FM Fast Track Volume 1 - 2024-02-19 17-12-41

CA INTERMEDIATE
FINANCIAL MANAGEMENT
VOLUME I
By
CA. Namit Arora Sir
This book is dedicated to my Mother
‘MRS. RAMAN ARORA’
ABOUT THE AUTHOR

Mr. Namit Arora is a First class commerce graduate and member of The
Institute of Chartered Accountants of India (ICAI). He has cleared both groups of
PCC examination and final examination in his first attempt.
He has vast experience of teaching even at such young age. He has taught
large number of students of various professional courses such as CA, CS, CMA
and also of undergraduate and post graduate course for university
examinations. He is also author of Taxmann.
His specialized knowledge helps the students to understand the topic
easily and his expert advice makes the revision very easy and fast.
He gives practical examples that help students to visualize the concepts
and his teaching style is very famous among the students.
PREFACE TO THIS EDITION
This is a comprehensive book having thoroughly explained concepts with lucid and systematic
presentation of the subject matter. All attempts are made in this book to keep concept easier
to understand and remember.
A special attention is given to presentation keeping in mind the examination needs to
the student. The book is primarily written for CA – INTERMEDIATE exams.
For any suggestion please mail me at canamitarora@gmail.com
A word to the students

My dear student, hard work is the key to success. Though smart work is publicized in today’s
world but to be smart, you have to work hard. So always be attentive in class and have
thorough revision after the class. It is also important to be motivated and inspired for working
hard. The key for success is:
“Work hard in class, be attentive and grab the concepts

&
Work smart during revision, select important questions for next
revision.”
ALL THE BEST

CA. NAMIT ARORA
INDEX
S. NO. CHAPTERS NAME PAGE NO. WEIGHTAGE
0 INTRODUCTION 0.1 – 0.3 –
1 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.1 – 1.23 5 – 10
2 LEVERAGES 2.1 – 2.39 5 – 10
3 MANAGEMENT OF RECEIVABLES & PAYABLES 3.1 – 3.21 5 – 10
4 MANAGEMENT OF WORKING CAPITAL 4.1 – 4.24 5 – 10
5 TREASURY & CASH MANAGEMENT 5.1 – 5.18 5
6 RATIO ANALYSIS 6.1 – 6.53 5 – 10
7 CAPITAL BUDGETING/INVESTMENT DECISION 7.1 – 7.62 10
8 COST OF CAPITAL 8.1 – 8.37 5 – 10
9 CAPITAL STRUCTURE 9.1 – 9.18 5 – 10
10 DIVIDEND DECISIONS 10.1 – 10.23 5
11 TABLES – –
CHAPTER 0 INTRODUCTION
INCOME STATEMENT & BALANCE SHEET
1. CA Intermediate Syllabus:
2. Study Pattern and Books:
0.1
INTRODUCTION CHAPTER 0
3. Financial Management:
Financial management refers to that managerial activity which is concerned with the arrangement
of funds from various sources with consideration of cost, control and risk involved with such
sources and application of these funds in an effective manner to maximize shareholders earning
and wealth (EPS and MPS).
4. Financial Management Decisions:
0.2
5. Considerations in Case of Financing Decision:
6. Objectives of Financial Management:
7. Economic Value Added: ROI – Cost of Capital (KC)
0.3
CHAPTER 1 CAPITAL STRUCTURE – EBIT & EPS ANALYSIS
EARNING PER SHARE (EPS) AND MARKET PRICE OF SHARE (MPS)
BQ 1
Paramount Produces Ltd. wants to raise `100 lakhs for a diversification project. Current estimate of
earnings before interest and taxes (EBIT) from the new projects is `22 lakhs per annum.
Cost of debt will be 15% for amounts up to and including `40 lakhs, 16% for additional amounts
up to and including `50 lakhs and 18% for additional amounts above `50 lakhs.
The equity shares (face value `10) of the company have a current market value of `40. This is
expected to fall to `32 if debts exceeding `50 lakhs are raised. The following options are under
consideration of the company:
Options Equity Debt
I 50% 50%
II 60% 40%
III 40% 60%
Determine the earning per share (EPS) for each option and state which option the company
should exercise. Tax rate applicable to the company is 50%.
[(I) `5.76 (II) `5.33 (III) `5.04]
BQ 2
A company needs `12,00,000 for the installation of a new factory which would yield an annual EBIT of
`2,00,000. The company has the objective of maximising the earnings per share.
It is considering the possibility of issuing equity shares plus raising a debt of `2,00,000,
`6,00,000 or `10,00,000.
The current market price per share is `40 which is expected to drop to `25 per share if the
market borrowings were to exceed `7,50,000. Cost of borrowings is indicated as under:
Upto `2,50,000 10% p.a.
Between `2,50,001 and `6,25,000 14% p.a.
Between `6,25,001 and `10,00,000 16% p.a.
Assuming the tax rate to be 50%, work out the EPS and the scheme which would meet the
objective of the management.
[(I) EPS `3.60 (II) EPS `4.20 (III) EPS `3.91; Alternative II should be selected]
BQ 3
A firm has an all equity capital structure consisting of 1,00,000 ordinary shares of `10 per share. The
firm wants to raise `250,000 to finance its investments and is considering three alternative methods of
financing:
1. To issue 25,000 ordinary shares at `10 each,
2. To borrow `2,50,000 at 8 per cent rate of interest,
3. To issue 2,500 preference shares of `100 each at an 8 per cent rate of dividend.
1.1
CAPITAL STRUCTURE – EBIT & EPS ANALYSIS CHAPTER 1
The expected firm’s earnings before interest and taxes after additional investment is `3,12,500 and the
tax rate is 50 per cent.
Calculate EPS under all three alternatives.
Answer
Statement of Earnings Per Share (EPS)
Particulars Equity Debt Preference
EBIT 3,12,500 3,12,500 3,12,500
Less: Interest @ 8% of `2,50,000 - 20,000 -
PBT 3,12,500 2,92,500 3,12,500
Less: Tax @ 50% 1,56,250 1,46,250 1,56,250
PAT 1,56,250 1,46,250 1,56,250
Less: Preference Dividend @ 8% of `2,50,000 - - 20,000
Earnings Available for Equity Shareholders 1,56,250 1,46,250 1,36,250
÷ No. of Equity shares:
Existing 1,00,000 1,00,000 1,00,000
New 25,000 - -
EPS `1.25 `1.4625 `1.3625
BQ 4
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 maximizing earnings per share.
It has three alternatives to finance the projects 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% up to `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%.
Which form of financing should the company choose?
Answer
Statement of EPS
Alternatives
Particulars
1 2 3
Earnings before interest and tax 5,00,000 5,00,000 5,00,000
Less: Interest:
@ 10% on first `2,50,000 25,000 25,000 25,000
@ 15% on `2,50,001 to `10,00,000 - 1,12,500 1,12,500
@ 20% on above `10,00,000 - - 1,00,000
EBT 4,75,000 3,62,500 2,62,500
Less: Tax @ 50% 2,37,500 1,81,250 1,31,250
EAT 2,37,500 1,81,250 1,31,250
÷ No. of Equity shares 15,000 10,000 8,000
(22,50,000/150) (15,00,000/150) (10,00,000/125)
EPS `15.833 `18.125 `16.406
Decision: The earning per share is higher in alternative II i.e. if the company finance the project by raising
debt of `10,00,000 & issue equity shares of `15,00,000. Therefore, the company should choose this
1.2
alternative to finance the project.
BQ 5
Best of Luck Ltd., a profit making company, has a paid-up capital of `100 lakhs consisting of 10 lakhs
ordinary shares of `10 each. Currently, it is earning an annual pre-tax profit of `60 lakhs. The company's
shares are listed and are quoted in the range of `50 to `80. The management wants to diversify
production and has approved a project which will cost `50 lakhs and which is expected to yield a pre-
tax income of `40 lakhs per annum.
To raise this additional capital, the following options are under consideration of the management:
(a) To issue equity share capital for the entire additional amount. It is expected that the new shares
(face value of `10) can be sold at a premium of `15.
(b) To issue 16% non-convertible debentures of `100 each for the entire amount.
(c) To issue equity capital for `25 lakhs (face value of `10) and 16% non-convertible debentures for
the balance amount. In this case, the company can issue shares at a premium of `40 each.
You are required to advise the management as to how the additional capital can be raised, keeping
in mind that the management wants to maximise the earnings per share to maintain its goodwill. The
company is paying income tax at 50%.
Answer
Statement of EPS
Alternatives
Particulars
Option I Option II Option III
Earnings before interest and tax 1,00,00,000 1,00,00,000 1,00,00,000
Less: Interest @ 16% on `50 Lakhs/`25 Lakhs - 8,00,000 4,00,000
EBT 1,00,00,000 92,00,000 96,00,000
Less: Tax @ 50% 50,00,000 46,00,000 48,00,000
EAT 50,00,000 46,00,000 48,00,000
÷ No. of Equity shares 12,00,000 10,00,000 10,50,000
EPS `4.17 `4.60 `4.57
Advise: Option II i.e. issue of 16% Debentures is most suitable to maximize the earnings per share.
BQ 6
Akash Limited provides you the following information:
Particulars `
Earnings before interest and tax 2,80,000
Less: Debenture interest @ 10% 40,000
Earnings before tax 2,40,000
Less: Income tax @ 50% 1,20,000
Earnings after tax 1,20,000
No. of Equity Shares (`10 each) 30,000
Earning per share (EPS) `4.00
Price Earning (PE) Ratio 10
The company has reserves and surplus of `7,00,000 lakhs and required `4,00,000 further for
modernisation. Return on Capital Employed (ROCE) is constant. Debt (Debt/Debt + Equity) Ratio higher
than 40% will bring the P/E Ratio down to 8 and increase the interest rate on additional debts to 12%.
1.3
You are required to ascertain the probable price on the share.

(1) If the additional capital are raised as debt and
(2) If the amount is raised by issuing equity shares at ruling market price.
Answer
Statement of Market Value Per Share (MPS)
Particulars Debt Plan Equity Plan
EBIT @ 20% of 18,00,000 (14,00,000 + 4,00,000) 3,60,000 3,60,000
Less: Interest: Existing 40,000 40,000
New (12% of `4,00,000) 48,000 -
EBT 2,72,000 3,20,000
Less: Tax @ 50% 1,36,000 1,60,000
PAT 1,36,000 1,60,000
÷ No. of Equity shares 30,000 40,000
EPS `4.53 `4.00
× PE Ratio 8 Times 10 Times
MPS `36.24 `40.00
Working notes:
1. Calculation of capital employed before expansion plan:
Equity share capital (30,000 shares × `10) `3,00,000

Retained earnings `7,00,000
Debentures (40,000/10%) `4,00,000
Total capital employed `14,00,000
2. Return on Capital Employed (ROCE):
EBIT 2,80 ,000

ROCE = × 100 = × 100 = 20%
Capital Employed 14 ,00 ,000
3. Debt Ratio if `4,00,000 is raised as debt:
8 ,00 ,000 ( 4 ,00 ,000 + 4 ,00 ,000 )

= × 100 = 44.44%
18 ,00 ,000 (14 ,00 ,000 + 4 ,00 ,000 )
As the debt ratio is more than 40% the P/E ratio will be brought down to 8 in Plan 1
4. Debt Equity Ratio if `4,00,000 is raised as Equity:
4 ,00 ,000
= × 100 = 22.22%
18 ,00 ,000
As the debt ratio is less than 40% the P/E ratio in this case will remain at 10 times in Plan 2.
5. Number of Equity Shares to be issued in Plan 2:
4 ,00 ,000
= = 10,000 shares
40
1.4
BQ 7
The following data are presented in respect of Quality Automation Ltd.:
Particulars `
Profit before interest and tax 52,00,000
Less: Debenture interest @ 12% 12,00,000
Profit before tax 40,00,000
Profit after tax 20,00,000
No. of Equity Shares (`10 each) 8,00,000
Earning per share (EPS) `2.50
Price Earning (PE) Ratio, 10
Market Price Per Share `25.00
The company is planning to start a new project requiring a total capital outlay of `40,00,000. You
are informed that a debt equity ratio (D/D+E) higher than 35% push the Ke up to 12.5% means reduce
PE ratio to 8 and rises the interest rate on additional amount borrowed at 14%.
Find out the probable price of share if:

(1) The additional funds are raised as a loan.
(2) The amount is raised by issuing equity shares.
(Note: Retained earnings of the company is `1.2 crore)
Answer
EBIT @ 17.⅓% of 3,40,00,000 (3,00,00,000 + 40,00,000) 58,93,333 58,93,333
Less: Interest: Existing 12,00,000 12,00,000
New (14% of `40,00,000) 5,60,000 -
EBT 41,33,333 46,93,333
Less: Tax @ 50% 20,66,667 23,46,667
PAT 20,66,666 23,46,666
÷ No. of Equity shares 8,00,000 9,60,000
EPS `2.583 `2.444
MPS `20.66 `24.44
Note: In this question EBIT after proposed extension is not given. Therefore, we can assume that existing
return on capital employed will be maintained.
Working notes:
Equity share capital (8,00,000 shares × `10) `80,00,000

Retained earnings `1,20,00,000
Debentures (12,00,000/12%) `1,00,00,000
Total capital employed `3,00,00,000
1.5
EBIT 52 ,00 ,000

ROCE = × 100 = × 100 = 17.⅓%
Capital Employed 3,00 ,00 ,000
3. Debt Equity Ratio if `40,00,000 is raised as Debt:
1 ,40 ,00 ,000 (1 ,00 ,00 ,000 + 40 ,00 ,000 )

= × 100 = 41.18%
3,40 ,00 ,000 (3,00 ,00 ,000 + 40 ,00 ,000 )
As the debt equity ratio is more than 35% the P/E ratio will be brought down to 8 in Plan 1
1 ,00 ,00 ,000

= × 100 = 29.41%
3 ,40 ,00 ,000
As the debt equity ratio is less than 35% the P/E ratio in this case will remain at 10 times in Plan
40 ,00 ,000
= = 1,60,000 shares
25
Decision: Though loan option has higher EPS but equity option has higher MPS therefore company
should raise additional fund through equity option.
INDIFFERENCE POINT
BQ 8
Ganesha Ltd. is setting up a project with a capital outlay of `60,00,000. It has the following two
alternatives in financing the project cost.
Alternative 1 : 100% Equity finance by issuing equity shares of `10 each
Alternative 2 : Debt-Equity ratio 2:1 (equity shares will be of `10 each)
The rate of interest payable on the debt is 18% p.a. The corporate rate of tax is 40%.
Calculate the indifference point between two alternative methods of financing.

[`10,80,000]
BQ 9
Aaina Ltd. is considering a new project which requires a capital investment of `9 crores. Interest on term
loan is 12% and Corporate Tax rate is 30%. Calculate the point of indifference for the project considering
the Debt Equity ratio insisted by the financing agencies being 2 : 1.
Answer
The capital investment can be financed in two ways i.e.
(i) By issuing equity shares only worth `9 crores or
(ii) By raising capital through taking a term loan of `6 crores and `3 crores through issuing equity
shares (as the company has to comply with the 2 : 1 Debt Equity ratio insisted by financing
agencies).
1.6
Calculation of point of Indifference:

(EBIT−I) (1−T) (EBIT−I) (1−T)
N1
= N2
(EBIT−Nil) (1−0.30) (EBIT−12% of 6,00,00,000) (1−0.30)
=
90,00,000 30,00,000
EBIT = 3 × (EBIT – 72,00,000)

EBIT = 2,16,00,0000 ÷ 2 = 1,08,00,000
Note: The face value of the equity shares is assumed as `10 per share.
BQ 10
A new project under consideration requires a capital outlay of `300 lakhs. The required funds can be
raised either fully by equity shares of `100 each or by equity shares of the value of `200 lakhs and by
loan of `100 lakhs at 15% interest. Assuming a tax rate of 50%.
Calculate the figure of profit before interest and tax that would keep the equity investors
indifferent to the two options. Verify your answer by calculating the EPS.
Answer
Calculation of Indifference point:
EBIT  I 1  T  = EBIT  I 1  T 
N1 N2
EBIT  NIL  1  0.50  = EBIT  15 ,00 ,000  1  0.50 

3,00 ,000 2,00 ,000
EBIT = `45,00,000
Verification:
Statement of EPS
Particulars Situation I Situation II
Profit before interest and tax 45,00,000 45,00,000
Less: Interest charges - 15,00,000
Profit before tax 45,00,000 30,00,000
Less: Tax @ 50% 22,50,000 15,00,000
Profit after tax 22,50,000 15,00,000
EPS `7.50 `7.50
BQ 11
Yoyo Limited presently has `36,00,000 in debt outstanding bearing an interest rate of 10 per cent. It
wishes to finance a `40,00,000 expansion programme and is considering three alternatives: additional
debt at 12 per cent interest, preference shares with an 11 per cent dividend, and the issue of equity
shares at `16 per share. The company presently has 8,00,000 shares outstanding and is in a 40 per cent
tax bracket.
(a) If earnings before interest and taxes are presently `15,00,000, what would be earnings per share
for the three alternatives, assuming no immediate increase in profitability?
(b) Analyse which alternative do you prefer? Compute how much would EBIT need to increase before
the next alternative would be best?
1.7
Answer
(a) Statement of EPS
Alternatives
Particulars
Debt Preference Equity
Less: Interest:
Existing @ 10% on `36,00,000 3,60,000 3,60,000 3,60,000
New 12% on `40,00,000 4,80,000 - -
EBT 6,60,000 11,40,000 11,40,000
Less: Tax @ 40% 2,64,000 4,56,000 4,56,000
EAT 3,96,000 6,84,000 6,84,000
Less: Preference Dividend - 4,40,000 -
Earnings Available for Equity Shareholders 3,96,000 2,44,000 6,84,000
÷ No. of Equity shares 8,00,000 8,00,000 10,50,000
EPS `0.495 `0.305 `0.651
(b) For the present EBIT level, equity share is clearly preferable. EBIT would need to increase by
`8,76,000 (`23,76,000 − `15,00,000) before next alternative i.e. debt would be best.
Working Note:
Indifference point between Equity (best option) and Debt (second best option) of financing:
EBIT  I1  T  = EBIT  I1  T 

N1 N2
EBIT  3,60 ,000  1  0.40  = EBIT  8 ,40 ,000  1  0.40 

1 ,05 ,000 80 ,000
EBIT = `23,76,000
BQ 12
Ganapati Limited is considering three financing plans. The key information is as follows:
(a) Total investment to be raised `2,00,000.
(b) Financing proportion of Plans:
Plans Equity Debt Preference Shares
A 100% - -
B 50% 50% -
C 50% - 50%
(c) Cost of debt is 8%
Cost of preference shares is 8%
(d) Tax rate 50%
(e) Equity shares of the face value of `10 each will be issued at a premium of `10 per share
(f) Expected EBIT is `80,000.
You are required to determine for each plan:

(1) Earnings per share
(2) Financial break-even-point
(3) Indicate if any of the plans dominate and compute the EBIT range among the plans for indifference.
1.8
Answer
(1) Statement of EPS
Alternatives
Particulars
A B C
Earnings before interest and tax 80,000 80,000 80,000
Less: Interest @ 8% on `1,00,000 - 8,000 -
EBT 80,000 72,000 80,000
Less: Tax @ 50% 40,000 36,000 40,000
EAT 40,000 36,000 40,000
Less: Preference Dividend @ 8% on `1,00,000 - - 8,000
Earning Available for Equity Shareholders 40,000 36,000 32,000
÷ No. of Equity shares (Issue price `20) 10,000 5,000 5,000
EPS `4.00 `7.20 `6.40
(2) Financial Break Even Point (EBIT equals to fixed financial cost):
Proposal A Financial B.E.P. = No Fixed Financial Cost = Zero

Proposal B Financial B.E.P. = Interest on Debt = 8,000
Pr eference Dividend 8,000
Proposal C Financial B.E.P. = =
(1  t ) 1 − 0.50
= 16,000
(3) Indifference Point:

Between Proposal A & B:
NA
= NB
(EBIT−0) (1−0.50) (EBIT−8,000) (1−0.50)
=
10,000 5,000
EBIT = `16,000
Between Proposal A & C:

(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
NA
= NC
(EBIT−0) (1−0.50) {(EBIT−0) (1−0.50) − 8,000}
10,000
= 5,000
EBIT = `32,000
Between Proposal B & C:

(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
NB
= NC
(EBIT−8,000) (1−0.50) {(EBIT−0) (1−0.50) − 8,000}
=
5,000 5,000
0.5 EBIT – 4,000 ≠ 0.5 EBIT – 8,000
There is no indifference point between the financial plans B and C. It can be seen that Financial Plan
B dominates Plan C. Since, the financial break-even point of the former is only `8,000 but in case of latter
it is `16,000.
1.9
BQ 13
Xylo Ltd. is considering the following two alternative financing plans:
Particulars Plan A Plan B

Equity Shares of `10 each 8,00,000 8,00,000
12% Debentures 4,00,000 -
Preference Shares of `100 each - 4,00,000
12,00,000 12,00,000
The indifference point between the plans is `4,80,000. Corporate tax rate 30%.
Calculate the rate of dividend on preference shares.
Answer
Pr eference Dividend 33 ,600
Rate of dividend = × 100 = × 100 = 8.40%
Pr eference Share Capital 4 ,00 ,000
Working Notes:
Calculation of preference dividend:
EBIT  I 1  T  = [EBIT  I 1  T ]  PD
N1 N2
4 ,80 ,000  48 ,000  1  0.30  = [ 4 ,80 ,000  Nil  1  0.30 ]  PD
80 ,000 80 ,000
3,02,400 = 3,36,000 – PD
Preference dividend (PD) = `33,600
BQ 14
Current Capital Structure of XYZ Ltd is as follows:
Equity Share Capital : 7 lakh shares of face value `20 each

Reserves : `10,00,000
9% bonds : `3,00,00,000
11% preference capital : 3,00,000 shares of face value `50 each
Additional Funds required : `5,00,00,000
XYZ Ltd is evaluating the following alternatives:
(1) Proposed alternative I: Raise the funds via 25% equity capital and 75% debt at 10%. PE ratio in
such scenario would be 12.
(2) Proposed alternative II: Raise the funds via 50% equity capital and rest from 12% Preference
capital. PE ratio in such scenario would be 11.
Any new equity capital would be issued at a face value of `20 each. Any new preferential capital would
be issued at a face value of `20 each. Tax rate is 34%
Determine the indifference point under both the alternatives.
1.10
Answer
Calculation of Indifference point between Proposal I & Proposal II:
Let the indifference point be X
[EBIT  I 1  T ]  PD [EBIT  I 1  T ]  PD
=
N1 N2
X  64 ,50 ,000  1  0.34   16 ,50 ,000 = X  27 ,00 ,000  1  0.34   46 ,50 ,000
13 ,25 ,000 19 ,50 ,000
.66 X  42 ,57 ,000  16 ,50 ,000 .66 X  17 ,82 ,000  46 ,50 ,000
=
1 ,325 1 ,950
.66 X  59 ,07 ,000 .66 X  64 ,32,0000

