value of Weight Cost of capital WACC (%)
capital (Rs.) (%)
9% Debentures 30,00,000 0.30 5.40 1.62
12% Preference Shares 10,00,000 0.10 12.00 1.20
Equity Share Capital 60,00,000 0.60 17.00 10.20
(Rs. 30 × 2,00,000 shares)
Total 1,00,00,000 1.00 13.02
EBIT Rs. 27,00,000
(b) (i) ROCE = = × 100 = 27%
Captial employed Rs. 1,00,00,000
Workings:
(I) Calculation of EBT: Rs.
Sales 75,00,000
Less: Variable costs 42,00,000
Contribution 33,00,000
Less: Fixed costs 6,00,000
EBIT 27,00,000
Less: Interest (12 % of Rs. 45,00,000) 5,40,000
EBT 21,60,000
Capital employed = Debt + Equity Shares = Rs. 1,00,00,000.
(ii) Since ROCE (27%) is higher than the interest payable on debt (12%). NSG has a
favourable financial leverage.
(iii) Capital employed = Total assets = Rs. 1,00,00,000
Net sales = Rs.75,00,000
Rs. 75,00,000
Therefore, turnover ratio = = 0.75
Rs. 1,00,00,000
The industry average is 3 against NSG’s ratio of 0.75. Hence NSG Ltd. has very low asset
leverage.

© The Institute of Chartered Accountants of India

 Contribution Rs. 33,00,000
(iv) Operating leverage = = = 1.22
EBIT Rs. 27,00,000

EBIT Rs. 27,00,000

Financial Leverage = = = 1.25
EBT Rs. 21,60,000

Contribution Rs. 33,00,000

Combined leverage = = = 1.53
EBT Rs. 21,60,000

Or
DCL = DOL × DFL = 1.22 × 1.25 = 1.53
(v) For EBT to become zero, a 100% reduction in the EBT is required. As the combined
leverage is 1.53, sales have to drop approx. by 100/1.53 = 65.36%. Hence, the new sales
will be:
Rs. 75,00,000 × (1 – 0.6536) = Rs. 25,98,000 (approx.)
(c) (i) Determination of Sales and Cost of goods sold:
Gross Profit
Gross Profit Ratio = × 100
Sales
25 Rs.4,00,000
Or, =
100 Sales
4,00,00,000
Or, Sales = = Rs. 16,00,000
25
Cost of Goods Sold = Sales – Gross Profit
= Rs. 16,00,000 - Rs. 4,00,000 = Rs. 12,00,000
(ii) Determination of Sundry Debtors:
Debtors velocity is 3 months or Debtors’ collection period is 3 months,
12months
So, Debtors’ turnover ratio = =4
3months
Credit Sales
Debtors’ turnover ratio =
Average AccountsReceivable
Rs.16,00,000
= =4
Bills Receivable+ SundryDebtors
Or, Sundry Debtors + Bills receivable = Rs. 4,00,000
Sundry Debtors = Rs. 4,00,000 – Rs. 25,000 = Rs. 3,75,000
(iii) Determination of Sundry Creditors:
Creditors velocity of 2 months or credit payment period is 2 months.
12 months
So, Creditors’ turnover ratio = =6
2 months

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 CreditPurchases *
Creditors turnover ratio =
Average AccountsPayables
Rs.12,10,000
= =6
Sundry Creditors+ Bills Payables
So, Sundry Creditors + Bills Payable = Rs. 2,01,667
Or, Sundry Creditors + Rs. 10,000 = Rs. 2,01,667
Or, Sundry Creditors = Rs. 2,01,667 – Rs. 10,000 = Rs. 1,91,667
(iv) Closing Stock
Cost of Goods Sold Rs.12,00,000
Stock Turnover Ratio = = =1.5
Average Stock Average Stock
So, Average Stock = Rs. 8,00,000
Opening Stock+ Closing Stock
Now Average Stock =
2
Opening Stock+ (Opening Stock+ Rs.10,000)
Or = Rs. 8,00,000
2
Or, Opening Stock = Rs. 7,95,000
So, Closing Stock= Rs. 7,95,000 + Rs. 10,000 = Rs. 8,05,000
(v) Calculation of Fixed Assets
Cost of GoodsSold
Fixed Assets Turnover Ratio = =4
FixedAssets
Rs.12,00,000
Or, =4
Fixed Assets

Or, Fixed Asset = Rs. 3,00,000

Workings:
* Calculation of Credit purchases:

Cost of goods sold = Opening stock + Purchases – Closing stock

Rs. 12,00,000 = Rs. 7,95,000 + Purchases – Rs. 8,05,000
Rs. 12,00,000 + Rs. 10,000 = Purchases
Rs. 12,10,000 = Purchases (credit).
Assumption:
(i) All sales are credit sales
(ii) All purchases are credit purchase
(iii) Stock Turnover Ratio and Fixed Asset Turnover Ratio may be calculated either
on Sales or on Cost of Goods Sold.

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 (d) As per MM model, the current market price of equity share is:
1
P0 = ×(D1 + P1 )
1+ k e
(i) If the dividend is not declared:
1
100 = (0 + P1 )
1+ 0.12
P1
100 = = P1 = Rs.112
1.12
The Market price of the equity share at the end of the year would be Rs.112.
(ii) If the dividend is declared:
1
100 = ×(10 + P1 )
1+ 0.12
10+ P1
100 =
1.12
112 = 10 + P 1
P1 = 112 – 10 = Rs.102
The market price of the equity share at the end of the year would be Rs.102.
(iii) In case the firm pays dividend of Rs.10 per share out of total profits of Rs. 5,00,000 and plans
to make new investment of Rs. 10,00,000, the number of shares to be issued may be found
as follows:
Total Earnings Rs.5,00,000
- Dividends paid (1,00,000)
Retained earnings 4,00,000
Total funds required 10,00,000
Fresh funds to be raised 6,00,000
Market price of the share 102
Number of shares to be issued (Rs.6,00,000 / 102) 5,882.35
or, the firm would issue 5,883 shares at the rate of Rs.102
2. (i) Computation of Weighted Average Cost of Capital based on existing capital structure
Existing Capital Weights After tax cost WACC (%)
Source of Capital
structure (Rs.) of capital (%)
(a) (b) (a)  (b)
Equity share capital (W.N.1) 40,00,000 0.500 15.00 7.500
11.5% Preference share capital 10,00,000 0.125 11.50 1.437
(W.N.2)
10% Debentures (W.N.3) 30,00,000 0.375 6.50 2.438
80,00,000 1.000 11.375

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 Working Notes (W.N.)
1. Cost of equity capital:
Expected Dividend (D1)
Ke = + Growth(g)
Current Market Price per Share (P 0)

Rs. 2
= + 0.05 = 0.15 or 15%
Rs. 20
2. Cost of preference share capital:
Annual preference share dividend (PD)
=
Net proceeds in the issue of preference share (NP)

Rs. 1,15,000
= = 0.115 or 11.5%
Rs. 10,00,000
3. Cost of 10% Debentures:
I(1  t) Rs. 3,00,000 (1- 0.35)
= = = 0.065 or 6.5%
NP Rs. 30,00,000
(ii) Computation of Weighted Average Cost of Capital based on new capital structure
Source of Capital New Capital Weights After tax cost WACC (%)
structure (Rs.) of capital (%)
(b) (a) (a)  (b)
Equity share capital (W.N. 4) 40,00,000 0.40 20.00 8.00
Preference share (W.N. 2) 10,00,000 0.10 11.50 1.15
10% Debentures (W.N. 3) 30,00,000 0.30 6.50 1.95
12% Debentures (W.N.5) 20,00,000 0.20 7.80 1.56
1,00,00,000 1.00 12.66
Working Notes (W.N.):
4. Cost of equity capital:
ExpectedDividend(D1 ) ` 2.40
Ke =  Growth(g) =  5%  20%
CurrentMarketPr iceper share(P0 ) ` 16

5. Cost of 12% Debentures

`2,40,000(1- 0.35)
Kd = = 0.078 or 7.8%
`20,00,000
3. Statement showing Evaluation of Credit Policies (Amount in lakhs)
Particulars Present Policy Proposed Proposed
Policy I Policy II
(Rs.) (Rs.) (Rs.)
A Expected Profit :
(a) Credit Sales 225.00 275.00 350.00
(b) Total Cost other than Bad Debts:

© The Institute of Chartered Accountants of India

 Variable Costs 135.00 165.00 210.00
(c) Bad Debts 7.50 22.50 47.50
(d) Expected Profit [(a)-(b)-(c)] 82.50 87.50 92.50
B Opportunity Cost of Investment in Receivables* 5.40 8.25 14.00
C Net Benefits [A-B] 77.10 79.25 78.50
Recommendation: The Proposed Policy I should be adopted since the net benefits under this policy is
higher than those under other policies.
Working Note:
*Calculation of Opportunity Cost of Average Investments
Collection Period Rate of Return
Opportunity Cost = Total Cost  
12 100
Present Policy = Rs.135 lakhs × 2.4/12 × 20% = Rs. 5.40 lakhs
Proposed Policy I = Rs. 165 lakhs × 3/12 × 20% = Rs. 8.25 lakhs
Proposed Policy II = Rs. 210 lakhs × 4/12 × 20% = Rs. 14.00 lakhs
4. (i) Computation of Earnings per Share (EPS)
Plans P (Rs.) Q (Rs.) R (Rs.)
Earnings before interest & tax (EBIT) 18,00,000 18,00,000 18,00,000
Less: Interest charges -- (2,00,000) --
Earnings before tax (EBT) 18,00,000 16,00,000 18,00,000
Less: Tax @ 50% (9,00,000) (8,00,000) (9,00,000)
Earnings after tax (EAT) 9,00,000 8,00,000 9,00,000
Less: Preference share dividend -- -- (2,00,000)
Earnings available for equity shareholders 9,00,000 8,00,000 7,00,000
No. of equity shares 2,00,000 1,00,000 1,00,000
E.P.S 4.5 8 7
(ii) Computation of Financial Break-even Points
Proposal ‘P’ =0
Proposal ‘Q’ = Rs. 2,00,000 (Interest charges)
Proposal ‘R’ = Earnings required for payment of preference share dividend i.e.
Rs. 2,00,000  0.5 (Tax Rate) = Rs. 4,00,000
(iii) Computation of Indifference Point between the Proposals
Combination of Proposals
(a) Indifference point where EBIT of proposal “P” and proposal ‘Q’ is equal
EBIT(1- 0.5) (EBIT -Rs.2,00,000)(1- 0.5)
=
2,00,000shares 1,00,000shares
0.5 EBIT = EBIT – Rs. 2,00,000
EBIT = Rs. 4,00,000

© The Institute of Chartered Accountants of India

 (b) Indifference point where EBIT of proposal ‘P’ and proposal ‘R’ is equal:
EBIT(1- 0.50) EBIT(1- 0.50) -Rs.2,00,000
=
2,00,000shares 1,00,000shares
0.5EBIT 0.5EBIT -Rs.2,00,000
=
2,00,000shares 1,00,000shares
0.25 EBIT = 0.5 EBIT – Rs. 2,00,000
Rs.2,00,000
EBIT = = Rs. 8,00,000
0.25
(c) Indifference point where EBIT of proposal ‘Q’ and proposal ‘R’ are equal
(EBIT -Rs.2,00,000)(1- 0.5) EBIT(1- 0.5) -Rs.2,00,000
=
1,00,000shares 1,00,000shares
0.5 EBIT – Rs.1,00,000 = 0.5 EBIT – Rs.2,00,000
There is no indifference point between proposal ‘Q’ and proposal ‘R’
Analysis: It can be seen that financial proposal ‘Q’ dominates proposal ‘R’, since the financial
break-even-point of the former is only Rs. 2,00,000 but in case of latter, it is Rs . 4,00,000.
5. (i) Calculation of Pay-back Period
Cash Outlay of the Project = Rs. 80,00,000
Total Cash Inflow for the first five years = Rs. 70,00,000
Balance of cash outlay left to be paid back in the 6 th year Rs. 10,00,000
Cash inflow for 6 th year = 16,00,000
So the payback period is between 5 th and 6th years, i.e.,
Rs.10,00,000
5 years + = 5.625 years or 5 years 7.5 months
Rs.6,00,000
(ii) Calculation of Net Present Value (NPV) @10% discount rate:
Year Net Cash Inflow Present Value at Present Value
(Rs.) Discount Rate of 10% (Rs.)
(a) (b) (c) = (a) × (b)
1 14,00,000 0.909 12,72,600
2 14,00,000 0.826 11,56,400
3 14,00,000 0.751 10,51,400
4 14,00,000 0.683 9,56,200
5 14,00,000 0.621 8,69,400
6 16,00,000 0.564 9,02,400
7 20,00,000 0.513 10,26,000
8 30,00,000 0.467 14,01,000
9 20,00,000 0.424 8,48,000
10 8,00,000 0.386 3,08,800
97,92,200
Net Present Value (NPV) = Cash Outflow – Present Value of Cash Inflows
7

© The Institute of Chartered Accountants of India

 = Rs. 80,00,000 – Rs. 97,92,200 = 17,92,200
(iii) Calculation of Profitability Index @ 10% discount rate:
Present Value of Cash inflows
Profitability Index =
Cost of the investment
Rs.97,92,200
= = 1.224
Rs.80,00,000
(iv) Calculation of Internal Rate of Return:
Net present value @ 10% interest rate factor has already been calculated in (ii) above, we will
calculate Net present value @15% rate factor.
Year Net Cash Inflow Present Value at Discount Present Value
(Rs.) Rate of 15% (Rs.)
(a) (b) (c) = (a)× (b)
1 14,00,000 0.870 12,18,000
2 14,00,000 0.756 10,58,400
3 14,00,000 0.658 9,21,200
4 14,00,000 0.572 8,00,800
5 14,00,000 0.497 6,95,800
6 16,00,000 0.432 6,91,200
7 20,00,000 0.376 7,52,000
8 30,00,000 0.327 9,81,000
9 20,00,000 0.284 5,68,000
10 8,00,000 0.247 1,97,600
78,84,000
Net Present Value at 15% = Rs. 78,84,000 – Rs. 80,00,000 = Rs. -1,16,000
As the net present value @ 15% discount rate is negative, hence internal rate of return falls in
between 10% and 15%. The correct internal rate of return can be calculated as follows:
NPVL
IRR = L H  L 
NPVL  NPVH
Rs.17,92,200
= 10% + 15% -10% 
Rs.17,92,200-(-Rs. 1,16,000)
Rs.17,92,200
= 10% + ×5% = 14.7%
Rs.19,08,200
6. (a) To achieve wealth maximization, a finance manager has to take careful decision in respect of:
(i) Investment decisions: These decisions relate to the selection of assets in which funds will
be invested by a firm. Funds procured from different sources have to be invested in various
kinds of assets. Long term funds are used in a project for various fixed assets and also for
current assets. The investment of funds in a project has to be made after careful assessment
of the various projects through capital budgeting. A part of long term funds is also to be kept
for financing the working capital requirements. Asset management policies are to be laid down
regarding various items of current assets. The inventory policy would be determined by the
8

© The Institute of Chartered Accountants of India

 production manager and the finance manager keeping in view the requirement of production
and the future price estimates of raw materials and the availability of funds.
(ii) Financing decisions: These decisions relate to acquiring the optimum finance to meet
financial objectives and seeing that fixed and working capital are effectively managed. The
financial manager needs to possess a good knowledge of the sources of available funds and
their respective costs and needs to ensure that the company has a sound capital structure,
i.e. a proper balance between equity capital and debt. Financing decisions also call for a
good knowledge of evaluation of risk, e.g. excessive debt carried high risk for an
organization’s equity because of the priority rights of the lenders.
(iii) Dividend decisions: These decisions relate to the determination as to how much and how
frequently cash can be paid out of the profits of an organisation as income for its
owners/shareholders. The dividend decision thus has two elements – the amount to be paid
out and the amount to be retained to support the growth of the organisation, the latter being
also a financing decision; the level and regular growth of dividends re present a significant
factor in determining a profit-making company’s market value, i.e. the value placed on its
shares by the stock market.
All three types of decisions are interrelated, the first two pertaining to any kind of organisation
while the third relates only to profit-making organisations, thus it can be seen that financial
management is of vital importance at every level of business activity, from a sole trader to the
largest multinational corporation.
(b) Disadvantages of Certainty Equivalent Method
1. There is no Statistical or Mathematical model available to estimate certainty Equivalent.
Assumption of risk being subjective, it varies on the perception of the risk by the management
because of bias and individual opinions involved.
2. There is no objective or mathematical method to estimate certainty equivalents. Certainty
Equivalent are subjective and vary as per each individual’s estimate.
3. Certainty equivalents are decided by the management based on their perception of risk.
However the risk perception of the shareholders who are the money lenders for the project is
ignored. Hence it is not used often in corporate decision making .
Risk-adjusted Discount Rate Vs. Certainty-Equivalent
Certainty Equivalent Method is superior to Risk Adjusted Discount Rate Method as it does not
assume that risk increases with time at constant rate. Each year's Certainty Equivalent Coefficient
is based on level of risk impacting its cash flow. Despite its soundness, it is not preferable like Risk
Adjusted Discount Rate Method. It is difficult to specify a series of Certainty Equivalent Coefficients
but simple to adjust discount rates.
(c) Various advantages of Stock Spills are as follows:
1. It makes the share affordable to small investors.
2. Number of shares may increase the number of shareholders; hence the potential of
investment may increase.

© The Institute of Chartered Accountants of India

 PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
SECTION B: ECONOMICS FOR FINANCE
ANSWERS
7. (a) The ratio of ∆Y to ∆I is called the investment multiplier, k.
Change inIncome ∆Y
k= Change in Investment ∆I
2400 𝟏 𝟏
Here = 4; 4 = 𝟏−𝑴𝑷𝑪 =
600 𝑴𝑷𝑺

4 – 4MPC = 1
4 MPC = 4-1 = 3
3
MPC= =0.75
4

MPS= 1-MPC = 0.25

(b) The exchange rate channel works through expenditure switching between dom estic and foreign
goods. A reduction in policy rate lowers interest rates and reduces the relative returns and investors
shift their funds into foreign assets and leads to depreciation in the exchange rate. Higher
competitiveness of domestic producers increase export volumes and higher prices of imports
discourage imports (or higher net exports) and increase demand for domestically produced goods
and services. Consequently, domestic output and employment increases. High policy rates
normally lead to an appreciation of the currency, as foreign investors seek higher returns and
increase their demand for the currency. Appreciation of the domestic currency make domestically
produced goods more expensive compared to foreign‐produced goods. This causes net exports to
fall; correspondingly domestic output and employment also fall.
(c) Perfect information which implies that both buyers and sellers have complete information about
anything that may influence their decision making is an important element of an effic ient
competitive market. Information failure occurs when lack of information can result in consumers
and producers making decisions that do not maximize welfare. Information failure is widespread
in numerous market exchanges due to complex nature of goods and services that are transacted,
inaccurate and incomplete data, and non-availability of correct information.
(d) Devaluation is a deliberate downward adjustment in the value of a country's currency relative to
another currency, group of currencies or standard.
8. (a) (i) Cash Reserve Ratio (CRR) refers to the fraction of the total net demand and time liabilities
(NDTL ie aggregate savings account, current account and fixed deposit balances ) of a
scheduled commercial bank in India which it should maintain as cash deposit with the Reserve
Bank. This requirement applies uniformly to all scheduled banks in the country irrespective of
its size or financial position. Non-Bank Financial Corporations (NBFCs) are outside the
purview of this reserve requirement.
Higher the CRR with the RBI, lower will be the liquidity in the system and availability of
lendable surpluses with the commercial banks and vice versa. During deflation, the RBI
reduces the CRR in order to enable the banks to expand credit and increa se the supply of
money available in the economy. In order to contain credit expansion during periods of
inflation, the RBI increases the CRR.
(ii) For economic efficiency to be achieved, the market price should reflect social costs and not
just the private costs. Social costs are private costs borne by individuals directly involved in
a transaction together with the external costs borne by third parties not directly involved in

10

© The Institute of Chartered Accountants of India

 the transaction. Social costs represent the true burdens carried by society in monetary and
non-monetary terms.
(b) (i) Leakages: A leakage is an outflow or withdrawal of income from the circular flow. Leakages
are money leaving the circular flow and therefore, not available for spending on currently
produced goods and services. Leakages reduce the flow of income.
Injections: An injection is a non-consumption expenditure. It is an expenditure on goods and
services produced within the domestic territory but not used by the domestic household for
consumption purposes. Injections are exogenous additions to the circular flow and add to the
total volume of the basic circular flow. In the two-sector model with households and firms,
household saving is the only leakage and investment is the only injection. In the three -sector
model which includes the government, saving and taxes are the two leakages and investment
and government purchases are the two injections. In the four-sector model which includes
foreign sector also, saving, taxes, and imports are the three leakages; investment,
government purchases, and exports are the three injections.
The state of equilibrium occurs when the total leakages are equal to the total injections that
occur in the economy. Savings + Taxes + Imports = Investment + Government Spending +
Exports
(ii) Moral hazard is associated with information failure and refers to a situation that increases the
probability of occurrence of a loss or a larger than normal loss, because of a change in the
unobservable or hard to observe behaviour of one of the parties in the transaction after the
transaction has been made. Moral hazard is opportunism characterized by an informed
person’s taking advantage of a less-informed person through an unobserved action. It arises
from lack of information about someone’s future behavior. Moral hazard occurs due to
asymmetric information i.e., an individual knows more about his or her own actions than other
people do. This leads to a distortion of incentives to take care or to exert effort when someone
else bears the costs of the lack of care or effort. For example, in the insurance market, the
expected loss from an adverse event increases as insurance coverage increases.
9. (a) (i) A unit of account is a common unit for measuring how much something is worth. The monetary
unit (for e.g. Rupee, Dollar) serves as a numeraire or common measure value in terms of
which the value of all goods, services, assets, liabilities, income, expen diture etc are
measured and expressed. This helps in measuring and fixing the exchange values in terms
of a common unit and avoids the problem of recording and expressing the value of each
commodity in terms of quantities of other goods. Use of money as a unit of account thus
• reduces the number of exchange ratios between goods and services
• makes it possible to keep business accounts
• allows meaningful interpretation of prices, costs, and profits, and
• facilitates a system of trade through orderly pricing, comparison of value and rational
economic choices.
(ii) The allocation responsibility of the governments involves suitable corrective action when
private markets fail to provide the right and desirable combination of goods and services to
ensure social welfare. In the absence of appropriate government intervention, market failures
may occur and the resources are likely to be misallocated by too much production of certain
goods or too little production of certain other goods. Thus, market failures provide the
rationale for government’s allocative function.
(b) Given C = 200+0.6Yd
I = Rs. 600 Crores

11

© The Institute of Chartered Accountants of India

 G = Rs.900 crores
T = Rs. 100 Crores
Exports, X = 200 Crores
Import function = M = 50+0.3Y
(i) Equilibrium level of GDP
Y = C + I + G+ (X-M)
= 200 + 0.6Yd+600+900+[200-(50+0.3Y)]
Y = 200 + 0.6Y- 60 + 1500 +150 - 0.3Y [Yd = Y – 100]
Y = 1790 + 0.3Y
Y-0.3Y = 1790
Y = 2557.14
(ii) Disposable Income
Yd = Y-T = 2557.14 - 100 = 2457.14
(iii) Net Exports at GDP level
X-M = 200-(50+0.3 Y)
= 200-(50+0.3(2557.14)]
= 150-767.14
=- 617.14 crore
10. (a) (i) The Marginal Standing Facility (MSF) is the last resort for banks to obtain funds once they
exhaust all borrowing options including the liquidity adjustment facility on which the rates are
lower compared to the MSF. Under this facility, the scheduled commercial banks can borrow
additional amount of overnight money from the central bank over and above what is available
to them through the LAF window by dipping into their Statutory Liquidity Ratio (SLR) portfolio
up to a limit (a fixed per cent of their net demand and time liabilities deposits (NDTL) liable to
change) at a penal rate of interest. The scheme has been introduced by RBI with the main
aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable
smooth monetary transmission in the financial system. This provides a safety valve against
unexpected liquidity shocks to the banking system.
(ii) NDPFC = Compensation of Employees + Operating Surplus + Mixed Income
= (viii) + (ix) + (iv) + (v) + (vi) + (vii) = 489 + 50+ 311 + 892 + 81 + 6 = 1829 Crores
GDPMP = NDPFC + Depreciation + Net Indirect Tax
= NDPFC + (ii) + (i) = 1829 + 42 + 208 = 2079 Crores
NNP FC= NDPFC + Net Factor Income from Abroad
= NDPFC + (iii) = 2079+ (-40) = 2039 Crores
(b) (i) The main forms of direct investments are: the opening of overseas companies, including the
establishment of subsidiaries or branches, creation of joint ventures on a contract basis, joint
development of natural resources and purchase or annexation of companies in the countr y
receiving foreign capital.

12

© The Institute of Chartered Accountants of India

 (ii) Voluntary Export Restraints (VERs) refer to a type of informal quota administered by an
exporting country voluntarily restraining the quantity of goods that can be exported out of a
country during a specified period of time.
11. (a) (i) Free trade policy is based on the principle of non-interference by government in foreign trade.
The distinction between domestic trade and international trade disappears and goods and
services are freely imported from and exported to the rest of the world. Buyers and sellers
from separate economies voluntarily trade without the domestic government helping or
hindering movements of goods and services between countries by applying tariffs, quotas,
subsidies or prohibitions on their goods and services. The theoretical case for free trade is
based on Adam Smith’s argument that the division of labour among countries leads to
specialization, greater efficiency, and higher aggregate production.
(ii) A safeguard measures is an action taken to protect a specific domestic industry from an
unexpected build-up of imports. Safeguard measures are initiated by countries to restrict
imports of a product temporarily if its domestic industry is injured or threatened with serious
injury caused by a surge in imports.
(b) (i) Adverse selection is a situation in which asymmetric information about quality eliminates high-
quality goods from a market. It a form of market failure which occurs when buyers have better
information than sellers due to hidden information, and this can distort the usual market
process. For example, in the insurance market adverse selection is the tendency for people
with higher risk to obtain insurance coverage to a greater extent than persons with lesser risk
because compared to insurance buyers, insurers know less about the health conditions of
buyers and are therefore unable to differentiate between high-risk and low-risk persons. If the
insurance company charges an average price, and only high-risk consumers buy insurance it
will make losses. It is therefore possible that there will be higher overall premium as firms
insure themselves against high-risk customers buying insurance. Then the low-risk customers
may not want to buy insurance because it is quite expensive. Economic agents end up either
selecting a sub-standard product or leaving the market altogether leading to a condition of
‘missing market’. If the sellers wish to do business profitably, they may have to incur
considerable costs in terms of time and money for identifying the extent of risk for different
buyers.
(b) (ii) There are two types of transactions in a forex market; current transactions which are carried
out in the spot market and contracts to buy or sell currencies for future delivery which are
carried out in forward and futures markets.
Or
The Liquidity Adjustment Facility(LAF) is a facility extended by the Reserve Bank of India to
the scheduled commercial banks (excluding RRBs) and primary dealers to avail of liquidity in
case of requirement (or park excess funds with the RBI in case of excess liquidity) on an
overnight basis against the collateral of government securities including state government
securities.

13

© The Institute of Chartered Accountants of India

 Test Series: March, 2019
MOCK TEST PAPER – 1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
Time Allowed – 3 Hours Maximum Marks – 100
PAPER 8A : FINANCIAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Maximum Marks – 60
1. Answer the following:
(a) With the help of following figures CALCULATE the market price of a share of a company by using:
(i) Walter’s formula
(ii) Dividend growth model (Gordon’s formula)
Earnings per share (EPS) Rs. 10
Dividend per share (DPS) Rs. 6
Cost of capital (k) 20%
Internal rate of return on investment 25%
Retention Ratio 60%
(b) From the following details of X Ltd., PREPARE the Income Statement for the year ended 31 st
March, 20X8:
Financial Leverage 2
Interest Rs. 5,000
Operating Leverage 3
Variable cost as a percentage of sales 75%
Income tax rate 30%
(c) Using the following information, PREPARE and complete the Balance Sheet given below:
(i) Total debt to net worth : 1:2
(ii) Total assets turnover : 2
(iii) Gross profit on sales : 30%
(iv) Average collection period : 40 days
(Assume 360 days in a year)
(v) Inventory turnover ratio based on cost of goods sold and year-end inventory : 3
(vi) Acid test ratio : 0.75

© The Institute of Chartered Accountants of India

 Balance Sheet
as on March 31, 20X8
Liabilities Rs. Assets Rs.
Equity Shares Capital 4,00,000 Plant and Machinery 
Reserves and Surplus 6,00,000 and other Fixed Assets
Total Debt: Current Assets:
Current Liabilities  Inventory 
Debtors 
- Cash 

(d) Determine the risk adjusted net present value of the following projects:
X Y Z
Net cash outlays (Rs.) 2,10,000 1,20,000 1,00,000
Project life 5 years 5 years 5 years
Annual Cash inflow (Rs.) 70,000 42,000 30,000
Coefficient of variation 1.2 0.8 0.4
The Company selects the risk-adjusted rate of discount on the basis of the coefficient of variation:
Coefficient of Variation Risk-Adjusted Rate of Return P.V. Factor 1 to 5 years At risk
adjusted rate of discount
0.0 10% 3.791
0.4 12% 3.605
0.8 14% 3.433
1.2 16% 3.274
1.6 18% 3.127
2.0 22% 2.864
More than 2.0 25% 2.689
[4 × 5 = 20 Marks]
2. (a) LIST the factors determining the dividend policy of a company. [3 Marks]
(b) A bank is analysing the receivables of J Ltd. in order to identify acceptable collateral for a short-
term loan. The company’s credit policy is 2/10 net 30. The bank lends 80 percent on accounts
where customers are not currently overdue and where the average payment period does not
exceed 10 days past the net period. A schedule of J Ltd.’s receivables has been prepared.
ANALYSE, how much will the bank lend on pledge of receivables, if the bank uses a 10 per cent
allowance for cash discount and returns?
Account Amount Days Outstanding in days Average Payment Period historically
Rs.
74 25,000 15 20
91 9,000 45 60
107 11,500 22 24
108 2,300 9 10
2

© The Institute of Chartered Accountants of India

 114 18,000 50 45
116 29,000 16 10
123 14,000 27 48
1,08,800
[7 Marks]
3. X Ltd. is considering to select a machine out of two mutually exclusive machines. The company’s cost
of capital is 15 per cent and corporate tax rate is 30 per cent. Other information relating to both machines
is as follows:
Machine – I Machine – II
Cost of Machine Rs. 30,00,000 Rs. 40,00,000
Expected Life 10 years. 10 years.
Annual Income
(Before Tax and Depreciation) Rs. 12,50,000 Rs. 17,50,000
Depreciation is to be charged on straight line basis:
You are required to CALCULATE:
(i) Discounted Pay Back Period
(ii) Net Present Value
(iii) Profitability Index
The present value factors of Re.1 @ 15% are as follows:
Year 01 02 03 04 05
PV factor @ 15% 0.870 0.756 0.658 0.572 0.497.
[10 Marks]
4. A Company earns a profit of Rs.6,00,000 per annum after meeting its interest liability of Rs.1,20,000 on
12% debentures. The Tax rate is 50%. The number of Equity Shares of Rs.10 each are 80,000 and the
retained earnings amount to Rs.18,00,000. The company proposes to take up an expansion scheme for
which a sum of Rs.8,00,000 is required. It is anticipated that after expansion, the company will be able
to achieve the same return on investment as at present. The funds required for expansion can be raised
either through debt at the rate of 12% or by issuing equity shares at par.
Required:
(i) COMPUTE the Earnings per Share (EPS), if:
➢ The additional funds were raised as debt
➢ The additional funds were raised by issue of equity shares.
(ii) ADVISE the company as to which source of finance is preferable . [10 Marks]
5. A company needs Rs.31,25,000 for the construction of a new plant. The following three plans are
feasible:
I The company may issue 3,12,500 equity shares at Rs. 10 per share.
II The company may issue 1,56,250 equity shares at Rs. 10 per share and 15,625 debentures of
Rs. 100 denomination bearing a 8% rate of interest.
III The company may issue 1,56,250 equity shares at Rs. 10 per share and 15,625 cumulative
preference shares at Rs. 100 per share bearing a 8% rate of dividend.

© The Institute of Chartered Accountants of India

 (i) if the company's earnings before interest and taxes are Rs. 62,500, Rs. 1,25,000,
Rs. 2,50,000, Rs. 3,75,000 and Rs. 6,25,000, DETERMINE earnings per share under each of
three financial plans? Assume a corporate income tax rate of 40%.
(ii) IDENTIFY which alternative would you recommend and why?
(iii) DETERMINE the EBIT -EPS indifference points by formulae between Financing Plan I and
Plan II and Plan I and Plan III. [10 Marks]
6. (a) EXPLAIN the difference between Business risk and Financial risk
(b) EXPLAIN as to how the wealth maximisation objective is superior to the profit maximisation
objective What is the cost of these sources?
(c) DISCUSS the dividend-price approach to estimate cost of equity capital [4 + 4+ 2 =10 Marks]

© The Institute of Chartered Accountants of India

 PAPER – 8 SECTION B : ECONOMICS FOR FINANCE
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question 7 is compulsory question.
Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above the
required number, then only the requisite number of questions first answered will be the evaluated the rest
answer shall be ignored
Working Notes should form part of the answer.
Maximum Marks - 40
7. (a) What do you understand by the term ‘final good”? (2 Marks)
(b) How would each of the following affect money multiplier and money supply?
(i) Fearing shortage of money in ATMs, people decides to hoard money.
(ii) Banks open large number of ATMs all over country.
(iii) During the festival season, people decide to use ATM s very often. (3 Marks)
(c) The table below shows the number of labour hours required to produce wheat and cloth in two
countries X and Y.
Commodity Country X Country Y
1 unit of cloth 4 1.0
1 unit of wheat 2 2.5
(i) Compare the productivity of labour in both countries in respect of both commodities
(ii) Which country has absolute advantage in the production of wheat?
(iii) Which country has absolute advantage in the production of cloth? (3 Marks)
(d) What is meant by Crowding out? (2 Marks)
8. (a) The equilibrium level of income of an economy is Rs. 2,000 crores. The autonomous consumption
expenditure is equal to Rs.100 crores and investment expenditure is Rs.500 crores. Calculate .
(i) Consumption expenditure level of National Income.
(ii) Marginal propensity to save and Marginal propensity to consume
(iii) Break-even level of Income. (5 Marks)
(b) (i) Describe rationale for the stabilisation function of government policy. (3 Marks)
(ii) Explain the concept of Demand for Money (2 Marks)
9. (a) (i) What is the crux of Heckscher-Ohlin theory of International Trade (3 Marks)
(ii) Define common resources? Why are they over used? (2 Marks)

(b) (i) Define Foreign Direct Investment (FDI). Mention two arguments made in favor of FDI to
developing economies like India? (3 Marks)
(ii) What is the nature of relationship between investment and income according to Keynes?
(2 Marks)

© The Institute of Chartered Accountants of India

10. (a) (i) Explain the term Contractionary Fiscal Policy. What are the measures under taken in a
contractionary fiscal policy? (3 Marks)
(ii) Explain the functioning of SLR? (2 Marks)
(b) (i) Explain why government imposes price ceilings (3 Marks)
(ii) What is Arbitrage? What is the outcome of Arbitrage (2 Marks)?
11. (a) (i) Outline different components of monetary policy framework for India? (3 Marks)
(ii) Write a note on two major components of Reserve Money (2 Marks)
(b) (i) Define aggregate demand. How do you derive the Keynesian aggregate demand schedule?
(3 Marks)
(ii) What is mean by Anti-dumping duties? (2 Marks)
OR
Explain the term on market failure (2 Marks)

© The Institute of Chartered Accountants of India

 Test Series: March, 2019
MOCK TEST PAPER – 1
INTERMEDIATE (IPC): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints

1. (a) Market price per share by

r
D+ (E - D)
(i) Walter’s formula: P = Ke
Ke

0.25
6+ (10 - 6)
P = 0.20
0.20
P = Rs.55
(ii) Gordon’s formula (Dividend Growth model): When the growth is incorporated in earnings
and dividend, the present value of market price per share (P o) is determined as follows:
Gordon’s theory:
E1(1  b)
P0 
Ke  br
Where,
P0 = Price per share
E1 = Earnings per share
b = Retention ratio; (1 - b = Payout ratio)
Ke = Cost of capital
r = IRR
br = Growth rate (g)
10 (1- 0.60) 4
Po = = Rs. = Rs.80
0.20 - (0.60  0.25) 0.05
(b) Workings:
EBIT EBIT
(i) Financial Leverage = Or, 2=
EBIT  Interest EBIT  Rs.5,000
Or, EBIT = Rs.10,000
Contribution
(ii) Operating Leverage =
EBIT
Contribution
Or, 3 =
Rs.10,000
Or, Contribution = Rs.30,000

© The Institute of Chartered Accountants of India

 Contribution Rs.30,000
(iii) Sales = = = Rs.1,20,000
P / VRatio 25%
(iv) Fixed Cost = Contribution – Fixed cost = EBIT
= Rs.30,000 – Fixed cost = Rs.10,000
Or, Fixed cost = Rs. 20,000
Income Statement for the year ended 31 st March, 20X8
Particulars Amount (Rs.)
Sales 1,20,000
Less: Variable Cost (75% of Rs.1,20,000) (90,000)
Contribution 30,000
Less: Fixed Cost (Contribution - EBIT) (20,000)
Earnings Before Interest and Tax (EBIT) 10,000
Less: Interest (5,000)
Earnings Before Tax (EBT) 5,000
Less: Income Tax @ 30% (1,500)
Earnings After Tax (EAT or PAT) 3,500

(c) Net worth = Capital + Reserves and surplus

= 4,00,000 + 6,00,000 = Rs.10,00,000
Total Debt 1

Networth 2
 Total debt = Rs. 5,00,000
Total Liability side = Rs. 4,00,000 + Rs. 6,00,000 + Rs. 5,00,000
= Rs. 15,00,000
= Total Assets
Sales
Total Assets Turnover =
Total assets
Sales
2=
Rs.15,00,000

 Sales = Rs. 30,00,000

Gross Profit on Sales : 30% i.e. Rs. 9,00,000
 Cost of Goods Sold (COGS) = Rs. 30,00,000 – Rs. 9,00,000
= Rs. 21,00,000
COGS
Inventory turnover =
Inventory

Rs. 21,00,000
3 =
Inventory

 Inventory = Rs. 7,00,000

2

© The Institute of Chartered Accountants of India

 Average debtors
Average collection period =
Sales / day
Debtors
40 =
Rs.30,00,000 / 360

 Debtors = Rs.3,33,333.
Current Assets - Stock (Quick Asset)
Acid test ratio =
Current liabilities
Current Assets - Rs.7,00,000
0.75 =
Rs.5,00,000

 Current Assets = Rs.10,75,000.

 Fixed Assets = Total Assets – Current Assets
= Rs.15,00,000 – Rs.10,75,000 = Rs.4,25,000
Cash and Bank balance = Current Assets – Inventory – Debtors
= Rs.10,75,000 – Rs.7,00,000 – Rs.3,33,333 = Rs.41,667
Balance Sheet as on March 31, 20X8
Liabilities Rs. Assets Rs.
Equity Share Capital 4,00,000 Plant and Machinery and other
Reserves & Surplus 6,00,000 Fixed Assets 4,25,000
Total Debt: Current Assets:
Current liabilities 5,00,000 Inventory 7,00,000
Debtors 3,33,333
Cash 41,667
15,00,000 15,00,000
(d) Statement showing the determination of the risk adjusted net present value
Projects Net Coefficient Risk Annual PV factor Discounted Net present
cash of adjusted cash 1-5 years cash inflow value
outlays variation discount inflow
rate
(Rs.) (Rs.) (Rs.) (Rs.)
(i) (ii) (iii) (iv) (v) (vi) (vii) = (v)  (viii) = (vii)
(vi)  (ii)
X 2,10,000 1.20 16% 70,000 3.274 2,29,180 19,180
Y 1,20,000 0.80 14% 42,000 3.433 1,44,186 24,186
Z 1,00,000 0.40 12% 30,000 3.605 1,08,150 8,150
2. (a) Factors Determining the Dividend Policy of a Company
(i) Liquidity: In order to pay dividends, a company will require access to cash. Even very
profitable companies might sometimes have difficulty in paying dividends if resources are tied
up in other forms of assets.
(ii) Repayment of debt: Dividend payout may be made difficult if debt is scheduled for repayment.
3

© The Institute of Chartered Accountants of India

 (iii) Stability of Profits: Other things being equal, a company with stable profits is more likely to
pay out a higher percentage of earnings than a company with fluctuating profits.
(iv) Control: The use of retained earnings to finance new projects preserves the company’s
ownership and control. This can be advantageous in firms where the present disposition of
shareholding is of importance.
(v) Legal consideration: The legal provisions lay down boundaries within which a company can
declare dividends.
(vi) Likely effect of the declaration and quantum of dividend on market prices.
(vii) Tax considerations and
(viii) Others such as dividend policies adopted by units similarly placed in the industry,
management attitude on dilution of existing control over the shares, fear of being branded as
incompetent or inefficient, conservative policy Vs non-aggressive one.
(ix) Inflation: Inflation must be taken into account when a firm establishes its dividend policy.
(b) Analysis of the receivables of J Ltd. by the bank in order to identify acceptable collateral for a short-
term loan:
(i) The J Ltd.’s credit policy is 2/10 net 30.
The bank lends 80 per cent on accounts where customers are not currently overdue and
where the average payment period does not exceed 10 days past the net period i.e. thirty
days. From the schedule of receivables of J Ltd. Account No. 91 and Account No. 114 are
currently overdue and for Account No. 123 the average payment period exceeds 40 days.
Hence Account Nos. 91, 114 and 123 are eliminated. Therefore, the selected Accounts are
Account Nos. 74, 107, 108 and 116.
(ii) Statement showing the calculation of the amount which the bank will lend on a pledge of
receivables if the bank uses a 10 per cent allowances for cash discount and returns
Account No. Amount 90 per cent of amount 80% of amount
(Rs.) (Rs.) (Rs.)
(a) (b) = 90% of (a) (c) = 80% of (b)
74 25,000 22,500 18,000
107 11,500 10,350 8280
108 2,300 2,070 1,656
116 29,000 26,100 20,880
Total loan amount 48,816
3. Working Notes:
30,00,000
Depreciation on Machine – I = = Rs. 3,00,000
10
40,00,000
Depreciation on Machine – II = = Rs. 4,00,000
10
Particulars Machine-I (Rs.) Machine – II (Rs.)
Annual Income (before Tax and Depreciation) 12,50,000 17,50,000
Less: Depreciation 3,00,000 4,00,000
Annual Income (before Tax) 9,50,000 13,50,000
Less: Tax @ 30% (2,85,000) (4,05,000)

© The Institute of Chartered Accountants of India

 Annual Income (after Tax) 6,65,000 9,45,000
Add: Depreciation 3,00,000 4,00,000
Annual Cash Inflows 9,65,000 13,45,000

Machine – I Machine - II
Year PV of Re Cash PV Cumulative Cash flow PV Cumulative PV
1 @ 15% flow PV

1 0.870 9,65,000 8,39,550 8,39,550 13,45,000 11,70,150 11,70,150

2 0.756 9,65,000 7,29,540 15,69,090 13,45,000 10,16,820 21,86,970
3 0.658 9,65,000 6,34,970 22,04,060 13,45,000 8,85,010 30,71,980
4 0.572 9,65,000 5,51,980 27,56,040 13,45,000 7,69,340 38,41,320
5 0.497 9,65,000 4,79,605 32,35,645 13,45,000 6,68,465 45,09,785

(i) Discounted Payback Period

Machine – I
(30,00,000  27,56,040)
Discounted Payback Period = 4 +
4,79,605
2,43,960
=4+ = 4 + 0.5087 = 4.5087 years or 4 years 6.10 months
4,79,605

Machine – II
(40,00,000  38,41,320)
Discounted Payback Period = 4+
6,68,465
1,58,680
=4+ = 4 + 0.2374 = 4.2374 years or 4 years 2.85 months
6,68,465

(ii) Net Present Value (NPV)

Machine – I
NPV = 32,35,645 – 30,00,000 = Rs. 2,35,645
Machine – II
NPV = 45,09,785 – 40,00,000 = Rs. 5,09,785
(iii) Profitability Index
Machine – I
32,35,645
Profitability Index = = 1.08
30,00,000

Machine – II
45,09,785
Profitability Index = = 1.13
40,00,000

© The Institute of Chartered Accountants of India

 Conclusion:
Method Machine - I Machine - II Rank
Discounted Payback Period 4.51 years 4.24 years II
Net Present Value Rs. .2,35,645 Rs. 5,09,785 II
Profitability Index 1.08 1.13 II
4. Working Notes:
1. Capital employed before expansion plan:
(Rs.)
Equity shares (Rs.10 × 80,000 shares) 8,00,000
Debentures {(Rs.1,20,000/12)  100} 10,00,000
Retained earnings 18,00,000
Total capital employed 36,00,000
2. Earnings before the payment of interest and tax (EBIT):
(Rs.)
Profit (EBT) 6,00,000
Add: Interest 1,20,000
EBIT 7,20,000
3. Return on Capital Employed (ROCE):
EBIT Rs.7,20,000
ROCE = ×100 = ×100 = 20%
Capital employed Rs.36,00,000

4. Earnings before interest and tax (EBIT) after expansion scheme:

After expansion, capital employed = Rs.36,00,000 + Rs.8,00,000
= Rs.44,00,000
Desired EBIT = 20%  Rs.44,00,000 = Rs.8,80,000
(i) Computation of Earnings Per Share (EPS) under the following options:
Present situation Expansion scheme
Additional funds raised as
Debt Equity
(Rs.) (Rs.) (Rs.)
Earnings before Interest and 7,20,000 8,80,000 8,80,000
Tax (EBIT)
Less: Interest - Old capital 1,20,000 1,20,000 1,20,000
- New capital -- 96,000 --
(Rs.8,00,000  12%)
Earnings before Tax (EBT) 6,00,000 6,64,000 7,60,000
Less: Tax (50% of EBT) 3,00,000 3,32,000 3,80,000
PAT 3,00,000 3,32,000 3,80,000
No. of shares outstanding 80,000 80,000 1,60,000

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 Earnings per Share (EPS) 3.75 4.15 2.38
 Rs.3,00,000   Rs.3,32,000   Rs.3,80,000 
 80,000   80,000   1,60,000 
     
(ii) Advise to the Company: When the expansion scheme is financed by additional debt, the
EPS is higher. Hence, the company should finance the expansion scheme by raising debt.
5. (i) Computation of EPS under three-financial plans.
Plan I: Equity Financing
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Interest 0 0 0 0 0
EBT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Tax @ 40% 25,000 50,000 1,00,000 1,50,000 2,50,000
PAT 37,500 75,000 1,50,000 2,25,000 3,75,000
No. of equity shares 3,12,500 3,12,500 3,12,500 3,12,500 3,12,500
EPS 0.12 0.24 0.48 0.72 1.20
Plan II: Debt – Equity Mix
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Interest 1,25,000 1,25,000 1,25,000 1,25,000 1,25,000
EBT (62,500) 0 1,25,000 2,50,000 5,00,000
Less: Tax @ 40% 25,000* 0 50,000 1,00,000 2,00,000
PAT (37,500) 0 75,000 1,50,000 3,00,000
No. of equity shares 1,56,250 1,56,250 1,56,250 1,56,250 1,56,250
EPS (Rs. 0.24) 0 0.48 0.96 1.92
* The Company can set off losses against the overall business profit or may carry forward it to next financia l
years.

Plan III: Preference Shares – Equity Mix

(Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Interest 0 0 0 0 0
EBT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Tax @ 40% 25,000 50,000 1,00,000 1,50,000 2,50,000
PAT 37,500 75,000 1,50,000 2,25,000 3,75,000
Less: Pref. dividend 1,25,000* 1,25,000* 1,25,000 1,25,000 1,25,000
PAT after Pref. dividend. (87,500) (50,000) 25,000 1,00,000 2,50,000
No. of Equity shares 1,56,250 1,56,250 1,56,250 1,56,250 1,56,250
EPS (0.56) (0.32) 0.16 0.64 1.60
* In case of cumulative preference shares, the company has to pay cumulativ e dividend to preference
shareholders, when company earns sufficient profits.
(ii) From the above EPS computations tables under the three financial plans we can see that when
EBIT is Rs. 2,50,000 or more, Plan II: Debt-Equity mix is preferable over the Plan I and Plan III, as
rate of EPS is more under this plan. On the other hand an EBIT of less than Rs.2,50,000, Plan I:

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 Equity Financing has higher EPS than Plan II and Plan III. Plan III Preference share-Equity mix is
not acceptable at any level of EBIT, as EPS under this plan is lower.
The choice of the financing plan will depend on the performance of the company and other macro-
economic conditions. If the company is expected to have higher operating profit Plan II: Debt –
Equity Mix is preferable. Moreover, debt financing gives more benefit due to availability of tax
shield.
(iii) EBIT – EPS Indifference point : Plan I and Plan II
EBIT1 ×(1- t) (EBIT2 - Interest) ×(1- t)
=
No.of equity shares(N1) No.of equity shares(N2 )
EBIT(1- 0.40) (EBIT -Rs.1,25,000)×(1- 0.40)
=
3,12,500shares 1,56,250shares
0.6 EBIT = 1.2 EBIT – Rs.1,50,000
Rs.1,50,000
EBIT = = Rs. 2,50,000
0.6
Indifference points between Plan I and Plan II is Rs. 2,50,000
EBIT – EPS Indifference Point: Plan I and Plan III
EBIT1 ×(1- t) EBIT3 ×(1- t)  Pr ef.dividend
=
No.of equity shares(N1 ) No.of equity shares(N3 )
EBIT1(1- 0.40) EBIT3(1- 0.40) -Rs.1,25,000
=
3,12,500shares 1,56,250shares
0.6 EBIT = 1.2 EBIT – Rs. 2,50,000
Rs.2,50,000
EBIT = = Rs. 4,16,667
0.6
Indifference points between Plan I and Plan III is Rs. 4,16,667.
6. (a) Business Risk and Financial Risk
Business risk refers to the risk associated with the firm’s operations. It is an unavoidable risk
because of the environment in which the firm has to operate and the business risk is represented
by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by
revenues and expenses. Revenues and expenses are affected by demand of firm’s products,
variations in prices and proportion of fixed cost in total cost.
Whereas, Financial risk refers to the additional risk placed on firm’s shareholders as a result of
debt use in financing. Companies that issue more debt instruments would have high er financial
risk than companies financed mostly by equity. Financial risk can be measured by ratios such as
firm’s financial leverage multiplier, total debt to assets ratio etc.
(b) A firm’s financial management may often have the following as their objectives:
(i) The maximisation of firm’s profit.
(ii) The maximisation of firm’s value / wealth.
The maximisation of profit is often considered as an implied objective of a firm. To achieve the
aforesaid objective various type of financing decisions may be taken. Options resulting into
maximisation of profit may be selected by the firm’s decision makers. They even sometime may
adopt policies yielding exorbitant profits in short run which may prove to be unhealthy for the

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 growth, survival and overall interests of the firm. The profit of the firm in this case is measured in
terms of its total accounting profit available to its shareholders.
The value/wealth of a firm is defined as the market price of the firm’s stock. The market price of a
firm’s stock represents the focal judgment of all market participants as to what the value of the
particular firm is. It takes into account present and prospective future earnings per share, the timing
and risk of these earnings, the dividend policy of the firm and many other factors that bear upon
the market price of the stock.
The value maximisation objective of a firm is superior to its profit maximisation objective due to
following reasons.
1. The value maximisation objective of a firm considers all future cash flows, dividends, earning
per share, risk of a decision etc. whereas profit maximisation objective does not consider the
effect of EPS, dividend paid or any other returns to shareholders or the wealth of the
shareholder.
2. A firm that wishes to maximise the shareholders wealth may pay regular dividends whereas
a firm with the objective of profit maximisation may refrain from dividend payment to its
shareholders.
3. Shareholders would prefer an increase in the firm’s wealth against its generation of increasing
flow of profits.
4. The market price of a share reflects the shareholders expected return, considering the long-
term prospects of the firm, reflects the differences in timings of the returns, considers risk and
recognizes the importance of distribution of returns.
The maximisation of a firm’s value as reflected in the market price of a share is viewed as a proper
goal of a firm. The profit maximisation can be considered as a part of the wealth maximisation
strategy.
(c) In dividend price approach, cost of equity capital is computed by dividing the expected dividend by
market price per share. This ratio expresses the cost of equity capital in relation to what yield the
company should pay to attract investors. It is computed as:
D1
Ke 
P0
Where,
D1 = Dividend per share in period 1
P0 = Market price per share today.

© The Institute of Chartered Accountants of India

 PAPER – 8B: ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/HINTS
7. (a) Final good is a good sold to final purchasers and is consumed by the end user in its present state.
It does not require any further processing and therefore will not undergo any further transformation
at the hands of producer. Once a final good has been sold, it passes out of the active economic
flow. The value of the final goods already includes the value of the intermediate goods that have
entered into their production as inputs.
(b) (i) When people hold more money, it increases the currency-deposit ratio; reduces money
multiplier; money supply declines.
(ii) ATMs let people to withdraw cash from the bank as and when needed, reduces cost of
conversion of deposits to cash and makes deposits relatively more convenient. People hold
less cash and more deposits, thus reducing the currency-deposit ratio; increasing the money
multiplier causing the money supply to increase.
(iii) If people, for any reason, are expected to withdraw money from ATMs with more frequency,
then banks will want to keep more reserves. This will raise the reserve ratio, and lower the
money multiplier. As a result, money supply will decline.
(c) (i) Productivity of labour (output per labour hour = the volume of output produced per unit of
labour input)
= output / input of labour hours
Output of commodity Units in Country X Units in Country Y
Cloth 0.25 1.0
Wheat 0.50 0.4
(ii) A country has an absolute advantage in producing a good over another country if it requires
fewer resources to produce that good. Since one hour of labour time produces 0.5 units of
wheat in country X against 0.4 units in country Y. Therefore, Country X has absolute
advantage in production of wheat.
(iii) Since one hour of labour time produces 1.0 units of rice in country Y against 0.25 units in
country X. Therefore, Country Y has absolute advantage in production of cloth.
(d) A decline in private spending may be partially or completely offset the expansion of demand
resulting from an increase in government expenditure. Crowding out effect is the negative effect
fiscal policy may generate when money from the private sector is ‘crowded out’ to the public sector.
Private investments, especially the ones which are interest –sensitive, will be reduced if interest
rates rise due to increased spending by government.
8. (a) (i) Consumption expenditure at equilibrium level of National Income
Y = C + I [ AD = C + I]
Putting the value of Investment Expenditure (I) = Rs.500 Crores and Income (Y) = Rs. 2000
crores, we get C = 2,000 – 500
C= Rs.1500 Crores
(ii) Marginal Propensity to Save (MPS)
Consumption function is given by
C = a + bY
1500 = 100 + 2000 b
2000 b = 1400
10

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 MPC = 0.7
MPS = 1-MPC = 1-0.7 = 0.3
(iii) Break-even level of Income attained at break-even point = C = Y
Putting Y = C
Y = 100 + 0.7 Y
0.3Y = 100
Y = 333.33
(b) (i) Stabilization function is one of the key functions of fiscal policy and aims at eliminating
macroeconomic fluctuations arising from suboptimal allocation. The stabilization function is
concerned with the performance of the aggregate economy in terms of labour employment
and capital utilization, overall output and income, general price levels, economic growth and
balance of international payments. Government’s stabilization intervention may be through
monetary policy as well as fiscal policy. Monetary policy has a singular objective of controlling
the size of money supply and interest rate in the economy, while fiscal policy aims at changing
aggregate demand by suitable changes in government spending and taxes.
(ii) The demand for money is a decision about how much of one’s given stock of wealth should
be held in the form of money rather than as other assets such as bonds. Demand for money
is actually demand for liquidity and a demand to store value.
9. (a) (i) The Heckscher-Ohlin theory of trade, also referred to as Factor-Endowment Theory of Trade
or Modern Theory of Trade, states that comparative advantage in cost of production is
explained exclusively by the differences in factor endowments.
A country tends to specialize in the export of a commodity whose production requires intensive
use of its abundant resources and imports a commodity whose production requires intensive
use of its scarce resources.
Accordingly, a capital abundant country will produce and export capital intensive goods
relatively more cheaply and a labour-abundant country will produce and export labour
intensive goods relatively more cheaply than another country.
(ii) Common access resources or common pool resources are a special class of impure public
goods which are non-excludable as people cannot be excluded from using them. These are
rival in nature and their consumption lessens the benefits available for others. This rival nature
of common resources is what distinguishes them from pure public goods, which exhibit both
non-excludability and non-rivalry in consumption. They are generally available free of charge.
Some important natural resources fall into this category.
Examples of common access resources are fisheries, common pastures, rivers, sea,
backwaters biodiversity etc. The earth’s atmosphere is perhaps the best example. Emissions
of carbon dioxide and other greenhouse gases have led to the depletion of the ozone layer
endangering environmental sustainability. Although nations are aware of the fact that reduced
global warming would benefit everyone, they have an incentive to free ride, with the result
that nothing positive is likely to be done to correct the problem.
(b) (i) Foreign direct investment is defined as a process whereby the resident of one country (i.e.
home country) acquires ownership of an asset in another country (i.e. the host country) and
such movement of capital involves ownership, control as well as management of the asset in
the host country. Direct investments are real investments in factories, assets, land, inventories
etc. and have three components, viz., equity capital, reinvested earnings and other direct
capital in the form of intra-company loans. Foreign direct investment also includes all
subsequent investment transactions between the investor and the enterprise and among
affiliated enterprises, both incorporated and unincorporated. FDI involves long term
11

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 relationship and reflects a lasting interest and control. According to the IMF and OECD
definitions, the acquisition of at least ten percent of the ordinary shares or voting power in a
public or private enterprise by non-resident investors makes it eligible to be categorized as
FDI. FDI may be categorized as horizontal, vertical, conglomerate and two- way direct foreign
investments which are reciprocal investments.
Benefits of Foreign Direct Investment
Following are the benefits ascribed to foreign investments:
(i) Entry of foreign enterprises usually fosters competition and generates a competitive
environment in the host country.
(ii) International capital allows countries to finance more investment than can be supported by
domestic savings resulting in higher productivity and enhanced output.
(ii) Keynes argued that, in the short run, investment is best viewed as an autonomous
expenditure, that is, it is independent of people’s income. The Keynesian model assumes that
the planned level of investment expenditure is constant with respect to current income.
Investment is determined by factors other than income such as business expectations and
economic policy.
10. (a) (i) When aggregate demand rises beyond what the economy can potentially produce by fully
employing its given resources; it gives rise to inflationary pressures in the economy. The
aggregate demand may rise due to large increase in consumption demand by households or
investment expenditure by entrepreneurs, or government expenditure. In these circumstances
inflationary gap occurs which tends to bring about rise in prices. Under such circumstances,
a contractionary fiscal policy will have to be used.
Contractionary fiscal policy refers to the deliberate policy of government applied to curtail
aggregate demand and consequently the level of economic activity. In other words, it is fiscal
policy aimed at eliminating an inflationary gap. This is achieved by adopting policy measures
that would result in the aggregate demand curve (AD) shift the to the left so the equilibrium
may be established at the full employment level of real GDP.
This can be achieved either by:
• Decrease in government spending.
• Increase in personal income taxes and/or business taxes.
• A combination of decrease in government spending and increase in personal income taxes
and/or business taxes.
(ii) Changes in SLR chiefly influence the availability of resources in the banking system for
lending. A rise in SLR -during periods of high liquidity - to lock up a rising fraction of a bank’s
assets in the form of eligible instruments – reduces the credit creation capacity of banks. A
reduction in SLR during periods of economic downturn has the opposite effect.
(b) (i) When prices of certain essential commodities rise excessively, government may resort to
controls in the form of price ceilings (also called maximum price) for making a resource or
commodity available to all at reasonable prices. For example: maximum prices of food grains
and essential items are set by government during times of scarcity. A price ceiling which is
set below the prevailing market clearing price will generate excess demand over supply.
With the objective of ensuring stability in prices and distribution, governments often intervene
in grain markets through building and maintenance of buffer stocks. It involves purchases
from the market during good harvest and releasing stocks during periods when production is
below average.

12

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 (ii) Arbitrage refers to the practice of making risk-less profits by intelligently exploiting price
differences of an asset at different dealing places. On account of arbitrage, regardless of
physical location, at any given moment, all markets tend to have the same exchange rate for
a given currency
11. (a) (i) The central bank in its execution of monetary policy, functions within an articulated monetary
policy framework which comprises of:
• the objectives of monetary policy, such as maintenance of price stability (or controlling
inflation) and achievement of economic growth
• the analytics of monetary policy which focus on the transmission mechanisms, or the ways
in which monetary policy actions get transmitted to the real economy and
• the operating procedure which relates to all aspects of implementation of monetary policy
namely, choosing the operating target, choosing the intermediate target, and choosing the
policy instruments.
(ii) Reserve money has two major components – currency in circulation and reserves. Currency
in circulation comprises currency with the public and cash in hand with banks. Reserves are
bank deposits with the central bank
(b) (i) Aggregate demand is the total quantity of finished goods and services that all sectors
(consumers, firms, government and the rest of the world) together wish to buy under different
conditions. The components of aggregate demand are consumption demand, investment
demand, government spending and net exports at each level of income. While consumption
demand is a function of the level of disposable income, the demand for investment,
government spending and net exports are autonomous, i.e. these are determined outside the
model and are specifically assumed to be independent of income.
The Keynesian aggregate demand schedule is obtained by vertically adding the demand for
consumption, investment demand, government spending and net exports at each level of
income.
AD= C+ I+ G+ NX

(ii) Anti-dumping measures consist of imposition of additional import duties to offset the effects
of dumping. These measures are initiated as safeguards to offset the foreign firm's unfair
price advantage. This is justified only if the domestic industry is seriously injured by import
competition, and protection is in the national interest (that is, the associated costs to
consumers would be less than the benefits that would accrue to producers).
OR

(ii) Market failure is a situation in which the free market fails to allocate resources efficiently in
the sense that there is either overproduction or underproduction of particular goods and
services leading to less than optimal market outcomes.