=
53 78
51.48X – 46,07,46,000 = 34.98X – 34,08,96,000
16.5 X = 11,98,50,000
X = `72,63,636.36
Working Notes:
(1) Calculation of number of Equity shares:
Under Proposal I = 7,00,000 Existing shares + 5,00 ,00 ,000  25% New shares
20
= 7,00,000 + 6,25,000 = 13,25,000 shares
Under Proposal II = 7,00,000 Existing shares + 5,00 ,00 ,000  50% New shares
20
= 7,00,000 + 13,50,000 = 19,50,000 shares
(2) Calculation of Interest:
Under Proposal I = 3,00,00,000 × 9% + (5,00,00,000 × 75%) × 10%

= 64,50,000
Under Proposal II = 3,00,00,000 × 9% = 27,00,000
(3) Calculation of Preference Dividend:
Under Proposal I = (3,00,000 × 50) × 11% = 16,50,000
Under Proposal II = 16,50,000 + (5,00,00,000 × 50%) × 12%

= 46,50,000
1.11
PAST YEAR QUESTIONS
PYQ 1
Alpha Ltd. requires funds amounting to `80,00,000 for its new project. To raise the funds, the company
has following two alternatives:
(1) To issue Equity Shares of `100 each (at par) amounting to `60,00,000 and borrow the balance
amount at the interest of 12% p.a.; or
(2) To issue Equity Shares of `100 each (at par) and 12% Debentures in equal proportion.
Find out the point of indifference between two modes of financing and state which option
will be beneficial in different situations assuming tax rate 30%.
[(Marks 5) Nov 2014]
Answer
Calculation of Indifference two modes of financing:
EBIT  I 1  T  = EBIT  I 1  T 
N1 N2
EBIT  12% of 20 lakhs  1  0.30 
= EBIT  12% of 40 lakhs  1  0.30 
60 ,000 40 ,000
EBIT = `9,60,000
Course of action:
(a) If expected EBIT is less than `9,60,000 : Alternate 1
(b) If expected EBIT is equal to `9,60,000 : Alternate 1 or 2
(c) If expected EBIT is more than `9,60,000 : Alternate 2
PYQ 2
India Limited requires `50,00,000 for a New Plant. This Plant is expected to yield Earnings before
Interest and Taxes of `10,00,000. While deciding about the Financial Plan, the Company considers the
objective of maximizing Earnings per Share.
It has 3 alternatives to finance the Project: by raising Debt of `5,00,000 or `20,00,000 or
`30,00,000 and the balance in each case, by issuing Equity Shares. The Company’s Share is currently
selling at `150, but it is expected to decline to `125 in case the funds are borrowed in excess of
`20,00,000.
The Funds can be borrowed at the rate of 9% upto `5,00,000, at 14% over `5,00,000 and upto
`20,00,000 and at 19% over `20,00,000. The Tax rate applicable to the Company is 40%.
Which form of financing should the Company choose? Show EPS Amount upto two decimal
points.
Answer
Statement of EPS
Alternatives
Particulars
1 2 3
1.12
Less: Interest:
@ 9% on first `5,00,000 45,000 45,000 45,000
@ 14% on `5,00,001 to `20,00,000 - 2,10,000 2,10,000
@ 19% on above `20,00,000 - - 1,90,000
EBT 9,55,000 7,45,000 5,55,000
Less: Tax @ 40% 3,82,000 2,98,000 2,22,000
EAT 5,73,000 4,47,000 3,33,000
÷ No. of Equity shares 30,000 20,000 16,000
(45,00,000/150) (30,00,000/150) (20,00,000/125)
EPS `19.10 `22.35 `20.8125
Decision: The earning per share is higher in alternative II i.e. if the company finance the project by
raising debt of `20,00,000 & issue equity shares of `30,00,000. Therefore, the company should choose
this alternative to finance the project.
PYQ 3
The X Ltd. Is willing to raise funds for its new project which requires an investment of `84,00,000. The
company has two options:
Option 1: To issue Equity Shares (`10 each) only.
Option 2: To avail term loan at an interest rate of 12%. But in this case, as insisted by the financing
agencies, the company will have to maintain a debt equity ratio of 2 : 1.
Find out the point of indifference for the project if corporate tax rate is 30%.
Answer
Calculation of point of Indifference:
EBIT  I 1  T  = EBIT  I 1  T 
N1 N2
EBIT  Nil  1  0.30  = EBIT  12% of 56 ,00 ,000  1  0.30 
8 ,40 ,000 2 ,80 ,000
EBIT = `10,08,000
Calculation of amount of Debt and Equity in option 2:
Debt amount = 84,00,000 × 2/3 = 56,00,000

Equity amount = 84,00,000 × 1/3 = 28,00,000
PYQ 4
Sun Ltd. is considering two financing plans. Details of which are as under:
(a) Funds requirement is `100 Lakhs.

(b) Financial plans:
Plan Equity Debts
I 100% -
II 25% 75%
(c) Cost of debt is 12% p.a.
(d) Tax rate is 30%
(e) Equity shares `10 each, issued at a premium of `15 per share
1.13
(f) Expected earnings before interest and tax (EBIT) `40,00,000
You are required to compute:

(1) EPS in each of them plan
(2) The Financial break-even-point
(3) Indifference point between I and II
[(5 Marks) May 2018]
Answer
Alternatives
Particulars
Plan I Plan II
Earnings before interest and tax 40,00,000 40,00,000
Less: Interest @ 12% on `75,00,000 - 9,00,000
EBT 40,00,000 31,00,000
Less: Tax @ 30% 12,00,000 9,30,000
EAT 28,00,000 21,70,000
÷ No. of Equity shares (Issue price `25) ÷ 4,00,000 ÷1,00,000
EPS `7.00 `21.70
Calculation of amount of number of Equity shares:

Under Plan I = 1,00,00,000 ÷ 25 (10 + 15) = 4,00,000
Under Plan I = 25,00,000 ÷ 25 (10 + 15) = 1,00,000
Plan I Financial B.E.P. = No Fixed Financial Cost = Zero
Plan II Financial B.E.P. = Interest on Debt = 9,00,000

(EBIT − I) (1 − t) (EBIT − I) (1 − t)
N1
= N1
(EBIT − Nil) (1 − 0.30) (EBIT −9,00,000) (1 − 0.30)
4,00,000
= 1,00,000
EBIT = `12,00,000
PYQ 5
Y Limited requires `50,00,000 for a new project. This project is expected to yield earnings before
interest and taxes of `10,00,000. While deciding about the financial plan, the company considers the
objective of maximizing earnings per share.
It has two alternatives to finance the project - by raising debt of `5,00,000 or `20,00,000 and the
balance, in each case, by issuing equity shares. The company’s share is currently selling at `300, but is
expected to decline to `250 in case the funds are borrowed in excess of `20,00,000. The funds can be
borrowed at the rate of 12% upto `5,00,000 and at 10% over `5,00,000. The tax rate applicable to the
company is 25%.
Which form of financing should the company choose?

[(5 Marks) Nov 2018]
Answer
1.14
Statement of EPS
Alternatives
Particulars
1 2
Earnings before interest and tax 10,00,000 10,00,000
Less: Interest:
@ 12% on first `5,00,000 60,000 60,000
@ 10% on `5,00,001 to `20,00,000 - 1,50,000
EBT 9,40,000 7,90,000
Less: Tax @ 25% 2,35,000 1,97,500
EAT 7,05,000 5,92,500
÷ No. of Equity shares 15,000 10,000
(45,00,000/300) (30,00,000/300)
EPS `47.00 `59.25
Decision: The earning per share is higher in alternative II i.e. if the company finance the project by
raising debt of `20,00,000 & issue equity shares of `30,00,000. Therefore, the company should choose
this alternative to finance the project.
PYQ 6
RM Steels Limited requires `10,00,000 for the construction of new plant. It is considering three financial
plans:
(1) The Company may issue 1,00,000 ordinary shares at `10 per share.
(2) The Company may issue 50,000 ordinary shares at `10 per share and 5,000 debentures of `100
denomination bearing 8% rate of interest.
(3) The Company may issue 50,000 ordinary shares at `10 per share and 5,000 preference shares at
`100 per share bearing a 8% rate of dividend.
If RM Steels Limited’s earnings before interest and taxes are `20,000, `40,000, `80,000, `1,20,000 and
`2,00,000. Tax rate is 50%.
You are required to compute the earning per share under each of the three plans? Which
alternative would you recommend for RM Steels and why?
[(10 Marks) May 2019]
Answer
1. Statement showing EPS with respect to various plans & different EBIT:
a. Equity Financing
Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 0 0 0 0 0
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% (10,000) (20,000) (40,000) (60,000) (1,00,000)
EAT 10,000 20,000 40,000 60,000 1,00,000
÷ No. of Equity Shares ÷ 1,00,000 ÷ 1,00,000 ÷ 1,00,000 ÷ 1,00,000 ÷ 1,00,000
EPS `0.10 `0.20 `0.40 `0.60 `1.00
b. Debt - Equity Mix

EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest (40,000) (40,000) (40,000) (40,000) (40,000)
1.15
EBT (20,000) 0 40,000 80,000 1,60,000

Less: Tax @ 50% *10,000 0 (20,000) (40,000) (80,000)
EAT (10,000) 0 20,000 40,000 80,000
÷ No. of Equity Shares ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000
EPS (`0.20) `0.00 `0.40 `0.80 `1.60
*10,000 is the tax saving in case of loss.
c. Preference Share - Equity Mix

EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 0 0 0 0 0
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% (10,000) (20,000) (40,000) (60,000) (1,00,000)
EAT 10,000 20,000 40,000 60,000 1,00,000
Less: Preferential Div. **(40,000) **(40,000) (40,000) (40,000) (40,000)
EAT after Pref. Dividend (30,000) (20,000) 0 20,000 60,000
÷ No. of Equity Shares ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000
EPS (`0.60) (`0.40) `0.00 `0.40 `1.20
**In case of cumulative preference shares, the company has to pay cumulative dividend to preference
shareholders, when company earns sufficient profits, so deducted here even in case of insufficient profit
to reach right decision.
2. Recommendation:
(a) If expected EBIT is less than `80,000 : Equity Finance (Alternative 1)
(b) If expected EBIT is equal to `80,000 : Equity or Debt - Equity Mix (Alternative 1 or 2)
(c) If expected EBIT is more than `80,000 : Debt – Equity Mix (Alternative 2)
PYQ 7
J Limited is considering three financing plans. The key information is as follows:
(a) Total investment to be raised `4,00,000.
(b) Plans showing the Financing proportion:
Plans Equity Debt Preference Shares
X 100% - -
Y 50% 50% -
Z 50% - 50%
(c) Cost of debt is 10%
Cost of preference shares is 10%
(d) Tax rate 50%
(e) Equity shares of the face value of `10 each will be issued at a premium of `10 per share.
(f) Expected EBIT is `1,00,000.
You are required to compute the following for each plan:

(1) Earnings per share (EPS)
(2) Financial break-even-point
(3) Indifference point between the plans and indicate if any of the plans dominate.
[(10 Marks) Nov 2020]
1.16
Answer
Alternatives
Particulars
X Y Z
Less: Interest @ 10% on `2,00,000 - 20,000 -
EBT 1,00,000 80,000 1,00,000
Less: Tax @ 50% 50,000 40,000 50,000
EAT 50,000 40,000 50,000
Less: Preference Dividend @ 10% on `2,00,000 - - 20,000
Earning Available for Equity Shareholders 50,000 40,000 30,000
÷ No. of Equity shares (Issue price `20) 20,000 10,000 10,000
(4,00,000 ÷ 20) (2,00,000 ÷ 20) (2,00,000 ÷ 20)
EPS `2.50 `4.00 `3.00
Proposal X Financial B.E.P. = No Fixed Financial Cost = Zero
Proposal Y Financial B.E.P. = Interest on Debt = 20,000
Pr eference Dividend
Proposal Z Financial B.E.P. =
(1  t )
20,000
= = 40,000
1 − 0.50

Between Proposal X & Y:
=
NX NY
(EBIT−0) (1−0.50) (EBIT−20,000) (1−0.50)
20,000
= 10,000
EBIT = `40,000
Between Proposal X & Z:
(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
NX
= NZ
(EBIT−0) (1−0.50) {(EBIT−0) (1−0.50) − 20,000}

20,000
= 10,000
EBIT = `80,000
Between Proposal Y & Z:
(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
=
NY NZ
(EBIT−20,000) (1−0.50) {(EBIT−0) (1−0.50) − 20,000}

10,000
= 10,000
0.5 EBIT – 10,000 ≠ 0.5 EBIT – 20,000

There is no indifference point between the financial plans Y and Z. It can be seen that Financial Plan
Y dominates Plan Z. Since, the financial break-even point of the former is only `20,000 but in case of
latter it is `40,000.
1.17
PYQ 8
Earnings before interest and tax of a company are `4,50,000. Currently the company has 80,000 equity
shares of `10 each, retained earnings of `12,00,000. It pays annual interest of `1,20,000 on 12%
Debentures. The company proposes to take up an expansion scheme for which it needs additional fund
of `6,00,000. It is anticipated that after expansion, the company will be able to achieve the same rate of
return on investment as at present. It can raise fund either through debts at rate of 12% p.a. or by issuing
Equity shares at par. Tax rate is 40%.
Compute the earning per share if:

(a) The additional funds were raised through debt.
(b) The additional funds were raised by issue of Equity shares.
Advise whether the company should go for expansion plan and which sources of finance
should be preferred.
[(10 Marks) Dec 2021]
Answer
Statement of EPS
Alternatives
Particulars
Debt Plan (i) Equity Plan (ii)
Earnings before interest and tax @ 15% of `36,00,000 5,40,000 5,40,000
Less: Interest:
Existing 1,20,000 1,20,000
New (12% on `6,00,000) 72,000 -
EBT 3,48,000 4,20,000
Less: Tax @ 40% 1,39,200 1,68,000
EAT 2,08,800 2,52,000
÷ No. of Equity shares
Existing 80,000 80,000
New - 60,000
EPS `2.61 `1.80
Advise to the company: Since EPS after expansion under debt plan is higher (`2.61) than Existing EPS
(`2.475), company should go for expansion plan and choose debt source of finance.
EPS before expansion =

EBIT  I 1  T  = 4 ,50 ,000  1 ,20 ,000  1  0.4  = `2.475
N 80 ,000
Working notes:

Equity share capital (80,000 shares × `10) `8,00,000
Retained earnings `12,00,000
Debentures (`1,20,000/12%) `10,00,000
Total capital employed `30,00,000
2. Return on capital employed (ROCE) or Return on Investment:

EBIT 4 ,50 ,000
ROCE = × 100 = × 100 = 15%
1.18
3. Capital employed after expansion = `36,00,000 (`30,00,000 + `6,00,000)
PYQ 9
The particulars related to Raj Ltd. for the year ended 31st March, 2022 are given as follows:
Output (units at normal capacity) 1,00,000
Selling price per unit `40
Variable cost per unit `20
Fixed cost `10,00,000
The capital structure of the company as on 31st March, 2022 is as follows:

Particulars `
Equity Share Capital (1,00,000 shares of `10 each) 10,00,000
Reserves and Surplus 5,00,000
Current Liabilities 5,00,000
Total 20,00,000
Raj Ltd. has decided to undertake an expansion project to use the market potential that will involve
`20,00,000. The company expects an increase in output by 50%. Fixed cost will be increased by
`5,00,000 and variable cost per unit will be decreased by 15%. The additional output can be sold at the
existing selling price without any adverse impact on the market.
The following alternative schemes for financing the proposed expansion program are planned:
Alternative Debt Equity Shares
1 `5,00,000 Balance
2 `10,00,000 Balance
3 `14,00,000 Balance
Slab wise interest rate for fund borrowed is as given follows:

Fund Limit Applicable Interest Rate
Upto `5,00,000 10%
Over `5,00,000 and upto `10,00,000 15%
Over `10,00,000 20%
Current market price per share is 200.
Find out which of the above mentioned alternatives would you recommend for raj Ltd. with
reference to the EPS, assuming a corporate tax rate is 40%?
[(10 Marks) May 2022]
Answer
Statement of EPS
Alternatives
Particulars
1 2 3
Expected output in units (1,00,000 + 50%) 1,50,000 1,50,000 1,50,000
Sales @ `40 per unit 60,00,000 60,00,000 60,00,000
Less: Variable Cost @ `17 (`20 - 15%) p.u. 25,50,000 25,50,000 25,50,000
Contribution 34,50,000 34,50,000 34,50,000
Less: Fixed Cost (`10,00,000 + `5,00,000) 15,00,000 15,00,000 15,00,000
1.19
Less: Interest:
@ 10% on first `5,00,000 50,000 50,000 50,000
@ 15% on `5,00,001 to `10,00,000 - 75,000 75,000
@ 20% on above `10,00,000 - - 80,000
EBT 19,00,000 18,25,000 17,45,000
Less: Tax @ 40% 7,60,000 7,30,000 6,98,000
EAT 11,40,000 10,95,000 10,47,000
÷ No. of Equity shares
Existing 1,00,000 1,00,000 1,00,000
New 7,500 5,000 3,000
(15,00,000/200) (10,00,000/200) (6,00,000/200)
EPS `10.60 `10.43 `10.17
Decision: The earning per share is higher in alternative I i.e. if the company finance the project by raising
debt of `5,00,000 & issue equity shares of `15,00,000. Therefore, the company should choose this
alternative to finance the project.
PYQ 10
The following information pertains to CIZA Ltd.:
Capital Structure: `
Equity share capital (`10 each) 8,00,000
Retained earnings 20,00,000
9% Preference share capital (`100 each) 12,00,000
12% Long-term loan 10,00,000
Interest coverage ratio 8
Income tax rate 30%
Price- earnings ratio 25
The company is proposed to take up an expansion plan, which requires an additional investment of
`34,50,000. Due to this proposed expansion, earnings before interest and taxes of the company will
increase by `6,15,000 per annum. The additional fund can be raised in following manner:
(a) By issue of equity shares at present market price, or
(b) By borrowing 16% Long-term loans from bank.
You are informed that Debt-equity ratio (Debt/Shareholders’ fund) in the range of 50% to 80% will
bring down the price-earnings ratio to 22 whereas; Debt-equity ratio over 80% will bring down the
price-earnings ratio to 18.
Advise which option is most suitable to raise additional capital so that the Market Price per
Share (MPS) is maximized.
[(10 Marks) May 23]
Answer
Particulars Equity Plan Debt Plan
EBIT (9,60,000 + 6,15,000) 15,75,000 15,75,000
New (16% of `34,50,000) - 5,52,000
EBT 14,55,000 9,03,000
Less: Tax @ 30% 4,36,500 2,70,900
1.20
PAT 10,18,500 6,32,100

Less: Preference dividend (9% of `12,00,000) 1,08,000 1,08,000
Earning for Equity shareholders 9,10,500 5,24,100
÷ No. of Equity shares (Existing + New) 1,03,000 80,000
EPS `8.84 `6.55
MPS `221.00 `117.90
Advise: Company should raise additional capital through Equity plan to maximize MPS.
Working notes:
10 ,00 ,000
= × 100 = 13.42%
74 ,50 ,000 ( 8 ,00 ,000  34 ,50 ,000  20 ,00 ,000  12 ,00 ,000 )
As the debt ratio is less than 50% the P/E ratio in this case will remain at 25 times in Plan 1.
2. Debt Ratio if `34,50,000 is raised as debt:

10 ,00 ,000  34 ,50 ,000
= × 100 = 111.25%
40 ,00 ,000 ( 8 ,00 ,000  20 ,00 ,000  12 ,00 ,000 )
As the debt ratio is more than 80% the P/E ratio will be brought down to 18 in Plan 2
3. Existing EBIT:
EBIT EBIT
Interest coverage ratio = = = 8
Interest 1 ,20 ,000
Existing EBIT = 9,60,000
(EBIT  I)( 1  t )  PD
4. Existing EPS =
N
( 9 ,60 ,000  1 ,20 ,000 ) (1  0.3)  1 ,08 ,000
= = `6
80 ,000
5. Present MPS = EPS × PE ratio = `6 × 25 = `150
34 ,50 ,000
6. Number of Equity Shares to be issued in Plan 1 = = 23,000 shares
150
PYQ 11
The data of K Textiles Ltd. are given as follows:
Particulars Amount (`)
Profit Before interest and Tax 50,00,000
Less: Interest on debentures @ 10% 10,00,000
No. of equity shares (`10 each) 10,00,000
EPS 2
1.21
PE 10
Market price per share 20
The Company is planning to start a new project needs to be having a total capital outlay of `40,00,000.
𝐷
You are informed that a debt equity ratio { } higher than 36% pushes the Ke (cost of equity) up to
𝐷 +𝐸
12.5%, means reducing the PE ratio to 8 and rises the interest rate on additional amount borrowed to
12%. Retained earnings of the company is `1.4 crores.
Find out the probable price of share if:

(a) The additional funds are raised as a loan
(b) The amount is raised by issuing equity shares.
[(10 Marks) Nov 23]
Answer
EBIT @ 14.71% of 3,80,00,000 (3,40,00,000 + 40,00,000) 55,89,800 55,89,800
New (12% of `40,00,000) 4,80,000 -
EBT 41,09,800 45,89,800
Less: Tax @ 50% 20,54,900 22,94,900
PAT 20,54,900 22,94,900
EPS `2.0549 `1.9124
MPS `16.44 `19.12
Note: In this question EBIT after proposed extension is not given. Therefore, we can assume that existing
return on capital employed will be maintained.
Working notes:
Equity share capital (10,00,000 shares × `10) `1,00,00,000

Retained earnings `1,40,00,000
Debentures (10,00,000/10%) `1,00,00,000
Total capital employed `3,40,00,000
EBIT 50 ,00 ,000

ROCE = × 100 = × 100 = 14.71%
Capital Employed 3 ,40 ,00 ,000
3. Debt Equity Ratio if `40,00,000 is raised as Debt:
1 ,40 ,00 ,000 (1 ,00 ,00 ,000  40 ,00 ,000 )

= × 100 = 36.84%
3,80 ,00 ,000 (3,40 ,00 ,000  40 ,00 ,000 )
1.22
As the debt equity ratio is more than 36% the P/E ratio will be brought down to 8 in Plan 1
1 ,00 ,00 ,000