13

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 Test Series: April, 2019
MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) The proportion and required return of debt and equity was recorded for a company with its
increased financial leverage as below:
Debt (%) Required return Equity Required Return (Ke) Weighted Average Cost of
(Kd ) (%) (%) (%) Capital (WACC) (K o )(%)

0 5 100 15 15
20 6 80 16 ?
40 7 60 18 ?
60 10 40 23 ?
80 15 20 35 ?
You are required to complete the table and IDENTIFY which capital structure is most beneficial for
this company. (Based on traditional theory, i.e., capital structure is relevant).
(b) Annova Ltd is considering raising of funds of about Rs.250 lakhs by any of two alternative methods,
viz., 14% institutional term loan and 13% non-convertible debentures. The term loan option would
attract no major incidental cost and can be ignored. The debentures would have to be issued at a
discount of 2.5% and would involve cost of issue of 2% on face value.
ADVISE the company as to the better option based on the effective cost of capital in each case.
Assume a tax rate of 50%.
(c) Probabilities for net cash flows for 3 years of a project of Ganesh Ltd are as follows:
Year 1 Year 2 Year 3
Cash Flow Probability Cash Flow Probability Cash Flow Probability
(Rs.) (Rs.) (Rs.)
2,000 0.1 2,000 0.2 2,000 0.3
4,000 0.2 4,000 0.3 4,000 0.4
6,000 0.3 6,000 0.4 6,000 0.2
8,000 0.4 8,000 0.1 8,000 0.1
CALCULATE the expected net cash flows and the present value of the expected cash flow, using
10 per cent discount rate. Initial Investment is Rs. 10,000

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 (d) With the help of the following information ANALYSE and complete the Balance Sheet of Anup Ltd.:
Equity share capital Rs. 1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt 0.40
Total debt to Equity share capital 0.60
Fixed assets to Equity share capital 0.60
Total assets turnover 2 Times
Inventory turnover 8 Times
(4 × 5 = 20 Marks)
2. (a) The capital structure of Anshu Ltd. as at 31.3.2019 consisted of ordinary share capital of
Rs. 5,00,000 (face value Rs. 100 each) and 10% debentures of Rs. 5,00,000 (Rs. 100 each). In
the year ended with March 2019, sales decreased from 60,000 units to 50,000 units. During this
year and in the previous year, the selling price was Rs. 12 per unit; variable cost stood at Rs. 8 per
unit and fixed expenses were at Rs. 1,00,000 p.a. The income tax rate was 30%.
You are required to CALCULATE the following:
(i) The percentage of decrease in earnings per share.
(ii) The degree of operating leverage at 60,000 units and 50,000 units.
(iii) The degree of financial leverage at 60,000 units and 50,000 units. (6 Marks)
(b) EXPLAIN the limitations of Leasing? (4 Marks)
3. (a) Navya Ltd has annual credit sales of Rs. 45 lakhs. Credit terms are 30 days, but its management
of receivables has been poor and the average collection period is 50 days, Bad debt is 0.4 per cent
of sales. A factor has offered to take over the task of debt administration and credit checking, at
an annual fee of 1 per cent of credit sales. Navya Ltd. estimates that it would save Rs. 35,000 per
year in administration costs as a result. Due to the efficiency of the factor, the average collection
period would reduce to 30 days and bad debts would be zero. The factor would advance 80 per
cent of invoiced debts at an annual interest rate of 11 per cent. Navya Ltd. is currently financing
receivables from an overdraft costing 10 per cent per year.
If occurrence of credit sales is throughout the year, COMPUTE whether the factor’s services should
be accepted or rejected. Assume 365 days in a year. (6 Marks)
(b) EXPLAIN the principles of “Trading on equity”. (4 Marks)
4. (a) Prem Ltd has a maximum of Rs. 8,00,000 available to invest in new projects. Three possibilities
have emerged and the business finance manager has calculated Net present Value (NPVs) for
each of the projects as follows :
Investment Initial cash outlay NPV
Rs. Rs.
Alfa (α) 5,40,000 1,00,000
Beta(β) 6,00,000 1,50,000
Gama (γ) 2,60,000 58,000
DETERMINE which investment/combination of investments should the company invest in, if we
assume that the projects can be divided? (6 Marks)

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 (b) Invest Corporation Ltd. adjusts risk through discount rates by adding various risk premiums to the
risk free rate. Depending on the resultant rate, the proposed project is judged to be a low, medium
or high risk project.
Risk level Risk free rate Risk Premium
(%) (%)
Low 8 4
Medium 8 7
High 8 10

DEMONSTRATE the acceptability of the project on the basis of Risk Adjusted rate. (4 Marks)
5. The following information is supplied to you:
Rs.
Total Earnings 2,00,000
No. of equity shares (of Rs. 100 each) 20,000
Dividend paid 1,50,000
Price/ Earnings ratio 12.5
Applying Walter’s Model
(i) DETERMINE whether the company is following an optimal dividend policy.
(ii) IDENTIFY, what should be the P/E ratio at which the dividend policy will have no effect on the
value of the share.
(iii) Will your decision change, if the P/E ratio is 8 instead of 12.5? ANALYSE. (10 Marks)
6. (a) DESCRIBE Bridge Finance.
(b) STATE Virtual Banking? DISCUSS its advantages.
(c) EXPLAIN Concentration Banking (4 + 4 + 2 = 10 Marks)

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 PAPER – 8B: ECONOMICS FOR FINANCE

Time Allowed – 1:15 Hours Maximum Marks - 40

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If
a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question 7 is compulsory question.
Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above the
required number, then only the requisite number of questions first answered will be the evaluated the rest
answer shall be ignored
Working Notes should form part of the answer.
7. (a) Suppose in an economy:
Consumption Function (C) = 100 + 0.9 Yd, where Yd = Y-T
Autonomous Investment (I) = Rs. 100 crores
Government Expenditure G = Rs. 120 crores
Taxes (T) = Rs.50 crores
Exports (X) = Rs.200 crores
Import Function (M) = 100 + 0.15Y

Where Y and Yd National Income and Personal Disposable Income respectively. All the figures are
in Rupees. Find the Equilibrium level of GDP? (3 Marks)
(b) Define permanent income and state its relationship to demand for real money balances?
(3 Marks)
(c) Explain why government imposes price ceilings? (2 Marks)
(d) What is meant by trade distortion? (2 Marks)
8. (a) (i) Explain how decline in interest rates influence economic activity by changing the incentives
for households and businesses to save or invest? (3 Marks)
(ii) Define Information Failure (3 Marks)
(b) (i) What is meant by nominal GDP-growth? (2 Marks)
(ii) Define optimal output from the point of view of social welfare? (2 Marks)
9. (a) (i) Explain the effects of monetary policy through balance sheet channel (3 Marks)
(ii) What is the major determinant of the economic functions of a government? (2 Marks)
(b) Calculate (a) GDPMP and (b) NNPFC from the following data: (5 Marks)
Particulars (Rs) In Crore
(i) Net indirect tax 208
(ii) Consumption of fixed capital 42
(iii) Net factor income from abroad -40
(iv) Rent 311
(v) Profits 892

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 (vi) Interest 81
(vii) Royalty 6
(viii) Wages and salary 489
(ix) Employer's contribution to Social Security Scheme 50
10. (a) (i) How do foreign direct investments enhance human capital in recipient countries? (3 Marks)
(ii) Distinguish between domestic subsidy and export subsidy? (2 Marks)
(b) (i) What do you understand by the term ‘final good”? (2 Marks)
(ii) Explain the different types of Externalities? How Externalities lead to welfare loss of markets?
(3 Marks)
11. (a) (i) What is the rationale for government intervention in allocation of resources? (3 Marks)
(ii) Distinguish between ‘non tariff measures’ and ‘non tariff barriers’ (3 Marks)
(b) (i) What do you understand by the term ‘cross rate’? (2 Marks)
(ii) What is the objective of policies requiring foreign entities to procure local contents? (2 Marks)
OR
What is meant by open market operations?

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 Test Series: April 2019
MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Computation of Weighted Average Cost of Capital (WACC) for each level of Debt-equity mix.
Debt Required Equity Required Kd × Proportion of debt + Weighted Average
(%) return (%) return (K e) Ke Proportion and equity Cost of Capital
(Kd )(%) (%) (WACC)(K o )(%)
0 5 100 15 0%(5%)+100%(15%) 15
20 6 80 16 20%(6%)+80%(16%) 14
40 7 60 18 40%(7%)+60%(18%) 13.6
60 10 40 23 60%(10%)+40%(23%) 15.2
80 15 20 35 80%(15%)+20%(35%) 19
The optimum mix is 40% debt and 60% equity, as this will lead to lowest WACC value i.e., 1 3.6%.
(b) Calculation of Effective Cost of Capital
Particulars Option 1 Option 2
14% institutional 13% Non-convertible
Term loan Debentures
(Rs. in Lakhs) (Rs. in lakhs)
(A) Effective capital to be raised Face value 250.00 250.00
Less: Discount Nil (6.25)
250.00 243.75
Less: Cost of issue Nil 5.00
Effective amount of capital 250.00 238.75
(B) Annual interest charges on face value of
Rs. 250 lakhs 35.0 32.50
Less: Tax benefit on interest @ 50% 17.5 16.25
17.5 16.25
(C) Effective cost of capital after tax B 16.25
x 100 x100
A 238.75
= 7.0% = 6.81% (approx)
So, the better option is raising of funds of Rs.250 lakhs by issue of 13% Non-convertible Debenture
(c)
Year 1 Year 2 Year 3
Cash Probability Expected Cash Probability Expected Cash Probability Expecte
Flow Value Flow Value Flow d Value
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
2,000 0.1 200 2,000 0.2 400 2,000 0.3 600
4,000 0.2 800 4,000 0.3 1200 4,000 0.4 1,600
6,000 0.3 1,800 6,000 0.4 2400 6,000 0.2 1,200

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 8,000 0.4 3,200 8,000 0.1 800 8,000 0.1 800
ENCF 6,000 4,800 4,200
The present value of the expected value of cash flow at 10 per cent discount rate has been
determined as follows:
ENCF1 ENCF2 ENCF3
Present Value of cash flow = + +
(1+ k)1 (1+ k)2 (1+ k)3
6,000 4,800 4,200
=  
(1.1)1 (1.1)2 (1.1)3
= (6,000 × 0.909) + (4,800 × 0.826) + (4,200 + 0.751)
= 12,573
Expected Net Present value = Present Value of cash flow - Initial Investment
= Rs. 12,573 – Rs.10,000 = Rs.2,573.
(d) MNOP Ltd.
Balance Sheet
Liabilities Rs. Assets Rs.
Equity share capital 1,00,000 Fixed assets 60,000
Current debt 24,000 Cash (balancing figure) 60,000
Long term debt 36,000 Inventory 40,000
1,60,000 1,60,000
Working Notes
1. Total debt = 0.60 x Equity share capital = 0.60 Rs. 1,00,000 = Rs. 60,000
Further, Current debt to total debt = 0.40. So, current debt = 0.40 × Rs.60,000 = Rs.24,000,
Long term debt = Rs.60,000 - Rs.24,000= Rs. 36,000
2. Fixed assets = 0.60 × Equity share Capital = 0.60 × Rs. 1,00,000 = Rs. 60,000
3. Total assets to turnover = 2 Times : Inventory turnover = 8 Times
Hence, Inventory /Total assets = 2/8=1/4, Total assets = Rs. 1,60,000
Therefore Inventory = Rs. 1,60,000/4 = Rs. 40,000
2. (a)
Sales in units 60,000 50,000
Rs. Rs.
Sales Value 7,20,000 6,00,000
Variable Cost (4,80,000) (4,00,000)
Contribution 2,40,000 2,00,000
Fixed expenses 1,00,000 1,00,000
EBIT 1,40,000 1,00,000
Debenture Interest (50,000) (50,000)
EBT 90,000 50,000
Tax @ 30% (27,000) (15,000)

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 Profit after tax (PAT) 63,000 35,000

63,000 35,000
(i) Earning per share (EPS) = = Rs. 12.6 = Rs. 7
5,000 5,000
Decrease in EPS = 12.6 – 7 = 5.6
5.6
% decrease in EPS =  100 = 44.44%
12.6
Contribution 2,40,000 2,00,000
(ii) Operating leverage = =
EBIT 1,40,000 1,00,000
= 1.71 2
EBIT 1,40,000 1,00,000
(iii) Financial Leverage = =
EBT 90,000 50,000
= 1.56 2
(b) Limitations are:
1) The lease rentals become payable soon after the acquisition of assets and no moratorium
period is permissible as in case of term loans from financial institutions. The lease
arrangement may, therefore, not be suitable for setting up of the new projects as it would
entail cash outflows even before the project comes into operation.
2) The leased assets are purchased by the lessor who is the owner of equipment. The seller’s
warranties for satisfactory operation of the leased assets may sometimes not be available to
lessee.
3) Lessor generally obtains credit facilities from banks etc. to purchase the leased equipment
which are subject to hypothecation charge in favour of the bank. Default in payment by the
lessor may sometimes result in seizure of assets by banks causing loss to the lessee.
4) Lease financing has a very high cost of interest as compared to interest charged on term loans
by financial institutions/banks.
Despite all these disadvantages, the flexibility and simplicity offered by lease finance is bound to
make it popular. Lease operations will find increasing use in the near future.
3. (a)
Rs.
Present level of receivables is 45 lakh× 50/365 6,16,438

In case of factor, receivables would reduce to 45 lakhs× 30/365 3,69,863

The costs of the existing policy are as follows:

Cost of financing existing receivables: 6,16,438×10% 61,644
Cost of bad debts: 45 lakhs × 0.4% 18,000
Cost of current policy 79,644
The cost under the factor are as follows:
Cost of financing new receivable through factor:
(Rs. 3,69,863 × 0.8 × 0.11) + (Rs. 3,69,863 × 0.2 × 0.10) 39,945
= (32,548 + 7,397)
3

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 Factor’s annual fee: 45 Lakhs × 0.01 45,000
Administration costs saved: (35,000)
Net cost under factor: 49,945
From the above analysis it is clear that the factor’s services are cheaper than Existing policy by
Rs. 29,699 (Rs. 79,644 - Rs.49,945) per year. Hence, the services of the factor should be
accepted.
(b) The term trading on equity means debts are contracted and loans are raised mainly on the basis
of equity capital. Those who provide debt have a limited share in the firm’s earning and hence
want to be protected in terms of earnings and values represented by equity capital. Since fixed
charges do not vary with firm’s earnings before interest and tax, a magnified effect is produced on
earning per share. Whether the leverage is favourable, in the sense, increase in earnings per
share more proportionately to the increased earnings before interest and tax, depends on the
profitability of investment proposal. If the rate of returns on investment exceeds their explicit cost,
financial leverage is said to be positive.
4. (a) Since funds available are restricted, the normal Net Present Value (NPV) rule of accepting
investments decisions with the highest NPVs cannot be adopted straight way. Further, as the
projects are divisible, a Profitability Index (PI) can be utilized to provide the most beneficial
combination of investment for Rio Ltd.
Project PV Per Rs. Rank as per PI
Alfa (α) Rs. 6,40,000 / Rs. 5,40,000 = 1.185 III
Beta (β) Rs. 7,50,000 / Rs. 6,00,000 = 1.250 I
Gama (γ) Rs. 3,18,000 / Rs. 2,60,000 = 1.223 II

Therefore Rio Ltd should invest Rs. 6,00,000 into project β (Rank I) earnings Rs. 1,50,000 and
Rs.2,00,000 into project γ (Rank II) earning Rs.44,615 Rs. 2,00,000 / Rs. 2,60,000 × Rs. 58,000

So, total NPV will be Rs.1,94,615 Rs. 1,50,000 + Rs. 44,615 from Rs. 8,00,000 of investment.

(b) Calculation of Risk Adjusted rate

Risk level Risk free rate (%) Risk Premium (%) Risk adjusted rate (%)
Low 8 4 12
Medium 8 7 15
High 8 10 18

The cash flows of the project considered are as following:

Point in time (yearly intervals) 0 1 2
Cash flow (Rs. in crore) (100) 45 80
If the project is judged to be Low risk
Years 0 1 2
PV (Rs. in crore) (100) 45 80
 40.18  63.78
1  0.12 (1  0.12)2

NPV = 40.18 + 63.78 – 100 = 3.96: Accept

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 If the project is judged to be Medium risk
Years 0 1 2
PV (Rs. in crore) (100) 45 80
 39.13  60.49
1  0.15 (1  0.15)2

NPV = 39.13 + 60.49 – 100 = (0.38): Reject

If the project is judged to be High risk
Years 0 1 2
PV (Rs. in crore) (100) 45 80
 38.14  57.45
1  0.18 (1  0.18)2

NPV = 38.14 + 57.45 – 100 = (4.41): Reject

5. (i) The EPS of the firm is Rs. 10 (i.e., Rs. 2,00,000/ 20,000). The P/E Ratio is given at 12.5 and the
cost of capital, ke, may be taken at the inverse of P/E ratio. Therefore, k e is 8 (i.e., 1/12.5). The
firm is distributing total dividends of Rs. 1,50,000 among 20,000 shares, giving a dividend per share
of Rs. 7.50. the value of the share as per Walter’s model may be found as follows:
D (r / K e )(E  D) 7.50 (.10 / .08)(10  7.5)
P  =  = Rs. 132.81
Ke Ke .08 .08
The firm has a dividend payout of 75% (i.e., Rs. 1,50,000) out of total earnings of Rs. 2,00,000.
since, the rate of return of the firm, r, is 10% and it is more than the k e of 8%, therefore, by
distributing 75% of earnings, the firm is not following an optimal dividend policy. The optimal
dividend policy for the firm would be to pay zero dividend and in such a situation, the market price
would be
D (r / K e )(E  D) 0 (.10 / .08)(10 - 0)
P=  =  = Rs. 156.25
ke Ke .08 .08

So, theoretically the market price of the share can be increased by adopting a zero payout.
(ii) The P/E ratio at which the dividend policy will have no effect on the value of the share is such at
which the ke would be equal to the rate of return, r, of the firm. The K e would be 10% (=r) at the
P/E ratio of 10. Therefore, at the P/E ratio of 10, the dividend policy would have no effect on the
value of the share.
(iii) If the P/E is 8 instead of 12.5, then the Ke which is the inverse of P/E ratio, would be 12.5 and in
such a situation ke> r and the market price, as per Walter’s model would be
D (r / K e )(E  D) 7.50 (.1/ .125) (10  7.5)
P=  = + = Rs. 76
Ke Ke .125 .125

6. (a) Bridge finance refers, normally, to loans taken by the business, usually from commercial banks for
a short period, pending disbursement of term loans by financial institutions, normally it takes time
for the financial institution to finalise procedures of creation of security, tie-up participation with
other institutions etc. even though a positive appraisal of the project has been made. However,
once the loans are approved in principle, firms in order not to lose further time in starting their
projects arrange for bridge finance. Such temporary loan is normally repaid out of the proceeds of
the principal term loans. It is secured by hypothecation of moveable assets, personal guarantees
and demand promissory notes. Generally rate of interest on bridge finance is higher as compared
with that on term loans.

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 (b) Virtual Banking and its Advantages
Virtual banking refers to the provision of banking and related services through the use of
information technology without direct recourse to the bank by the customer.
The advantages of virtual banking services are as follows:
➢ Lower cost of handling a transaction.
➢ The increased speed of response to customer requirements.
➢ The lower cost of operating branch network along with reduced staff costs leads to cost
efficiency.
Virtual banking allows the possibility of improved and a range of services being made available to
the customer rapidly, accurately and at his convenience.
(c) Concentration Banking: In concentration banking the company establishes a number of strategic
collection centres in different regions instead of a single collection centre at the head office. This
system reduces the period between the time a customer mails in his remittances and the time when
they become spendable funds with the company. Payments received by the different collection
centers are deposited with their respective local banks which in turn transfer all surplus funds to
the concentration bank of head office

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 PAPER 8B : ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/HINTS
7. (a) National Income
Y = C+I+G+(X-M)
= (100+0.9Yd) +100+120+200-(100+0.15Y)
= 100+0.9(Y-T) +100+120+200-100-0.15Y
= 100+0.9(Y-50) +100+120+200-100-0.15Y
Y= 375+0.75Y
Y-0.75Y= 375
0.25Y= 375

100
Y= 375×  1500
25
(b) According to Milton Friedman, permanent income is a measure of wealth which is the present
discounted value of all expected future incomes. As distinguished from transitory income, it is the
normal income or the income that people expect to persist into the future. The nominal demand for
money is a function of total wealth, which is represented by permanent income divided by the
discount rate, defined as the average return on the five asset classes in the monetarist theory
world, namely: money, bonds, equity, physical capital and human capital.
(c) In order to protect the interest of consumer’s government fixes the maximum price of the
commodity. This maximum price is generally lower than the equilibrium price. This is calle d control
price or ceiling price. This price is fixed by the government because poor people cannot afford to
buy the commodity at equilibrium price. This situation arises when the production of a co mmodity
is less than its demand. In India government has a control price or ceiling price of the commodities
which it considers essential for the masses. For examples maximum prices of food grains and
essential items like some goods such as wheat, rice, sugar, kerosene oil etc. are during scarcity.
(d) Trade is distorted if quantities of commodities produced, bought, and sold and their prices are
higher or lower than levels that would usually exist in a competitive market. For example, barriers
to imports such as tariffs, domestic subsidies and quantitative restrictions can make agricultural
products more costly in a market of a country. The higher prices will result in higher production of
crop. Then export subsidies are needed to sell the surplus output in the world markets, where
prices are low. Thus, the subsidising countries can be producing and exporting considerably more
than what they normally would.
8. (a) (i) Lower interest rates increases disposable incomes and influence the spending decisions of
households and businesses by reducing the amount of interest they pay on debt. Reductions
in interest rates which they receive on deposits reduce the incentives for households to save
and may encourage them to borrow and spend now rather than later, in particular, on durable
goods, such as cars and household appliances, and housing. Lower interest rates are thus
associated with higher household consumption and housing investment. Similarly, with lower
interest rates the cost of borrowing declines, expected returns on investment projects
increase, and these encourage businesses to borrow and increase their spending on
investment (in capital assets like new equipment or buildings). Since households and
businesses substitute between spending now and in the future, overall, lower interest rates
should be associated with an increase in business investment.

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 (ii) Perfect information which implies that both buyers and sellers have complete information
about anything that may influence their decision making is an important element of an efficient
competitive market. Information failure occurs when lack of information can result in
consumers and producers making decisions that do not maximize welfare. Information failure
is widespread in numerous market exchanges due to complex nature of goods and services
that are transacted, inaccurate and incomplete data, and non-availability of correct
information.
(b) (i) Nominal GDP is calculated in terms of current prices. Nominal GDP growth refers to the
percentage change in nominal GDP over a specific period of time. Since the effect of inflation/
deflation is not removed, it does not present the true picture of growth of the economy.
(ii) Optimal output is the ideal quantity of output that ensures maximum level of social welfare.
This will occur at a level of output where social marginal cost (SMC) = social marginal benefit.
(SMB) At this level of output the society’s resources are utilised in the most efficient way.
9. (a) (i) A direct effect of monetary policy on the firm’s balance sheet comes through an increase in
interest rates leading to an increase in the payments that the firm must make to repay its
floating rate debts. Logically, as a firm’s cost of credit rises, the strength of its balance sheet
deteriorates. An indirect effect occurs when the same increase in interest rates works to
reduce the capitalized value of the firm’s long‐lived assets. Reduced net worth of businesses
and individuals make it tougher for them to qualify for loans at any interest rate, thus reducing
spending and price pressures. Hence, a policy‐induced increase in the short‐term interest
rate not only acts immediately to depress spending through the traditional interest rate
channel, it also acts, possibly with a time-lag, to raise each firm’s cost of capital through the
balance sheet channel. These together aggravate the decline in output and employment.
Conversely, a reduction in interest rates can increase the borrowing capacity of households
and businesses. This is because lower interest rates are associated with higher asset prices.
In turn, higher asset prices increase the equity (or collateral) of existing assets that a bank
can lend against. As a result, borrowers with existing assets may be able to borrow more,
which can lead to more spending.
(ii) The nature of the economic system determines the size and scope of the economic functions
of the government. In a centrally planned socialistic economy, the state owns all productive
resources and makes all important economic decisions. On the contrary, in a m arket
economy, all important economic decisions are made by individuals and firms who want to
maximise self interest and there is only limited role for the government. In a mixed economic
system, both markets and government contribute towards resource allocation decisions.
(b) NDPFC = Compensation of Employees + Operating Surplus + Mixed Income
= (viii) + (ix) + (iv) + (v) + (vi) + (vii) = 489 + 50+ 311 + 892 + 81 + 6 = 1829 Crores
GDPMP = NDPFC + Depreciation + Net Indirect Tax
= NDPFC + (ii) + (i) = 1829 + 42 + 208 = 2079 Crores
NNP Fc= NDPFC + Net Factor Income from Abroad
= NDPFC + (iii) = 2079+ (-40) = 2039 Crores
10. (a) (i) Since FDI involves setting up of production base (in terms of factories, power plants, etc.) it
generates direct employment in the recipient country. Subsequent FDI as well as domestic
investments propelled in the downstream and upstream projects that come up in multitude
of other services generate multiplier effects on employment and income. FDI not only creates
direct employment opportunities but also, through backward and forward linkages, it is able
to generate indirect employment opportunities as well.Foreign direct investments also
promote relatively higher wages for skilled jobs. However, jobs that require expertise and
entrepreneurial skills for creative decision making may generally be retained in the home
8

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 country and therefore the host country is left with routine management jobs that demand only
lower levels of skills and ability. This may result in ‘crowding in’ of people in jobs requiring low
skills, perpetuation of low labour standards and differential treatment.
FDIs are likely use labor-saving technology and capital-intensive methods in a labour-
abundant country and cause labour displacement. Such technology is inappropriate for a
labour-abundant country as it does not support generation of jobs which is a crucial
requirement to address poverty and unemployment which are the two fundamental areas of
concern for the less developed countries. Not only that foreign entities fail to support
employment generation, but they may also drive out domestic firms from the industry resulting
in serious problems of displacement of labour.
(b) (i) A final good is a good sold to final purchasers and is consumed by the end user in its present
state. It does not require any further processing and therefore will not undergo any further
transformation at the hands of producer. Once a final good has been sold, it passes out of
the active economic flow. The value of the final goods already includes the value of the
intermediate goods that have entered into their production as inputs.
(ii) Externalities, also referred to as 'spillover effects', 'neighbourhood effects' 'third-party effects'
or 'side-effects', occur when the actions of either consumers or producers result in costs or
benefits that do not reflect as part of the market price. Externalities cause market inefficiencies
because they hinder the ability of market prices to convey accurate information about how
much to produce and how much to buy. Since externalities are not reflected in market prices,
they can be a source of economic inefficiency. The four possible types of externalities are
negative externality initiated in production which imposes an external cost on others, positive
production externality, less commonly seen, initiated in production that confers external
benefits on others, negative consumption externalities initiated in consumption which produce
external costs on others, positive consumption externality initiated in consumption that
confers external benefits on others. Each of the above may be received by another in
consumption or in production.
11. (a) (i) The allocation responsibility of the governments involves suitable corrective action when
private markets fail to provide the right and desirable combination of goods and services to
ensure social welfare. In the absence of appropriate government intervention, market failures
may occur and the resources are likely to be misallocated by too much production of certain
goods or too little production of certain other goods. Thus, market failures provide the
rationale for government’s allocative function.
(ii) Non tariff measures are policy measures other than ordinary customs tariffs that can
potentially have an economic effect on international trade in goods, changing quantities
traded, or prices or both (UNCTAD, 2010). For example, the sound use of NTMs like sanitary
and phytosanitary measures and licensing could be legitimately used to ensure consumer
health and to protect plant and animal life and environment
NTMs are not the same as non-tariff barriers (NTBs). NTMs are sometimes used as means
to circumvent free-trade rules and favour domestic industries at the expense of foreign
competition. In this case they are called non-tariff barriers (NTBs). NTBs are a subset of NTMs
that have a 'protectionist or discriminatory intent' and implies a negative impact on trade.
NTMs only become NTBs when they are more trade restrictive than necessary. Some
examples of NTBs are compulsory standards, often not based on international norms or
genuine science; stringent technical regulations requiring alterations in production processes,
testing regimes which require complex procedures and product approvals requiring inspection
of individual premises
(b) (i) The rate between Y and Z which is derived from the given rates of another set of two pairs of
currency (say, X and Y, and, X and Z) is called cross rate.

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 (ii) Local content policies requiring the purchase or use by a foreign enterprise of domestic
products and employment of the local workforce seek to ensure that the maximum benefits
from production activities accrue to local economic actors. These are essentially aimed at
reducing the volume or value of imports or at restraining the employment of foreign labour.
OR
Open market operations are conducted by the RBI by way of sale or purchase of government
securities to adjust money supply conditions. The central bank sells government securities to
suck out liquidity from the system and buys back government securities to infuse liquidity into
the system. When the RBI feels that there is excess liquidity in the market, it resorts to sale
of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions
are tight, the RBI will buy securities from the market, thereby releasing liquidity into the
market. These operations are often conducted on a day-to-day basis in a manner that
balances inflation while helping the banks to continue lending.

10

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 Test Series: October, 2019
MOCK TEST PAPER 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) The following figures are collected from the annual report of XYZ Ltd.:

Net Profit Rs.60 lakhs

Outstanding 10% preference shares Rs.100 lakhs
No. of equity shares 5 lakhs
Return on Investment 20%
Cost of capital i.e. (Ke) 14%
CALCULATE price per share using Gordon’s Model when dividend pay-out is (i) 25%;
(ii) 50% and (iii) 100%.
(b) RPS Company presently has Rs. 36,00,000 in debt outstanding bearing an interest rate of 10 per
cent. It wishes to finance a Rs. 40,00,000 expansion programme and is considering three
alternatives: additional debt at 12 per cent interest, preferred stock with an 11 per cent dividend,
and the sale of common stock at Rs. 16 per share. The company presently has 8,00,000 shares
of common stock outstanding and is in a 40 per cent tax bracket.
(i) If earnings before interest and taxes are presently Rs. 15,00,000, CALCULATE earnings per
share for the three alternatives, assuming no immediate increase in profitability?
(ii) CALCULATE indifference point between debt and common stock.
(c) MNP Limited has made plans for the year 2019 -20. It is estimated that the company will employ
total assets of Rs.50,00,000; 30% of assets being financed by debt at an interest cost of 9% p.a.
The direct costs for the year are estimated at Rs. 30,00,000 and all other operating expenses are
estimated at Rs. 4,80,000. The sales revenue are estimated at Rs. 45,00,000. Tax rate is assumed
to be 40%. CALCULATE:
(i) Net profit margin (After tax);
(ii) Return on Assets (After tax);
(iii) Asset turnover; and
(iv) Return on Equity.
(d) A Ltd. and B Ltd. are identical in every respect except capital structure. A Ltd. does not employ
debts in its capital structure whereas B Ltd. employs 12% Debentures amounting to Rs.100 lakhs.
Assuming that :
1

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 (i) All assumptions of M-M model are met;
(ii) Income-tax rate is 30%;
(iii) EBIT is Rs. 25,00,000 and
(iv) The Equity capitalization rate of ‘A' Ltd. is 20%.
CALCULATE the value of both the companies and also find out the Weighted Average Cost of
Capital for both the companies. [4 × 5 = 20 Marks]
2. (a) B LLP. has the following balance sheet and Income statement information:
Balance Sheet as on March 31st 2019
Liabilities (Rs.) Assets (Rs.)
Partners’ Capital 80,00,000 Net Fixed Assets 1,00,00,000
Term Loan 60,00,000 Inventories 45,00,000
Retained Earnings 35,00,000 Trade Receivables 40,50,000
Trade Payables 15,00,000 Cash & Bank 4,50,000
1,90,00,000 1,90,00,000
Income Statement for the year ending March 31st 2019
(Rs.)
Sales 34,00,000
Operating expenses (including Rs. 6,00,000 depreciation) 12,00,000
EBIT 22,00,000
Less: Interest 6,00,000
Earnings before tax 16,00,000
Less: Taxes 5,60,000
Net Earnings (EAT) 10,40,000
COMPUTE the degree of operating, financial and combined leverages at the current sales level, if
all operating expenses, other than depreciation, are variable costs. [3 Marks]
(b) H Ltd. is considering a new product line to supplement its range of products. It is anticipated that
the new product line will involve cash investments of Rs.70,00,000 at time 0 and Rs.1,00,00,000
in year 1. After-tax cash inflows of Rs. 25,00,000 are expected in year 2, Rs.30,00,000 in year 3,
Rs.35,00,000 in year 4 and Rs.40,00,000 each year thereafter through year 10. Although the
product line might be viable after year 10, the company prefers to be conservative and end all
calculations at that time.
(i) If the required rate of return is 15 per cent, FIND OUT the net present value of the project? Is
it acceptable?
(ii) COMPUTE NPV if the required rate of return were 10 per cent?
(iii) COMPUTE the internal rate of return? [7 Marks]
3. You are given the following information:
(i) Estimated monthly Sales are as follows:
Rs. Rs.
January 1,00,000 June 80,000
February 1,20,000 July 1,00,000

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 March 1,40,000 August 80,000
April 80,000 September 60,000
May 60,000 October 1,00,000

(ii) Wages and Salaries are estimated to be payable as follows:

Rs. Rs.
April 9,000 July 10,000
May 8,000 August 9,000
June 10,000 September 9,000
(iii) Of the sales, 80% is on credit and 20% for cash. 75% of the credit sales are collected within one
month and the balance in two months. There are no bad debt losses.
(iv) Purchases amount to 80% of sales and are made and paid for in the month preceding the sales.
(v) The firm has taken a loan of Rs.1,20,000. Interest @ 10% p.a. has to be paid quarterly in January,
April and so on.
(vi) The firm is to make payment of tax of Rs. 5,000 in July, 2019.
(vii) The firm had a cash balance of Rs. 20,000 on 1 St April, 2019 which is the minimum desired level
of cash balance. Any cash surplus/deficit above/below this level is made up by tempora ry
investments/liquidation of temporary investments or temporary borrowings at the end of each
month (interest on these to be ignored).
Required
PREPARE monthly cash budgets for six months beginning from April, 2019 on the basis of the above
information. [10 Marks]
4. ABC Ltd. has the following capital structure which is considered to be optimum as on 31st March, 2019
(Rs.)
14% Debentures 30,00,000
11% Preference shares 10,00,000
Equity Shares (10,000 shares) 1,60,00,000
2,00,00,000
The company share has a market price of Rs. 236. Next year dividend per share is 50% of year 2019
EPS. The following is the trend of EPS for the preceding 10 years which is expected to continue in
future.
Year EPS (Rs.) Year EPS Rs.)
2010 10.00 2015 16.10
2011 11.00 2016 17.70
2012 12.10 2017 19.50
2013 13.30 2018 21.50
2014 14.60 2019 23.60
The company issued new debentures carrying 16% rate of interest and the current market price of
debenture is Rs. 96.
Preference share Rs. 9.20 (with annual dividend of Rs. 1.1 per share) were also issued. The company
is in 50% tax bracket.
3

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 (A) CALCULATE after tax:
(i) Cost of new debt
(ii) Cost of new preference shares
(iii) New equity share (consuming new equity from retained earnings)
(B) CALCULATE marginal cost of capital when no new shares are issued.
(C) COMPUTE the amount that can be spent for capital investment before new ordinary shares must
be sold. Assuming that retained earnings for next year’s investment are 50 percent of 2019.
(D) COMPUTE marginal cost of capital when the funds exceeds the amount calculated in (C), assuming
new equity is issued at Rs. 200 per share? [10 Marks]
5. (a) CALCULATE Variance and Standard Deviation on the basis of following information:
Project A Project B
Possible
Cash Flow Probability Cash Flow Probability
Event
(Rs.) (Rs.)
A 80,000 0.10 2,40,000 0.10
B 1,00,000 0.20 2,00,000 0.15
C 1,20,000 0.40 1,60,000 0.50
D 1,40,000 0.20 1,20,000 0.15
E 1,60,000 0.10 80,000 0.10
[8 Marks]
(b) A firm maintains a separate account for cash disbursement. Total disbursement are Rs.10,50,000
per month or Rs. 1,26,00,000 per year. Administrative and transaction cost of transferring cash to
disbursement account is Rs.20 per transfer. Marketable securities yield is 8% per annum.
COMPUTE the optimum cash balance according to William J. Baumol model. [2 Marks]
6. (a) DISCUSS the Inter relationship between investment, financing and dividend decisions.
(b) What is debt securitisation? EXPLAIN the basics of debt securitisation process.
(c) EXPLAIN the concept of discounted payback period. (4 + 4+ 2 =10 Marks)

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 PAPER – 8B: ECONOMICS FOR FINANCE

Time Allowed – 1:15 Hours Maximum Marks - 40

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If
a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question 7 is compulsory question.
Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above the
required number, then only the requisite number of questions first answered will be the evaluated the rest
answer shall be ignored
Working Notes should form part of the answer.
7. (a) Calculate National Income by Value Added Method with the help of following data-
Particulars Rs. (in crore)
Sales 700
Opening stock 500
Intermediate Consumption 350
Closing Stock 400
Net Factor Income from Abroad 30
Depreciation 150
Excise Tax 110
Subsidies 50 (3 Marks)
(b) Define Social Good? What is the similarity and dissimilarity between Social Goods and Common
Pool Resources? (2 Marks)
(c) Why Marginal Standing Facility (MSF) would be the last resort for banks? (3 Marks)
(d) Assume that 15% specific tariff is levied by the government on every sunglass which is imported
into India, and if 2000 sunglasses are imported and price of each sunglass is Rs.1000/- , then find
out the amount of total tariff revenue collected by the government? (2 Marks)
8. (a) (i) Suppose M 3 = Rs. 450000 Crore
Currency with Public = Rs 3000 Crore
Demand Deposits of Banks = Rs. 100000 Crore
Other deposits with RBI= Rs. 100000 Crore
Saving Deposits with Post Office Saving Banks = Rs. 150000 Crore
Total deposits with the Post Office Savings Organization (excluding National Saving
Certificate) = Rs. 20000 Crore
National Saving Certificate = Rs. 250 Crore
Calculate Net Time Deposits and M 4 with the banking system? (3 Marks)
(ii) Compare transaction demand for money according to Keynes and Baumol & Tobin?
(2 Marks)

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 (b) How does trade increase economic efficiency and which view argued that trade is a zero- sum
game and how? (3 Marks)
(c) Is country like India unable to estimate their National Income wholly by one method? Give
comments (2 Marks)
9. (a) How does the government intervene to minimize market power? (5 Marks)
(b) Define the deposit expansion multiplier? How it is calculated? (3 Marks)
(c) Suppose MPC is 0.8 and it is planned to increase National Income by Rs. 3000 Crore then how
much increase in investment is required to fulfill this target? (2 Marks)
10. (a) What is meant by foreign exchange market? What are the roles played by the participants in the
foreign exchange market? (5 Marks)
(b) Define ‘Net Factor Income from Abroad’ (3 Marks)
(c) Determine the government spending multiplier when there is an increase of Rs.100 crore in
government spending and MPC is 0.75 ? And also find out the net effect of Rs. 100 crore spending?
(2 Marks)
11. (a) (i) What are the main advantages of fixed rate regime in an open economy? (3 Marks)
(ii) How the autonomous expenditure multiplier is stated in four sector model? (2 Marks)
(b) (i) What is non- discretionary fiscal polic y and how it occurs? (3 Marks)
(ii) Explain the concept of demand for money?
(2 Marks)
Or

Define the term Regional Trade Agreement (RTAs)? (2 Marks)

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 Test Series: October, 2019
MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints

1. (a)
Rs. in lakhs
Net Profit 60
Less: Preference dividend 10
Earning for equity shareholders 50
Therefore earning per share 50/5 = Rs.10.00
Price per share according to Gordon’s Model is calculated as follows:
E1(1  b)
P0 
Ke  br
Here, E1 = 10, Ke = 14%, r = 20%
(i) When dividend pay-out is 25%
10  0.25 2.5
P0  = = -250
0.14  (0.75  0.2) 0.14  0.15
As per the Gordon’s Dividend relevance model, the Cost of equity (K e) should be greater than
the growth rate i.e. br. In this case Ke is 14% and br = 15%, hence, the equity investors would
prefer capital appreciation than dividend.
(ii) When dividend pay-out is 50%
10  0.5 5
P0  = = 125
0.14  (0.5  0.2) 0.14  0.10

(iii) When dividend pay-out is 100%

10 1 10
P0  = = 71.43
0.14  (0  0.2) 0.14
(b) (i) (Rs. in thousands)
Debt Preferred Common
Stock Stock
Rs. Rs. Rs.
EBIT 1,500 1,500 1,500
Interest on existing debt 360 360 360
Interest on new debt 480  
Profit before taxes 660 1,140 1,140
Taxes 264 456 456
Profit after taxes 396 684 684
1

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 Preferred stock dividend  440 
Earnings available to common 396 244 684
shareholders
Number of shares 800 800 1,050
Earnings per share .495 .305 .651
(ii) Mathematically, the indifference point between debt and common stock is (Rs in thousands):
EBIT *  Rs. 840 EBIT *  Rs. 360

800 1,050

EBIT* (1,050) – Rs. 840(1,050) = EBIT* (800) – Rs. 360 (800)

250EBIT* = Rs. 5,94,000
EBIT* = Rs. 2,376
(c) The net profit is calculated as follows:
Rs.
Sales Revenue 45,00,000
Less: Direct Costs 30,00,000
Gross Profits 15,00,000
Less: Operating Expense 4,80,000
Earnings before Interest and tax (EBIT) 10,20,000
Less: Interest on debt (9% × 15,00,000) 1,35,000
Earnings before Tax) (EBT) 8,85,000
Less: Taxes (@ 40%) 3,54,000
Profit after Tax (PAT) 5,31,000
(i) Net Profit Margin (After Tax)
EBIT (1 - t) Rs.10,20,000×(1- 0.4)
Net Profit Margin = ×100 = = 13.6%
Sales Rs.45,00,000
(ii) Return on Assets (ROA) (After tax)
EBIT (1-t)
ROA =
Total Assets
Rs.10,20,000 (1- 0.4) Rs.6,12,000
= =
Rs.50,00,000 Rs.50,00,000
= 0.1224 = 12.24 %
(iii) Asset Turnover
Sales Rs. 45,00,000
Asset Turnover = = = 0.9
Assets Rs.50,00,000
Asset Turnover = 0.9 times
(iv) Return on Equity (ROE)
PAT Rs.5,31,000
ROE = = = 15.17%
Equity Rs.35,00,000

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 ROE = 15.17%
(d) (i) Calculation of Value of ‘A Ltd.’ and ‘B Ltd’ according to MM Hypothesis
Market Value of ‘A Ltd’ (Unlevered)
EBIT 1 - t  Rs.25,00,000 1 - 0.30  Rs.17,50,000
Vu = = = = Rs. 87,50,000
Ke 20% 20%
Market Value of ‘B Ltd.’ (Levered)
Vg = Vu + TB
= Rs. 87,50,000 + (Rs.1,00,00,000 × 0.30)
= Rs. 87,50,000 + Rs.30,00,000 = Rs.1,17,50,000
(ii) Computation of Weighted Average Cost of Capital (WACC)
WACC of ‘A Ltd.’ = 20% (i.e. Ke = Ko)
WACC of ‘B Ltd.’
B Ltd. (Rs.)
EBIT 25,00,000
Interest to Debt holders (12,00,000)
EBT 13,00,000
Taxes @ 30% (3,90,000)
Income available to Equity Shareholders 9,10,000
Total Value of Firm 1,17,50,000
Less: Market Value of Debt (1,00,00,000)
Market Value of Equity 17,50,000
Return on equity (Ke) = 9,10,000 / 17,50,000 0.52
Computation of WACC B. Ltd
Component of Capital Amount Weight Cost of Capital WACC
Equity 17,50,000 0.149 0.52 0.0775
Debt 1,00,00,000 0.851 0.084* 0.0715
Total 1,17,50,000 0.1490
*Kd= 12% (1- 0.3) = 12% × 0.7 = 8.4%
WACC = 14.90%
2. (a) Computation of Degree of Operating (DOL), Financial (DFL) and Combined leverages (DCL).
Rs. 34,00,000 - Rs. 6,00,000
DOL = = 1.27
Rs. 22,00,000
Rs.22,00,000
DFL = = 1.38
Rs. 16,00,000
DCL = DOLDFL = 1.271.38 = 1.75

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 (b) (i)
Year Cash flow Discount Factor Present value
(15%)
(Rs.) (Rs.)
0 (70,00,000) 1.000 (70,00,000)
1 (1,00,00,000) 0.870 (87,00,000)
2 25,00,000 0.756 18,90,000
3 30,00,000 0.658 19,74,000
4 35,00,000 0.572 20,02,000
510 40,00,000 2.163 86,52,000
Net Present Value (11,82,000)

As the net present value is negative, the project is unacceptable.

(ii) Similarly, NPV at 10% discount rate can be computed as follows:
Year Cash flow Discount Factor Present value
(10%)
(Rs.) (Rs.)
0 (70,00,000) 1.000 (70,00,000)
1 (1,00,00,000) 0.909 (90,90,000)
2 25,00,000 0.826 20,65,000
3 30,00,000 0.751 22,53,000
4 35,00,000 0.683 23,90,500
510 40,00,000 2.974 1,18,96,000
Net Present Value 25,14,500
Since NPV = Rs.25,14,500 is positive, hence the project would be acceptable.
NPVat LR
(iii) IRR = LR   (HR  LR)
NPVat LR  NPV at HR
Rs.25,14,500
= 10% +  (15%  10%)
Rs.25,14,500  ( )11,82,000
= 10% + 3.4012 or 13.40%
3. Computation – Collections from Debtors
Particulars Feb Mar Apr May Jun Jul Aug Sep
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
Total Sales 1,20,000 1,40,000 80,000 60,000 80,000 1,00,000 80,000 60,000
Credit
Sales (80% 96,000 1,12,000 64,000 48,000 64,000 80,000 64,000 48,000
of total
Sales)
Collection
(within one month) 72,000 84,000 48,000 36,000 48,000 60,000 48,000

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 Collection
24,000 28,000 16,000 12,000 16,000 20,000
(within two months)
Total Collections 1,08,000 76,000 52,000 60,000 76,000 68,000

Monthly Cash Budget for Six Months: April to September, 2019

Particulars April May June July August Sept.
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
Receipts:
Opening Balance 20,000 20,000 20,000 20,000 20,000 20,000
Cash Sales 16,000 12,000 16,000 20,000 16,000 12,000
Collections fr om 1,08,000 76,000 52,000 60,000 76,000 68,000
Debtors
Total Receipts (A) 1,44,000 1,08,000 88,000 1,00,000 1,12,000 1,00,000

Payments:
Purchases 48,000 64,000 80,000 64,000 48,000 80,000
Wages and Salaries 9,000 8,000 10,000 10,000 9,000 9,000
Interest on Loan 3,000 ----- ----- 3,000 ----- -----
Tax Payment ----- ----- ----- 5,000 ----- -----
Total Payment (B) 60,000 72,000 90,000 82,000 57,000 89,000
Minimum Cash Balance 20,000 20,000 20,000 20,000 20,000 20,000
Total Cash Required (C) 80,000 92,000 1,10,000 1,02,000 77,000 1,09,000
Surplus/ (Deficit) (A)-(C) 64,000 16,000 (22,000) (2,000) 35,000 (9,000)
Investment/F inancing:
Total effect of
(Invest)/ Financing (D) (64,000) (16,000) 22,000 2,000 (35,000) 9,000
Closing Cash Balance 20,000 20,000 20,000 20,000 20,000 20,000
(A) + (D) - (B)

4. (A) (i) Cost of new debt

I(1  t)
Kd =
P0
16 (1  0.5)
=  0.0833
96
(ii) Cost of new preference shares
PD 1.1
Kp =   0.12
P0 9.2
(iii) Cost of new equity shares
D1
Ke = g
P0
11.80
  0.10  0.05 + 0.10 = 0.15
236
Calculation of D1
D1 = 50% of 2019 EPS = 50% of 23.60 = Rs. 11.80
5

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 (B) Calculation of marginal cost of capital
Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debenture 0.15 0.0833 0.0125
Preference Share 0.05 0.12 0.0060
Equity Share 0.80 0.15 0.1200
Marginal cost of capital 0.1385

(C) The company can spend the following amount without increasing marginal cost of capital and
without selling the new shares:
Retained earnings = (0.50) (236 × 10,000) = Rs. 11,80,000
The ordinary equity (Retained earnings in this case) is 80% of total capital
11,80,000 = 80% of Total Capital
Rs.11,80,000
Capital investment before issuing equity = = Rs.14,75,000
0.80
(D) If the company spends in excess of Rs.14,75,000 it will have to issue new shares.
Rs. 11.80
The cost of new issue will be = + 0.10 = 0.159
200
The marginal cost of capital will be:
Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debentures 0.15 0.0833 0.0125
Preference Shares 0.05 0.1200 0.0060
Equity Shares (New) 0.80 0.1590 0.1272
0.1457

5. (a) Calculation of Expected Value for Project A and Project B

Project A Project B
Possible Net Cash Probability Expected Cash Flow Probability Expected
Event Flow Value (Rs.) Value
(Rs.) (Rs.) (Rs.)
A 80,000 0.10 8,000 2,40,000 0.10 24,000
B 1,00,000 0.20 20,000 2,00,000 0.15 30,000
C 1,20,000 0.40 48,000 1,60,000 0.50 80,000
D 1,40,000 0.20 28,000 1,20,000 0.15 18,000
E 1,60,000 0.10 16,000 80,000 0.10 8,000
ENCF 1,20,000 1,60,000
Project A
Variance (σ2) = (80,000 – 1,20,000)2 × (0.1) + (1,00,000 -1,20,000)2 × (0.2) + (1,20,000 – 1,20,000)2
× (0.4) + (1,40,000 – 1,20,000)2 × (0.2) + (1,60,000 – 1,20,000)2 × (0.1)

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 = 16,00,00,000 + 8,00,00,000 + 0 + 8,00,00,000 + 16,00,00,000
= 48,00,00,000
Standard Deviation (σ) = Variance(2 ) = 48,00,00,000 = 21,908.90

Project B:
Variance(σ2) = (2,40,000 – 1,60,000)2 × (0.1) + (2,00,000 – 1,60,000)2 × (0.15) + (1,60,000 –
1,60,000)2 ×(0.5) + (1,20,000 – 1,60,000)2 × (0.15) + (80,000 – 1,60,000)2 × (0.1)
= 64,00,00,000 + 24,00,00,000 + 0 + 24,00,00,000 + 64,00,00,000
= 1,76,00,00,000
Standard Deviation (σ) = 1,76,00,00,000 = 41,952.35

2×Rs.1,26,00,000×Rs.20
(b) The optimum cash balance C = = Rs.79,372.54
0.08
6. (a) Inter-relationship between Investment, Financing and Dividend Decisions: The finance
functions are divided into three major decisions, viz., investment, financing and dividend decisions.
It is correct to say that these decisions are inter-related because the underlying objective of these
three decisions is the same, i.e. maximisation of shareholders’ wealth. Since investment, financing
and dividend decisions are all interrelated, one has to consider the joint impact of these decisions
on the market price of the company’s shares and these decisions should also be solved jointly. The
decision to invest in a new project needs the finance for the investment. The financing decision, in
turn, is influenced by and influences dividend decision because retained earnings used in internal
financing deprive shareholders of their dividends. An efficient financial management can ensure
optimal joint decisions. This is possible by evaluating each decision in relation to its effect on the
shareholders’ wealth.
The above three decisions are briefly examined below in the light of their inter-relationship and to
see how they can help in maximising the shareholders’ wealth i.e. market price of the company’s
shares.
Investment decision: The investment of long term funds is made after a careful assessment of
the various projects through capital budgeting and uncertainty analysis. However, only that
investment proposal is to be accepted which is expected to yield at least so much return as is
adequate to meet its cost of financing. This have an influence on the profitability of the company
and ultimately on its wealth.
Financing decision: Funds can be raised from various sources. Each source of funds involves
different issues. The finance manager has to maintain a proper balance between long -term and
short-term funds. With the total volume of long-term funds, he has to ensure a proper mix of loan
funds and owner’s funds. The optimum financing mix will increase return to equity shareholders
and thus maximise their wealth.
Dividend decision: The finance manager is also concerned with the decision to pay or declare
dividend. He assists the top management in deciding as to what portion of the profit should be paid
to the shareholders by way of dividends and what portion should be retained in the business. An
optimal dividend pay-out ratio maximises shareholders’ wealth.
The above discussion makes it clear that investment, financing and dividend decisions are
interrelated and are to be taken jointly keeping in view their joint effect on the shareholders’ wealth .

© The Institute of Chartered Accountants of India

 (b) Debt Securitisation: It is a method of recycling of funds. It is especially beneficial to financial
intermediaries to support the lending volumes. Assets generating steady cash flows are packaged
together and against this asset pool, market securities can be issued, e.g. housing finance, auto
loans, and credit card receivables.
Process of Debt Securitisation
(i) The origination function – A borrower seeks a loan from a finance company, bank, HDFC. The
credit worthiness of borrower is evaluated and contract is entered into with repayment
schedule structured over the life of the loan.
(ii) The pooling function – Similar loans on receivables are clubbed together to create an
underlying pool of assets. The pool is transferred in favour of Special purpose Vehicle (SPV),
which acts as a trustee for investors.
(iii) The securitisation function – SPV will structure and issue securities on the basis of asset pool.
The securities carry a coupon and expected maturity which can be asset-based/mortgage
based. These are generally sold to investors through merchant bankers. Investors are –
pension funds, mutual funds, insurance funds.
The process of securitization is generally without recourse i.e. investors bear the credit risk
and issuer is under an obligation to pay to investors only if the cash flows are received by him
from the collateral. The benefits to the originator are that assets are shifted off the balance
sheet, thus giving the originator recourse to off-balance sheet funding.
(c) Concept of Discounted Payback Period
Payback period is time taken to recover the original investment from project cash flows. It is also
termed as break even period. The focus of the analysis is on liquidity aspect and it suffers from the
limitation of ignoring time value of money and profitability. Discounted payback period consi ders
present value of cash flows, discounted at company’s cost of capital to estimate breakeven period
i.e. it is that period in which future discounted cash flows equal the initial outflow. The shorter the
period, better it is. It also ignores post discounted payback period cash flows.

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 PAPER 8B : ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/HINTS
7. (a) NI = GDP (MP) –Depreciation +NFIA- Net Indirect Tax
Where GDP (MP) = Value of output- intermediate consumption
Value of Output = Sales+ change in stock
= 700+ (400-500)
= 600
GDP (MP) = 600-350 = 250
Therefore NI= 250-150 +30-(110-50)
= 70 Crore
(b) A Social Good is defined as one which all enjoy in common in the sense that each individual’s
consumption of such a good leads to no subtraction from any other individuals consumption of that
good. Similarity between Social Goods and Common Pool Resources is that both are non -
excludable whereas dissimilarity is seen in their nature that is Social Goods are non-rival which
means that the use of these goods does not reduce the availability for others, while Common Pool
Resources are rival in nature which means that the use of these resources reduce the availability
for others.
(c) The Marginal Standing Facility (MSF) refers to the facility under which scheduled commercial banks
can borrow additional amount of overnight money from the central bank over and above what is
available to them through the LAF window by dipping into their Statutory Liquidity Ratio (SLR)
portfolio up to a limit .The scheme has been introduced by RBI with the main aim of reducing
volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary
transmission in the financial system. Banks can borrow through MSF on all working days except
Saturdays, between 7.00 pm and 7.30 pm, in Mumbai. The minimum amount which can be
accessed through MSF is ` 1 crore and more will be available in multiples of ` 1 crore. The MSF
would be the last resort for banks once they exhaust all borrowing options including the liquidity
adjustment facility on which the rates are lower compared to the MSF.
(d) Specific tariff is an import duty which levied as a fixed charge per unit of the good imported.
Therefore amount in total tariff revenue = 2000*15%
= Rs. 300/-
In this case, total Rs. 300/- is collected, whether the price of a sunglass is of Rs. 1000 or Rs. 2000
for different brand.
8. (a) (i) M 3 = M 1+ net time deposits with the banking system
M 1= Currency notes and coins with the public+ demand deposits of banks+ other deposits
with RBI
Therefore, Net time deposits with the banking system = M 3 - M 1
450000- 3000-100000-100000
= Rs. 247000 Crore
M 4 = M 3 + total deposits with the post office savings organization (excluding National savings
Certificate)
M 4 = 450000 + 20000
M 4 = 470000 Crore.

© The Institute of Chartered Accountants of India

 (ii) The transaction demand for money according to Keynes is interest-inelastic; whereas Baumol
and Tobin show that money held for transaction purposes is interest elastic.
(b) Economic efficiency increases due to quantitative and qualitative benefits of extended division of
labour, economies of large scale production, betterment of manufacturing capabilities, increased
competitiveness and profitability by adoption of cost reducing technology and business practices
and decrease in the likelihood of domestic monopolies. Efficient deployment of productive
resources - natural, human, industrial and financial resources ensures productivity gains.
Mercantilist argued that trade is a zero sum game. Mercantilism advocated maximizing exports in
order to bring in more precious metals and minimizing imports through the state imposing very high
tariffs on foreign goods. This view argues that trade is a ‘zero-sum game’, with winners who win
does so only at the expense of losers and one country’s gain is equal to another country’s loss, so
that the net change in wealth or benefits among the participants is zero.
(c) Yes, Countries like India are unable to estimate their national income wholly by one method. There
are various sectors in an economy and national income generated by these sectors is estimated
by using different methods. For example, in agricultural sector, net value added is estimated by
the production method, in small scale sector net value added is estimated by the income method
and in the construction sector net value added is estimated by the expenditure method.
9. (a) Market power is an important factor that contributes to inefficiency because it results in higher
prices than competitive prices. In addition, market power also tends to restrict output and leads to
deadweight loss. Because of the social costs imposed by monopoly, governments intervene by
establishing rules and regulations designed to promote competition and prohibit actions that are
likely to restrain competition. These legislations differ from country to country. For example, in
India, we have the Competition Act, 2002(as amended by the Competition (Amendment) Act,
2007) to promote and sustain competition in markets. Such legislations generally aim at prohibiting
contracts, combinations and collusions among producers or traders which are in restraint of trade
and other anticompetitive actions such as predatory pricing. On the contrary, some of the regulatory
responses of government to incentive failure tend to create and protect monopoly positions of firms
that have developed unique innovations. For example, patent and copyright laws grant exclusive
rights of products or processes to provide incentives for invention and innovation. Policy options
for limiting market power also include price regulation in the form of setting maximum prices that
firms can charge. Price regulation is most often used for natural monopolies that c an produce the
entire output of the market at a cost that is lower than what it would be if there were several firms.
If a firm is a natural monopoly, it is more efficient to permit it serve the entire market rather than
have several firms who compete each other. Examples of such natural monopoly are electricity,
gas and water supplies. In some cases, the government‘s regulatory agency determines an
acceptable price, so as to ensure a competitive or fair rate of return. This practice is called rate-of-
return regulation. Another approach to regulation is setting price-caps based on the firm’s variable
costs, past prices, and possible inflation and productivity growth.
(b) The deposit expansion multiplier describes the amount of additional money created by c ommercial
bank through the process of lending the available money it has in excess of the central bank's
reserve requirements. The deposit expansion multiplier is, thus inextricably tied to the bank's
reserve requirement. This measure tells us how much new money will be created by the banking
system for a given increase in the high powered money. It reflects a bank's ability to increase the
money supply. The deposit expansion multiplier is the reciprocal of the required reserve ratio.
If reserve ratio is 20%, then credit multiplier = 1/0.20 = 5.
The deposit expansion multiplier = 1/ Required Reserve Ratio

10

© The Institute of Chartered Accountants of India

 (c) Given, MPC = 0.8
Planned to increase National Income by= Rs. 3000 Crore
1
K =
1  MPC
1
=5
1  0 .8
Y
We also know K =
I
3000
So 5 =
I
∆I = 600 Crore.
10. (a) The wide-reaching collection of markets and institutions that handle the exchange of foreign
currencies is known as the foreign exchange market. Being an over-the-counter market, it is not
a physical place; rather, it is an electronically linked network of big banks, dealers and foreign
exchange brokers who bring buyers and sellers together.
The major participants in the exchange market are central banks, com mercial banks, governments,
foreign exchanged dealers, multinational corporations that engage in international trade and
investments, non-bank financial institutions such as asset management firms, insurance
companies, brokers, arbitrageurs and speculators. The central banks participate in the foreign
exchange markets, not to make profit, but essentially to contain the volatility of exchange rate to
avoid sudden and large appreciation or depreciation of domestic currency and to maintain stability
in exchange rate in keeping with the requirements of national economy. If the domestic currency
fluctuates excessively, it causes panic and uncertainty in the business world. Commercial banks
participate in the foreign exchange market either on their own account or for their clients. When
they trade on their own account, banks may operate either as speculators or arbitrageurs/or both.
The bulk of currency transactions occur in the inter-bank market in which the banks trade with each
other. Foreign exchange brokers participate in the market as intermediaries between different
dealers or banks. Arbitrageurs profit by discovering price differences between pairs of currencies
with different dealers or banks. Speculators, who are bulls or bears, are deliberate risk-takers who
participate in the market to make gains which result from unanticipated changes in exchange rates.
Other participants in the exchange market are individuals who form only a very insignificant fraction
in terms of volume and value of transactions.
(b) The difference between the aggregate amount that a country's citizens and companies earn
abroad, and the aggregate amount that foreign citizens and overseas companies earn in that
country.
1
(c) Government spending multiplier =
1  MPC
1 1
= =4
1  0.75 0.25

Net effect of Rs 100 crore spending is Rs. 100 crore* 4 = Rs. 400 crore

11

© The Institute of Chartered Accountants of India

11. (a) (i) In an open economy, the main advantages of a fixed rate regime are, firstly, a fixed exchange
rate avoids currency fluctuations and eliminates exchange rate risks and transaction costs
that can impede international flow of trade and investments. A fixed exchange rate can thus
greatly enhance international trade and investment. Secondly, a fixed exchange rate syste m
imposes discipline on a country’s monetary authority and therefore is more likely to generate
lower levels of inflation. Thirdly, the government can encourage greater trade and investment
as stability encourages investment. Fourthly, exchange rate peg c an also enhance the
credibility of the country’s monetary policy. And lastly, in the fixed or managed floating (where
the market forces are allowed to determine the exchange rate within a band) exchange rate
regimes, the central bank is required to stand ready to intervene in the foreign exchange
market and, also to maintain an adequate amount of foreign exchange reserves for this
purpose.
(ii) The autonomous expenditure multiplier in a four sector model includes the effects of foreign
1
transactions and is stated as where v is the propensity to import which is greater than
1- b + v
zero. The greater the value of v, the lower will be the autonomous expenditure multiplier.
(b) (i) Non-discretionary fiscal policy or automatic stabilizers are part of the structure of the economy
and are ‘built-in’ fiscal mechanisms that operate automatically to reduce the expansions and
contractions of the business cycle. It occurs through automatic adjustments in government
expenditures and taxes without any deliberate governmental action i.e. by limiting the
increase in disposable income during an expansionary phase and limiting the decrease in
disposable income during the contraction phase of the business cycle.
(ii) The demand for money is a decision about how much of one’s given stock of wealth should
be held in the form of money rather than as other assets such as bonds. Demand for money
is actually demand for liquidity and a demand to store value.
Or
Regional Trade Agreements (RTAs) are defined as grouping of countries, which are formed
under the objective of reducing barriers to trade between member countries; not necessarily
belonging to the same geographical region.