= × 100 = 26.31%
3 ,80 ,00 ,000
As the debt equity ratio is less than 36% the P/E ratio in this case will remain at 10 times in Plan 2.
40 ,00 ,000
= = 2,00,000 shares
20
Decision: Though loan option has higher EPS but equity option has higher MPS therefore company
should raise additional fund through equity option.
SUGGESTED REVISION FOR EXAM:
BQ: 2, 4, 7, 11, 12, 13, 14
PYQ: 4, 6, 8, 9, 11
1.23
CHAPTER 2 LEVERAGES
CHAPTER 2 LEVERAGES
OPERATING, FINANCIAL AND COMBINED LEVERAGES
BQ 1
Calculate the operating leverage for each of the four firms A, B, C and D from the following price and cost
data:
Particulars A (`) B (`) C (`) D (`)
Sales price per unit 20 32 50 70
Variable cost per unit 6 16 20 50
Fixed operating cost 60,000 40,000 1,00,000 Nil
Units sold 5,000 5,000 5,000 5,000
Answer
Statement Showing Degree of Operating Leverage
Particulars A (`) B (`) C (`) D (`)
Sales (units) 5,000 5,000 5,000 5,000
Sales value 1,00,000 1,60,000 2,50,000 3,50,000
Less: Variable cost 30,000 80,000 1,00,000 2,50,000
Contribution 70,000 80,000 1,50,000 1,00,000
Less: Fixed operating cost 60,000 40,000 1,00,000 Nil
EBIT 10,000 40,000 50,000 1,00,000
OL (Contribution ÷ EBIT) 7 times 2 times 3 times 1 time
BQ 2
A Company produces and sells 10,000 shirts. The selling price per shirt is `500. Variable cost is `200
per shirt and fixed operating cost is `25,00,000.
(a) Calculate operating leverage, (b) If sales are up by 10%, then what is the impact on EBIT?
Answer
(a) Statement of Profitability
Particulars `
Sales (10,000 × 500) 50,00,000
Less: Variable cost (10,000 × 200) 20,00,000
Contribution 30,00,000
Less: Fixed cost 25,00,000
Profit before interest and tax 5,00,000
Contributi on 30 ,00 ,000
Operating Leverage = = = 6 times
EBIT 5 ,00 ,000
(b) Impact on EBIT, if sales are go up by 10%:

Δ EBIT (in %) = Δ Sales × DOL = 10% × 6 times = 60%
Δ EBIT (in amount) = Existing EBIT × 60%

= 5,00,000 × 60% = Increase by `3,00,000
2.1
LEVERAGES CHAPTER 2
BQ 3
Consider the following information for Omega Ltd:
Earning Before Interest and Tax (EBIT) `15,750

Fixed cost `1,575
Earning Before Tax (EBT) `7,000
Calculate percentage change in earnings per share, if sales increase by 5%
Answer
Contributi on EBIT  Fixed cos t
Combined Leverage = =
EBT EBT
15 ,750  1 ,575
= = 2.475 times
7 ,000
% change in EPS = % increase in sales × CL

= 5% × 2.475 times = 12.375%
BQ 4
From the following information extracted from the books of accounts of Imax Ltd., Calculate percentage
change in earnings per share, if sales increase by 10% and Fixed Operating cost is `1,57,500:
EBIT (Earnings before Interest and Tax) `31,50,000

Earnings before Tax (EBT) `14,00,000
Answer
Calculation of percentage change in Earnings per share:
Δ EPS (in %) = Δ Sales × CL = 10% × 2.3625 times = 23.625%
Working note:
Contributi on 31 ,50 ,000 + 1 ,57 ,500
Combined Leverage = = = 2.3625
EBT 14 ,00 ,000
BQ 5
Betatronics Ltd. has the following balance sheet and income statement information:
Balance Sheet as on 31st March, 2023

Liabilities ` Assets `
Equity Capital (`10 per share) 8,00,000 Net Fixed Assets 10,00,000
Retained Earnings 3,50,000 Current Assets 9,00,000
10% Debentures 6,00,000
19,00,000 19,00,000
Income Statement for the year ending 31st March, 2023

Particulars `
Sales 3,40,000
Less: Operating Expenses (including `60,000 depreciation) 1,20,000
EBIT 2,20,000
2.2
CHAPTER 2 LEVERAGES
Less: Interest @ 10% of 6,00,000 60,000

EBT
1,60,000
Less: Taxes
56,000
EAT
1,04,000
(a) Determine the degree of operating, financial and combined leverages at the current sales level, if
all operating expenses, other than depreciation, are variable costs.
(b) If total assets remain at the same level, but sales (i) increase by 20 percent and (ii) decrease by 20
percent, what will be the earnings per share at the new sales level?
Answer
(a) Calculation of Degree of Operating (DOL), Financial (DFL) and Combined leverages (DCL):
Contributi on 3,00 ,000  60 ,000

Degree of Operating Leverage = = = 1.27
EBIT 2,20 ,000
EBIT 2 ,20 ,000

Degree of Financial Leverage = = = 1.38
EBT 1 ,60 ,000
Degree Combined Leverage = DOL × DFL = 1.27 × 1.38 = 1.75
(b) Earnings per share at the new sales level:
EPS if sales level increases by 20% = Existing EPS + increase (% increase in sales × CL)
= `1.30 + 35% (20% × 1.75 times) = `1.755
EPS if sales level decreases by 20% = Existing EPS - decrease (% decrease in sales × CL)
= `1.30 - 35% (20% × 1.75 times) = `0.845
Working Notes:
(i) Variable Costs = `60,000 (total cost − depreciation)
(ii) Variable Costs at:
(a) Sales level, `4,08,000 = `72,000 (increase by 20%)
(b) Sales level, `2,72,000 = `48,000 (decrease by 20%)
BQ 6
The Sale revenue of TM excellence Ltd. @ `20 per unit of output is `20 lakhs and Contribution is `10
lakhs. At the present level of output the DOL of the company is 2.5. The company does not have any
Preference Shares. The number of Equity Shares are 1 lakh. Applicable corporate income tax rate is 50%
and the rate of interest on Debt Capital is 16% p.a.
What is the EPS (At sales revenue of `20 lakhs) and amount of Debt Capital of the company
if a 25% decline in Sales will wipe out EPS.
Answer
( EBIT  I) (1  t ) (4,00,000 − 1,50,000) (1 −0.50)
(A) Earnings Per Share = =
Equity shares 1,00,000
= `1.25
2.3
LEVERAGES CHAPTER 2
(B) Amount of DEBT = Interest ÷ Rate of interest = 1,50,000 ÷ 16%

= `9,37,500
Working Note:
(1) Calculation of Fixed Cost:
DOL = = = 2.5 times
EBIT EBIT
EBIT = 10,00,000 ÷ 2.5 = `4,00,000
Fixed Cost = Contribution – EBIT = 10,00,000 – 4,00,000 = `6,00,000
(2) Calculation of Degree of Combined Leverage:

Question says that 25% change in sales will wipe out EPS, wipe out means it will reduce EPS by
100%.
% Change in EPS 100 %
DCL = = = 4 times
% Change in Sales 25 %
(3) Calculation of EBT and Interest:

DCL = = = 4 times
EBT EBT
EBT = 10,00,000 ÷ 4 = `2,50,000
Interest = EBIT – EBT = 4,00,000 – 2,50,000 = `1,50,000
BQ 7
Consider the following information for Mega Ltd.:
Production level 2,500 units
Contribution per unit 150
Operating leverage 6
Combined leverage 24
Tax rate 30%
Compute its earnings after tax.
Answer
Earning after tax = EBT (1 - t)
= `15,625 (1 - 0.30) = `10,937.50
Working Notes:
Contributi on
Combined leverage =
EBT
Contributi on 2,500 × 150
24 times = =
EBT EBT
3,75,000
 EBT = = `15,625
24
2.4
CHAPTER 2 LEVERAGES
BQ 8
The balance sheet of Alpha Numeric Company is given below:
Equity Share Capital 90,000 Net Fixed Assets 2,25,000
(`10 per share) Current Assets 75,000
Retained Earning 30,000
10% Long Term Debt 1,20,000
Current Liabilities 60,000
3,00,000 3,00,000
The company's total assets turnover ratio is 3 times, its fixed operating cost is `1,50,000 and its
variable operating cost ratio is 50%. The income tax rate is 50%.
You are required to:

(1) Calculate the different type of leverages for the company and EPS.
(2) Determine the likely level of EBIT if EPS is (a) `1.00, (b) `2.00 and (c) `Nil.
[(1) OL: 1.5 times, FL: 1.04 times, CL: 1.56 times; EPS : `16(2) EBIT: (a) `30,000 (b) `48,000 (c)
`12,000]
BQ 9
Calculate the operating leverage, financial leverage and combined leverage from the following data
under situations I and II and financial plans A and B:
Installed capacity 4,000 units
Actual production and sales 75% of the Capacity
Selling price `30 per unit
Variable cost `15 per unit
Fixed cost:
Under situation I `15,000
Under situation II `20,000
Capital structure:
Plan A Plan B
Equity `10,000 `15,000
Debt (rate of interest at 20%) `10,000 `5,000
Capital Employed `20,000 `20,000
Answer
Statement Showing OL, FL and CL
Situation I Situation II
Particulars
Plan A Plan B Plan A Plan B
Sales (3,000 × `30) 90,000 90,000 90,000 90,000
Less: Variable cost 45,000 45,000 45,000 45,000
Contribution 45,000 45,000 45,000 45,000
Less: Fixed Cost 15,000 15,000 20,000 20,000
EBIT 30,000 30,000 25,000 25,000
Less: Interest 2,000 1,000 2,000 1,000
EBT 28,000 29,000 23,000 24,000
2.5
LEVERAGES CHAPTER 2
OL (Contribution ÷ EBIT) 1.5 1.5 1.8 1.8

FL (EBIT ÷ EBT) 1.07 1.03 1.09 1.04
CL (Contribution ÷ EBT) 1.61 1.55 1.96 1.88
BQ 10
The capital structure of the Progressive Corporation consists of an ordinary share capital of
`1,00,00,000 (share of `100 par value) and `10,00,000 of 10% debentures.
Sales increased by 20% from 1,00,000 units to 1,20,000 units, the selling price is `10 per unit;
variable cost amounts to `6 per unit and fixed expenses amount to `2,00,000. The income tax rate is
assumed to be 50%.
You are required to calculate the following:

(i) The percentage increase in earnings per share;
(ii) The degree of operating leverage at 1,00,000 units and 1,20,000 units.
(iii) The degree of financial leverage at 1,00,000 units and 1,20,000 units.
(iv) Comment on the behavior of operating and financial leverages in relation to increase in
production from 1,00,000 units to 1,20,000 units.
Answer
(i) Calculation of % increase in EPS
Particulars 1,00,000 units 1,20,000 units
Sales @ `10 per unit 10,00,000 12,00,000
Less: Variable cost 6,00,000 7,20,000
Contribution 4,00,000 4,80,000
Less: Fixed cost 2,00,000 2,00,000
Less: Interest @ 10% of `10 lacs 1,00,000 1,00,000
Less: Tax @ 50% 50,000 90,000
Profit after tax 50,000 90,000
÷ No. of shares 1,00,000 1,00,000
Earning per share `0.50 `0.90
% increase in EPS [(0.90 – 0.50) ÷ 0.50] × 100 - +80%
Contributi on
(ii) Degree of Operating Leverage =
EBIT
4 ,00 ,000
At 1,00,000 units = = 2 times
2 ,00 ,000
4 ,80 ,000
At 1,20,000 units = = 1.71 times
2 ,80 ,000
EBIT
(iii) Degree of Financial Leverage =
EBT
2 ,00 ,000
1 ,00 ,000
2 ,80 ,000
At 1,20,000 units = = 1.56 times
1 ,80 ,000
(iv) Increase in production and sales will result in decrease in risk.
2.6
CHAPTER 2 LEVERAGES
INCOME STATEMENT
BQ 11
The following financial data have been furnished by A Ltd and B Ltd for the year ended 31.03.2023:
Particulars A Ltd B Ltd
Operating leverage 3:1 4:1
Financial leverage 2:1 3:1
Interest charges per annum `12,00,000 `10,00,000
Corporate tax rate 40% 40%
Variable cost as % of sales 60% 50%
Prepare Income statements of the two companies. Also comment on the financial position
and structure of the two companies.
[Profit After Tax: A Ltd `7,20,000 and B Ltd `3,00,000; Finance leverage for B Ltd is higher and
indicates higher financial risk and a higher percentage of debt in the capital structure of B Ltd.]
BREAK EVEN POINT, MARGIN OF SAFETY AND OPERATING LEVERAGE
BQ 12
X Corporation has estimated that for a new product, its break even point is 2,000 units, if the item is sold
for `14 per unit. The cost accounting department has currently identified variable cost of `9 per unit.
Calculate the operating leverage for sales volume of 2,500 units and 3,000 units. What do
you infer from the operating leverage of the sales volumes of 2,500 units and 3,000 units and their
difference, if any?
Answer
Statement Showing Operating Leverage
Particulars 2,500 units 3,000 units
Sales @ `14 per unit 35,000 42,000
Less: Variable cost @ `9 per unit 22,500 27,000
Contribution 12,500 15,000
Less: Fixed cost 10,000 10,000
Earning before interest and tax 2,500 5,000
Operating Leverage  Contributi on  12 ,500 15 ,000
 EBIT  2 ,500 5 ,000
= 5 times = 3 times
Difference between operating leverage at 2,500 units and 3,000 units = 2 times (5 - 3)
Working Notes:
Fixed cost = BEP in units × contribution per unit

= 2,000 units × `5 (14 - 9) = `10,000
Inference: Sales and risk have inverse relationship. Increase in sales would result in decrease in risk.
2.7
LEVERAGES CHAPTER 2
BQ 13
On the basis of following detail calculate Break-even point and Operating Leverage of Product X and
Product Y and comment on relationship of Break-even point and Operating Leverage:
Particulars Product X Product Y
Number of Unit Sold 1,000 1,000
Sale Price per unit `40 `20
Variable Cost per unit `20 `12
Fixed Cost `15,000 `5,000
Answer
Statement Showing Operating Leverage and Break-even Point
Particulars Product X Product Y
Sale 40,000 20,000
Less: Variable Cost per unit 20,000 12,000
Less: Fixed cost 15,000 5,000
Earning before interest and tax 5,000 3,000
Operating Leverage  Contributi on  20 ,000 8 ,000
 EBIT  5,000 3,000
= 4 times = 2.67 times
15,000 5,000
Fixed Cost
Break-even point 20 8
Contributi on Per Unit
= 750 units = 625 units
Relationship: Firm with high Operating Leverage has high Break-even point.
BQ 14
On the basis of following information calculate Operating leverage with the help of Margin of Safety:
Particulars Product X
Number of Unit Sold 1,000
Sale Price per unit `50
Variable Cost per unit `30
Fixed Cost `15,000
Answer
Statement Showing Operating Leverage
Particulars Product X
Sale 50,000
Less: Variable Cost per unit 30,000
Contribution 20,000
Less: Fixed cost 15,000
Earning before interest and tax 5,000
Break-even point (Fixed Cost ÷ Contribution per unit) or (15,000 ÷ 20) 750 units
Margin of Safety (1,000 units – 750 units) 250 units
Margin of Safety to Sales (250 units ÷ 1,000 units) 0.25
Operating Leverage (1 ÷ MOS to sales ratio) or (1 ÷ 0.25) 4 times
BQ 15
From the following information, prepare Income Statement of Company A & B:
Particulars Company A Company B
2.8
CHAPTER 2 LEVERAGES
Margin of safety 0.20 0.25

Interest `3,000 `2,000
Profit volume ratio 25% 33.33%
Financial Leverage 4 3
Tax rate 45% 45%
Answer
Income Statement
Particulars Company A Company B
Sales 80,000 36,000
Less: Variable cost (b.f.) 60,000 24,000
Less: Fixed cost (b.f.) 16,000 9,000
Profit before interest and tax 4,000 3,000
Less: Interest 3,000 2,000
Profit before tax 1,000 1,000
Less: Tax @ 45% 450 450
Profit after tax 550 550
Working Notes (Company A):

(a) Company A:
Financial Leverage = EBIT/(EBIT - Interest)
= EBIT/(EBIT – `3,000) = 4 times
EBIT = 4 EBIT – `12,000
EBIT = `4,000
Company B:
= EBIT/(EBIT – `2,000) = 3 times
EBIT = 3 EBIT – `6,000
EBIT = `3,000
(b) Company A:
Operating Leverage = 1/Margin of Safety = 1/0.20 = 5 times
Operating Leverage = Contribution/EBIT

= Contribution/`4,000 = 5 times
Contribution = `20,000
Company B:
Operating Leverage = 1/Margin of Safety = 1/0.25 = 4 times

= Contribution/`3,000 = 4 times
(c) Company A:
Sales = Contribution/PV Ratio = `20,000/0.25 = `80,000
Company B:
Sales = Contribution/PV Ratio = `12,000/0.33 = `36,000
2.9
LEVERAGES CHAPTER 2
BQ 16
Company P and Q are having same earnings before tax. However, the margin of safety of Company P is
0.20 and, for Company Q, is 1.25 times than that of Company P. The interest expense of Company P is
`1,50,000 and, for Company Q, is 1/3rd less than that of Company P. Further, the financial leverage of
Company P is 4 and, for Company Q, is 75% of Company P. Other information is given as below:
Particulars Company P Company Q
Profit volume ratio 25% 33.33%
Tax rate 45% 45%
You are required to prepare Income Statement for both the companies.
Answer
Income Statement
Particulars Company P Company Q
Sales 40,00,000 18,00,000
Contribution 10,00,000 6,00,000
Less: Fixed cost 8,00,000 4,50,000
Less: Interest 1,50,000 1,00,000
Less: Tax @ 45% 22,500 22,500
Working Notes:
(a) Margin of Safety:

For Company P = 0.20
For Company Q = 0.20 × 1.25 = 0.25
(b) Interest Expenses:

For Company P = `1,50,000
For Company Q = `1,50,000 - 1/3 of `1,50,000 = `1,00,000
(c) Financial Leverage:

For Company P = 4
For Company Q = 4 × 75% = 3
(d) EBIT:
For Company A
Financial Leverage = EBIT/(EBIT- Interest)
4 = EBIT/(EBIT- `1,50,000)
4 EBIT – `6,00,000 = EBIT
3 EBIT = `6,00,000
EBIT = `2,00,000
For Company B
3 = EBIT/(EBIT – `1,00,000)
3 EBIT – `3,00,000 = EBIT
2.10
CHAPTER 2 LEVERAGES
2 EBIT = `3,00,000
EBIT = `1,50,000
(e) Contribution:
For Company A
Operating Leverage = 1/Margin of Safety = 1/0.20 = 5
5 = Contribution/`2,00,000
Contribution = `10,00,000
For Company B
Operating Leverage = 1/Margin of Safety = 1/0.25 = 4
4 = Contribution/`1,50,000
(f) Sales:
For Company A
Profit Volume Ratio = 25%
Profit Volume Ratio = (Contribution/Sales) × 100
25% = `10,00,000/Sales
Sales = `10,00,000/25%
Sales = `40,00,000
For Company B
Profit Volume Ratio = 33.33%
Therefore, Sales = `6,00,000/33.33%
Sales = `18,00,000
PREFERENCE SHARE CAPITAL
BQ 17
The following is the income statement of XYZ Ltd for the year 2023:
Sales `50,00,000
Variable cost `10,00,000
Contribution `40,00,000
Fixed cost `20,00,000
EBIT `20,00,000
Interest `5,00,000
Profit before tax `15,00,000
Tax at 40% `6,00,000
Profit after tax `9,00,000
Preference dividend `1,00,000
Profit for equity share holders `8,00,000
The company has 4,00,000 equity shares issued to the shareholder.
2.11
LEVERAGES CHAPTER 2
Find out:
(1) Operating leverage,
(2) Financial leverage,
(3) Combined leverage,
(4) What would be the EPS if the sales level increases by 10% and the EPS if the sales level decreases
by 20%.
Answer
(i) Operating Leverage = = = 2 times
EBIT 20 ,00 ,000
EBIT
(ii) Financial Leverage =
Pr eference Dividend
EBT 
1  Tax
20 ,00 ,000
= = 1.50 times
1 ,00 ,000
15,00 ,000 
1  0.40
(iii) Combined Leverage = OL × FL = 2 × 1.5 = 3 times
(iv) EPS if sales level increases by 10% = Existing EPS + increase (% increase in sales × CL)
= `2.00 + 30% (10% × 3 times) = `2.60
EPS if sales level decreases by 20% = Existing EPS - decrease (% decrease in sales × CL)
= `2.00 - 60% (20% × 3 times) = `0.80
BQ 18
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.
Answer
(A) Interest = EBIT – EBT = (68,00,000–60%–16,32,000)–7,13,333
= `3,74,667
(B) EPS of X Ltd. = {EBT (1 – t) – PD} ÷ No of Equity Shares

= {7,13,333 (1 – 0.3) – 10,000} ÷ 1,50,000 = `3.26
(C) Amount of DEBT = Interest ÷ Rate of interest

= 3,74,667 ÷ 12% = `31,22,225
Working Note:
Calculation of CL and EBT:
Question says that 25% decrease in sales will result in 100% decrease in EPS:

Combined Leverage = = = 4 times
2.12
CHAPTER 2 LEVERAGES
= Contributi on = 68 ,00 ,000  60%

EBT  EBT 
1  Tax 1  0.30
27 ,20 ,000
4 =
EBT  33 ,333
4 EBT – 1,33,332 = 27,20,000
EBT = 7,13,333
MISCELLANEOUS
BQ 19
The following particulars relating to Navya Ltd. for the year ended 31st March 2023 is given:
Output 1,00,000 units at normal
Selling price per unit capacity
Variable cost per unit `40
Fixed cost `20
`10,00,000
The capital structure of the company as on 31st March, 2023 is as follows:

Particulars `
Equity share capital (1,00,000 shares of `10 each) 10,00,000
Reserves and surplus 5,00,000
Current liabilities 5,00,000
Total 30,00,000
Navya Ltd. has decided to undertake an expansion project to use the market potential, that will involve
`10 lakhs. The company expects an increase in output by 50%. Fixed cost will be increased by `5,00,000
and variable cost per unit will be decreased by 10%. The additional output can be sold at the existing
selling price without any adverse impact on the market.
The following alternative schemes for financing the proposed expansion programme are planned:
(1) Entirely by equity shares of `10 each at par.

(2) `5 lakh by issue of equity shares of `10 each and the balance by issue of 6% debentures of `100
each at par.
(3) Entirely by 6% debentures of `100 each at par.
Find out which of the above-mentioned alternatives would you recommend for Navya Ltd.
with reference to the risk and return involved, assuming a corporate tax of 40%.
Answer
Statement Showing Profitability of Alternative Schemes for Financing
Particulars Existing Alt 1 Alt 2 Alt 3
2.13
LEVERAGES CHAPTER 2
Production (in units) 1,00,000 1,50,000 1,50,000 1,50,000

Sales value @ `40 per unit 40,00,000 60,00,000 60,00,000 60,00,000
Less: Variable cost @ `20/ `18 per unit 20,00,000 27,00,000 27,00,000 27,00,000
Contribution 20,00,000 33,00,000 33,00,000 33,00,000
Less: Fixed cost 10,00,000 15,00,000 15,00,000 15,00,000
EBIT 10,00,000 18,00,000 18,00,000 18,00,000
Less: Interest on loan: 70,000 70,000 70,000
Existing @ 7% of `10,00,000 70,000 - 30,000 60,000
New @ 6% of `5/`10 Lakh -
EBT 9,30,000 17,30,000 17,00,000 16,70,000
Less: Tax @ 40% (3,72,000) (6,92,000) (6,80,000) (6,68,000)
EAT 5,58,000 10,38,000 10,20,000 10,02,000
÷ Number of Equity Shares (Existing + New) ÷ 1,00,000 ÷ 2,00,000 ÷ 1,50,000 ÷ 1,00,000
EPS `5.58 `5.19 `6.80 `10.02
Operating leverage (Contribution ÷ EBIT) 2.00 1.83 1.83 1.83
Financial Leverage (EBIT ÷ EBT) 1.08 1.04 1.06 1.08
Combined Leverage (Contribution ÷ EBT) 2.15 1.91 1.94 1.98
Lower
Risk - Lowest Highest
than Alt 3
Lower
Return - Lowest Highest
than Alt 3
From the above figures, we can see that the Operating Leverage is same in all alternatives though
Financial Leverage differs. Alternative (3) uses the maximum amount of debt and result into the highest
degree of financial leverage, followed by alternative (2). Accordingly, risk of the company will be
maximum in these options. Corresponding to this scheme, however, maximum EPS (i.e., `10.02 per
share) will be also in option (3).
So, if Navya Ltd. is ready to take a high degree of risk, then alternative (3) is strongly
recommended. In case of opting for less risk, alternative (2) is the next best option with a reduced
EPS of `6.80 per share. In case of alternative (1), EPS is even lower than the existing option, hence
not recommended.
BQ 20
A firm’s details are as under:
Sales (@100 per unit) `24,00,000

Variable Cost 50%
Fixed Cost `10,00,000
It has borrowed `10,00,000 @ 10% p.a. and its equity share capital is `10,00,000 (`100 each).
Assuming tax rate 50%.
Calculate:
(1) Operating Leverage

(2) Financial Leverage
(3) Combined Leverage
(4) Return on Investment as ROE
(5) If the sales increases by `6,00,000; what will the new EBIT?
2.14
CHAPTER 2 LEVERAGES
Answer
(1) Operating Leverage = = = 6 times
EBIT 2 ,00 ,000
EBIT 2 ,00 ,000

(2) Financial Leverage = = = 2 times
EBT 1 ,00 ,000
(3) Combined Leverage = OL × FL = 6×2 = 12 times
Earnings for Equity

(4) ROI as ROE = × 100
Equity shareholde r' s fund
50 ,000
= × 100 = 5%
10 ,00 ,000
(5) New EBIT:
Δ EBIT (in %) = Δ Sales × DOL = 25% × 6 times
= 150% or 1.5 times
New EBIT = Existing EBIT + 150% = 2,00,000 + 150%
= `5,00,000
Calculation of EPS
Particulars `
Sales 24,00,000
Less: Variable cost @ of 50% of sales 12,00,000
Less: Fixed cost 10,00,000
EBIT 2,00,000
Less: Interest @ 10% of 10,00,000 1,00,000
EBT 1,00,000
Less: Tax @ 50% 50,000
EAT 50,000
BQ 21
A firm has sales of `75,00,000 variable cost is 56% and fixed cost is `6,00,000. It has a debt of `45,00,000
at 9% and equity of `55,00,000.
(i) What is the firm’s ROI?

(ii) Does it have favourable financial leverage?
(iii) If the firm belongs to an industry whose capital turnover is 3, does it have a high or low capital
turnover?
(iv) What are the operating, financial and combined leverages of the firm?
(v) If the sales is increased by 10% by what percentage EBIT will increase?
(vi) At what level of sales the EBT of the firm will be equal to zero?
(vii) If EBIT increases by 20%, by what percentage EBT will increase?
2.15
LEVERAGES CHAPTER 2
Answer
Income Statement
Particulars `
Sales 75,00,000
Less: Fixed costs 6,00,000
EBIT 27,00,000
Less: Interest @ 9% of 45,00,000 4,05,000
EBT 22,95,000
EBIT 27 ,00 ,000

(i) ROI = ×100 = ×100 = 27%
Capital Employed 45 ,00 ,000  55 ,00 ,000
(ii) ROI is 27% and Interest on debt is 9%, hence, it has a favourable financial leverage.
Net Sales 75 ,00 ,000

(iii) Capital Turnover = = = 0.75
Capital 1 ,00 ,00 ,000
Firm has very low capital turnover as compared to industry average of 3.
(iv) Calculation of Operating, Financial and Combined leverages:

Operating Leverage = = = 1.222
EBIT 27 ,00 ,000
EBIT 27 ,00 ,000

Financial Leverage = = = 1.176
EBT 22 ,95 ,000
Combined Leverage = OL × FL = 1.222 × 1.176 = 1.437
(v) Operating leverage is 1.22. So if sales is increased by 10% then EBIT will be increased by 1.222
× 10 i.e. 12.22% (approx)
(vi) EBT = Sales – Variable cost – Fixed cost – Interest

Nil = Sales – 56% sales – 6,00,000 – 4,05,000
44% of sales = 10,05,000
Sales = 22,84,091
Hence at `22,84,091 sales level EBT of the firm will be equal to Zero.
(vii) Financial leverage is 1.176. So, if EBIT increases by 20% then EBT will increase by 1.18 × 20% =
23.52% (approx)
2.16
CHAPTER 2 LEVERAGES
PAST YEAR QUESTIONS
PYQ 1
A company had the following Balance Sheet as on 31st March, 2014:
[in crores]
Equity Share Capital 5.00 Fixed Assets (Net) 12.50
(50 lakh shares of `10 each) Current Assets 7.50
Reserve and Surplus 1.00
15% Debentures 10.00
Current Liabilities 4.00
20.00 20.00
The additional information given is as under:

Fixed cost per annum (excluding interest) 4 crores
Variable operating cost ratio 65%
Total assets turnover ratio 2.5
Income Tax rate 30%
Required:
(i) Earnings Per Share
(ii) Operating Leverage
(iii) Financial Leverage
(iv) Combined Leverage
Answer
(i) Calculation of EPS:
EAT 840 Lakhs
EPS = = = `16.80
No. of Shares 50 Lakhs
(ii) Calculation of OL:
Contributi on 17 .50 Crores
OL = = = 1.296 times
EBIT 13 .50 Crores
(iii) Calculation of FL:
EBIT 13 .50 Crores
FL = = = 1.125 times
EBT 12 .00 Crores
(iv) Calculation of CL:
CL = OL × FL = 1.296 × 1.125 = 1.458 times
Working Notes:
Income Statement
Particulars ` (in crores)
Sales (2.5 times of 20 crores) 50.00
Less: Variable Cost @ 65% of 50 crores 32.50
Contribution 17.50
Less: Fixed Cost 4.00
2.17
LEVERAGES CHAPTER 2
EBIT 13.50
Less: Interest @ 15% of 10 crores 1.50
EBT 12.00
Less: Tax @ 30% 3.60
EAT 8.40
PYQ 2
The capital structure of RST Ltd. is as follows:
Equity share capital of `10 each : `8,00,000
10% Preference share capital of `100 each : `5,00,000
12% Debenture of `100 each : `7,00,000
Additional Information:
Profit after tax (tax rate 30%) : `2,80,000
Operating expenses (including depreciation `96,800) : 1.50 times of EBIT
Equity share dividend paid : 15%
Market price per equity share : `23.00
Required to calculate:
(i) Operating and financial leverage.
(ii) Cover the preference and equity share dividends.
(iii) The earning yield and price earning ratio.
(iv) The net fund flow.
Note: All operating expenses (excluding depreciation) are variable.

Answer
(i) Operating & Financial leverage:
Contributi on 5,80 ,800
Operating Leverage = = = 1.2 times
EBIT 4 ,84 ,000
EBIT 4 ,84 ,000

Financial Leverage = =
EBT  4 ,00 ,000 
1  Tax 1  0.30
= 1.473 times
(ii) Calculation of cover the preference & equity share dividends:

Pr ofit after tax 2 ,80 ,000
Cover the Preference Share Dividend = =
Pr eference dividend 50 ,000
= 5.6 times
Pr ofit after tax  Pr eference dividend

Cover the Equity Share Dividend =
Equity dividend
2,80 ,000  50 ,000
= = 1.92 times
15 % of 8 ,00 ,000
(iii) Earning yield & price earning ratio:
2.18
CHAPTER 2 LEVERAGES
EPS 2.875
Earning Yield Ratio = × 100 = × 100 = 12.50%
MPS 23 .00
MPS 23 .00
Price Earning Ratio = = = 8 times
EPS 2.875
PAT  Pr eference dividends 2,80 ,000  50 ,000

Calculation of EPS = =
No . of Equity shares 80 ,000
= `2.875
(iv) Net fund flow:

Net fund flow = PAT - Preference dividends - Equity dividends + Depreciation
= 2,80,000 – 50,000 – 1,20,000 + 96,800 = `2,06,800
Calculation of contribution
Particulars `
Add: Tax (2,80,000 × 30/70) 1,20,000
Add: Interest on debenture (7,00,000 × 12%) 84,000
Earning before interest and tax 4,84,000
Add: Fixed cost (only depreciation) 96,800
PYQ 3
Following information are related to four firms of the same industry:
Firm Change in Revenue Change in Operating Income Change in EPS
P 27% 25% 30%
Q 25% 32% 24%
R 23% 36% 21%
S 21% 40% 23%
Find out:
(i) Degree of operating leverage , and
(ii) Degree of combined leverage of all the firms.
Answer
% Change in opereating income
(i) Degree of Operating Leverage =
% Chacge in revenue
P = 25% ÷ 27% = 0.93

Q = 32% ÷ 25% = 1.28
R = 36% ÷ 23% = 1.57
S = 40% ÷ 21% = 1.91
% Change in EPS
(ii) Degree of Combined Leverage =
% Chacge in revenue
P = 30% ÷ 27% = 1.11

2.19
LEVERAGES CHAPTER 2
Q = 24% ÷ 25% = 0.96

R = 21% ÷ 23% = 0.91
S = 23% ÷ 21% = 1.10
PYQ 4
The capital structure of the ABC Ltd as at 31.03.15 consists of ordinary share capital of `5,00,000 (face
value `100 each) and 10% debentures of `5,00,000 (`100 each). In the year ended March 15, sales
decreased from 60,000 units to 50,000 units. During the year and in the previous year, the selling price
is `12 per unit; variable cost stood at `8 per unit and fixed expenses were at `1,00,000 p.a. The income
tax rate was 30%.

(i) The percentage 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.
[(5 Marks) June 2015]
Answer
(i) Calculation of % decrease in EPS
Particulars 60,000 units 50,000 units
Sales @ `12 per unit 7,20,000 6,00,000
Less: Variable cost @ `8 per unit 4,80,000 4,00,000
Less: Fixed cost 1,00,000 1,00,000
Less: Interest @ 10% of `5,00,000 50,000 50,000
Less: Tax @ 30% 27,000 15,000
÷ No. of shares 5,000 5,000
12.60  7.00
% Decrease in EPS = × 100 = 44.44%
12.60
Contributi on
(ii) Degree of Operating Leverage =
EBIT
2 ,40 ,000
At 60,000 units = = 1.71 times
1 ,40 ,000
2 ,00 ,000
At 50,000 units = = 2 times
1 ,00 ,000
EBIT
(iii) Degree of Financial Leverage =
EBT
1 ,40 ,000
At 60,000 units = = 1.56 times
90 ,000
1 ,00 ,000
At 50,000 units = = 2 times
50 ,000
2.20
CHAPTER 2 LEVERAGES
PYQ 5
From the following details of X Ltd., prepare the Income Statement for the year ended 31st December
2014:
Financial Leverage : 2
Interest : `2,000
Operating Leverage : 3
Variable cost as a % of sales : 75%
Income tax rate : 30%
Answer
Income Statement for the year ended 31st December, 2014
Particulars `
Sales 48,000
Less: Variable cost 36,000
Contribution 12,000
Less: Fixed cost 8,000
EBIT 4,000
Less: Interest 2,000
EBT 2,000
Less: Tax @ 30% 600
EAT 1,400
Working Notes:
(a) Calculation of EBIT:
EBIT EBIT
Financial Leverage = 2 = =
EBT EBIT  Interest
EBIT
= or EBIT = `4,000
EBIT  2 ,000
(b) Calculation of Contribution:

Contributi on Contributi on
Operating Leverage = 3 = =
EBIT 4 ,000
(c) Calculation of Sales:

Contributi on 12 ,000
Sales Value = = = `48,000
PV Ratio 100 %  75 %
PYQ 6
A company had the following Balance Sheet as on 31st March, 2015.
Equity Share Capital of `10 each 40,00,000 Fixed Assets (Net) 1,28,00,000
Reserve and Surplus 8,00,000 Current Assets 32,00,000
1,60,00,000 1,60,00,000
2.21
LEVERAGES CHAPTER 2

Fixed cost per annum (excluding interest) `32,00,000
Total assets turnover ratio 2.5
Income Tax rate 30%
Required:
(i) Operating Leverage, (ii) Financial Leverage, (iii) Combined Leverage and (iv) EPS
Answer
(i) Calculation of OL:
Contributi on 1 ,20 ,00 ,000
OL = = = 1.364 times
EBIT 88 ,00 ,000
(ii) Calculation of FL:

EBIT 88 ,00 ,000
FL = = = 1.158 times
EBT 76 ,00 ,000
(iii) Calculation of CL:
CL = OL × FL = 1.364 × 1.158 = 1.579 times
(iv) Calculation of EPS:

EAT 53 ,20 ,000
EPS = = = `13.30
No . of Shares 4 ,00 ,000
Working Notes:
Income Statement
Particulars `
Sales (2.5 times of 1,60,00,000) 4,00,00,000
Less: Variable Cost @ 70% of 400 Lacs 2,80,00,000
Contribution 1,20,00,000
Less: Fixed Cost 32,00,000
EBIT 88,00,000
Less: Interest @ 15% of 80,00,000 12,00,000
EBT 76,00,000
Less: Tax @ 30% 22,80,000
EAT 53,20,000
PYQ 7
The following information related to YZ company Ltd. for the year ended 31st March, 2016 are
available to you:
Equity share capital of `10 each : `50,00,000
12% Bonds of `1,000 each : `37,00,000
Sales : `84,00,000
Fixed cost (Excluding Interest) : `6,96,000
2.22
CHAPTER 2 LEVERAGES
Financial leverage : 1.49

Profit Volume Ratio : 27.55%
Income Tax Rate : 40%
You are required to calculate:

(a) Operating Leverage;
(b) Combined Leverage; and
(c) Earning Per Share. [upto two decimal points]
Answer
(a) Operating Leverage = = = 1.43 times
EBIT 16 ,18 ,200
(b) Combined Leverage = OL × FL = 1.43 × 1.49 = 2.13 times
PAT 6 ,51 ,624

(c) Earnings Per Share = = = `1.303
No of Equity shares 5 ,00 ,000
Working Notes:
1. Contribution = Sales × PV Ratio = 84 Lacs × 27.55%= 23,14,200
2. EBIT = Contribution - Operating Fixed Cost

= 23,14,200 – 6,96,000 = 16,18,200
3. Profit after tax = (EBIT – Interest) (1 - t)

= (16,18,200 – 5,32,160) (1 – 0.40) = 6,51,624
4. Interest:
Financial Leverage = EBIT ÷ EBT = 16,18,200 ÷ EBT
= 1.49
EBT = 16,18,200 ÷ 1.49 = 10,86,040

Interest = EBIT – EBT = 16,18,200 – 10,86,040
= 5,32,160
Other interest = Total interest – Interest on bonds

= 5,32,160 – 12% of 37,00,000 = 88,160
Note: The question can also be solved by using interest on Bonds only, answer will be changed
accordingly.
PYQ 8
You are given the following information of 5 firms of the same industry:
Firm Change in Revenue Change in Operating Income Change in EPS
M 28% 26% 32%
N 27% 34% 26%
P 25% 38% 23%
Q 23% 43% 27%
R 25% 40% 28%
2.23
LEVERAGES CHAPTER 2
Find out:
(a) Degree of operating leverage , and
(b) Degree of combined leverage of all the firms.
Answer
% Change in opereating income
(a) Degree of Operating Leverage =
% Chacge in revenue
M = 26% ÷ 28% = 0.93

N = 34% ÷ 27% = 1.26
P = 38% ÷ 25% = 1.52
Q = 43% ÷ 23% = 1.87
R = 40% ÷ 25% = 1.60
% Change in EPS
(b) Degree of Combined Leverage =
% Chacge in revenue
M = 32% ÷ 28% = 1.14

N = 26% ÷ 27% = 0.96
P = 23% ÷ 25% = 0.92
Q = 27% ÷ 23% = 1.17
R = 28% ÷ 25% = 1.12
PYQ 9
The following details of a company for the year ended 31 March, 2017 are given below:
Operating leverage 2 times
Combined leverage 2.5 times
Fixed Cost (Excluding interest) `3.40 lakhs
Sales `50.00 lakhs
8% Debentures of `100 each `30.25 lakhs
Equity Share Capital of `10 each `34.00 lakhs
Income tax rate 30 per cent
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 1.5, 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?
Answer
(i) Calculation of Financial Leverage:
Financial Leverage = CL ÷ OL = 2.50 ÷ 2 = 1.25
(ii) P/V Ratio and EPS:

P/V ratio = × 100 = × 100 = 13.60%
Sales 50 ,00 ,000
2.24
CHAPTER 2 LEVERAGES
PAT 68 ,600
EPS = = = `0.20
Calculation of contribution:
Operating leverage = =
Contributi on  FC Contributi on  3,40 ,000
= 2 times
2 C – 6,80,000 = Contribution (C) = 6,80,000
Calculation of PAT:
Profit after tax = (Contribution – fixed cost – interest) (1 - t)
= (6,80,000 – 3,40,000 – 8% of 30,25,000)(1 - 0.30) = 68,600
(iii) Assets turnover:

Sales 50 ,00 ,000
Assets turnover = = = 0.778
Total Assets 34 ,00 ,000  30 ,25 ,000
0.778< 1.5 means lower than industry assets turnover.
(iv) Level of sales to earn zero EBT:

EBT = Sales – Variable cost – Fixed cost – Interest
Nil = Sales – 86.40% sales – 3,40,000 – 2,42,000
13.60% of sales = 5,82,000
Sales = 42,79,412
Note: The question can also be solved by first calculating EBIT with the help of Financial Leverage,
answer will be changed accordingly.
PYQ 10
Following are the selected financial information of A Ltd and B Ltd for the year ended March 31,
2018:
A Ltd B Ltd
Variable cost ratio 60% 50%
Interest `20,000 `1,00,000
Operating Leverage 5 2
Financial Leverage 3 2
Tax rate 30% 30%
You are required to find out:

(1) EBIT
(2) Sales
(3) Fixed cost
(4) Identify the company which is better placed with reasons based on leverages.
Answer
EBIT
(1) Financial Leverage = EBIT - Interest
2.25
LEVERAGES CHAPTER 2
EBIT
Financial Leverage (A Ltd) = = 3 times
EBIT - 20,000
EBIT = `30,000
EBIT
Financial Leverage (B Ltd) = EBIT - 1,00,000
= 2 times
EBIT = `2,00,000
Contribution
(2) Operating Leverage = EBIT
Contribution
Operating Leverage (A Ltd) = 30,000
= 5 times
Sales = `1,50,000 ÷ 40% (PV) = `3,75,000

Contribution
Operating Leverage (B Ltd) = 2,00,000
= 2 times
Sales = `4,00,000 ÷ 50% (PV) = `8,00,000
(3) Contribution = EBIT + Fixed Cost
Contribution (A Ltd) = 30,000 + Fixed Cost = `1,50,000
Fixed cost = `1,20,000
Contribution (B Ltd) = 2,00,000 + Fixed Cost = `4,00,000
Fixed cost = `2,00,000
(4) Comment based on leverage: B Ltd is better than A Ltd having lower degree of Business risk,
Financial risk and overall risk.
PYQ 11
The following data have been extracted from the books of LM Ltd:
Sales `100 Lakhs

Interest payable per annum `10 Lakhs
Operating leverage 1.2
Combined leverage 2.16
You are required to find out:
(1) The Financial leverage

(2) Fixed cost and
(3) P/V ratio
2.26
CHAPTER 2 LEVERAGES
Answer
(1) Financial Leverage = Combined leverage ÷ Operating leverage
= 2.16 ÷ 1.2 = 1.8 times
(2) Calculation of fixed cost:

EBIT
Financial Leverage = EBIT - Interest
= 1.8 times
EBIT
= EBIT - 10,00,000
= 1.8 times
EBIT = `22,50,000
Contribution
Operating Leverage = EBIT
= 1.2 times
Contribution = `22,50,000 × 1.2 = `27,00,000
Fixed cost = Contribution – EBIT

= `27,00,000 – 22,50,000 = `4,50,000
(3) P/V ratio = Contribution ÷ Sales

= 27,00,000 ÷ 1,00,00,000 = 27%
PYQ 12
Following is Balance Sheet of Soni Ltd. as on 31st March, 2018.
Equity Share Capital of `10 each 25,00,000 Non Current Assets 60,00,000
Reserve and Surplus 5,00,000 Current Assets 40,00,000
Non Current liabilities (12% Debt) 50,00,000
1,00,00,000 1,00,00,000
Additional information:
Fixed cost per annum (excluding interest) `20,00,000
Total assets turnover ratio 5 times
Income Tax rate 25%

(1) Prepare Income Statement
(2) Calculate the following and comment:
(a) Operating Leverage
(b) Financial Leverage
(c) Combined Leverage
[(10 Marks) Nov 2018]
Answer
(1) Income Statement
Particulars `
2.27
LEVERAGES CHAPTER 2
Sales (5 times of 1,00,00,000) 5,00,00,000

Less: Variable Cost @ 60% of 500 Lacs 3,00,00,000
Contribution 2,00,00,000
EBIT 1,80,00,000
Less: Interest @ 12% of 50,00,000 6,00,000
EBT 1,74,00,000
Less: Tax @ 25% 43,50,000
EAT 1,30,50,000
(2) Calculation of OL:

Contributi on 2,00,00,000
OL = = = 1.11 times
EBIT 1,80,00,000
It indicates fixed cost in cost structure. It indicates sensitivity of earnings before interest and tax (EBIT)
to change in sales at a particular level.
Calculation of FL:
EBIT 1,80,00,000
FL = = = 1.03 times
EBT 1,74,00,000
The financial leverage is very comfortable since the debt service obligation is small vis-à-vis EBIT.
Calculation of CL:
CL = OL × FL = 1.11 × 1.03 = 1.15 times
The combined leverage studied the choice of fixed cost in cost structure and choice of debt in capital
structure. It studies how sensitive the change in EPS is vis-à-vis change in sales.
PYQ 13
A company has sales of `1,00,00,000; variable cost is 55% of sales and fixed cost is `6,00,000. The capital
structure of the company is: Equity `1,20,00,000 and 8% Debt `80,00,000.
Calculate:
(1) Operating, Financial and Combined Leverages.
(2) If the sales amount is increased by 12%, by what percentage EBIT will increase?
Answer
Contributi on 1,00,00,000 × 45%
(1) Operating Leverage = = = 1.154 times
EBIT 45,00,000 − 6,00,000
EBIT 39,00,000
Financial Leverage = = = 1.196 times
EBT 39,00,000 − 8% of 80,00,000
Combined Leverage = OL × FL = 1.154 × 1.196 = 1.38 times
(2) % increase on EBIT:
2.28
CHAPTER 2 LEVERAGES
Δ EBIT (in %) = Δ Sales × DOL = 12% × 1.154 times = 13.848%
PYQ 14
The capital structure of the Shiva Ltd. consists of an ordinary share capital of `20,00,000 (share of `100
par value) and `20,00,000 of 10% debentures.
Sales increased by 20% from 2,00,000 units to 2,40,000 units, the selling price is `10 per unit;
variable cost amounts to `6 per unit and fixed expenses amount to `4,00,000. The income tax rate is
assumed to be 50%.