12

© The Institute of Chartered Accountants of India

 Test Series: May, 2020
MOCK TEST PAPER- 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If
a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) The data relating to two companies are as given below:
Company A Company B
Equity Capital Rs.6,00,00,000 Rs.3,50,00,000
15% Debentures Rs.40,00,000 Rs.65,00,000
Output (units) per annum 6,00,000 1,50,000
Selling price/ unit Rs.60 Rs.500
Fixed Costs per annum Rs.70,00,000 Rs.1,40,00,000
Variable Cost per unit Rs.30 Rs.275
You are required to CALCULATE the Operating leverage, Financial leverage and Combined
leverage of the two Companies.
(b) ABC Limited has the following book value capital structure:
Equity Share Capital (1 crore shares @ Rs.10 each) Rs.1,000 lakh
Reserves and Surplus Rs.2,250 lakh
9% Preference Share Capital (5 lakh shares @ Rs.100 each) Rs.500 lakh
8.5% Debentures (1.5 lakh debentures @ Rs.1,000 each) Rs.1,500 lakh
12% Term Loans from Financial Institutions Rs.500 lakh

- The debentures of ABC Limited are redeemable at par after five years and are quoting at Rs.985
per debenture.
- The current market price per equity share is Rs.60. The prevailing default-risk free interest rate on
10-year GOI Treasury Bonds is 5.5%. The average market risk premium is 7%. The beta of the
company is 1.85
- The preference shares of the company are redeemable at 10% premium after 5 years is currently
selling at Rs.102 per share.
The applicable income tax rate for the company is 35%.
Required:
CALCULATE weighted average cost of capital of the company using market value weights.
1

© The Institute of Chartered Accountants of India

 (c) A company proposes to install a machine involving a Capital Cost of Rs.72,00,000. The life of the
machine is 5 years and its salvage value at the end of the life is nil. The machine will produce the
net operating income after depreciation of Rs.13,60,000 per annum. The Company’s tax rate is
35%.
The Net Present Value factors for 5 years are as under:
Discounting Rate : 14 15 16 17 18 19
Cumulative factor : 3.43 3.35 3.27 3.20 3.13 3.06

You are required to COMPUTE the internal rate of return (IRR) of the proposal.
(d) A&R Ltd. is an all equity financed company with a market value of Rs.25,000 lakh and cost of equity
(Ke) 18%. The company wants to buyback equity shares worth Rs.5,000 lakh by issuing and
raising 10% debentures redeemable at 10% premium after 5 years. Rate of tax may be taken as
35%. Applying Modigliani-Miller (MM) (with taxes), you are required to CALCULATE after
restructuring:
(i) Market value of A&R Ltd.
(ii) Cost of Equity (K e)
(iii) Weighted average cost of capital (using market weights). [4 × 5 Marks = 20 Marks]
2. ZX Ltd. has a paid-up share capital of Rs.1,00,00,000, face value of Rs.100 each. The current market
price of the shares is Rs.100 each. The Board of Directors of the company has an agenda of meeting to
pay a dividend of 50% to its shareholders. The company expects a net income of Rs.75,00,000 at the
end of the current financial year. Company also plans for a capital expenditure for the next fina ncial year
for a cost of Rs.95,00,000, which can be financed through retained earnings and issue of new equity
shares.
Company’s desired rate of investment is 15%.
Required:
Following the Modigliani- Miller (MM) Hypothesis, DETERMINE value of the company when:
(i) It does not pay dividend and
(ii) It does pay dividend [10 Marks]
3. A&R Ltd. has undertaken a project which has an initial investment of Rs.2,000 lakhs in plant & machinery
and Rs.800 lakhs for working capital. The plant & machinery would have a salvage value of Rs. 474.61
lakhs at the end of the fifth year. The plant & machinery would depreciate at the rate of 25% p.a. on
WDV method. The other details of the project for the five year period are as follows:
Sales 10,00,000 units p.a.
Selling price per unit Rs.500
Variable cost 50% of selling price
Fixed overheads (excluding depreciation) Rs.300 lakh p.a.
Corporate tax rate 35%
Rate of interest on bank loan 12%
After tax required rate of return 15%

© The Institute of Chartered Accountants of India

 Required:
(i) CACULATE net present value (NPV) of the project and DETERMINE the viability of the project.
(ii) DETERMINE the sensitivity of project’s NPV under each of the following condition:
a. Decrease in selling price by 10%;
b. Increase in cost of plant & machinery by 10%.
PV factor Year-1 Year-2 Year-3 Year-4 Year-5
12% 0.892 0.797 0.711 0.635 0.567
15% 0.869 0.756 0.657 0.571 0.497

[10 Marks]
4. The following accounting information and financial ratios of A&R Limited relate to the year ended 31st
March, 2020:
Inventory Turnover Ratio 6 Times
Creditors Turnover Ratio 10 Times
Debtors Turnover Ratio 8 Times
Current Ratio 2.4
Gross Profit Ratio 25%
Total sales Rs.6,00,00,000; cash sales 25% of credit sales; cash purchases Rs.46,00,000; working
capital Rs.56,00,000; closing inventory is Rs.16,00,000 more than opening inventory.
You are required to CALCULATE:
(i) Average Inventory
(ii) Purchases
(iii) Average Debtors
(iv) Average Creditors
(v) Average Payment Period
(vi) Average Collection Period
(vii) Current Assets
(viii) Current Liabilities.
Take 365 days a year [10 Marks]
5. (a) Cost sheet of A&R Ltd. provides the following particulars:
Amount per unit (Rs.)
Raw materials cost 200.00
Direct labour cost 75.00
Overheads cost 150.00
Total cost 425.00
Profit 75.00
Selling Price 500.00

© The Institute of Chartered Accountants of India

 The Company keeps raw material in stock, on an average for four weeks; work-in-progress, on an
average for one week; and finished goods in stock, on an average for two weeks.
The credit allowed by suppliers is three weeks and company allows four weeks credit to its debtors.
The lag in payment of wages is one week and lag in payment of overhead expenses is two weeks.
The Company sells one-fifth of the output against cash and maintains cash-in-hand and at bank
put together at Rs.2,50,000.
Required:
PREPARE a statement showing estimate of Working Capital needed to finance an activity level of
2,60,000 units of production. Assume that production is carried on evenly throughout the year, and
wages and overheads accrue similarly. Work-in-progress stock is 80% complete in all respects.
(b) The following information is provided by the P Ltd. for the year ending 31 st March, 2020.
Raw Material storage period 52 days
Work in progress conversion period 18 days
Finished Goods storage period 20 days
Debt Collection period 75 days
Creditors' payment period 25 days
Annual Operating Cost 45 crore
(Including depreciation of Rs.42,00,000)
(1 year = 360 days)
You are required to CALCULATE Operating Cycle period and Number of Operating Cycles in a
year. [8 + 2 = 10 Marks]
6. Answer the followings:
(a) EXPLAIN in brief the Pecking order theory.
(b) EXPLAIN Over-capitalisation. STATE its causes and consequences.
(c) EXPLAIN in short the term Letter of Credit.
OR
"Financing a business through borrowing is cheaper than using equity." Briefly EXPLAIN.
[4+4+2 = 10 Marks]

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question 7 is compulsory question.
Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above
the required number, then only the requisite number of questions first answered will be the evaluated
the rest answer shall be ignored
Working Notes should form part of the answer.

QUESTIONS
7. (a) How are the following transactions treated in national income calculation? What is the ratio nale in
each case?
(i) Electricity sold to a steel plant
(ii) Electric power sold to a consumer household
(iii) A car manufacturer procuring parts and components from the market (3 Marks)
(b) What do you mean by price ceiling? Explain it with the help of examples. (2 Marks)
(c) How the following affect money multiplier and money supply?
(i) Banks open large number ATMs all over the country.
(ii) If banks decide to keep 100% reserves. (3 Marks)
(d) How does trade increase economic efficiency? (2 Marks)
8. (a) Examine the situation if aggregate expenditures exceeds the economy’s production capacity.
(2 Marks)
(b) How do the markets fail in an economy? What are the main reasons behind this market fai lure
and economic inefficiency? (3 Marks)
(c) Explain operating procedures in the context of monetary policy of India? (2 Marks)
(d) How does Escalated tariff structure work and discriminated ? (3 Marks)
9. (a) Fiscal policy achieve social justice and equity. Comment on this with the help of examples.
(5 Marks)
(b) What does the reserve money determine? Compute Reserve Money from the following data -
Particulars Rs. in Crore
Currency in circulation 14903.90
RBI’s net non-monetary liabilities 4945.80

© The Institute of Chartered Accountants of India

 Banker’s deposits with RBI 5780.60
Other deposits with RBI 317.20
Long term deposits of residents 321.10 (3 Marks)
(c) What are the major functions of the WTO? (2 Marks)
10. (a) An increase in investment by Rs. 700 crore leads to increase in national income by
Rs 3,500 crore. Calculate marginal propensity to consume and change in saving. (3 Marks)
(b) What effect does government expenditure have on money supply? (2 Marks)
(c) Define tariff and what are its effects on the importing and exporting countries? (5 Marks)
11. (a) Calculate the GNP at market price using value added method with the help of following data –
Particulars Rs. in crore
Value of output in primary sector 1000
Net factor income from abroad -20
Value of output in tertiary sector 700
Intermediate consumption in secondary sector 400
Value of output in secondary sector 900
Government transfer payments 600
Intermediate consumption in primary sector 500
Intermediate consumption in tertiary sector 400
(5 Marks)
(b) What do you mean by common pool resources and why producers and consumers do not pay for
these resources? (3 Marks)
(c) What role does Market Stabilisation Scheme (MSS) play in our economy? (2 Marks)
OR
What is meant by import quotas? (2 Marks)

© The Institute of Chartered Accountants of India

 Test Series: May, 2020
MOCK TEST PAPER- 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Suggested Answers/ Hints

1. (a) Computation of Operating leverage, Financial leverage and Combined leverage of two
companies
Company A Company B
Output units per annum 6,00,000 1,50,000
(Rs.) (Rs.)
Selling price / unit 60 500
Sales revenue 3,60,00,000 7,50,00,000
(6,00,000 units × Rs.60) (1,50,000 units × Rs.500)
Less: Variable costs 1,80,00,000 4,12,50,000
(6,00,000 units × Rs.30) (1,50,000 units × Rs.275)
Contribution (C) 1,80,00,000 3,37,50,000
Less: Fixed costs 70,00,000 1,40,00,000
EBIT (Earnings before Interest and tax) 1,10,00,000 1,97,50,000
Less: Interest @ 15% on debentures 6,00,000 9,75,000
PBT 1,04,00,000 1,87,75,000

Operating Leverage =
Contribution 1.64 1.71
EBIT (Rs.1,80,00,000 ÷ (Rs.3,37,50,000 ÷
1,10,00,000) Rs. 1,97,50,000)

Financial Leverage =
EBIT 1.06 1.05
PBT (Rs.1,10,00,000 ÷ (Rs.1,97,50,000 ÷
Rs.1,04,00,000) Rs. 1,87,75,000)
Combined Leverage = DOL × DFL 1.74 1.80
(1.64 × 1.06) (1.71 × 1.05)
(b) Working Notes:
(1) Computation of cost of debentures (Kd) :
(1,000 − 985)
Rs.85(1 − 0.35) + 55.25 + 3
Kd = 5 = = 0.0586 or 5.86%
(1,000 + 985) 992.5
2
(2) Computation of cost of term loans (KT) :
= r (1− t)
= 0.12 (1− 0.35) = 0.078 or 7.8%

© The Institute of Chartered Accountants of India 1

 (3) Computation of cost of preference capital (KP) :
Preference Dividend + (RV - NP) / n
Kp =
(RV + NP) / 2

(110 − 102)
Rs.9 + 9 + 1.6
= 5 = = 0.1 or 10%
(110 + 102) 106
2
(4) Computation of cost of equity (Ke) :
= Rf + ß(Rm – Rf)
Or, = Risk free rate + (Beta × Risk premium)
= 0.055 + (1.85 × 0.07) = 0.1845 or 18.45%
Calculation of Weighted Average cost of capital Using market value weights
Source of Capital Market value of capital Weights After tax cost WACC (%)
structure (Rs. in lakh) of capital (%)

Equity share capital

6,000 0.71 18.45 13.09
(1 crore shares × Rs.60 )
9% Preference share
capital 510 0.06 10.00 0.60
(5 lakh shares × Rs.102)
8.5 % Debentures
1,477.5 0.17 5.86 0.99
(1.5 lakh × Rs.985)
12% Term loans 500 0.06 7.80 0.47
8,487.50 1.000 15.15
(c)
Computation of cash inflow per annum Rs.
Net operating income per annum 13,60,000
Less: Tax @ 35% 4,76,000
Profit after tax 8,84,000
Add: Depreciation (Rs.72,00,000 / 5 years) 14,40,000
Cash inflow 23,24,000

The IRR of the investment can be found as follows:

NPV = − Rs. 72,00,000 + Rs. 23,24,000 (PVAF5, r) = 0
Rs.72,00,000
or PVA F5 r ( Cumulative factor) = = 3.09
Rs.23,24,000
Computation of Internal Rate of Return (IRR)
Discounting rate 15% 19%
Cumulative factor 3.35 3.06
Total NPV (Rs.) 77,85,400 71,11,440

© The Institute of Chartered Accountants of India 2

 (Rs.23,24,000 × 3.35) ( Rs.23,24,000 × 3.06)
Internal outlay (Rs.) 72,00,000 72,00,000
Surplus (Deficit) (Rs.) 5,85,400 (88,560)
NPV at LR
IRR = LR + ×(HR -LR)
NPV at LR - NPV at HR
5,85,400
= 15% + ×(19% -15%)
5,85,400 - (-88,560)

= 15% +3.47 =18.47%

(d) Value of a company (V) = Value of equity (S) + Value of debt (D)
A&R Ltd. is all equity financed company, its value would equal to value of equity.
Net Income (NI)
Market value of equity = =
Ke

In the question, market value of equity is Rs.25,000 lakh and cost of equity (Ke) is 18%. The Net
Income (NI) is calculated as follows:
Net income (NI) for equity - holders
= Market Value of Equity
Ke

Net income (NI) for equity holders

= 25,000 lakh
0.18
Net income for equity holders = 4,500 lakh
Net Income (NI) is after tax income, the before tax income would be
4,500lakh
EBT= = 6,923.07 lakh.
(1 − 0.35)

Since, A&R Ltd. is an all equity financed and there is no interest expense, so here EBT is equal to EBIT.
After issuing 10% debentures, the A&R Ltd would become a levered company.
(i) The value of A&R Ltd. after issuing debentures would be calculated as follows:
Value of a levered company (Vg)
= Value of an unlevered company (Vu) + Tax benefit (TB)
= Rs.25,000 lakh + (Rs.5,000 lakh × 35%)
= Rs.25,000 + Rs.1,750 = Rs.26,750
(ii) Cost of Equity (Ke)
Total Value = Rs.26,750 lakh
Less: Value of Debt = Rs. 5,000 lakh
Value of Equity = Rs. 21,750
4,175lakh
Ke = =0.1919 = 19.19%
21,750lakh

© The Institute of Chartered Accountants of India 3

 (iii) WACC (on market value weight)
Components of Costs Amount (lakh) Cost of Capital (%) Weight WACC (%)
Equity 21,750 19.19 0.81 15.54
Debt 5,000 8.10 0.19 1.54
26,750 17.08
Workings Note:
1. (Rs. in lakh)
All Equity Debt and Equity
EBIT (as calculated above) 6,923.07 6,923.07
Interest to debt-holders - 500.00
EBT 6,923.07 6,423.07
Taxes (35%) 2,423.07 2,248.07
Income available to equity shareholders 4,500.00 4,175.00
Income to debt holders plus income available to shareholders 4,500.00 4,675.00

(5,500 − 5,000)
Rs.500(1 − 0.35) +
2. Cost of Debenture (Kd) = 5
(5,500 + 5,000)
2
Rs.325 + 100
= = 0.081 or 8.1%
5,250
2. As per MM Hypothesis, value of firm/ company is calculated as below:
(n + Δn)P1 - I + E
Vf or nP₀ =
(1+ K e )
Where,
Vf = Value of firm in the beginning of the period
n = number of shares in the beginning of the period
∆n = number of shares issued to raise the funds required
I = Amount required for investment
E = total earnings during the period
(i) Value of the ZX Ltd. when dividends are not paid.
(n + Δn)P1 - I + E
nPₒ =
1+ K e

 20,00,000 
 1,00,000 +  ×Rs.115 - Rs.95,00,000 + Rs.75,00,000
 115 
nP₀ =
(1+ 0.15)

Rs.1,35,00,000 - Rs.95,00,000 + Rs.75,00,000

= = Rs.1,00,00,000
(1+ 0.15)

© The Institute of Chartered Accountants of India 4

 Working notes:
1. Price of share at the end of the period (P1)
P1 + D1
Pₒ =
1+ K e
P1 + 0
100 = or, P₁= 115
1+ 0.15
2. Calculation of funds required for investment
Earnings Rs.75,00,000
Dividend distributed Nil
Fund available for investment Rs.75,00,000
Total Investment Rs.95,00,000
Balance Funds required Rs.20,00,000
3. Calculation of no. of shares required to be issued for balance fund
Funds required 20,00,000
No. of shares (∆n) = = shares
Price at end (P1 ) 115
(ii) Value of the ZX Ltd. when dividends are paid.
(n + Δn)P1 - I + E
nPₒ =
1+ K e
 70,00,000 
 1,00,000 +  ×Rs.65 - Rs.95,00,000 + Rs.75,00,000
 65 
nP₀ =
(1+ 0.15)

Rs.1,35,00,000 - Rs.95,00,000 + Rs.75,00,000

= = Rs.1,00,00,000
(1+ 0.15)
Working notes:
4. Price of share at the end of the period (P1)
P1 + D1
Pₒ =
1+ K e
P1 + 50
100 = or, P₁= Rs.65
1+ 0.15
5. Calculation of funds required for investment
Earnings Rs.75,00,000
Dividend distributed Rs.50,00,000
Fund available for investment Rs.25,00,000
Total Investment Rs.95,00,000
Balance Funds required Rs.70,00,000

© The Institute of Chartered Accountants of India 5

 6. Calculation of no. of shares required to be issued for balance fund
Funds required 70,00,000
No. of shares (∆n) = = =1,07,693 shares(approx.)
Price at end (P1 ) 65

Note- As per MM-hypothesis of dividend irrelevance, value of firm remains same irrespective of
dividend paid. In the solution, there may be variation in value, which is due to rounding off error.

3. (i) Calculation of Net Present Value (NPV):

Year-1 Year-2 Year-3 Year-4 Year-5
Sales volume (Qty. in lakh) 10 10 10 10 10
Contribution per unit (Rs.) 250 250 250 250 250
(Selling price – variable cost)
Total contribution (Rs.in lakh) 2,500 2,500 2,500 2,500 2,500
Less: Fixed overheads (Rs. In 300 300 300 300 300
lakh)
PBDT 2,200 2,200 2,200 2,200 2,200
Less: Depreciation (Rs. in lakh) 500 375 281.25 210.94 158.20
(Working note-1)
PBT 1,700 1,825 1,918.75 1,989.06 2,041.80
Less: Tax @ 35% 595 638.75 671.56 696.17 714.63
PAT 1,105 1,186.25 1,247.19 1,292.89 1,327.17
Add: Depreciation 500 375 281.25 210.94 158.20
Add: Salvage value of plant & - - - - 474.61
machinery
Add: Working capital - - - - 800
Net Cash inflow 1,605 1,561.25 1,528.44 1,503.83 2,759.98
P.V factor @15% 0.869 0.756 0.657 0.571 0.497
P.V of cash inflows 1,394.74 1,180.31 1,004.18 858.68 1,371.71

Net Present Value = P.V of cash inflows – P.V of cash outflows

= Rs. (1,394.74+1,180.31+1,004.18+858.68+1,371.71) – (Rs.2,000 + Rs. 800)
= Rs.3,009.62 lakh
The NPV of the project is positive, hence, the project is viable.
Working note-1:
Year-1 Year-2 Year-3 Year-4 Year-5
Opening balance 2,000 1,500 1,125 843.75 632.81
Depreciation @25% 500 375 281.25 210.94 158.20
Closing WDV 1,500 1,125 843.75 632.81 474.61

© The Institute of Chartered Accountants of India 6

 (ii) Determination of sensitivity of NPV w.r.t.
a. Decrease in selling price by 10%
Year-1 Year-2 Year-3 Year-4 Year-5
Sales volume (Qty. in lakh) 10 10 10 10 10
New Selling price 450 450 450 450 450
Variable cost 250 250 250 250 250
Contribution per unit (Rs.) 200 200 200 200 200
(Selling price – variable cost)
Total contribution (Rs.in lakh) 2,000 2,000 2,000 2,000 2,000
Less: Fixed overheads (Rs. In 300 300 300 300 300
lakh)
PBDT 1,700 1,700 1,700 1,700 1,700
Less: Depreciation (Rs. in 500 375 281.25 210.94 158.20
lakh) (Working note-1)
PBT 1,200 1,325 1,418.75 1,489.06 1,541.80
Less: Tax @ 35% 420 463.75 496.56 521.17 539.63
PAT 780 861.25 922.19 967.89 1,002.17
Add: Depreciation 500 375 281.25 210.94 158.20
Add: Salvage value of plant & - - - - 474.61
machinery
Add: Working capital - - - - 800
Net Cash inflow 1,280 1,236.25 1,203.44 1,178.83 2,434.98
P.V factor @15% 0.869 0.756 0.657 0.571 0.497
P.V of cash inflows 1,112.32 934.61 790.66 673.11 1,210.18
NPV = Rs. (1,112.32+934.61+790.66+673.11+1,210.18) – (Rs. 2,000 + Rs. 800)
= Rs. 4,720.88 – Rs. 2,800 = 1,920.88 lakh
10% reduction in selling price reduces the NPV by 36.18% (3,009.62-1,920.88/3,009.62)
b. Increase in project cost by 10%
Year-1 Year-2 Year-3 Year-4 Year-5
PBDT 2,200 2,200 2,200 2,200 2,200
Less: Depreciation (Rs. in 550 412.5 309.37 232.03 174.03
lakh) (Working note-2)
PBT 1,650 1,787.50 1,890.63 1,967.97 2,025.97
Less: Tax @ 35% 577.50 625.63 661.72 688.79 709.09
PAT 1072.50 1,161.87 1,228.91 1,279.18 1,316.88
Add: Depreciation 550 412.5 309.37 232.03 174.03
Add: Salvage value of - - - - 474.61
plant & machinery
Add: Working capital - - - - 800
Net Cash inflow 1,622.50 1,574.37 1,538.28 1,511.21 2,765.52

© The Institute of Chartered Accountants of India 7

 P.V factor @15% 0.869 0.756 0.657 0.571 0.497
P.V of cash inflows 1,409.95 1,190.22 1,010.65 862.90 1,374.46
NPV = Rs. (1,409.95+1,190.22+1,010.65+862.90+1,374.46) – (Rs. 2,200 + Rs. 800)
= Rs. 5,848.18 – Rs. 3,000 = 2,848.18 lakh
10% increase in project cost reduces the NPV only by 5.36% (3,009.62 -
2,848.18/3,009.62)
Working note-2:
Year-1 Year-2 Year-3 Year-4 Year-5
Opening balance 2,200 1,650 1,237.50 928.13 696.10
Depreciation @25% 550 412.5 309.37 232.03 174.03
Closing WDV 1,650 1,237.50 928.13 696.10 522.07

4. (i) Computation of Average Inventory

Gross Profit = 25% of Rs.6,00,00,000 = Rs.1,50,00,000
Cost of goods sold (COGS) = Sales - Gross Profit
= Rs.6,00,00,000 – Rs.1,50,00,000
= Rs.4,50,00,000
COGS
Inventory Turnover Ratio =
Average Inventory

Rs.4, 50,00,000
6=
Average inventory

Average inventory = Rs.75,00,000

(ii) Computation of Purchases
Purchases = COGS + (Closing Stock – Opening Stock)
= Rs.4,50,00,000 + 16,00,000*
Purchases = Rs.4,66,00,000
* Increase in Stock = Closing Stock – Opening Stock = Rs.16,00,000
(iii) Computation of Average Debtors
25
Let Credit Sales be Rs.100, Cash sales = × 100 = Rs.25
100
Total Sales = 100 + 25= Rs.125
Total sales is Rs.125 credit sales is Rs.100
Rs. 6,00,00,000 × 100
If total sales is Rs.6,00,00,000, then credit sales is =
125
Credit Sales = Rs.4,80,00,000
Cash Sales = (Rs.6,00,00,000 – Rs.4,80,00,000) = Rs.1,20,00,000

© The Institute of Chartered Accountants of India 8

 Net Credit Sales
Debtors Turnover Ratio = =8
Average debtors

Rs.4,80,00,000
= =8
Average debtors
Rs.4,80,00,000
Average Debtors =
8
Average Debtors = Rs.60,00,000
(iv) Computation of Average Creditors
Credit Purchases = Purchases – Cash Purchases
= Rs.4,66,00,000 – Rs.46,00,000 = Rs.4,20,00,000
Credit Purchases
Creditors Turnover Ratio =
Average Creditors
Rs.4, 20,00,000
10 =
Average Creditors
Average Creditors = Rs.42,00,000
(v) Computation of Average Payment Period
Average Creditors
Average Payment Period =
Average Daily Credit Purchases
Rs. 42,00,000 Rs. 42,00,000
= Credit Purchases = Rs. 4,20,00,000
� � � �
365 365

Rs.42,00,000
= × 365 = 36.5 days
Rs.4,20,00,000
Alternatively
Average Payment Period = 365/Creditors Turnover Ratio
365
= = 36.5 days
10
(vi) Computation of Average Collection Period
Average Debtors
Average Collection Period = × 365
Net Credit Sales
Rs.60,00,000
= × 365 = 45.625 days
Rs.4,80,00,000
Alternatively
365
Average collection period =
Debtors Turnover Ratio
365
= = 45.625 days
8

© The Institute of Chartered Accountants of India 9

 (vii) Computation of Current Assets
Current Assets (CA)
Current Ratio =  2.4
Current Liabilities (CL)
2.4 Current Liabilities = Current Assets
CA
or CL =
2.4
Further, Working capital = Current Assets – Current liabilities
CA
So, Rs.56,00,000 = CA -
2.4
1.4CA
Rs.56,00,000 = Or, 1.4 CA = Rs.1,34,40,000
2.4
CA = Rs.96,00,000
(viii) Computation of Current Liabilities
Rs.96,00,000
Current liabilities = = Rs.40,00,000
2.4
5. (a) Statement showing Estimate of Working Capital Needs
(Amount in Rs.) (Amount in Rs.)
A. Current Assets
(i) Inventories:
Raw material (4 weeks)
 2,60,000units×Rs.200 
 × 4 weeks 
 52 weeks  40,00,000
WIP Inventory (1 week)
 2,60,000units×Rs.425 
 ×1week  × 0.8 17,00,000
 52 weeks 
Finished goods inventory (2 weeks)
 2,60,000units×Rs.425  99,50,000
 × 2 weeks  42,50,000
 52 weeks 
(ii) Receivables (Debtors) (4 weeks)
 2,60,000units×Rs.425  4
 × 4 weeks  × 68,00,000
 52 weeks  5th
(iii) Cash and bank balance 2,50,000
Total Current Assets 1,70,00,000
B. Current Liabilities:
(i) Payables (Creditors) for materials (3 weeks)
 2,60,000units×Rs.200  30,00,000
 × 3 weeks 
 52 weeks 

© The Institute of Chartered Accountants of India 10

 (ii) Outstanding wages (1 week)
 2,60,000units×Rs.75  3,75,000
 ×1week 
 52 weeks 
(iii) Outstanding overheads (2 weeks)
 2,60,000units×Rs.150 
 × 2 weeks 
 52 weeks  15,00,000

Total Current Liabilities 48,75,000

Net Working Capital Needs (A – B) 1,21,25,000
(b) Calculation of Operating Cycle Period and number of Operating Cycle in a Year
Operating Cycle Period = R + W + F + D – C
= 52 + 18 + 20 + 75 – 25 = 140 days
360
Number of Operating Cycle in a Year =
Operating Cycle Period
= 360/140 = 2.57 times
6. (a) This theory states that firms prefer to issue debt when they are positive about future earnings.
Equity is issued when they are doubtful and internal finance is insufficient.
The pecking order theory argues that the capital structure decision is affected by manager’s choice
of a source of capital that gives higher priority to sources that reveal the least amount of
information.
Pecking order theory suggests that managers may use various sources for raising of fund in the
following order.
1. Managers first choice is to use internal finance
2. In absence of internal finance they can use secured debt, unsecured debt, hybrid debt etc.
3. Managers may issue new equity shares as a last option.
So briefly under this theory rules are
Rule 1: Use internal financing first.
Rule 2: Issue debt next
Rule 3: Issue of new equity shares at last
(b) Over-capitalization and its Causes and Consequences
It is a situation where a firm has more capital than it needs or in other words assets are worth less
than its issued share capital, and earnings are insufficient to pay dividend and interest.
Causes of Over Capitalization
Over-capitalisation arises due to following reasons:
(i) Raising more money through issue of shares or debentures than company can employ
profitably.
(ii) Borrowing huge amount at higher rate than rate at which company can earn.
(iii) Excessive payment for the acquisition of fictitious assets such as goodwill etc.
(iv) Improper provision for depreciation, replacement of assets and distribution of dividends at a
higher rate.
(v) Wrong estimation of earnings and capitalization.

© The Institute of Chartered Accountants of India 11

 Consequences of Over-Capitalisation
Over-capitalisation results in the following consequences:
(i) Considerable reduction in the rate of dividend and interest payments.
(ii) Reduction in the market price of shares.
(iii) Resorting to “window dressing”.
(iv) Some companies may opt for reorganization. However, sometimes the matter gets worse and
the company may go into liquidation.
(c) Letter of Credit: It is an arrangement by which the issuing bank on the instructions of a customer
or on its own behalf undertakes to pay or accept or negotiate or authorizes another bank to do so
against stipulated documents subject to compliance with specified terms and conditions.
Or
“Financing a business through borrowing is cheaper than using equity”
(i) Debt capital is cheaper than equity capital from the point of its cost and interest being
deductible for income tax purpose, whereas no such deduction is allowed for dividends.
(ii) Issue of new equity dilutes existing control pattern while borrowing does not result in dilution
of control.
(iii) In a period of rising prices, borrowing is advantageous. The fixed monetary outgo decreases
in real terms as the price level increases.

© The Institute of Chartered Accountants of India 12

 PAPER 8B: ECONOMICS FOR FINANCE
ANSWERS / HINTS
7. (a) (i) Being an intermediate good, electricity sold to a steel plant will not be included in national
income calculation. The underlying principle is that only finished goods and services which
are directly sold to the consumer for final consumption would be included. The value of the
final output, namely steel, includes the value of electricity used up in the production
process. Counting electricity sold to a steel plant separately will lead to the error of double
counting and exaggerate the value of steel production.
(ii) Electric power sold to a consumer household would be included in the calculation of GDP
since it is a final good consumed by the end user. Electric power sold to a consumer does
not require any further processing and does not undergo any further transformation before
use. Once a final good has been sold, it passes out of the active economic flow.
(iii) The value of parts and components procured from the market by a car manufacturer will not
be included in national income calculation because these are intermediate goods used in
car production. Value is added to the parts and components through the process of
production and the same is resold. The value of the final output, namely car, includes the
value of the parts and components. Counting parts and components separately will lead to
the error of double counting and exaggerate the value of car production.
(b) Price ceiling is a government intervention in regulated market economies wherein an upper limit
is set on the price charged for a product or service and the sellers are bound to abide by such
limits. The objective is to influence the outcomes of a market on the grounds of fairness and
equity. When prices of certain essential commodities rise excessively, government may resort to
controls in the form of price ceilings (also called maximum price) for making a resource or
commodity available to all at reasonable prices. For example: maximum prices of food grains and
essential items are set by government during times of scarcity. A price ceiling which is set below
the prevailing market clearing price will generate excess demand over supply.
(c) (i) ATMs let people to withdraw cash from the bank as and when needed, reduces cost of
conversion of deposits to cash and makes deposits relatively more convenient. People hold
less cash and more deposits, thus reducing the currency-deposit ratio; increasing the
money multiplier causing the money supply to increase.
(ii) If banks decides to keep 100% reserves, then the Money multiplier = 1/required reserve
ratio = 1/100% = 1. Deposits simply substitute for the currency that is held by banks as
reserves and therefore no new money is created by banks.
(d) Economic efficiency increases due to quantitative and qualitative benefits of extended division of
labour, economies of large scale production, betterment of manufacturing capabilities, increased
competitiveness and profitability by adoption of cost reducing technology and business practices
and decrease in the likelihood of domestic monopolies. Efficient deployment of productive
resources -natural, human, industrial and financial resources ensures productivity gains.
8. (a) Aggregate expenditure or Aggregate demand is the sum of all Planned expenditures for the entire
economy. When aggregate expenditure exceeds an economy’s production capacity at full
employment level, the resulting strain on resources creates demand - pull inflation or higher price
level. Nominal output will increase, but it merely reflects higher prices, rather than additional real
output.
(b) Market fails in an economy when the free market leads to misallocation of society's scarce
resources or in other words, there is either overproduction or underproduction of particular goods
and services leading to a less than optimal outcome.
The four main reasons for market failure are: market power, externalities, public goods, and
incomplete information.

© The Institute of Chartered Accountants of India 13

 Excessive market power causes single producer or small number of producers to produce and
sell less output than would be produced and charge a higher price.
Externalities hinder the ability of market prices to convey accurate information about how much to
produce and how much to buy.
Public goods, due to their special characteristics such as non-excludability and non-rivalry, are
not produced at all or produced less than optimal quantities. These have Free rider problem
causing over-use, degradation and depletion of common resources resulting in market failure.
Information failure manifests in asymmetric information causing adverse selection and moral
hazard.
(c) Operating procedures are the variety of rules, traditions and practices used in the actual
implementation of monetary policy. It encompasses, basically, a set of tactics such as choice of
the operating target and policy instruments, the nature and frequency of use of policy
instruments, market interventions, the width of corridor for market interest rates and the manner
of policy signals to effect desired changes in the intermediate targets.
(d) Escalated Tariff structure refers to the system wherein the nominal tariff rates on imports of
manufactured goods are higher than the nominal tariff rates on intermediate inputs and raw
materials, i.e the tariff on a product increases as that product moves through the value-added
chain. For example a four percent tariff on iron ore or iron ingots and twelve percent tariff on steel
pipes. This type of tariff is discriminatory as it protects manufacturing industries in importing
countries and dampens the attempts of developing manufacturing industries of exporting
countries. This has special relevance to trade between developed countries and developing
countries. Developing countries are thus forced to continue to be suppliers of raw materials
without much value addition.
9. (a) Fiscal policy is a chief instrument available for governments to influence income distribution and
plays a significant role in reducing inequality and achieving equity and social justice. The
distribution of income in the society is influenced by fiscal policy both directly and indirectly.
While current disposable incomes of individuals and corporates are dependent on direct taxes,
the potential for future earnings is indirectly influenced by the nation’s fiscal policy choices.
Government revenues and expenditure have traditionally been regarded as important instruments
for carrying out desired redistribution of income. Following are few measures to achieve desired
distributional effects.
• A progressive direct tax system ensures that those who have greater ability to pay
contribute more towards defraying the expenses of government and that the tax burden is
distributed fairly among the population.
• Indirect taxes can be differential: for example, the commodities which are primarily
consumed by the richer income group, such as luxuries, are taxed heavily and the
commodities the expenditure on which form a larger proportion of the income of the lower
income group, such as necessities, are taxed light.
• A carefully planned policy of public expenditure helps in redistributing income from the rich
to the poorer sections of the society. This is done through spending programmes targeted
on welfare measures for the disadvantaged, such as
(i) poverty alleviation programmes
(ii) free or subsidized medical care, education, housing, essential commodities etc. to
improve the quality of living of poor
(iii) infrastructure provision on a selective basis
(iv) various social security schemes under which people are entitled to old-age pensions,
unemployment relief, sickness allowance etc.

© The Institute of Chartered Accountants of India 14

 (v) subsidized production of products of mass consumption
(vi) public production and/ or grant of subsidies to ensure sufficient supply of essential
goods, and
(vii) strengthening of human capital for enhancing employability etc.
Choice of a progressive tax system with high marginal taxes may act as a strong deterrent
to work save and invest. Therefore, the tax structure has to be carefully framed to mitigate
possible adverse impacts on production and efficiency. Additionally, the redistributive fiscal
policy and the extent of spending on redistribution should be consistent with the
macroeconomic policy objectives of the nation.
(b) The Reserve money determines the level of liquidity and price level in the economy. It is
calculated by the following formula-
Reserve Money = Currency in circulation + Bankers’ deposits with the RBI + Other deposits with
the RBI
= 14903.90 + 5780.60 + 317.20 = 21001.7 Crore
(c) The principal objective of the WTO is to facilitate the flow of international trade smoothly, freely,
fairly and predictably. The WTO does its functions by acting as a forum for trade negotiations
among member governments, administering trade agreements, reviewing national trade policies,
assisting developing countries in trade policy issues, through technical assistance and training
programmes and cooperating with other international organizations.
10. (a) Increase in investment ( ∆ I) = Rs 700 crore
Increase in national income ( ∆Y )= Rs.3,500 crore
∆Y
Multiplier (K) =
∆I
K = 3500/ 700 = 5

1
We know, K =
1 − MPC
1
1 – MPC =
5
1 – MPC = 0.2
MPC = 1 – 0.2
MPC = 0.8
We also know, MPC + MPS = 1
Or, MPS = 1– MPC
= 1 – 0.8
= 0.2
Change in saving ( ∆S ) = ∆Y × MPS
= 3,500 crore × 0.2
= 700 crore

© The Institute of Chartered Accountants of India 15

 (b) Whenever the central and the state governments’ cash balances fall short of the minimum
requirement, they are eligible to avail a facility called Ways and Means Advances
(WMA)/overdraft (OD) facility. When the Reserve Bank lends to the governments under Ways
and Means Advances (WMA)/overdraft (OD) , it results in the generation of excess reserves (i.e.,
excess balances of commercial banks with the Reserve Bank). The excess reserves thus created
can potentially lead to an increase in money supply through the money multiplier process.
(c) Tariff is defined as a financial charge in the form of a tax, imposed at the border on goods going
from one customs territory to another. Tariffs are the most visible and universally used trade
measures. Tariffs are aimed at altering the relative prices of goods and services imported, so as
to contract the domestic demand and thus regulate the volume of their imports. Tariffs leave the
world market price of the goods unaffected; while raising their prices in the domestic market. The
main goals of tariffs are to raise revenue for the government, and more importantly to protect the
domestic import-competing industries.
A tariff levied on an imported product affects both the country exporting a product and the country
importing that product.
(i) Tariff barriers create obstacles to trade, decrease the volume of imports and exports and
therefore of international trade. The prospect of market access of the exporting country is
worsened when an importing country imposes a tariff.
(ii) By making imported goods more expensive, tariffs discourage domestic consumers from
consuming imported foreign goods. Domestic consumers suffer a loss in consumer surplus
because they must now pay a higher price for the good and also because compared to free
trade quantity, they now consume lesser quantity of the good.
(iii) Tariffs encourage consumption and production of the domestically produced import
substitutes and thus protect domestic industries.
(iv) Producers in the importing country experience an increase in well-being as a result of
imposition of tariff. The price increase of their product in the domestic market increases
producer surplus in the industry. They can also charge higher prices than would be possible
in the case of free trade because foreign competition has reduced.
(v) The price increase also induces an increase in the output of the existing firms and possibly
addition of new firms due to entry into the industry to take advantage of the new high profits
and consequently an increase in employment in the industry.
(vi) Tariffs create trade distortions by disregarding comparative advantage and prevent
countries from enjoying gains from trade arising from comparative advantage. Thus, tariffs
discourage efficient production in the rest of the world and encourage inefficient production
in the home country.
(vii) Tariffs increase government revenues of the importing country by the value of the total tariff
it charges.
11. (a) GDPMP = (Value of output in primary sector - intermediate consumption of primary sector) +
(value of output in secondary sector - intermediate consumption of secondary sector) + (value of
output in tertiary sector - intermediate consumption of tertiary sector)
GDPMP = (1000-500) + (900-400) + (700-400)
= 500+ 500 +300 = Rs.1300 crore
GNPMP = GDPMP + NFIA
= 1300 – 20 = Rs. 1280 crore
(b) Common pool resources are a special class of impure public goods which are non-excludable as
people cannot be excluded from using them. These are rival in nature and their consumption

© The Institute of Chartered Accountants of India 16

 lessens the benefits available for others. This rival nature of common resources is what
distinguishes them from pure public goods, which exhibit both non-excludability and non-rivalry in
consumption. They are generally available free of charge. Some important natural resources fall
into this category.
Since price mechanism does not apply to common resources, producers and consumers do not
pay for these resources and therefore, they overuse them and cause their depletion and
degradation.
(c) Under the Market Stabilisation Scheme (MSS) the Government of India borrows from the RBI
(such borrowing being additional to its normal borrowing requirements) and issues treasury-
bills/dated securities that are utilized for absorbing from the market excess liquidity of a more
enduring nature arising from large capital inflows.
OR
An import quota is a direct restriction which specifies that only a certain physical amount of the
good will be allowed into the country during a given time period, usually one year. Import quotas
are typically set below the free trade level of imports and are usually enforced by issuing
licenses. This is referred to as a binding quota.

© The Institute of Chartered Accountants of India 17

 Test Series: October, 2020
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) ABC Pvt. Ltd. is considering relaxing its present credit policy for accounts receivable and is in the
process of evaluating two proposed policies. Currently, the company has annual credit sales of
` 50 lakhs and accounts receivable turnover ratio of 4 times a year. The current level of loss due
to bad debts is ` 1,50,000. The company is required to give a return of 20% on the investment in
new accounts receivable. The company’s variable costs are 70% of the selling price. Given the
following information, IDENTIFY which is the better policy?
(Amount in `)
Particulars Present Policy Proposed Policy 1 Proposed Policy 2
Annual credit sales 50,00,000 60,00,000 67,50,000
Accounts receivable turnover ratio 4 times 3 times 2.4 times
Bad debt losses 1,50,000 3,00,000 4,50,000

(b) The annual report of XYZ Ltd. provides the following information for the Financial Year 2019-20:
Particulars Amount (`)
Net Profit 50 lakhs
Outstanding 15% preference shares 100 lakhs
No. of equity shares 5 lakhs
Return on Investment 20%
Cost of capital i.e. (K e) 16%

CALCULATE price per share using Gordon’s Model when dividend pay-out is-
(i) 25%;
(ii) 50%;
(iii) 100%.

© The Institute of Chartered Accountants of India

 (c) ABC Ltd. is considering a project “X” with an initial outlay of ` 16,00,000 and the possible three
cash inflow attached with the project is as follows:
(Amount in ` ‘000)
Particular Year 1 Year 2 Year 3
Scenario 1 550 500 800
Scenario 2 650 550 900
Scenario 3 750 600 1000
Assuming the cost of capital as 9%.
(i) DETERMINE NPV in each scenario.
(ii) If ABC Ltd. is certain about the 1st and 2nd year’s results in scenario 2 but uncertain about the
third year’s cash flow, DETERMINE NPV expecting scenario 1 in the third year.
Year 1 2 3
DF @ 9% 0.917 0.842 0.772

(d) Using the information given below, PREPARE the Balance Sheet of SKY Private Limited:
(i) Current ratio 1.6 :1
(ii) Cash and Bank balance 15% of total current assets
(iii) Debtors turnover ratio 12 times
(iv) Stock turnover (cost of goods sold) ratio 16 times
(v) Creditors turnover (cost of goods sold) ratio 10 times
(vi) Gross profit ratio 20%
(vii) Capital gearing ratio 0.6
(viii) Depreciation rate 15% on W.D.V.
(ix) Net fixed Assets 20% of total assets
(Assume all purchase and sales are on credit)
Balance Sheet of SKY Private Limited as at 31.03.2020
Liabilities Amount in ` Assets Amount in `
Share Capital 25,00,000 Fixed assets
Reserve & surplus ? Opening WDV ?
12% Long term debt ? Less: Depreciation ? ?
Current liabilities
Creditors ? Current Assets
Provisions & outstanding
Stock ?
expenses ? 68,50,000
Debtors ?
Cash and bank balance ? ?
Total ? Total ?
(Detailed working notes are not required to be shown) [4 × 5 Marks = 20 Marks]

© The Institute of Chartered Accountants of India

2. Sinha Steel Ltd. requires ` 30,00,000 for a new plant which expects to yield earnings before interest
and taxes of ` 5,00,000. While deciding about the financial plan, the company considers the objective
of maximizing earnings per share. It has three alternatives to finance the project as follows -
Alternative Debt Equity Shares
1 ` 2,50,000 balance
2 ` 10,00,000 balance
3 ` 15,00,000 balance
The company's share is currently selling at ` 200, but is expected to decline to ` 160 in case the funds
are borrowed in excess of ` 10,00,000.
Slab wise interest rate for fund borrowed are as follows -
Fund Limit Applicable Interest rate
up-to ` 2,50,000 10%
over ` 2,50,000 and up-to ` 10,00,000 15%
over ` 10,00,000 20%

The tax rate applicable to the company is 50 percent.

ANALYSE which form of financing should the company choose? [10 Marks]
3. P Ltd. has the following capital structure at book-value as on 31 st March, 2020:
Particulars (`)
Equity share capital (10,00,000 shares) 3,00,00,000
11.5% Preference shares 60,00,000
10% Debentures 1,00,00,000
4,60,00,000

The equity shares of the company are sold for ` 300. It is expected that the company will pay next year
a dividend of ` 15 per equity share, which is expected to grow by 5% p.a. forever. Assume a 35%
corporate tax rate.
Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital
structure.
(ii) COMPUTE the new WACC, if the company raises an additional ` 50 lakhs debt by issuing 12%
debentures. This would result in increasing the expected equity dividend to ` 20 and leave the
growth rate unchanged, but the price of equity share will fall to ` 250 per share. [10 Marks]
4. A firm can make investment in either of the following two projects. The firm anticipates its cost of capital
to be 10%. The pre-tax cash flows of the projects for five years are as follows:
Year 0 1 2 3 4 5
Project A (`) (2,00,000) 35,000 80,000 90,000 75,000 20,000
Project 8 (`) (2,00,000) 2,18,000 10,000 10,000 4,000 3,000
Ignore Taxation.
An amount of ` 35,000 will be spent on account of sales promotion in year 3 in case of Project A. This
has not been taken into account in calculation of pre-tax cash flows.

© The Institute of Chartered Accountants of India

 The discount factors are as under:
Year 0 1 2 3 4 5
PVF (10%) 1 0.91 0.83 0.75 0.68 0.62
You are required to calculate for each project:
(i) The payback period
(ii) The discounted payback period
(iii) Desirability factor
(iv) Net Present Value [10 Marks]
5. (a) Following Balance Sheet and Income Statement have been obtained from the books of accounts
of Benaca Pvt. Ltd.
Balance Sheet as on March 31 st 2020
Liabilities Amount (`) Assets Amount (`)
Equity Capital (`10 per share) 80,00,000 Net Fixed Assets 1,00,00,000
10% Debt 60,00,000 Current Assets 90,00,000
Retained Earnings 35,00,000
Current Liabilities 15,00,000
1,90,00,000 1,90,00,000
Income Statement for the year ending March 31 st 2020
Particulars Amount (`)
Sales 34,00,000
Less: Operating expenses (including ` 6,00,000 depreciation) (12,00,000)
EBIT 22,00,000
Less: Interest (6,00,000)
Earnings before tax 16,00,000
The tax rate applicable to the company is 35 percent.
(i) DETERMINE the degree of operating, financial and combined leverages at the current sales
level, if all operating expenses, other than depreciation, are variable costs.
(ii) If total assets remain at the same level, but sales (i) increase by 20 percent and (ii) decrease
by 20 percent, COMPUTE the earnings per share at the new sales level? [8 Marks]
(b) EXPLAIN certainty equivalents, one of the techniques of risk analysis. [2 Marks]
6. (a) DISCUSS Agency Problem and Agency Cost. [4 Marks]
(b) EXPLAIN in brief the features of Commercial Papers. [4 Marks]
(c) EXPLAIN Billing float and Mail float with reference to management of cash.
Or
STATE any four factors which need to be considered while planning for working capital
requirement. [2 Marks]

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 Section B: ECONOMICS FOR FINANCE
Question No. 7 is compulsory.
Answer any three questions from the rest.
Working notes should form parts of the respective answers.
Marks: 40
7. (a) Assume in an economy, saving function is S = -10 + 0.2Y and autonomous investment is I = 50
crore. Find out the equilibrium level of income and consumption. If investment increases by ` 5
crores, what will be the new level of income and consumption? (3 Marks)
(b) Are health and education pure public goods? Comment (2 Marks)
(c) Why does measurement of money supply essential from a monetary policy perspective? Explain.
(2 Marks)
(d) Which technical measures are applied to protect human, animal or plant life from risks arising
from additives, pests, contaminants, toxins or disease-causing organisms. Explain with an
example. (3 Marks)
8. (a) How do governments ensure that market power does not create distortions in the market?
(3 Marks)
(b) Do you think money is a unique store of value? (2 Marks)
(c) Countries China and India have a total of 6000 hours each of labour available each day to
produce shirts and trousers. Both countries use equal number of hours on each good each day.
China produces 1000 shirts and 300 trousers per day. India produces 300 shirts and 200 trousers
per day.
In the absence of trade:
i. Which country has absolute advantage in producing Shirts and Trousers?
ii. Which country has comparative advantage in producing Shirts and Trousers? (5 Marks)
9. (a) Calculate Gross Domestic Product at market price (GDPMP) and derive National Income from the
following data (in Crores of Rupees) (5 Marks)
Particulars in ` Crore
Inventory investment 400
Exports 350
Indirect taxes 150
Net factor income from abroad - 75
Personal consumption expenditure 7500
Gross residential construction investment 700
Depreciation 100
Imports 200
Government purchases of goods and services 1800
Gross public investment 400
Gross business fixed investment 375
5

© The Institute of Chartered Accountants of India

 (b) Define near public goods. Is it desirable to keep people away from such goods? Give comments.
(2 Marks)
(c) Write a note on Cash Reserve Ratio (CRR). Explain the operation of CRR. (3 Marks)
10. (a) (i) Define common resources. Why are they overused? (2 Marks)
(ii) Explain the free rider problem. Give examples (3 Marks)
(b) Distinguish between Leakages and Injections in the circular flow of income? (2 Marks)
(c) Differentiate Trade- Related Investment Measures (TRIMS) and Trade-Related Aspects of
Intellectual Property Rights (TRIPS). (3 Marks)
11. (a) Explain the Fisher’s Quantity theory of demand for money? (5 Marks)
(b) (i) How are the following transactions treated in national income calculation? What is the
rationale in each case? (3 Marks)
(1) Expenditure by government on providing free education.
(2) Capital gain on sale of a house.
(3) Mineral wealth of a nation.
(ii) Define Contractionary monetary policy (2 Marks)
OR
Differentiate Crawling Peg and Crawling Bands.

© The Institute of Chartered Accountants of India

 Test Series: October, 2020
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints
1. (a) Statement showing the Evaluation of Accounts Receivable Policies
(Amount in `)
Particulars Present Proposed Proposed
Policy Policy 1 Policy 2
A Expected Profit:
(a) Credit Sales 50,00,000 60,00,000 67,50,000
(b) Total Cost other than Bad Debts:
(i) Variable Costs 35,00,000 42,00,000 47,25,000
(c) Bad Debts 1,50,000 3,00,000 4,50,000
(d) Expected Profit [(a) – (b) – (c)] 13,50,000 15,00,000 15,75,000
B Opportunity Cost of Investments in 1,75,000 2,80,000 3,93,750
Accounts Receivable (Working Note)
C Net Benefits (A – B) 11,75,000 12,20,000 11,81,250

Recommendation: The Proposed Policy 1 should be adopted since the net benefits under this
policy are higher as compared to other policies.
Working Note:
Calculation of Opportunity Cost of Average Investments
Opportunity Cost = Total Cost × Collection period/12 × Rate of Return/100
Present Policy = ` 35,00,000 × 3/12 × 20% = ` 1,75,000
Proposed Policy 1 = ` 42,00,000 × 4/12 × 20% = ` 2,80,000
Proposed Policy 2 = ` 47,25,000 × 5/12 × 20% = ` 3,93,750
(b) Price per share according to Gordon’s Model is calculated as follows:
Particulars Amount in `
Net Profit 50 lakhs
Less: Preference dividend 15 lakhs
Earnings for equity shareholders 35 lakhs
Therefore, earning per share 35 lakhs/5 lakhs = ` 7.00
Price per share according to Gordon’s Model is calculated as follows:
E1(1  b)
P0 
Ke  br
Here, E1 = 7, Ke = 16%
(i) When dividend pay-out is 25%
1

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 7  0.25 1.75
P0  = = 175
0.16  (0.75  0.2) 0.16  0.15
(ii) When dividend pay-out is 50%
7  0.5 3.5
P0  = = 58.33
0.16  (0.5  0.2) 0.16  0.10
(iii) When dividend pay-out is 100%
7 1 7
P0  = = 43.75
0.16  (0  0.2) 0.16
(c) (i) The possible outcomes under different scenario will be as follows:
(Amount in ` ‘000)
Year PVF Scenario 1 Scenario 2 Scenario 3
@ 9%
Cash Flow PV Cash Flow PV Cash Flow PV
0 1.000 (1600) (1600) (1600) (1600) (1600) (1600)
1 0.917 550.00 504.35 650.00 596.05 750.00 687.75
2 0.842 500.00 421.00 550.00 463.10 600.00 505.20
3 0.772 800.00 617.60 900.00 694.80 1000.00 772.00
NPV (57.05) 153.95 364.95
(ii) The company is bit confident about the estimates in the first two years, but not sure about the
third year’s cash inflow, the NPV in such case expecting scenario 1 in the third year will be
as follows:
= -16,00,000 + (6,50,000 × 0.917 + 5,50,000 × 0.842 + 8,00,000 × 0.772)
= -16,00,000 + (5,96,050 + 4,63,100 + 6,17,600)
= ` 76,750
(d) Working Notes
1. Computation of Current Assets and Cash & Bank Balance
Current Assets (CA)
Current Ratio = = 1.6
Current Liabilities (CL)
Current Assets = 1.6 Current Liabilities = 1.6 × ` 68,50,000 = ` 1,09,60,000/-
So, Cash and Bank Balance=15% of Current Assets = ` 16,44,000
2. Computation of Total Assets, Fixed assets and Depreciation
Total Assets = Net Fixed assets+ Current Asset
Or, Total Assets = 20% of Total Asset + ` 1,09,60,000
Or, Total Assets = ` 1,37,00,000
So, Net Fixed assets = 20% of Total Asset = ` 27,40,000
27,40,000
Depreciation = ´ 15% = Rs4,83,529
85%
Fixed Assets = ` 27,40,000 + Rs4,83,529 = ` 32,23,529

© The Institute of Chartered Accountants of India

 3. Calculation of stock, Debtors and Creditors
Stock + Debtors = Current Assets – Cash & Bank
= ` 1,09,60,000 – ` 16,44,000
= ` 93,16,000
Now, let Sales be x
Credit Sales x
So, Debtors (Credit Sales) = =
Debtors turnover ratio 12
Sales - 20% of Sales
Further, Stock (on Cost of Goods Sold) =
16
x - 20% of x
=
16
x 4x
x-
= 5 = 5
16 16
x
=
20
x x
So, + = Rs. 93,16,000
12 20
10x + 6x
Or, = Rs. 93,16,000
120
16x
Or, = Rs. 93,16,000
120
Or, x = ` 6,98,70,000
So, Sales = ` 6,98,70,000
Cash of Goods Sold (COGS) = ` 5,58,96,000
Stock (COGS/16) = ` 34,93,500
Debtors (Sales/12) = ` 58,22,500
Creditors (COGS/10) = ` 55,89,600
4. Calculation of Provision of outstanding Expenses
= ` 68,50,000 – ` 55,89,600
= ` 12,60,400
5. Share Capital + Reserve of surplus + long term debt = Total Asset or total liability –
Current liability
Or, Reserve & surplus + long term debt = ` 1,37,00,000 – 68,50,000 – 25,00,000
= ` 43,50,000

© The Institute of Chartered Accountants of India

 Calculation of long term Debt and Reserve & Surplus
Now, Capital Earning ratio = 0.6
12% long term Debt
So, = 0.6
Equity Share Capital + Reserve & Surplus
43,50,000 - Reserve & Surplus
Or, = .6
25,00,000 + Reserve & Surplus

Or, Reserve & Surplus = ` 17,81,250

So, 12% long term debt = ` 25,68,750
Balance Sheet of SKY Private Limited as at 31.03.2020
Liabilities ` Assets `
Share Capital 25,00,000 Fixed assets
Reserve & Surplus 17,81,250 Opening WDV 32,23,529
12% Long term debt 25,68,750 Less: Depreciation 4,83,529 27,40,000
Current Liabilities
Creditors 55,89,600 Current Assets
Provisions & Stock 34,93,500
outstanding
expenses 12,60,400 68,50,000
Debtors 58,22,500
Cash and bank 16,44,000
balance 1,09,60,000
Total 1,37,00,000 1,37,00,000
2. Alternative I = Raising Debt of ` 2.5 lakh + Equity of ` 27.5 lakh.
Alternative II = Raising Debt of ` 10 lakh + Equity of `20 lakh.
Alternative III = Raising Debt of ` 15 lakh + Equity of ` 15 lakh.
Calculation of Earnings per share (EPS):
(Amount in `)
Particulars FINANCIAL ALTERNATIVES
Alternative I Alternative II Alternative III
Expected EBIT 5,00,000 5,00,000 5,00,000
Less: Interest (working note i) (25,000) (1,37,500) (2,37,500)
Earnings before taxes 4,75,000 3,62,500 2,62,500
Less: Taxes @ 50% (2,37,500) (1,81,250) (1,31,250)
Earnings after taxes (EAT) 2,37,500 1,81,250 1,31,250
Number of shares (working note ii) 13,750 10,000 9,375
Earnings per share (EPS) 17.27 18.125 14.00
Financing Alternative II (i.e. Raising debt of `10 lakh and issue of equity share capital of ` 20 lakh) is
the option which maximises the earnings per share.

© The Institute of Chartered Accountants of India

 Working Notes:
(i) Calculation of interest on Debt (Amount in `)
Alternative I (2,50,000 × 10%) 25,000
Alternative II (2,50,000 × 10%) 25,000
(7,50,000 × 15%) 1,12,500 1,37,500
Alternative III (2,50,000 × 10%) 25,000
(7,50,000 × 15%) 1,12,500
(5,00,000 × 20%) 1,00,000 2,37,500
(ii) Number of equity shares to be issued
Alternative I = ` 27,50,000/ ` 200 (Market Price of share)
= 13,750 shares
Alternative II = ` 20,00,000/ ` 200
= 10,000 shares
Alternative III = ` 15,00,000/ ` 160
= 9,375 shares
3. (i) Computation of Weighted Average Cost of Capital based on existing capital structure
Source of Capital Existing Capital Weights After tax cost WACC (%)
structure (`) of capital (%)
(a) (b) (a) × (b)
Equity share capital (W.N.1) 3,00,00,000 0.652 10.00 6.52
11.5% Preference share capital 60,00,000 0.130 11.50 1.50
10% Debentures (W.N.2) 1,00,00,000 0.218 6.50 1.42
Total 4,60,00,000 1.000 9.44

Working Notes:
1. Cost of Equity Capital:
Expecteddividend(D1 )
Ke =  Growth(g)
Current Market Pr ice(P0 )

` 15
= + 0.05
` 300
= 10%
2. Cost of 10% Debentures
Interest(1  t)
Kd =
Net proceeds

` 1,00,000 (1 - 0.35)
=
` 1,00,00,000
= 0.065 or 6.5%

© The Institute of Chartered Accountants of India

 (ii) Computation of Weighted Average Cost of Capital based on new capital structure
Source of Capital New Capital Weights After tax cost WACC (%)
structure (`) of capital (%)
(a) (b) (a) x (b)
Equity share capital (W.N.3) 3,00,00,000 0.588 13.00 7.64
11.5% Preference share capital 60,00,000 0.118 11.50 1.36
10% Debentures (W.N.2) 1,00,00,000 0.196 6.50 1.27
12% Debentures (W.N.4) 50,00,000 0.098 7.80 0.76
Total 5,10,00,000 1.000 11.03

Working Notes:
3. Cost of Equity Capital:
` 20
Ke = + 0.05
` 250
= 13%
4. Cost of 12% Debentures
` 6,00,000 (1- 0.35)
Kd =
` 50,00,000
= 0.078 or 7.8%
4. Calculation of Present Value of cash flows
Year PV factor Project A Project B
@ 10% Cash flows (`) Discounted Cash flows (`) Discounted
Cash flows Cash flows
0 1.00 (2,00,000) (2,00,000) (2,00,000) (2,00,000)
1 0.91 35,000 31,850 2,18,000 1,98,380
2 0.83 80,000 66,400 10,000 8,300
3 0.75 55,000(90,000-35,000) 41,250 10,000 7,500
4 0.68 75,000 51,000 4,000 2,720
5 0.62 20,000 12,400 3,000 1,860
Net Present Value 2,900 18,760
(i) The Payback period of the projects:
Project-A: The cumulative cash inflows up-to year 3 is `1,70,000 and remaining amount required
to equate the cash outflow is ` 30,000 i.e. (` 2,00,000 – ` 1,70,000) which will be recovered from
year-4 cash inflow. Hence, Payback period will be calculated as below:
` 30,000
3 years + = 3.4 years Or 3 years 4.8 months Or 3 years 4 months and 24 days
` 75,000
Project-B: The cash inflow in year-1 is ` 2,18,000 and the amount required to equate the cash
outflow is ` 2,00,000, which can be recovered in a period less than a year. Hence, Payback period
will be calculated as below:

© The Institute of Chartered Accountants of India

 ` 2,00,000
= 0.917 years Or 11 months
` 2,18,000
(ii) Discounted Payback period for the projects:
Project-A: The cumulative discounted cash inflows up-to year 4 is ` 1,90,500 and remaining
amount required to equate the cash outflow is ` 9,500 i.e. (` 2,00,000 – ` 1,90,500) which will be
recovered from year-5 cash inflow. Hence, Payback period will be calculated as below:
` 9,500
4 years + = 4.766 years Or 4 years 9.19 months Or 4 years 9 months and 6 days
` 12,400
Project-B: The cash inflow in year-1 is `1,98,380 and remaining amount required to equate the
cash outflow is ` 1,620 i.e. (` 2,00,000 – ` 1,98,380) which will be recovered from year-2 cash
inflow. Hence, Payback period will be calculated as below:
` 1,620
1 year + = 1.195 years Or 1 Year 2.34 months Or 1 Year 2 months and 10 days.
` 8,300
(iii) Desirability factor of the projects
DiscountedvalueCashInflows
Desirability Factor (Profitability Index) =
Discountedvalue of CashOutflows
` 2,02,900
Project A = = 1.01
` 2,00,000
` 2,18,760
Project B = = 1.09
` 2,00,000
(iv) Net Present Value (NPV) of the projects:
Please refer the above table.
Project A- ` 2,900
Project B- ` 18,760
5 (a) (i) Degree of operating, financial and combined leverages at the current sales level-
Contribution
DOL =
EBIT
` 34,00,000 - ` 6,00,000
= = 1.27
` 22,00,000
EBIT
DFL =
EBT
` 22,00,000
= = 1.375
` 16,00,000
DCL = DOL × DFL = 1.27 × 1.38 = 1.75
(ii) Earnings per share at the new sales level
(Amount in `)
Particulars Increase by 20% Decrease by 20%
Sales level 40,80,000 27,20,000
Less: Variable expenses 7,20,000 4,80,000
7

© The Institute of Chartered Accountants of India

 Less: Fixed cost 6,00,000 6,00,000
Earnings before interest and taxes 27,60,000 16,40,000
Less: Interest 6,00,000 6,00,000
Earnings before taxes 21,60,000 10,40,000
Less: Taxes @35% 7,56,000 3,64,000
Earnings after taxes (EAT) 14,04,000 6,76,000
Number of equity shares 8,00,000 8,00,000
EPS 1.76 0.85

Working Notes:
Variable Costs = ` 6,00,000 (total cost - depreciation)
Variable Costs at:
(i) Sales level, ` 40,80,000 = ` 7,20,000 (increase by 20%)
(ii) Sales level, ` 27,20,000 = ` 4,80,000 (decrease by 20%)
(b) Certainty Equivalents: As per CIMA terminology, “An approach to dealing with risk in a capital
budgeting context. It involves expressing risky future cash flows in terms of the certain cashflow
which would be considered, by the decision maker, as their equivalent, that is the decision maker
would be indifferent between the risky amount and the (lower) riskless amount considered to be its
equivalent.”
The certainty equivalent is a guaranteed return that the management would accept rather than
accepting a higher but uncertain return. This approach allows the decision maker to incorporate
his or her utility function into the analysis. In this approach a set of risk less cash flow is generated
in place of the original cash flows.
6 (a) Agency Problem and Agency Cost: Though in a sole proprietorship firm, partnership etc., owners
participate in management but incorporates, owners are not active in management so, there is a
separation between owner/ shareholders and managers. In theory, managers should act in the best
interest of shareholders however in reality, managers may try to maximise their individual goal like
salary, perks etc., so there is a principal agent relationship between managers and owners, which
is known as Agency Problem. In a nutshell, Agency Problem is the chances that managers may
place personal goals ahead of the goal of owners. Agency Problem leads to Agency Co st. Agency
cost is the additional cost borne by the shareholders to monitor the manager and control their
behaviour to maximise shareholders wealth. Generally, Agency Costs are of four types (i)
monitoring (ii) bonding (iii) opportunity (iv) structuring.
(b) Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the
form of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in
the year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources of
short- term borrowings and to provide an additional instrument to investors. Subsequently, in
addition to the Corporate, Primary Dealers and All India Financial Institutions have also been
allowed to issue Commercial Papers. Commercial papers are issued in denominations of ` 5 lakhs
or multiples thereof and the interest rate is generally linked to the yield on the one-year government
bond.
All eligible issuers are required to get the credit rating from Credit Rating Info rmation Services of
India Ltd, (CRISIL), or the Investment Information and Credit Rating Agency of India Ltd (ICRA) or
the Credit Analysis and Research Ltd (CARE) or the FITCH Ratings India Pvt. Ltd or any such
other credit rating agency as is specified by the Reserve Bank of India.
8

© The Institute of Chartered Accountants of India

 (c) Billing Float: An invoice is the formal document that a seller prepares and sends to the purchaser
as the payment request for goods sold or services provided. The time between the sale and the
mailing of the invoice is the billing float.
Mail Float: This is the time when a cheque is being processed by post office, messenger service
or other means of delivery.
OR
Some of the factors which need to be considered while planning for working capital
requirement are-
(i) Cash: Identify the cash balance which allows for the business to meet day- to-day expenses,
but reduces cash holding costs.
(ii) Inventory: Identify the level of inventory which allows for uninterrupted production but
reduces the investment in raw materials and hence increases cash flow; the techniques like
Just in Time (JIT) and Economic order quantity (EOQ) are used for this.
(iii) Receivables: Identify the appropriate credit policy, i.e., credit terms which will attract
customers, such that any impact on cash flows and the cash conversion cycle will be offset
by increased revenue and hence Return on Capital (or vice versa). The tools like Discounts
and allowances are used for this.
(iv) Short-term Financing Options: Inventory is ideally financed by credit granted by the
supplier; dependent on the cash conversion cycle, it may however, be necessary to utilize a
bank loan (or overdraft), or to “convert debtors to cash” through “factoring” in order to finance
working capital requirements.
(v) Nature of Business: For e.g. in a business of restaurant, most of the sales are in Cash.
Therefore, need for working capital is very less.
(vi) Market and Demand Conditions: For e.g. if an item’s demand far exceeds its production,
the working capital requirement would be less as investment in finished goods inventory would
be very less.
(vii) Technology and Manufacturing Policies: For e.g. in some businesses the demand for
goods is seasonal, in that case a business may follow a policy for steady production through
out over the whole year or instead may choose policy of production only during the demand
season.
(viii) Operating Efficiency: A company can reduce the working capital requirement by eliminating
waste, improving coordination etc.
(ix) Price Level Changes: For e.g. rising prices necessitate the use of more funds for maintaining
an existing level of activity. For the same level of current assets, higher cash outlays ar e
required. Therefore, the effect of rising prices is that a higher amount of working capital is
required.