(1) The percentage increase in earnings per share;
(2) Financial leverage at 2,00,000 units and 2,40,000 units.
(3) Operating leverage at 2,00,000 units and 2,40,000 units.
(4) Comment on the behavior of operating and financial leverages in relation to increase in
production from 2,00,000 units to 2,40,000 units.
[(10 Marks) May 2019]
Answer
(1) Calculation of % increase in EPS
Particulars 2,00,000 units 2,40,000 units
Sales @ `10 per unit 20,00,000 24,00,000
Less: Fixed cost 4,00,000 4,00,000
Less: Interest @ 10% of `20,00,000 2,00,000 2,00,000
Less: Tax @ 50% 1,00,000 1,80,000
Profit after tax 1,00,000 1,80,000
÷ No. of shares 20,000 20,000
9.00 − 5.00
% increase in EPS = 5.00
× 100 = 80%
EBIT
(2) Financial Leverage =
EBT
4 ,00 ,000
2,00 ,000
5 ,60 ,000
At 2,40,000 units = = 1.56 times
3 ,60 ,000
Contributi on
(3) Operating Leverage =
EBIT
8 ,00 ,000
4 ,00 ,000
9 ,60 ,000
At 2,40,000 units = = 1.71 times
5,60 ,000
(4) Increase in production and sales will result in decrease in risk.
2.29
LEVERAGES CHAPTER 2
PYQ 15
The balance sheet of Gitashree Ltd. is given below:
Equity Share Capital 1,80,000 Net Fixed Assets 4,50,000
(`10 per share) Current Assets 1,50,000
Retained Earning 60,000
10% Long Term Debt 2,40,000
6,00,000 6,00,000
The company's total assets turnover ratio is 4 times, its fixed operating cost is `2,00,000 and its
variable operating cost ratio is 60%. The income tax rate is 30%.

1. (a) Degree of Operating Leverage.
(b) Degree of Financial Leverage.
(c) Degree of Combined Leverage.
2. Determine the likely level of EBIT if EPS is (A) `1.00, (B) `2.00 and (C) `Nil.
[(10 Marks) Nov 2019]
Answer
1. (a) Operating Leverage = = = 1.26
EBIT 7 ,60 ,000
EBIT 7 ,60 ,000

(b) Financial Leverage = = = 1.03
EBT 7 ,36 ,000
(c) Combined Leverage = OL × FL = 1.26 × 1.03 = 1.30
2. Calculation of likely level of EBIT:

(EBIT − I) (1 − t)
Earnings Per Share = N
(EBIT − 24,000) (1 − 0.30)
Case A: `1.00 =
18,000
or EBIT = `49,714
(EBIT − 24,000) (1 − 0.30)
Case B: `2.00 = 18,000
or EBIT = `75,429
(EBIT − 24,000) (1 − 0.30)
Case C: `0.00 = 18,000
or EBIT = `24,000
Working Note: Income Statement

Particulars `
Sales (4 times of 6,00,000) 24,00,000
Less: Variable Cost @ 60% of 24,00,000 14,40,000
EBIT 7,60,000
Less: Interest @ 10% of 2,40,000 24,000
EBT 7,36,000
2.30
CHAPTER 2 LEVERAGES
PYQ 16
The following data is available for Stone Ltd.:
Particulars `
Sales 5,00,000
EBIT 1,00,000
Profit before tax 75,000
Using the concept of leverage, find out:

(i) The percentage change in taxable income if EBIT increases by 10%.
(ii) The percentage change in EBIT if sales increases by 10%.
(iii) The percentage change in taxable income if sales increases by 10%.
Also verify the results in each of the above case.

[(10 Marks) Nov 2020]
Answer
(i) % change in taxable income (EBT) = % increase in EBIT × FL
= 10% × 1.333 times = 13.33%
(ii) % change in EBIT = % increase in Sales × OL

= 10% × 3 times = 30%
(iii) % change in taxable income (EBT) = % increase in Sales × CL

= 10% × 4 times = 40%
Verification in each case:

(i) % change in taxable income if EBIT increases by 10%:
Revised taxable income (EBT) = EBIT + 10% - Interest

= 1,00,000 + 10% - 25,000 = 85,000
85,000−75,000
% change in taxable income = 75,000
×100 = 13.33%
(ii) % change in EBIT if Sales increases by 10%:
Revised EBIT = (Sales + 10%) - Variable cost @ 40% - Fixed cost

= (5,00,000 + 10%) – 40% of 5,50,000 – 2,00,000
= 1,30,000
1,30,000−1,00,000
% change in EBIT = 1,00,000
×100 = 30%
(iii) % change in taxable income if Sales increases by 10%:
Revised taxable income (EBT) = (Sales + 10%) - VC@40% - Fixed cost - Interest
2.31
LEVERAGES CHAPTER 2
= (5L + 10%) – 40% of 5.5L – 2L – 25,000

= 1,05,000
1,05,000−75,000
% change in taxable income = 75,000
×100 = 40%
Working Note:
(a) Operating Leverage = = = 3 times
EBIT 1 ,00 ,000
EBIT 1 ,00 ,000
(b) Financial Leverage = = = 1.333 times
EBT 75 ,000
(c) Combined Leverage = OL × FL = 3 × 1.333 = 4 times
PYQ 17
The following information related to XYZ Company Ltd. for the year ended 31st March, 2020 are as
follows:
Equity share capital of `100 each : `50 Lakhs
12% Bonds of `1,000 each : `30 Lakhs
Sales : `84 Lakhs
Fixed cost (Excluding Interest) : `7.5 Lakhs
Financial leverage : 1.39
Profit Volume Ratio : 25%
Market Price per Equity Share : `200
Income Tax Rate Applicable : 30%

(i) Operating Leverage
(ii) Combined Leverage
(iii) Earning Per Share
(iv) Earning Yield
[(10 Marks) Jan 2021]
Answer
(i) Operating Leverage = = = 1.56 times
EBIT 13 ,50 ,000
(ii) Combined Leverage = OL × FL = 1.56 × 1.39 = 2.16 times
PAT 6 ,93 ,000

(iii) Earnings Per Share = = = `13.86
No of Eq . sh . 50 ,000
EPS 13.86
(iv) Earnings Yield = × 100 = × 100 = 6.93%
MPS 200
Working Notes:
(1) Contribution = Sales × PV Ratio = 84 Lakhs × 25% = 21,00,000
(2) EBIT = Contribution - Fixed Cost
= 21,00,000 – 7,50,000 = 13,50,000
2.32
CHAPTER 2 LEVERAGES
(3) Profit after tax = (EBIT – Interest) (1 - t)

= (13,50,000 – 12% of 30,00,000) (1 – 0.30) = 6,93,000
PYQ 18
A Company had the following Balance Sheet as on 31st March 31, 2021:
Liabilities ` (in Crores) Assets ` (in Crores)
Equity Share Capital 7.50 Building 12.50
(75 lakhs Shares of `10 each) Machinery 6.25
Reserve and Surplus 1.50 Current Assets:
15% Debentures 15.00 Stock 3.00
Current Liabilities 6.00 Debtors 3.25
Bank Balance 5.00
30.00 30.00
Fixed costs per annum (excluding interest) : `6 Crores
Variable operating costs ratio : 60% of sales
Total assets turnover ratio : 2.5 times
Income tax rate : 40%
Calculate the following and comment:

(a) Earnings per share
(b) Operating Leverage
(c) Financial Leverage
(d) Combined Leverage [(10 Marks) July 2021]
Answer
(a) Statement of EPS
Particulars ` (in Crores)
Sales @ (2.50 times of `30 Crores) 75.00
Less: Variable cost @ 60% 45.00
Contribution 30.00
Less: Fixed cost 6.00
EBIT 24.00
Less: Interest @ 15% of 15 Crores 2.25
EBT 21.75
Less: Tax @ 40% 8.70
EAT 13.05
÷ No. of Equity Shares ÷ 0.75
EPS `17.40
EPS indicates the amount the company earns per share. Investors use this as a guide while valuing the
share and making investment decisions. It is also an indicator used in comparing firms within an
industry or industry segment.
Contributi on 30 Crores
(b) Operating Leverage = = = 1.25 times
EBIT 24 Crores
It indicates the choice of technology and fixed cost in cost structure. It is level specific. When firm
operates beyond operating break-even level, then operating leverage is low. It indicates sensitivity of
earnings before interest and tax (EBIT) to change in sales at a particular level.
2.33
LEVERAGES CHAPTER 2
EBIT 24 Crores
(c) Financial Leverage = = = 1.10 times
EBT 21 .75 Crores
The financial leverage is very comfortable since the debt service obligation is small vis-a-vis EBIT.
(d) Combined Leverage = OL × FL = 1.25 × 1.10 = 1.38 times
The combined leverage studies the choice of fixed cost in cost structure and choice of debt in capital
structure. It studies how sensitive the change in EPS is vis-a-vis change in sales.
PYQ 19
Information of A Ltd. is given below:
 Earnings after tax : 5% of sales
 Income tax rate : 50%
 Degree of Operating leverage : 4 times
 10% Debenture in capital structure : `3 lakhs
 Variable costs : `6 lakhs
Required:
(i) From the given data complete following statement:
Sales XXXX
Less: Variable Costs `6,00,000
Contribution XXXX
Less: Fixed costs XXXX
EBIT XXXX
Less: Interest expenses XXXX
EBT XXXX
Less: Income tax XXXX
EAT XXXX
(ii) Calculate Financial Leverage and Combined Leverage.

(iii) Calculate percentage change in earning per share, if sales increased by 5%.
[(10 Marks) Dec 2021]
Answer
(i) Statement of EAT
Particulars `
Sales 12,00,000
Less: Variable Costs 6,00,000
EBIT 1,50,000
Less: Interest expenses @ 10% of `3 lakhs 30,000
EBT 1,20,000
Less: Income tax 60,000
EAT @5% of `12,00,000 `60,000
EBIT 1 ,50 ,000

(ii) Financial Leverage = = = 1.25 times
EBT 1 ,20 ,000
2.34
CHAPTER 2 LEVERAGES
Combined Leverage = OL × FL = 4 × 1.25 = 5 times
(iii) % change in EPS = % change in Sales × CL= 5% × 5 = + 25%
Working Notes:
(a) Operating Leverage = = = 4
EBIT Contributi on  FC
Contribution = 4 Contribution – 4 Fixed cost
- 3 Contribution = - 4 Fixed cost
¾ Contribution = Fixed cost
Contribution = Sales – Variable cost = Sales – `6,00,000
∴ Fixed cost = ¾ or 75% of contribution = 75% (Sales - `6,00,000)

= 75% Sales - `4,50,000
(b) EAT = 5% of Sales

EBT = EAT ÷ (1 - t) = 5% Sales ÷ (1 – 0.5)
= 10% Sales
(c) EBT = Sales – Variable cost – Fixed cost – Interest

10% Sales = Sales - `6,00,000 – (75% Sales - `4,50,000) - `30,000
10% Sales = Sales - `6,00,000 – 75% Sales + `4,50,000 - `30,000
10% Sales = 25% Sales - `1,80,000
15% Sales = `1,80,000
Sales = `1,80,000 ÷ 15% = `12,00,000
(d) EBT = 10% of Sales = 10% of `12,00,000

= `1,20,000
(e) EBIT = EBT + Interest = `1,20,000 + `30,000

= `1,50,000
(f) Fixed cost = 75% of Contribution = 75% of `6,00,000

= `4,50,000
PYQ 20
Details of a company for the year ended 31st March, 2022 are given below:
Sales : `86,00,000
Profit Volume (P/V) Ratio : 35%
Fixed Cost excluding interest expense : `10,00,000
10% Debt : `55,00,000
Equity Share Capital of `10 each : `75,00,000
Income Tax Rate : 40%
Required:
(1) Determine company’s Return on Capital Employed (Pre-tax) and EPS.
(2) Does the company have a favourable financial leverage?
(3) Calculate operating and combined leverage of the company.
2.35
LEVERAGES CHAPTER 2
(4) Calculate percentage change in EBIT, if sales increases by 10%

(5) At what level of sales, the Earning before tax (EBT) of the company will be equal to zero?
[(10 Marks) May 2022]
Answer
EBIT 20 ,10 ,000
(1) ROCE = ×100 = ×100 = 15.46%
Capital Employed 55,00 ,000  75,00 ,000
Statement of EPS
Particulars `
Sales 86,00,000
Less: Variable cost @ of 65% (100 – P/V ratio) of sales 55,90,000
EBIT 20,10,000
Less: Interest @ 10% of 55,00,000 5,50,000
EBT 14,60,000
Less: Income Tax @ 40% 5,84,000
EAT 8,76,000
÷ Number of Equity Shares ÷ 7,50,000
EPS 1.168
(2) ROCE is 15.46% and Interest on debt is 10%, hence, it has a favourable financial leverage.
(3) Calculation of Operating and Combined leverages:

Operating Leverage = = = 1.497
EBIT 20 ,10 ,000

Combined Leverage = = = 2.062
EBT 14 ,60 ,000
(4) Operating leverage is 1.497. So if sales is increased by 10% then EBIT will be increased by 1.497
× 10 i.e. 14.97% (approx.)
(5) EBT = Sales – Variable cost – Fixed cost – Interest

Nil = Sales – 65% sales – 10,00,000 – 5,50,000
35% of sales = 15,50,000
Sales = `44,28,571
PYQ 21
The following information is available for SS Ltd.
Profit volume (PV) ratio - 30%
Operating leverage - 2.00
Financial leverage - 1.50
Loan - `1,25,000
Post-tax interest rate - 5.6%
Tax rate - 30%
Market Price per share (MPS) - `140
Price Earnings Ratio (PER) - 10
2.36
CHAPTER 2 LEVERAGES

(1) Prepare the Profit-Loss statement of SS Ltd. and
(2) Find out the number of equity shares.
[(10 Marks) Nov 2022]
Answer
(1) Profit-Loss Statement
Particulars Company A
Sales 2,00,000
Less: Variable cost (b.f.) 1,40,000
Contribution 60,000
Less: Fixed cost (b.f.) 30,000
Earnings before interest and tax (EBIT) 30,000
Profit before tax 20,000
Less: Tax @ 30% 6,000
Profit after tax 14,000
(2) Number of Equity Shares = PAT/EPS = `14,000/`14 = 1,000 Shares
Working Notes:
(a) Financial Leverage = EBIT/(EBIT - Interest)
= EBIT/(EBIT – `10,000*) = 1.5
EBIT = 1.5 EBIT – `15,000
EBIT = `30,000
*Interest = Loan × Pre-tax interest rate

= `1,25,000 × 8% [5.6% ÷ (1 – 0.3)] = `10,000
(b) Operating Leverage = Contribution/EBIT

= Contribution/30,000 = 2.00
(c) Sales = Contribution/PV Ratio

= `60,000/0.30 = `2,00,000
(d) EPS = MPS/PE Ratio

= `140/10 times = `14
PYQ 22
Following information is given for X Ltd:
Total contribution (`) 4,25,000

Operating leverage 3.125
15% Preference shares (`100 each) 1,000
Number of equity shares 2,500
Tax rate 50%
Calculate EPS of X Ltd., if 40% decrease in sales will result EPS to zero.
[(5 Marks) May 23]
2.37
LEVERAGES CHAPTER 2
Answer
EPS of X Ltd. = {EBT (1 – t) – PD} ÷ No of Equity Shares
= {2,00,000 (1 – 0.5) – 15,000} ÷ 2,500 = `34
Working Note:
Calculation of CL and EBT:
Question says that 40% decrease in sales will result in 100% decrease in EPS:

Combined Leverage = = = 2.5 times
= Contributi on = 4 ,25,000
Pr eference Dividend 15,000
EBT  EBT 
1  Tax 1  0.50
4 ,25 ,000
2.5 =
EBT  30 ,000
2.5 EBT – 75,000 = 4,25,000
EBT = 2,00,000
PYQ 23
The following details of Shiva Ltd. for the year ended 31st March, 2023 are given below:
Operating Leverage 1.4
Combined Leverage 2.8
Fixed Cost (Excluding interest) `2.04 lakhs
Sales `30 lakhs
12% Debentures of `10 each `21.25 lakhs
Equity Share Capital of `10 each `17.00 lakhs
Income Tax Rate 30%
Required:
(a) Calculate P/V ratio and Earning Per Share (EPS)
(b) If the company belongs to an industry, whose assets turnover is 1.5, does it have a high or low
assets turnover?
(c) Financial Leverage
[(5 Marks) Nov 23]
Answer
(a) P/V Ratio and EPS:
P/V ratio = × 100 = × 100 = 23.80%
Sales 30 ,00 ,000
PAT 1 ,78 ,500
EPS = = = `1.05
Calculation of contribution:
OL = = = 1.4 times
Contributi on  FC Contributi on  2,04 ,000
2.38
CHAPTER 2 LEVERAGES
1.4 Contribution – 2,85,600 = Contribution = 7,14,000
Calculation of PAT:
Profit after tax = (Contribution – fixed cost – interest) (1 - t)
= (23.80% of 30 lacs – 2.04 lacs – 12% of 21.25lacs)(1-0.30)
= 1,78,500
(b) Assets turnover:

Sales 30 ,00 ,000
Assets turnover = = = .784
Total Assets 38 ,25 ,000
0.784 < 1.5 means lower than industry assets turnover.
(c) Calculation of Financial Leverage:
Financial Leverage = CL ÷ OL = 2.80 ÷ 1.40 = 2 times
BQ: 3, 5, 6, 8, 9, 10, 13, 14, 15, 16, 18, 21
PYQ: 1, 2, 9, 16, 19, 21, 23
2.39
CHAPTER 3 MANAGEMENT OF RECEIVABLES & PAYABLES
CHAPTER 3 MANAGEMENT OF RECEIVABLES AND PAYABLES
EVALUATION OF CREDIT POLICIES
BQ 1
Gemini Products Ltd. is considering the revision of its credit policy with a view to increasing its sales
and profits. Currently all its sales are on credit and the customers are given one month time to settle the
dues. It has a contribution of 40% on sales and it can raise additional funds at a cost of 20% per annum.
The marketing director of the company has given the following options with draft estimates for
consideration:
Particulars Existing Option 1 Option 2 Option 3
Sales (` in lacs) 200 210 220 250
Credit period (in months) 1 1.5 2 3
Bad debts (` in lacs) 2 2.5 3 5
Cost of administration (` in lacs) 1.20 1.30 1.5 3.00
Advise the company to take the right decision. (Workings should form part of the answer)
Answer
Statement of Evaluation of Credit Policies (Total Approach)
Classifications (in Lakhs)
Particulars
Existing Option 1 Option 2 Option 3
Credit sales 200 210 220 250
Less: Variable cost @ 60% 120 126 132 150
Profit before bad debts and admin cost 80 84 88 100
Less: Bad debts 2 2.5 3 5
Less : Cost of administration 1.2 1.3 1.5 3
Expected Profit 76.80 80.20 83.5 92
Less: Cost of funds 2 3.15 4.40 7.50
Net Benefit 74.80 77.05 79.10 84.50
Working Notes:
Calculation of cost of funds
Existing Option 1 Option 2 Option 3
120 × 1/12 × 20% 126 × 1.5/12 × 20% 132 × 2/12 × 20% 150 × 3/12 × 20%
= 2.00 = 3.15 = 4.40 = 7.50
Select Option 3 with credit of 3 months having higher net benefit.
BQ 2
ABC Ltd. is considering the following credit policy alternatives:
Particulars Existing Option 1 Option 2
Sales (` in lacs) 10.00 9.60 12.00
Credit period (in days) 30 41 60
Bad debts (% of sales) 5 3.33 6
Cost of administration (` in lacs) .20 .12 .25
Average effective collection period (in days) 45 51 72
3.1
MANAGEMENT OF RECEIVABLES AND PAYABLES CHAPTER 3
The average effective collection period differs from the credit period as all debtors do not strictly adhere
to the condition stipulated. The company achieves a contribution of 40% on sales and the firm requires
a 20% p.a. return on investment.
You are required to suggest which credit period is more suitable to the company. Do you
have any further suggestions to make to the management in the context of your finding?
Answer
Statement of Evaluation of Credit Policies (Total Approach)
Credit sales 10,00,000 9,60,000 12,00,000
Less: Variable cost @ 60% 6,00,000 5,76,000 7,20,000
Profit before bad debts and admin cost 4,00,000 3,84,000 4,80,000
Less: Bad debts 50,000 31,968 72,000
Less : Cost of administration 20,000 12,000 25,000
Expected Profit 3,30,000 3,40,032 3,83,000
Less: Cost of funds 14,795 16,096 28,405
Net Benefit 3,15,205 3,23,936 3,54,595
Working notes: Calculation of required return on investment:

Existing = 6,00,000 × 45/365 × 20% = 14,795
Option 1 = 5,76,000 × 51/365 × 20% = 16,096
Option 2 = 7,20,000 × 72/365 × 20% = 28,405
Select Option 2 with credit period of 60 Days. It is further suggested that company should collect
amount from debtors within credit period allowed.
BQ 3
The following are the details regarding the operation of a firm during a period of 12 months:
Sales `12,00,000
Selling price `10 per unit
Variable cost `7 per unit
Total cost `9 per unit
Credit period allowed to customers One month
The firm is considering a proposal for a more liberal extension of credit by increasing the average
collection period from one month to two months. This relaxation is expected to increase the sales by
25%.
You are required to advise the firm regarding adopting of the new credit policy, presuming
that the firm's required return on investment is 25%.
Answer
Statement of Evaluation of Proposed Policy
Policies
Particulars
Present Proposed
Sales units 1,20,000 1,50,000
Sales value 12,00,000 15,00,000
Less: Variable cost @ `7 per unit/ 70% 8,40,000 10,50,000
3.2
Less: Fixed Cost (1,20,000 × `2) 2,40,000 2,40,000

Expected Profit 1,20,000 2,10,000
Less: Required return @ 25% on investment in debtors 22,500 53,750
Net Benefit 97,500 1,56,250
Calculation of required return on investment in cost of debtors:
Existing = (8,40,000 + 2,40,000) × 1/12 × 25% = 22,500

Proposed = (10,50,000 + 2,40,000) × 2/12 × 25% = 53,750
Analysis: The proposal for a more liberal extension of credit by increasing the average collection period
from one month to two months is suggested to adopt.
BQ 4
A company sells 40,000 units of its product per year @ `35 per unit. The average cost per unit is `31 out
of which variable cost per unit is `28. The average collection period is 60 days. Bad debts losses are 3%
on sales and the collection charges amount to `15,000.
The company is considering the proposal to follow stricter collection policy which would bring
down the losses on account of bad debts to 1% of sales and average collection period to 45 days. It would,
however, reduce the sales volume by 1,000 units and increase collection expenses to `25,000. The
company requires a rate of return of 20%.
Would you recommend the adoption of the new credit policy? (Assume 360 days in a year for
the purpose of your calculation.)
Answer
Statement of Evaluation of Proposed policy
Policies
Particulars
Present Proposed
Sales units 40,000 39,000
Sales value @ `35 per unit 14,00,000 13,65,000
Less: Variable cost @ `28 per unit 11,20,000 10,92,000
Less: Fixed Cost (40,000 × `3) 1,20,000 1,20,000
Profit before cost of credit 1,60,000 1,53,000
Less: Bad debts @ 3% / 1% 42,000 13,650
Less: Collection charges 15,000 25,000
Less: Required return @ 20% on investment in debtors 41,333 30,300
Net Benefit 61,667 84,050
Analysis: Company should adopt stricter policy of credit i.e. 45 days of credit having higher net benefit.
Working notes: Calculation of required return on investment in cost of debtors:
Existing = (11,20,000 + 1,20,000) × 60/360 × 20% = 41,333

Proposed = (10,92,000 + 1,20,000) × 45/360 × 20% = 30,300
BQ 5
Mosaic Limited has current sales of `15 lakhs per year. Cost of sales is 75 per cent of sales and bad debts
are one per cent of sales. Cost of sales comprises 80 per cent variable costs and 20 per cent fixed costs,
3.3
while the company’s required rate of return is 12 per cent. Mosaic Limited currently allows customers
30 days’ credit, but is considering increasing this to 60 days’ credit in order to increase sales.
It has been estimated that this change in policy will increase sales by 15 per cent, while bad debts
will increase from one per cent to four per cent. It is not expected that the policy change will result in an
increase in fixed costs and creditors and stock will be unchanged.
Should Mosaic Limited introduce the proposed policy? Analyse (Assume a 360 days year)
Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 15,00,000 17,25,000
Less: Variable cost @ 80% 9,00,000 10,35,000
Less: Fixed cost 2,25,000 2,25,000
Profit before bad debt losses 3,75,000 4,65,000
Less: Bad debt losses @1%/4% 15,000 69,000
Less: Required return on investment ‘WN’ 11,250 25,200
Net Benefit 3,48,750 3,70,800
Advise: Mosaic Limited should introduce the proposed policy.
Working notes:
Calculation of Variable cost:

Existing = 15,00,000 × 75% × 80% = 9,00,000
Proposed = 9,00,000 + 15% = 10,35,000
Calculation of Fixed cost:

Existing = 15,00,000 × 75% × 20% = 2,25,000
Proposed = Same as at existing level = 2,25,000
Calculation of required return:

Existing = 11,25,000 × 30/360 × 12% = 11,250
Proposed = 12,60,000 × 60/360 × 12% = 25,200
BQ 6
A trader whose current sales are in the region of `6 lakhs per annum and an average collection period
of 30 days wants to pursue a more liberal policy to improve sales. A study made by a management
consultant reveals the following information:
Increase in Collection Present default
Credit Policy Increase in Sales
Period anticipated
A 10 days `30,000 1.5%
B 20 days `48,000 2%
C 30 days `75,000 3%
D 45 days `90,000 4%
3.4
The selling price per unit is `3. Average cost per unit is `2.25 and variable costs per unit are `2. The
current bad debt loss is 1%. Required return on additional investment is 20%. Assume a 360 days year.
Analyse which of the above policies would you recommend for adoption?
Answer
Statement of Evaluation of Credit Policies
Particulars Existing A B C D
No of units 2,00,000 2,10,000 2,16,000 2,25,000 2,30,000
Credit sales @ `3 per unit 6,00,000 6,30,000 6,48,000 6,75,000 6,90,000
Less: Variable cost @ `2 per unit 4,00,000 4,20,000 4,32,000 4,50,000 4,60,000
Less: Fixed cost (2.25 - 2) × 2,00,000 50,000 50,000 50,000 50,000 50,000
Profit before bad debt losses 1,50,000 1,60,000 1,66,000 1,75,000 1,80,000
Less: Bad debt losses 6,000 9,450 12,960 20,250 27,600
Expected Profit 1,44,000 1,50,550 1,53,040 1,54,750 1,52,400
Less: Req. return on investment 7,500 10,444 13,389 16,667 21,250
Net Benefit 1,36,500 1,40,106 1,39,651 1,38,083 1,31,150
Recommendation: The Proposed Policy A (i.e. increase in collection period by 10 days or total 40 days)
should be adopted since the net benefits under this policy are higher as compared to other policies.
Working notes:
Calculation of cost required rate of return:
Collection Period
Required rate of return = Total cost × × Rate of return
360 Days
30
Existing Policy = 4,50,000 × × 20% = 7,500
360 Days
40
Credit Policy A = 4,70,000 × × 20% = 10,444
360 Days
50
Credit Policy B = 4,82,000 × × 20% = 13,389
360 Days
60
Credit Policy C = 5,00,000 × × 20% = 16,667
360 Days
75
Credit Policy D = 5,10,000 × × 20% = 21,250
360 Days
BQ 7
XYZ Corporation is considering relaxing its present credit policy and is in the process of evaluating two
proposed policies. Currently, the firm 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 firm is
required to give a return of 25% on the investment in new accounts receivables. The company’s variable
costs are 70% of the selling price. Given the following information, identify which is the better option?
Policies
Particulars
Present Option 1 Option 2
Annual credit sales `50,00,000 `60,00,000 `67,50,000
Account receivable turnover ratio 4 times 3 times 2.4 times
Bad debt losses `1,50,000 `3,00,000 `4,50,000
3.5
Answer
Credit sales 50,00,000 60,00,000 67,50,000
Less: Variable cost @ 70% 35,00,000 42,00,000 47,25,000
Profit before bad debt losses 15,00,000 18,00,000 20,25,000
Less: Bad debt losses 1,50,000 3,00,000 4,50,000
Expected Profit 13,50,000 15,00,000 15,75,000
Less: Required return on investment ‘WN’ 2,18,750 3,50,000 4,92,188
Net Benefit 11,31,250 11,50,000 10,82,812
Working notes:
Calculation of required return on investment:
Existing = 35,00,000 × 1/4 × 25% = 2,18,750

Option 1 = 42,00,000 × 1/3 × 25% = 3,50,000
Option 2 = 47,25,000 × 1/2.4 × 25% = 4,92,188
Recommendation: The Proposed Policy I (option 1) should be adopted since the net benefits under this
policy are higher as compared to other policies.
BQ 8
A company is presently having credit sales of `12,00,000. The existing credit terms are 1/10 net 45 days
and average collection period is 30 days. The current bad debts loss is 1.5%.
In order to accelerate the collection process further as also to increase sales, the company is
contemplating liberalization of its existing credit terms to 2/10 net 45 days.
It is expected that sales are likely to increase 1/3 of existing sales, bad debts increase to 2% of
sales and average collection period to decline to 20 days.
The contribution to sales ratio of the company is 22% and opportunity cost of investment in
receivables is 15 percent (pre tax). 50 percent and 80 percent of customers in term of sales revenue are
expected to avail cash discount under existing and liberalisation scheme respectively. The tax rate is
30%.
Should the company change its credit terms? (Assume 360 days in a year).
Answer
Policies
Particulars
Present Proposed
Sales value 12,00,000 16,00,000
Contribution @ 22% 2,64,000 3,52,000
Less: Bad debts 18,000 32,000
Less: Cash discount (WN) 6,000 25,600
Less: Opportunity cost of investment in receivables (WN) 11,700 10,400
Net Benefit Before Tax 2,28,300 2,84,000
Less: Tax @ 30% 68,490 85,200
Net Benefit After Tax 1,59,810 1,98,800
3.6
Advise: Company should change its credit terms having higher net benefit.
Working notes:
(1) Calculation of opportunity cost of investment in receivables:
Existing = 9,36,000 × 15% × 30/360 = 11,700
Proposed = 12,48,000 × 15% × 20/360 = 10,400
(2) Calculation of cash discount:

Existing = 12,00,000 × 50% × 1% = 6,000
Proposed = 16,00,000 × 80% × 2% = 25,600
BQ 9
As a part of the strategy to increase sales and profits, the sales manager of a company proposes to sell
goods to a group of new customers with 10% risk of non-payment. This group would require one and a
half months credit and is likely to increase sales by `1,00,000 p.a. Production and Selling expenses
amount to 80% of sales and the income-tax rate is 50%. The company’s minimum required rate of return
(after tax) is 25%.
(1) Should the sales manager’s proposal be accepted?

(2) Also find the degree of risk of non-payment that the company should be willing to assume if
the required rate of return (after tax) were (i) 30%, (ii) 40% and (iii) 60%.
Answer
(1) Statement of Evaluation
Particulars `
Increase in sales 1,00,000
Less: Cost of sales @ 80% 80,000
Profit before bad debts 20,000
Less: Bad debts @ 10% 10,000
Expected PBT 10,000
Less: Tax @ 50% 5,000
Expected PAT 5,000
Less: Required return after tax (80,000 × 1.5/12 × 25%) 2,500
Net Benefit (After Tax) 2,500
Advise: The sales manager’s proposal should be accepted.
(2) Computation the Degree of risk of non-payment:
Required returnafter tax = (Sales – Cost of sales – Risk of non payment) (1 - t)
Case I
80,000 × 1.5/12 × 30% = (1,00,000 – 80,000 - Risk of non payment) (1 - .50)
Risk of non payment = 14,000
Degree of risk of non-payment = 14,000/
1,00,000 × 100 = 14%
Case II
3.7

1,00,000 × 100 = 12%
Case III
1,00,000 × 100 = 8%
BQ 10
Slow Payers are regular customer of Goods Dealers Ltd., Calcutta and have approached the sellers of
extension of a credit facility for enabling them to purchase goods from Goods Dealer Ltd. On an analysis
of past performance and on the basis of information supplied, the following pattern of payment schedule
is regard to Slow Payers:
Pattern of Payment Schedule
At the end of 30 Days 15% of the bills
Non-recovery 1% of the bills
Slow Payers want to enter into a firm commitment for purchase of goods of `15 Lacs in 2023,
deliveries to be made in equal quantities on the first day of each quarter in the calendar year. The price
per unit of commodity is `150 on which a profit of `5 per unit is expected to be made. It is anticipated
by Goods Dealers Ltd. that taking up of this contract would mean an extra recurring expenditure of
`5,000 per annum.
If the opportunity cost of funds in the hands of Goods dealers is 24% per annum, would you
as the finance manager of the seller recommend the grant of credit to Slow Payers? Workings
should form part of your answer. Assume year of 365 days.
Answer
Statement of Evaluation of Credit Policy
Particulars Proposed
Sales in units 10,000
Sales value @ `150 per unit 15,00,000
Less: Variable cost @ `145 per unit 14,50,000
Less: Extra recurring expenditure 5,000
Profit before bad debt 45,000
Less: Bad debts @ 1% 15,000
Expected Profit 30,000
Less: Opportunity cost of investment in receivables (WN) 68,788
Net Benefit (38,788)
Recommendation: The proposed policy should not be adopted since the net benefit under this policy is
negative.
Working notes:
Calculation of Opportunity cost of average investment:
3.8
Average Collection Period

Opportunity cost = Total cost × × Rate
365
= 14,55,000 × 71.90/365 × 24% = 68,788
Calculation of Average collection period:

Average collection period = 30 days × 15% + 60 days × 34% + 90 days × 30% + 100 days × 20%
= 71.90 Days
BQ 11
Star Limited manufacturer of color TV sets, are considering the liberalization of existing credit terms to
three of their large customers A, B and C. The credit period and likely quantity of TV sets that will be
lifted by the customers are as follows:
Quantity Lifted (No. of TV Sets)
Credit Period (Days) A B C
0 1,000 1,000 -
30 1,000 1,500 -
60 1,000 2,000 1,000
90 1,000 2,500 1,500
The selling price per TV set is `9,000. The expected contribution is 20% of the selling price. The cost of
carrying debtors averages 20% per annum.
You are required:

(a) Determine the credit period to be allowed to each customer. (Assume 360 days in a year for
calculation purposes).
(b) What other problems the company might face in allowing the credit period as determined in (a)
above?
Answer
(a) In case of customer A, there is no increase in sales even if the credit is given. Hence, it is suggested
not to extend any credit period to customer A. Statement of evaluation for B and C is given below:
(` Lakhs)
Particulars Customer B Customer C
Credit period (days) 0 30 60 90 60 90
Sales (units) 1,000 1,500 2,000 2,500 1,000 1,500
Sales 90 135 180 225 90 135
Less: Variable cost @ 80% 72 108 144 180 72 108
Contribution 18 27 36 45 18 27
Less: Cost of debtors @ 20% - 1.8 4.8 9 2.4 5.4
Net Benefit 18 25.2 31.2 36 15.6 21.6
The excess of contribution over cost of carrying Debtors is highest in case of credit period of 90 days in
respect of both the customers B and C. Hence, credit period of 90 days should be allowed to B and C.
(b) Problems:
1. Customer A is taking 1,000 TV sets whether credit is given or not. Customer C is taking 1,000
TV sets at credit for 60 days. Hence, A also may demand credit for 60 days compulsorily.
2. B will take 2,500 TV sets at credit for 90 days whereas C would lift 1,500 sets only. In such case
B will demand further relaxation in credit period i.e. B may ask for 120 days credit.
3.9
BQ 12
A company offers standard credit terms of 60 days net. Its cost of short term borrowings is 16% per
annum. Determine whether a 2.5% discount should be offered for payment within7 days to customers
who would normally pay after (i) 60 days (ii) 80 days, and (iii) 105 days.
Answer
This cost of using a discount to obtain funds and improve liquidity should be compared with alternative
sources of finance. If the cost of short term borrowings is 16%, then cost of discount offer must be less
than this, otherwise discount need not be offered. A customer who is paying after 60, 80 or 105 days
involves a cost @ 16% per annum for the respective period.
If the firm offers a discount @ 2.5% for payment within 7 days, then it means that 97.5% of the fund will
be available for 53 days, 73 days and 98 days respectively. The percentage cost of getting funds for
respective period is `2.50/`97.50.
However, the annual percentage cost of the discount in each case is the discount should be offered to
customers who would have paid after 80 or 105 days, and not to those who would have paid after 60
days. The reason is being that the cost of funds is 16% and the customers who would have paid after 60
days, would inflict a cost of 17.66% if the discount terms are offered to them.
2.50
(a) × 365 = 17.66% p.a.
97.50 53
2.50
(b) × 365 = 12.82% p.a.
97.50 73
2.50
(c) × 365 = 9.55% p.a.
97.50 98
FACTORING SERVICES
BQ 13
A company is considering using a factor, the following information is relevant:
(a) The current average collection period for the company's debts is 80 days and ½% of debt default.
The factor has agreed to pay over money due, after 60 days, and it will suffer loss of any bad debts.
(b) The annual charge for the factoring is 2% of turnover payable annually in arrears. Administration
cost saving will total `1,00,000 per annum.
(c) Annual sales, all on credit are `1,00,00,000. Variable costs total 80% of sales price. The company's
cost of borrowings is 15% per annum. Assume year consisting of 365 days. Should the company
enter into a factoring agreement?
Answer
Particulars `
(A) Savings:
Saving in administration cost 1,00,000
Saving in bad debts (0.5% of 1,00,00,000) 50,000
*Saving in cost of debtors (1,00,00,000 × 80% × 80 – 60/365 × 15%) 65,753
Total (A) 2,15,753
3.10
(B) Cost:
Annual charges (2% of 1,00,00,000) 2,00,000
Total (B) 2,00,000
Net Benefit (A -B) 15,753
*Presently, the debtors of the company pay after 80 days. However, the factor has agreed to pay after
60 days only. So, the investment in Debtors will be reduced by 20 days.
Conclusion: Yes, company should enter into factoring agreement.
BQ 14
A Factoring firm has credit sales of `360 lakhs and its average collection period is 30 days. The financial
controller estimates, bad debt losses are around 2% of credit sales. The firm spends `1,40,000 annually
on debtors administration. This cost comprises of telephonic and fax bills along with salaries of staff
members. These are the avoidable costs. A Factoring firm has offered to buy the firm’s receivables. The
factor will charge 1% commission and will pay an advance against receivables on an interest @15% p.a.
after withholding 10% as reserve.
What should the firm do? Assume 360 days in a year.
Answer
Statement of Effective Cost of Factoring to the Firm
Particulars `
(1) Cost of factoring:
Factoring commission (1% of 3,60,00,000) 3,60,000
Interest charges (33,375 × 360 Days/30 Days) 4,00,500
Total (A) 7,60,500
(2) Savings:
Saving in credit administration cost 1,40,000
Saving in bad debts (2% of 3,60,00,000) 7,20,000
Total (B) 8,60,000
Net Benefits to Firm (B - A) 99,500
Working Notes:
Calculation of advance:
Particulars `
Average receivables (360 Lakhs × 30/360) 30,00,000
Less: Factor reserve @ 10% of 30,00,000 3,00,000
27,00,000
Less: Commission @ 1% of 30,00,000 30,000
Amount available for advance 26,70,000
Less: Interest (26,70,000 × 15% × 30/360) 33,375
Amount of advance 26,36,625
Advice: Since the savings to the firm exceeds the cost to the firm on account of factoring, therefore, the
proposal is acceptable.
BQ 15
A Ltd. has a total sale of `6.4 crores and its average collection period is 90 days. The past experience
indicates that bad debt losses are 1.5% on sales.
3.11
The expenditure incurred by the firm in administering its receivable collection efforts is `10,00,000. A
factor is prepared to buy the firm’s receivables by charging 2% commissions.
The factor will pay advance on receivables to the firm at an interest rate of 18% p.a. after withholding
10% as reserve.
(1) Calculate the effective cost of factoring to the firm (360 Days in a year),
(2) If bank finance for working capital is available at 14% interest, should the firm avail of factoring
service?
Answer
(1) Statement of Effective Cost of Factoring to the Firm
Particulars `
Factoring commission (3,20,000 × 360 Days/90 Days) 12,80,000
Interest charges (6,33,600 × 360 Days/90 Days) 25,34,400
Total (1) 38,14,400

(2) Savings:
Saving in bad debts (1.5% of 6,40,00,000) 9,60,000
Total (2) 19,60,000

Effective cost of factoring (1 - 2) 18,54,400
Rate of effective cost  

18 ,54 ,400 13.79%
100 
 1 ,34 ,46 ,400 
Working Notes:
Calculation of advance:
Particulars `
Average receivables (6,40,00,000 × 90/360) 1,60,00,000
Less: Factor reserve @ 10% of 1,60,00,000 16,00,000
Maximum possible advance 1,44,00,000
Less: Commission @ 2% of 1,60,00,000 3,20,000
Amount available for advance 1,40,80,000
Less: Interest (1,40,80,000 × 18% × 90/360) 6,33,600
Amount of advance 1,34,46,400
(2) If bank finance for working capital is available at 14%, firm should avail factoring service at
13.79% which is lower than bank interest.
Note: Alternatively rate of effective cost also can be calculated by some authors on amount avail for
advance (1,40,80,000).
3.12
MANAGEMENT OF PAYABLES (CREDITORS)
BQ 16
ABC Ltd has been offered credit terms from its major supplier 2/10 net 45. If ABC Ltd. can invest the
additional cash and can obtain an annual return of 25% per annum and the amount of invoice is `10,000.
Should ABC Ltd accept the discount offer?
Answer
Statement of Evaluation of Discount Offer
Particulars Refuse Accept
Payment to supplier 10,000 9,800
Less: Return from investing `9,800 between day 10 and day 45 (235) -
(`9,800 × 35/365 × 25%)
Net Cost 9,765 9,800
Advise: Thus it is better for the company to refuse the discount, as return on cash retained is more than
the saving on account of discount.
BQ 17
The Dolce Company purchases raw materials on terms of 2/10, net 30. A review of the company’s
records by the owner, Mr. Gautam, revealed that payments are usually made 15 days after purchases
are made. When asked why the firm did not take advantage of its discounts, the accountant, Mr. Rohit,
replied that it cost only 2% for these funds, whereas a bank loan would cost the company 12%.
(a) Analyse, what mistake is Rohit making?

(b) If the firm could not borrow from the bank and was forced to resort to the use of trade credit
funds, what suggestion might be made to Rohit that would reduce the annual interest cost?
Identify.
Answer
(a) Rohit’s argument of comparing 2% discount with 12% bank loan rate is not rational as 2%
discount can be earned by making payment 5 days in advance i.e. within 10 days rather 15 days
as payments are made presently. Whereas 12% bank loan rate is for a year.
Assume that the purchase value is `100, the discount can be earned by making payment within
10 days is `2, therefore, net payment would be `98 only. Annualized benefit:
2 365
× × 100 = 148.98% p.a.
98 5
This means cost of not taking cash discount is 148.98%.
(b) If the bank loan facility could not be available, then in this case the company should resort to
utilise maximum credit period as possible. Therefore, payment should be made in 30 days to
reduce the interest cost. The annual interest cost in such case:
2 365
× × 100 = 37.24% p.a.
98 20
3.13
PAST YEAR QUESTIONS
PYQ 1
PQR Ltd. having annual sales of `30,00,000, is re considering its present collection policy. At present the
average collection period is 50 days, bad debt losses are 5% of sales. The company is incurring an
expenditure of `30,000 on account of collection of receivables. Cost of funds is 10 percent.
The alternative policies are:
Alternative I Alternative II
Average collection period reduced to 40 days 30 days
Bad debt losses 4% of sales 3% of sales
Collection expenses `60,000 `95,000
Evaluate the alternatives on the basis of incremental approach and state which alternative
is more beneficial.
Answer
Particulars Current Alternate 1 Alternate 2
Sales 30,00,000 30,00,000 30,00,000
Cost of investment in Debtors 41,096 32,877 24,658
1. Saving in cost in Debtors - 8,219 16,438
Bad debt losses 1,50,000 1,20,000 90,000
2. Saving in Bad debt losses - 30,000 60,000
Collection expenses 30,000 60,000 95,000
3. Increase in collection expenses - 30,000 65,000
Incremental Benefit (1 + 2 - 3) - 8,219 11,438
Analysis: Since incremental benefit over present policy is higher in case of alternative II, select
Alternative II. It is suggested to reduce the collection period from existing 50 days to 30 days.
Working Notes:
Calculation of cost of investment in debtors:
Existing = 30,00,000 × 50/365 × 10% = 41,096
Alternative I = 30,00,000 × 40/365 × 10% = 32,877
Alternative II = 30,00,000 × 30/365 × 10% = 24,658
Note: In absence of Cost of Sales, sales has been taken for purpose of calculating investment in
receivables.
PYQ 2
A new customer has approached a firm to establish new business connection. The customer require 1.5
month of credit. If the proposal is accepted, the sales of the firm will go up by `2,40,000 per annum. The
new customer is being considered as a member of 10% risk of non-payment group.
The cost of sales amounted to 80% of sales. The tax rate is 30% and required rate of return is
40% (after tax).
Should the firm accept the offer? Give your opinion on the basis of calculations.
3.14
Answer
Particulars `
Increase in sales 2,40,000
Less: Cost of sales @ 80% 1,92,000
Profit before cost of credit 48,000
Less: Risk of non payments @ 10% 24,000
Expected PBT 24,000
Less: Tax @ 30% 7,200
Expected PAT 16,800
Less: Required return after tax (WN) 9,600
Net Benefit (After Tax) 7,200
Conclusion: Since company has positive benefit after fulfill of required return from investment in
debtors, offer should be accepted.
Working notes: Calculation of cost of investment in debtors:
Existing = 1,92,000 × 1.5/12 × 40% = 9,600
PYQ 3
A firm has total sales as `200 lakhs of which 80% is on credit. It is offering credit term of 2/40, net 120.
Of the total, 50% of customers avail of discount and the balance pay in 120 days. Past experience
indicates that bad debt losses are around 1% of credit sales. The firm spends about `2,40,000 per annum
to administer its credit sales. These are avoidable as a factor is prepared to buy the firm’s receivables.
He will charge 2% commission. He will pay advance against receivables to the firm at an interest rate of
18% after withholding 10% as reserve.
(i) What is the effective cost of factoring? Consider year as 360 days.
(ii) If bank finance for working capital is available at 14% interest, should the firm avail of factoring
service?
Answer
(i) Statement of Effective Cost of Factoring to the Firm
Particulars `
Factoring commission (`71,111 × 360 Days/80 Days) 3,20,000
Interest charges (`31,28,889 × 18%) 5,63,200
Total (A) 8,83,200
(2) Savings:
Saving in bad debts (1% × 80% × `2,00 Lakhs) 1,60,000
Total (B) 4,00,000
Effective cost of factoring (A - B) 4,83,200
Rate of effective cost  
4 ,83,200
 100  16.09%
 30 ,03,733 
Working Notes:
3.15
1. Calculation of advance:
Particulars `
Average receivables (`200 Lakhs × 80% × 80/360) 35,55,556
Less: Factor reserve @ 10% of `35,55,556 3,55,556
Maximum possible advance 32,00,000
Less: Commission @ 2% of `35,55,556 71,111
Amount available for advance 31,28,889
Less: Interest (`31,28,889 × 18% × 80/360) 1,25,156
Amount of advance 30,03,733
2. Average collection period = 40 Days × ½ + 120 Days × ½ = 80 Days
(ii) If bank finance for working capital is available at 14%, firm will not avail factoring services as 14%
is less than 16.08% (or 15.44%).
PYQ 4
A trader whose current sales are `4,20,000 per annum and an average collection period of 30 days,
wants to pursue a more liberal policy to improve sales. A study made by a management consultant
reveals the following information:
Increase in Collection Present default
Credit Policy Increase in Sales
Period anticipated
I 10 days `21,000 1.5%
II 30 days `52,500 3%
III 45 days `63,000 4%
The selling price per unit is `3. Average cost per unit is `2.25 and variable cost per unit is `2. The current
bad-debts loss is 1%. Required return on additional investment is 20%. Assume a 360 days year.
Which of the above policies would you recommend for adoption?

Answer
Particulars Present I II III
No of units 1,40,000 1,47,000 1,57,500 1,61,000
Credit sales @ `3 per unit 4,20,000 4,41,000 4,72,500 4,83,000
Less: Variable cost @ `2 per unit 2,80,000 2,94,000 3,15,000 3,22,000
Less: Fixed cost (2.25 - 2) × 1,40,000 35000 35,000 35,000 35,000
Profit before bad debt losses 1,05,000 1,12,000 1,22,500 1,26,000
Less: Bad debt losses 4,200 6,615 14,175 19,320
Expected Profit 1,00,800 1,05,385 1,08,325 1,06,680
Less: Required return on investment 5,250 7,311 11,667 14,875
Net Benefit 95,550 98,074 96,658 91,805
Recommendation: Proposed Policy I (i.e. increase in collection period by 10 days or total 40 days)
should be adopted since the net benefits under this policy are higher as compared to other policies.
Working notes:
Calculation of cost required rate of return:
3.16
Collection Period
Required rate of return = Total cost × × Rate of return
360 Days
30
Existing = 3,15,000 × × 20% = 5,250
360 Days
40
Credit Policy I = 3,29,000 × × 20% = 7,311
360 Days
60
Credit Policy II = 3,50,000 × × 20% = 11,667
360 Days
75
Credit Policy III = 3,57,000 × × 20% = 14,875
360 Days
PYQ 5
A current credit sales of a firm is `15,00,000 and the firm still has an unutilized capacity. In order to
boost its sales, the firm is willing to relax its credit policy.
The firm proposes a new credit policy of 2/10 net 60 days as against the present policy of 1/10
net 45 days. The firm expects an increase in the sales by 12%. However, it is also expected that bad debts
will go upto 2% of sales from 1.5%.
The contribution to sales ratio of the firm is 28%. The firm's tax rate is 30% and firm requires an
after tax return of 15% on its investment. 50 percent and 80 percent of customers in term of sales
revenue are expected to avail cash discount under existing and liberalization scheme respectively.
Should the firm change its credit period?

Answer
Policies
Particulars
Present Proposed
Sales value 15,00,000 16,80,000
Less: Variable cost @ 72% of sales 10,80,000 12,09,600
Less: Bad debts @ 1.5% / 2% 22,500 33,600
Less: Cash Discount ‘WN’ 7,500 26,880
Expected PBT 3,90,000 4,09,920
Less: Tax @ 30% 1,17,000 1,22,976
Expected PAT 2,73,000 2,86,944
Less: Cost of investment in debtors ‘WN’ 12,205 9,942
Net benefit after tax 2,60,795 2,77,002
Yes, the firm should change its credit period.
Working notes:
1. Calculation of opportunity cost of investment in receivables:

Existing = 10,80,000 × 15% × 27.5 (.5×10+.5×45)/365 = 12,205
Proposed = 12,09,600 × 15% × 20 (.8×10+.2×60)/365 = 9,942
3.17
2. Calculation of cash discount:

Existing = 15,00,000 × 50% × 1% = 7,500
Proposed = 16,80,000 × 80% × 2% = 26,880
PYQ 6
A company is considering to engage a factor. The following information is available:
 The current average collection period for the company's debtors is 90 days and ½% of debtors
default. The factor has agreed to pay money due after 60 days, and will take the responsibility of any
loss on account of bad debts.
 The annual charge for the factoring is 2% of turnover. Administration cost saving is likely to be
`1,00,000 per annum.
 Annual credit sales are `1,20,00,000. Variable costs is 80% of sales price. The company's cost of
borrowings is 15% per annum. Assume 360 days in a year.
Should the company enter into a factoring agreement?

Answer
Particulars `
(A) Savings:
Saving in bad debts (0.5% of 1,20,00,000) 60,000
*Saving in cost of debtors (1,20,00,000 × 80% × 90 – 60/360 × 15%) 1,20,000
Total (A) 2,80,000
(B) Cost:
Annual charges (2% of 1,20,00,000) 2,40,000
Total (B) 2,40,000
Net Benefit (A -B) 40,000
PYQ 7
MN Ltd has a current turnover of `30,00,000 p.a. Cost of sale is 80% of turnover and bad debts are 2%
of turnover. Cost of sales includes 70% Variable cost and 30% Fixed cost, while company’s required rate
of return is 15%. MN Ltd. currently allows 15 days credit to its customer, but it is considering increase
this to 45 days credit in order to increase turnover.
It has been estimated that this change in policy will increase turnover by 20%, while bad debts
will increase by 1%. It is not expected that the policy change will result in an increase in fixed cost and
creditors and stock will be unchanged.
Should MN Ltd introduce the proposed policy? (Assume 360 days year)
[(10 Marks) Nov 2018]
3.18
Answer
Policies
Particulars
Present Proposed
Sales value 30,00,000 36,00,000
Less: Variable cost 70% of 80% of sales 16,80,000 20,16,000
Less: Fixed cost (30% of 80% of current sales 30,00,000) 7,20,000 7,20,000
Less: Bad debts @ 2%/3% 60,000 1,08,000
Less: Required return 15,000 51,300
Net Benefit 5,25,000 7,04,700
Yes, the firm should change its credit period.
Working Notes: Calculation of required return in debtors:
Existing = (16,80,000 + 7,20,000) × 15/360 × 15% = 15,000

Proposed = (20,16,000 + 7,20,000) × 45/360 × 15% = 51,300
PYQ 8
Current annual sales of SKD Ltd. `360 Lakhs. It’s directors are of the opinion that company’s current
expenditure on receivables management is too high and with a view to reduce the expenditure they are
considering following two new alternate credit policies:
Policy X Policy Y
Average collection period 1.5 months 1 month
% of default 2% 1%
Annual collection expenditure `12 Lakhs `20 lakhs
Selling price per unit of product is `150. Total cost per unit is `120. Current credit terms are 2 months
and percentage of default is 3%. Current annual collection expenditure is `8 Lakhs. Required rate of
return on investment of SKD Ltd. is 20%.
Determine which credit policy SKD Ltd. should follow.

[(5 Marks) July 2021]
Answer
Particulars Current Policy Policy X Policy Y
Sales Units (3,60,00,000 ÷ `150) 2,40,000 2,40,000 2,40,000
Sales value 3,60,00,000 3,60,00,000 3,60,00,000
Less: Cost @ `120 per units 2,88,00,000 2,88,00,000 2,88,00,000
Profit before cost of credit 72,00,000 72,00,000 72,00,000
Less: Bad debts @ 3%/2%/1% 10,80,000 7,20,000 3,60,000
Less: Annual Collection Expenses 8,00,000 12,00,000 20,00,000
Expected Profit 53,20,000 52,80,000 48,40,000
Less: Cost of investment in debtors 9,60,000 7,20,000 4,80,000
Net Benefit 43,60,000 45,60,000 43,60,000
3.19
Recommendation: The proposed policy X should be adopted having higher net benefit.
Working Notes: Calculation of cost of investment in debtors:
Current policy = 3,60,00,000 × 80% × 2/12 × 20% = 9,60,000

Policy X = 3,60,00,000 × 80% × 1.5/12 × 20% = 7,20,000
Policy Y = 3,60,00,000 × 80% × 1/12 × 20% = 4,80,000
PYQ 9
A factoring firm has offered a to buy it’s accounts receivables. The relevant information is given
below.
(a) The current average collection period for the company's debts is 80 days and ½% of debtors
default. The factor has agreed to pay over money due, to the company after 60 days, and it will
suffer losses of any bad debts also.
(b) Factor will charge commission @2%.
(c) The company spends `1,00,000 p.a. on administration of debtor. These are avoidable cost.
(d) Annual credit sales are `90,00,000. Total variable costs is 80% of sales. The company's cost of
borrowings is 15% per annum. Assume 365 days in a year.
Should the company enter into a factoring agreement?

[(5 Marks) Dec 2021]
Answer
Particulars `
(A) Savings:
Saving in bad debts (0.5% of 90,00,000) 45,000
*Saving in cost of debtors (90,00,000 × 80% × 80 – 60/365 × 15%) 59178
Total (A) 2,04,178
(B) Cost:
Annual charges (2% of 90,00,000) 1,80,000
Total (B) 1,80,000
Net Benefit (A - B) 24,178
PYQ 10
A company has current sale of `12 lakhs per year. The profit-volume ratio is 20% and post-tax cost of
investment in receivables is 15%. The current credit terms are 1/10, net 50 days and average collection
period is 40 days. 50% of customers in terms of sales revenue are availing cash discount and bad debt
is 2% of sales.
In order to increase sales, the company want to liberalize its existing credit terms to 2/10, net 35 days.
Due to which, expected sales will increase to `15 lakhs. Percentage of default in sales will remain same.
3.20
Average collection period will decrease by 10 days. 80% of customers in terms of sales revenue are
expected to avail cash discount under this proposed policy. Tax rate is 30%.
Advise, should the company change its credit terms. (Assume 360 days in a year.)
[(5 Marks) May 23]
Answer
Policies
Particulars
Present Proposed
Sales value 12,00,000 15,00,000
Contribution @ 20% 2,40,000 3,00,000
Less: Bad debts @ 2% of sales 24,000 30,000
Less: Cash discount (WN) 6,000 24,000
Expected Profit Before Tax 2,10,000 2,46,000
Less: Tax @ 30% 63,000 73,800
Expected Profit After Tax 1,47,000 1,72,200
Less: Cost of investment (WN) 16,000 15,000
Net Benefit After Tax 1,31,000 1,57,200
Advise: Company should change its credit terms having higher net benefit after tax.
Working notes:
(1) Calculation of Cost of investment:
Existing = 9,60,000 × 15% × 40/360 = 16,000
Proposed = 12,00,000 × 15% × 30/360 = 15,000
(2) Calculation of cash discount:

Existing = 12,00,000 × 50% × 1% = 6,000
Proposed = 15,00,000 × 80% × 2% = 24,000
BQ: 5, 6, 7, 8, 9, 10, 13, 15, 17
PYQ: 1, 3, 10
3.21
CHAPTER 4 MANAGEMENT OF WORKING CAPITAL
OPERATING OR WORKING CAPITAL CYCLE METHOD
BQ 1
From the following information of XYZ Ltd., you are required to calculate:
(a) Net operating cycle period.
(b) Number of operating cycles in a year.
Raw material inventory consumed during the year `6,00,000

Average stock of raw material `50,000
Annual cost of production `5,00,000
Average work-in-progress inventory `30,000
Annual cost of goods sold `8,00,000
Average finished goods stock held `40,000
Average collection period from debtors 45 days
Average credit period availed 30 days
No. of days in a year 360 days
Answer
(a) Operating cycle = R+W+F+D–C
= 30 + 22 + 18 + 45 – 30 = 85 Days
Calculations:
Average stock of raw materials
Raw materials storage period (R) =
Average cos t of raw materials consumptio n per day
50 ,000
= = 30 days
6 ,00 ,000  360
Average stock of WIP

WIP holding period =
Average cos t of production per day
30 ,000
= = 22 days
5 ,00 ,000  360
Average stock of FG
Finished Goods storage period =
Average cos t of goods sold per day
40 ,000
= = 18 days
8 ,00 ,000  360
(b) Number of operating cycles in the year:
360 360
= = 4.24 times
Operating cycle period 85
BQ 2
Following information is forecasted by R Limited for the year ending 31st March, 2023:
4.1
MANAGEMENT OF WORKING CAPITAL CHAPTER 4
Balance as at 31.03.23 Balance as at 31.03.22

(` in Lakh) (` in Lakh)
Raw Material 65 45
Work-in-process 51 35
Finished goods 70 60
Receivables 135 112
Payables 71 68
Annual purchases of raw materials (all credit) 400
Annual cost of production 450
Annual cost of goods sold 525
Annual operating cost 325
Sales (all credit) 585
You may take one year as equal to 365 days

(i) Net operating cycle period.
(ii) Number of operating cycles in the year.
(iii) Amount of working capital requirement.
Answer
(i) Operating cycle = R+W+F+D–C
= 53 + 35 + 45 + 77 – 63 = 147 Days
(ii) Number of operating cycles in the year:

365 365
= = 2.48 times
Operating cycle period 147
(iii) Amount of working capital required:

Annual operating cos t 325 Lakhs
= = `131 Lakhs
Number of operating cycles 2.48
Calculations:
55
= = 53 days
380 ÷ 365
Raw materials consumption = Opening RM + Purchases – Closing RM

= 45 + 400 – 65 = 380

43
= = 35 days
450 ÷ 365
Average stock of FG
65
= = 45 days
525 ÷ 365
4.2
Average book debts

Debtors collection period =
Average credit sales per day
123.5
= = 77 days
585 ÷ 365
Average trade creditors

Credit period availed =
Average credit purchases per day
69.5
= = 63 days
400 ÷ 365
Calculation of averages:
1. Average stock of raw materials = (45 + 65) ÷ 2 = 55
2. Average stock of WIP = (35 + 51) ÷ 2 = 43
3. Average stock of FG = (60 + 70) ÷ 2 = 65
4. Average receivables = (112+ 135) ÷ 2 = 123.5
5. Average payables = (68 + 71) ÷ 2 = 69.5
COMPONENTWISE ESTIMATION
BQ 3
A Company provided the following data:
Cost per unit (`)
Raw materials `52.00
Direct labour `19.50
Overheads `39.00
Total cost `110.50
Profit `19.50
Selling price `130.00
The following additional information is available:

Average raw materials in stock : one month;
Average materials in process : half-a-month;
Average finished goods in stock : one month;
Credit allowed by suppliers : one month;
Credit allowed to debtors : two months;
Time lag in payment of wages : one and a half weeks;
Time lag in payment of Overheads : one month;
Sales : 25% on cash basis;
Expected cash balance : `1,20,000.
You are required to prepare a statement showing the working capital needed to finance a
level of activity of 70,000 units of annual output. The production is carried throughout the year on
even basis and wages and overheads accrue similarly. (Calculation can be made on the basis of 30
days a month and 52 weeks a year).
[`17,01,562]
BQ 4
On 1st January, the Managing Director of Naureen Ltd. wishes to know the amount of working capital
that will be required during the year. From the following information prepare the working capital
4.3
requirements forecast.
Production during the previous year was 60,000 units. It is planned that this level of activity
would be maintained during the present year.
The expected ratios of the cost to selling prices are Raw materials 60%, Direct wages 10% and
Overheads 20%.
Raw materials are expected to remain in store for an average of 2 months before issue to
production. Each unit is expected to be in process for one month, the raw materials being fed into the
pipeline immediately and the labour and overhead costs accruing evenly during the month. Finished
goods will stay in the warehouse awaiting dispatch to customers for approximately 3 months. Credit
allowed by creditors is 2 months from the date of delivery of raw material. Credit allowed to debtors is
3 months from the date of dispatch.
Selling price is ` 5 per unit. There is a regular production and sales cycle. Wages and overheads
are paid on the 1st of each month for the previous month. The company normally keeps cash in hand to
the extent of ` 20,000.
You are required to prepare the forecast statement. The finance manager is particularly
interested in applying the quantitative techniques for forecasting the working capital needs of the
company.
Answer
Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw materials (1,80,000 × 2/12) 30,000
Work in progress:
Material (1,80,000 × 100% × 1/12) 15,000
Labour and Overheads (30,000 + 60,000 × 50% × 1/12) 3,750
Finished goods (2,70,000 × 3/12) 67,500
Debtors (2,70,000 × 3/12) 67,500
Cash 20,000
Total (A) 2,03,750
(B) Current Liabilities:
Creditors (1,80,000 × 2/12) 30,000
Outstanding labour (30,000 × 1/12) 2,500
Outstanding overhead (60,000 × 1/12) 5,000
Total (B) 37,500
Working Capital (A - B) 1,66,250
Working Notes:
Projected Income Statement
Particulars `
Raw materials (60,000 × 5 × 60%) 1,80,000
Direct Labour (60,000 × 5 × 10%) 30,000
Overheads including depreciation (60,000 × 5 × 20%) 60,000
Total cost 2,70,000
Profit (60,000 × 5 × 10%) 30,000
Sales (60,000 × 5) 3,00,000
4.4
BQ 5
The following annual figures relate to XYZ Co.
Sales (at 2 months' credit) `36,00,000

Materials consumed (suppliers extend two months’ credit) `9,00,000
Wages paid (1 month lag in payment) `7,20,000
Cash Manufacturing expenses (1 month lag in payment) `9,60,000
Administrative expenses (cash 1 month lag in payment) `2,40,000
Sales promotion expenses (paid quarterly in advance) `1,20,000
The company sells its products on gross profit 25%. Depreciation is considered as a part of the
cost of production. It keeps one month’s stock each of raw materials and finished goods and a cash
balance of `1,00,000. Assuming a 20% safety margin, ignore work-in-process.
Find out the requirements of working capital of the company on cash cost basis.
Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials (9,00,000 × 1/12) 75,000

Finished Goods (25,80,000 × 1/12) 2,15,000
Debtors (29,40,000 × 2/12) 4,90,000
Cash 1,00,000
Prepaid Sales Promotion Expenses (1,20,000 × 1/4) 30,000
Total (A) 9,10,000
Creditors (9,00,000 × 2/12) 1,50,000

Outstanding labour (7,20,000 × 1/12) 60,000
Outstanding Manufacturing Expenses (9,60,000 × 1/12) 80,000
Outstanding Administrative Expenses (2,40,000 × 1/12) 20,000
Total (B) 3,10,000
Working Capital Before Provision (A - B) 6,00,000