© The Institute of Chartered Accountants of India

 PAPER 8B : ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/HINTS
7. (a) S= I
-10 + 0.2Y = 50
0.2Y = 50+ 10
Y = 300 crore
C= Y- S
Where S= -10 + 0.2 (300) = 50
C= 300-50 = 250 crore
With the increase in investment by ` 5 crores, the new investment will become equal to ` 55
crores.
S= I
-10 + 0.2Y = 55
Y= 325 crores
C= 270 crores
(b) No, A pure public good is non-rivalrous and non-excludable in nature therefore education and
health services are not pure public goods; rather they are quasi-public goods that possess nearly
all of the qualities of the private goods and some of the benefits of public good. It is clearly
possible to exclude people who do not pay from availing these services
(c) Measurement of money supply is essential from a monetary policy perspective because it
enables a framework to evaluate whether the stock of money in the economy is consistent with
the standards for price stability, to understand the nature of deviations from this standard and to
study the causes of money growth.
(d) Sanitary and Phyto -Sanitary (SPS) measures are applied to protect human, animal or plant life
from risks arising from additives, pests, contaminants, toxins or disease-causing organisms and
to protect biodiversity. These include ban or prohibition of import of certain goods, all measures
governing quality and hygienic requirements, production processes, and associated compliance
assessments. For example; prohibition of import of poultry from countries affected by avian flu,
meat and poultry processing standards to reduce pathogens, residue limits for pesticides in foods
etc.
8. (a) Market power is an important factor that contributes to inefficiency due to higher prices than
competitive prices. Because of the social costs imposed by monopoly, governments intervene by
establishing rules and regulations designed to promote competition and prohibit actions that are
likely to restrain competition. Policy options also include price regulation in the form of setting
maximum prices that firms can charge based on the firm’s variable costs, past prices, and
possible inflation and productivity growth. These are some methods by which the government
ensures that market does not create distortions.
(b) Financial assets other than money are also performing the function of store of value. Just as
money has, the financial assets have fixed nominal value over time and represent generalized
purchasing power. Therefore, money is not a unique store of value.

10

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 (c) Goods produced by each country

Country Shirts Trousers

China 1000 300
India 300 200
Each country has 6000 hours of labour and uses 3000 hours each for both the goods. Therefore,
the number of hours spent per unit on each good
Country Shirts Trousers
China 3 10
India 10 15
Since China produces both goods in less time, it has absolute advantage in both shirts and
trousers.
Comparative advantage: Comparing the opportunity costs of both goods we have
China
Opportunity cost of Shirts 3/10 = 0.3
Opportunity cost of Trousers 10/3 =3.33
India
Opportunity cost of Shirts 10/15 = 0.67
Opportunity cost of Trousers 15/10 =1.5
For producing shirts
China has lower opportunity cost for producing shirts, therefore China has comparative
advantage
For producing Trousers
India has lower opportunity cost for producing Trousers, therefore India has comparative
advantage.
9. (a) GDPMP = Personal consumption expenditure + Gross investment (Gross business fixed
investment + inventory investment) + Gross residential construction investment + Gross public
investment + Government purchases of goods and services + Net Exports (exports-imports)
GDPMP = 7500 + 775 + 700 + 400 + 1800 + 150
= 11325 crores
NNP FC (National Income) = GNP FC – Depreciation
Where GNPFC = GNPMP - Indirect Taxes
And GNPMP = GDPMP + Net factor income from abroad
 GNPMP = 11325 – 75 = 11250 crores
GNPFC = 11250 – 150 = 11100 crores
NNP FC (National Income) = 11100 – 100 = 11000 crores
(b) Near public good (for e.g. education, health services) possess nearly all of the qualities of the
private goods and some of the benefits of public good. It is easy to keep people away from them
by charging a price or fee. However, it is undesirable to keep people away from such goods
because the society would be better off if more people consume them. This particular
11

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 characteristic namely, the combination of virtually infinite benefits and the ability to charge a price
results in some near public goods being sold through markets and others being provided by
government. As such, people argue that these should not be left to the market alone.
(c) Cash Reserve Ratio (CRR) refers to the fraction of the total net demand and time liabilities
(NDTL) of a scheduled commercial bank in India which it should maintain as cash deposit with
the Reserve Bank. Higher the CRR, lower is the credit creation capacity of banks. Reducing CR R
during deflation results in expansion of credits by banks and increases the supply of money
available in the economy. Increasing the CRR during inflation helps in containing credit
expansion.
10. (a) (i) Common access resources or common pool resources are a special class of impure public
goods which are non-excludable as people cannot be excluded from using them. These are
rival in nature and their consumption lessens the benefits available for others. Since price
mechanism does not apply to ‘common resources’, producers and consumers do not pay for
these resources and therefore, they overuse them and cause their depletion and
degradation.
(ii) The incentive to let other people pay for a good or service, the benefits of which are enjoyed
by an individual is known as the free rider problem. In other words, free riding is ‘benefiting
from the actions of others without paying’. Example is national defence. The government
provides defence for all its citizens regardless of much they contribute in tax es. Another
example is Wikipedia- few people contribute (financially or otherwise), but everyone gets to
use it.
(b) Leakages are withdrawals from the economy as a result of taxation, spending on imports, and
monetary savings. It reduces the flow of income. On the other hand, Injections are additions and
contributions to the economy through government spending, money from exports, and
investments made by firms. Injections increase the flow of income.
(c) Trade-Related Investment Measures (TRIMs) is an agreement on trade related investment
measures which specifies the rule that are applicable to domestic regulation a country applies to
foreign investors. The agreement is applicable to all the members of WTO. It expands disciplines
governing investment measures in relation to cross-border investments by stipulating that
countries receiving foreign investments shall not impose investment measures such as
requirements, conditions and restrictions inconsistent with the provisions of the principle of
national treatment and general elimination of quantitative restrictions. On the other hand, Trade -
Related Aspects of Intellectual Property Rights (TRIPS) is an international agreement among
various members of WTO on intellectual property rights. It is one of th e most comprehensive
multilateral agreements on intellectual rights. It stipulates most-favoured-nation treatment and
national treatment for intellectual properties, such as copyright, trademarks, geographical
indications, industrial designs, patents, IC layout designs and undisclosed information.
11. (a) According to Fisher, quantity theory of money demonstrate that there is strong relationship
between money and price level and the quantity of money is the main determinant of the price
level or the value of money. In other words, changes in the general level of commodity prices or
changes in the value or purchasing power of money are determined first and foremost by
changes in the quantity of money in circulation.
Fisher’s version, also termed as ‘equation of exchange’ or ‘transaction approach’ is formally
stated as follows:
MV=PT
Where, M= the total amount of money in circulation (on an average) in an economy, V =
transactions velocity of circulation i.e. the average number of times across all transactions a unit
of money(say Rupee) is spent in purchasing goods and services, P = average price level (P=
MV/T), T = the total number of transactions.
12

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 Later, Fisher extended the equation of exchange to include demand (bank) deposits (M’) and
their velocity (V’) in the total supply of money. Thus, the expanded form of the equation of
exchange becomes:
MV + M'V' = PT
Where M' = the total quantity of credit money, V' = velocity of circulation of credit money. The
total supply of money in the community consists of the quantity of actual money (M) and its
velocity of circulation (V). Velocity of money in circulation (V) and the velocity of credit money (V')
remain constant. T is a function of national income.
Since full employment prevails, the volume of transactions T is fixed in the short run. Briefly put,
the total volume of transactions (T) multiplied by the price level (P) represents the demand for
money. The demand for money (PT) is equal to the supply of money (MV + M'V)'. In any given
period, the total value of transactions made is equal to PT and the value of money flow is equal
to MV+ M'V'.
Fisher did not specifically mention anything about the demand for money; but the same is
embedded in his theory as dependent on the total value of transactions undertaken in the
economy. Thus, there is an aggregate demand for money for transactions purpose and more the
number of transactions people want, greater will be the demand for money. The total volume of
transactions multiplied by the price level (PT) represents the demand for money.
(b) (i) 1. Expenditure by government on providing free education is included while estimating
national income, as it is part of government final consumption expenditure. Since the
service provided by the government are not sold in the market, the only way they can
be valued in money terms is by adding up the money spent by the government in the
production of the service.
2. Capital gain on sale of the house is not be included while estimating national income,
as it is already included in the year when it is built and to avoid double counting which
means counting value of the same commodity more than once.
3. It is a part of national wealth and is not included in national income. However, that part
of mineral wealth which has been extracted during the current year will be included in
national income under the product method.
(ii) Contractionary monetary policy is a policy used by monetary authorities to contract the
money supply and reduce economic activity by raising interest rates to slow the rate of
borrowing by companies, individuals and banks.
OR
Currency is adjusted periodically in small amounts at a fixed; pre announced rate in
response to changes in certain quantitative indicators is called Crawling Peg. On the other
hand, when currency is maintained within certain fluctuation margins say (±1-2 %) around a
central rate that is adjusted periodically is Crawling Bands.

13

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 Test Series: March, 2021
MOCK TEST PAPER –1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8A: FINANCIAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If
a candidate has not opted for Hindi medium his/ her answer in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.

Time Allowed – 3 Hours (For both the part of paper 8) Maximum Marks – 60
1. Answer the following:
(a) The following information is given:
Dividend per share (DPS) Rs. 9
Cost of capital (K e) 19%
Internal rate of return on investment 24%
Retention Ratio 25%
CALCULATE the market price per share by using:
(i) Walter’s formula
(ii) Gordon’s formula (Dividend Growth model)
(b) SN Ltd. has furnished the following ratios and information relating to the year ended 31 st March
2021:
Share Capital Rs. 6,25,000
Working Capital Rs. 2,00,000
Gross Margin 25%
Inventory Turnover 5 times
Average Collection Period 1.5 months
Current Ratio 1.5:1
Quick Ratio 0.7:1
Reserves & Surplus to Bank & Cash 3 times
Further, the assets of the company consist of fixed assets and current assets, while its current
liabilities comprise bank credit and others in the ratio of 3:1. Assume 360 days in a year.
You are required to PREPARE the Balance Sheet as on 31 st March 2021.
(Note- Balance sheet may be prepared in traditional T Format.)
(c) Following information are related to four firms of the same industry:
Change in Change in Operating Change in Earning
Firm
Revenue Income per Share
P 25% 23% 30%
1

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 Q 27% 30% 26%
R 24% 36% 20%
S 20% 30% 20%
For all the firms, FIND OUT:
(i) Degree of operating leverage, and
(ii) Degree of combined leverage.
(d) HN Limited is considering total investment of Rs. 20 lakhs. You are required to CALCULATE
the level of earnings before interest and tax (EBIT) at which the EPS indifference point
between the following financing alternatives will occur:
(i) Equity share capital of Rs. 12,00,000 and 14% debentures of Rs. 8,00,000.
Or
(ii) Equity share capital of Rs. 8,00,000, 16% preference share capital of Rs. 4,00,000 and
14% debentures of Rs. 8,00,000.
Assume the corporate tax rate is 30% and par value of equity share is Rs.10 in each case.
(4 × 5 Marks = 20 Marks)
2. CALCULATE the WACC by using Market value weights.
The capital structure of the company is as under:
(Rs.)
Debentures (Rs.100 per debenture) 10,00,000
Preference shares (Rs.100 per share) 10,00,000
Equity shares (Rs.10 per share) 20,00,000
40,00,000
The market prices of these securities are:
Debentures Rs. 115 per debenture
Preference shares Rs. 120 per preference share
Equity shares Rs. 265 each.
Additional information:
(1) Rs.100 per debenture redeemable at par, 10% coupon rate, 2% floatation cost,
10-year maturity.
(2) Rs.100 per preference share redeemable at par, 5% coupon rate, 2% floatation cost and 10 -
year maturity.
(3) Equity shares have a floatation cost of Rs. 1 per share.
The next year expected dividend is Rs. 5 with an annual growth of 15%. The firm has the
practice of paying all earnings in the form of dividend.
Corporate tax rate is 30%. Use YTM method to calculate cost of debentures and preference shares.
(10 Marks)

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 3. PREPARE monthly cash budget for the first six months of 2021 on the basis of the following
information:
(i) Actual and estimated monthly sales are as follows:
Actual (Rs.) Estimated (Rs.)
October 2020 2,00,000 January 2021 60,000
November 2020 2,20,000 February 2021 80,000
December 2020 2,40,000 March 2021 1,00,000
April 2021 1,20,000
May 2021 80,000
June 2021 60,000
July 2021 1,20,000
(ii) Operating Expenses (including salary & wages) are estimated to be payable as follows:
Month (Rs.) Month (Rs.)
January 2021 22,000 April 2021 30,000
February 2021 25,000 May 2021 25,000
March 2021 30,000 June 2021 24,000
(iii) Of the sales, 75% is on credit and 25% for cash. 60% of the credit sales are collected after
one month, 30% after two months and 10% after three months.
(iv) Purchases amount to 80% of sales and are made on credit and paid for in the month preceding
the sales.
(v) The firm has 12% debentures of Rs.1,00,000. Interest on these has to be paid quarterly in
January, April and so on.
(vi) The firm is to make an advance payment of tax of Rs. 5,000 in April.
(vii) The firm had a cash balance of Rs. 40,000 at 31st Dec. 2020, which is the minimum desired
level of cash balance. Any cash surplus/deficit above/below this level is made up by temporary
investments/liquidation of temporary investments or temporary borrowings at the end of each
month (interest on these to be ignored). (10 Marks)
4. (a) N&B Ltd. is considering one of two mutually exclusive proposals, Projects A and B, which
require cash outlays of Rs. 34,00,000 and Rs. 33,00,000 respectively. The certainty-
equivalent (C.E) approach is used in incorporating risk in capital budgeting decisions. The
current yield on government bonds is 5% and this is used as the risk free rate. The expected
net cash flows and their certainty equivalents are as follows:
Year-end Project A Project B
Cash Flow (Rs.) C.E. Cash Flow (Rs.) C.E.
1 16,75,000 0.8 16,75,000 0.9
2 15,00,000 0.7 15,00,000 0.8
3 15,00,000 0.5 15,00,000 0.7
4 20,00,000 0.4 10,00,000 0.8
5 21,20,000 0.6 9,00,000 0.9

© The Institute of Chartered Accountants of India

 PV factor at 5% are as follows:
Year 1 2 3 4 5
PV factor 0.952 0.907 0.864 0.823 0.784

DETERMINE which project should be accepted. (8 Marks)

(b) DISCUSS the advantages of Certainty Equivalent Method. (2 Marks)
5. GG Pathology Lab Ltd. is using 2D sonography machine which has reached the end of its useful
life. The lab is intending to upgrade along with the technology by investing in 3D sonography
machine as per the choices preferred by the patients. Following new 3D s onography machine of
two different brands with same features is available in the market:
Brand Cost of Life of Maintenance Cost (Rs.) SLM
machine machine Depreciation rate
(Rs.) (Rs.) Year 1-5 Year 6-10 Year 11-15 (%)
X 15,00,000 15 50,000 70,000 98,000 6
Y 10,00,000 10 70,000 1,15,000 - 6

Residual Value of machines shall be dropped by 10% and 40% of Purchase price for Brand X and
Y respectively in the first year and thereafter shall be depreciated at the rate mentioned above on
the original cost.
Alternatively, the machine of Brand Y can also be taken on rent to be returned back to the owner
after use on the following terms and conditions:
• Annual Rent shall be paid in the beginning of each year and for first year it shall be
Rs. 2,24,000. Annual Rent for the subsequent 4 years shall be Rs. 2,25,000.
• Annual Rent for the final 5 years shall be Rs. 2,70,000.
• The Rent/Agreement can be terminated by GG Labs by making a payment of Rs. 2,20,000 as
penalty. This penalty would be reduced by Rs. 22,000 each year of the period of rental
agreement.
You are required to:
(i) ADVISE which brand of 3D sonography machine should be acquired assuming that the use of
machine shall be continued for a period of 20 years.
(ii) STATE which of the option is most economical if machine is likely to be used for a period of 5
years?
The cost of capital of GG Labs is 12%.
The present value factor of Rs. 1 @ 12% for different years is given as under:
Year PVF Year PVF
1 0.893 9 0.361
2 0.797 10 0.322
3 0.712 11 0.287
4 0.636 12 0.257

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 5 0.567 13 0.229
6 0.507 14 0.205
7 0.452 15 0.183
8 0.404 16 0.163
(10 Marks)
6. (a) DISCUSS the advantages and disadvantages of Wealth maximization principle. (4 Marks)
(b) DISCUSS in brief the characteristics of Debentures. (4 Marks)
(c) DEFINE Security Premium Notes.
Or
DEFINE Masala bond. (2 Marks)

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question 7 is compulsory question.
Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above
the required number, then only the requisite number of questions first answered will be the evaluated
the rest answer shall be ignored
Working Notes should form part of the answer.

QUESTIONS
7. (a) How is the measurement of National Income done in India? (2 Marks)
(b) What are the important Characteristics of Public Good? Why does market fails to produce public
goods? (3 Marks)
(c) Calculate Personal Income and Personal Disposable Income from the following data (In crores of
Rupees) (5 Marks)
Particular Rs. In crores
(i) National Income 2000
(ii) Undistributed Profits 175
(iii) Net Interest Payment made by households 35
(iv) Corporate Tax 20
(v) Transfer payment to the households from firms 25
And government
(vi) Personal Income Tax 50
(vii) Non-Tax Payments 40
8. (a) Calculate Operating Surplus and Net Value added at Factor Cost from the following data:
Particulars Rs in Crore
(i) Compensation of Employee 600
(ii) Intermediate Consumption 200
(iii) Sales 4500
(iv) Depreciation 200
(v) Rent 300
(vi) Interest 500
(vii) Mixed Income of Self Employed 700
(viii) Purchase of materials 90
(ix) Opening Stock 50
(x) Closing Stock 60
6

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 (xi) Excise Tax 70
(xii) Subsidies 20 (5 Marks)
(b) What do you understand by the term “Tragedy of Common’s “in Public Finance. (2 Marks)
(c) How fiscal Policy can be used as a tool for Reduction in inequalities of Income and Wealth?
(3 Marks)
9. (a) What is the effect of government expenditure on Money Supply? (2 Marks)
(b) What is credit multiplier and how it is calculated? (3 Marks)
(c) In an economy the equations are given as follows:
C = 200 + 0.80 Yd, I = 400, G = 300, T = 100, TR = 50
Find the equilibrium level of Income. (5 Mark)
10. (a) What is Factor Price–Equalization Theorem of International Trade? (2 Marks)
(b) The developing countries will have disadvantage if they engage in liberal trade
Explain in detail. (3 Marks)
(c) The Role of bank rate as an instrument of monetary policy? (3 Marks)
(d) What is the difference between Repo and Reverse Repo Rate? (2 Marks)
11. (a) What is Cambridge – Approach theory of demand for Money? (2 Marks)
(b) Relevance of Monetary Policy Committee and its impact? (3 Marks)
(c) What is the leakages-injections approach in two sector circular flow Model? (3 Marks)
(d) What are the conceptual three functions framework of the responsibilities of Government in Public
Finance? (2 Marks)

© The Institute of Chartered Accountants of India

 Test Series: March, 2021
MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8A: FINANCIAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Working:
Calculation of Earnings per share (EPS):
DPS
EPS =
Dividend Payout Ratio
Rs. 9
EPS= 1-0.25 = Rs.12
Market price per share by
(i) Walter’s model:
r
D+ (E-D)
P = Ke
Ke
0.24
Rs. 9 + (Rs. 12 - Rs. 9)
0.19
=
0.19
= Rs. 67.31
(ii) Gordon’s model (Dividend Growth model):
Do (1+g)
Po =
Ke - g

Where,
Po = Present market price per share.
g = Growth rate (br) = 0.25 × 0.24 = 0.06
b = Retention ratio
k = Cost of Capital
r = Internal rate of return (IRR)
D0 = Dividend per share
E = Earnings per share
Rs. 9(1+0.06)
=
0.19-0.06
Rs. 9.54
= = Rs.73.38
0.13

Alternatively,
E(1- b)
Po =
k - br
12 (1-0.25) 9
Po = = = Rs. 69.23
0.19 - 0.06 0.13

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 (b) Workings:
Current Assets(CA) 1.5
1. Current Ratio = =
Current Liabilities(CL) 1
 CA = 1.5 CL
Also, CA - CL = Rs. 2,00,000
1.5 CL- CL = Rs. 2,00,000
Rs. 2,00,000
CL = 0.5
= Rs. 4,00,000
CA = 1.5 × Rs. 4,00,000 = Rs. 6,00,000
2. Bank Credit (BC) to Other Current Liabilities (OCL) ratio = 3:1
Bank Credit (BC) 3
=
Other Current Liabilities (OCL) 1
BC = 3 OCL
Also, BC + OCL = CL
3 OCL + OCL = Rs. 4,00,000
Rs. 4,00,000
OCL = = Rs. 1,00,000
4
Bank Credit = 3 × Rs. 1,00,000 = Rs. 3,00,000
Current Assets - Inventories
3. Quick Ratio =
Current Liabilities
Rs. 6,00,000-Inventories
0.7 =
Rs. 4,00,000
Inventories = Rs. 6,00,000 – Rs. 2,80,000 = Rs. 3,20,000
4. Inventory Turnover = 5 times
Cost of goods sold (COGS)
Inventory Turnover =
Average Inventory
Cost of goods sold (COGS)
Average Inventory =
Inventory Turnover
COGS = Rs. 3,20,000 × 5 = Rs. 16,00,000
Sales - COGS
5. Gross Margin = × 100 = 25%
Sales
16,00,000
Sales = = Rs. 21,33,333.33
0.75
6. Average Collection Period (ACP) = 1.5 months = 45 days
360 360
Debtors Turnover = = = 8 times
ACP 45
Sales
Also, Debtors Turnover =
Average Debtors
Rs.21,33,333.33
Hence, Debtors = = Rs.2,66,667
8

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 7. Bank & Cash = CA - (Debtors + Inventory)
= Rs. 6,00,000 – (Rs. 2,66,667 + 3,20,000) = Rs. 13,333
Reserves & Surplus
8. =3
Bank & Cash
Reserves & Surplus = 3 × Rs. 13,333 = Rs. 40,000
Balance Sheet of SN Ltd. as on 31 st March 2021
Liabilities (Rs.) Assets (Rs.)
Share Capital 6,25,000 Fixed Assets 4,65,000
Reserves & Surplus 40,000 (Balancing Figure)
Current Liabilities: Current Assets:
Bank Credit 3,00,000 Inventories 3,20,000
Other Current Liabilities 1,00,000 Debtors 2,66,667
Bank & Cash 13,333
10,65,000 10,65,000
(c) Calculation of Degree of Operating leverage and Degree of Combined leverage
Firm Degree of Operating Leverage Degree of Combined Leverage
(DOL) (DCL)
%changeinOperatingIncome %changeinEPS
= =
%changeinRevenue %changeinRevenue

23% 30%
P = 0.92 = 1.2
25% 25%
30% 26%
Q = 1.11 = 0.96
27% 27%
36% 20%
R = 1.50 = 0.83
24% 24%
30% 20%
S = 1.50 = 1.00
20% 20%

(d) Computation of level of earnings before interest and tax (EBIT)

In case alternative (i) is accepted, then the EPS of the firm would be:
(EBIT − Interest) (1− tax rate) (EBIT − 0.14  8,00,000) (1 − 0.3)
EPS Alternative (i) = =
No. of equity shares 1,20,000 shares

In case the alternative (ii) is accepted, then the EPS of the firm would be
(EBIT − Interest) (1− tax rate) - PD
EPS Alternative (ii) =
No. of equity shares
(EBIT − 0.14  8,00,000) (1 − 0.3) - 0.16  4,00,000
=
80,000 shares

© The Institute of Chartered Accountants of India

 In order to determine the indifference level of EBIT, the EPS under the two alternative plans should
be equated as follows:
(EBIT − 0.14  8,00,000) (1 − 0.3) (EBIT − 0.14  8,00,000) (1 − 0.3) - 0.16  4,00,000
=
1,20,000 shares 80,000 shares
0.7EBIT − 78,400 0.7EBIT − 1,42,400
Or, =
1,20,000 80,000
Or 1.40 EBIT − Rs. 1,56,800 = 2.10 EBIT − Rs. 4,27,200
Or 0.70 EBIT = Rs. 2,70,400
2,70,400
Or EBIT =
0.7
Or EBIT = Rs. 3,86,285.71 (approx.)
2. (i) Cost of Equity (K e)
D1 Rs. 5
= +g = + 0.15 = 0.1689 or 16.89%
P0 - F Rs.265- Re.1
(ii) Cost of Debt (K d)
Calculation of NPV at discount rate of 5% and 7%
Year Cash Discount Present Discount Present Value
flows factor @ 5% Value factor @ 7% (Rs.)
(Rs.)
0 112.7 1.000 (112.7) 1.000 (112.7)
1 to 10 7 7.722 54.05 7.024 49.17
10 100 0.614 61.40 0.508 50.80
NPV +2.75 -12.73
Calculation of IRR
2.75 2.75
IRR = 5% + ( 7% - 5% ) = 5% + ( 7% - 5% ) = 5.36%
2.75-(-12.73) 15.48
Cost of Debt (K d) = 5.36%
(iii) Cost of Preference shares (K p)
Calculation of NPV at discount rate of 2% and 5%
Year Cash Discount Present Discount Present Value
flows factor @ Value factor @ (Rs.)
(Rs.) 2% 5%
0 117.6 1.000 (117.6) 1.000 (117.6)
1 to 10 5 8.983 44.92 7.722 38.61
10 100 0.820 82.00 0.614 61.40
NPV +9.32 -17.59
Calculation of IRR
9.32 9.32
IRR = 2% + 9.32-(-17.59) (5%-2%)= 2% + 26.91 (5%-2%)= 3.04%

Cost of Preference Shares (K p) = 3.04%

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 Calculation of WACC using market value weights
Source of capital Market Value Weights After tax WACC (Ko)
cost of
capital
(Rs.) (a) (b) (c) = (a)×(b)
10% Debentures (Rs.115× 10,000) 11,50,000 0.021 0.0536 0.00113
5% Preference shares (Rs.120× 12,00,000 0.022 0.0304 0.00067
10,000)
Equity shares (Rs.265 × 2,00,000) 5,30,00,000 0.957 0.1689 0.16164
5,53,50,000 1.000 0.16344
WACC (Ko) = 0.16344 or 16.344%
3. Monthly Cash Budget for first six months of 2021
(Amount in Rs.)
Particulars Jan. Feb. Mar. April May June
Opening balance 40,000 40,000 40,000 40,000 40,000 40,000
Receipts:
Cash sales 15,000 20,000 25,000 30,000 20,000 15,000
Collection from debtors 1,72,500 97,500 67,500 67,500 82,500 70,500
Total cash available (A) 2,27,500 1,57,500 1,32,500 1,37,500 1,42,500 1,25,500
Payments:
Purchases 64,000 80,000 96,000 64,000 48,000 96,000
Operating Expenses 22,000 25,000 30,000 30,000 25,000 24,000
Interest on debentures 3,000 - - 3,000 - -
Tax payment - - - 5,000 - -
Total payments (B) 89,000 1,05,000 1,26,000 1,02,000 73,000 1,20,000
Minimum cash balance 40,000 40,000 40,000 40,000 40,000 40,000
desired
Total cash needed (C) 1,29,000 1,45,000 1,66,000 1,42,000 1,13,000 1,60,000
Surplus/(deficit) (A - C) 98,500 12,500 (33,500) (4,500) 29,500 (34,500)
Investment/financing
Temporary Investments (98,500) (12,500) - - (29,500) -
Liquidation of temporary 33,500 4,500
investments or temporary - 34,500
borrowings
Total effect of 4,500 (29,500) 34,500
investment/financing(D) (98,500) (12,500) 33,500
Closing cash balance (A +
D - B) 40,000 40,000 40,000 40,000 40,000 40,000

Workings:
1. Collection from debtors: (Amount in Rs.)
Year 2020 Year 2021
Oct. Nov. Dec. Jan. Feb. Mar. April May June
Total sales 2,00,000 2,20,000 2,40,000 60,000 80,000 1,00,000 1,20,000 80,000 60,000

© The Institute of Chartered Accountants of India

 Credit sales
(75% of total
sales) 1,50,000 1,65,000 1,80,000 45,000 60,000 75,000 90,000 60,000 45,000
Collections:
One month 90,000 99,000 1,08,000 27,000 36,000 45,000 54,000 36,000
Two months 45,000 49,500 54,000 13,500 18,000 22,500 27,000
Three months 15,000 16,500 18,000 4,500 6,000 7,500
Total
collections 1,72,500 97,500 67,500 67,500 82,500 70,500

2. Payment to Creditors: (Amount in Rs.)

Year 2021
Jan Feb Mar Apr May Jun Jul
Total sales 60,000 80,000 1,00,000 1,20,000 80,000 60,000 1,20,000
Purchases 96,000
(80% of total sales) 48,000 64,000 80,000 96,000 64,000 48,000
Payment:
One month prior 64,000 80,000 96,000 64,000 48,000 96,000

4. (a) Statement Showing the Net Present Value of Project A

Year end Cash Flow C.E. Adjusted Cash Present value Total Present
(Rs.) flow (Rs.) factor at 5% value (Rs.)
(a) (b) (c) = (a)  (b) (d) (e) = (c) (d)
1 16,75,000 0.8 13,40,000 0.952 12,75,680
2 15,00,000 0.7 10,50,000 0.907 9,52,350
3 15,00,000 0.5 7,50,000 0.864 6,48,000
4 20,00,000 0.4 8,00,000 0.823 6,58,400
5 21,20,000 0.6 12,72,000 0.784 9,97,248
PV of total Cash Inflows 45,31,678
Less: Initial Investment 34,00,000
Net Present Value 11,31,678
Statement Showing the Net Present Value of Project B

Year end Cash Flow C.E. Adjusted Cash Present value Total Present
(Rs.) flow (Rs.) factor at 5% value (Rs.)
(a) (b) (c) = (a)  (b) (d) (e) = (c) (d)
1 16,75,000 0.9 15,07,500 0.952 14,35,140
2 15,00,000 0.8 12,00,000 0.907 10,88,400
3 15,00,000 0.7 10,50,000 0.864 9,07,200
4 10,00,000 0.8 8,00,000 0.823 6,58,400
5 9,00,000 0.9 8,10,000 0.784 6,35,040
PV of total Cash Inflows 47,24,180
Less: Initial Investment 33,00,000
Net Present Value 14,24,180
Project B has NPV of Rs. 14,24,180 which is higher than the NPV of Project A. Thus, N&B Ltd.
should accept Project B.

© The Institute of Chartered Accountants of India

 (b) Advantages of Certainty Equivalent Method:
1. The certainty equivalent method is simple and easy to understand and apply.
2. It can easily be calculated for different risk levels applicable to different cash flows. For
example, if in a particular year, a higher risk is associated with the cash flow, it can be easily
adjusted and the NPV can be recalculated accordingly.
5. Since the life span of each machine is different and time span exceeds the useful lives of each modeI,
we shall use Equivalent Annual Cost method to decide which brand should be chosen.
(i) If machine is used for 20 years
(a) Residual value of machine of brand X
= [Rs. 15,00,000 – (1 - 0.10)] - (Rs. 15,00,000 × 0.06 × 14) = Rs. 90,000
(b) Residual value of machine of brand Y
= [Rs. 10,00,000 – (1 - 0.40)] - (Rs. 10,00,000 × 0.06 × 9) = Rs. 60,000
Present Value (PV) of cost if machine of brand X is purchased
Period Cash Outflow (Rs.) PVF @ 12% PV (Rs.)
0 15,00,000 1.000 15,00,000
1-5 50,000 3.605 1,80,250
6-10 70,000 2.046 1,43,220
11-15 98,000 1.161 1,13,778
15 (90,000) 0.183 (16,470)
19,20,778
PVAF for 1-15 years = 6.812
Rs.19,20,778
Equivalent Annual Cost = = Rs. 2,81,969.76
6.812
Present Value (PV) of cost if machine of brand Y is purchased
Period Cash Outflow (Rs.) PVF @ 12% PV (Rs.)
0 10,00,000 1.000 10,00,000
1-5 70,000 3.605 2,52,350
6-10 1,15,000 2.046 2,35,290
10 (60,000) 0.322 (19,320)
14,68,320
PVAF for 1-10 years = 5.651
Rs.14,68,320
Equivalent Annual Cost = = Rs. 2,59,833.66
5.651
Present Value (PV) of cost if machine of brand Y is taken on rent
Period Cash Outflow (Rs.) PVF @ 12% PV (Rs.)
0 2,24,000 1.000 2,24,000
1-4 2,25,000 3.038 6,83,550
5-9 2,70,000 2.291 6,18,570
15,26,120

© The Institute of Chartered Accountants of India

 PVAF for 1-10 years = 5.651
Rs.15,26,120
Equivalent Annual Cost = = Rs. 2,70,061.94
5.651
Decision: Since Equivalent Annual Cash Outflow is least in case of purchase of Machine of brand
Y the same should be purchased.
(ii) If machine is used for 5 years
(a) Scrap value of machine of brand X
= [Rs. 15,00,000 – (1 - 0.10)] - (Rs. 15,00,000 × 0.06 × 4) = Rs. 9,90,000
(b) Scrap value of machine of brand Y
= [Rs. 10,00,000 – (1 - 0.40)] - (Rs. 10,00,000 × 0.06 × 4) = Rs. 3,60,000
Present Value (PV) of cost if machine of brand X is purchased
Period Cash Outflow (Rs.) PVF @ 12% PV (Rs.)
0 15,00,000 1.000 15,00,000
1-5 50,000 3.605 1,80,250
5 (9,90,000) 0.567 (5,61,330)
11,18,920
Present Value (PV) of cost if machine of brand Y is purchased
Period Cash Outflow (Rs.) PVF @ 12% PV (Rs.)
0 10,00,000 1.000 10,00,000
1-5 70,000 3.605 2,52,350
5 (3,60,000) 0.567 (2,04,120)
10,48,230
Present Value (PV) of cost if machine of brand Y is taken on rent
Period Cash Outflow (Rs.) PVF @ 12% PV (Rs.)
0 2,24,000 1.000 2,24,000
1-4 2,25,000 3.038 6,83,550
5 1,10,000* 0.567 62,370
9,69,920
* [Rs. 2,20,000 - (Rs. 22,000 × 5) = Rs. 1,10,000]
Decision: Since Cash Outflow is least in case of rent of Machine of brand Y the same should be
taken on rent.
6. (a) Advantages and disadvantages of Wealth maximization principle.
Advantages:
(i) Emphasizes the long term gains
(ii) Recognises risk or uncertainty
(iii) Recognises the timing of returns
(iv) Considers shareholders’ return.

© The Institute of Chartered Accountants of India

 Disadvantages:
(i) Offers no clear relationship between financial decisions and share price.
(ii) Can lead to management anxiety and frustration.
(b) Characteristics of Debentures are as follows:
• Normally, debentures are issued on the basis of a debenture trust deed which lists the terms
and conditions on which the debentures are floated.
• Debentures are either secured or unsecured.
• May or may not be listed on the stock exchange.
• The cost of capital raised through debentures is quite low since the interest payable on
debentures can be charged as an expense before tax.
• From the investors' point of view, debentures offer a more attractive prospect than the
preference shares since interest on debentures is payable whether or not the company makes
profits.
• Debentures are thus instruments for raising long-term debt capital.
• The period of maturity normally varies from 3 to 10 years and may also increase for projects
having high gestation period.
(c) Secured Premium Notes: Secured Premium Notes is issued along with a detachable warrant and
is redeemable after a notified period of say 4 to 7 years. The conversion of detachable warrant into
equity shares will have to be done within time period notified by the company.
Or
Masala bond: Masala (means spice) bond is an Indian name used for Rupee denominated bond
that Indian corporate borrowers can sell to investors in overseas markets. These bonds are issued
outside India but denominated in Indian Rupees. NTPC raised Rs. 2,000 crore via masala bonds
for its capital expenditure in the year 2016.

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
ANSWERS / HINTS
7. (a) National Accounts Statistics in India are compiled by National Accounts Division in the Central
Statistics Office, Ministry of Statistics and Programme Implementation. The estimates are
published both annually and quarterly. This publication is the key source of macroeconomic data
of the country and as per the mandate of FRBM Act 2003, the Ministry of Finance uses the GDP
numbers (at current prices) to determine the fiscal targets. The Ministry has released the new
series of National Accounts by revising the base year from 2004-05 to 2011-12. The revision of
National Accounts was done by CSO in January 2015.
(b) Once the Public good is provided, the additional resource cost of another person consuming the
goods is zero.
Characteristics of Public Goods:
(a) is non -rival in consumption
(b) are non-excludable
(c) are characterised by indivisibility
(d) are generally more vulnerable to issues such as externalities, inadequate property rights and
free rider problems.
Because of the peculiar characteristics of public goods such as indivisibility, non -excludability,
competitive market will fail to generate economically efficient outputs of public goods.
(c) Personal Income = National Income - Undistributed Profits - Net Interest Payments made by
households - corporate tax + Transfer payments to the households from firms and government
= 2000-175- 35- 20 + 25
= 1795 Crores
Personal Disposable Income = Personal Income – Personal Income Taxes – Non-Tax payments
= 1795 –50 –40
= 1705 crores
8. (a) GVAmp = Value of Output - Intermediate Consumption
= (Sales + Change in Stocks) – Intermediate Consumption
= 4500 + 10 – 200
= 4,310 crores
GVA mp= 4 ,310 cr
NVAmp = GVAmp -- Depreciation
= 4, 310 – 200
= 4,110 cr
NVA fc = NVA mp – (Indirect Taxes – Subsidies)
= 4,110 – (70- 20)
= 4,060 cr.

10

© The Institute of Chartered Accountants of India

 NDPfc = NVAfc = Compensation of employees + Operating Surplus + Mixed Income of self
employed
4,060 = 600 + Operating Surplus + 700
Operating Surplus = 2760 cr
(b) The Problem of the Tragedy of commons was first described by Garrett Hardin. Economists used
the term to describe the problem which occurs when rivalrous and non-excludable goods are
overused to the disadvantage of the entire world. The term “commons “is derived from the
traditional English legal term of “Common land “ where farmers / peasant would graze their
livestock, hunt and collect wild plants and other produce. Everyone has access to a commonly
held pasture there and are no rules for sustainable numbers for grazing. The outcome of the
individual rational economic decisions of cattle owners was market failure because these actions
resulted in degradation, depletion or even destruction of the resource leading to welfare loss for
the entire society.
(c) Government’s fiscal policy has a strong influence on the performance of the macro economy in
terms of employment, price stability, economic growth, and external balances. Proceeds from
progressive taxes to be used for financing public services, especially those that benefit low -income
households (for example, supply of essential food grains at highly subsidized prices to BPL
households). The challenge before any government is how to design its budgetary policy so that
the pursuit of one goal does not jeopardize the other.
9. (a) Whenever the Central and the State government’s cash balances fall short of the minimum
requirement, they are eligible to avail of a facility called Ways and Means Advances
(WMA/Overdraft facility). When the reserve bank lends to the governments under WMA/OD it
results in the generation of excess reserves. The excess reserves thus created can potentially
lead to an increase in money supply through the money multiplier process.
(b) The Credit Multiplier is also referred to as the deposit multiplier or the deposit expansion multiplier,
describes the amount of additional money created by commercial bank through the process of
lending the available money it has in excess of the central bank’s reserve requirements. It is the
reciprocal of the required reserve ratio.
Credit Multiplier = 1 ÷ by required reserve ratio
(c) Yd = Y-T + TR
Yd = Y- 100 +50
Y = C + I +G
Y = 200 + 0.80 (Y- 100 +50) + 400 + 300
Y = 200 + 0.80 Y- 0.80 X 50 + 700
Y = 900 + 0.80 Y- 40
Y- 0.80Y = 860
0.20 Y = 860
Y = 860 ÷ 0.20 = 4350

11

© The Institute of Chartered Accountants of India

10. (a) The factor price equalisation theorem postulates that if the prices of the output of goods are
equalized between countries engaged in free trade, then the price of the input factor will also be
equalised between countries. This implies that the wages and rent will converge across the
countries with free trade or in other words, trade in goods is a perfect substitute for trade in factors.
(b) The developing countries find themselves disproportionately disadvantage and vulnerable with
regard to adjustments due to lack of human as well as physical capital, poor infrastructure,
inadequate institutions, political instabilities etc. Developing countries also complain that they face
exceptionally high tariffs on selected products in many markets and this obstructs their vital
exports.
(c) The bank rate has been aligned to the Marginal Standing Facility (MSF) rate and therefore as and
when the MSF rate changes alongside policy repo rate changes automatically. Now bank rate is
used only for calculating penalty on default in the maintenance of Cash Reserve Ratio (CRR) and
Statutory Liquidity Ratio (SLR).
(d) Repo or repurchase option is a collaterised lending because banks borrow money from RBI to fulfil
their short-term monetary requirements by selling securities to RBI with an explicit agreement to
repurchase the same at predetermined date and at a fixed rate. The rate charged by RBI for this
transaction is called the ‘repo rate’.
The Reverse repo is defined as an instrument for lending funds by purchasing securities on a
mutually agreed future date at an agreed price which includes interest for the funds lent.
11. (a) The Cambridge approach holds that money increases utility in the following two ways:
• enabling the possibility of split-up sale and purchase to two different points of time rather than
being simultaneous and
• being a hedge against uncertainty.
The Cambridge money demand function is stated as:
Md = K PY
Md = is the demand of money balances,
Y = real national income
P = average price level of currently produced goods and services
PY = nominal income
K = proportion of nominal income (PY) that people want to hold as Cash Balances.
The term ‘k’ in the above equation is called Cambridge K is a parameter reflecting economic
structure and monetary habits, namely the ratio of desired money balances to total transactions to
income and the ratio of desired money balances to total transactions.
(b) The Monetary Policy Committee was constituted in September 2016. The Committee is required
to meet four times a year and decision taken in the meeting is published after conclusion of the
meeting. Based on the review of the macroeconomic and monetary developments in the economy,
the monetary policy will determine the policy rate required to achieve the inflation target. The fixing
of the benchmark policy interest rate (repo rate) is made through debate and majority vote by the
panel of experts of the committee.

12

© The Institute of Chartered Accountants of India

 (c) A leakage is referred to as an outflow of income from the circular flow model. Leakages are that
part of income which is not used to purchase goods and services or what households withdraw
from the circular flow. An injection is an inflow of income to the circular flow. Due to injection of
income in the circular flow, the volume of income increases. Investment is an injection in the
circular flow. The Circular flow will be balanced and therefore in equilibrium when the inje ctions
are equal to the leakages.
(d) Richard Musgrave in his classic treatise “The Theory of Public Finance” introduced the three-
branch taxonomy of the role of government in a market economy. The functions of the government
are to be separated into three namely: resource allocation, income redistribution and
macroeconomic stabilization. The allocation and redistribution function are primarily
microeconomic functions while stabilization is a macroeconomic function. The allocation function
aims to correct the sources of inefficiency in the economic system while distribution role ensures
that the distribution of wealth and income is fair. Monetary and fiscal Policy, maintenance of high
levels of employment and price stability fall under the stabilization function.

13

© The Institute of Chartered Accountants of India

 Test Series: April, 2021
MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) Kee Ltd. and Lee Ltd. are identical in every respect except for capital structure. Kee Ltd. does not
employ debt in its capital structure, whereas Lee Ltd. employs 12% debentures amounting to
Rs. 20 lakhs. Assuming that:
(i) All assumptions of MM model are met;
(ii) The income tax rate is 30%;
(iii) EBIT is Rs. 5,00,000 and
(iv) The equity capitalization rate of Kee Ltd. is 25%.
CALCULATE the average value of both the Companies.
(b) The following data is available in respect of N Ltd. for the year ended 31 st March, 2021:
Rs. (in Crore)
Share capital (@ Rs. 10 per share) 25.00
Reserves 15.00
Profit after tax (PAT) 3.70
Dividends paid 3.00
P/E ratio 26.70
Using Walter’s Model:
(i) COMMENT on the firm’s dividend policy;
(ii) DETERMINE the optimum payout ratio and
(iii) DETERMINE the P/E ratio at which dividend payout will have no effect on share price.
(c) XYZ Ltd. has Owner's equity of Rs. 2,00,000 and the ratios of the company are as follows:
Current debt to total debt 0.3
Total debt to Owner's equity 0.5
Fixed assets to Owner's equity 0.6

1
 Total assets turnover 2 times
Inventory turnover 10 times
COMPLETE the following Balance Sheet from the information given above:
Liabilities (Rs.) Assets (Rs.)
Current Debt - Cash -
Long-term Debt - Inventory -
Total Debt - Total Current Assets -
Owner's Equity - Fixed Assets -

(d) In March, 2021 Tiruv Ltd.'s share was sold for Rs. 219 per share. A long term earnings growth rate
of 11.25% is anticipated. Tiruv Ltd. is expected to pay dividend of Rs. 5.04 per share.
(i) DETERMINE the rate of return an investor can expect to earn assuming that dividends are
expected to grow along with earnings at 11.25% per year in perpetuity?
(ii) It is expected that Tiruv Ltd. will earn about 15% on book equity and shall retain 60% of
earnings. In this case, whether, there would be any change in growth rate and cost of equity?
ANALYSE. (4 × 5 = 20 Marks)
2. (a) SG Ltd. is considering a project “Z” with an initial outlay of Rs. 7,50,000 and life of 5 years. The
estimates of project are as follows:
Lower Estimates Base Upper Estimates
Sales (units) 4,500 5,000 5,500
(Rs.) (Rs.) (Rs.)
Selling Price p.u. 175 200 225
Variable cost p.u. 100 125 150
Fixed Cost 50,000 75,000 1,00,000
Depreciation included in Fixed cost is Rs. 35,000 and corporate tax is 25%.
Assuming the cost of capital as 15%, DETERMINE NPV in three scenarios i.e worst, base and best
case scenario.
PV factor for 5 years at 15% are as follows:
Years 1 2 3 4 5
P.V. factor 0.870 0.756 0.658 0.572 0.497
(7 Marks)
(b) Development Finance Corporation issued zero interest deep discount bonds of face value of
Rs. 1,50,000 each issued at Rs. 3,750 & repayable after 25 years. COMPUTE the cost of debt if
there is no corporate tax. (3 Marks)
3. WQ Limited is considering relaxing its present credit policy and is in the process of evaluating two
proposed polices. Currently, the firm has annual credit sales of Rs. 180 lakh and Debtors turnover ratio
of 4 times a year. The current level of loss due to bad debts is Rs. 6 lakh. The firm is required to give a
return of 25% on the investment in new accounts receivables. The company’s variable costs are 60% of
the selling price. Given the following information, DETERMINE which is a better Policy?

2
 (Amount in lakhs)
Present Proposed Policy
Policy Option I Option II
Annual credit sales (Rs.) 180 220 280
Debtors turnover ratio 4 3.2 2.4
Bad debt losses (Rs.) 6 18 38
(10 Marks)
4. City Clap Ltd. is in the business of providing housekeeping services. There is a proposal before the
company to purchase a mechanized cleaning system for a sum of Rs. 40 lakhs. The present system of
the company is to use manual labour for the cleaning job. You are provided with the following
information:
Proposed Mechanized System:
Cost of the machine Rs. 40 lakhs
Life of the machine 7 years
Depreciation (on straight line basis) 15%
Operating cost of mechanized system Rs. 20 lakhs per annum
Present system (Manual):
Manual labour 350 persons
Cost of manual labour Rs. 15,000 per person per annum
The company has an after-tax cost of fund at 10% per annum.
The applicable tax rate is 50%.
PV factor for 7 years at 10% are as follows:
Years 1 2 3 4 5 6 7
P.V. factor 0.909 0.826 0.751 0.683 0.621 0.564 0.513

You are required to DETERMINE whether it is advisable to purchase the mechanized cleaning system.
Give your recommendations with workings. (10 Marks)
5. Following data of MT Ltd. under Situations 1, 2 and 3 and Financial Plan A and B is given:
Installed Capacity (units) 3,600
Actual Production and Sales (units) 2,400
Selling price per unit (Rs.) 30
Variable cost per unit (Rs.) 20
Fixed Costs (Rs.): Situation 1 3,000
Situation 2 6,000
Situation 3 9,000

3
 Capital Structure :
Particulars Financial Plan
A B
Equity Rs. 15,000 Rs. 22,500
Debt Rs. 15,000 Rs. 7,500
Cost of Debt 12% 12%
Required:
(i) CALCULATE the operating leverage and financial leverage.
(ii) FIND out the combinations of operating and financial leverage which give the highest value and
the least value. (10 Marks)
6. (a) EXPLAIN in brief the features of Commercial Paper.
(b) DESCRIBE how agency problem can be addressed.
(c) DEFINE Debt Securitisation.
Or
EXPLAIN the principles of “Trading on equity”. (4 + 4 + 2 =10 Marks)

4
 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question 7 is compulsory question.
Attempt any three from the remaining four questions
In case, any candidate answers extra questions(s)/sub-question(s)/sub-question(s) over and above
the required number, then only the requisite number of questions first answered will be the evaluated
the rest answer shall be ignored
Working Notes should form part of the answer.

QUESTIONS
7. (a) What are the Challenges in Computation of National Income in India? (2 Marks)
(b) Calculate National Income by Expenditure Method and Income Method with th e help of the
following data:
Items Rs. In Cr ores
(i) Compensation of Employees 2000
(ii) Mixed Income of Self Employed 1000
(iii) Net Factor Income of Abroad 50
(iv) GST 100
(v) Subsidies 60
(vi) Private Final Consumption Expenditure 700
(vii) Government Final Consumption Expenditure 800
(viii) Export 200
(ix) Import 120
(x) Net Domestic Capital Formation 500
(xi) Profit 400
(xii) Interest 300
(xiii) Rent 600
(xiv) Depreciation 200 (5 Marks)
(c) How does Free Rider Problems causes market failure? (3 Marks)
8. (a) Calculate Personal Disposable Income from the following data:
Items Rs. In crores
(i) NNPfc 5000
(ii) Undistributed Profit 200
(iii) Net interest payments made by households 400
(iv) Corporate Tax 600
(v) Transfer Payments to the households from firms and government 500
5
 (vi) Personal Income Taxes 1200
(vii) Non tax Payments 800 (3 Marks)
(b) How does government subsidies help in balancing the role as allocative function? (2 Marks)
(c) What is Speculative demand for Money. Explain with the help of a diagram? (3 Marks)
(d) Define Balanced budget and the process for calculating the same? (2 Marks)
9. (a) How does Government Intervention helps in correcting externalities? (3 Marks)
(b) Fiscal Policy can be used as a tool for redistribution and economic growth: Comment. (2 Marks)
(c) What are the major differences between Foreign Direct Investment and Foreign Portfolio
Investment? (3 Marks)
(d) How is New Trade Policy (NTT) beneficial for development of Foreign Trade? (2 Marks)
10. (a) Calculate M3 from the Following data?
Items Rs in crores
Currency Notes and Coins with the people 5000
Demand Deposit with the banking system 4000
Other Deposits with the RBI 3000
Time Deposit with banking system 1000
Saving Deposit with Post office 500 (3 Marks)
(b) Why is The Quantity Theory of Money Important? (2 Marks)
(c) What is crowding out effect and how did it impact fiscal Policy? (3 Marks)
(d) What are the important barriers in International Trade ? How does its resolution help in
development of international Trade? (2 Marks)
11. (a) Explain the three Sector Model of determination of National Income? (3 Marks)
(b) Why is the role of government important in solving the free rider problem? (2 Marks)
(c) What are the mechanism through which monetary policy work? (3 Marks)
(d) Under Floating Rate Regime how exchange rate is determined? (2 Marks)

6
 Test Series: April 2021
MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Kee Ltd. (pure Equity) i.e. unlevered company:
EAT = EBT (1 – t)
= EBIT (1 - 0.3) = Rs. 5,00,000 × 0.7 = Rs. 3,50,000
(Here, EBIT = EBT as there is no debt)
EAT
Value of unlevered company Kee Ltd. =
Equity capitalization rate

Rs. 3,50,000
= = Rs. 14,00,000
25%
Lee Ltd. (Equity and Debt) i.e levered company:
Value of levered company = Value of Equity + Value of Debt
= Rs. 14,00,000 + (Rs. 20,00,000 × 0.3)
= Rs. 20,00,000
(b) Workings:
PAT Rs. 3.7 crores
1. Earnings per share (E) = = = Rs. 1.48
No. of shares 2.5 crore shares
PAT Rs. 3.7 crores
2. Return on Investment (r) = x 100 = x 100 = 9.25%
Net worth Rs. (25 + 15) crores
Dividend paid Rs. 3 crores
3. Dividend per share (D) = = = Rs. 1.2
No. of shares 2.5 crore shares
Dividend Rs. 3 crores
Dividend payout ratio = x 100 = x 100 = 81.08%
PAT Rs. 3.7 crores
4. Current Market Price (P o) = P/E Ratio x E = 26.7 x Rs. 1.48 = Rs. 39.52
5. Growth rate (g) =bxr = (1 - 0.8108) x 0.0925 = 1.75%
D(1+g) Rs. 1.2 (1 + 0.0175)
6. Cost of Capital (K e) = +g = + 0.0175= 4.84%
Po Rs. 39.52
(i) The value of the share as per Walter’s model:
r
D+ (E-D) 1.2 + 0.0925 (1.48-1.2)
P= Ke =
0.0484
= Rs. 35.85
Ke 0.0484
The firm has a dividend payout of 81.08% (i.e., Rs. 3 crores) out of Profit after tax of
Rs. 3.7 crores with value of the share at Rs. 35.85. The rate of return on investment (r)
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 is 9.25% and it is more than the K e of 4.84%, therefore, by distributing 81.08% of
earnings, the firm is not following an optimal dividend policy.
(ii) Under Walter’s model, when return on investment is more than cost of capital (r > K e),
the market share price will be maximum if 100% retention policy is followed. So, t he
optimal payout ratio would be to pay zero dividend and in such a situation, the market
price would be:
0.0925
0 + 0.0484 (1.48 - 0)
P= = Rs. 58.44
0.0484
(iii) The P/E ratio at which dividend payout will have no effect on share price is at which the
Ke would be equal to the rate of return (r) of the firm i.e. 9.25%.
D (1+g)
So, Ke = +g
Po
Rs. 1.2 (1 + 0.0175)
0.0925 = + 0.0175
Po
 Po = Rs. 16.28
If Po is Rs. 16.28, then, P/E Ratio will be:
Po Rs. 16.28
= = = 11 times
E Rs. 1.48
Therefore, at the P/E ratio of 11, the dividend payout will have no effect on share price.
(c) Balance Sheet
Liabilities (Rs.) Assets (Rs.)
Current debt 30,000 Cash (balancing figure) 1,20,000
Long term debt 70,000 Inventory 60,000
Total Debt 1,00,000 Total Current Assets 1,80,000
Owner's Equity 2,00,000 Fixed Assets 1,20,000
Total liabilities 3,00,000 Total Assets 3,00,000
Workings:
1. Total debt = 0.50 x Owner's Equity = 0.50 x Rs. 2,00,000 = Rs. 1,00,000
Further, Current debt to Total debt = 0.30
So, Current debt = 0.30 × Rs. 1,00,000 = Rs. 30,000
Long term debt = Rs. 1,00,000 - Rs. 30,000 = Rs. 70,000
2. Fixed assets = 0.60 × Owner's Equity = 0.60 × Rs. 2,00,000 = Rs. 1,20,000
3. Total Liabilities = Total Debt + Owner’s Equity
= Rs. 1,00,000 + Rs. 2,00,000 = Rs. 3,00,000
Total Assets = Total Liabilities = Rs. 3,00,000
Total assets to turnover = 2 Times; Inventory turnover = 10 Times
Hence, Inventory /Total assets = 2/10=1/5,
Therefore Inventory = Rs. 3,00,000/5 = Rs. 60,000

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 (d) (i) According to Dividend Discount Model approach the firm’s expected or required return
on equity is computed as follows:
D1
Ke   g
P0
Where,
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
5.04
Therefore, K e   0.1125 = 13.55%
219
(ii) With rate of return on retained earnings (r) of 15% and retention ratio (b) of 60%, new
growth rate will be as follows:
g = br = 0.60 x 0.15 = 0.09 or 9%
Accordingly, dividend will also get changed and to calculate this, first we shall calculate
previous retention ratio (b 1) and then EPS assuming that rate of return on retained
earning (r) is same.
With previous Growth Rate of 11.25% and r =15%, the retention ratio comes out to be:
0.1125 = b1 x 0.15
b1 = 0.75 and payout ratio = 0.25
With 0.25 payout ratio, the EPS will be as follows:
5.04
EPS = = Rs. 20.16
0.25
With new payout ratio of 40% (1 – 0.60) the new dividend will be:
D1 = Rs. 20.16 x 0.40 = Rs. 8.064
Accordingly new Ke will be:
8.064
Ke   0.09 = 12.68%
219
2. (a) (i) Calculation of Yearly Cash Inflow
In worst case: High costs and Low price (Selling price) and volume(Sales units) are taken.
In best case: Low costs and High price(Selling price) and volume(Sales units) are taken.
Worst Case Base Best Case
Sales (units) (A) 4,500 5,000 5,500
(Rs.) (Rs.) (Rs.)
Selling Price p.u. 175 200 225
Less: Variable cost p.u. 150 125 100
Contribution p.u. (B) 25 75 125
Total Contribution (A x B) 1,12,500 3,75,000 6,87,500
Less: Fixed Cost 1,00,000 75,000 50,000
EBT 12,500 3,00,000 6,37,500
Less: Tax @ 25% 3,125 75,000 1,59,375
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 EAT 9,375 2,25,000 4,78,125
Add: Depreciation 35,000 35,000 35,000
Cash Inflow 44,375 2,60,000 5,13,125
(ii) Calculation of NPV in different scenarios
Worst Case Base Best Case
Initial outlay (A) (Rs.) 7,50,000 7,50,000 7,50,000
Cash Inflow (c) (Rs.) 44,375 2,60,000 5,13,125
Cumulative PVF @ 15% (d) 3.353 3.353 3.353
PV of Cash Inflow (B = c x d) (Rs.) 1,48,789.38 8,71,780 17,20,508.13
NPV (B - A) (Rs.) (6,01,210.62) 1,21,780 9,70,508.13
(b) Here,
Redemption Value (RV)= Rs.1,50,000
Net Proceeds (NP) = Rs. 3,750
Interest = 0
Life of bond = 25 years
There is huge difference between RV and NP therefore in place of approximation method we
should use trial & error method.
FV = PV x (1 + r) n
1,50,000 = 3,750 x (1 + r) 25
40 = (1 + r) 25
Trial 1: r = 15%, (1.15) 25 = 32.919
Trial 2: r = 16%, (1.16) 25 = 40.874
Here:
L = 15%; H = 16%
NPVL = 32.919 - 40 = - 7.081
NPVH = 40.874 - 40 = + 0.874
NPVL
IRR = L+ (H - L)
NPVL - NPVH
-7.081
= 15% + × (16% - 15%)= 15.89%
-7.081 - (0.874)
3. Statement showing evaluation of Credit Policies
(Amount in lakhs)
Particulars Present Proposed Policy
(Rs.) (Rs.)
Option I Option II
A Expected Profit:
(a) Credit Sales 180 220 280
(b) Total Cost other than Bad Debts:
Variable Costs (60%) 108 132 168

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 (c) Bad Debts 6 18 38
(d) Expected Profit [(a)-(b)-(c)] 66 70 74
B Opportunity Cost of Investment in Debtors (Refer 6.75 10.31 17.5
workings)
C Net Benefits [A - B] 59.25 59.69 56.5
Recommendation: The Proposed Policy I should be adopted since the net benefits under this
policy is higher than those under other policies.
Workings:
Calculation of Opportunity Cost of Investment in Debtors
Collection Period * Rate of Return
Opportunity Cost = Total Cost  
12 100
*Collection period (in months) = 12/Debtors turnover ratio
12/4 25
Present Policy = Rs. 108 × × = Rs. 6.75 lakhs
12 100
12/3.2 25
Proposed Policy I = Rs. 132 × × = Rs. 10.31 lakhs
12 100
12/2.4 25
Proposed Policy II = Rs. 168 × × = Rs. 17.5 lakhs
12 100
4. Calculation of NPV
(Rs.) (Rs.)
Cost of Manual System (Rs. 15,000 x 350) 52,50,000
Less: Cost of Mechanised System:
Operating Cost 20,00,000

Depreciation (Rs. 40,00,000 x 0.15) 6,00,000 26,00,000

Saving per annum 26,50,000
Less: Tax (50%) 13,25,000
Saving after tax 13,25,000
Add: Depreciation 6,00,000
Cash flow per annum 19,25,000
Cumulative PV Factor for 7 years @ 10% 4.867
Present value of cash flow for 7 years 93,68,975
Less: Cost of the Machine 40,00,000
NPV 53,68,975
The mechanized cleaning system should be purchased since NPV is positive by
Rs. 53,68,975.

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5. (i) Operating Leverage
Situation 1 Situation 2 Situation 3
(Rs.) (Rs.) (Rs.)
Sales (S)
2,400 units @ Rs. 30 per unit 72,000 72,000 72,000
Less: Variable Cost (VC) @ Rs. 20 per unit 48,000 48,000 48,000
Contribution (C) 24,000 24,000 24,000
Less: Fixed Cost (FC) 3,000 6,000 9,000
EBIT 21,000 18,000 15,000
C Rs. 24,000 Rs. 24,000 Rs. 24,000
Operating Leverage =
EBIT Rs. 21,000 Rs. 18,000 Rs. 15,000
= 1.14 = 1.33 = 1.60

Financial Leverage
Financial Plan
A (Rs.) B (Rs.)
Situation 1
EBIT 21,000 21,000
Less: Interest on debt 1,800 900
(Rs. 15,000 x 12%);(Rs. 7,500 x 12%)
EBT 19,200 20,100
EBIT Rs. 21,000 Rs. 21,000
Financial Leverage = = 1.09 = 1.04
EBT Rs. 19,200 Rs. 20,100
Situation 2
EBIT 18,000 18,000
Less: Interest on debt 1,800 900
EBT 16,200 17,100
EBIT Rs. 18,000 Rs. 18,000
Financial Leverage = = 1.11 = 1.05
EBT Rs. 16,200 Rs. 17,100
Situation 3
EBIT 15,000 15,000
Less: Interest on debt 1,800 900
EBT 13,200 14,100
EBIT Rs. 15,000 Rs. 15,000
Financial Leverage = = 1.14 = 1.06
EBT Rs. 13,200 Rs. 14,100

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 (ii) Combined Leverages
CL = OL x FL
Financial Plan
A (Rs.) B (Rs.)
(a) Situation 1 1.14 x 1.09 = 1.24 1.14 x 1.04 = 1.19
(b) Situation 2 1.33 x 1.11 = 1.48 1.33 x 1.05 = 1.40
(c) Situation 3 1.60 x 1.14 = 1.82 1.60 x 1.06 = 1.70
The above calculations suggest that the highest value is in Situation 3 financed by Financial
Plan A and the lowest value is in the Situation 1 financed by Financia l Plan B.
6. (a) A Commercial Paper is an unsecured money market instrument issued in the form of a
promissory note. The Reserve Bank of India introduced the commercial paper scheme in the
year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources
of short-term borrowings and to provide an additional instrument to investors. Subsequently,
in addition to the Corporate, Primary Dealers and All India Financial Institutions have also
been allowed to issue Commercial Papers. Commercial papers are issued in denominations
of Rs. 5 lakhs or multiples thereof and the interest rate is generally linked to the yield on the
one-year government bond.
(b) Agency problem between the managers and shareholders can be addressed if the interests
of the managers are aligned to the interests of the share- holders. It is easier said than done.
However, following efforts have been made to address these issues:
 Managerial compensation is linked to profit of the company to some extent and also with
the long term objectives of the company.
 Employee is also designed to address the issue with the underlying assumption that
maximisation of the stock price is the objective of the investors.
 Effecting monitoring can be done.
(c) Debt Securitisation is a process in which illiquid assets are pooled into marketable securities
that can be sold to investors. The process leads to the creation of financial instruments that
represent ownership interest in, or are secured by a segregated income producing asset or
pool of assets. These assets are generally secured by personal or real property such as
automobiles, real estate, or equipment loans but in some cases are unsecured.
Or
The use of long-term fixed interest-bearing debt and preference share capital along with equity
share capital is called financial leverage or trading on equity. The use of long-term debt
increases the earnings per share if the firm yields a return higher than the cost of debt. The
earnings per share also increase with the use of preference share capital but due to the fact
that interest is allowed to be deducted while computing tax, the leverage impact of debt is
much more. However, leverage can operate adversely also if the rate of interest on long -term
loan is more than the expected rate of earnings of the firm. Therefore, it needs caution to plan
the capital structure of a firm.

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 PAPER 8B: ECONOMICS FOR FINANCE
ANSWERS / HINTS
7. (a) There are innumerable challenges in the computation of National Income in India. These
challenges are more complex in underdeveloped and developing countries. Some of the
challenges are given below:
(a) Inadequacy of data and lack of reliability of available data.
(b) Presence of non- monetised sector.
(c) Production for self-consumption
(d) Absence of recording of data due to illiteracy and Ignorance.
(e) Lack of Proper occupational classification and
(f) Accurate estimation of consumption of fixed capital.
(b) By Income Method:
NNPFC = National Income = Compensation of Employees + Operating Surplus (rent + interest +
profit) + Mixed Income of self-employed + Net Factor Income from abroad
= 2000 +(400 +300+600) + 1000+ 50
= 4350Cr
By Expenditure Method:
GDPmp = Private Final Consumption Expenditure + Government Final Consumption Expenditure
+ Gross Domestic Capital Formation (Net domestic Capital Formation + Net Export
= 700 + 800 + 500 + 80
= 2080 cr
NNPFC or National Income = GDPmp – depreciation + NFIA – Net Indirect Taxes
= 2080 – 200 + 50- 40
= 1890 Cr

(c) A free rider is a person who benefits from something without expending effort or paying for it. In
other words, free riders are those who utilizes goods without paying for their use. Since private
goods are excludable, free riding mostly occurs in the case of public goods. The free-rider problem
leads to under provisions of a good or service and thus causes market failure. As such if the free -
rider problem cannot be solved, the following two outcomes are possible:
(i) No public good will be provided in private markets.
(ii) Private markets will seriously under produce public goods even though these goods provide
valuable service to the society.
8. (a) Personal Income = National Income – Undistributed Profit- Net interest payments made by
households – Corporate Tax + Transfer payments to the households from
firms and Government
= 5000—200-- 400—600+ 500
= 4300 Cr

8
 Personal Disposable Income = Personal Income – Personal Income Taxes – Non-Tax Payments
= 4300 - 1200 – 800
= 2300 cr

(b) Subsidy is a form of market intervention by government. It involves the government directly paying
part of the cost to the producers (consumers) in order to promote the production (consumption) of
goods and services. The aim of subsidy is to intervene with market equilibrium to reduce the costs
and thereby the market prices of goods and services and encourage increased production and
consumption. Major subsidies in India are fertilizer subsidy, food subsidy, interest subsidy etc.
(c) The Speculative motive reflects people’s desire to hold cash in order to be equipped to exploit any
attractive investment opportunity requiring cash expenditure. According to Keynes, people demand
to hold money balances to take advantage of the future changes in the rate of interest, which is
same as future change in bond prices. The market value of bonds and the market rate of interest
are inversely related.
When we go from the Individual speculative demand for money to the aggregate speculative
demand for money, the discontinuity of the Individual wealth- holder’s demand curve for the
speculative cash balances disappears and we obtain a continuous downward sloping demand
function showing the inverse relationship between the current rate of interest and the speculative
demand for money as shown in the figure below:

According to Keynes, the higher the rates of interest, lower the speculative demand for money,
and lower the rate of interest, higher the speculative demand for money.
(d) The government budget is said to be in balance when ∆G = ∆T. The balanced budget multi plier is
always equal to 1. The balanced budget multiplier is obtained by adding up the government
spending multiplier (fiscal multiplier) and the tax multiplier.
Balanced budget multiplier = ∆Y ÷ ∆G + ∆Y ÷ ∆ T
= 1 ÷1-b + -b ÷ 1-b
= 1-b ÷ 1-b = 1
9. (a) Externalities cause market inefficiencies because they hinder the ability of market prices to convey
accurate information about how much to produce and how much to buy. Such externalities are not
reflected in market prices, they can be a source of economic inefficiency. When negative
production externalities exist, social costs exceed private cost. If producers do not take into
account the externalities, there will be over – production and market failure and unwarranted social

9
 consequences. The Government can play a role in reducing negative externalities by taxing goods
when their production generates spill over cost. The Government can also intervene in regulating
negative externalities like pollution.
(b) Fiscal Policy can be used as a tool for economic growth and desired distribution of income. This
can be done through spending programmes targeted at disadvantage strata of the society some
examples are like poverty alleviation programme, free or subsidized amenities to improve the
quality of living of poor, strengthening of human capital, education, research, and development
which will provide momentum for long term growth. A progressive tax structure carefully planned
public expenditure policy can help in redistribution of income from rich to the poor s ections of the
population.
(c) Major differences between FDI and Foreign Portfolio Investment are as follows
Foreign Direct Investment Foreign Portfolio Investment
Investment involves creation of physical assets Investment is only in financial assets.
Has a long-term interest and therefore Only short-term interest and generally remain
invested for long invested in short periods.
Relatively difficult to withdraw Relatively easy to withdraw
Not inclined to be speculative Speculative in nature
Often accompanied by technology transfer Not accompanied by technology transfer.
Direct impact on employment of labour and No direct impact on employment of labour and
wages. wages.
Enduring interest in management and control No abiding interest in management and Control.

(d) New Trade Policy (NTT) is an economic theory and that was developed in the 1970’s as a way to
understand International Trade patterns. NTT helps in understanding why developed and big
countries trade partners are when they are trading similar goods and services. These Countries
constitutes more than 50 % of the world trade. This is particularly true in key economic sectors
such as electronics, IT, food and automotive. Those countries with the advantages will dominate
the market and takes the form of monopolistic competition. According to NTT, two key concepts
give advantage to countries that import goods to compete with products from home country namely
economies of scale and network effects.
10. (a) M1 = Currency notes and coins with the people + demand deposit with banking system (Current
and saving deposits accounts) + other deposits with the RBI
= 5000 + 4000 + 3000
= 12000 cr
M3 = M1 + time deposits with the banking system
= 12000 + 1000
= 13000cr
(b) The Quantity theory of money was propounded by Irving Fisher. According to him there is strong
relationship between money and price level and the quantity of money is the main determinant of
the price level or value of money.
Fisher version also termed as ‘Equation of Exchange ‘is formally stated as follows:
MV = PT

10
 M= the total amount of money in circulation
V = transactions velocity of circulation
P = average price level
T = Total number of transactions
Subsequently Fisher extended the equation of exchange to include demand bank deposit (M’) and
Velocity (V’) in the total supply of money.
The Expanded Form of the equation becomes:
MV + M’V’ = PT
Where M’ = the total quantity of credit money
V’ = velocity of circulation of credit money.
(c) Government Spending would sometimes substitute private spending and when this happens the
impact of government spending on aggregate demand would be smaller than what it would be and
therefore fiscal policy may become ineffective. The crowding out view is that a rapid growth of
government spending leads to a transfer of scarce productive resources from the private sector to
the public sector where productivity might be lower. An increase in the size of government
spending during recessions will crowd out private spending in an economy and lead to reduction
in the economy’s ability to self -correct from the recession and possibly also reduces the economy’s
prospects of long run economic growth.
(d) Trade barriers create obstacles to trade, reduces the prospect of market access, make imported
goods more expensive, increase consumption of domestic goods, protect domestic Industries, and
increase government revenues.
Technical barriers to trade are Standards and Technical Regulations that define the specific
characteristics that a product should have such as its size, shape, design,
labelling/marking/packaging functionality or performance and production methods, exclud ing
measures covered by the SPS agreement. The resolution of trade barriers will definitely be helpful
in functioning of trade. There are different forum and trade agreements between countries for the
resolution of the obstacle.
11. (a) Aggregate demand in three sector model of closed economy consists of three components namely,
household consumption (c), desired business investment demand (I) and the government sector’s
demand for goods and services (G). Thus, in equilibrium
Y = C+I + G
Since there is no foreign sector, GDP and national income are equal. As prices are assumed to be
fixed, all variables and all changes are in real terms. The Three -sector Keynesian model is
commonly constructed assuming that government purchases are autonomous. This is not a
realistic assumption, but it will simplify the analysis.
AD = C+I+G
AS = C+S+T
Thus, equilibrium is determined at a point where both aggregate demand and aggregate supply
are equal.
C+I+G = Y = C+S+T

11
(b) Free riders are those who utilise goods without paying for their use. Since private goods are
excludable, free riding mostly occurs in the case of public goods. The free rider problem leads to
under provision of a good or services and thus causes market failure. The problem occurs because
of the failure of Individual to reveal their real or true preferences for the public good through their
willingness to pay. Because of the free-rider problem, there is no meaningful demand curve for
public goods. If Individuals make no offer to pay for public goods, there is market failure in the
case of these goods and the profit- maximising firms will not produce them.
(c) Monetary Policy is intended to influence macro-economic variables such as aggregate demand,
quantity of money, interest rate to influence overall economic performance. There are five different
mechanism through which monetary policy influences the price level and the national income:
(a) the interest rate channel
(b) the exchange rate channel
(c) the quantum channel (e.g., relating to money supply and credit)
(d) the asset price channel via equity and real estate prices and
(e) the expectation channel
Changes in monetary policy may have impact on people’s expectations about inflation and
therefore on aggregate demand. This in turn affects employment and output in the economy.
(d) An exchange rate regime is the system by which a country manages its currency with respect to
foreign currencies. There are two major types of exchange rate regimes namely floating exchange
rate regime and fixed exchange rate regime.
A floating exchange rate allows a government to pursue its own independent monetary policy and
there is no need for market intervention or maintenance of reserves. However, volatile exchange
rates generate a lot of uncertainties with regard to international transaction.

12
 Test Series: October, 2021

MOCK TEST PAPER - 1

INTERMEDIATE (NEW): GROUP – II

PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE

PAPER 8A: FINANCIAL MANAGEMENT

Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.

Question No. 1 is compulsory.

Attempt any four questions from the remaining five questions.

Working notes should form part of the answer.

Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) In respect of two companies having same business risk, following information is given:
Capital employed = ` 4,00,000; EBIT = ` 60,000; Ke = 12%
Sources Levered Company (`) Unlevered Company (`)
Debt (@10%) 1,50,000 Nil
Equity 1,50,000 3,00,000

Investor is holding 20% shares in levered company. CALCULATE increase in annual earnings of
investor if he switches his holding from Levered to Unlevered company.
(b) The following is the capital structure of Sharda Ltd. as on 31.12.2020:
(`)
Equity shares: 2,00,000 shares (of ` 100 each) 2,00,00,000
9% Preference Shares (of ` 100 each) 60,00,000
8% Debentures 90,00,000
3,50,00,000

The market price of the company’s share is ` 120 and it is expected that a dividend of ` 12 per
share would be declared for the year 2021. The dividend growth rate is 5% and the company is in
the 30% tax bracket.
(i) CALCULATE the company’s weighted average cost of capital.
(ii) Further, in order to finance an expansion plan, the company intends to borrow a fund of
` 2 crores bearing 12% rate of interest. In this situation, WHAT will be the company’s revised
weighted average cost of capital? This financing decision is expected to increase dividend
from ` 12 to ` 14 per share. However, the market price of equity share is expected to decline
from ` 120 to ` 115 per share.
In case of both (i) and (ii) above, use market value weight while calculating weighted average cost
of capital.

© The Institute of Chartered Accountants of India

 (c) ABC Ltd. has total sales of 10,00,000 all of which are credit sales. It has a gross profit ratio of 25%
and a current ratio of 2. The company’s current liabilities are ` 2,00,000. Further, it has inventories
of ` 80,000, marketable securities of ` 50,000 and cash of ` 30,000. From the above information:
(i) CALCULATE the average inventory, if the expected inventory turnover ratio is three times?
(ii) Also CALCULATE the average collection period if the opening balance of debtors is expected
to be ` 1,50,000.
Assume 360 days a year.
(d) M Ltd. belongs to a risk class for which the capitalization rate is 12%. It has 40,000 outstanding
shares and the current market price is ` 200. It expects a net profit of ` 5,00,000 for the year and
the Board is considering dividend of ` 10 per share.
M Ltd. requires to raise ` 10,00,000 for an approved investment expenditure. ILLUSTRATE, how
the MM approach affects the value of M Ltd. if dividends are paid or not paid.
[4 × 5 Marks = 20 Marks]
2. Sophisticated Limited is considering three financing plans. The key information is as follows:
(a) Total investment amount to be raised ` 4,00,000
(b) Plans of Financing Proportion:
Plans Equity Debt Preference Shares
A 100% - -
B 50% 50% -
C 50% - 50%

(c) Cost of debt 10%

Cost of preference shares 10%
(d) Tax rate 30%
(e) Equity shares of the face value of ` 10 each will be issued at a premium of ` 10 per share.
(f) Expected EBIT is ` 10,00,000.
You are required to DETERMINE for each plan: -
(i) Earnings per share (EPS)
(ii) The financial break-even point.
(iii) Indicate if any of the plans dominate and compute the EBIT range among the plans for indifference.
[10 Marks]
3. Sadbhavna Limited is a manufacturer of computers. It wants to introduce artificial intelligence while
making computers. It estimates that the annual savings from the artificial intelligence (AI) include a
reduction of five employees with annual salaries of ` 3,00,000 each, ` 3,00,000 from reduction in
production delays caused by inventory problem, reduction in lost sales ` 2,50,000 and ` 2,00,000 from
billing issues.
The purchase price of the system for installation of artificial intelligence is ` 20,00,000 with installation
cost of ` 1,00,000. The life of the system is 5 years and it will be depreciated on a straight -line basis.
The salvage value is zero which will be its market value after the end of its life of five years.
2

© The Institute of Chartered Accountants of India

 However, the operation of the new system for AI requires two computer specialists with annual salaries
of ` 5,00,000 per person. Also, the estimated maintenance and operating expenses of 1,50,000 is
required.
The company’s tax rate is 30% and its required rate of return is 12%.
From the above information:
(i) CALCULATE the initial cash outflow and annual operating cash flow over its life of 5 years.
(ii) Further, EVALUATE the project by using Payback Period, Net Present Value and Profitability Index.
(iii) You are also REQUIRED to obtain the cash flows and NPV on the assumption that book salvage
value for depreciation purposes is ` 2,00,000 even though the machine is having no real worth in
terms of its resale value. Also, the book salvage value of ` 2,00,000 is allowed for tax purposes.
Also COMMENT on the acceptability of the project in (ii) and (iii) above. [10 Marks]
4. The following figures and ratios are related to a company:
(i) Sales for the year (all credit) ` 30,00,000
(ii) Gross Profit ratio 25 percent
(iii) Fixed assets turnover (based on cost of goods sold) 1.5
(iv) Stock turnover (based on cost of goods sold) 6
(v) Liquid ratio 1:1
(vi) Current ratio 1.5 : 1
(vii) Receivables (Debtors) collection period 2 months
(viii) Reserves and surplus to Share capital 0.6 : 1
(ix) Capital gearing ratio 0.5
(x) Fixed assets to net worth 1.20 : 1
You are REQUIRED to prepare:
(a) Balance Sheet of the company on the basis of above details.
(b) The statement showing working capital requirement, if the company wants to make a provision for
contingencies @ 10 percent of net working capital including such provision. [10 Marks]
5. (a) The following details of PQR Limited for the year ended 31st March, 2021 are given below:

Operating leverage 1.4

Combined leverage 2.8
Fixed Cost (Excluding interest) ` 2.10 lakhs
Sales ` 40.00 lakhs
10% Debentures of ` 100 each ` 25.00 lakhs
Equity Share Capital of ` 10 each ` 20.00 lakhs
Income tax rate 30 per cent

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 REQUIRED:
(i) Calculate Financial leverage
(ii) Calculate P/V ratio and Earning per Share (EPS)
(iii) If the company belongs to an industry, whose assets turnover is 1.6, does it have a high or
low assets turnover?
(iv) At what level of sales, the Earning before Tax (EBT) of the company will be equal to zero?
In the question, assume that 10% Debentures and Share Capital consists of total liabilities.
[8 Marks]
(b) Write a short note on electronic fund transfer. [2 Marks]
6. (a) BRIEFLY explain the three finance function decisions. [4 Marks]
(b) EXPLAIN sensitivity analysis and its various steps. [4 Marks]
(c) WRITE two main objectives of Financial Management.
Or
BRIEFLY describe the financial needs of a business. [2 Marks]

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 PAPER 8B: ECONOMICS FOR FINANCE

Question 1 is compulsory
Students can answer 3 out of the 4 remaining
Maximum Marks – 40
1. (a) How is Personal Income and Disposable Personal Income defined and calculated? (3 Marks)
(b) How Fiscal Policy had a strong influence on the performance of macro economy? (2 Marks)
(c) Calculate the Operating Surplus (3 Marks)
Particulars ` in Crores
Compensation of employees 200
Intermediate Consumption 800
Rent 600
Interest 500
Consumption of fixed capital 300
Net Indirect Taxes 400
Mixed Income 700
Sales 2500
(d) What are the analytics of Monetary Policy? (2 Marks)
2. (a) What is supra regional sector in an economy? (2 Marks)
(b) What is the difference between Classical and Keynesian theory of determination
of National Income? (2 Marks)
(c) How is Cambridge approach different from classical approach in the theory
of demand for money? (3 Marks)
(d) What are the reason for superiority of Hecksher Ohlin theory of International Trade
over the theory of comparative advantage? (3 Marks)
3. (a) What are the conceptual problem confronted in estimating national income? (3 Marks)
(b) What are the role of subsidy as part of government intervention in public finance? (2 Marks)
(c) How does fluctuations in exchange rate impact the domestic economy? (3 Marks)
(d) What lead to emergence of WTO as a forum for Trade negotiation? (2 Marks)
4. (a) Market failure is a situation in which free market leads to misallocation of
society’s scarce resources? Comment (2 Marks)
(b) Calculate National Income by Expenditure Method? (3 Marks)
Items ` In crore
Private Final Consumption Expenditure 1000
Government Final Consumption Expenditure 800
Net factor Income from abroad 40

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 Net Indirect Taxes 60
Net Exports -80
Net Domestic Capital Formation 70
National debt Interest 50
Net Current Transfer to abroad 20

(c) What are the different modes of foreign Direct Investment? (3 Marks)
(d) What is open market operations? (2 Marks)
5. (a) What is the role of fiscal Policy during recession? (3 Marks)
(b) What are Club goods and how it is defined? (2 Marks)
(c) What are the impact of liquidity trap on the economy? (3 Marks)
(d) Why do people hold money balances? (2 Marks)

© The Institute of Chartered Accountants of India

 Test Series: October, 2021
MOCK TEST PAPER 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
SUGGESTED ANSWERS/ HINTS
1. (a) 1. Valuation of firms
Particulars Levered Firm (`) Unlevered Firm (`)
EBIT 60,000 60,000
Less: interest (1,50,000 x 10%) 15,000 Nil

Earnings available to Equity Shareholder/K e 45,000 60,000

12% 12%
Value of Equity 3,75,000 5,00,000
Debt 1,50,000 Nil
Value of Firm 5,25,000 5,00,000
Value of Levered company is more than that of unlevered company. Therefore, investor will
sell his shares in levered company and buy shares in unlevered company. To maintain the
level of risk he will borrow proportionate amount and invest that amount also in shares of
unlevered company.
2. Investment & Borrowings
Sell shares in Levered company (3,75,000x20%) 75,000
Borrow money (1,50,000 x 20%) 30,000
Buy shares in Unlevered company 1,05,000
3. Change in Return
Income from shares in Unlevered company
(1,05,000 x 12%) 12,600
Less: interest on loan (30,000 x 10%) 3,000
Net Income from unlevered firm 9,600
Income from Levered firm (75000 x 12%) 9,000
Incremental Income due to arbitrage 600
(b) (i) Computation of the weighted average cost of capital
Source of finance Market Value Weight After tax Cost WACC (%)
of capital (`) of capital (%)
(a) (b) (c) (d) = (b) × (c)
Equity share (Working note 1) 2,40,00,000 0.6154 15 9.231
[`120 × 2,00,000 shares]
9% Preference share 60,00,000 0.1538 9 1.3842
8% Debentures 90,00,000 0.2308 5.60 1.2925
3,90,00,000 1.0000 11.9077
1

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 (ii) Computation of Revised Weighted Average Cost of Capital
Source of finance Market Weight After tax Cost WACC (%)
Value of of capital (%)
(a) capital (`) (b) (c) (d) = (b) × (c)
Equity shares (Working note 2) 2,30,00,000 0.3966 17.17 6.8096
[`115 × 2,00,000 shares]
9% Preference shares 60,00,000 0.1034 9.00 0.9306
8% Debentures 90,00,000 0.1552 5.60 0.8691
12% Loan 2,00,00,000 0.3448 8.40 2.8963
5,80,00,000 1.0000 11.5056
Working Notes:
(1) Cost of Equity Shares
Ke = {Dividend Per Share (D 1)/Market Price Share (P 0)} + Growth Rate
= 12/120 + 0.05
= 0.15 or 15%
(2) Revised cost of equity shares (K e)
Revised Ke = 14/115 + 0.05
= 0.1717 or 17.17%
(c) (i) Calculation of Average Inventory
Since gross profit is 25% of sales, the cost of goods sold should be 75% of the sales.
75
Cost of goods sold = 10,00,000 x = 7,50,000
100
Cos t of goods sold
Inventory Turnover =
AverageInventory

7,50,000
3 =
AverageInventory

7,50,000
Average Inventory = = 2,50,000
3
(ii) Calculation of Average Collection Period
AverageDebtors
Average Collection Period = x 360
Credit Sales

OpeningDebtors + ClosingDebtors
Where, Average Debtors =
2
Calculation of Closing balance of debtors
` `
Current Assets (2 x 2,00,000) 4,00,000
Less: Inventories 80,000
2

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 Marketable Securities 50,000
Cash 30,000 1,60,000
Debtors Closing Balance 2,40,000
1,50,000 + 2,40,000
Now, Average Debtors = = 1,95,000
2
1,95,000
So, Average Collection Period = x 360 = 70.2 or 70 days
10,00,000
(d) Given,
Cost of Equity (Ke) 12%
Number of shares in the beginning (n) 40,000
Current Market Price (P 0) `200
Net Profit (E) `5,00,000
Expected Dividend (D1) `10 per share
Investment (I) `10,00,000

Situation 1 – When dividends are paid Situation 2 – When dividends are not paid
P1+ D1 P1+ D1
(i) P0 = (i) P0 =
1+ Ke 1+ Ke

P1+ 10 P1+ 0
200 = 200 =
1+ 0.12 1+ 0.12

P1 + 10 = 200 x 1.12 P1 + 0 = 200 x 1.12

P1 = 224 – 10 = 214 P1 = 224 – 0 = 224
(ii) Calculation of funds required (ii) Calculation of funds required
= Total Investment - (Net profit - Dividend) = Total Investment - (Net profit - Dividend)
= 10,00,000 - (5,00,000 – 4,00,000) = 10,00,000 – (5,00,000 - 0)
= 9,00,000 = 5,00,000
(iii) No. of shares required to be issued for (iii) No. of shares required to be issued for
balance fund balance fund
FundsRe quired FundsRe quired
No. of shares = No. of shares =
Pr ice at end(P1) Pr ice at end(P1)

9,00,000 5,00,000
∆n = = 4205.61 ∆n = = 2232.14
214 224
(iv) Calculation of value of firm (iv) Calculation of value of firm
(n + n)P1− I + E (n + n)P1− I + E
Vf = Vf =
1+ Ke 1+ Ke

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 9,00,000 5,00,000
(40,000 + )214 − 10,00,000 + 5,00,000 (40,000 + )224 − 10,00,000 + 5,00,000
= 214 = 224
1+ 0.12 1+ 0.12

94,60,000 – 5,00,000 94,60,000 – 5,00,000

= = 80,00,000 = = 80,00,000
1.12 1.12

2. (i) Computation of Earnings per share (EPS)

Plans A B C
Earnings before interest and tax 10,00,000 10,00,000 10,00,000
(EBIT)
Less: Interest charges --- (20,000) ---
(10% × `2 lakh)
Earnings before tax (EBT) 10,00,000 9,80,000 10,00,000
Less: Tax (@ 30%) (3,00,000) (2,94,000) (3,00,000)
Earnings after tax (EAT) 7,00,000 6,86,000 7,00,000
Less: Preference Dividend --- --- (20,000)
(10% × `2 lakh)
Earnings available for Equity 7,00,000 6,86,000 6,80,000
shareholders (A)
No. of Equity shares (B) 20,000 10,000 10,000
(` 4 lakh ÷ ` 20) (` 2 lakh ÷ ` 20) (` 2 lakh ÷ ` 20)
EPS ` [(A) ÷ (B)] 35 68.6 68
(ii) Calculation of Financial Break-even point
Financial break-even point is the earnings which are equal to the fixed finance charges and
preference dividend.
Plan A: Under this, plan there is no interest or preference dividend payment. Hence, the Financial
Break-even point will be zero.
Plan B: Under this plan, there is an interest payment of ` 20,000 and no preference dividend.
Hence, the Financial Break-even point will be ` 20,000 (Interest charges).
Plan C: Under this plan, there is no interest payment but an after tax preference dividend of
` 20,000 is paid. Hence, the Financial Break- even point will be before tax earnings of ` 28,571
(i.e. ` 20,000 ÷ 0.7)
(iii) Computation of indifference point between the plans.
The indifference between two alternative methods of financing is calculated by applying the
following formula.
(EBIT − l1 )(1− T) (EBIT − l2 )(1− T)
=
E1 E2

Where,
EBIT = Earnings before interest and tax.
l1 = Fixed charges (interest or pref. dividend) under Alternative 1
l2 = Fixed charges (interest or pref. dividend) under Alternative 2
4

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 T = Tax rate
E1 = No. of equity shares in Alternative 1
E2 = No. of equity shares in Alternative 2

Now, we can calculate indifference point between different plans of financing.

(a) Indifference point where EBIT of Plan A and Plan B is equal.
(EBIT − 0)(1− 0.3) (EBIT − 20,000)(1− 0.3)
=
20000 10,000

0.7 EBIT (10,000) = (0.7 EBIT – 14,000) (20,000)

7,000 EBIT = 14,000 EBIT – 28 crores
EBIT = 40,000
(b) Indifference point where EBIT of Plan A and Plan C is equal
(EBIT − 0)(1− 0.3) (EBIT − 0)(1− 0.3) − 20,000
=
20000 10,000

0.7 EBIT (10,000) = (0.7 EBIT – 20,000) (20,000)

7000 EBIT = 14,000 EBIT – 40 crores
EBIT = 57,142.86
(c) Indifference point where EBIT of Plan B and Plan C are equal
(EBIT − 20,000)(1− 0.3) (EBIT − 0)(1− 0.3) − 20,000
=
10000 10,000

(0.7 EBIT – 14,000) (10,000) = (0.7 EBIT – 20,000) (10,000)

7,000 EBIT – 14 crore = 7,000 EBIT - 20 crore
There is no indifference point between the financial plans B and C.
3. (i) Project’s Initial Cash Outlay
Cost 20,00,000
Installation Expenses 1,00,000
Total Cash Outflow 21,00,000
Depreciation per year = 21,00,000/5 = 4,20,000
Project’s Operating Cash Flows over its 5-year life
Savings (A)
Reduction in salaries (` 3,00,000 x 5) 15,00,000
Reduction in production delays 3,00,000
Reduction in lost sales 2,50,000
Gains due to timely billing 2,00,000
22,50,000

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 Costs (B)
- Depreciation 4,20,000
- Additional Specialist Cost (` 5,00,000 x 2) 10,00,000
- Maintenance Cost 1,50,000
15,70,000
Increase in Profit before tax (A – B) 6,80,000
Less: Tax @ 30% 2,04,000
Profit after tax 4,76,000
Cash Inflows = Profit after tax + Depreciation
= 4,76,000 + 4,20,000 = 8,96,000
(ii) Evaluation of the project by using NPV Method
Year Cash Inflows PVAF (12%,5y) Total PV
1-5 8,96,000 3.605 32,30,080
Less: Total Initial Cash Outflow 21,00,000
Net Present Value 11,30,080
Since NPV is positive, therefore, the project is acceptable.
Evaluation of the project by using Profitability Index Method
Profitability Index = Present Value of Cash Inflows/Present Value of Cash Outflows
= 32,30,080/21,00,000
= 1.538
Since, the profitability index is more than 1, the project is acceptable.
Calculation of the Project’s Payback*
Year Net Cash Flow Cumulative Cash Flow
1 8,96,000 8,96,000
2 8,96,000 17,92,000
3 8,96,000 26,88,000
4 8,96,000 35,84,000
5 8,96,000 44,80,000
Here, the payback period is 2 years plus a fraction of the 3 rd year
So, payback period = 2 years + 3,08,000/8,96,000
= 2.34 years
* Payback period may also be solved directly as follows: 21,00,000/8,96,000 = 2.34 years
(iii) Project’s cash flows and NPV assuming that the book salvage for depreciation purpose is
` 2,00,000
Depreciation = (` 21,00,000 – 2,00,000)/5 = 3,80,000
Cash Inflows for the years 1 to 5 are:
Savings (calculated as earlier) 22,50,000

© The Institute of Chartered Accountants of India

 Less: Costs
- Depreciation 3,80,000
- Additional Specialists cost 10,00,000
- Maintenance cost 1,50,000 15,30,000
Profit before tax 7,20,000
Less: Tax @ 30% 2,16,000
Profit after tax 5,04,000
Cash Inflow (5,04,000 + 3,80,000) 8,84,000
Calculation of NPV
It may be noted that at the end of year 5, the book value of the project would be ` 2,00,000 but its
realizable value is nil. So, the capital loss of ` 2,00,000 will result in tax savings of ` 60,000 (i.e.,
` 2,00,000 x 30%), as the capital loss is available for tax purposes in view of the information given.
Therefore, at the end of year 5, there would be an additional inflow of ` 60,000. The NPV may now
be calculated as follows:
Year Cash Flow (`) PVAF (12%, n) PV
1-5 8,84,000 3.605 31,86,820
5 60,000 0.567 34,020
PV of inflows 32,20,840
Outflows 21,00,000
NPV 11,20,840
As the NPV of the project is positive, the project is acceptable.
4. Working Notes:
(i) Cost of Goods Sold = Sales – Gross Profit (25% of Sales)
= ` 30,00,000 – ` 7,50,000
= ` 22,50,000
(ii) Closing Stock = Cost of Goods Sold / Stock Turnover
= ` 22,50,000/6 = ` 3,75,000
(iii) Fixed Assets = Cost of Goods Sold / Fixed Assets Turnover
= ` 22,50,000/1.5
= ` 15,00,000
(iv) Current Assets:
Current Ratio = 1.5 and Liquid Ratio = 1
Stock = 1.5 – 1 = 0.5
Current Assets = Amount of Stock × 1.5/0.5
= ` 3,75,000 × 1.5/0.5 = ` 11,25,000

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 (v) Liquid Assets (Debtors and Cash)
= Current Assets – Stock

= ` 11,25,000 – ` 3,75,000
= ` 7,50,000
(vi) Debtors = Sales × Debtors Collection period /12

= ` 30,00,000 × 2 /12
= ` 5,00,000
(vii) Cash = Liquid Assets – Debtors

= ` 7,50,000 – ` 5,00,000 = ` 2,50,000

(viii) Net worth = Fixed Assets /1.2
= ` 15,00,000/1.2 = ` 12,50,000

(ix) Reserves and Surplus

Reserves and Share Capital = 0.6 + 1 = 1.6
Reserves and Surplus = ` 12,50,000 × 0.6/1.6
= ` 4,68,750
(x) Share Capital = Net worth – Reserves and Surplus
= ` 12,50,000 – ` 4,68,750
= ` 7,81,250
(xi) Current Liabilities = Current Assets/Current Ratio
= ` 11,25,000/1.5 = ` 7,50,000
(xii) Long-term Debts
Capital Gearing Ratio = Long-term Debts / Equity Shareholders’ Fund
Long-term Debts = ` 12,50,000 × 0.5 = ` 6,25,000
(a) Preparation of Balance Sheet of a Company
Balance Sheet
Liabilities Amount (`) Assets Amount (`)
Equity Share Capital 7,81,250 Fixed Assets 15,00,000
Reserves and Surplus 4,68,750 Current Assets
Long-term Debts 6,25,000 Stock 3,75,000
Current Liabilities 7,50,000 Debtors 5,00,000
Cash 2,50,000
26,25,000 26,25,000

© The Institute of Chartered Accountants of India

 (b) Statement Showing Working Capital Requirement
(`) (`)
Current Assets
(i) Stocks 3,75,000
(ii) Receivables (Debtors) 5,00,000
(iii) Cash in hand & at bank 2,50,000
A. Current Assets: Total 11,25,000
Current Liabilities
B. Current Liabilities: Total 7,50,000
Net Working Capital (A – B)
3,75,000
Add: Provision for contingencies
41,667
(1/9th of Net Working Capital)
Working capital requirement
4,16,667
5. (a) (i) Financial leverage
Combined Leverage = Operating Leverage x Financial Leverage
So, financial leverage = Combined Leverage/Operating Leverage
= 2.8/1.4 = 2
(ii) P/V Ratio and EPS
Contribution
Operating Leverage =
Contribution- FixedCost
Contribution
1.4 =
Contribution- 2,10,000

1.4 Contribution – 2,94,000 = Contribution

0.4 Contribution = 2,94,000
Contribution = 7,35,000
Contribution 7,35,000
Now, P/V Ratio = x100 = x100 = 18.375%
Sales 40,00,000

Profit after tax (PAT)

EPS =
No. of equity shares

Earning before tax (EBT) = Contribution – Fixed Cost – Interest

= 7,35,000 – 2,10,000 – 2,50,000
= 2,75,000
Profit after tax = EBT – Tax @ 30%
= 2,75,000 – 82,500
= 1,92,500
1,92,500
EPS = = 0.9625
2,00,000

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 (iii) Asset Turnover
Total Assets = Equity Share Capital + Debentures = ` 20 lakhs + ` 25 lakhs = ` 45 lakhs
Sales 40,00,000
Asset Turnover = = = 0.89
Total Assets 45,00,000
0.89 < 1.6, means lower than industry turnover.
(iv) EBT zero means 100% reduction in EBT. Since combined leverage is 2.8, sales have to be
dropped by 100/2.8 = 35.71%. Hence new sales will be
40,00,000 x (100% - 35.71%) = 25,71,600
(b) Electronic Fund Transfer: With the developments which took place in the information technology,
the present banking system has switched over to the computerization of banks branches to offer
efficient banking services and cash management services to their customers. The network wil l be
linked to the different branches, banks. This helped the customers in the following ways:
(i) Instant updating of accounts.
(ii) Quick transfer of funds.
(iii) Instant information about foreign exchange rates.
6. (a) The three finance function decisions are as follows:
Investment decisions: These decisions relate to the selection of assets in which funds will be
invested by a firm. Funds procured from different sources have to be invested in various kinds of
assets. Long term funds are used in a project for various fixed assets and also for current assets.
The investment of funds in a project has to be made after careful assessment of the various projects
through capital budgeting. A part of long-term funds is also to be kept for financing the working
capital requirements.
Financing decisions: These decisions relate to acquiring the optimum finance to meet financial
objectives and seeing that fixed and working capital are effectively managed. The financial
manager needs to possess a good knowledge of the sources of available funds and their respective
costs and needs to ensure that the company has a sound capital structure, i.e. a proper balance
between equity capital and debt. Such managers also need to have a very clear understanding as
to the difference between profit and cash flow, bearing in mind that profit is of little use unless the
organisation is adequately supported by cash to pay for assets and sustain the working capital
cycle.
Dividend decisions: These decisions relate to the determination as to how much and how
frequently cash can be paid out of the profits of an organization as income for its
owners/shareholders. The dividend decision thus has two elements – the amount to be paid out
and the amount to be retained to support the growth of the organization, the latter being also a
financing decision. The level and regular growth of dividends represent a significant factor in
determining a profit-making company’s market value, i.e. the value placed on its shares by the
stock market.
(b) Sensitivity Analysis and its various steps: Sensitivity analysis put in simple terms is a modeling
technique which is used in Capital Budgeting decisions which is used to study the impact of
changes in the variables on the outcome of the project. In a project, several variables like
weighted average cost of capital, consumer demand, price of the produc t, cost price per unit etc.
operate simultaneously.
The changes in these variables impact the outcome of the project. It therefore becomes very
difficult to assess change in which variable impacts the project outcome in a significant way. In
Sensitivity Analysis, the project outcome is studied after taking into change in only one variable.

10

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 The more sensitive is the NPV, the more critical is that variable. So, Sensitivity analysis is a way
of finding impact in the project’s NPV (or IRR) for a given change in one of the variables.
Sensitivity Analysis is conducted by following the steps as below:
(i) Finding variables, which have an influence on the NPV (or IRR) of the project .
(ii) Establishing mathematical relationship between the variables.
(iii) Analysis the effect of the change in each of the variables on the NPV (or IRR) of the project.
(c) Two main objectives of Financial Management
Profit Maximisation
It has traditionally been argued that the primary objective of a company is to earn profit; he nce the
objective of financial management is also profit maximisation. This implies that the finance
manager has to make his decisions in a manner so that the profits of the concern are maximised.
Each alternative, therefore, is to be seen as to whether or not it gives maximum profit.
Wealth / Value Maximisation
We will first like to define what is Wealth / Value Maximization Model. Shareholders wealth are the
result of cost benefit analysis adjusted with their timing and risk i.e. time value of money.
So, Wealth = Present Value of benefits – Present Value of Costs
It is important that benefits measured by the finance manager are in terms of c ash flow. Finance
manager should emphasis on Cash flow for investment or financing decisions not on Accounting
profit. The shareholder value maximization model holds that the primary goal of the firm is to
maximize its market value and implies that business decisions should seek to increase the net
present value of the economic profits of the firm.
OR
(c) Financial Needs of a Business: Business enterprises need funds to meet their different types of
requirements. All the financial needs of a business may be grouped into the following three
categories-
Long-term financial needs: Such needs generally refer to those requirements of funds which are
for a period exceeding 5-10 years. All investments in plant, machinery, land, buildings, etc., are
considered as long-term financial needs.
Medium- term financial needs: Such requirements refer to those funds which are required for a
period exceeding one year but not exceeding 5 years.
Short- term financial needs: Such type of financial needs arises to finance current assets such
as stock, debtors, cash, etc. Investment in these assets is known as meeting of working capital
requirements of the concern for a period not exceeding one year.

11

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 PAPER 8B: ECONOMICS FOR FINANCE
SUGGESTED ANSWER
1. (a) Personal income is a measure of actual current income receipts of persons from all sources
which may or may not be earned from productive activities during a given period. Personal
income excludes retained earnings, indirect business taxes, corporate income taxes and
contributions towards social security.
Personal Income = NI - Undistributed profits – Net interest payments made by households –
Corporate Tax +Transfer Payments to the households from firms and government.
Disposable personal income is a measure of amount of the money in the hands of the individuals
that is available for their consumption or savings. Disposable personal income is derived from
personal income by subtracting the direct taxes paid by individuals and other compulsory
payments made to the government
Disposable Income = Personal Income - Personal Income Taxes – Nontax payments
(b) Fiscal policy involves the use of government spending, taxation and borrowing to influence both
the pattern of economic activity and level of growth of aggregate. demand, output, and
employment. It includes any design on the part of the government to change the price level,
composition, or timing of government expenditure or to alter the burden, structure, or frequency
of tax payment. In other words, fiscal policy is designed to influence the pattern and level of
economic activity in a country.
(c) GVAmp = GVAmp – Intermediate Consumption
= (Sales + Change in stock)- Intermediate Consumption
= 2500 – 800
= 1700 cr
GDPmp = GVAmp = 1700cr
NDPmp = GDP mp – Consumption of fixed Capital
= 1700 – 300
= 1400cr
NDPfc = NDPmp- Net Indirect taxes
= 1400- 400
= 1000cr
NDPfc = Compensation of employees + Operating Surplus + Mixed Income
1000 = 200 + operating surplus + 700
Operating Surplus = 100cr

(d) The monetary policy is intended to influence macro- economic variables such as aggregate
demand, quantity of money and credit, interest rates etc., so as to influence overall economic
performance. The process or channels through which the change of monetary aggregates affects
the level of product and prices is known as ‘monetary transmission mechanism’.
Generally central banks use the short-term interest rate as the policy instrument. These interest
rate changes affect macro-economic variables such as consumption, investment, and exports
which in turn influence aggregate demand, output, and employment. Changes in monetary policy
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 may have impact on people’s expectations about inflation and therefore on aggregate demand.
This in turn affects employment and output in the economy.
2. (a) In the preparation of State income estimates, certain activities such as railways, communications,
banking. and insurance and central government administration, that cut across state boundaries,
and thus their economic contribution cannot be assigned to any one state directly are known as
the ‘supra-regional sectors’ of the economy. The estimates for these supra regional activities are
compiled for the economy as a whole and allocated to the states based on relevant indicators.
(b) The classical economists maintained that the economy is self‐regulating and is always capable of
automatically achieving equilibrium at the ‘natural level’ of real GDP or output, which is the level
of real GDP that is obtained when the economy's resources are fully employed. . If an excess in
the labour force (unemployment) or products exist, the wage or price of these will adjust to
absorb the excess. According to them, there will be no involuntary unemployment.
Keynesian believe that prices and wages are not so flexible; they are sticky, especially
downward. The stickiness of prices and wages in the downward direction prevents the economy's
resources from being fully employed and thereby prevents the economy from returning to the
natural level of real GDP. Therefore, output will remain at less than the full employment level as
long as there is insufficient spending in the economy
(c) Classical Approach: Changes in the general level of commodity prices or changes in the value
or purchasing power of money are determined first and foremost by changes in the quantity of
money in circulation.
Fisher’s version, also termed as ‘equation of exchange’ or ‘transaction approach’ is formally
stated as follows:
MV = PT
Where, M = the total amount of money in circulation in an economy
V = transactions velocity of circulation
P = average price level
T = the total number of transactions.
Cambridge Approach
The demand for money was primarily determined by the need to conduct transactions which will
have a positive relationship to the money value of aggregate expenditure. Since the latter is
equal to money national income, the Cambridge money demand function is stated as:
Md = k PY
Md = is the demand for money balances,
Y = real national income
P = average price level of currently produced goods and services
PY = nominal income
K = proportion of nominal income (PY) that people want to hold as cash balances
The term ‘k’ in the above equation is called ‘Cambridge k’ is a parameter reflecting economic
structure and monetary habits, namely the ratio of total transactions to income and the ratio of
desired money balances to total transactions. The neoclassical theory changed the focus of the
quantity theory of money-to-money demand and hypothesized that demand for money is a
function of only money income.

13

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 (d) The law of comparative advantage states that even if one nation is less efficient than the other
nation in the production of all commodities, there is still scope for mutually beneficial tra de. The
first nation should specialize in the production and export of the commodity in which its absolute
disadvantage is smaller and import the commodity in which its absolute disadvantage is greater.
Ricardo based his law of comparative advantage on the ‘labour theory of value’, which assumes
that the value or price of a commodity depends exclusively on the amount of labour going into its
production. This is quite unrealistic because labour is not the only factor of production, nor is it
used in the same fixed proportion in the production of all commodities.
The Heckscher-Ohlin theory of trade states that comparative advantage in cost of production is
explained exclusively by the differences in factor endowments of the nations. In a general sense
of the term, ‘factor endowment’ refers to the overall availability of usable resources including both
natural and man-made means of production. Nevertheless, in the exposition of the modern
theory, only the two most important factors—labour and capital—are taken into account.
The Heckscher-Ohlin Trade Theorem establishes that a country tends to specialize in the export
of a commodity whose production requires intensive use of its abundant resources and imports a
commodity whose production requires intensive use of its scarce resources.
3. (a) Usually it is difficult to separate labour income from capital income because in many instances
people provide both labour and capital services. Such is the case with self -employed people like
lawyers, engineers, traders, proprietors etc. Other’s problems include:
(a) lack of an agreed definition of national income,
(b) accurate distinction between final goods and intermediate goods,
(c) issue of transfer payments,
(d) services of durable goods,
(e) difficulty of incorporating distribution of income,
(f) valuation of a new good at constant prices, and valuation of government services
(b) Subsidy is a form of market intervention by government. It involves the government directly
paying part of cost to the producers or consumers in order to promote the production
(consumption) of goods and services. The aim of subsidy is to intervene with market equilibrium
to reduce the costs and thereby the market price of goods and services and encourage increased
production and consumption. Major subsidies in India are fertiliser subsidy, food subsidy, interest
subsidy, etc.
(c) Exchange rate changes affect economic activity in the domestic economy. A depreciation of
domestic currency primarily increases the price of foreign goods relative to goods produced in
the home country and diverts spending from foreign goods to domestic goods. Increased
demand, both for domestic import-competing goods and for exports, encourages economic
activity and creates output expansion. Overall, the outcome of exchange rate depreciation is an
expansionary impact on the economy at an aggregate level. The positive effect of currency
depreciation, however, largely depends on whether the switching of demand has taken place in
the right direction and in the right amount, as well as on the capacity of the home economy to
meet that increased demand by supplying more goods.
(d) The WTO Agreements as acknowledged in the preamble of the Agreement creating the World
Trade Organization, include raising standards of living, ensuring full employment and a large and
steadily growing volume of real income and effective demand, and expanding the production of
and trade in goods and services. The WTO, whose primary purpose is to open trade for the
benefit of all, does its functions by acting as a forum for trade negotiations among member
governments, administering trade agreements, reviewing national trade policies, assisting

14

© The Institute of Chartered Accountants of India

 developing countries in trade policy issues, through technical assistance and training
programmes and cooperating with other international organizations.
4. (a) The reason for market failure lies in the fact that though perfectly competitive markets work
efficiently, most often the prerequisites of competition are unlikely to be present in an economy.
Market power can cause markets to be inefficient because it keeps price higher and output lower
than the outcome of equilibrium of supply and demand.
The demand-side market failures are said to occur when demand curves do not consider the full
willingness of consumers to pay for a product. The supply-side market failures happen when
supply curves do not incorporate the full cost of producing the product.
(b) GDPmp = Private final Consumption Expenditure + Government final Consumption expenditure +
Gross domestic capital formation + Net Export
= 1800 +70 + (-80)
= 1790 Cr
NDPfc = GDPmp- Consumption of fixed Capital + Net Indirect Taxes
= 1790+60
= 1850 cr
NNPfc = NDPfc + Net factor Income from abroad
= 1850+40
= 1890 cr
(c) FDI is an important monetary source for India's economic development. The import -substitution
strategy of industrialisation followed by India post-independence era, stressed on an extremely
careful and selective approach while formulating FDI policy. The government’s strategy favouring
foreign investments and the prevalent robust business environment have ensured that foreign
capital keeps flowing into the country
Modes of FDI is as follows:
(i) Opening of a subsidiary or associate company in a foreign country,
(ii) Equity injection into an overseas company,
(iii) Acquiring a controlling interest in an existing foreign company,
(iv) Mergers and acquisitions(M&A)
(v) Joint venture with a foreign company.
(vi) Green field investment (establishment of a new overseas affiliate for freshly starting
production by a parent company).
(vii) Brownfield investments (a form of FDI which makes use of the existing infrastruc ture by
merging, acquiring, or leasing, instead of developing a completely new one . For e.g., in
India 100% FDI under automatic route is allowed in Brownfield Airport projects.
(d) Open Market Operations (OMO) is a general term used for market operations conducted by the
Reserve Bank of India by way of sale/ purchase of Government securities to/ from the market
with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When
the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby sucking
out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities
from the market, thereby releasing liquidity into the market.

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5. (a) The tools of fiscal policy are taxes, government expenditure, public debt, and the budget. A
recession sets in with a period of declining real income, as measured by real GDP and a situation
of rising unemployment.
During recession incomes are reduced leading to lower tax payments. Government expenditures
increase due to increased transfer payments. These together provide proportionally more
disposable income available for consumption spending to households.
The tax policy during recession and depression, is framed to encourage private consumption and
investment. A general reduction in income taxes and low corporate taxes increases aggregate
demand and investments respectively.
(b) The Concept of Club goods was first studied by Buchanan. Impure public goods which are
replicable and therefore individuals who are excluded from one facility may get similar services
from an equivalent provider. Examples of club goods are facilities such as swimming pools,
fitness centres etc.
(c) Empirical evidence of liquidity trap is found during the global financial crisis of 2008 in the United
States and Europe. Short-term interest rates moved close to zero. Some economists argued that
these developed economies were in a liquidity trap. Even tripling of the monetary base in the US
between 2008 and 2011 failed to produce significant effect on the domestic prices.
When interest rates fall to very low levels, the expectation is that since the interest rate is very
low it cannot go further lower and that in all possibility it will move upwards. When interest rates
rise, the bond prices will fall. To hold bonds at this low interest rate is to take the almost certain
risk of a capital loss. Therefore, the desire to hold bonds is very low and approaches zero, and
the demand to hold money in liquid form as alternative to bond holding approaches infinity. In
other words, investors would maintain cash savings rather than hold bonds. The speculative
demand becomes perfectly elastic with respect to interest rate and the speculative money
demand curve becomes parallel to the X axis. This situation is called a ‘Liquidity trap’.
(d) Transaction, precautionary and speculative demand – depends on the nature of the holder-
institutional payments mechanisms and the gap between receipt and use of money, amount of
income and changes in incomes, general level of prices, cost of conversion from near money to
money etc.

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© The Institute of Chartered Accountants of India

 Test Series: November, 2021
MOCK TEST PAPER - 2
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANCIAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) XYZ Company’s equity share is quoted in the market at ` 25 per share currently. The company
pays a dividend of ` 5 per share and the investor’s market expects a growth rate of 5% per year.
You are required to:
(i) CALCULATE the company’s cost of equity capital.
(ii) If the company issues 12% debentures of face value of ` 100 each and realises ` 95 per
debenture while the debentures are redeemable after 10 years at a premium of 12%,
CALCULATE cost of debenture using YTM?
Assume tax rate to be 30%.
(b) ABC Limited is setting up a project with a capital outlay of ` 90,00,000. It has two alternatives in
financing the project cost.
Alternative-I: 100% equity finance by issuing equity shares of ` 10 each
Alternative-II: Debt-equity ratio 2:1 (issuing equity shares of ` 10 each)
The rate of interest payable on the debts is 18% p.a. The corporate tax rate is 30%. CALCULATE
the indifference point between the two alternative methods of financing.
(c) The capital structure of PS Ltd. for the year ended 31 st March, 2021 consisted as follows:

Particulars Amount in `

Equity share capital (face value ` 10 each) 10,000

10% debentures (` 100 each) 1,00,000

During the year 2020-21, sales decreased to 10,000 units as compared to 12,000 units in the
previous year. However, the selling price stood at ` 12 per unit and variable cost at ` 8 per unit
for both the years. The fixed expenses were at ` 20,000 p.a. and the income tax rate is 30%.
You are required to CALCULATE the following:
(i) The degree of financial leverage at 12,000 units and 10,000 units.
(ii) The degree of operating leverage at 12,000 units and 10,000 units.
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© The Institute of Chartered Accountants of India

 (iii) The percentage change in EPS due to change in units sold.
(d) The following information is supplied to you:

Particulars `

Total Earnings 5,00,000

Equity shares (of ` 100 each) 50,00,000

Dividend paid 3,75,000

Price/ Earnings ratio 12.5

Applying Walter’s Model:

(i) ANALYSE whether the company is following an optimal dividend policy.
(ii) COMPUTE P/E ratio at which the dividend policy will have no effect on the value of the
share.
(iii) Will your decision change, if the P/E ratio is 8 instead of 12.5? ANALYSE.
[4 × 5 Marks = 20 Marks]
2. Jensen and spencer pharmaceutical is in the business of manufacturing pharmaceutical drugs
including the newly invented Covid vaccine. Due to increase in demand of Covid vaccines, the
production had increased at all time high level and the company urgently needs a loan to meet the
cash and investment requirements. It had already submitted a detailed loan proposal and project
report to Expo-Impo bank, along with the financial statements of previous three years as follows:
Statement of Profit and Loss (In ` ‘000)
2018–19 2019–20 2020–21
Sales
Cash 400 960 1,600
Credit 3,600 8,640 14,400
Total sales 4,000 9,600 16,000
Cost of goods sold 2,480 5,664 9,600
Gross profit 1,520 3,936 6,400
Operating expenses:
General, administration, and selling expenses 160 900 2,000
Depreciation 200 800 1,320
Interest expenses (on borrowings) 120 316 680
Profit before tax (PBT) 1,040 1,920 2,400
Tax @ 30% 312 576 720
Profit after tax (PAT) 728 1,344 1,680

© The Institute of Chartered Accountants of India

 BALANCE SHEET (In ` ‘000)
2018–19 2019–20 2020–21
Assets
Non-Current Assets
Fixed assets (net of depreciation) 3,800 5,000 9,400
Current Assets
Cash and cash equivalents 80 200 212
Accounts receivable 600 3,000 4,200
Inventories 640 3,000 4,500
Total 5,120 11,200 18,312
Equity & Liabilities
Equity share capital (shares of ₹10 each) 2,400 3,200 4,000
Other Equity 728 2,072 3,752
Non-Current borrowings 1,472 2,472 5,000
Current liabilities 520 3,456 5,560
Total 5,120 11,200 18,312

INDUSTRY AVERAGE OF KEY RATIOS

Ratio Sector Average
Current ratio 2.30:1
Acid test ratio (quick ratio) 1.20:1
Receivable turnover ratio 7 times
Inventory turnover ratio 4.85 times
Long-term debt to total debt 24%
Debt-to-equity ratio 35%
Net profit ratio 18%
Return on total assets 10%
Interest coverage ratio (times interest earned) 10

As a loan officer of Expo-Impo Bank, you are REQUIRED to apprise the loan proposal on the basis of
comparison with industry average of key ratios considering closing balance for accounts receivable of
` 6,00,000 and inventories of ` 6,40,000 respectively as on 31st March, 2018. [10 Marks]
3. Superb Ltd. constructs customized parts for satellites to be launched by USA and Canada. The parts
are constructed in eight locations (including the central headquarter) around the world. The Finance
Director, Ms. Kuthrapali, chooses to implement video conferencing to speed up the budget process
and save travel costs. She finds that, in earlier years, the company sent two officers from each
location to the central headquarter to discuss the budget twice a year. The average travel cost per
3

© The Institute of Chartered Accountants of India

 person, including air fare, hotels and meals, is ` 27,000 per trip. The cost of using video conferencing
is ` 8,25,000 to set up a system at each location plus ` 300 per hour average cost of telephone time
to transmit signals. A total 48 hours of transmission time will be needed to complete the budget each
year. The company depreciates this type of equipment over five years by using straight line method.
An alternative approach is to travel to local rented video conferencing facilities, which can be rented
for ` 1,500 per hour plus ` 400 per hour averge cost for telephone charges. You are Senior Officer of
Finance Department. You have been asked by Ms. Kuthrapali to EVALUATE the proposal and
SUGGEST if it would be worthwhile for the company to implement video conferencing. [10 Marks]
4. On 01st April, 2020, the Board of Director of ABC Ltd. wish to know the amount of working capital that
will be required to meet the programme they have planned for the year. From the following
information, PREPARE a working capital requirement forecast and a forecast profit and loss account
and balance sheet:
Issued share capital ` 6,00,000
10% Debentures ` 1,00,000
Fixed Assets ` 4,50,000
Production during the previous year was 1,20,000 units; it is planned that this level of activity should
be maintained during the present year.
The expected ratios of cost to selling price are: raw materials 60%, direct wages 10% overheads 20%
Raw materials are expected to remain in store for an average of two months before issue to
production. Each unit of production is expected to be in process for one month. The time lag in wage
payment is one month.
Finished goods will stay in the warehouse awaiting dispatch to customers for approximately three
months.
Credit allowed by creditors is two months from the date of delivery of raw materials. Credit given to
debtors is three months from the date of dispatch.
Selling price is ` 5 per unit.
There is a regular production and sales cycle and wages and overheads accrue evenly. [10 Marks]
5. (a) PQR Ltd. has under its consideration a project with an initial investment of
` 2,25,00,000. Three probable cash inflow scenarios with their probabilities of occurrence have
been estimated as below:

Annual cash inflow (`) 50,00,000 75,00,000 1,00,00,000

Probability 0.2 0.7 0.1

The project life is 5 years and the desired rate of return is 12%. The estimated terminal values for
the project assets under the three probability alternatives are ` 0, ` 50,00,000 and ` 75,00,000
respectively.
You are required to:
(i) CALCULATE the probable NPV;
(ii) CALCULATE the worst-case NPV and the best-case NPV; and
(iii) STATE the probability occurrence of the worst case, if the cash flows are perfectly
positively correlated over time. [8 Marks]
4

© The Institute of Chartered Accountants of India

 (b) ‘Pecking order theory’ suggests manager to use various sources for raising of fund in certain
order. BRIEF out that order. [2 Marks]
6. (a) BRIEF out any four types of Preference shares along with its feature. [4 Marks]
(b) EXPLAIN any four types of Packing Credit. [4 Marks]
(c) EXPLAIN: Callable bonds and Puttable bonds.
Or
Briefly DESCRIBE bridge finance. [2 Marks]

© The Institute of Chartered Accountants of India

 Test Series: November, 2021
MOCK TEST PAPER - 2
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8B: ECONOMICS FOR FINANCE
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. (a) What is the distinction between taxes on production and product taxes? (Marks 2)
(b) Describe the relevance of Circular flow of income in the measurement of National Income (Marks 3)
(c) What are the factors behind the concept of multiplier? (Marks 3)
(d) Suppose the Consumption function of the economy is given by: (Marks 2)
C = 40 + 0.8 Y
and Investment Function is given by
I = 30 + 0.4 Y
What will be the equilibrium level of national Income?

2. (a) What is the role of the government in the management of the fiscal parameters
of the economy? (Marks 3)
(b) What is the rationale of measuring money supply?. (Marks 2)
(c) Calculate GDP and National Income from the Following data: (Marks 5)
Item Rs. In crore

Depreciation 400

Exports 1200

Imports 900

Net Factor income from rest of the world 600

Change in business inventories 200

Gross private domestic fixed Investment 400

Indirect Taxes 7000

Subsidies 500

© The Institute of Chartered Accountants of India

 State government consumption and investment expenditure 700

Central government consumption and investment expenditure 800

Private Consumption Expenditure 5000

3. (a) What are the Operating Procedures and Instruments of Monetary Policy? (Marks 3)
(b) What is the Process of determination of Nominal Exchange Rate ? (Marks 2)
(c) What are the Factors that leads to market Failure? (Marks 3)
(d) What are the advantage of Foreign Portfolio Investment? (Marks 2)

4 (a) What is countervailing duty and how does it effect trade policy? (Marks 3)
(b) How is economy effected by crowding out effect? (Marks 2)
(c). Elaborate the reason why tragedy of the commons occurs? (Marks 3)
(d) What is the usefulness of the National Income Account? (Marks 2)

5. (a) What is the effect of New Trade Policy on Industries? (Marks 3)

(b) Why is government intervention required in case of demerit good? (Marks 2)
(c) What are the limitation of Fiscal Policy? (Marks 3)
(d). What are the export related measures as an instrument of Trade Policy? (Marks 2)

© The Institute of Chartered Accountants of India

 Test Series: November, 2021
MOCK TEST PAPER 2
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
SUGGESTED ANSWERS/ HINTS
1. (a) (i) Cost of Equity Capital (Ke):
Ke = Expecteddividendper share(D1) +Growthrate(g)
Marketpriceper share(P0)

` 5 × 1.05
= + 0.05 = 26%
` 25
(ii) Cost of Debenture (Kd):
Using Present Value method (or YTM)
Identification of relevant cash flows

Year Cash flows

0 Current market price (P0) = ` 95

1 to 10 Interest net of tax [I(1-t)] = 12% of ` 100 (1 – 0.30) = ` 8.40

10 Redemption value (RV) = ` 100 (1.12) = ` 112

Calculation of Net Present Values (NPV) at two discount rates

Year Cash Discount factor Present Discount factor Present

flows @ 9% (L) Value @ 10% (H) Value

0 (95) 1.0000 (95.00) 1.0000 (95.00)

1 to 10 8.40 6.4176 53.91 6.1445 51.61

10 112 0.4224 47.31 0.3855 43.18

NPV +6.22 -0.21

Calculation of IRR
NPVL
IRR = L + (H-L )
NPVL -NPVH
6.22 6.22
= 9% + �10% - 9%�= 9% + 6.43 = 9.97%
6.22 - (- 0.21)
Therefore, Kd = 9.97%
(b) Calculation of Indifference point between the two alternatives of financing.
Alternative-I By issue of 9,00,000 equity shares of `10 each amounting to ` 90 lakhs. No
financial charges are involved.

© The Institute of Chartered Accountants of India

 Alternative-II By raising the funds in the following way:
Debt = ` 60 lakhs
Equity = ` 30 lakhs (3,00,000 equity shares of ` 10 each)
18
Interest payable on debt = 60,00,000× = ` 10,80,000
100
The difference point between the two alternatives is calculated by:

(EBIT - I1 ) (1- T) (EBIT - I2 ) (1- T)

=
E1 E2
(EBIT − 0) (1 − 0.30) (EBIT − 10,80,000) (1 − 0.30)
=
9,00,000 3,00,000
(EBIT) (0.70) (EBIT − 10,80,000) (0.70)
=
9,00,000 3,00,000

EBIT(0.70) 0.70 (EBIT − 10,80,000)

=
3 1

EBIT = 3EBIT−32,40,000
−2 EBIT = −32,40,000
EBIT = 32,40,000
2

EBIT = ` 16,20,000
Therefore, at EBIT of ` 16,20,000, earnings per share for the two alternatives is equal.
(c)

Sales in units 12,000 10,000

(`) (`)

Sales Value 1,44,000 1,20,000

Variable Cost (96,000) (80,000)

Contribution 48,000 40,000

Fixed expenses (20,000) (20,000)

EBIT 28,000 20,000

Debenture Interest (10,000) (10,000)

EBT 18,000 10,000

Tax @ 30% (5,400) (3,000)

Profit after tax (PAT) 12,600 7,000

EBIT ` 28,000 ` 20,000
(i) Financial Leverage= = = 1.56 = =2
EBT ` 18,000 ` 10,000

© The Institute of Chartered Accountants of India

 Contribution ` 48,000 ` 40,000
(ii) Operating leverage = = ` 28,000 = 1.71 = ` 20,000 = 2
EBIT

(iii) Earnings per share (EPS) ` 12,600 ` 7,000

= ` 1,000 = ` 12.6 = ` 1,000 = ` 7

Decrease in EPS = ` 12.6 – ` 7 = ` 5.6

% decrease in EPS 5.6

= 12.6 X 100 = 44.44%

(d) (i) The EPS of the firm is ` 10 (i.e. ` 5,00,000/ 50,000). r = 5,00,000/ 50,00,000 = 10%.
The P/E Ratio is given at 12.5 and the cost of capital, Ke, may be taken at the inverse
of P/E ratio. Therefore, Ke is 8 (i.e., 1/12.5). The firm is distributing total dividends of
` 3,75,000 among 50,000 shares, giving a dividend per share of ` 7.50. The value of
the share as per Walter’s model may be found as follows:
r 0.1
D+ (E - D) 7.5+ (10 - 7.5)
P = Ke = 0.08 = ` 132.81
Ke 0.08

The firm has a dividend payout of 75% (i.e., ` 3,75,000) out of total earnings of
` 5,00,000. Since, the rate of return of the firm, r, is 10% and it is more than the Ke of
8%, therefore, by distributing 75% of earnings, the firm is not following an optimal
dividend policy. The optimal dividend policy for the firm would be to pay zero dividend
and in such a situation, the market price would be,
0.1
0+ (10 - 0)
0.08 = ` 156.25
0.08
So, theoretically, the market price of the share can be increased by adopting a zero
payout.
(ii) The P/E ratio at which the dividend policy will have no effect on the value of the share
is such at which the Ke would be equal to the rate of return, r, of the firm. The Ke would
be 10% (= r) at the P/E ratio of 10. Therefore, at the P/E ratio of 10, the dividend policy
would have no effect on the value of the share.
(iii) If the P/E is 8 instead of 12.5, then the Ke which is the inverse of P/E ratio, would be
12.5 and in such a situation ke> r and the market price, as per Walter’s model would
be:
r 0.1
D+ (E - D) 7.5 + (10 - 7.5)
P = Ke = 0.125 = ` 76
Ke 0.125

2. (In ` ‘000)

Ratio Formula 2018–19 2019–20 2020–21 Industry

Average

Current Current Assets 1,320 6,200 8,912 2.30:1

ratio Current Liabilities 520 3,456 5,560

© The Institute of Chartered Accountants of India

 = 2.54 = 1.80 = 1.60

Acid test Quick Assets 680 3,200 4,412 1.20:1

ratio (quick Current Liabilities 520 3,456 5,560
ratio)
= 1.31 = 0.93 = 0.79

Receivable Credit Sales 3,600 8,640 14,400 7 times

turnover Average Accounts Receivable (600+600)/2 (600+ 3,000)/2 (3,000+ 4,200)/2
ratio =6 = 4.80 =4

Inventory COGS 2,480 5,664 9,600 4.85 times

turnover Average Inventory (640+640)/2 (640+ 3,000)/2 (3,000+ 4,500)/2
ratio = 3.88 = 3.11 = 2.56

Long-term Long term Debt 1,472 2,472 5,000 24%

× 100 × 100 × 100 × 100
debt to Total Debt 1,992 5,928 10,560
total debt = 41.70% = 47.35%
= 73.90%

Debt-to- Long term Debt 1,472 2,472 5,000 35%

× 100 × 100 × 100 × 100
equity ratio Shareholders' Equity 3,128 5,272 7,752
= 46.89% = 64.50%
= 47.06%

Net profit Net Profit 728 1,344 1,680 18%

×100 × 100 × 100 × 100
ratio Sales 4,000 9,600 16,000
= 14% = 10.5%
= 18.2%

Return on Net Profit after taxes 728 1,344 1,680 10%

×100 × 100 × 100 × 100
total assets Total assets 5,120 11,200 18,312
= 12% = 9.17%
= 14.22%

Interest EBIT 1,160 2,236 3,080 10

coverage Interest 120 316 680
ratio (times
= 9.67 = 7.08 = 4.53
interest
earned)

Conclusion:
In the last two years, the current ratio and quick ratio are less than the ideal ratio (2:1 and 1:1
respectively) indicating that the company is not having enough resources to meet its current
obligations. Receivables are growing slower. Inventory turnover is slowing down as well, indicating a
relative build-up in inventories or increased investment in stock. High Long-term debt to total debt
ratio and Debt to equity ratio compared to that of industry average indicates high dependency on
4

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 long term debt by the company. The net profit ratio is declining substantially and is much lower than
the industry norm. Additionally, though the Return on Total Asset(ROTA) is near to industry average,
it is declining as well. The interest coverage ratio measures how many times a company can cover
its current interest payment with its available earnings. A high interest coverage ratio means that an
enterprise can easily meet its interest obligations, however, it is declining in the case of Jensen &
Spencer and is also below the industry average indicating excessive use of debt or inefficient
operations.
On overall comparison of the industry average of key ratios than that of Jensen & Spencer, the
company is in deterioration position. The company’s profitability has declined steadily over the
period. However, before jumping to the conclusion relying only on the key ratios, it is pertinent to
keep in mind the industry, the company dealing in with i.e. manufacturing of pharmaceutical drugs.
The pharmaceutical industry is one of the major contributors to the economy and is expected to grow
further. After the covid situation, people are more cautious towards their health and are going to
spend relatively more on health medicines. Thus, while analysing the loan proposal, both the factors,
financial and non-financial, needs to be kept in mind.
3. Option I : Cost of travel, in case Video Conferencing facility is not provided
Total Trip = No. of Locations × No. of Persons × No. of Trips per Person = 7×2×2 = 28 Trips
Total Travel Cost (including air fare, hotel accommodation and meals) (28 trips × ` 27,000 per trip)
= ` 7,56,000
Option II : Video Conferencing Facility is provided by Installation of Own Equipment at
Different Locations
Cost of Equipment at each location (` 8,25,000 × 8 locations) = ` 66,00,000
Economic life of Machines (5 years). Annual depreciation (66,00,000/5) = ` 13,20,000
Annual transmission cost (48 hrs. transmission × 8 locations × ` 300 per hour) = ` 1,15,200
Annual cost of operation (13,20,000 + 1,15,200) = ` 14,35,200
Option III : Engaging Video Conferencing Facility on Rental Basis
Rental cost (48 hrs. × 8 location × ` 1,500 per hr) = ` 5,76,000
Telephone cost (48 hrs.× 8 locations × ` 400 per hr.) = ` 1,53,600
Total rental cost of equipment (5,76,000 + 1,53,600) = ` 7,29,600
Analysis: The annual cash outflow is minimum, if video conferencing facility is engaged on rental
basis. Therefore, Option III is suggested.
4. Forecast Profit and Loss Account for the period 01.04.2020 to 31.03.2021
Particulars ` Particulars `
Materials consumed 3,60,000 By Sales 1,20,000 @ ` 5 6,00,000
1,20,000 @ ` 3
Direct wages : 60,000
1,20,000 @ ` 0.50
Overheads : 1,20,000
1,20,000 @ ` 1
5

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 Gross profit c/d 60,000
6,00,000 6,00,000
Debenture interest 10,000 By gross profit b/d 60,000
(10% of 1,00,000)
Net profit c/d 50,000
60,000 60,000

Working Capital Requirement Forecast for the year 01.04.2020 to 31.03.2021

Particulars Period Total (`) Current Assets (`) Current
(Months) Liabilities (`)
Raw Work-in- Finished Debtors Creditors
materials progress goods
1. Material
In store 2 60,000
In work-in- 1 30,000
progress
In finished 3 90,000
goods
Credit to 3 90,000
debtors
9
Less : 2 60,000
Credit from
creditors
Net block 7 2,10,000
period
2. Wages:
In work-in- 1/2 2,500
progress
In finished 3 15,000
goods
Credit to 3 15,000
debtors
6½
Less : Time 1 5,000
lag in
payment

© The Institute of Chartered Accountants of India

 Net block 5½ 27,500
period
3. Overhead
s:
In work-in- ½ 5,000
progress
In finished 3 30,000
goods
Credit to 3 30,000
debtors
Net block 6½ 65,000
period
4. Profit
Credit to 3 15,000
debtors
Net block 3 15,000
period
Total (`) 3,17,500 60,000 37,500 1,35,000 1,50,000 65,000
Forecast Balance Sheet as on 31.03.2021
(`) (`)
Issued share capital 6,00,000 Fixed Assets 4,50,000
Profit and Loss A/c 50,000 Current Assets:
10% Debentures 1,00,000 Stock:
Sundry creditors 65,000 Raw materials 60,000
Bank overdraft- Work-in-progress 37,500
Balancing figure 17,500 Finished goods 1,35,000 2,32,500
Debtors 1,50,000

8,32,500 8,32,500

The Total amount of working capital, thus, stands as follows: `

Requirement as per working capital 3,17,500
Less: Bank overdraft as per balance sheet 17,500
Net requirement 3,00,000

© The Institute of Chartered Accountants of India

 Notes:
1. Average monthly production: 1,20,000 ÷ 12 = 10,000 units
2. Average cost per month:
Raw Material 10,000 × (` 5 × 0.6) = ` 30,000
Direct wages 10,000 × (` 5 × 0.1) = ` 5,000
Overheads 10,000 × (` 5 × 0.2) = ` 10,000
3. Average profit per month: 10,000 × (` 5 × 0.1) = ` 5,000
4. Wages and overheads accrue evenly over the period and, hence, are assumed to be completely
introduced for half the processing time.
5. (a) (i) Calculation of Net Present Value (NPV)

Year Prob. = 0.2 Prob. = 0.7 Prob. = 0.1

Cash flow Probable Cash flow Probable Cash flow Probable Total Cash PVF@ PV of Total
cash flow cash flow cash flow flow 12% cash flow

0 (2,25,00,000) 1.0000 (2,25,00,000)

1 to 5 50,00,000 10,00,000 75,00,000 52,50,000 1,00,00,000 10,00,000 72,50,000 3.6048 2,61,34,800

5 0 0 50,00,000 35,00,000 75,00,000 7,50,000 42,50,000 0.5674 24,11,450

Net Present Value (NPV) 60,46,250

(ii) Worst and Best case is the case where expected annual cash inflows are
minimum and maximum respectively.
Calculation of Worst Case and Best Case NPV:
Year PVF@ Worst case Best Case
12%
Cash flows PV of Cash Cash flows PV of Cash
flows flows
0 1.0000 (2,25,00,000) (2,25,00,000) (2,25,00,000) (2,25,00,000)
1 to 5 3.6048 50,00,000 1,80,24,000 1,00,00,000 3,60,48,000
5 0.5674 0 0 75,00,000 42,55,500
NPV (44,76,000) 1,78,03,500

Worst case NPV = ` (44,76,000)

Best Case NPV = ` 1,78,03,500
(iii) The cash flows are perfectly positively correlated over time means cash flow in first
year will be cash flows in subsequent years. The cash flow of ` 50,00,000 is the worst
case cash flow and its probability is 20%, thus, possibility of worst case is 20%.
(b) Pecking order theory suggests that managers may use various sources for raising of fund in
the following order:
1. Managers first choice is to use internal finance.
8

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 2. In absence of internal finance, they can use secured debt, unsecured debt, hybrid debt
etc.
3. Managers may issue new equity shares as a last option.
6. (a)

Sl. No. Type of Preference Shares Salient Features

1 Cumulative Arrear Dividend will accumulate.

2 Non-cumulative No right to arrear dividend.

3 Redeemable Redemption should be done.

4 Participating Can participate in the surplus which remains

after payment to equity shareholders.

5 Non- Participating Cannot participate in the surplus after payment

of fixed rate of Dividend.

6 Convertible Option of converting into equity Shares.

(b) (i) Clean packing credit: This is an advance made available to an exporter only on
production of a firm export order or a letter of credit without exercising any charge or
control over raw material or finished goods. It is a clean type of export advance. Each
proposal is weighed according to particular requirements of the trade and credit
worthiness of the exporter. A suitable margin has to be maintained. Also, Export Credit
Guarantee Corporation (ECGC) cover should be obtained by the bank.
(ii) Packing credit against hypothecation of goods: Export finance is made available on
certain terms and conditions where the exporter has pledge able interest and the
goods are hypothecated to the bank as security with stipulated margin. At the time of
utilising the advance, the exporter is required to submit, along with the firm export
order or letter of credit relative stock statements and thereafter continue submitting
them every fortnight and/or whenever there is any movement in stocks.
(iii) Packing credit against pledge of goods: Export finance is made available on certain
terms and conditions where the exportable finished goods are pledged to the banks
with approved clearing agents who will ship the same from time to time as required by
the exporter. The possession of the goods so pledged lies with the bank and is kept
under its lock and key.
(iv) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture, processing,
purchasing, or packing of goods meant for export against a firm order qualifies for the
packing credit guarantee issued by Export Credit Guarantee Corporation.
(v) Forward exchange contract: Another requirement of packing credit facility is that if
the export bill is to be drawn in a foreign currency, the exporter should enter into a
forward exchange contact with the bank, thereby avoiding risk involved in a possible
change in the rate of exchange.
(c) (i) Callable bonds: A callable bond has a call option which gives the issuer the right to
redeem the bond before maturity at a predetermined price known as the call price
(Generally at a premium).

© The Institute of Chartered Accountants of India

 (ii) Puttable bonds: Puttable bonds give the investor a put option (i.e. the right to sell the
bond) back to the company before maturity.
OR
(c) Bridge Finance: Bridge finance refers to loans taken by a company normally from
commercial banks for a short period because of pending disbursement of loans
sanctioned by financial institutions. Though it is of short-term nature but since it is an
important step in the facilitation of long-term loan, therefore it is being discussed along with
the long term sources of funds. Normally, it takes time for financial institutions to disburse
loans to companies. However, once the loans are approved by the term lending institutions,
companies, in order not to lose further time in starting their projects, arrange short term loans
from commercial banks. The bridge loans are repaid/ adjusted out of the term loans as and
when disbursed by the concerned institutions. Bridge loans are normally secured by
hypothecating movable assets, personal guarantees and demand promissory notes.
Generally, the rate of interest on bridge finance is higher as compared with that on term loans

10

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 Test Series: November, 2021
MOCK TEST PAPER 2
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8B : ECONOMICS FOR FINANCE
SUGGESTED ANSWERS/ HINTS

1. (a) Production taxes are paid in relation to production and are independent of the volume of actual
production. Examples of production taxes are land revenues, stamps and registration fees and tax
on profession, factory license fee, taxes to be paid to the local authorities, pollution tax etc.
Product taxes are paid on per unit of product. Examples of product taxes are excise duties, sales tax,
service tax and import-export duties.
(b) Circular flow of income refers to the continuous circulation of production, income generation and
expenditure involving different sectors of the economy. There are three different interlinked phases in a
circular flow of income, namely: production, distribution, and disposition.
(i) In the production phase, firms produce goods and services with the help of factor services.
(ii) In the income or distribution phase, the flow of factor incomes in the form of rent, wages,
interest, and profits from firms to the households occurs
(iii) In the expenditure or disposition phase, the income received by different factors of
production is spent on consumption goods and services and investment goods. This
expenditure leads to further production of goods and services and sustains the circular flow.
(c) The multiplier concept is central to Keynes's theory because it explains how shifts in investment
caused by changes in business expectations set off a process that causes not only investment but
also consumption to vary. The multiplier shows how shocks to one sector are transmitted
throughout the economy. Increase in income due to increase in initial investment, does not go on
endlessly. If the increased income goes out of the cycle of consumption expenditure, there is a
leakage from income stream which reduces the effect of multiplier. The more powerful these
leakages are the smaller will be the value of multiplier.
(d) Y = C +I
Y = 40 + 0.2Y + 30 + 0.3Y
Y = 70 + 0.5Y
Y = 70 /0.5
Y = 140
2. (a) The significance of fiscal policy as a strategy for achieving certain socio-economic objectives was not
recognized or widely acknowledged before 1930 due to the faith in the limited role of government
advocated by the then prevailing laissez- faire approach. Governments of all countries pursue
innumerable policies to accomplish their economic goals such as rapid economic growth, equitable
distribution of wealth and income, reduction of poverty, price stability, exchange rate stability, full-
employment, balanced regional development etc. Government budget is one among the most
powerful instruments of economic policy.
Fiscal policy involves the use of government spending, taxation and borrowing to influence both the
pattern of economic activity and level of growth of aggregate demand, output, and employment.

© The Institute of Chartered Accountants of India

 (b) The term money supply denotes the total quantity of money available to the people in an
economy. The quantity of money at any point of time is a measurable concept.
Rationale of money supply:
• It facilitates analysis of monetary developments in order to provide deeper understanding of the
causes of money growth.
• It is essential from a monetary policy perspective as it provides a framework to evaluate whether
the stock of money in the economy is consistent with the standards for price stability and to
understand the nature of deviations from this standard. The central banks all over the world
adopt monetary policy to stabilise price level and GDP growth by directly controlling the
supply of money. This is achieved mainly by managing the quantity of monetary base. The
success of monetary policy depends to a large extent on the controllability of the monetary
base and the money supply.
(c) GDPmp = Private consumption expenditure + Gross Private (both fixed and inventories) +
Gross expenditure (Central & State) + Net Exports
= 5000+ 400 + 200 + 700 + 800 + (1200-900)
= 7400cr
National Income = GDPmp – Net Indirect Taxes
= 7400-6500-600
= 300cr
3 (a) The operating framework relates to all aspects of implementation of monetary policy
• The operating targets refer to the financial variables that can be controlled by the central bank to
a large extent through the monetary policy instruments.
• The intermediate targets are variables which the central bank can hope to influence to a
reasonable degree through the operating targets. The intermediate targets display a
predictable and stable relationship with the goal variables.
• The monetary policy instruments are the various tools that a central bank can use to influence
money market and credit conditions and pursue its monetary policy objectives. The day-to-day
implementation of monetary policy by central banks through various instruments is referred
to as ‘operating procedures.
In general, the direct instruments comprise of:
(a) the required cash reserve ratios and liquidity reserve ratios prescribed from time to time.
(b) directed credit which takes the form of prescribed targets for allocation of credit to preferred
sectors
(c) administered interest rates wherein the deposit and lending rates are prescribed by the
central bank.
The indirect instruments mainly consist of:
(a) Repos
(b) Open market operations
(c) Standing facilities, and
(d) Market-based discount window.

© The Institute of Chartered Accountants of India

 (b) As you already know, the key framework for analyzing prices is the operation of forces of supply
and demand in markets. Usually, the supply of and demand for foreign exchange in the domestic
foreign exchange market determine the external value of the domestic currency, or in other words,
a country’s exchange rate.
Individuals, institutions, and governments participate in the foreign exchange market for a
number of reasons. On the demand side, people desire foreign currency to:
• purchase goods and services from another country
• for unilateral transfers such as gifts, awards, grants, donations or endowment.
• to make investment income payments abroad
• to purchase financial assets, stocks, or bonds abroad
• to open a foreign bank account
• to acquire direct ownership of real capital, and
• for speculation and hedging activities related to risk-taking or risk- avoidance activity
Determination of Nominal Exchange Rate

The equilibrium rate of exchange is determined by the interaction of the supply and demand for a
particular foreign currency. In figure the demand curve (D$) and supply curve (S$) of dollars intersect
to determine equilibrium exchange rate.
(c) There are four major reasons for market failure. They are:
• Market power,
• Externalities,
• Public goods, and
• Incomplete information
Market Power: Market power is the ability of a firm to profitably raise the market price of a good
or service over its marginal cost.
Externalities: The unique feature of an externality is that it is initiated and experienced not through
the operation of the price system, but outside the market. Since it occurs outside the price
mechanism, it has not been compensated for, or in other words it is uninternalized or the cost of it is
not borne by the parties.
Public Goods: A public good is defined as one which all enjoy in common in the sense that
everyone’s consumption of such a good lead to no subtraction from any other individuals’
consumption of that good.

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 Incomplete information: Information failure is widespread in numerous market exchanges. When
this happens misallocation of scarce resources takes place and equilibrium price, and quantity is not
established through price mechanism. This results in market failure.
(d) Foreign portfolio investment (FPI) is not concerned with either manufacture of goods or with
provision of services. Such investors also do not have any intention of exercising voting power or
controlling or managing the affairs of the company in whose securities they invest. The sole intention of
a foreign portfolio investor is to earn a remunerative return through investment in foreign securities
and is primarily concerned about the safety of their capital, the likelihood of appreciation in its
value, and the return generated.
• Portfolio capital moves to a recipient country which has revealed its potential for higher
returns and profitability.
• Investment is only in financial assets
• Only short-term interest and generally remain invested for short periods
• Relatively easy to withdraw
• Not accompanied by technology transfer
• No direct impact on employment of labour and wages
• No abiding interest in management and control
• Securities are held purely as a financial investment and no significant degree of influence on
the management of the enterprise
4 (a) Countervailing duties are tariffs that aim to offset the artificially low prices charged by exporters who
enjoy export subsidies and tax concessions offered by the governments in their home country. If a
foreign country does not have a comparative advantage in a particular good and a government subsidy
allows the foreign firm to be an exporter of the product, then the subsidy generates a distortion
from the free-trade allocation of resources. In such cases, CVD is charged in an importing
country to negate the advantage that exporters get from subsidies to ensure fair and market-
oriented pricing of imported products and thereby protecting domestic industries and firms.
(b) The crowding out view is that a rapid growth of government spending leads to a transfer of scarce
productive resources from the private sector to the public sector where productivity might be lower. An
increase in the size of government spending during recessions will ‘crowd-out’ private spending in
an economy and lead to reduction in an economy’s ability to self-correct from the recession, and
possibly also reduce the economy’s prospects of long-run economic growth. Crowding out effect is
the negative effect fiscal policy may generate when money from the private sector is ‘crowded out’ to
the public sector.
During deep recessions, crowding-out is less likely to happen as private sector investment is already
minimal and therefore there is only insignificant private spending to crowd out. Moreover, during a
recession phase the government would be able to borrow from the market without increasing
interest rates.
(c) Economists use the term to describe the problem which occurs when rivalrous but non excludable
goods are overused to the disadvantage of the entire world. The term “commons” is derived from the
traditional English legal term of “common land” where farmers/peasants would graze their
livestock, hunt, and collect wild plants and other produce. Everyone has access to a commonly
held pasture; there are no rules about sustainable numbers for grazing. The outcome of the
individual rational economic decisions of cattle owners was market failure because these actions
resulted in degradation, depletion or even destruction of the resource leading to welfare loss for
the entire society.
(d) The estimates of national income show the composition and structure of national income in terms
of different sectors of the economy, the periodical variations in them and the broad sectoral shifts in an
4

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 economy over time. It is also possible to make temporal and spatial comparisons of the trend and
speed of economic progress and development. Using this information, the government can fix various
sector-specific development targets for different sectors of the economy and formulate suitable
development plans and policies to increase growth rates.
5 (a) New Trade Policy helps in understanding why developed and big countries trade partners are when
they are trading similar goods and services. These countries constitute more than 50% of world trade.
This is particularly true in key economic sectors such as electronics, IT, food, and automotive. NTT
argues that, because of substantial economies of scale and network effects, it pays to export phones
to sell in another country. Those countries with the advantages will dominate the market, and the
market takes the form of monopolistic competition.
According to NTT, two key concepts give advantages to countries that import goods to compete with
products from the home country:
Economies of Scale: As a firm produces more of a product, its cost per unit keeps going down. So, if
the firm serves domestic as well as foreign market instead of just one, then it can reap the benefit of
large scale of production consequently the profits are likely to be higher.
Network effects refer to the way one person’s value for a good or service is affected by the value of
that good or service to others. The value of the product or service is enhanced as the number of
individuals using it increases. This is also referred to as the ‘bandwagon effect’. Consumers like more
choices, but they also want products and services with high utility, and the network effect increases
utility obtained from these products over others.
(b) Demerit goods are goods which are believed to be socially undesirable. The consumption of demerit
goods imposes significant negative externalities on the society as a whole and therefore the
private costs incurred by individual consumers are less than the social costs experienced by the
society. The production and consumption of demerit goods are likely to be more than optimal under
free markets. The government should therefore intervene in the marketplace to discourage their
production and consumption. Imposing unusually high taxes on producing or purchasing the good
making them very costly and unaffordable to many is perhaps the most commonly used method
for reducing the consumption of a demerit good.
(c) Fiscal policy changes may at times be badly timed due to the various lags so that it is highly possible
that an expansionary policy is initiated when the economy is already on a path of recovery and
vice versa. The imitation of fiscal policy is :-
• There are difficulties in instantaneously changing governments’ spending and taxation
policies.
• It is practically difficult to reduce government spending on various items such as defence and
social security as well as on huge capital projects which are already midway.
• Public works cannot be adjusted easily along with movements of the trade cycle because
many huge projects such as highways and dams have long gestation period.
• Due to uncertainties, there are difficulties of forecasting when a period of inflation or deflation
may set in and promptly determining the accurate policy to be undertaken.
• There are possible conflicts between different objectives of fiscal policy such that a policy
designed to achieve one goal may adversely affect another.
• Supply-side economists are of the opinion that certain fiscal measures will cause disincentives
• Deficit financing increases the purchasing power of people.
• Increase is government borrowing creates perpetual burden on even future generations as
debts have to be repaid.

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 (d) Trade Policy encompasses all instruments that government may use to promote or restrict
imports and exports.
Export related measures are:
1. Ban on export.
2. Export Taxes.
3. Export Subsidies and incentives.
4. Voluntary Export Restraints
Over the past few decades, significant transformations are happening in terms of growth as well
as terms of flows and pattern of global trade. The increasing importance of developing countries
has been a salient feature of the shitting global trade patterns.

© The Institute of Chartered Accountants of India

 Test Series: March, 2022
MOCK TEST PAPER –1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) The following figures have been extracted from the annual report of Xee Ltd.:
Net Profit ` 75 lakhs
Outstanding 12% preference shares ` 250 lakhs
No. of equity shares 3 lakhs
Return on Investment 20%
Cost of capital i.e. (K e) 16%
COMPUTE the approximate dividend pay-out ratio so as to keep the share price at ` 105 by using
Walter’s model?
(b) Owner's equity of Yay Ltd. is ` 6,00,000. The financial ratios of the company are given below:
Current debt to total debt 0.4
Total debt to Owner's equity 0.6
Fixed assets to Owner's equity 0.6
Total assets turnover 2 times
Inventory turnover 8 times
COMPLETE the following Balance Sheet from the information given above:
Liabilities (`) Assets (`)
Current Debt - Cash -
Long-term Debt - Inventory -
Total Debt - Total Current Assets -
Owner's Equity - Fixed Assets -
9,60,000 -
(c) The capital structure of Roshan Ltd. for the year ended 31 st March, 2022 consisted as follows:
Particulars Amount (`’ 000)
Equity share capital (face value ` 100 each) 1,50,000
10% debentures (` 100 each) 1,50,000
1

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 During the year 2021-22, sales of the company decreased to 15,00,000 units as compared to
18,00,000 units in the previous year. However, the selling price stood at ` 120 per unit and variable
cost at ` 80 per unit for both the years. The fixed expenses were at ` 3 crore p.a. and the income
tax rate is 30%.
You are required to CALCULATE the following:
(i) The degree of financial leverage at 18,00,000 units and 15,00,000 units.
(ii) The degree of operating leverage at 18,00,000 units and 15,00,000 units.
(iii) The percentage change in EPS.
(d) (i) A company’s equity share is quoted in the market at ` 125 per share currently. The company
pays a dividend of ` 10 per share and the investor’s market expects a growth rate of 6% per
year. CALCULATE the company’s cost of equity capital.
(ii) If the company issues 10% debentures of face value of ` 100 each and realises ` 98 per
debenture while the debentures are redeemable after 12 years at a premium of 1 0%,
CALCULATE cost of debenture using YTM?
Assume Tax Rate to be 50%. [4 × 5 Marks = 20 Marks]
2. PRI Ltd. and SHA Ltd. are identical, however, their capital structure (in market-value terms) differs as
follows:
Company Debt Equity
PRI Ltd. 60% 40%
SHA Ltd. 20% 80%

The borrowing rate for both companies is 8% in a no-tax world and capital markets are assumed to be
perfect.
(a) (i) If Mr. Rhi, owns 6% of the equity shares of PRI Ltd., DETERMINE his return if the Company
has net operating income of ` 9,00,000 and the overall capitalization rate of the company (K o)
is 18%.
(ii) CALCULATE the implied required rate of return on equity of PRI Ltd.
(b) SHA Ltd. has the same net operating income as PRI Ltd.
(i) CALCULATE the implied required equity return of SHA Ltd.
(ii) ANALYSE why does it differ from that of PRI Ltd. [10 Marks]
3. Following information is forecasted by Gween Limited for the year ending 31 st March, 2022:
Balance as at Balance as at
31st March, 2022 31st March, 2021
(` in lakh) (` in lakh)
Raw Material 845 585
Work-in-progress 663 455
Finished goods 910 780
Receivables 1,755 1,456
Payables 923 884
Annual purchases of raw material (all credit) 5,200
Annual cost of production 5,850
Annual cost of goods sold 6,825
2

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 Annual operating cost 4,225
Annual sales (all credit) 7,605

Considering one year as equal to 365 days, CALCULATE:

(i) Net operating cycle period.
(ii) Number of operating cycles in the year.
(iii) Amount of working capital requirement. [10 Marks]
4. A manufacturing company is presently paying a garbage disposer company ` 0.50 per kilogram to
dispose-off the waste resulting from its manufacturing operations. At normal operating capacity, the
waste is about 2,00,000 kilograms per year.
After spending ` 1,20,000 on research, the company discovered that the waste could be sold for ` 5
per kilogram if it was processed further. Additional processing would, however, require an investment of
` 12,00,000 in new equipment, which would have an estimated life of 10 years with no salvage value.
Depreciation would be calculated by straight line method.
No change in the present selling and administrative expenses is expected except for the costs incurred
in advertising ` 40,000 per year, if the new product is sold. Additional processing costs would include
variable cost of ` 2.50 per kilogram of waste put into process along with fixed cost of ` 60,000 per year
(excluding Depreciation).
There will be no losses in processing, and it is assumed that the total waste proce ssed in a given year
will be sold in the same year. Estimates indicate that 2,00,000 kilograms of the product could be sold
each year.
The management when confronted with the choice of disposing off the waste or processing it further
and selling it, seeks your ADVICE. Which alternative would you RECOMMEND? Assume that the firm's
cost of capital is 15% and it pays on an average 50% Tax on its income.
Consider Present value of Annuity of ` 1 per year @ 15% p.a. for 10 years as 5.019. [10 Marks]
5. (a) X Ltd. is considering two mutually exclusive projects A and B.
Net Cash flow probability distribution of each project has been given below:
Project-A Project-B
Net Cash Flow (`) Probability Net Cash Flow (`) Probability
1,72,000 0.30 3,38,000 0.20
1,82,000 0.30 3,18,000 0.30
1,92,000 0.40 2,98,000 0.50

(i) COMPUTE the following:

(I) Expected Net Cash Flow of each project.
(II) Variance of each project.
(III) Standard Deviation of each project.
(IV) Coefficient of Variation of each project.
(ii) IDENTIFY which project do you recommend? Give reason. [8 Marks]
(b) DISTINGUISH between Sensitivity Analysis & Scenario Analysis. [2 Marks]

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6. (a) ‘Financial distress is a position where Cash inflows of a firm are inadequate to meet all its current
obligations.’
Based on above mentioned context, EXPLAIN Financial Distress along with Insolvency. [4 Marks]
(b) EXPLAIN any four types of Packing Credit. [4 Marks]
(c) EXPLAIN in brief Callable bonds and Puttable bonds.
Or
STATE in brief four features of Samurai Bond. [2 Marks]

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 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
QUESTIONS
1. (a) How does national income can be explained as a flow concept? (2 Marks)
(b) How GDP and GNP differ in their treatment of international transaction? (3 Marks)
(c) What role tariff plays as response to trade distortions? (2 Marks)
(d) Calculate Gross National Product at Market Price Using Value added Method: (3 Marks)
` in Crores
Value of output in Primary Sector 700
Value of output in Secondary Sector 900
Value of output in tertiary Sector 1000
Intermediate Consumption in Primary Sector 350
Intermediate Consumption in Secondary Sector 250
Intermediate Consumption in Tertiary Sector 100
Net Factor from Abroad 40

2. (a) Explain Investment multiplier and its relevance in two sector model? (2 Marks)
(b) According to Keynesian theory of income and employment how aggregate effective demand
helps in determining national income? (3 Marks)
(c) Calculate Equilibrium level of national income from the following data: (3 Marks)
C = 20+0.60 Yd
I = 80
G = 30
T = 30
(d) Calculate the Velocity of Money: (2 Marks)
Money Supply = 2000
Price = 100
Value of Transaction: 60
3. (a) Explain how the role of State is Pivotal in Public Finance? (3 Marks)
(b) What are the conflict in designing budgetary Policy? (2 Marks)
(c) What are the rationale for the government Stabilization Function? (2 Marks)
(d) Explain the Characteristic of Private Good. (3 Marks)
4. (a) What are the distinction between pure and impure public good? (3 Marks)
(b) Elucidate the limitation of Fiscal Policy? (2 Marks)
(c) What is Balanced budget multiplier? (2 Marks)
5

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 (d) How does the Situation of Liquidity Trap happen? (3 Marks)
5. (a) Explain the reason for empirical analysis of money supply? (3 Marks)
(b) What are the indirect instrument of implementing monetary policy? (2 Marks)
(c) Explain the importance of market stabilization Scheme? (3 Marks)
(d) Do International Trade beneficial for all nations? (2 Marks)
OR
What role tariff plays as response to trade distortions?

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 Test Series: March, 2022
MOCK TEST PAPER –1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints
The solutions contained herein may be based on certain assumptions. Therefore, Question may be solved based on any
other logical alternative assumption/ approach/ presentation.

1. (a)

Particulars (`’ in lakhs)

Net Profit 75
Less: Preference dividend 30
Earnings for equity shareholders 45
Earnings per share 45/3 = ` 15

Let, the dividend per share be D to get share price of ` 105

r
D+ (E-D)
Ke
P =
Ke
0.20
D+ (15-D)
0.16
105 =
0.16
0.16D + 3 - 0.20D
16.8 =
0.16
0.04D = 3 – 2.688
D = 7.80
DPS 7.80
D/P ratio = ×100 = ×100 = 52%
EPS 15

So, the required dividend pay-out ratio will be = 52%

(b) Balance Sheet

Liabilities (`) Assets (`)

Current debt 1,44,000 Cash (balancing figure) 3,60,000
Long term debt 2,16,000 Inventory 2,40,000
Total Debt 3,60,000 Total Current Assets 6,00,000
Owner's Equity 6,00,000 Fixed Assets 3,60,000
Total liabilities 9,60,000 Total Assets 9,60,000

Working Notes:
1. Total debt = 0.60 x Owner's Equity = 0.60 x ` 6,00,000 = ` 3,60,000

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 Further, Current debt to Total debt = 0.40.
So, Current debt = 0.40 × ` 3,60,000 = ` 1,44,000
Long term debt = ` 3,60,000 - ` 1,44,000 = ` 2,16,000
2. Fixed assets = 0.60 × Owner's Equity = 0.60 × ` 6,00,000 = ` 3,60,000
3. Total Assets = Total Liabilities = ` 9,60,000
Total assets to turnover = 2 Times; Inventory turnover = 8 Times
Hence, Inventory /Total assets = 2/8=1/4,
Therefore, Inventory = ` 9,60,000/4 = ` 2,40,000
(c) Income Statement with required calculations
Particulars Previous Year Current Year
Sales (in units) 18,00,000 15,00,000
No. of shares 15,00,000 15,00,000
(`’ 000) (`’ 000)
Sales Value 2,16,000 1,80,000
Variable Cost (1,44,000) (1,20,000)
Contribution 72,000 60,000
Fixed expenses (30,000) (30,000)
EBIT 42,000 30,000
Debenture Interest (15,000) (15,000)
EBT 27,000 15,000
Tax @ 30% (8,100) (4,500)
Profit after tax (PAT) 18,900 10,500
(i) Financial Leverage ` 42,000 ` 30,000
= =
EBIT ` 27,000 ` 15,000
= EBT
= 1.56 =2
(ii) Operating leverage ` 72,000 ` 60,000
= =
Contribution ` 42,000 ` 30,000
= = 1.71 =2
EBIT
(iii) Earnings per share (EPS) ` 18,900 ` 10,500
= ` 1,500 =
PAT ` 1,500
= = ` 12.6
No. of shares =`7
Decrease in EPS = ` 12.6 – ` 7 = ` 5.6
5.6
% decrease in EPS = 12.6  100
= 44.44%

(d) (i) Cost of Equity Capital (Ke):

Expected dividend per share (D1)
Ke = + Growth rate(g)
Market price per share (P0)
` 10 × 1.06
= + 0.06 = 0.1448 or 14.48%
` 125

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 (ii) Cost of Debenture (K d):
Using Present Value method (YTM)
Identification of relevant cash flows

Year Cash flows

0 Current market price (P 0) = ` 98
1 to 12 Interest net of tax [I(1-t)] = 10% of ` 100 (1 – 0.5) = ` 5
12 Redemption value (RV) = ` 100 (1.10) = ` 110

Calculation of Net Present Values (NPV) at two discount rates

Year Cash Discount factor Present Discount factor Present
flows (`) @ 5% (L) Value (`) @ 10% (H) Value (`)
0 (98) 1.000 (98.00) 1.000 (98.00)
1 to 12 5 8.863 44.32 6.814 34.07
12 110 0.557 61.27 0.319 35.09
NPV +7.59 -28.84

Calculation of IRR
NPVL
IRR = L+ NPVL - NPVH (H-L)
7.59
= 5%+ 7.59-(-28.84) (10%-5%)= 6.04%

Therefore, K d = 6.04%
NOI ` 9,00,000
2. Value of PRI Ltd. = = = ` 50,00,000
Ko 18%

(a) (i) Return on Shares of Mr. Rhi on PRI Ltd.

Particulars Amount (`)
Value of the company 50,00,000
Market value of debt (60% x ` 50,00,000) 30,00,000
Market value of shares (40% x ` 50,00,000) 20,00,000
Particulars Amount (`)
Net operating income 9,00,000
Interest on debt (8% × ` 30,00,000) 2,40,000
Earnings available to shareholders 6,60,000
Return on 6% shares (6% × ` 6,60,000) 39,600
` 6,60,000
(ii) Implied required rate of return on equity of PRI Ltd. = = 33%
` 20,00,000
(b) (i) Calculation of Implied rate of return of SHA Ltd.
Particulars Amount (`)
Total value of company 50,00,000

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 Market value of debt (20% × ` 50,00,000) 10,00,000
Market value of equity (80% × ` 50,00,000) 40,00,000
Particulars Amount (`)
Net operating income 9,00,000
Interest on debt (8% × ` 10,00,000) 80,000
Earnings available to shareholders 8,20,000
` 8,20,000
Implied required rate of return on equity = = 20.5%
` 40,00,000
(ii) Implied required rate of return on equity of SHA Ltd. is lower than that of PRI Ltd. because
SHA Ltd. uses less debt in its capital structure. As the equity capitalisation is a linear function
of the debt-to-equity ratio when we use the net operating income approach, the decline in
required equity return offsets exactly the disadvantage of not employing so much in the way
of “cheaper” debt funds.
3. Working Notes:
1. Raw Material Storage Period (R)
Average Stock of Raw Material
= × 365
Annual Consumption of Raw Material
` 585 + ` 845
2
= × 365 = 53 days
` 4,940

Annual Consumption of Raw Material = Opening Stock + Purchases - Closing Stock

= ` 585 + ` 5,200 – ` 845 = ` 4,940 lakh
2. Work – in - Progress (WIP) Conversion Period (W)
Average Stock of WIP
= ×365
Annual Cost of Production
` 455 + ` 663
2
= × 365 = 35 days
` 5,850

3. Finished Stock Storage Period (F)

Average Stock of Finished Goods
= ×365
Cost of Goods Sold
` 780 + ` 910
2
= × 365 = 45 days.
` 6,825

4. Receivables (Debtors) Collection Period (D)

Average Receivables
= ×365
Annual Credit Sales
` 1,456 + ` 1,755
2
= × 365 = 77 days
` 7,605

5. Payables (Creditors) Payment Period (C)

Average Payables for materials
= ×365
Annual Credit purchases
4

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 ` 884 + ` 923
2
= × 365 = 64 days
` 5,200

(i) Net Operating Cycle Period

=R+W+F+D-C
= 53 + 35 + 45 + 77 – 64 = 146 days
(ii) Number of Operating Cycles in the Year
365 365
= = = 2.5 times
Operating Cycle Period 146
(iii) Amount of Working Capital Required
Annual Operating Cost ` 4,225
= = = ` 1,690 lakh
Number of Operating Cycles 2.5

Note: Number of days may vary due to fraction.

4. Evaluation of Alternatives:
Savings in disposing off the waste

Particulars (`)
Outflow (2,00,000 × ` 0.50) 1,00,000
Less: tax savings @ 50% 50,000
Net Outflow per year 50,000
Calculation of Annual Cash inflows in Processing of waste Material

Particulars Amount (`) Amount (`)

Sale value of waste (` 5 × 2,00,000 kilograms) 10,00,000
Less: Variable processing cost (` 2.50 × 2,00,000 kilograms) 5,00,000
Less: Fixed processing cost 60,000
Less: Advertisement cost 40,000
Less: Depreciation 1,20,000 (7,20,000)
Earnings before tax (EBT) 2,80,000
Less: Tax @ 50% (1,40,000)
Earnings after tax (EAT) 1,40,000
Add: Depreciation 1,20,000
Annual Cash inflows 2,60,000

Total Annual Benefits = Annual Cash inflows + Net savings (adjusting tax) in
disposal cost
= ` 2,60,000 + ` 50,000 = ` 3,10,000
Calculation of Net Present Value

Year Particulars Amount (`)

0 Investment in new equipment (12,00,000)
5

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 1 to 10 Total Annual benefits × PVAF (10 years, 15%)
` 3,10,000 × 5.019 15,55,890
Net Present Value 3,55,890
Recommendation: Processing of waste is a better option as it gives a positive Net Present Value.
Note- Research cost of ` 1,20,000 is not relevant for decision making as it is sunk cost.
5 (a) (i) (I) Calculation of Expected Net Cash Flow (ENCF) of Project A and Project B
Project A Project B
Net Cash Probability Expected Net Net Cash Probability Expected Net
Flow (`) Cash Flow Flow (`) Cash Flow
(`) (`)
1,72,000 0.30 51,600 3,38,000 0.20 67,600
1,82,000 0.30 54,600 3,18,000 0.30 95,400
1,92,000 0.40 76,800 2,98,000 0.50 1,49,000
ENCF 1,83,000 3,12,000
(II) Variance of Projects
Project A
Variance (σ 2) = (1,72,000 – 1,83,000)2 × (0.3) + (1,82,000 - 1,83,000)2 × (0.3) + (1,92,000
– 1,83,000)2 × (0.4)
= 3,63,00,000 + 3,00,000 + 3,24,00,000 = 6,90,00,000
Project B
Variance(σ 2) = (3,38,000 – 3,12,000) 2 × (0.2) + (3,18,000 – 3,12,000) 2 × (0.3) + (2,98,000
– 3,12,000) 2 × (0.5)
= 13,52,00,000 + 1,08,00,000 + 9,80,00,000 = 24,40,00,000
(III) Standard Deviation of Projects
Project A
Standard Deviation (σ) = √Variance(σ2 ) = √6,90,00,000 = 8,306.624
Project B
Standard Deviation (σ) = √Variance(σ2 )= √24,40,00,000 = 15,620.499
(IV) Coefficient of Variation of Projects

Projects Coefficient of variation Risk Expected Net

Standard Deviation
(Expected Net Cash Flow) Cash Flow

A 8,306.624 Less Less

= 0.045 or 4.5%
1,83,000
B 15,620.499 More More
= 0.050 or 5.0%
3,12,000

(ii) In project A risk per rupee of cash flow is 0.045 (approx.) while in project B it is 0.050 (approx.).
Therefore, Project A is better than Project B.
6

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 (b) Sensitivity Analysis Vs. Scenario Analysis: Sensitivity analysis and Scenario analysis both help
to understand the impact of the change in input variable on the outcome of the project. However,
there are certain basic differences between the two.
Sensitivity analysis calculates the impact of the change of a single input variable on the outcome
of the project viz., NPV or IRR. The sensitivity analysis thus enables to identify that single critical
variable which can impact the outcome in a huge way and the range of outcomes of the project
given the change in the input variable.
Scenario analysis, on the other hand, is based on a scenario. The scenario may be recession or
a boom wherein depending on the scenario, all input variables change. Scenario Analysis
calculates the outcome of the project considering this scenario where the variables have changed
simultaneously. Similarly, the outcome of the project would also be considered for the normal and
recessionary situation. The variability in the outcome under the three different scenarios would help
the management to assess the risk a project carries. Higher deviation in the outcome can be
assessed as higher risk and lower to medium deviation can be assessed accordingly.
Scenario analysis is far more complex than sensitivity analysis because in scenario analysis all
inputs are changed simultaneously, considering the situation in hand while in sensitivity analysis,
only one input is changed and others are kept constant.
6 (a) Financial Distress and Insolvency: There are various factors like price of the product/ service,
demand, price of inputs e.g., raw material, labour etc., which is to be managed by an organisation
on a continuous basis. Proportion of debt also need to be managed by an organisation very
delicately. Higher debt requires higher interest and if the cash inflow is not sufficient then it will put
lot of pressure to the organisation. Both short term and long-term creditors will put stress to the
firm. If all the above factors are not well managed by the firm, it can create situation known as
distress, so financial distress is a position where Cash inflows of a firm are inadequate to meet all
its current obligations.
Now if distress continues for a long period of time, firm may have to sell its ass et, even many times
at a lower price. Further when revenue is inadequate to revive the situation, firm will not be able to
meet its obligations and become insolvent. So, insolvency basically means inability of a firm to
repay various debts and is a result of continuous financial distress.
(b) Types of Packing Credit-
(i) Clean packing credit: This is an advance made available to an exporter only on production
of a firm export order or a letter of credit without exercising any charge or control over raw
material or finished goods. It is a clean type of export advance. Each proposal is weighed
according to particular requirements of the trade and credit worthiness of the exporter. A
suitable margin has to be maintained. Also, Export Credit Guarantee Corpora tion (ECGC)
cover should be obtained by the bank.
(ii) Packing credit against hypothecation of goods: Export finance is made available on
certain terms and conditions where the exporter has pledge able interest and the goods are
hypothecated to the bank as security with stipulated margin. At the time of utilising the
advance, the exporter is required to submit, along with the firm export order or letter of credit
relative stock statements and thereafter continue submitting them every fortnight and/or
whenever there is any movement in stocks.
(iii) Packing credit against pledge of goods: Export finance is made available on certain terms
and conditions where the exportable finished goods are pledged to the banks with approved

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 clearing agents who will ship the same from time to time as required by the exporter. The
possession of the goods so pledged lies with the bank and is kept under its lock and key.
(iv) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture, processing,
purchasing, or packing of goods meant for export against a firm order qualifies for the packing
credit guarantee issued by Export Credit Guarantee Corporation.
(v) Forward exchange contract: Another requirement of packing credit facility is that if the
export bill is to be drawn in a foreign currency, the exporter should enter into a forward
exchange contact with the bank, thereby avoiding risk involved in a possible change in the
rate of exchange.
(c) (i) Callable bonds: A callable bond has a call option which gives the issuer the right to redeem
the bond before maturity at a predetermined price known as the call price (Generally at a
premium).
(ii) Puttable bonds: Puttable bonds give the investor a put option (i.e. the right to sell the bond)
back to the company before maturity.
Or
Features of Samurai Bond:
• Samurai bonds are denominated in Japanese Yen JPY
• Issued in Tokyo
• Issuer Non- Japanese Company
• Regulations: Japanese
• Purpose: Access of capital available in Japanese market
• Issue proceeds can be used to fund Japanese operation
• Issue proceeds can be used to fund a company’s local opportunities.
• It can also be used to hedge foreign exchange risk

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 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
ANSWERS
1. (a) National income is a ‘flow’ measure of output per time period for example, per year and includes
only those goods and services produced in the current period i.e. produced during the time
interval under consideration. The value of market transactions such as exchange of goods which
already exist or are previously produced, do not enter into the calculation of national income.
Therefore, the value of assets such as stocks and bonds which are exchanged during the
pertinent period are not included in national income as these do not directly involve current
production of goods and services. However, the value of services that accompany the sale and
purchase e.g., fees paid to real estate agents and lawyers represent current production and,
therefore, is included in national income.
(b) The two concepts GDP and GNP differ in their treatment of international transactions. The term
‘national’ refers to normal residents of a country who may be within or outside the domestic
territory of a country and is a broader concept compared to the term ‘domestic’. For example,
GNP includes earnings of Indian corporations overseas and Indian residents working overseas;
but GDP does not include these. In other words, GDP excludes net factor income from abroad.
Conversely, GDP includes earnings from current production in India that accrue to foreign
residents or foreign-owned firms; GNP excludes those items. For instance, profits earned in India
by X Company, a foreign-owned firm, would be included in GDP but not in GNP. Similarly, profits
earned by Company Y, an Indian company in UK would be excluded from GDP but included in
GNP.
(c) Sometimes countries engage in 'unfair' foreign-trade practices which are trade distorting in nature
and adverse to the interests of the domestic firms. The affected importing countries, upon
confirmation of the distortion, respond quickly by measures in the form of tariff responses to
offset the distortion. These policies are often referred to as "trigger -price" mechanisms.
(d) GDPMP = Value of output in primary Sector – Intermediate Consumption in Primary Sector +
Value of output in Secondary Sector – Intermediate Consumption in Secondary Sector + Value of
output in Tertiary Sector – Intermediate Consumption
= (700-350) + (900 – 250) + (1,000 – 100)
= 350+650+900 = 1900
GNPMP = GDPMP + NFIA
= 1900+(-40)
= 1860
2. (a) It is a process of multiple increases in equilibrium income due to increase in investment and how
much increase occurs depends upon the marginal propensity to consume. In our two -sector
model, a change in aggregate demand may be caused by change in consump tion expenditure or
in business investment or in both. Since consumption expenditure is a stable function of income,
changes in income are primarily from changes in the autonomous components of aggregate
demand, especially from changes in the unstable investment component.
(b) According to the Keynesian theory of income and employment, national income depends upon
the aggregate effective demand. If the aggregate effective demand falls short of that output at
which all those who are both able and willing to work are employed, it will result in unemployment
in the economy. Consequently, there will be a gap between the economy's actual and optimum
potential output. On the contrary, if the aggregate effective demand exceeds the economy's full
employment output, it will result in inflation. Nominal output will increase, but it simply reflects
higher prices, rather than additional real output. It is not necessary that the equilibrium aggregate
9

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 output will also be the full employment aggregate output. It is undesir able and a cause of great
concern for the society and government if large number of people remains unemployed. In the
absence of government policies to stabilize the economy, incomes will be unstable because of
the instability of investment. Full employment could be maintained in a capitalist economy only if
governments are willing to incur countercyclical budgetary deficits to offset the inbuilt tendency
towards private over-saving. By making appropriate changes in government spending (G) and
taxes, the government can counteract the effects of shifts in investment. Appropriate changes in
fiscal policy by adjusting government expenditure and taxes could keep the autonomous
expenditure constant even in the face of undesirable changes in the investment.
(c) C = 20+0.60 Yd
I = 80
G = 30
T = 30
Y = C +I+G
= a + bYd+I + G
= 20+0.60Y– 18+80+30
Y = 112 + 0.60y
Y – 0.60 y = 112
112
Y= = 280
0.40
(d) Money Supply = 2000 bn.
Price = 100
Value of Transaction: 60
MV = PT
2000×V = 100×60
100  60
V= =3
2000
3. (a) According to Musgrave, the state is the instrument by which the needs and concerns of the
citizens are fulfilled and therefore, public finance is connected with economic mechanisms that
should ideally lead to the effective and optimal allocation of limited resources. This logic, in
effect, makes it necessary for the government to intervene in the market to bring about
improvement in social welfare. In the absence of appropriate government intervention, market
failures may occur and the resources are likely to be misallocated with too much production of
certain goods or too little production of certain other goods. The allocation responsibility of the
governments involves suitable corrective action when private markets fail to provide the right and
desirable combination of goods and services. Briefly put, market failures provide the rationale for
government’s allocative function.
(b) There is often a conflict between the different goals and functions of budgetary policy. Effective
policy design to meet the diverse goals of government is very difficult to conceive and to
implement. The challenge before any government is how to design its budgetary policy so that
the pursuit of one goal does not jeopardize the other. The distribution function aims at
redistribution of income so as to ensure equity and fairness to promote the wellbeing of all
sections of people and is achieved through taxation, public expenditure, regulation and
preferential treatment of target populations.

10

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 (c) The rationale for the stabilization function of the government is derived from the Keynesian
proposition that a market economy does not automatically generate full employment and price
stability and therefore the governments should pursue deliberate stabilization policies. The
market system has inherent tendencies to create business cycles. The market mechanism is
limited in its capacity to prevent or to resolve the disruptions caused by the fluctuations in
economic activity.
(d) The Characteristic of Private Good is as :
• Private goods refer to those goods that yield utility to people. Since they are scarce anyone
who wants to consume them must purchase them.
• Owners of private goods can exercise private property rights and can prevent others from
using the good or consuming their benefits.
• Private goods do not have the free-rider problem. This means that private goods will be
available to only those persons who are willing to pay for them.
• All private goods and services can be rejected by the consumers if their needs, preferences
or budgets change.
• Additional resource costs are involved for producing and supplying additional quantities of
private goods.
4. (a) The concept of pure public good is often criticized by many who point out that such goods are not
in fact observable in the real world. They argue that goods which perfectly satisfy nonrivalness
and non-excludability are not easy to come across. For example, if the government provides law
and order or medical care, the use of law courts or medical care by some individuals subtracts
the consumption of others if they need to wait. As another example, we may take defence. If
armies are mostly deployed in the northern borders, it may not result in the same amount of
protection to people in the south.
An example of an impure public good would-be cable television. It is non- rivalrous because the
use of cable television by other individuals will in no way reduce your enjoyment of it. The good is
excludable since the cable TV service providers can refuse connection if you do not pay for set
top box and recharge it regularly.
(b) The limitation of Fiscal Policy is as:
• One of the biggest problems with using discretionary fiscal policy to counteract fluctuations
is the different types of lags involved in fiscal-policy action.
• Fiscal policy changes may at times be badly timed due to the various lags so that it is highly
possible that an expansionary policy is initiated when the economy is already on a path of
recovery and vice versa.
• There are difficulties in instantaneously changing governments’ spending and taxation
policies.
• It is practically difficult to reduce government spending on various items such as defence
and social security as well as on huge capital projects which are already midway.
• Due to uncertainties, there are difficulties of forecasting when a period of inflation or
deflation may set in and also promptly determining the accurate policy to be undertake n.
(c) The government budget is said to be in balance when ∆G = ∆ T. The balanced budget multiplier
is always equal to 1.
The balanced budget multiplier is obtained by adding up the government spending multiplier
(fiscal multiplier) and the tax multiplier.

11

© The Institute of Chartered Accountants of India

 ΔY ΔY
Balanced Budget multiplier = +
ΔG ΔT
1 −b 1 − b
= + = =1
1− b 1− b 1− b
(d) At a very high interest rate, say r*, the opportunity cost of holding money (in terms of foregone
interest) is high and therefore, people will hold no money in speculative balances. When interest
rates fall to very low levels, the expectation is that since the interest rate is very low it cannot go
further lower and that in all possibility it will move upwards. When interest rates rise, the bond
prices will fall (interest rates and bond prices are inversely related). To hold bonds at this low
interest rate is to take the almost certain risk of a capital loss (as the interest rate rises and bond
prices fall). Therefore, the desire to hold bonds is very low and approaches zero, and the demand
to hold money in liquid form as alternative to bond holding approaches infinity. In other words,
investors would maintain cash savings rather than hold bonds. The speculative demand becomes
perfectly elastic with respect to interest rate and the speculative money demand curve becomes
parallel to the X axis. This situation is called a ‘Liquidity trap’.
5. (a) The empirical analysis of money supply is important for two reasons:
1. It facilitates analysis of monetary developments in order to provide a deeper understanding
of the causes of money growth.
2. It is essential from a monetary policy perspective as it provides a framework to evaluate
whether the stock of money in the economy is consistent with the standards for price
stability and to understand the nature of deviations from this standard. The central banks all
over the world adopt monetary policy to stabilize price level and GDP growth by directly
controlling the supply of money. This is achieved mainly by managing the q uantity of
monetary base. The success of monetary policy depends to a large extent on the
controllability of the monetary base and the money supply.
(b) For implementing monetary policy, a central bank can act directly, using its regulatory powers, or
indirectly, using its influence on money market conditions as the issuer of reserve money.
The indirect instruments mainly consist of:
(a) Repos
(b) Open market operations
(c) Standing facilities, and
(d) Market-based discount window.
(c) This instrument for monetary management was introduced in 2004 following a MoU between the
Reserve Bank of India and the Government of India with the primary aim of aiding the sterilization
operations of the RBI. Sterilization is the process by which the monetary authorit y sterilizes the
effects of significant foreign capital inflows on domestic liquidity by off -loading parts of the stock
of government securities held by it. Surplus liquidity of a more enduring nature arising from large
capital inflows is absorbed through sale of short-dated government securities and treasury bills.
Under this scheme, the Government of India borrows from the RBI (such borrowing being
additional to its normal borrowing requirements) and issues treasury-bills/dated securities for
absorbing excess liquidity from the market arising from large capital inflows.
(d) International trade is often not equally beneficial to all nations. Potential unequal market access
and disregard for the principles of fair-trading system may even amplify the differences between
trading countries, especially if they differ in their wealth. Economic exploitation is a likely outcome
when underprivileged countries become vulnerable to the growing political power of corporations
operating globally.

12

© The Institute of Chartered Accountants of India

 OR
Sometimes countries engage in 'unfair' foreign-trade practices which are trade distorting in nature
and adverse to the interests of the domestic firms. The affected importing countries, upon
confirmation of the distortion, respond quickly by measures in the form of tariff responses to
offset the distortion. These policies are often referred to as "trigger -price" mechanisms.

13

© The Institute of Chartered Accountants of India

 Test Series: April, 2022
MOCK TEST PAPER – II
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANCIAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) Following data is available in respect of two companies having same business risk:
Capital employed = ` 4,00,000, EBIT = ` 60,000 and Ke = 12.5%
Sources Levered Company (`) Unlevered Company (`)
Debt (@10%) 2,00,000 Nil
Equity 2,00,000 4,00,000
An investor is holding 15% shares in levered company. CALCULATE the increase in annual earnings
of investor if he switches his holding from Levered to Unlevered company.
(b) From the given details, PREPARE Income Statement for Alpha Ltd. and Beta Ltd.
Particulars Alpha Ltd. Beta Ltd.
Operating Leverage 1.875 1.800
Financial Leverage 1.600 1.250
PV Ratio 60% 50%
Profit after tax ` 3,00,000 ` 2,40,000
Tax rate 40% 40%

(c) An enterprise is investing ` 100 lakhs in a project. The risk-free rate of return is 7%. Risk premium
expected by the Management is 7%. The life of the project is 5 years. Following are the cash flows
that are estimated over the life of the project.
Year Cash flows (` in lakhs)
1 25
2 60
3 75
4 80
5 65
1

© The Institute of Chartered Accountants of India

 CALCULATE Net Present Value of the project based on Risk free rate and also on the basis of
Risks adjusted discount rate.
(d) From the following information, you are required to PREPARE a summarised Balance Sheet for
Rudra Ltd. for the year ended 31st March, 2022
Debt Equity Ratio 1:1
Current Ratio 3:1
Acid Test Ratio 8:3
Fixed Asset Turnover (on the basis of sales) 4
Stock Turnover (on the basis of sales) 6
Cash in hand 5,00,000
Stock to Debtor 1:1
Sales to Net Worth 4
Capital to Reserve 1:2
Gross Profit 20% of Cost
COGS to Creditor 10:1
Interest for entire year is yet to be paid on Long Term loan @ 10%. (4 × 5 = 20 Marks)
2. (a) The Modern Chemicals Ltd. requires ` 25,00,000 for a new plant. This plant is expected to yield
earnings before interest and taxes of ` 5,00,000. While deciding about the financial plan, the
company considers the objective of maximising earnings per share. It has three alternatives to
finance the project- by raising debt of ` 2,50,000 or ` 10,00,000 or ` 15,00,000 and the balance,
in each case, by issuing equity shares. The company’s share is currently selling at ` 150, but is
expected to decline to ` 125 in case the funds are borrowed in excess of ` 10,00,000. The funds
can be borrowed at the rate of 10% upto ` 2,50,000, at 15% over ` 2,50,000 and upto ` 10,00,000
and at 20% over ` 10,00,000. The tax rate applicable to the company is 50%. ANALYSE, which
form of financing should the company choose? (7 Marks)
(b) “Operating risk is associated with cost structure, whereas financial risk is associated with capital
structure of a business concern.” Critically EXAMINE this statement. (3 Marks)
3. The following annual figures relate to manufacturing entity:
A. Sales at one month credit 84,00,000
B. Material consumption 60% of sales value
C. Wages (paid in a lag of 15 days) 12,00,000
D. Cash Manufacturing Expenses 3,00,000
E. Administrative Expenses 2,40,000
F. Creditors extend 3 months credit for payment.
G. Cash manufacturing and administrative expenses are paid 1 months in arrear.

© The Institute of Chartered Accountants of India

 The company maintains stock of raw material equal to economic order quantity. The company incurs
` 100 as per ordering cost per order and opportunity cost of capital is 15% p.a. The optimum cash
balance is determined using Baumol’s model. The bank charges ` 10 for each cash withdrawal. Finished
goods are held in stock for 1 month. The company maintains a bank balance of `12,00,000 on an
average. Creditors are paid through net banking and all other expenses are incurred in cash which is
withdrawn from bank.
Assuming a 20% safety margin, you are required to ESTIMATE the amount of working capital that needs
to be invested by the Company. (10 Marks)
4. Manoranjan Ltd is a News broadcasting channel having its broadcasting Centre in Mumbai. There are
total 200 employees in the organisation including top management. As a part of employee benefit
expenses, the company serves tea or coffee to its employees, which is outsourced from a third -party.
The company offers tea or coffee three times a day to each of its employees. 120 employees prefer tea
all three times, 40 employees prefer coffee all three times and remaining prefer tea only once in a day.
The third-party charges ` 10 for each cup of tea and ` 15 for each cup of coffee. The company works
for 200 days in a year.
Looking at the substantial amount of expenditure on tea and coffee, the finance department has
proposed to the management an installation of a master tea and coffee vending machine which will cost
` 10,00,000 with a useful life of five years. Upon purchasing the machine, the company will have to
enter into an annual maintenance contract with the vendor, which will require a payment of ` 75,000
every year. The machine would require electricity consumption of 500 units p.m. and current incremental
cost of electricity for the company is ` 12 per unit. Apart from these running costs, the company will
have to incur the following consumables expenditure also:
(1) Packets of Coffee beans at a cost of ` 90 per packet.
(2) Packet of tea powder at a cost of ` 70 per packet.
(3) Sugar at a cost of ` 50 per Kg.
(4) Milk at a cost of ` 50 per litre.
(5) Paper cup at a cost of 20 paise per cup.
Each packet of coffee beans would produce 200 cups of coffee and same goes for tea powder packet.
Each cup of tea or coffee would consist of 10g of sugar on an average and 100 ml of milk.
The company anticipate that due to ready availability of tea and coffee through vending machines its
employees would end up consuming more tea and coffee. It estimates that the consumption will increase
by on an average 20% for all class of employees. Also, the paper cups consumption will be 10% more
than the actual cups served due to leakages in them.
The company is in the 25% tax bracket and has a current cost of capital at 12% per annum. Straight line
method of depreciation is allowed for the purpose of taxation. You as a financial consultant is required
to ADVISE on the feasibility of acquiring the vending machine.
PV factors @ 12%:
Year 1 2 3 4 5
PVF 0.8929 0.7972 0.7118 0.6355 0.5674
(10 Marks)
3

© The Institute of Chartered Accountants of India

5. The capital structure of RV Limited as on 31 st March, 2022 as per its Balance Sheet is as follows:
Particulars `
Equity shares of ` 10 each 25,00,000
10% Preference shares of ` 100 each 5,00,000
Retained earnings 5,00,000
13% debentures of ` 100 each 20,00,000

The market price of equity shares is ` 50 per share. Expected dividend on equity shares is ` 3 per
share. The dividend per share is expected to grow at the rate of 8%.
Preference shares are redeemable after eight years and the current market price is ` 80 per share.
Debentures are redeemable after five years and are currently selling at ` 90 per debenture.
The tax rate applicable to the company is 35%.
CALCULATE weighted average cost of capital using:
(i) Book value proportions
(ii) Market value proportions (10 Marks)
6. (a) DISCUSS in briefly any two long term sources of finance for a partnership firm.
(b) DISCUSS the limitations of financial ratios
(c) EXPLAIN the term ‘Payback reciprocal’. (4 + 4 + 2 =10 Marks)

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
QUESTIONS
1. (a) Describe the system of regional accounts in India? (3 Marks)
(b) What is the distinction between Production taxes and Product taxes? (2 Marks)
(c) In an economy suppose (5 Marks)
` Income
Consumption Function 100+ 0.60 Yd
Government Spending 150
Investment spending 125
Tax @ Tx 30+0.05Y
Transfer Payments Tr = 50
Exports X = 40
Import M = 25+0.1Y
Yd = Disposable Income
Y = National Income
Calculate
1. The equilibrium level of national Income
2. Consumption
3. Net Export
2. (a) What will be the outcome when aggregate expenditure is more than the output ? (3 Marks)
(b) Why is multiplier important in Keynesian theory of determination of National Income? (2 Marks)
(c) Calculate National Income with the help of Income and Expenditure Method. (5 Marks)
` in Crore
Compensation of employee 1000
Net Factor Income from Abroad 50
Indirect Tax 100
Subsidy 20
Private Final consumption expenditure 800
Government final Consumption Expenditure 900
Net Domestic Capital Formation 700
Consumption of fixed Capital 120
Operating Surplus 1400
Mixed Income 600
Employer’s contribution to social feeling scheme 300
Net Export 20

© The Institute of Chartered Accountants of India

3. (a) In the times of recession What should be the Public Revenue and Expenditure Policy? (3 Marks)
(b) Why should government perform the allocation function in an economy? (2 Marks)
(c) Elaborate on the redistribution effect of a tax and Transfer Policy? (2 Marks)
(d) Comment on the role of bank rate as the instrument of monetary policy. (3 Marks)
4. (a) In the Context of International Trade, What do you understand by Factor Equalization Theorem?
(2 Marks)
(b) How is Anti-Dumping Duties constitute a threat to International Trade? (3 Marks)
(c) What are different technical barrier to trade and their effect on trade? (3 Marks)
(d) What is Free Trade area and how it is different from Trading Block? (2 Marks)
5. (a) What are the salient Feature of Modern theory of Trade? (3 Marks)
(b) What are the major reasons for market failure? (3 Marks)
(c) What are the important function of Money? (2 Marks)
(d) What are the theories in respect of determination of money supply? (2 Marks)
Or
What are the direct forms of Foreign direct Investment?

© The Institute of Chartered Accountants of India

 Test Series: April 2022
MOCK TEST PAPER – II
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANCIAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Valuation of firms
Particulars Levered Firm Unlevered Firm
(`) (`)
EBIT 60,000 60,000
Less: Interest on debt (10% × ` 2,00,000) 20,000 Nil
Earnings available to Equity shareholders 40,000 60,000
Ke 12.5% 12.5%
Value of Equity (S) 3,20,000 4,80,000
(Earnings available to Equity shareholders/K e)
Debt (D) 2,00,000 Nil
Value of Firm (V) = S + D 5,20,000 4,80,000
Value of Levered company is more than that of unlevered company. Therefore, investor will
sell his shares in levered company and buy shares in unlevered company. To maintain the
level of risk he will borrow proportionate amount and invest that amount also in shares of
unlevered company.
Investment & Borrowings (`)
Sell shares in Levered company (` 3,20,000 x 15%) 48,000
Borrow money (` 2,00,000 x 15%) 30,000
Buy shares in Unlevered company 78,000
Change in Return (`)
Income from shares in Unlevered company
(` 78,000 x 12.5%) 9,750
Less: Interest on loan (` 30,000 x 10%) 3,000
Net Income from unlevered firm 6,750
Less: Income from Levered firm (` 48,000 x 12.5%) 6,000
Incremental Income due to arbitrage 750
(b)
Particulars Alpha Ltd. (`) Beta Ltd. (`)
Sales 25,00,000 18,00,000
Less: Variable Cost 10,00,000 9,00,000 (Bal. fig.)
Contribution 15,00,000 9,00,000

© The Institute of Chartered Accountants of India

 Less: Fixed Cost 7,00,000 4,00,000 (Bal. fig.)
EBIT 8,00,000 5,00,000
Less: Interest 3,00,000 1,00,000 (Bal. fig.)
PBT 5,00,000 4,00,000
Less: Tax (40%) 2,00,000 1,60,000
PAT 3,00,000 2,40,000
Working Note:
Particulars Alpha Ltd. Beta Ltd.
PAT ` 3,00,000 ` 2,40,000
Tax Rate (t) 40% 40%
 PBT = PAT/(I-t) 3,00,000 2,40,000
= 5,00,000 = 4,00,000
1-0.4 1-0.4
Finance Leverage 1.60 1.25
 EBIT = PBT × FL 5,00,000 × 1.6 4,00,000 × 1.25
= 8,00,000 = 5,00,000
Operating Leverage 1.875 1.800
Contribution = EBIT × OL 8,00,000 × 1.875 5,00,000 × 1.8
= 15,00,000 = 9,00,000
PV ratio 60% 50%
Contribution 15,00,000 9,00,000
 Sales = = 25,00,000 = 18,00,000
PV ratio .60 .50
(c) The Present Value of the Cash Flows for all the years by discounting the cash flow at 7% is
calculated as below:
Year Cash flows Discounting Factor Present value of Cash
(` in lakhs) @7% Flows (` in Lakhs)
1 25 0.935 23.38
2 60 0.873 52.38
3 75 0.816 61.20
4 80 0.763 61.04
5 65 0.713 46.35
Total of present value of Cash flow 244.34
Less: Initial investment 100
Net Present Value (NPV) 144.34
Now, when the risk-free rate is 7 % and the risk premium expected by the Management is 7
%. So, the risk adjusted discount rate is 7 % + 7 % =14%.
Discounting the above cash flows using the Risk Adjusted Discount Rate would be as below:

Year Cash flows Discounting Factor Present Value of Cash Flows

(` in Lakhs) @14% (` in lakhs)
1 25 0.877 21.93
2 60 0.769 46.14
2

© The Institute of Chartered Accountants of India

 3 75 0.675 50.63
4 80 0.592 47.36
5 65 0.519 33.74
Total of present value of Cash flow 199.80
Initial investment 100
Net present value (NPV) 99.80

(d) Balance Sheet of Rudra Ltd.

Liabilities Amount (`) Assets Amount (`)

Capital 10,00,000 Fixed Assets 30,00,000
Reserves 20,00,000 Current Assets:
Long Term Loan @ 10% 30,00,000 Stock in Trade 20,00,000
Current Liabilities: Debtors 20,00,000
Creditors 10,00,000 Cash 5,00,000
Other Short-term Current 2,00,000
Liability (Other STCL)
Outstanding Interest 3,00,000
75,00,000 75,00,000
Working Notes:
Let sales be ` x
Balance Sheet of Rudra Ltd.

Liabilities Amount (`) Assets Amount (`)

Capital Fixed Assets x/4
Reserves Current Assets:
Net Worth x/4 Stock in Trade x/6
Long Term Loan @ 10% x/4 Debtors x/6
Cash 5,00,000
Current liabilities:
Creditors x/12
Other Short-term Current Liability
Outstanding Interest
Total Current Liabilities x/9+5,00,000/3
Total Total
x
1. Fixed Asset Turnover = 4 =
Fixed Assets
x
Fixed Assets =
4
3

© The Institute of Chartered Accountants of India

 x
2. Stock Turnover = 6 =
stock
x
Stock =
6
x
3. Sales to net worth = 4 = net worth
x
Net worth = 4
4. Debt: Equity =1:1
Long Term Loan 1
Net worth = 1
x
Long term loan = Net worth = 4
5. Gross Profit to Cost = 20%
GP
= 20%
Sales − G P
GP
= 20%
x −G P
GP = 0.2 x – 0.2 GP
1.2 GP = 0.2 x
0.2x
GP =
1.2
GP = x/6
Cost of Goods Sold = x – x/6 = 5/6 x
6. COGS to creditors = 10:1
COGS 10
=
Creditors 1
5
x
6 10
=
creditors 1
5x x
Creditors = =
60 12
Stock
7. =1
Debtor
x
Debtor = Stock =
6

© The Institute of Chartered Accountants of India

 8. Current Ratio =3:1
Stock+Debtors+Cash 3
=
Current Liabilities 1
x x
+ + 5,00,000
6 6
=3
Current Liabilities
x
+ 5,00,000
3
= CL
3
x 5,00,000
CL = +
9 3
9. CA = 3CL
 x 5,00,000 
= 3 + 
9 3 
x
CA = + 5,00,000
3
10. Net worth + Long Term Loan + Current Liability = Fixed Asset + Current Assets
x x x 5,00,000 x x
+ + + = + + 5,00,000
4 4 9 3 4 3
x x x 5,00,000
+ - = 5,00,000 −
4 9 3 3
9x + 4x − 12x 15,00,000 − 5,00,000
=
36 3
x 10,00,000
=
36 3
x = 1,20,00,000
11. Now, from above calculations, we get,
x 1,20,00,000
-> Fixed Asset = = = 30,00,000
4 4
x 1,20,00,000
-> Stock = = = 20,00,000
6 6
x 1,20,00,000
-> Debtor = = = 20,00,000
6 6
-> Net Worth =x/4 = 30,00,000
Now, Capital to Reserve is 1 : 2
Capital = ` 10,00,000
and, Reserve = ` 20,00,000

© The Institute of Chartered Accountants of India

 x
-> Long Term Loan = = 30,00,000
4
-> Outstanding Interest = 30,00,000×10% = 3,00,000
x 1,20,00,000
-> Creditors = = = 10,00,000
12 12
-> Current Liabilities = Creditors + Other STCL + Outstanding
Interest
x 5,00,000
+ = 10,00,000+ Other STCL + 3,00,000
9 3
1,20,00,000 5,00,000
+ = 13,00,000+ Other STCL
9 3
15,00,000 = Other STCL + 13,00,000
Other STCL = 2,00,000
2. (a) Calculation of Earnings per share for three alternatives to finance the project
Alternatives
Particulars I II III
To raise debt To raise debt of To raise debt of
of `2,50,000 ` 10,00,000 and ` 15,00,000 and
and equity of equity of equity of
` 22,50,000 ` 15,00,000 ` 10,00,000
(`) (`) (`)
Earnings before interest and 5,00,000 5,00,000 5,00,000
tax
Less: Interest on debt at the 25,000 1,37,500 2,37,500
rate of (10% on (10% on (10% on
` 2,50,000) ` 2,50,000) ` 2,50,000)
(15% on (15% on
` 7,50,000) ` 7,50,000)
(20% on
` 5,00,000)
Earnings before tax 4,75,000 3,62,500 2,62,500
Less: Tax (@ 50%) 2,37,500 1,81,250 1,31,250
Earnings after tax: (A) 2,37,500 1,81,250 1,31,250
Number of shares :(B) 15,000 10,000 8,000
(Refer to working note)
Earnings per share: (A)/(B) 15.833 18.125 16.406
So, the earning per share (EPS) is higher in alternative II i.e. if the company finance the project
by raising debt of ` 10,00,000 and issue equity shares of ` 15,00,000. Therefore, the company
should choose this alternative to finance the project.

© The Institute of Chartered Accountants of India

 Working Note:

Alternatives
I II III
Equity financing : (A) ` 22,50,000 ` 15,00,000 ` 10,00,000
Market price per share : (B) ` 150 ` 150 ` 125
Number of equity share: (A)/(B) 15,000 10,000 8,000

(b) “Operating risk is associated with cost structure whereas financial risk is associated with
capital structure of a business concern”.
Operating risk refers to the risk associated with the firm’s operations. It is represented by the
variability of earnings before interest and tax (EBIT). The variability in turn is influenced by
revenues and expenses, which are affected by demand of firm’s products, variations in prices
and proportion of fixed cost in total cost. If there is no fixed cost, there would be no operating
risk. Whereas financial risk refers to the additional risk placed on firm’s shareholders as a
result of debt and preference shares used in the capital structure of the concern. Companies
that issue more debt instruments would have higher financial risk than companies financed
mostly by equity.
3. Statement of working capital Requirement
Particular (`) (`)
A. Current Assets
Stock of Raw Material (W.N. 2) 81,975
 1 5,45,000
Stock of finished Goods  65,40,000  
 12 
 1 5,65,000
Average Receivables (at Cost)  67,80,000  
 12 
Bank Balance 12,00,000
Cash Balance (W.N. 3) 15,232
Gross Working Capital 24,07,207
B. Current Liabilities
 3 12,60,000
Average Creditor for materials  50,40,000  
 12 
 0.5  50,000
Outstanding Wages  12,00,000  
 12 
 1 25,000
Outstanding Cash Manufacturing Expenses  3,00,000  
 12 
 1 20,000
Outstanding administrative Expenses  2,40,000  
 12 
13,55,000
Net Working Capital (A-B) 10,52,207

© The Institute of Chartered Accountants of India

 Add: Safety Margin @ 20% 2,10,441
Total Working Capital Requirement 12,62,648

Working Notes:
1. Computation of annual cash Cost of Production & Sales

Material Consumed (84,00,000 × 60%) 50,40,000

Wages 12,00,000
Manufacturing expenses 3,00,000
Cash Cost of production 65,40,000
(+) Administrative Expenses 2,40,000
Cash Cost of Sales 67,80,000

2. Computation of stock of Raw Material

A = 50,40,000
B = 100
C = 0.15
2AB 2  50,40,000 100
 EOQ = = = ` 81,975
C 0.15
3. Calculation of Cash Balance
A = 12,00,000+3,00,000+2,40,000
A = 17,40,000
B = 10
C = 0.15
2AB 2 17,40,000 10
Optimal Cash Balance = = = ` 15,232
C 0.15
4. A. Computation of CFAT (Year 1 to 5)
Particulars Amount (`)
(a) Savings in existing (120 × 10 ×3) + (40 ×15 × 3) + (40 ×10 × 1) 11,60,000
Tea & Coffee charges x 200 days
(b) AMC of machine (75,000)
(c) Electricity charges 500 ×12 ×12 (72,000)
(d) Coffee Beans (W.N.) 144 × 90 (12,960)
(e) Tea Powder (W.N.) 480 × 70 (33,600)
(f) Sugar (W.N.) 1248 × 50 (62,400)
(g) Milk (W.N.) 12480 × 50 (6,24,000)
(h) Paper Cup (W.N.) 1,37,280 × 0.2 (27,456)
(i) Depreciation 10,00,000/5 (2,00,000)
Profit before Tax 52,584
8

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 (-) Tax @ 25% (13,146)
Profit after Tax 39,438
Depreciation 2,00,000
CFAT 2,39,438
B. Computation of NPV
Year Particulars CF PVF @ 12% PV
0 Cost of machine (10,00,00) 1 (10,00,000)
1-5 CFAT 2,39,438 3.6048 8,63,126
Net Present Value (1,36,874)

Since NPV of the machine is negative, it should not be purchased.

Working Note:
Computation of Qty of consumable
No. of Tea Cups = [(120 × 3 × 200 days) + (40 × 1 × 200 days) × 1.2 = 96,000
No. of Coffee cups = 40 × 3 × 200 days × 1.2 = 28,800
28,800
No. of coffee beans packet = 200 = 144
96,000
No. of Tea Powder Packets = 200 = 480
(96,000 + 28,800) × 10 g
Qty of Sugar = 1,000 g
= 1248 kgs

(96,000 + 28,800) × 100 ml

Qty of Milk = 1,000 ml
= 12,480 litres

No. of paper cups = (96,000 + 28,800) × 1.1 = 1,37,280

5. Working Notes:
(i) Cost of Equity (K e)
D1 Rs. 3
+g = + 0.08 = 0.14 i.e. 14%
P Rs. 50
(ii) Cost of preference shares (K p)
RV − NP
10 +
(100 − 80 )
D+ 12.5
n = 8 = = 0.1389 = 13.89%
RV + NP 100 + 80 90
2 2
(iii) Cost of debenture (K d)
RV − NP (100 − 90 )
I (1 − t ) + 13(1 − 0.35) +
8.45 + 2
n = 5 = = 0.11 i.e. 11%
RV + NP 100 + 90 95
2 2

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 Or,

 RV − NP   (100 − 90 ) 
I + n   13 +
5

 RV + NP  (1 – t) =   (1 – 0.35) = 0.1026 i.e. 10.26%
   100 + 90 
 2   2 

Weighted Average cost of capital (Book Value)

Amount (`) Weight (W) Cost (K) WxK

Equity shares 25,00,000 0.4546 0.14 0.0636
Preference shares 5,00,000 0.0909 0.1389 0.0126
Retained Earnings 5,00,000 0.0909 0.14 0.0127
Debentures 20,00,000 0.3636 0.1026 0.0373
55,00,000 0.1262
Or (if Kd is 11%) the WACC = 0.1289
Thus, WACC (Book value based) = 12.62% or 12.89%
Weighted Average cost of capital (Market Value)

Amount (`) Weight (W) Cost (K) WxK

Equity shares 1,25,00,000 0.85 0.14 0.119
Preference shares 4,00,000 0.028 0.1389 0.0039
Debentures 18,00,000 0.122 0.1026 0.0125
1,47,00,000 0.1354

Or (if Kd is 11%) the WACC = 0.1363

Thus, WACC (Market value based) = 13.54% or 13.63%
6. (a) The two sources of long-term finance for a partnership firm are as follows:
Loans from Commercial Banks: Commercial banks provide long term loans for the purpose
of expansion or setting up of new units. Their repayment is usually scheduled over a long
period of time. The liquidity of such loans is said to depend on the anticipated income of the
borrowers.
As part of the long term funding for a partnership firm, the banks also fund the long term
working capital requirement (it is also called WCTL i.e. working capital term loan).
Lease financing: Leasing is a general contract between the owner and user of the asset over
a specified period of time. The asset is purchased initially by the lessor (leasing company) and
thereafter leased to the user (lessee firm) which pays a specified rent at periodical intervals.
Thus, leasing is an alternative to the purchase of an asset out of own or borrowed funds.
Moreover, lease finance can be arranged much faster as compared to term loans from financial
institutions.

10

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 (b) The limitations of financial ratios are listed below:
(i) Diversified product lines: Many businesses operate a large number of divisions in quite
different industries. In such cases ratios calculated on the basis of aggregate data cannot
be used for inter-firm comparisons.
(ii) Financial data are badly distorted by inflation: Historical cost values may be substantially
different from true values. Such distortions of financial data are also carried in the
financial ratios.
(iii) Seasonal factors may also influence financial data.
(iv) To give a good shape to the popularly used financial ratios (like current ratio, debt - equity
ratios, etc.): The business may make some year-end adjustments. Such window dressing
can change the character of financial ratios which would be different had there been no
such change.
(v) Differences in accounting policies and accounting period: It can make the accounting
data of two firms non-comparable as also the accounting ratios.
(vi) There is no standard set of ratios against which a firm’s ratios can be compared:
Sometimes a firm’s ratios are compared with the industry average. But if a firm desires
to be above the average, then industry average becomes a low standard. On the other
hand, for a below average firm, industry averages become too high a standard to achieve.
(vii) Financial ratios are inter-related, not independent: Viewed in isolation one ratio may
highlight efficiency. But when considered as a set of ratios they may speak differently.
Such interdependence among the ratios can be taken care of through multivariate
analysis.
(c) Financial ratios provide clues but not conclusions. These are tools only in the hands of experts
because there is no standard ready-made interpretation of financial ratios
As the name indicates it is the reciprocal of payback period. A major drawback of the
payback period method of capital budgeting is that it does not indicate any cut of f period for
the purpose of investment decision. It is, however, argued that the reciprocal of the payback
would be a close approximation of the Internal Rate of Return (later discussed in detail) if the
life of the project is at least twice the payback period and the project generates equal amount
of the annual cash inflows. In practice, the payback reciprocal is a helpful tool for quickly
estimating the rate of return of a project provided its life is at least twice the payback period.
The payback reciprocal can be calculated as follows:
Average annual cash in flow
Payback Reciprocal =
Initial investment

11

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 PAPER 8B: ECONOMICS FOR FINANCE
Time Allowed – 1:15 Hours Maximum Marks - 40
ANSWERS
1. (a) Regional accounts provide an integrated database on the innumerable transactions taking place
in the regional economy and help decision making at the regional level. At present, practically all
the states and union territories of India compute state income estimates and district level
estimates. State Income or Net State Domestic Product (NSDP) is a measure in monetary terms
of the volume of all goods and services produced in the state within a given period of time
(generally a year) accounted without duplication. Per Capita State Income is obtained by dividing
the NSDP (State Income) by the midyear projected population of the state.
The state level estimates are prepared by the State Income Units of the respective State
Directorates of Economics and Statistics (DESs). The Central Statistical Organization assists the
States in the preparation of these estimates by rendering advice on conceptual and
methodological problems
(b) Production taxes are paid or received in relation to production and are independen t of the volume
of actual production. Examples of production taxes are land revenues, stamps and registration
fees and tax on profession, factory license fee, taxes to be paid to the local authorities, pollution
tax etc.
Product taxes are paid or received on per unit of product. Examples of product taxes are excise
duties, sales tax, service tax and import-export duties.
(c) C = 100+0.60 Y d
Yd = Y – T + Transfer Payment
C = 100+0.60 (Y – 30 + 0.5 Y + 50)
= 100+0.60Y – 18 + 0.3Y + 30
C = 112+0.90Y
Y=C+I+G+X–M
= 112+0.90Y + 125+150+ [40 – (25+0.1Y)]
Y = 387+ 0.90Y+15 – 0.1Y
= 402+1.10Y
Y – 0.80 Y = 402
0.20 Y = 402
Y = 402/.20
= ` 2010 Cr.
C = 100+0.6 Y
= 100+0.6 (2010)
= 1306 Cr.
Net Export = X – M
= 40-25-0.1 Y
= 15 – 0.1 (2010)
= 15 – 201
= ` (-) 186 Cr.
12

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2. (a) As aggregate expenditures exceed aggregate output then excess demand makes businesses to
sell more than what they currently produce. The unexpected sales would draw down inventories
and result in less inventory investment than business firms planned. They will react by hiring
more workers and expanding production. This will increase the nation’s aggregate income. It also
follows that with demand outstripping production, desired investment will exceed actual
investment.
(b) Multiplier refers to the phenomenon whereby a change in an injection of expenditure will lead to a
proportionately larger change (or multiple changes) in the equilibrium level of national income.
The multiplier concept is central to Keynes's theory because it explains how shifts in investment
caused by changes in business expectations set off a process that causes not only investment
but also consumption to vary. The multiplier shows how shocks to one sector are transmitted
throughout the economy.
(c) By expenditure Method.
= Private final Consumption Expenditure + Government Final consumption Expenditure + Gross
domestic Capital formation (Net domestic Capital formation + depreciation) + Net Export
= 800+900+700+120+20 = ` 2540 Cr.
NNPFC or NI = GDPMP – depreciation + Net factor Income from abroad – Net Indirect tax
= 2540 – 120+50 – 80
` 2390 Cr.
Income Method:
Compensation of employee NNPFC or NI = Operating Surplus + Mixed Income of self employed +
NFIA
= 1000+1400+600+50 = ` 3050 Cr.
3. (a) During recession, in order to ensure income protection, the government increases its expenditure
or cut down taxes or adopts a combination of both so that aggregate demand is kept stable or
even boosted up with more money put into the hands of the people. On the other hand, to control
high inflation the government cuts down its expenditure or raises taxes. In other words, an
expansionary fiscal policy is adopted to alleviate recession and a contractionary fiscal policy is
resorted to for controlling high inflation. The nature of the budget also has important implications
on a country’s economic activity. While deficit budgets are expected to stimulate economic
activity, surplus budget tend to slow down economic activity. Generally, government’s fiscal
policy has a strong influence on the performance of the macro economy in terms of employment,
price stability, economic growth, and external balance.
(b) Government intervention in resource allocation is necessary and justified to ensure social welfare
through optimal allocation of resources. Government should perform the allocation function in an
economy because it is the responsibility of the governments to initiate suitable corrective action
when private markets fail to provide the right and desirable combination of goods and services.
Government intervention in resource allocation is also warranted in the case of goods which we
cannot produce on our own, or buy at a price from the market and in the case of merit goods and
goods which involve externalities
(c) Inequality and the resulting loss of social welfare is sought to be tackled by government through
an appropriately framed tax and transfer policy. This involves progressive taxation combined with
provision of subsidy to low- income households. Proceeds from progressive taxes may be used
to finance public services, especially those such as public housing, which particularly benefit low -
income households. Few examples are supply of essential food grains at highly subsidized prices
to BPL households, free or subsidised education, healthcare, housing, rations and basic goods
etc to the deserving people.
13

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 (d) The bank rate once used to be the policy rate in India i.e., the key interest rate based on which
all other short term interest rates moved. Discounting/rediscounting of bills of excha nge by the
Reserve Bank has been discontinued on introduction of Liquidity Adjustment Facility (LAF). As a
result, the bank rate has become dormant as an instrument of monetary management.
The bank rate has been aligned to the Marginal Standing Facility (MSF) rate and, therefore, as,
and when the MSF rate changes alongside policy repo rate changes, the bank rate also changes
automatically. Briefly put, MSF assumed the role of bank rate and currently the bank rate is
purely a signalling rate, and most interest rates are delinked from the bank rate. Now, bank rate
is used only for calculating penalty on default in the maintenance of Cash Reserve Ratio (CRR)
and the Statutory Liquidity Ratio (SLR).
4. (a) The ‘Factor-Price Equalization’ Theorem states that international trade tends to equalize the
factor prices between the trading nations. In the absence of foreign trade, it is quite likely that
factor prices are different in different countries. International trade equalizes the absolute and
relative returns to homogenous factors of production and their prices. In other words, the wages
of homogeneous labour and returns to homogeneous capital will be the same in all those nations
which engage in trading.
The factor price equalization theorem is in fact a corollary to the Heckscher -Ohlin trade theory. It
holds true only as long as Heckscher-Ohlin Theorem holds true.
(b) Dumping is unfair and constitutes a threat to domestic producers and therefore when dump ing is
found, anti-dumping measures may be initiated as a safeguard instrument by imposing additional
import duties/tariffs so as to offset the foreign firm's unfair price advantage. This is justified only if
the domestic industry is seriously injured by import competition, and protection is in the national
interest (that is, the associated costs to consumers would be less than the benefits that would
accrue to producers). For example: In January 2017, India imposed anti -dumping duties on
colour-coated or pre-painted flat steel products imported into the country from China and
European nations for a period not exceeding six months and for jute and jute products from
Bangladesh and Nepal
(c) Technical Barriers to Trade (TBT) are ‘Standards and Technical Regulations’ that define the
specific characteristics that a product should have, such as its size, shape, design, labelling /
marking / packaging, functionality or performance and production methods, excluding measures
covered by the SPS Agreement.
TBT measures are standards-based measures that countries use to protect their consumers and
preserve natural resources, but these can also be used effectively as obstacles to imports or to
discriminate against imports and protect domestic products. Altering products and production
processes to comply with the diverse requirements in export markets may be either impossible
for the exporting country or would obviously raise costs, hurting the competitiveness of the
exporting country. Some examples of TBT are: food laws, quality standards, industrial standards,
organic certification, eco-labelling, and marketing and label requirements.
(d) Free-trade area is a group of countries that eliminate all tariff and quota barriers on trade with
the objective of increasing exchange of goods with each other. The trade among the member
states flows tariff free, but the member states maintain their own distinct external tariff with
respect to imports from the rest of the world. In other words, the members retain indep endence in
determining their tariffs with non-members.
Trading Bloc has a group of countries that have a free trade agreement between themselves
and may apply a common external tariff to other countries. Example: Arab League (AL),
European Free Trade Association (EFTA).

14

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5. (a) The Salient feature of the theory is:
• It explains the causes of differences in comparative costs as differences in factor
endowments
• Based on money cost which is more realistic.
• Widened the scope to include labour and capital as important factors of production. This is
2-factor model and can be extended to more factors.
• International trade is only a special case of inter-regional trade.
• Considers the relative prices of the factors which influence the comparative costs of the
goods
• Attributes the differences in comparative advantage to the differences in factor endowments.
• Considers factor price differences as the main cause of commodity price differences
• Explains the differences in comparative advantage in terms of differences in factor
endowments.
• Positive; concentrates based on trade
(b) There are four major reasons for market failure. They are:
• Market power: Excessive market power causes the single producer or small number of
producers to produce and sell less output than would be produced and charge a higher
price in a competitive market
• Externalities: Externalities cause market inefficiencies because they hinder the ability of
market prices to convey accurate information about how much to produce and how much to
buy. Since externalities are not reflected in market prices, they can be a source of economic
inefficiency.
• Public goods: Public goods do not conform to the settings of market exchange and left to
the market, they will not be produced at all or will be underproduced. This is because the
price becomes zero.
• Incomplete information: Complete information is an important element of competitive
market. Perfect information implies that both buyers and sellers have complete inf ormation
about anything that may influence their decision making.
(c) The functions of money are acting as a medium of exchange to facilitate easy exchanges of
goods and services, providing a ‘common measure of value’ or ‘common denominator of value’,
serving as a unit or standard of deferred payments and facilitating storing of value both as a
temporary abode of purchasing power and as a permanent store of value.
Money should be generally acceptable, durable, difficult to counterfeit, relative ly scarce, easily
transported, divisible without losing value and effortlessly recognizable
(d) There are two alternate theories in respect of determination of money supply. According to the
first view, money supply is determined exogenously by the central bank. The second view holds
that the money supply is determined endogenously by changes in the economic activities which
affect people’s desire to hold currency relative to deposits, rate of interest, etc. The current
practice is to explain the determinants of money supply based on ‘money multiplier approach’
which focuses on the relation between the money stock and money supply in terms of the
monetary base or high-powered money. The monetary base is the sum of currency in circulation
and bank reserves. This approach holds that total supply of nominal money in the economy is
determined by the joint behavior of the central bank, the commercial banks and the public.

15

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 Or
The main forms of direct investments are: the opening of overseas companies, including the
establishment of subsidiaries or branches, creation of joint ventures on a contract basis, joint
development of natural resources and purchase or annexation of companies in the country
receiving foreign capital.

16

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 Test Series: September, 2022
MOCK TEST PAPER –1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) The capital structure of a Company is given below:
Source of capital Book Value (`)
Equity shares @ ` 100 each 24,00,000
9% Cumulative preference shares @ ` 100 each 4,00,000
11% Debentures 12,00,000
40,00,000
The company had paid equity dividend @ 25% for the last year which is likely to grow @ 5% every
year. The current market price of the company’s equity share is ` 200.
Considering corporate tax @ 30%, you are required to CALCULATE:
(i) Cost of capital for each source of capital.
(ii) Weighted average cost of capital.
(b) Following information is provided relating to SVB Ltd.:
Sales price ` 21 per unit
Variable cost ` 13.50 per unit
Break-even point 30,000 units
You are required to CALCULATE operating leverage at sales volume 37,500 units and 45,000
units.
(c) PI Limited has the following Balance Sheet as on March 31, 2020 and March 31, 2021:
Balance Sheet
Particulars March 31, 2020 March 31, 2021
Sources of Funds:
Shareholders’ Funds 87,500 87,500
Loan Funds 1,22,500 1,05,000
2,10,000 1,92,500

© The Institute of Chartered Accountants of India

 Applications of Funds:
Fixed Assets 87,500 1,05,000
Cash and bank 15,750 14,000
Receivables 49,000 38,500
Inventories 87,500 70,000
Other Current Assets 35,000 35,000
Less: Current Liabilities (64,750) (70,000)
2,10,000 1,92,500
The Income Statement of the PI Ltd. for the year ended is as follows:
Particulars March 31, 2020 March 31, 2021
Sales 7,87,500 8,33,000
Less: Cost of Goods sold (7,30,100) (7,38,500)
Gross Profit 57,400 94,500
Less: Selling, General and Administrative expenses (38,500) (61,250)
Earnings before Interest and Tax (EBIT) 18,900 33,250
Less: Interest Expense (12,250) (10,500)
Earnings before Tax (EBT) 6,650 22,750
Less: Tax (1,995) (6,825)
Profits after Tax (PAT) 4,655 15,925
You are required to CALCULATE for the year 2020-21:
(i) Inventory turnover ratio
(ii) Financial Leverage
(iii) Return on Capital Employed (after tax)
(d) Following information is given for WN Ltd.:
Earnings ` 30 per share
Dividend ` 9 per share
Cost of capital 15%
Internal Rate of Return on investment 20%
You are required to CALCULATE the market price per share using-
(i) Gordon’s formula
(ii) Walter’s formula [4 × 5 Marks = 20 Marks]
2. Embros Ltd. is planning to invest in a new product with a project life of 8 years. Initial equipment cost
will be ` 35 crores. Additional equipment costing ` 2.50 crores will be purchased at the end of the third
year from the cash inflow of this year. At the end of 8 th year, the original equipment will have no resale
value, but additional equipment can be sold at 10% of its original cost. A working capital of ` 4 crores
will be needed, and it will be released at the end of 8th year. The project will be financed with sufficient
amount of equity capital.

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 The sales volumes over eight years have been estimated as follows:
Year 1 2 3 4−5 6−8
Units 14,40,000 21,60,000 52,00,000 54,00,000 36,00,000
Sales price of ` 120 per unit is expected and variable expenses will amount to 60% of sales revenue.
Fixed cash operating costs will amount ` 3.60 crores per year. The loss of any year will be set off from
the profits of subsequent year. The company follows straight line method of depreciation and is subject
to 30% tax rate. Considering 12% after-tax cost of capital for this project, you are required to
CALCULATE the net present value (NPV) of the project and advise the management to take appropriate
decision.
PV factors @ 12% are:

Year 1 2 3 4 5 6 7 8
.893 .797 .712 .636 .567 .507 .452 .404
[10 Marks]
3. GT Ltd. is taking into account the revision of its credit policy with a view to increasing its sales and profit.
Currently, all its sales are on one month credit. Other information is as follows:
Contribution 2/5th of Sales Revenue
Additional funds raising cost 20% per annum
The marketing manager of the company has given the following options along with estimates for
considerations:
Particulars Current Position Option I Option II Option III
Sales Revenue (`) 40,00,000 42,00,000 44,00,000 50,00,000
Credit period (in months) 1 1½ 2 3
Bad debts (% of sales) 2 2½ 3 5
Cost of Credit administration (`) 24,000 26,000 30,000 60,000
You are required to ADVISE the company for the best option. [10 Marks]
4. A Ltd. is considering investing in new project with the following details:
Initial capital cost ` 100 Crores
Annual unit sales 1.25 Crores
Selling price ` 100 per unit
Variable cost ` 50 per unit
Fixed cost ` 12.50 Crores per year
Discounting Rate 6%
Considering life of the project as 3 years, you are required to:
(a) CALCULATE the NPV of the project.
(b) COMPUTE the impact on the project’s NPV considering a 5% adverse variance in following
variables:
(i) Selling Price per Unit
(ii) Variable Cost Per Unit
3

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 (iii) Fixed Cost Per Unit
WHICH variable is having maximum effect?
(c) MEASURE the maximum sensitivity of the project to change in the variable (as found in part (b)
above) such that NPV becomes zero.
PV factors @ 6% are:
Year 1 2 3 4 5
PV Factor 0.943 0.890 0.840 0.792 0.747
[10 Marks]
5. (a) Leo Ltd. has a net operating income of ` 21,60,000 and the total capitalisation of ` 120 lakhs. The
company is evaluating the options to introduce debt financing in the capital structure and the
following information is available at various levels of debt value.
Debt value (`) Interest rate (%) Equity Capitalisation rate (%)
0 N.A. 12.00
10,00,000 7.00 12.50
20,00,000 7.00 13.00
30,00,000 7.50 13.50
40,00,000 7.50 14.00
50,00,000 8.00 15.00
60,00,000 8.50 16.00
70,00,000 9.00 17.00
80,00,000 10.00 20.00
You are required to COMPUTE the equity capitalization rate if MM approach is followed. Assume
that the firm operates in zero tax regime and calculations to be based on book values. [8 Marks]
(b) BRIEF OUT the remedies for Over-Capitalisation. [2 Marks]
6. (a) A finance executive of an organisation plays an important role in the company’s goals, policies,
and financial success. WHAT his responsibilities include? [4 Marks]
(b) WHAT is the meaning of Venture Capital Financing. STATE some characteristics of it. [4 Marks]
(c) BRIEF OUT certain sources of finance- Inter Corporate Deposits and Certificate of Deposit.
Or
STATE in brief four features of Plain Vanilla Bond. [2 Marks]

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 PAPER 8B: ECONOMICS FOR FINANCE
Question 1 is compulsory
Students can answer 3 out of the 4 remaining
Maximum Marks – 40
1. (a) How the measurement of national Income in India is done? (2 Marks)
(b) What is the distinction between classical and Keynesian theory in the determination of national
income? (3 Marks)
(c) Calculate the National Income with the help of Income Method and Expenditure Method?
(5 Marks)
Item ` in crores
Net-factor income from abroad 50
Compensation of employees 1000
Net Indirect taxes 150
Rent 500
Profit 700
Private final consumption expenditure 1500
Net domestic capital formation 600
Depreciation 200
Interest 500
Mixed Income of self employed 900
Export 90
Import 60
Government final Consumption expenditure 1200
Operating surplus 1700
Employer’s Contribution to social security Scheme 250
2. (a) What do you understand by Gross Investment? (2 Marks)
(b) Elaborate the Concept of deflationary gap and how this impact the economy? (3 Marks)
(c) Calculate M3 from the following data: (3 Marks)
Components ` in Crore
Currency with the Public 15,000
Demand Deposit with Banks 12,000
Time Deposit with Banks 10,000
Other Deposit with Reserve bank 70,000

(d) Efficiency of market is affected by monopoly power: Comment. (2 Marks)

3. (a) What are the different motive for holding cash according to Keynes? (2 Marks)
(b) What is escalated tariff structure? (2 Marks)
(c) What is the relationship between money multiplier and money supply? (3 Marks)

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 (d) Describe the various interventionist measures adopted by the government? (3 Marks)
4. (a) How do changes in Statutory liquidity ratio impact the economy? (2 Marks)
(b) What is meant by Foreign Portfolio Investment? (2 Marks)
(c) What is the market Outcome of Price Ceiling? (3 Marks)
(d) What is Pump Priming? (3 Marks)
5. (a) Define Public good. Why do you consider national defence as a Public good? (3 Marks)
(b) What role does market Stabilization Scheme (MSS) Play in our Economy? (3 Marks)
(c) What is the distinction between Nominal GDP and Real GDP? (2 Marks)
(d) For an Economy C = 40 + 0.75Y d,
I = 60
G= 75
Transfer Payment = 100
Income Tax = 0.2 y
Calculate the equilibrium of Income (2 Marks)
Or
What is trading Block?

© The Institute of Chartered Accountants of India

 Test Series: September, 2022
MOCK TEST PAPER –1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints
1. (a) (i) Calculation of Cost of Capital for each source of capital:
(a) Cost of Equity share capital:
D0 (1+ g) 25%  `100(1 + 0.05)
Ke = +g = + 0.05
Market Pr iceper share(P0 ) `200

`26.25
= + 0.05 = 0.18125 or 18.125%
`200
(b) Cost of Preference share capital (K p) = 9%
(c) Cost of Debentures (K d) = r (1 – t)
= 11% (1 – 0.3) = 7.7%
(ii) Weighted Average Cost of Capital
Source Amount (`) Weights After tax Cost of WACC (%)
Capital (%)
(a) (b) (c) = (a)  (b)
Equity share 24,00,000 0.60 18.125 10.875
9% Preference share 4,00,000 0.10 9.000 0.900
11% Debentures 12,00,000 0.30 7.700 2.310
40,00,000 1.00 14.085
(b) Computation of Operating Leverage (OL)
Selling Price = ` 21 per unit
Variable Cost = ` 13.50 per unit
Fixed Cost = BEP × (Selling price – Variable cost) = 30,000 × (21 – 13.50) = 30,000 × 7.5 =
2,25,000

Particulars For 37,500 units (`) For 45,000 units (`)

Sales (@ ` 21 /unit) 7,87,500 9,45,000
Less: Variable Cost (@ 13.50 /unit) 5,06,250 6,07,500
Contribution 2,81,250 3,37,500
Less: Fixed Cost 2,25,000 2,25,000
Earnings before Interest and tax (EBIT) 56,250 1,12,500
Contribution 2,81,250 3,37,500
Operating Leverage ( ) ( ) ( )
EBIT 56,250 1,12,500

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 Operating Leverage 5 times 3 times
(c) Ratios for the year 2020-21
(i) Inventory turnover ratio
COGS ` 7,38,500
= = ` (87,500 + 70,000) = 9.4
Average Inventory 2

(ii) Financial leverage

EBIT ` 33,250
= = = 1.46
EBT ` 22,750

(iii) ROCE
EBIT (1- t) ` 33,250 (1-0.3) ` 23,275
= = 2,10,000+ 1,92,500 = ` 2,01,250 × 100 = 11.56 %
Average Capital Employed ` ( 2
)

(d) (i) As per Gordon’s Model, Price per share is computed using the formula:
E1(1 − b)
P0 =
Ke − br
Where,
P0 = Price per share
E1 = Earnings per share
b = Retention ratio; (1 - b = Pay-out ratio)
Ke = Cost of capital
r = IRR
br = Growth rate (g)
Applying the above formula, price per share
30×0.3* 9
P0 = 0.15-0.70×0.2 = = ` 900
0.01
`9
*Dividend pay-out ratio = = 0.3 or 30%
` 30
(ii) As per Walter’s Model, Price per share is computed using the formula:
r
D+Ke (E-D)
Price (P) = Ke
Where,
P = Market Price of the share
E = Earnings per share
D = Dividend per share
Ke = Cost of equity/ rate of capitalization/ discount rate
r = Internal rate of return/ return on investment
Applying the above formula, price per share

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 9 + 0.20
0.15
(30 - 9) 37
P = = = ` 246.67
0.15 0.15
2. Calculation of year-wise Cash Inflow (` in crores)
Year Sales VC FC Dep. Profit Tax PAT Dep. Cash
(60% of Sales Value) (@30%) inflow
1 17.28 10.368 3.6 4.375 (1.063) - (1.0630) 4.375 3.312
2 25.92 15.552 3.6 4.375 2.393 0.3990* 1.9940 4.375 6.369
3 62.4 37.44 3.6 4.375 16.985 5.0955 11.8895 4.375 16.2645
4−5 64.8 38.88 3.6 4.825# 17.495 5.2485 12.2465 4.825 17.0715
6−8 43.2 25.92 3.6 4.825 8.855 2.6565 6.1985 4.825 11.0235
* (30% of 2.393 – 30% of 1.063) = 0.7179 – 0.3189 = 0.3990
# 4.375 + (2.50 - .25)/5 = 4.825

Calculation of Cash Outflow at the beginning

Particulars `
Cost of New Equipment 35,00,00,000
Add: Working Capital 4,00,00,000
Outflow 39,00,00,000
Calculation of NPV

Year Cash inflows PV factor NPV

(`) (`)
1 3,31,20,000 .893 2,95,76,160
2 6,36,90,000 .797 5,07,60,930
3 16,26,45,000 - 2,50,00,000 = 13,76,45,000 .712 9,80,03,240
4 17,07,15,000 .636 10,85,74,740
5 17,07,15,000 .567 9,67,95,405
6 11,02,35,000 .507 5,58,89,145
7 11,02,35,000 .452 4,98,26,220
8 11,02,35,000 + 4,00,00,000 + 25,00,000 = 15,27,35,000 .404 6,17,04,940
Present Value of Inflow 55,11,30,780
Less: Out flow 39,00,00,000
Net Present Value 16,11,30,780
Advise: Since the project has a positive NPV, it may be accepted.
3. Statement Showing Evaluation of Credit Policies
(` in lakhs)
Particulars Current position Option I Option II Option III
(1 month) (1.5 months) (2 months) (3 months)
Sales Revenue 40,00,000 42,00,000 44,00,000 50,00,000

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 Contribution @ 40% 16,00,000 16,80,000 17,60,000 20,00,000
Increase in contribution over − 80,000 1,60,000 4,00,000
current level (A)
Debtors = 1 × 40,00,000 1.5 × 42,00,000 2 × 44,00,000 3 × 50,00,000
Average Collection period x Credit Sale
( ) 12 12 12 12
12
= 3,33,333.33 = 5,25,000 = 7,33,333.33 = 12,50,000
Increase in debtors over − 1,91,666.67 4,00,000.00 9,16,666.67
current level
Cost of funds for additional − 38,333.33 80,000.00 1,83,333.33
amount of debtors @ 20% (B)
Credit administrative cost 24,000 26,000 30,000 60,000
Increase in credit − 2,000 6,000 36,000
administration cost over
present level (C)
Bad debts 80,000 1,05,000 1,32,000 2,50,000
Increase in bad debts over − 25,000 52,000 1,70,000
current levels (D)
Net gain/loss A – (B + C + D) − 14,666.67 22,000.00 10,666.67
Advise: It is suggested that the company GT Ltd. should implement Option II with a net gain of
` 22,000 which has a credit period of 2 months.
4. (a) Calculation of Net Cash Inflow per year
Particulars Amount (`)
A Selling price per unit 100
B Variable cost per unit 50
C Contribution per unit (A - B) 50
D Number of units sold per year 1.25 Crores
E Total Contribution (C × D) ` 62.50 Crores
F Fixed cost per year ` 12.50 Crores
G Net cash inflow per year (E - F) ` 50 Crores
Calculation of Net Present Value (NPV) of the Project
Year Year Cash Flow PV factor @ 6% Present Value (PV)
(` in Cr.) (` in Cr.)
0 (100.00) 1.000 (100.00)
1 50.00 0.943 47.15
2 50.00 0.890 44.50
3 50.00 0.840 42.00
Net Present Value 33.65
Here, NPV represent the most likely outcomes and not the actual outcomes. The actual outcome
can be lower or higher than the expected outcome.

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 (b) Sensitivity Analysis considering 5 % Adverse Variance in following variable
Particulars Base Selling Price Variable Cost Fixed Cost
per Unit Per Unit increased to
Reduced to increased to ` 13.125 crores
` 95 ` 52.50 per year
(`) (`) (`) (`)
A Selling price per unit 100 95 100 100
B Variable cost per unit 50 50 52.50 50
C Contribution per unit (A - B) 50 45 47.50 50
(` in Cr.) (` in Cr.) (` in Cr.) (` in Cr.)
D Number of units sold per 1.25 1.25 1.25 1.25
year (units in Crores)
E Total Contribution (C × D) 62.50 56.25 59.375 62.50
F Fixed cost per year 12.50 12.50 12.50 13.125
G Net Cash Inflow per year (E 50.00 43.75 46.875 49.375
- F)
H PV of Net cash Inflow per 133.65 116.94 125.30 131.98
year (G × 2.673)
I Initial capital cost 100.00 100 100 100
J NPV (H - I) 33.65 16.94 25.30 31.98
Difference in NPV - (16.71) (8.35) (1.67)
Percentage Change in - (49.66%) (24.81%) (4.96%)
NPV
The above table shows that by changing one variable at a time by 5% (adverse) while keeping the
others constant, the impact in percentage terms on the NPV of the project is maximum in selling
price by 49.66%.
(c) For 49.66% change in NPV, Selling Price per Unit needs to be reduced by 5%
Thus, for 100% change in NPV (such that NPV becomes zero), sensitivity to change in Selling
5
price would be = ×100 = 10.07%
49.66

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5. (a) As per MM approach, cost of the capital (K o) remains constant, and cost of equity increases linearly
with debt.
NOI
Value of a Firm =
K0
21,60,000
 1,20,00,000 =
k0
21,60,000
 K0 = = 18%
1,20,00,000
D
Under MM approach, k e = k 0 + (k0 − kd )
E
Statement of equity capitalization under MM approach

Debt Equity Debt/ Kd Ko Ko-kd Ke = Ko+(Ko-Kd) (D/E)

Value (`) Value (`) Equity (%) (%) (%) (%)

- 1,20,00,000 0.0000 NA 18.00 18.00 18.00

10,00,000 1,10,00,000 0.0909 7.00 18.00 11.00 19.00

20,00,000 1,00,00,000 0.2000 7.00 18.00 11.00 20.20

30,00,000 90,00,000 0.3333 7.50 18.00 10.50 21.50

40,00,000 80,00,000 0.5000 7.50 18.00 10.50 23.25

50,00,000 70,00,000 0.7143 8.00 18.00 10.00 25.14

60,00,000 60,00,000 1.0000 8.50 18.00 9.50 27.50

70,00,000 50,00,000 1.4000 9.00 18.00 9.00 30.60

80,00,000 40,00,000 2.0000 10.0 18.00 8.00 34.00

0

(b) Remedies for Over-Capitalisation: Following steps may be adopted to avoid the negative
consequences of over-capitalisation-
(i) Company should go for thorough reorganization.
(ii) Buyback of shares.
(iii) Reduction in claims of debenture-holders and creditors.
(iv) Value of shares may also be reduced. This will result in sufficient funds for the company to
carry out replacement of assets.
6. (a) A finance executive of an organisation plays an important role in the company’s goals,
policies, and financial success. His responsibilities include:
(i) Financial analysis and planning: Determining the proper amount of funds to employ in the
firm, i.e. designating the size of the firm and its rate of growth.
(ii) Investment decisions: The efficient allocation of funds to specific assets.

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 (iii) Financing and capital structure decisions: Raising funds on favourable terms as possible
i.e. determining the composition of liabilities.
(iv) Management of financial resources (such as working capital).
(v) Risk management: Protecting assets.
(b) Venture Capital Financing: The venture capital financing refers to financing of new high risky
venture promoted by qualified entrepreneurs who lack experience and funds to give shape to their
ideas. In broad sense, under venture capital financing, venture capitalist make investment to
purchase equity or debt securities from inexperienced entrepreneurs who undertake highly risky
ventures with potential to succeed in future.
Some of the characteristics of Venture Capital financing are:
 It is basically an equity finance in new companies.
 It can be viewed as a long-term investment in growth-oriented small/medium firms.
 Apart from providing funds, the investor also provides support in form of sales strategy,
business networking and management expertise, enabling the growth of the entrepreneur.
(c) Inter Corporate Deposits: The companies can borrow funds for a short period, say 6 months,
from other companies which have surplus liquidity. The rate of interest on inter corporate deposits
varies depending upon the amount involved and the time period.
Certificate of Deposit (CD): The certificate of deposit is a document of title similar to a time
deposit receipt issued by a bank except that there is no prescribed interest rate on s uch funds.
The main advantage of CD is that banker is not required to encash the deposit before maturity
period and the investor is assured of liquidity because he can sell the CD in secondary market.
Or
Features of Plain Vanilla Bond:
• The issuer would pay the principal amount along with the interest rate.
• This type of bond would not have any options.
• This bond can be issued in the form of discounted bond or can be issued in the form of coupon
bearing bond.

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 PAPER 8B: ECONOMICS FOR FINANCE
SUGGESTED ANSWER
1. (a) National Accounts Statistics (NAS) in India are compiled by National Accounts Division in the
Central Statistics Office, Ministry of Statistics and Programme Implementation (MOSPI). Annual as
well as quarterly estimates are published. This publication is the key source -material for all
macroeconomic data of the country. As per the mandate of the Fiscal Responsibility and Budget
Management Act 2003, the Ministry of Finance uses the GDP numbers ( at current prices) to
determine the fiscal targets.
(b) The classical economists maintained that the economy is self‐regulating and is always capable of
automatically achieving equilibrium at the ‘natural level’ of real GDP or output, which is the level of
real GDP that is obtained when the economy's resources are fully employed. While circumstances
arise from time to time that cause the economy to fall below or to exceed the natural level of real
GDP, wage and price flexibility will bring the economy back to the natural level of real GDP. If an
excess in the labour force (unemployment) or products exist, the wage or price of these will adjust
to absorb the excess. According to them, there will be no involuntary unemployment.
Keynes argued that markets would not automatically lead to full-employment equilibrium and the
resulting natural level of real GDP. The economy could settle in equilibrium at any level of
unemployment. Keynesians believe that prices and wages are not so flexible; they are sticky,
especially downward. The stickiness of prices and wages in the downward direction prevents the
economy's resources from being fully employed and thereby prevents the economy from returning
to the natural level of real GDP.
(c) By Income Method
NNPFC or National Income = Compensation of employees + Operating surplus + Mixed Income of
self-employed + NFIA
= 1000+ 1700 + 900 + 50
= 3650 Cr
By Expenditure Method
GDPMP = Private Final Consumption Expenditure + Government Final consumption expenditure +
Gross domestic Capital formation (Net domestic capital formation + depreciation) + Net Export
= 1500 + 1200 + (600+200) +30
= 3530 Cr
2. (a) Gross Investment is that part of country's total expenditure which is not consumed but added to the
nation's fixed tangible assets and stocks. It consists of the acquisition of fixed assets and the
accumulation of stocks. The stock accumulation is in the form of changes in stock of raw materials,
fuels, finished goods and semi-finished goods awaiting completion. Thus, gross investment includes
final expenditure on machinery and equipment and own account production of machinery and
equipment, expenditure on construction, expenditure on changes in inventories, and expenditure on
the acquisition of valuables such as, jewellery and works of art.
(b) If the aggregate demand is for an amount of output less than the full employment level of output,
then we say there is deficient demand. Deflationary gap is thus a measure of the extent of
deficiency of aggregate demand, and it causes the economy’s income, output, and employment to
decline, thus pushing the economy to under- employment equilibrium.

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 (Deficient Demand - Deflationary Gap)

(c) M3 = M1 + Time deposit with banking system

= Currency with the Public + Demand deposit with Banks + Other deposit with banks + Time deposit
with banking system
= 15000+ 12000+ 70000+10000
= 107000 crores
(d) The presence of monopoly power affects the efficiency of markets in different degrees leading to
under-production and higher prices than would exist under conditions of competition. These distort
the choices available to consumers and reduce their welfare.
3. (a) According to Keynes, people hold money (M) in cash for three motives:
(i) Transactions motive,
(ii) Precautionary motive, and
(iii) Speculative motive.
The transaction motive for holding cash is directly related to the level of in - come and relates to
‘the need for cash for the current transactions for personal and business exchange.
The amount of money demanded under the precautionary motive is to meet unforeseen and
unpredictable contingencies involving money payments and depends on the size of the income,
prevailing economic as well as political conditions and personal characteristics of the individual
such as optimism/ pessimism, farsightedness etc.
The speculative motive reflects people’s desire to hold cash in order to be equipped to exploit any
attractive investment opportunity requiring cash expenditure. The speculative demand for money
and interest are inversely related.
(b) Escalated Tariff structure refers to the system wherein the nominal tariff rates on imports of
manufactured goods are higher than the nominal tariff rates on intermediate inputs and raw
materials, i.e., the tariff on a product increase as that product moves through the value-added
chain. For example, a four percent tariff on iron ore or iron ingots and twelve percent tariff on steel
pipes. This type of tariff is discriminatory as it protects manufacturing industries in importing
9

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 countries and dampens the attempts of developing manufacturing industries of exporting countries.
This has special relevance to trade between developed countries and developing countries.
Developing countries are thus forced to continue to be suppliers of raw materials without much
value addition.
(c) If the central bank of a country wants to stimulate economic activity it does so by infusing liquidity
into the system. Let us take the example of open market operations (OMO) by central banks.
Purchase of government securities injects high powered money (monetary base) into the system.
Assuming that banks do not hold excess reserves and people do not hold more currency than
before, and also that there is demand for loans from businesses, the credit creation process by
the banking system in the country will create money to the tune of
∆Money Supply = 1/ R X ∆ Reserve
The effect of an open market sale is very similar to that of open market purchase, but in the opposite
direction. In other words, an open market purchase by central bank will reduce the reserves and
thereby reduce the money supply.
(d) Adam Smith is often described as a bold advocate of free markets and minimal governmental
activity. However, Smith saw an important resource allocation role for government when he
underlined the role of government in national defence, maintenance of justice and the rule of law,
establishment and maintenance of highly beneficial public institutions and public works which the
market may fail to produce on account of lack of sufficient profits. Since the 1930s, more specifically
as a consequence of the great depression, the state’s role in the economy has been distinctly
gaining in importance, and therefore, the traditional functions of the state as described above, have
been supplemented with what is referred to as economic functions (also called fiscal functions or
public finance function). While there are differences among different countries in respect of the
nature and extent of government intervention in economies, all of them agree on one point that the
governments are expected to play a major role in the economy. This comes out of the belief that
government intervention will invariably influence the performance of the economy in a positive way.
4. (a) The SLR is also a powerful tool for controlling liquidity in the domestic market by means of
manipulating bank credit. Changes in the SLR chiefly influence the availability of resources in the
banking system for lending. A rise in the SLR which is resorted to during periods of high liquidity,
tends to lock up a rising fraction of a bank’s assets in the form of eligible instruments, and this
reduces the credit creation capacity of banks. A reduction in the SLR during periods of economic
downturn has the opposite effect. The SLR requirement also facilitates a captive market for
government securities.
(b) Foreign portfolio investment (FPI) is not concerned with either manufacture of goods or with
provision of services. Such investors also do not have any intention of exercising voting power or
controlling or managing the affairs of the company in whose securities they invest. The sole
intention of a foreign portfolio investor is to earn a remunerative return through investment in foreign
securities and is primarily concerned about the safety of their capital, the likelihood of appreciation
in its value, and the return generated. Logically, portfolio capital moves to a recipient country which
has revealed its potential for higher returns and profitability.
(c) Price ceilings prevent a price from rising above a certain level. When a price ceiling is set below
the equilibrium price, quantity demanded will exceed quantity supplied, and excess demand or
shortages will result. For example: maximum prices of food grains and essential items are set by
government during times of scarcity. A price ceiling which is set below the prevailing market
clearing price will generate excess demand over supply.

10

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 A price ceiling will only impact the market if the ceiling is set below the free- market equilibrium
price. This is because a price ceiling above the equilibrium price will lead to the product being sold
at the equilibrium price. If the ceiling is less than the economic price, the immediate result will be
a supply shortage.
(d) Pump priming involves a one-shot injection of government expenditure into a depressed economy
with the aim of boosting business confidence and encouraging larger private investment. It is a
temporary fiscal stimulus in order to set off the multiplier process. The argument is that with a
temporary injection of purchasing power into the economy through a rise in government spending
financed by borrowing rather than taxes, it is possible for government to bring about permanent
recovery from a slump. Pump priming was widely used by governments in the post-war era in order
to maintain full employment; however, it became discredited later when it failed to halt rising
unemployment and was held responsible for inflation.
5. (a) A public good (also referred to as a collective consumption good or a social good) is defined as
one which all individuals enjoy in common in the sense that each individual’s consumption of such
a good leads to no subtraction from any other individual’s consumption of that good.
National defence has all characteristics of a public good. It yields utility to people; its consumption
is essentially nonrival, non-excludable and collective in nature and is characterized by
indivisibility. National defence is available for all individuals whether they pay taxes or not and it is
impossible to exclude anyone within the country from consuming and benefiting from it. No direct
payment by the consumer is involved in the case of defence. Once it is provided, the add itional
resource cost of another person consuming it is zero. Defence also has the unique feature of
public good i.e. it does not conform to the settings of market exchange. Though defence is
extremely valuable for the well being of the society, left to market, it will not be produced at all or
will be under produced.
(b) This instrument for monetary management was introduced in 2004 following a MoU between the
Reserve Bank of India (RBI) and the Government of India (GoI) with the primary aim of aiding the
sterilization operations of the RBI. (Sterilization is the process by which the monetary authority
sterilizes the effects of significant foreign capital inflows on domestic liquidity by off-loading parts of
the stock of government securities held by it). Surplus liquidity of a more enduring nature arising
from large capital inflows is absorbed through sale of short-dated government securities and
treasury bills. Under this scheme, the Government of India borrows from the RBI (such borrowing
being additional to its normal borrowing requirements) and issues treasury-bills/dated securities for
absorbing excess liquidity from the market arising from large capital inflows.
(c) When GDP is estimated on the basis of current year’s market prices, it is called ‘nominal GDP’ or
‘GDP at current prices. For example, GDP of year 2020-21 may be measured using prices of
2020-21. Nominal GDP changes from year to year for two reasons. First, the amount of goods and
services produced changes, and second, market prices change. Changes in GDP due to changes
in prices fail to correctly explain the performance of the economy in producing goods and services.
Real GDP is calculated in such a way that the goods and services produced in a particular year are
evaluated at some constant set of prices or constant prices. In other words, it is calculated using
the prices of a selected ‘base year’. For example, if 2011-12 is selected as the base year, then real
GDP for 2020-21 will be calculated by taking the quantities of all goods and services produced in
2020-21 and multiplying them by their 2011-12 prices.
(d) Y = Y – Tax + Transfer Payments
= Y-0.2y +100

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 = 0.8Y+100
C = 40 + 0.75Yd
= 40 + 0.75(0.8Y +100)
= 40 + 0.6Y + 75
= 115 +0.6Y
Now
Y = C + I +G
Y = 115 +0.6Y + 60 +75
Y-0.6Y = 250
0.4Y = 250
Y = 250/0.4 = 625 cr
Or
Trading Bloc has a group of countries that have a free trade agreement between themselves and
may apply a common external tariff to other countries. Example: Arab League (AL), European Free
Trade Association (EFTA).

12

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 Test Series: October 2022
MOCK TEST PAPER - 2
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
SUGGESTED ANSWERS/ HINTS
1. (a)
Cost Structure for 52000 units
Particulars Amount (`)
Raw Material @ ` 400P 2,08,00,000
Direct Wages @ ` 150 78,00,000
Manufacturing Overheads@ ` 200 1,04,00,000
Selling and Distribution OH@ ` 100 52,00,000
Total Cost 4,42,00,000
Sales@`1000 5,20,00,000

Particulars Calculation Amount (`)

A. Current Assets:
4
Raw Material Stock 2,08,00,000 x 16,00,000
52
Work in Progress 2, 08, 00, 000 +
( 78,00,000 + 1,04,00,000 ) x 4
(WIP) Stock 2 52 23,00,000

Finished Goods 4 34,00,000

4,42,00,000 x
Stock 52
8
Receivables 5,20,00,000 x 80,00,000
52
Cash 50,000
Total Current Assets 1,53,50,000
B. Current Liabilities:
4
Creditors 20800000 x 16,00,000
52
C. Working Capital
Estimates(A-B) 1,37,50,000
(b) Break Even Sales = ` 6800000×0.75 = ` 51,00,000
Income Statement (Amount in `)
Original Calculation of Interest Now at present
at BEP (backward level
calculation)
Sales 68,00,000 51,00,000 68,00,000
Less: Variable Cost 40,80,000 30,60,000 40,80,000
1

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 Contribution 27,20,000 20,40,000 27,20,000
Less: Fixed Cost 16,32,000 16,32,000 16,32,000
EBIT 10,88,000 4,08,000 10,88,000
Less: Interest (EBIT-PBT) ? 3,93,714 3,93,714
PBT ? 14,286(10,000/70%) 6,94,286
Less: Tax @ 30%(or PBT-PAT) ? 4,286 2,08,286
PAT ? 10,000(Nil+10,000) 4,86,000
Less: Preference Dividend 10,000 10,000 10,000
Earnings for Equity share holders ? Nil (at BEP) 4,76,000
Number of Equity Shares 1,50,000 1,50,000 1,50,000
EPS ? - 3.1733
So Interest=`3,93,714, EPS=`3.1733, Amount of debt=3,93,714/12%=` 32,80,950
(c) Statement showing the Evaluation of Accounts Receivable Policies
(Amount in `)
Particulars Present Proposed Proposed
Policy Policy 1 Policy 2
A Expected Profit:
(a) Credit Sales 55,00,000 65,00,000 70,00,000
(b) Total Cost other than Bad Debts:
(i) Variable Costs (75%) 41,25,000 48,75,000 52,50,000
(c) Bad Debts 2,00,000 3,50,000 5,00,000
(d) Expected Profit [(a) – (b) – (c)] 11,75,000 12,75,000 12,50,000
B Opportunity Cost of Investments in Accounts 1,23,750 1,82,813 2,62,500
Receivable (Working Note)
C Net Benefits (A – B) 10,51,250 10,92,187 9,87,500

Recommendation: The Proposed Policy 1 should be adopted since the net benefits under this
policy are higher as compared to other policies.
Working Note:
Calculation of Opportunity Cost of Average Investments
Opportunity Cost = Total Cost × Collection period/12 × Rate of Return/100
Present Policy = ` 41,25,000 × 2.4/12 × 15% = `1,23,750
Proposed Policy 1 = ` 48,75,000× 3/12 × 15% = ` 1,82,813
Proposed Policy 2 = ` 52,50,000× 4/12 × 15% = ` 2,62,500
(d) Price per share according to Gordon’s Model is calculated as follows:
Particulars Amount in `
Net Profit 78 lakhs
Less:Preference dividend(120 18 lakhs
lakhs@15%)
Earnings for equity shareholders 60 lakhs

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 Earnings Per Share 60 lakhs/6 lakhs = ` 10.00
Price per share according to Gordon’s Model is calculated as follows:
E1(1 − b)
P0 =
Ke − br
Here, E1 = 10, Ke = 16%
(i) When dividend pay-out is 30%
10 × 0.30 3
P0 = = = `150
0.16 − (0.70 × 0.2) 0.16 − 0.14
(ii) When dividend pay-out is 50%
10 × 0.5 5
P0 = = = `83.33
0.16 − (0.5 × 0.2) 0.16 − 0.10
(iii) When dividend pay-out is 100%
10 × 1 10
P0 = = =` 62.5
0.16 − (0 × 0.2) 0.16
2. Calculation of Equity Share capital and Reserves and surplus:
Alternative 1:
`2,00,000 x 100
Equity Share capital = `20, 00,000 + =`21,50,000
133.3333
`2,00,000 x 33.3333
Reserves= `10,00,000 + =`10,50,000
133.3333
Alternative 2:
` 9,00,000x100
Equity Share capital = ` 20,00, 000 + =`27,20,000
125
` 9,00,000 x25
Reserves= `10,00,000 + =`11,80,000
125
Capital Structure Plans
Amount in `
Capital Alternative 1 Alternative 2
Equity Share capital 21,50,000 27,20,000
Reserves and surplus 10,50,000 11,80,000
10% long term debt 15,00,000 15,00,000
14% Debentures 8,00,000 -
8% Irredeemable Debentures - 1,00,000
Total Capital Employed 55,00,000 55,00,000

Computation of Present Earnings before interest and tax (EBIT)

EPS (`) 21
No. of equity shares 20,000

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 Earnings for equity shareholders (I x II) (`) 4,20,000
Profit Before Tax (III/75%) (`)[ 5,60,000
Interest on long term loan (1500000 x 10%) (`) 1,50,000
EBIT (IV + V) (`) 7,10,000
EBIT after expansion = `7,10,000 +` 2,00,000 = `9,10,000
Evaluation of Financial Plans on the basis of EPS, MPS and Financial Leverage
Amount in `
Particulars Alternative I Alternate II
EBIT 9,10,000 9,10,000
Less: Interest: 10% on long term loan (1,50,000) (1,50,000)
14% on Debentures (1,12,000) Nil
8% on Irredeemable Debentures Nil. (8000)
PBT 6,48,000 7,52,000
Less: Tax @25% (1,62,000) (1,88,000)
PAT 4,86,000 5,64,000
No. of equity shares 21,500 27,200
EPS 22.60 20.74
Applicable P/E ratio (Working Note 1) 7 8.5
MPS (EPS X P/E ratio) 158.2 176.29
Financial Leverage EBIT/PBT 1.40 1.21
Working Note 1
Alternative I Alternative II
Debt:
`15,00,000 +`8,00,000 23,00,000 -
`15,00,000 +`1,00,000 - 16,00,000
Total capital Employed (`) 55,00,000 55,00,000
Debt Ratio (Debt/Capital employed) =0.4182 =0.2909
=41.82% =29.09%
Change in Equity: `21,50,000-`20,00,000 1,50,000
`27,20,000-`20,00,000 7,20,000
Percentage change in equity 7.5% 36%
Applicable P/E ratio 7 8.5
Calculation of Cost of equity and various type of debt
Alternative I Alternative II
A) Cost of equity
EPS 22.60 20.74
DPS (EPS X 60%) 13.56 12.44
Growth (g) 10% 10%
Po (MPS) 158.2 176.29
4

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 Ke= Do (1 + g)/ Po 13.56 (1.1) 12.44 (1.1)
158.2 176.29
=9.43% =7.76%
B) Cost of Debt:
10% long term debt 10% + (1-0.25) 10% +(1-0.25)
= 7.5% = 7.5%
14% redeemable debentures 14(1-0.25) + (110-100/10) nil
110+100/2
= 10.5 + 1 / 10.5
= 10.95%
8% irredeemable debenture NA 8000(1-0.25)/1,00,00 = 6%
Calculation of Weighted Average cost of capital (WACC)
Alternative 1 Alternative 2
Cost WACC Weights Cost WACC
Capital Weights (%) (%)
Equity Share Capital 0.3909 9.43 3.69% 0.4945 7.76 3.84%
Reserves and Surplus 0.1909 9.43 1.80% 0.2145 7.76 1.66%
10% Long term Debt 0.2727 7.50 2.05% 0.2727 7.50 2.05%
14% Debenture 0.1455 10.95 1.59%
8% Irredeemable Debentures - 0.0182 6 0.11%
9.12% 7.66%
Calculation Marginal Cost of Capital (MACC)
Alternative 1 Alternative 2
Amount(weight) Cost Amount (weight) Cost MACC
Capital (%) MACC (%)
Equity Share Capital ` 1,50,000(0.15) 9.43 1.41% `7,20,000(0.72) 7.76 5.59%
Reserves and Surplus ` 50,000(0.05) 9.43 0.47% `1,80,000(0.18) 7.76 1.40%
14% Debenture ` 8,00,000(0.80) 10.95 8.76% - 0.00%
8% Irredeemable
Debentures - `1,00,000(0.10) 6 0.60%
Total Capital Employed `10,00,000 10.65% `10,00,000 7.58%
Summary of solution:
Alternate I Alternate II
Earning per share (EPS) 22.60 20.74
Market price per share (MPS) 158.20 176.29
Financial leverage 1.4043 1.2101
Weighted Average cost of capital (WACC) 9.12% 7.66%
Marginal cost of capital (MACC) 10.65% 7.58%

© The Institute of Chartered Accountants of India

 Alternative 1 of financing will be preferred under the criteria of EPS, whereas Alternative II of
financing will be preferred under the criteria of MPS, Financial leverage, WACC and marginal
cost of capital.
3. 1. Current Ratio = 3:1
Current Assets (CA)/Current Liability (CL) = 3:1
CA = 3CL
WC = 10,00,000
CA – CL = 10,00,000
3CL – CL = 10,00,000
2CL = 10,00,000
10,00,000
CL =
2
CL = `5,00,000
CA = 3 x 5,00,000
CA = `15,00,000
2. Acid Test Ratio = CA – Stock / CL = 1:1
15,00,000 - Stock
= =1
5,00,000
15,00,000 – stock = 5,00,000
Stock = `10,00,000
3. Stock Turnover ratio (on sales) = 5
Sales
=5
Avg stock
Sales
=5
10,00,000
Sales = `50,00,000
4. Gross Profit = 50,00,000 x 40% = `20,00,000
Net profit (PBT) = 50,00,000 x 10% = `5,00,000
5. PBIT/PBT = 2.2
PBIT = 2.2 x 5,00,000
PBIT= 11,00,000
Interest = 11,00,000 – 5,00,000 = `6,00,000
6,00,000
Long term loan = = `50,00,000
0.12
6. Average collection period = 30 days
30
Receivables = x 50.00.000 = 4,16,667
360
7. Fixed Assets Turnover Ratio = 0.8
6

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 50,00,000/ Fixed Assets = 0.8
Fixed Assets = `62,50,000
Income Statement
Amount (`)
Sales 50,00,000
Less: Cost of Goods Sold 30,00,000
Gross Profit 20,00,000
Less: Operating Expenses 9,00,000
Less: Interest. 6,00,000
Net Profit 5,00,000

Balance sheet

Liabilities Amount (`) Assets Amount (`)

Equity share capital 22,50,000 Fixed asset 62,50,000
Long term debt 50,00,000 Current assets:
Current liability 5,00,000 Stock 10,00,000
Receivables 4,16,667
Other 83,333 15,00,000
77,50,000 77,50,000
4. (a) Calculation of Cash Flow After Tax (CFAT) in original scenario
Sr. No. Particulars
1 Sales units 1,50,000
(`)
2 Sale Price p.u. 120
3 Sales 1,80,00,000
4 Variable Cost p.u. 60
5 Variable Cost 90,00,000
6 Contribution (3-4) 90,00,000
7 Fixed OH (Excluding Depreciation) 22,50,000
8 Depreciation 30,00,000
9 EBIT or PBT (6-7-8) 37,50,000
10 Tax@40% 15,00,000
11 Profit After Tax (PAT) 22,50,000
12 Add: Depreciation 30,00,000
13 CFAT 52,50,000

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 Calculation of NPV in original Scenario
Years Particulars Cash Flows PVF PV
0 Initial Investment (1,50,00,000) 1 (1,50,00,000)
0 Initial WC introduced (60,00,000) 1 (60,00,000)
1 to 5 CFAT 52,50,000 3.6048 189,25,075
5 WC released 60,00,000 0.5674 34,04,561
NPV 13,29,636
Since the NPV of the project is Positive the project is viable.
(b) Sensitivity Analysis of the project under various conditions
Sr. Particulars (i)Selling (ii)Variable (iii)Plant
No. Price Cost &Machinery
reduced by increased by cost
10% 10% increased by
10%
1 Sales units 1,50,000 1,50,000 1,50,000
A `m ` `
2 Sale Price p.u. 108 120 120
3 Sales 162,00,000 180,00,000 180,00,000
4 Variable Cost p.u. 60 66 60
5 Variable Cost 90,00,000 99,00,000 90,00,000
6 Contribution (3-4) [or Contribution per 72,00,000 81,00,000 90,00,000
unit x1,50,000 units)
7 Fixed OH (Excluding Depreciation) 22,50,000 22,50,000 22,50,000
8 Depreciation 30,00,000 30,00,000 33,00,000
9 EBIT or PBT (6-7-8) 19,50,000 28,50,000 34,50,000
10 Tax 7,80,000 11,40,000 13,80,000
11 PAT 11,70,000 17,10,000 20,70,000
12 Add: Depreciation 30,00,000 30,00,000 33,00,000
13 CFAT 41,70,000 47,10,000 53,70,000
14 PV of CFAT (CFAT x3.6048) 150,31,917 169,78,496 193,57,648
15 WC released (60,00,000 x0.5674) 34,04,561 34,04,561 34,04,561
16 Initial Investment (1,50,00,000) (1,50,00,000) (1,50,00,000)
17 Initial WC introduced (60,00,000) (60,00,000) (60,00,000)
18 NPV (14+15-16-17) (25,63,522) (6,16,943) 2,62,209
19 % Change in NPV [Based on original -292.80% -146.40% -80.28%
NPV (13,29,636)]
From the above calculations it can be seen that change in selling price is most sensitive and has
the maximum effect on the NPV.

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5. (a) Income Statement
Particulars Amount (`)
Sales 1,11,00,000
Contribution (Sales × P/V ratio) 27,75,000
Less: Fixed cost (excluding Interest) (7,15,000)
EBIT (Earnings before interest and tax) 20,60,000
Less: Interest on debentures (12% × ` 60,91,400) (7,30,968)
EBT (Earnings before tax) 13,29,032
Less: Tax @ 30% 3,98,710
PAT (Profit after tax) 9,30,322
(i) Operating Leverage:
Contribution ` 27,75,000
= = = 1.35
EBIT ` 20,60,000
(ii) Combined Leverage:
= Operating Leverage × Financial Leverage
= 1.35 × 1.55 = 2.09 (Approx)
Or,
Contribution EBIT
Combined Leverage = ×
EBIT EBT
Contribution ` 20,60,000
Combined Leverage = = = 2.09 (Approx)
EBT `13,29,032
(iii) Earnings per share (EPS):
PAT ` 9,30,322
= = = ` 1.42
No.of shares outstanding 6,55,000 equity shares

(b) Seed Capital Assistance: The seed capital assistance has been designed by IDBI for
professionally or technically qualified entrepreneurs. All the projects eligible for financial
assistance from IDBI, directly or indirectly through refinance are eligible under the scheme. The
project cost should not exceed ` 2 crores and the maximum assistance under the project will be
restricted to 50% of the required promoter’s contribution or ` 15 lacs whichever is lower.
The seed capital assistance is interest free but carries a security charge of one percent per annum
for the first five years and an increasing rate thereafter
6. (a) NPV versus IRR: NPV and IRR methods differ in the sense that the results regarding the choice
of an asset under certain circumstances are mutually contradictory under two methods. In case of
mutually exclusive investment projects, in certain situations, they may give contradictory results
such that if the NPV method finds one proposal acceptable, IRR favours another. The different
rankings given by the NPV and IRR methods could be due to size disparity problem, time disparity
problem and unequal expected lives.
The net present value is expressed in financial values whereas internal rate of return (IRR) is
expressed in percentage terms.

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 In the net present value cash flows are assumed to be re-invested at cost of capital rate. In IRR
reinvestment is assumed to be made at IRR rates.
(b) Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the
form of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in
the year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources of
short- term borrowings and to provide an additional instrument to investors. Subsequently, in
addition to the Corporate, Primary Dealers and All India Financial Institutions have also been
allowed to issue Commercial Papers. Commercial papers are issued in denominations of ` 5 lakhs
or multiples thereof and the interest rate is generally linked to the yield on the one-year government
bond.
All eligible issuers are required to get the credit rating from Credit Rating Information Services of
India Ltd, (CRISIL), or the Investment Information and Credit Rating Agency of India Ltd (ICRA) or
the Credit Analysis and Research Ltd (CARE) or the FITCH Ratings India Pvt. Ltd or any such
other credit rating agency as is specified by the Reserve Bank of India.
(c) Desirability Factor/Profitability Index
In certain cases, we have to compare a number of proposals each involving different amount of
cash inflows. One of the methods of comparing such proposals is to work out what is known as the
‘Desirability factor’ or ‘Profitability index’. In general terms, a project is acceptable if its profitability
index value is greater than 1.
Mathematically, the desirability factor is calculated as below:
Sum of Discounted Cash inflows
Initial Cash outlay or Total Discounted Cash outflow (as the case may be)
OR
(c) Cut-off Rate: It is the minimum rate which the management wishes to have from any project.
Usually this is based upon the cost of capital. The management gains only if a project gives return
of more than the cut - off rate. Therefore, the cut - off rate can be used as the discount rate or the
opportunity cost rate.

10

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 PAPER 8B: ECONOMICS FOR FINANCE

1. (a) Production taxes or subsidies that are paid or received in relation to production and are
independent of the volume of actual production. Examples of production taxes are land revenues,
stamps and registration fees and tax on profession, factory license fee, taxes to be paid to the local
authorities, pollution tax etc. Examples of production subsidies are subsidies to railways, subsidies
to village and small industries.
Product taxes or subsidies that are paid or received on per unit of product. Examples of product
taxes are excise duties, sales tax, service tax and import-export duties. Examples of product
subsidies are food, petroleum, and fertilizer subsidies.
(b) SNA, developed by United Nations, provides a comprehensive conceptual and accounting
framework for compiling and reporting macroeconomic statistics for analyzing and evaluating the
performance of an economy.
(c) GVAMP = Gross Value Output MP – Intermediate consumption
= (Sales + change in stock) – Intermediate consumption
= 3000-500 = 2500
GDPMP = GVAMP = 2500 Crores
NDPMP = GDPMP – consumption of fixed capital
= 2500 – 100
= 2400 Crores
NDP FC = NDPMP – NIT
= 2400 – 800 = 1600 Crores
NDPFC = Compensation of employees + Operating surplus + Mixed income of Self Employed
1600 = 700+ 200 + Operating Surplus
Operating Surplus = 700Cr
2. (a) MPC = ∆C/∆Y =7000-5000 ÷10000-6000 =2000/4000
MPC =0.50
As we know, MPC + MPS = 1
Thus MPS = 1-MPC
MPS = 1- 0.50
MPS = 0.50
(b) Circular flow of income refers to the continuous interlinked phases in circulation of production,
income generation and expenditure involving different sectors of the economy. These processes
of production, distribution and disposition keep going on simultaneously and enable us to look at
national income from three different angles namely: as a flow of production or value added, as a
flow of income and as a flow of expenditure. Each of these different ways of looking at national
income suggests a different method of calculation and requires a different set of data.
(c) If the aggregate demand is for an amount of output greater than the full employment level of output,
then we say there is excess demand. Excess demand gives rise to an ‘infla tionary gap’.
(d) Maximizing social welfare is one of the primary and most commonly manifest reasons for
government intervention in the market. However, it is also possible that instead of eliminating
market distortions, sometimes government intervention may contribute to generate them.
Governments should, therefore, identify and evaluate the inefficiencies that may result from market
11

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 failure and the potential inefficiencies associated with deliberate government policies framed to
redress market failure.
3. (a) Subsidy is a form of market intervention by government. It involves the government directly paying
part of cost to the producers (or consumers) in order to promote the production (consumption) of
goods and services. The aim of subsidy is to intervene with market equilibrium to reduce the costs
and thereby the market price of goods and services and encourage increased production and
consumption. Major subsidies in India are fertiliser subsidy, food subsidy, interest subsidy, etc.
(b) Environmental pollution is regarded as a source of market failure because third parties experience
negative effects from this activity in which they did not choose to be involved. The social cost
exceeds private cost and if producers do not take into account the externalities, th ere will be
overproduction and market failure.
(c) Economists use the term ‘tragedy of the commons’ to describe the problem which occurs when
rivalrous but non-excludable goods are overused to the disadvantage of the entire universe. For
example, everyone has access to a commonly held pasture; there are no rules about sustainable
numbers for grazing. The outcome of the individual rational economic decisions of cattle owners
would be market failure because these actions result in the degradation, depletion or even
destruction of the resource leading to welfare loss for the entire society.
(d) Price floor is defined as an intervention to raise market prices if the government feels the price is
too low. In this case, since the new price is higher, the producers benefit. For a price floor to be
effective, the minimum price has to be higher than the equilibrium price. For example, many
governments intervene by establishing price floors to ensure that farmers make enough money by
guaranteeing a minimum price that their goods can be sold for. The most common example of a
price floor is the minimum wage. This is the minimum price that employers can pay workers for
their labour.
4. (a) Spending multiplier (also known as Keynesian or fiscal policy multiplier) represen ts the multiple by
which GDP increases or decreases in response to an increase and decrease in government
expenditures and investment, holding the real money supply constant. Quantitatively, the
government spending multiplier is the same as the investment multiplier. It is the reciprocal of the
marginal propensity to save (MPS). The higher the MPS, lower the multiplier, and lower the MPS,
higher the multiplier.
(b) Fiscal policy suffers from limitations such as limitations in respect of choice of appropria te policy,
recognition lag, decision lag, implementation lag, impact lag, inappropriate timing, difficulties of
forecasting due to uncertainties, possible conflicts between different objectives, possibility of
generating disincentives, practical difficulty to reduce government expenditures and the possibility
of certain fiscal measures replacing private spending or crowding out private spending.
(c) Whenever the central and the state governments’ cash balances fall short of the minimum
requirement, they are eligible to avail of a facility called Ways and Means Advances
(WMA)/overdraft (OD) facility. When the Reserve Bank of India lends to the governments under
WMA /OD, it results in the generation of excess reserves (i.e., excess balances of commercial
banks with the Reserve Bank). This happens because when the government incurs expenditure, it
involves debiting the government balances with the Reserve Bank and crediting the receiver (for
e.g., salary account of government employee) account with the commercial bank. The excess
reserves thus created can potentially lead to an increase in money supply through the money
multiplier process.
(d) M1 = Currency with public + Demand Deposits with Banking System + Other Deposits with the RBI
= 80000 crore + 100000 crores + 250000 crores
= 430000 cr

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5. (a) The factor price equalization theorem postulates that if the prices of the output of goods are
equalized between countries engaged in free trade, then the price of the input factors will also be
equalized between countries. This implies that the wages and rents will converge across the
countries with free trade, or in other words, trade in goods is a perfect substitute for trade in factors.
The Heckscher- Ohlin theorem, thus, puts forth that foreign trade eliminates the factor price
differentials. The factor price equalization theorem is in fact a corollary to the Heckscher-Ohlin
trade theory. It holds true only as long as Heckcher-Ohlin Theorem holds true.
(b) Dumping is unfair and constitutes a threat to domestic producers and therefore when dumping is
found, anti-dumping measures may be initiated as a safeguard instrument by imposing additional
import duties/tariffs so as to offset the foreign firm's unfair price advantage. This is justified only if
the domestic industry is seriously injured by import competition, and protection is in the national
interest (that is, the associated costs to consumers would be less than the benefits that would
accrue to producers). For example: In January 2017, India imposed anti-dumping duties on colour-
coated or pre- painted flat steel products imported into the country from China and European
nations for a period not exceeding six months and for jute and jute products from Bangladesh and
Nepal.
(c) A fixed exchange rate, also referred to as pegged exchange rate, is an exchange rate regime under
which a country’s government announces, or decrees, what its currency will be wo rth in terms of
either another country’s currency or a basket of currencies or another measure of value, such as
gold.
A fixed exchange rate avoids currency fluctuations and eliminates exchange rate risks and
transaction costs, enhances international trade and investment, and lowers the levels of inflation.
But the central bank has to maintain an adequate amount of reserves and be always ready to
intervene in the foreign exchange market.
(d) A horizontal direct investment is said to take place when the investor establishes the same type
of business operation in a foreign country as it operates in its home country, for example, a cell
phone service provider based in the United States moving to India to provide the same service.
A vertical investment is one under which the investor establishes or acquires a business activity
in a foreign country which is different from the investor’s main business activity yet in some way
supplements its major activity. For example, an automobile manufacturing company may a cquire
an interest in a foreign company that supplies parts or raw materials required for the company.
OR
Import subsidies also exist in some countries. An import subsidy is simply a payment per unit or as
a percent of value for the importation of a good (i.e., a negative import tariff).

13

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 Test Series: October 2022

MOCK TEST PAPER - 2

INTERMEDIATE: GROUP – II

PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE

PAPER 8A: FINANCIAL MANAGEMENT

Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.

Question No. 1 is compulsory.

Attempt any four questions from the remaining five questions.

Working notes should form part of the answer.

Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) PREPARE a working capital estimate to finance an activity level of 52,000 units a year (52 weeks)
based on the following data:
Raw Materials - ` 400 per unit
Direct Wages - ` 150 per unit
Overheads (Manufacturing) - `200 per unit
Overheads (Selling & Distribution) - `100perunit
Selling Price - ` 1,000 per unit, Raw materials & Finished Goods remain in stock for 4 weeks, Work
in process takes 4 weeks. Debtors are allowed 8 weeks for payment whereas creditors allow us 4
weeks.
Minimum cash balance expected is `50,000. Receivables are valued at Selling Price.
(b) Axar Ltd. has a Sales of ` 68,00,000 with a Variable cost Ratio of 60%.
The company has fixed cost of `16,32,000. The capital of the company comprises of 12% long
term debt, `1,00,000 Preference Shares of ` 10 each carrying dividend rate of 10% and 1,50,000
equity shares.
The tax rate applicable for the company is 30%.
At current sales level, DETERMINE the Interest, EPS and amount of debt for the firm if a 25%
decline in Sales will wipe out all the EPS.
(c) Avesh Pvt. Ltd. is considering relaxing its present credit policy for accounts receivable and is in
the process of evaluating two proposed policies. Currently, the company has annual credit sales
of ` 55 lakhs and accounts receivable turnover ratio of 5 times a year. The current level of loss
due to bad debts is ` 2,00,000. The company is required to give a return of 15% on the
investment in new accounts receivable. The company’s variable costs are 75% of the selling
price. Given the following information, IDENTIFY which is the better policy?
(Amount in `)
Particulars Present Policy Proposed Policy 1 Proposed Policy 2
Annual credit sales 55,00,000 65,00,000 70,00,000

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 Accounts receivable turnover ratio 5 times 4 times 3 times
Bad debt losses 2,00,000 3,50,000 5,00,000
(d) The annual report of XYZ Ltd. provides the following information for the Financial Year 2019-20:
Particulars Amount (`)
Net Profit 78 lakhs
Outstanding 15% preference shares 120 lakhs
No. of equity shares 6 lakhs
Return on Investment 20%
Cost of capital i.e. (Ke) 16%
CALCULATE price per share using Gordon’s Model when dividend pay-out is-
(i) 30%;
(ii) 50%;
(iii) 100%. [4 × 5 Marks = 20 Marks]
2. The financial advisor of Sun Ltd is confronted with following two alternative financing plans for raising
` 10 lakhs that is needed for plant expansion and modernization
Alternative I: Issue 80% of funds with 14% Debenture [Face value (FV) ` 100] at par and redeem at a
1
premium of 10% after 10 years and balance by issuing equity shares at 33 % premium.
3
Alternative II: Raise 10% of funds required by issuing 8% Irredeemable Debentures [Face value (FV)
` 100] at par and the remaining by issuing equity shares at current market price of `125.
Currently, the firm has an Earnings per share (EPS) of ` 21
The modernization and expansion programme is expected to increase the firm’s Earnings before Interest
and Taxation (EBIT) by ` 200,000 annually.
The firm’s condensed Balance Sheet for the current year is given below:
Balance Sheet as on 31.3.2022
Liabilities Amount (`) Assets Amount (`)
Current Liabilities 5,00,000 Current Assets 16,00,000
10% Long Term Loan 15,00,000 Plant & Equipment (Net) 34,00,000
Reserves & Surplus 10,00,000
Equity Share Capital (FV: ` 100 each) 20,00,000
TOTAL 50,00,000 TOTAL 50,00,000

However, the finance advisor is concerned about the effect that issuing of debt might have on the firm.
The average debt ratio for firms in industry is 35%.He believes if this ratio is exceeded, the P/E ratio of
the company will be 7 because of the potentially greater risk.
If the firm increases its equity capital by more than 10 %, he expects the P/E ratio of the company will
increase to 8.5 irrespective of the debt ratio.
Assume Tax Rate of 25%. Assume target dividend pay-out under each alternative to be 60% for the next
year and growth rate to be 10% for the purpose of calculating Cost of Equity

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 SUGGEST with reason which alternative is better on the basis of each of the below given criteria:
I. Earnings per share (EPS) & Market Price per share (MPS)
II. Financial Leverage
III. Weighted Average Cost of Capital & Marginal Cost of Capital (using Book Value weights)
[10 Marks]
3. From the following information and ratios, PREPARE the Balance sheet as at 31st March 2022 and
lncome statement for the year ended on that date for M/s Ganguly & Co -
Average Stock `10 lakh
Current Ratio 3:1
Acid Test Ratio 1:1
PBIT to PBT 2.2:1
Average Collection period (Assume 360 days in a year) 30 days
Stock Turnover Ratio (Use sales as turnover) 5 times
Fixed assets turnover ratio 0.8 times
Working Capital `10 lakh
Net profit Ratio 10%
Gross profit Ratio 40%
Operating expenses (excluding interest) ` 9 lakh
Long term loan interest 12%
Tax Nil
[10 Marks]
4. The initial investment outlay for a capital investment project consists of ` 150 lacs for Plant & machinery
and ` 60 lacs for Working Capital. Other details are summarized below:
Sales – 1.5 lakh units of output per year for years 1 to 5
Selling Price - 120 per unit of output
Variable cost - 60 per unit of output
Fixed overheads (excluding depreciation) - 22.5 lakhs per year for years 1 to 5
Salvage value of Plant & machinery Equal to the Written Down Value (WDV) at the end of year 5
Tax rate 40%
Time horizon 5 years
Post tax cut off rate 12%. PVAF (12%,5 Years) is 3.6048.PV @12% 5th year is 0.5674.
Rate of depreciation 20% on the Straight-Line Method (SLM)
Required:
(a) INDICATE the financial viability of the project by calculating the NPV
(b) DETERMINE the sensitivity of the project’s NPV under each of the following conditions:
(i) Decrease in selling price by 10%
(ii) Increase in variable cost by 10%
(iii) Increase in cost of Plant & machinery by 10% [10 Marks]
5. (a) The following information is related to Navya Company Ltd. for the year ended 31 st March 2022:
3

© The Institute of Chartered Accountants of India

 Equity share capital (` 10 each) ` 65,50,000
12% Bonds of ` 1,00 each ` 60,91,400
Sales ` 111 lakhs
Fixed cost (excluding interest) ` 7,15,000
Financial leverage 1.55
Profit-volume Ratio 25%
Income Tax Applicable 30%
You are required to CALCULATE:
(i) Operating Leverage.
(ii) Combined leverage; and
(iii) Earnings per share.
Show calculations upto two decimal points. [8 Marks]
(b) Write a short note on seed capital assistance. [2 Marks]
6. (a) DISTINGUISH between Net Present Value and Internal Rate of Return. [4 Marks]
(b) EXPLAIN in brief the features of Commercial Papers. [4 Marks]
(c) What do you UNDERSTAND by desirability factor/profitability index? [2 Marks]
Or
WRITE a short note on “Cut-off Rate”.

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
Question 1 is compulsory
Students can answer 3 out of the 4 remaining
1. (a) What is the distinction between Production Taxes and Product Taxes? (3 Marks)
(b) What is the System of National Accounts (SNA)? (2 Marks)
(c) Calculate the Operating Surplus with the help of the following data- (5 Marks)
Particulars ` in Crores
Sales 3000
Compensation of employees 700
Intermediate consumption 500
Rent 300
Interest 200
Net indirect tax 800
Consumption of Fixed Capital 100
Mixed Income of Self Employed 200
2. (a) Calculate Marginal Propensity to Save (MPS) and Marginal Propensity to Consume (MPC) from
the following data: (3 Marks)
Income (`) (Y) Consumption (`) (C)
6000 5000
10000 7000

(b) What is Circular flow of Income? (2 Marks)

(c) What do you understand by Inflationary gap? (2 Marks)
(d) What are the reasons for government intervention in the market? (3 Marks)
3. (a) Why do government gives Subsidies? (3 Marks)
(b) Environmental pollution is regarded as a source of market failure: Comment. (2 Marks)
(c) What is Tragedy of commons? (2 Marks)
(d) Explain the concept of Price Floor? (3 Marks)
4. (a) What is Government Spending Multiplier? (2 Marks)
(b) What are the limitation of Fiscal Policy? (2 Marks)
(c) What is the effect of Government Expenditure on Money Supply? (3 Marks)
(d) Calculate Narrow Money (M 1) from the following data (3 Marks)
Currency with public 80000 cr
Demand Deposits with Banking System 100000 cr
Time Deposits with Banking System 200000 cr
Other Deposits with RBI 250000 cr
Saving Deposits of Post office saving banks 50000 cr

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5. (a) Explain in brief The factor price equalisation theorem? (3 Marks)
(b) What is meant by an ‘Anti-dumping’ measure? (3 Marks)
(c) What are the advantage of fixed exchange rate regime? (2 Marks)
(d) Distinguish between horizontal, vertical, type of foreign Investments. (2 Marks)
OR
What is Import subsidies?

© The Institute of Chartered Accountants of India

 Test Series: March, 2023
MOCK TEST PAPER –1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:
(a) Following are the selected financial Information of Alt Car Limited for the year ended 31 st March
2022:
Financial Leverage 3
Interest ` 85,000
Operating Leverage 2
Variable cost as a percentage of sales 85%
Income tax rate 25%
You are required to PREPARE the Income Statement.
(b) Roma Nov Ltd. has a capital of `25,00,000 in equity shares of `100 each. The shares are currently
quoted at `120. The company proposes to declare a dividend of `15 per share at the end of the
current financial year. The capitalization rate for the risk class of which the company belongs is
15%. COMPUTE market price of the share at the end of the year, if
(i) Dividend is not declared.
(ii) Dividend is declared.
Assuming that the company pays the dividend and has net profits of `9,00,000 and makes new
investments of `15,00,000 during the period, CALCULATE number of new shares to be issued?
Use the MM model.
(c) Based on the following particulars SHOW various assets and liabilities of Raina Ltd.
Fixed assets turnover ratio
10 times
(Based on Cost of sales)
Capital turnover ratio
3 times
(Based on Cost of sales)
Inventory Turnover 10 times
Receivable turnover 5 times
Payable turnover 5 times
GP Ratio 40%

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 Gross profit during the year amounts to Rs.15,00,000. There is no long -term loan or overdraft.
Reserve and surplus amount to Rs.5,00,000. Ending inventory of the year is Rs. 40,000 above the
beginning inventory.
(d) Aeron We Ltd. is considering two alternative financing plans as follows:
Particulars Plan – A (`) Plan – B (`)
Equity shares of ` 100 each 90,00,000 90,00,000
Preference Shares of ` 100 each - 20,00,000
9% Debentures 20,00,000 -
1,10,00,000 1,10,00,000

The indifference point between the plans is `7,60,000. Corporate tax rate is 25%. CALCULATE
the rate of dividend on preference shares. (4 × 5 Marks = 20 Marks)
2. RML Limited needs `6,50,00,000 for the Expansion purposes. The following three plans are feasible:
(I) The Company may issue 6,50,000 equity shares at `100 per share.
(II) The Company may issue 4,00,000 equity shares at `100 per share and 2,50,000 debentures of
`100 denomination bearing a 9% rate of interest.
(III) The Company may issue 4,00,000 equity shares at `100 per share and 2,50,000 cumulative
preference shares at `100 per share bearing a 9% rate of dividend.
(i) If the Company's earnings before interest and taxes are `15,62,500, `22,50,000, `62,50,000,
`93,75,000 and `1,56,25,000, CALCULATE the earnings per share under each of three
financial plans? Assume a Corporate Income tax rate of 25%.
(ii) WHICH alternative would you recommend and why? (10 Marks)
3. You are given the following information:
(i) Estimated monthly Sales are as follows:

` `
January 5,50,000 June 4,40,000
February 6,60,000 July 5,50,000
March 7,70,000 August 4,40,000
April 4,40,000 September 3,30,000
May 3,30,000 October 5,50,000

(ii) Wages and Salaries are estimated to be payable as follows:

` `
April 49,500 July 55,000
May 44,000 August 49,500
June 55,000 September 49,500

(iii) Of the sales, 75% is on credit and 25% for cash. 60% of the credit sales are collected within one
month and the balance in two months. There are no bad debt losses.

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 (iv) Purchases amount to 75% of sales and are made and paid for in the month preceding the sales.
(v) The firm has taken a loan of `6,00,000. Interest @ 12% p.a. has to be paid quarterly in January,
April and so on.
(vi) The firm is to make payment of tax of `26,000 in July 2023.
(vii) The firm had a cash balance of `35,000 on 1St April 2023 which is the minimum desired level of
cash balance. Any cash surplus/deficit above/below this level is made up by temporary
investments/liquidation of temporary investments or temporary borrowings at the end of each
month (interest on these to be ignored).
Required:
PREPARE monthly cash budgets for six months beginning from April, 2023 on the basis of the above
information. (10 Marks)
4. Yellow bells Ltd. wants to replace its old machine with new automatic machine. The old machine had
been fully depreciated for tax purpose but has a book value of `3,50,000 on 31st March 2022. The
machine cannot fetch more than `45,000 if sold in the market at present. It will have no realizable value
after 10 years. The company has been offered `1,60,000 for the old machine as a trade in on the new
machine which has a price (before allowance for trade in) of `6,50,000. The expected life of new
machine is 10 years with salvage value of `63,000.
Further, the company follows straight line depreciation method but for tax purpose, wri tten down value
method depreciation @ 9% is allowed taking that this is the only machine in the block of assets.
Given below are the expected sales and costs from both old and new machine:

Old machine (`) New machine (`)

Sales 11,74,500 11,74,500
Material cost 2,61,000 1,83,063
Labour cost 1,95,750 1,59,500
Variable overhead 81,563 68,875
Fixed overhead 1,30,500 1,41,375
Depreciation 34,800 60,175
Profit Before Tax (PBT) 4,70,888 5,61,513
Tax @ 25% 1,17,722 1,40,378
Profit After Tax (PAT) 3,53,166 4,21,134

From the above information, ANALYSE whether the old machine should be replaced or not if required
rate of return is 10%? Ignore capital gain tax.
PV factors @ 10%:

Year 1 2 3 4 5 6 7 8 9 10
PVF 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386

(10 Marks)

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5. BIG BLOCK Ltd. is considering two mutually exclusive projects X and Y. You have been given below
the Net Cash flow probability distribution of each project:
Project- X Project – Y
Net Cash Flow (`) Probability Net Cash Flow (`) Probability
3,12,500 0.2 9,75,000 0.1
3,75,000 0.2 8,25,000 0.3
4,37,500 0.6 6,75,000 0.6
(i) REQUIRED:
(a) Expected Net Cash Flow of each project.
(b) Variance of each project.
(c) Standard Deviation of each project.
(d) Coefficient of Variation of each project.
(ii) IDENTIFY which project would you recommend? Give reasons. (10 Marks)
6. (a) What is debt securitisation? EXPLAIN the basics of debt securitisation process.
(b) DISCUSS Agency Problem and Agency Cost.
(c) DEFINE Security Premium Notes. (4 + 4+ 2 =10 Marks)

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
Question 1 is compulsory
Students can answer 3 out of the 4 remaining
Maximum Marks – 40
1. (a) Why Keynesian Equilibrium does not occur at Full Employment level? (2 Marks)
(b) Outline the difficulties in measurement of national income in India? (3 Marks)
(c) Calculate value of output from the following data: (5 Marks)
S. No. Particulars ` In lakhs
1. Net value added at factor cost 800
2. Intermediate consumption 500
3. Excise duty 400
4. Subsidy 60
5. Depreciation 80
2. (a) The nominal and real GDP respectively of a country in a particular year are 5000 Crores and
` 6000 Crores respectively. Calculate GDP deflator and analyze the on the level of prices of the
year in comparison with the base year. (2 Marks)
(b) Calculate Gross value at factor cost (3 Marks)
S. No. Particulars
1. Units of output sold (Unit) 1000
2. Price per unit of output (`) 30
3. Depreciation (`) 1000
4. Intermediate cost (`) 12000
5. Closing Stock (`) 3000
6. Opening Stock (`) 2000
7. Excise (`) 2500
8. Sales Tax (`) 3500

(c) What are the factors that causes leakages in the multiplier? (3 Marks)
(d) What is government failure? (2 Marks)
3. (a) At the time of recession what Policy government adopt for revenue and expenditure? (2 Marks)
(b) Externalities may be unidirectional or reciprocal. Substantiate this Statement with Suitable
Example? (3 Marks)
(c) What is Government Spending Multiplier? (3 Marks)
(d) What is crowding out effect? (2 Marks)
4. (a) What is the distinction between Expansionary and Contractionary fiscal Policy? (3 Marks)
(b) What is the distinction between Hard Peg and Soft Peg ? (2 Marks)
(c) What is the Anti-Dumping Duties? (3 Marks)
(d) What is Rules of Origin as Instrument of trade Policy? (2 Marks)

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5. (a) What are the advantage of floating Exchange Rate? (3 Marks)
(b) The speculative demand for money and interest are inversely related. Comment . (2 Marks)
(c) What are advantage of Positive Externalities? (2 Marks)
(d) Suppose C= 80 + 0.40 (Y- T + TR); I = 400; T= 20+0.5Y; TR= 50; G =200
Find out equilibrium level of Income? (3 Marks)
OR
What is Nominal GDP?

© The Institute of Chartered Accountants of India

 Test Series: March, 2023
MOCK TEST PAPER –1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints
EBIT
1. (a) (i) Financial Leverage =
EBIT - Interest
EBIT
Or, 3=
EBIT - Interest
EBIT
Or, 3=
EBIT -` 85000
Or, EBIT = `1,27,500
Contribution
(ii) Operating Leverage =
EBIT
Contribution
Or, = =2
1,27,500
Or, Contribution = ` 2,55,000
Contribution 2,55,000
(iii) Sales = = = `17,00,000
P / V Ratio 15%
(iv) Now, Contribution – Fixed cost = EBIT
Or ` 2,55,000 – Fixed cost = `1,27,500
Or Fixed Cost =`1,27,500
Income Statement for the year ended 31st March 2022
Particulars `
Sales 17,00,000
Less: Variable Cost (85% of Rs.17,00,000) (14,45,000)
Contribution 2,55,000
Less: Fixed Cost (Contribution - EBIT) (1,27,500)
Earnings Before Interest and Tax (EBIT) 1,27,500
Less: Interest (85,000)
Earnings Before Tax (EBT) 42,500
Less: Income Tax @ 25% (10,625)
Earnings After Tax (EAT or PAT) 31,875

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 (b) Given,
Cost of Equity (K e) 15%
Number of shares in the beginning (n) 25,000
Current Market Price (P 0) 120
Net Profit (E) 9,00,000
Expected Dividend (D 1) 15
Investment (I) 15,00,000
Computation of market price per share, when:
(i) No dividend is declared:
P1 +D1
Po =
1+k e
P1 + 0
`120 =
1 + 0.15
P1 = `138 – 0 = ` 138
(ii) Dividend is declared:
P1 + 15
`120 =
1 + 0.15
P1 = `138 – `15 = ` 123
Calculation of number of shares required for investment.
`
Earnings 9,00,000
Dividend distributed 3,75,000
Fund available for investment 5,25,000
Total Investment 15,00,000
Balance Funds required 15,00,000 – 5,25,000 = 9,75,000

Funds required
No. of shares =
Price at end(P1 )
9,75,000
= = 7,927 Shares(approx.)
123

Gross Profit
(c) G. P. ratio = = 40
Sales
Gross Profit 15,00,000
(a) Sales = x 100 = x100
40 40
= 37,50,000
(b) Cost of Sales = Sales Gross Profit = = ` 37,50,000 - ` 15,00,000
= ` 22,50,000

© The Institute of Chartered Accountants of India

 Sales
(c) Receivable turnover = =5
Receivables
Sales 37,50,000
= Receivables = =
5 5
= `7,50,000
Cost of Sales
(d) Fixed assets turnover = =10
Fixed Assets
Cost of Sales ` 22,50,000
Or Fixed assets = =
10 10
= ` 2,25,000
Cost of Sales
(e) Inventory turnover = = 10
Average Stock
Cost of Sales 22,50,000
Average Stock = = = ` 2,25,000
10 10
Opening Stock + Closing stock Opening stock + Opening stock + 40,000
Average Stock = =
2 2
Average Stock = Opening+ ` 20,000
Opening Stock= Average Stock- ` 20,000
Average Stock = ` 2,25,000 – ` 20,000
Opening Stock = ` 2,05,000
Closing Stock = Opening Stock + ` 40,000
Closing Stock = ` 2,05,000 +` 40,000 =` 2,45,000
Purchase
(f) Payable turnover = =5
Payables
Purchases = Cost of Sales + Increase in Stock
Purchases = `22,50,000 + `40,000 = `22,90,000
Purchase ` 22,90,000
Payables = = = `4,58,000
5 5
Cost of Sales ` 22,50,000
(h) Capital Employed = =
3 3
= `7,50,000
Equity share Capital = Capital Employed – Reserves & Surplus
= `7,50,000 – `5,00,000 = `2,50,000
Balance Sheet of T Ltd as on……
Liabilities ` Assets `
Capital 2,50,000 Fixed Assets 2,25,000
Reserve & Surplus 5,00,000 Stock 2,45,000
Payables 4,58,000 Receivables 7,50,000
Other Current Assets (balancing 2,38,000
figure)
14,58,000 14,58,000

© The Institute of Chartered Accountants of India

 (d) Computation of Rate of Preference Dividend
(EBIT- Interest) (1 -t) (EBIT(1-t) - Preference Dividend
=
No. of Equity Shares (N1 ) No. of Equity Shares (N2 )

(7,60,000 - 1,80,000) x (1-0.25) 7,60,000 (1-0.25) - Preference Dividend

=
90,000 shares 90,000 shares
4,35,000 5,70,000 - Preference Dividend
=
90,000 shares 90,000 shares
` 4,35,000 = ` 5,70,000 – Preference Dividend
Preference Dividend = ` 5,70,000 – ` 4,35,000 = ` 1,35,000
Preference Dividend
Rate of Dividend = ×100
Preference share capital

1,35,000
= ×100=6.75 %
20,00,000

2. Computation of EPS under three-financial plans.

Plan I: Equity Financing
(`) (`) (`) (`) (`)
EBIT 15,62,500 22,50,000 62,50,000 93,75,000 1,56,25,000
Interest 0 0 0 0 0
EBT 15,62,500 22,50,000 62,50,000 93,75,000 1,56,25,000
Less: Tax @ 25% 3,90,625 5,62,500 15,62,500 23,43,750 39,06,250
PAT 11,71,875 16,87,500 46,87,500 70,31,250 1,17,18,750
No. of equity shares 6,50,000 6,50,000 6,50,000 6,50,000 6,50,000
EPS 1.80 2.60 7.21 10.82 18.03

Plan II: Debt – Equity Mix

(`) (`) (`) (`) (`)
EBIT 15,62,500 22,50,000 62,50,000 93,75,000 1,56,25,000
Less: Interest 22,50,000 22,50,000 22,50,000 22,50,000 22,50,000
EBT (6,87,500) 0 40,00,000 71,25,000 1,33,75,000
Less: Tax @ 25% 1,71,875* 0 10,00,000 17,81,250 33,43,750
PAT (5,15,625) 0 30,00,000 53,43,750 1,00,31,250
No. of equity shares 4,00,000 4,00,000 4,00,000 4,00,000 4,00,000
EPS (`) (1.29) 0.00 7.50 13.36 25.08
* The Company can set off losses against the overall business profit or may carry forward it to next
financial years.
Plan III: Preference Shares – Equity Mix
(`) (`) (`) (`) (`)
EBIT 15,62,500 22,50,000 62,50,000 93,75,000 1,56,25,000
Less: Interest 0 0 0 0 0

© The Institute of Chartered Accountants of India

 EBT 15,62,500 22,50,000 62,50,000 93,75,000 1,56,25,000
Less: Tax @ 25% 3,90,625 5,62,500 15,62,500 23,43,750 39,06,250
PAT 11,71,875 16,87,500 46,87,500 70,31,250 1,17,18,750
Less: Pref. dividend * 22,50,000 22,50,000 22,50,000 22,50,000 22,50,000
PAT after Pref. dividend. (10,78,125) (5,62,500) 24,37,500 47,81,250 94,68,750
No. of Equity shares 4,00,000 4,00,000 4,00,000 4,00,000 4,00,000
EPS (2.70) (1.41) 6.09 11.95 23.67
* In case of cumulative preference shares, the company has to pay cumulative dividend to preference
shareholders.
(ii) In case of lower EBIT Plan I i.e Equity Financing is better however in case of higher EBIT
Plan II i.e Debt=Equity Mix is best.
3. Computation – Collections from Customers
Particulars Feb Mar Apr May Jun Jul Aug Sep
(`) (`) (`) (`) (`) (`) (`) (`)
Total Sales 6,60,000 7,70,000 4,40,000 3,30,000 4,40,000 5,50,000 4,40,000 3,30,000
Credit Sales
(75% of total 4,95,000 5,77,500 3,30,000 2,47,500 3,30,000 4,12,500 3,30,000 2,47,500
Sales)
Collection
(within one 2,97,000 3,46,500 1,98,000 1,48,500 1,98,000 2,47,500 1,98,000
month)
Collection
(within two 1,98,000 2,31,000 1,32,000 99,000 1,32,000 1,65,000
months)
Total
5,44,500 4,29,000 2,80,500 2,97,000 3,79,500 3,63,000
Collections

Monthly Cash Budget for Six Months: April to September 2023

Particulars April May June July August Sept.
(`) (`) (`) (`) (`) (`)
Receipts:
Opening Balance 35,000 35,000 35,000 35,000 35,000 35,000
Cash Sales 1,10,000 82,500 1,10,000 1,37,500 1,10,000 82,500
Collections from Debtors 5,44,500 4,29,000 2,80,500 2,97,000 3,79,500 3,63,000
Total Receipts (A) 6,89,500 5,46,500 4,25,500 4,69,500 5,24,500 4,80,500
Payments:
Purchases 2,47,500 3,30,000 4,12,500 3,30,000 2,47,500 4,12,500
Wages and Salaries 49,500 44,000 55,000 55,000 49,500 49,500
Interest on Loan 18,000 ----- ----- 18,000 ----- -----
Tax Payment ----- ----- ----- 26,000 ----- -----
Total Payment (B) 3,15,000 3,74,000 4,67,500 4,29,000 2,97,000 4,62,000
Minimum Cash Balance 35,000 35,000 35,000 35,000 35,000 35,000
Total Cash Required (C) 3,50,000 4,09,000 5,02,500 4,64,000 3,32,000 4,97,000
Surplus/ (Deficit) (A)-(C) 3,39,500 1,37,500 -77,000 5,500 1,92,500 -16,500

© The Institute of Chartered Accountants of India

 Investment/Financing:
Total effect of (Invest)/
-3,39,500 -1,37,500 77,000 -5,500 -1,92,500 16,500
Financing (D)
Closing Cash Balance (A)
35,000 35,000 35,000 35,000 35,000 35,000
+ (D) - (B)

4. (i) Calculation of Base for depreciation or Cost of New Machine

Particulars (`)
Purchase price of new machine 6,50,000
Less: Sale price of old machine 1,60,000
4,90,000
(ii) Calculation of Profit before tax as per books
Old machine New machine Difference
Particulars
(`) (`) (`)
PBT as per books 4,70,888 5,61,513 90,625
Add: Depreciation as per books 34,800 60,175 25,375
Profit before tax and depreciation (PBTD) 5,05,688 6,21,688 1,16,000
Calculation of Incremental NPV
Dep. @ Tax @ Cash PV of Cash
PVF PBTD PBT
Year 9% 25% Inflows Inflows
@ 10% (`) (`) (`) (`) (`) (`)
(5) = (4) x (6) = (4) – (7) = (6) x
1 2 3 4(2-3)
0.25 (5) + (3) (1)
1 0.909 1,16,000.00 44,100.00 71,900.00 17,975.00 98,025.00 89,104.73
2 0.826 1,16,000.00 40,131.00 75,869.00 18,967.25 97,032.75 80,149.05
3 0.751 1,16,000.00 36,519.21 79,480.79 19,870.20 96,129.80 72,193.48
4 0.683 1,16,000.00 33,232.48 82,767.52 20,691.88 95,308.12 65,095.45
5 0.621 1,16,000.00 30,241.56 85,758.44 21,439.61 94,560.39 58,722.00
6 0.564 1,16,000.00 27,519.82 88,480.18 22,120.05 93,879.95 52,948.29
7 0.513 1,16,000.00 25,043.03 90,956.97 22,739.24 93,260.76 47,842.77
8 0.467 1,16,000.00 22,789.16 93,210.84 23,302.71 92,697.29 43,289.63
9 0.424 1,16,000.00 20,738.14 95,261.86 23,815.47 92,184.53 39,086.24
10 0.386 1,16,000.00 18,871.70 97,128.30 24,282.07 91,717.93 35,403.12
5,83,834.77
Add: PV of Salvage value of new machine (` 63,000 ´ 0.386) 24,318.00
Total PV of incremental cash inflows 6,08,152.77
Less: Cost of new machine [as calculated in point(i)] 4,90,000.00
Incremental Net Present Value 1,18,152.77

Analysis: Since the Incremental NPV is positive, the old machine should be replaced.

© The Institute of Chartered Accountants of India

5. (i) (a) Expected Net Cash Flow (ENCF) of Projects
Project X Project Y
Net Cash Expected Net Net Cash Expected Net
Flow Probability Cash Flow Flow Probability Cash Flow
(`) (`) (`) (`)
3,12,500 0.2 62,500 9,75,000 0.1 97,500
3,75,000 0.2 75,000 8,25,000 0.3 2,47,500
4,37,500 0.6 2,62,500 6,75,000 0.6 4,05,000
4,00,000 7,50,000
(b) Variance of Projects
Project X
= (`3,12,500 – `4,00,000) 2 (0.2) + (`3,75,000 – `4,00,000) 2 (0.2) + (`4,37,500 – `4,00,000) 2
(0.6)
= `1,53,12,50,000 + `12,50,00,000 + `84,37,50,000
= `2,50,00,00,000
Project Y
= (`9,75,000 – `7,50,000) 2 (0.1) + ` (8,25,000 – `7,50,000) 2 (0.3) + (`6,75,000 – `7,50,000) 2
(0.6)
= `5,06,25,00,000 + `1,68,75,00,000 + `3,37,50,00,000
= `10,12,50,00,000
(c) Standard Deviation of Projects
Project X
= Variance

=√ 2,50,00,00,000 = ` 50,000

Project Y
= Variance
= √10,12,50,00,000

= `10,0623.06
(d) Coefficient of Variation of Projects
Standard Deviation
Project Coefficient of variation =
Expected Net Cash Flow
50,000
X = 0.125 or 12.5%
4,00,000

1,00,623.06
Y = 0.1342 or 13.42%
7,50,000

(ii) Coefficient of Variation of Project X is 0.125 and Project Y is 0.1342. So, the risk per rupee of net
cash flow is less of Project X, therefore, Project X is better than Project Y.

© The Institute of Chartered Accountants of India

6. (a) Debt Securitisation: It is a method of recycling of funds. It is especially beneficial to financial
intermediaries to support the lending volumes. Assets generating steady cash flows are packaged
together and against this asset pool, market securities can be issued, e.g. housing finance, auto
loans, and credit card receivables.
Process of Debt Securitisation
(i) The origination function – A borrower seeks a loan from a finance company, bank, HDFC. The
credit worthiness of borrower is evaluated and contract is entered into with repayment
schedule structured over the life of the loan.
(ii) The pooling function – Similar loans on receivables are clubbed together to create an
underlying pool of assets. The pool is transferred in favour of Special purpose Vehicle (SPV),
which acts as a trustee for investors.
(iii) The securitisation function – SPV will structure and issue securities on the basis of asset pool.
The securities carry a coupon and expected maturity which can be asset -based/mortgage
based. These are generally sold to investors through merchant bankers. Investors are –
pension funds, mutual funds, insurance funds.
The process of securitization is generally without recourse i.e. investors bear the credit risk
and issuer is under an obligation to pay to investors only if the cash flows are received by him
from the collateral. The benefits to the originator are that assets are shifted off the balance
sheet, thus giving the originator recourse to off-balance sheet funding.
(b) Agency Problem and Agency Cost: Though in a sole proprietorship firm, partnership etc., owners
participate in management but incorporates, owners are not active in management so, there is a
separation between owner/ shareholders and managers. In theory, managers should act in the best
interest of shareholders however in reality, managers may try to maximise their individual goal like
salary, perks etc., so there is a principal agent relationship between managers and owners, which
is known as Agency Problem. In a nutshell, Agency Problem is the chances that managers may
place personal goals ahead of the goal of owners. Agency Problem leads to Agency Cost. Agency
cost is the additional cost borne by the shareholders to monitor the manager and control their
behaviour to maximise shareholders wealth. Generally, Agency Costs are of four types (i)
monitoring (ii) bonding (iii) opportunity (iv) structuring.
(c) Secured Premium Notes: Secured Premium Notes is issued along with a detachable warrant and
is redeemable after a notified period of say 4 to 7 years. The conversion of detachable warrant into
equity shares will have to be done within time period notified by the company.

© The Institute of Chartered Accountants of India

 PAPER 8B: ECONOMICS FOR FINANCE
ANSWERS
1. (a) Keynesian equilibrium with equality of planned aggregate expenditures and output need not take
place at full employment. If the aggregate expenditure line intersects the 45-degree line at the level
of potential GDP, then there is full employment equilibrium. There is no recession, and
unemployment is at the natural rate. But there is no guarantee that the equilibrium will occur at the
potential GDP level of output. The economy can settle at any equilibrium which might be higher or
lower than the full employment equilibrium.
(b) There are many conceptual difficulties related to measurement which are difficult to resolve, such
as:
(a) lack of an agreed definition of national income,
(b) accurate distinction between final goods and intermediate goods,
(c) issue of transfer payments,
(d) services of durable goods,
(e) difficulty of incorporating distribution of income,
(f) valuation of a new good at constant prices, and valuation of government services
(c) NVA at FC = Value of Output – Intermediate Consumption – Depreciation – (Excise Duty – Subsidy)
Thus, Value of output = Net value added at factor cost + Intermediate consumption + Depreciation
+ (Excise duty-Subsidy)
= 800 + 500 + 80 + (400-60)
= ₹ 1720 lakhs
2. (a) Nominal GDP = 5000 Crores Real GDP = 6 000 Crores
Nominal GDP
DP Deflator = ×100
Real GDP
= 5000÷6000 × 100
= 83.33
The price level has fallen since GDP deflator is less than 100 at 83.33
(b) Gross value at factor cost = Total Sales + Change in Stock - Intermediate Consumption – Net
Indirect Tax
= (1000 x 30) + (3000 - 2000) – 12000 - (2500 + 3500)
= ₹ 13000
(c) The leakages are caused due to:
• progressive rates of taxation which result in no appreciable increase in consumption despite
increase in income.
• high liquidity preference and idle saving or holding of cash balances and an equivalent fall in
marginal propensity to consume.
• increased demand for consumer goods being met out of the existing stocks or through
imports.
• additional income spent on purchasing existing wealth or purchase of government securities

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© The Institute of Chartered Accountants of India
 and shares from shareholders or bond holders.
• undistributed profits of corporations
• part of increment in income used for payment of debts.
• case of full employment additional investment will only lead to inflation, and
• scarcity of goods and services despite having high MPC
(d) A government failure is said to occur when government intervention in the market creates
inefficiency and leads to misallocation of society’s scarce resources. The possible sources of this
type of government failures are inadequate information, political self-interest, conflicting objectives,
bureaucracy, corruption and red tape, and high administrative costs involved in government
intervention. Government failure may be relatively inconsequential if it gets restricted to being
simply ineffective and therefore the costs of such intervention are limited to the resources wasted
for such intervention. Government failure is more serious when such intervention has generated
new and serious problems which will have far reaching adverse consequences on the welfare of
citizens. Governments should, therefore, identify and evaluate the inefficiencies that may result
from market failure and the potential inefficiencies associated with deliberate government policies
framed to redress market failure.
3. (a) Government expenditure injects more money into the economy and stimulates demand. On the
other hand, taxes reduce the disposable income of people and therefore, reduce effective demand.
During recession, in order to ensure income protection, the government increases its expenditure
or cuts down taxes or adopts a combination of both so that aggregate demand is kept stable or
even boosted up with more money put into the hands of the people. On the other hand, to control
high inflation the government cuts down its expenditure or raises taxes. In other words, an
expansionary fiscal policy is adopted to alleviate recession and a contractionary fiscal policy is
resorted to for controlling high inflation. Generally, government’s fiscal policy has a strong influence
on the performance of the macro economy in terms of employment, price stability, economic
growth, and external balance.
(b) The unique feature of an externality is that it is initiated and experienced not through the operation
of the price system, but outside the market. Since it occurs outside the price mechanism, it has not
been compensated for, or in other words it is uninternalized or the cost (benefit) of it is not borne
(paid) by the parties. Suppose a workshop creates ear- splitting noise and imposes an externality
on a baker who produces smoke and disturbs the workers in the workshop, then this is a case of
reciprocal externality. If an accountant who is disturbed by loud music but has not imposed any
externality on the singers, then the externality is unidirectional.
(c) Spending multiplier (also known as Keynesian or fiscal policy multiplier) represents the multiple by
which GDP increases or decreases in response to an increase and decrease in government
expenditures and investment, holding the real money supply constant. Quantitatively, the
government spending multiplier is the same as the investment multiplier. It is the reciprocal of the
marginal propensity to save (MPS). Higher the MPS, lower the multiplier, and lower the MPS, higher
the multiplier.
(d) The crowding out view is that a rapid growth of government spending leads to a transfer of scarce
productive resources from the private sector to the public sector where productivity might be lower.
An increase in the size of government spending during recessions will ‘crowd-out’ private spending
in an economy and lead to reduction in an economy’s ability to self-correct from the recession, and
possibly also reduce the economy’s prospects of long-run economic growth.

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© The Institute of Chartered Accountants of India
4. (a) The distinction between Expansionary and Contractionary Policy is as follows:
Expansionary fiscal policy is designed to stimulate the economy during the contractionary phase
of a business cycle and is accomplished by increasing aggregate expenditures and aggregate
demand through an increase in all types of government spending and / or a decrease in taxes.
Contractionary fiscal policy is designed to restrain the levels of economic activity of the economy
during an inflationary phase by decreasing the aggregate expenditures and aggregate demand
through a decrease in all types of government spending and/ or an increase in taxes.
(b) Hard peg: An exchange rate policy where the central bank sets a fixed and unchanging value for
the exchange rate.
Soft peg: An exchange rate policy under which the exchange rate is generally determined by the
market, but in case the exchange rate tend to be move speedily in one direction, the central bank
will intervene in the market.
(c) An anti-dumping duty is a protectionist tariff that a domestic government imposes on foreign
imports that it believes are priced below fair market value. Dumping occurs when manufacturers
sell goods in a foreign country below the sales prices in their domestic market or below their full
average cost of the product. Dumping may be persistent, seasonal, or cyclical. Dumping may also
be resorted to as a predatory pricing practice to drive out established domestic producers from the
market and to establish monopoly position.
(d) Country of origin means the country in which a good was produced, or in the case of a traded
service, the home country of the service provider. Rules of origin are the criteria needed by
governments of importing countries to determine the national source of a product. Their importance
is derived from the fact that duties and restrictions in several cases depend upon the source of
imports. Important procedural obstacles occur in the home countries for making available
certifications regarding origin of goods, especially when different components of the product
originate in different countries.
5. (a) A floating exchange rate has many advantages:
(i) A floating exchange rate has the greatest advantage of allowing a Central bank and /or
government to pursue its own independent monetary policy.
(ii) Floating exchange rate regime allows exchange rate to be used as a policy tool: for example,
policymakers can adjust the nominal exchange rate to influence the competitiveness of the
tradable goods sector.
(iii) As there is no obligation or necessity to intervene in the currency markets, the central bank
is not required to maintain a huge foreign exchange reserves.
(b) So long as the current rate of interest is higher than the critical rate of interest, a typical wealth-
holder would hold in his asset portfolio only government bonds, and if the current rate of interest
is lower than the critical rate of interest, his asset portfolio would consist wholly of cash. When the
current rate of interest is equal to the critical rate of interest, a wealth-holder is indifferent to holding
either cash or bonds.
(c) Since positive externalities promote welfare, governments implement policies that promote positive
externalities. When positive externalities are present, government may attempt to solve the
problem through corrective subsidies to the producers aimed at either increasing the supply of the
good or through corrective subsidies to consumers aimed at increasing the demand for the good.

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 (d) Y = C + I + G
Y= 80 + 0.40 (Y- T + TR) + I+ G
Y = 100 +0.40(Y – 20 - 0.5Y + 50) + 400 + 200
Y = 100 + 0.40Y – 8- 0.2Y + 20 + 600
Y = 712 + 0.2Y
Y-0.2Y = 712
0.8 Y = 712
Y = 712 ÷ 0.8
= 890
OR
Gross Domestic Product (GDP) evaluated at current market prices and is not inflation adjusted.
Therefore, nominal values of GDP for different time periods can differ due to changes in quantities
of goods and services and/or changes in general price levels.

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