Add : Safety Margin @ 20% of 6,00,000 1,20,000
Working Capital 7,20,000
Working Notes:
Projected Income Statement (Cash Cost Basis)
Particulars `
Raw Materials 9,00,000
Wages 7,20,000
Manufacturing Expenses (in cash) 9,60,000
Cash Cost of Goods Sold 25,80,000
Administration Expenses (in cash) 2,40,000
Sales Promotion Expenses (in cash) 1,20,000
Cash Cost of Sales 29,40,000
4.5
NEW PROJECT
BQ 6
Aneja Limited, 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 is 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
Direct wages `30
Overheads (exclusive of depreciation) `60
Total cost `170
Selling price `200
Raw materials in stock: average 4 weeks consumption, work-in-progress (assume 50%

completion stage in respect of conversion cost but 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 Average 8 weeks
Lag in payment of wages Average 1.5 weeks
Cash at banks (for smooth operation) `25,000
Assume that production is carried on evenly throughout the year (52 weeks) and wages and
overheads accrue similarly. All sales are on credit basis only.
Find out The net working capital required.
Answer
(a) Statement of Working Capital Requirement
Particulars `
(1) Current Assets:
Raw materials (86,40,000 × 4/52) 6,64,615
Work in progress [4,000 units × (80 + 15 + 30)] 5,00,000
Finished goods (8,000 units × 170) 13,60,000
Debtors (1,63,20,000 × 8/52) 25,10,769
Cash 25,000
Total (1) 50,60,384
(2) Current Liabilities:
Creditors (86,40,000 + 6,64,615) × 4/52 7,15,740
Outstanding labour (31,80,000 × 1.5/52) 91,731
Total (2) 8,07,471
Working Capital (1 - 2) 42,52,913
Working Notes:
Particulars `
4.6
Raw materials (1,08,000 × 80) 86,40,000

Direct labour (1,04,000 + ½ × 4,000) × 30 31,80,000
Overheads (1,04,000 + ½ × 4,000) × 60 63,60,000
Cost Upto Factory 1,81,80,000
Less: Closing WIP 4,000 units × (80 + 15 + 30) (5,00,000)
Cost of Production (1,08,000 units) 1,76,80,000
Less: Closing FG 8,000 units × 170 (13,60,000)
Cost of Goods Sold (96,000 units) 1,63,20,000
Profit 28,80,000
Sales (96,000 × 200) 1,92,00,000
BQ 7
PQ Ltd. a company newly commencing business in 2023 has the under-mentioned projected P & L
Account:
Particulars ` `
Sales 2,10,000
Cost of goods sold 1,53,000
Gross Profit 57,000
Administrative Expenses 14,000
Selling Expenses 13,000 27,000
Profit Before Tax 30,000
Provision for taxation 10,000
Profit After Tax 20,000
The cost of goods sold has been arrived at as under:

Materials used 84,000
Wages and manufacturing Expenses 62,500
Depreciation 23,500
Cost of Finished Goods Produced 1,70,000
Less: Stock of Finished Goods 17,000
(10% of goods produced not yet sold) 1,53,000
The figure given above relate only to finished goods and not to work-in-progress. Goods equal to 15%
of the year’s production (in terms of physical units) will be in process on the average requiring full
materials but only 40% of the other expenses. The company believes in keeping materials equal to two
months consumption in stock.
All expenses will be paid one month in advance. Suppliers of materials will extend 1-½months
credit. Sales will be 20% for cash and rest at two months credit. 70% of the income tax will be paid in
advance in quarterly installments. The company wishes to keep `8,000 in cash. 10% has to be added to
the estimated figure for unforeseen contingencies.
Prepare an estimate of working capital on cash cost basis.
Answer
Particulars `
(1) Current Assets:
Raw materials (96,600 × 2/12) 16,100
Work in progress 16,350
4.7
Finished goods 14,650

Debtors (1,58,850 × 80% × 2/12) 21,180
Prepaid expenses:
Wages and Manufacturing Expenses (66,250 × 1/12) 5,521
Administrative Expenses (14,000 × 1/12) 1,167
Selling Expenses (13,000 × 1/12) 1,083
Advance tax paid [(70% of 10,000) × 3/12] 1,750
Cash 8,000
Total (1) 85,801
Creditors (96,600 + 16,100) × 1.5/12 14,088
Provision for Tax (Net of Advance Tax) (10,000 × 30%) 3,000
Total (2) 17,088
Working Capital Before Provision(1 - 2) 68,713
Add : Provision for Contingencies @ 10% of 68,713 6,871
Working Capital Including Provision 75,584
Working Notes:
Particulars `
Raw Materials (84,000 + 15%) 96,600
Wages and Manufacturing Expenses (62,500 + 15% of 62,500 × 40%) 66,250
Cost Upto Factory 1,62,850
Less: Closing WIP (84,000 × 15%) + (15% of 62,500 × 40%) (16,350)
Cost of Production 1,46,500
Less: Closing FG (10% of 1,46,500) (14,650)
Cost of Goods Sold 1,31,850
Administrative Expenses 14,000
Selling Expenses 13,000
OTHERS
BQ 8
The management of Trux Company Ltd. is planning to expand its business and consults you to prepare
an estimated working capital statement. The records of the company reveals the following annual
information:
The records of the company revealed the following annual information:

Sales:
Domestic at one month’s credit `18,00,000
Export at three month’s credit `8,10,000
(Sales price 10% below Domestic price)
Material used (suppliers extend two months credit) `6,75,000
Lag in payment of wages - ½ month `5,40,000
Lag in payment of manufacturing expenses (cash) - 1 month `7,65,000
Lag in payment of administrative expenses - 1 month `1,80,000
Sales promotion expenses payable quarterly in advance `1,12,500
Income tax payable in four installments (of which one falls in the next financial year)`1,68,000
4.8
Rate of gross profit is 20%. Ignore work-in-progress and depreciation. The company keeps one
month’s stock of raw materials and finished goods (each) and believes in keeping `2,50,000 available to
it including the overdraft limit of `75,000 not yet utilized by the company. The management is also of
the opinion to make 10% margin for contingencies on computed figure.
You are required to prepare the estimated working capital statement for next year.
Answer
Particulars `
(A) Current Assets:
Raw Materials (6,75,000 × 1/12) 56,250
Finished Goods (21,60,000 × 1/12) 1,80,000
Debtors:
Domestic (14,40,000 + 77,586) × 1/12 1,26,466
Export (7,20,000 + 34,914) × 3/12 1,88,729
Cash (2,50,000 – 75,000) 1,75,000
Prepaid Sales Promotion Expenses (1,12,500 × 1/4) 28,125
Total (A) 7,54,570
Creditors (6,75,000 × 2/12) 1,12,500
Outstanding labour (5,40,000 × 0.5/12) 22,500
Outstanding Manufacturing Expenses (7,65,000 × 1/12) 63,750
Outstanding Administrative Expenses (1,80,000 × 1/12) 15,000
Income Tax Payable(1,68,000 × 1/4) 42,000
Total (B) 2,55,750
Add : Safety Margin @ 10% of 4,98,820 49,882
Working Notes:
1. Calculation of Cash cost of Debtors:
Export sales (10% below domestic sales price) = 8,10,000
Export sales equivalent to domestic sales = 8,10,000 × 100 = 9,00,000

90
Total equivalent domestic sales = 18,00,000 + 9,00,000 = 27,00,000
Apportionment of cash cost of sales except sales promotion expenses in proportion of equivalent
domestic sales between Domestic and Foreign Sales:
Domestic sales = 21,60,000 × 18 ,00 ,000 = 14,40,000

27 ,00 ,000
Foreign sales = 21,60,000 × 9 ,00 ,000 = 7,20,000

27 ,00 ,000
Apportionment of sales promotion expenses between Domestic and Foreign Sales in sales ratio:
4.9
Domestic sales = 1,12,500 × 18 ,00 ,000 = 77,586

26 ,10 ,000
Foreign sales = 1,12,500 × 8 ,10 ,000 = 34,914

26 ,10 ,000
2. Projected Income Statement

Particulars `
Wages 5,40,000
Administration Expenses (in cash) 1,80,000
Sales Promotion Expenses (in cash) 1,12,500
Assumption: Administrative expenses is related to production.
BQ 9
M.A. Limited is commencing a new project of a plastic component. The following cost information has
been ascertained for annual production of 12,000 units which is the full capacity.
(Cost per unit)
Materials `40
Direct labour and variable expenses `20
Fixed manufacturing expenses `6
Depreciation `10
Fixed administrative expenses `4
The selling price per unit is expected to be `96 and the selling expenses `5 per unit 80% of which
is variable. In the first two years of operation, productivity and sales are expected to be as follows:
Year Productivity Sales

No. of units No. of units
1 6,000 5,000
2 9,000 8,500
To assess the working capital requirement, the following additional information is available:
(a) Stock of Materials 2.25 months average

(b) Work-in-Progress Nil
(c) Debtors 1 month's average sales
(d) Cash balance `10,000
(e) Creditors for supply of materials 1 month's average purchase
(f) Creditors for expenses 1 month average of all expenses
Prepare for two years:
(1) Projected Statement of Profit and Loss (ignoring taxation) and

(2) Projected Statement of working capital requirements.
4.10
Answer
(1) M.A. Limited
Projected Statement of Profit and Loss
Particulars Year 1 Year 2
Production (in units) 6,000 9,000
Sales (in units) 5,000 8,500
Materials 2,40,000 3,60,000
Direct labour and variable expenses 1,20,000 1,80,000
Fixed manufacturing expenses 72,000 72,000
Depreciation 1,20,000 1,20,000
Fixed administrative expenses 48,000 48,000
Cost of production 6,00,000 7,80,000
Add: Opening FG (Year 1: Nil; Year 2: 1,000 units) Nil 1,00,000
Total cost of goods available for sale 6,00,000 8,80,000
Less: Closing FG (Year 1: 1,000; Year 2: 1,500 units) (1,00,000) (1,32,000)
Cost of goods sold 5,00,000 7,48,000
Selling expenses: Variable @ `4 per unit sold 20,000 34,000
Fixed 12,000 12,000
Cost of sales 5,32,000 7,94,000
Profit or loss (52,000) 22,000
Sales 4,80,000 8,16,000
(2) Projected Statement of Working Capital Requirement

Particulars Year 1 Year 2
(A) Current Assets:
Raw materials 45,000 67,500
Finished goods 1,00,000 1,32,000
Debtors (on sales value) 40,000 68,000
Cash 10,000 10,000
Total (A) 1,95,000 2,77,500
Creditors (Purchase = RMC + CS - OS) 23,750 31,875
Outstanding expenses 22,667 28,833
Total (B) 46,417 60,708
Working Capital (A - B) 1,48,583 2,16,792
Assumptions:
1. Administrative expenses is related to production.
2. Stock of finished goods is valued as per weighted average method.
BQ 10
A firm has the following data for the year ending 31st March, 2023:
Sales (1,00,000 @ `20) `20,00,000
Earnings before Interest and Taxes `2,00,000
Fixed Assets `5,00,000
The three possible current assets holdings of the firm are `5,00,000, `4,00,000 and `3,00,000. It
is assumed that fixed assets level is constant and profits do not vary with current assets levels.
Explain the effect of the three alternative current assets policies.
4.11
Answer
Effect of Alternative Working Capital Policy
Particulars Conservative Moderate Aggressive
Sales 20,00,000 20,00,000 20,00,000
Earnings before interest and tax (EBIT) 2,00,000 2,00,000 2,00,000
Current Assets 5,00,000 4,00,000 3,00,000
Fixed Assets 5,00,000 5,00,000 5,00,000
Total Assets 10,00,000 9,00,000 8,00,000
Return on Total Assets (EBIT ÷ Total Assets) 20% 22.22% 25%
Current Assets/Fixed Assets 1.00 0.80 0.60
The aforesaid calculation shows that the conservative policy provides greater liquidity (solvency)
to the firm, but lower return on total assets. On the other hand, the aggressive policy gives higher return,
but low liquidity and thus is very risky. The moderate policy generates return higher than Conservative
policy but lower than aggressive policy. This is less risky than aggressive policy but riskier than
conservative policy.
DOUBLE SHIFT
BQ 11
Samreen Enterprises has been operating its manufacturing facilities till 31.03.2022 on a single
shift working with the following cost structure:
Per unit
Cost of Materials `6.00
Wages (out of which 40% fixed) `5.00
Overheads (out of which 80% fixed) `5.00
Profit `2.00
Selling price `18.00
Sales during 2021-2022 `4,32,000
As at 31.03.22 the company held:
Stock of raw materials (at cost) `36,000

Work-in-progress (valued at prime cost) `22,000
Finished goods (valued at total cost) `72,000
Sundry debtors `1,08,000
In view of increased market demand, it is proposed to double production by working an extra

shift. It is expected that a 10% discount will be available from suppliers of raw materials in view of
increased volume of business. Selling price will remain the same. The credit period allowed to customers
will remain unaltered. Credit availed of from suppliers will continue to remain at the present level i.e. 2
months. Lag in payment of wages and expenses will continue to remain half a month.
You are required to assess the additional working capital requirement, if the policy to
increase output is implemented (Assessment of impact of double shift for long term as a matter of
production policy).
Answer
4.12
Statement of Working Capital for Single Shift and Double Shift Working
Single Shift (24,000) Double Shift (48,000)
Particulars
P. U. Units Total P. U. Units Total
(A) Current Assets:
Raw Materials Stock 6.00 6,000 36,000 5.40 12,000 64,800
WIP Stock 11.00 2,000 22,000 9.40 2,000 18,800
FG Stock 16.00 4,500 72,000 12.40 9,000 1,11,600
Debtors 16.00 6,000 96,000 12.40 12,000 1,48,800
Total (A) - - 2,26,000 - - 344,000
Creditors 6.00 4,000 24,000 5.40 8,000 43,200
Outstanding Wages 5.00 1,000 5,000 4.00 2,000 8,000
Outstanding Overheads 5.00 1,000 5,000 3.00 2,000 6,000
Total (B) - - 34,000 - - 57,200
Working Capital (A - B) - - 1,92,000 - - 2,86,800
Increase in working capital requirement is `94,800 (`2,86,800 - `1,92,000).
Working Notes:
1. Statement of Cost at Single Shift and Double Shift Working
Single Shift (24,000) Double Shift (48,000)
Particulars
P. U. Total P. U. Total
Raw Materials 6.00 1,44,000 5.40 2,59,200
Wages Variable 3.00 72,000 3.00 1,44,000
Wages Fixed 2.00 48,000 1.00 48,000
Prime Cost 11.00 2,64,000 9.40 4,51,200
Overhead Variable 1.00 24,000 1.00 48,000
Overhead Fixed 4.00 96,000 2.00 96,000
Total Cost 16.00 3,84,000 12.40 5,95,200
Profit 2.00 48,000 5.60 2,68,800
Sales Value 18.00 4,32,000 18.00 8,64,000
2. Sales units in 2021-2022 = Sales ÷ Sale Price per unit

= `4,32,000 ÷ `18 = 24,000 units
3. Raw Material units on 31.03.2022 = Raw Material Stock ÷ Raw Material cost per unit
= `36,000 ÷ `6 = 6,000 units
4. WIP units on 31.03.2022 = WIP Stock ÷ Prime cost per unit

= `22,000 ÷ `11 = 2,000 units
5. Finished Goods units on 31.03.2022 = Finished Goods Stock ÷ Total cost per unit
= `72,000 ÷ `16 = 4,500 units
6. Debtors units on 31.03.2022 = Sundry debtors ÷ Sale Price per unit

= `1,08,000 ÷ `18 = 6,000 units
7. Credit allowed to Customers = 6,000 ÷ (24,000 units ÷ 12 months)

= 3 months
4.13
PAST YEAR QUESTIONS
PYQ 1
The following information is provided by the DPS Limited for the year ending 31st March, 2013
Raw material storage period 55 days

Work-in progress conversion period 18 days
Finished Goods storage period 22 days
Debt collection period 45 days
Creditor’s payment period 60 days
Annual Operating cost (including depreciation of `2,10,000) `21,00,000
1 year 360 days

I. Operating Cycle period.
II. Number of Operating Cycle in a year.
III. Amount of working capital required of the company on a cash cost basis.
IV. The company is a market leader in its product, there is virtually no competitor in the market.
Based on a market research it is planning to discontinue sales on credit and deliver products
based on pre-payment. Thereby, it can reduce its working capital requirement substantially.
What would be the reduction in working capital requirement due to such decision?
[(Marks 8) May 2013, May 2015, Jan 2021]
Answer
I. Operating cycle = R+W+F+D–C = 55 + 18 + 22 + 45 – 60
= 80 Days
360
II. No. of operating cycle = = 4.5 times
80
Operating cycle
III. Working Capital = Annual cash operating cost ×
360 Days
80 Days
= (`21,00,000 – `2,10,000) × = `4,20,000
360 Days
IV. In case of cash sales operating cycle period will reduce by 45 Days (Debt collection period).
80 Days  35 Days
Reduction in working capital = (`21,00,000 – `2,10,000) ×
360 Days
= `2,36,250
PYQ 2
Black Limited has furnished the following cost sheet:
Per Unit
Raw Material `98
Direct Labour `53
Factory Overhead `88
Total Cost `239
Profit `43
Selling Price `282
4.14
Factory overheads includes depreciation of `15 per unit at budgeted level of activity
Additional Information:
(i) Average raw material in stock 3 weeks
(ii) Average work-in-progress 2 weeks
(% of completion with respect to Materials 75% and Labour and Overhead 70%)
(iii) Finished goods in stock 4 weeks
(iv) Credit allowed to debtors 2.5 weeks
(v) Credit allowed by creditors 3.5 weeks
(vi) Time lag in payment of labour 2 weeks
(vii) Time lag in payment of factory overheads 1.5 weeks
(viii) Company sells, 25% of the output against cash
(ix) Cash in hand and bank is desired to be maintained `2,25,000
(x) Provision for contingencies is required @ 4% of working capital requirement including that
provision.
You are required to prepare a statement showing estimate of working capital needed to
finance a budgeted activity level of 1,04,000 units of production. Finished stock, debtors and
overheads are taken at cash cost.
Answer
Particulars `
(A) Current Assets:
Raw Materials (1,01,92,000 × 3/52) 5,88,000
Work-in-progress:
Materials (1,01,92,000 × 75%) × 2/52 2,94,000
Labour and Overhead [(55,12,000 + 75,92,000) × 70%] × 2/52 3,52,800
Finished Goods (2,32,96,000 × 4/52) 17,92,000
Debtors (2,32,96,000 × 75% × 2.5/52) 8,40,000
Cash 2,25,000
Total (A) 40,91,800
Creditors (1,01,92,000 × 3.5/52) 6,86,000
Outstanding labour (55,12,000 × 2/52) 2,12,000
Outstanding Factory Overhead (75,92,000 × 1.5/52) 2,19,000
Total (B) 11,17,000
Add : Provision for contingencies @ 4% of wc including provision 1,23,950
Working Capital (29,74,800 ÷ 96%) 30,98,750
Working Notes:
Projected Income Statement (Production of 1,04,000 units)
Particulars `
Raw Materials (1,04,000 × 98) 1,01,92,000
Wages (1,04,000 × 53) 55,12,000
4.15
Factory Overhead in cash [1,04,000 × 73 (88 - 15)] 75,92,000

Cash Cost 2,32,96,000
PYQ 3
The following data relating to an auto component manufacturing company is available for the year
2014:
Raw material held in storage 20 days
Debtors collection period 30 days
Conversion process period (raw materials 100%, other cost 50%) 10 days
Finished Goods storage period 45 days
Credit period from supplier 60 days
Advance payment to supplier 5 days
Total cash operating expenses per annum `800 Lakhs
1 year 360 days
75% of total cash operating expenses for raw materials. 360 days assumed in a year.
(a) Each item of current assets and current liabilities,

(b) The working capital requirement, if the company wants to maintain a cash balance of `10 Lakhs
at all the times.
[(Marks 8) June 2015]
Answer
(a) Calculation of each item of current assets and current liabilities:
Stock of Raw Materials = `600 Lacs × 20/360 = `33.33 Lacs
Debtors = `800 Lacs × 30/360 = `66.67 Lacs
Stock of WIP = [(`600 Lacs ×100%) + (`200 Lacs ×50%)] × 10/360

= `19.44 Lacs
Stock of Finished Goods = `800 Lakhs × 45/360 = `100 Lacs
Advance to Supplier = `600 Lakhs × 5/360 = `8.33 Lacs
Creditors = `600 Lakhs × 60/360 = `100 Lacs
(b) Calculation of working capital requirement:
Working Capital = Current Assets – Current Liabilities

= (RM Stock + Debtors + WIP Stock + FG Stock + Advance to
Supplier + Cash Balance) - Creditors
= (`33.33 + `66.67 + `19.44 + `100 + `8.33 + `10) – `100
= `137.77 Lakhs

Particulars ` (in Lakhs)
4.16
Raw Materials (75% of 800) 600

Other Operating Expenses (25% of 800) 200
Cash Cost 800
PYQ 4
PQ Limited wants to expand its business and has applied for a loan from a commercial bank for its
growing financial requirements.
The records of the company reveals that the company sells goods in the domestic market at a
gross profit of 25% not counting depreciation as part of the cost of goods sold.
The following additional information is also available for you:

Sales:
Home at one month’s credit `1,20,00,000
Export at three month’s credit `54,00,000
(Sales price 10% below Home price)
Material used (suppliers extend two months’ credit) `45,00,000
Wages paid ½ month in arrear `36,00,000
Manufacturing expenses (cash) paid (1 month in arrear) `54,00,000
Administrative expenses paid 1 month in arrear `12,00,000
Income tax payable in four installments
(of which one falls in the next financial year) `15,00,000
The company keeps one month’s stock of raw materials and finished goods (each) and believes in
keeping `10,00,000 available to it including the overdraft limit of `5,00,000 not yet utilized by the
company. Assume a 15% margin for contingencies.
You are required to ascertain the requirement of the working capital of the company.
Answer
Particulars `
(A) Current Assets:
Raw Materials (45,00,000 × 1/12) 3,75,000
Finished Goods (1,47,00,000 × 1/12) 12,25,000
Debtors:
Home (98,00,000 × 1/12) 8,16,667
Export (49,00,000 × 3/12) 12,25,000
Cash (10,00,000 – 5,00,000) 5,00,000
Total (A) 41,41,667
Creditors (45,00,000 × 2/12) 7,50,000
Outstanding labour (36,00,000 × 0.5/12) 1,50,000
Outstanding Manufacturing Expenses (54,00,000 × 1/12) 4,50,000
Outstanding Administrative Expenses (12,00,000 × 1/12) 1,00,000
Income Tax Payable (15,00,000 × 1/4) 3,75,000
Total (B) 18,25,000
Add: Contingency Margin @ 15% of 23,16,667 3,47,500
4.17
Working Notes:
1. Calculation of Cash cost of Debtors:
Export sales (10% below home sales price) = 54,00,000
Export sales equivalent to home sales = 54,00,000 × 100 = 60,00,000

90
Total equivalent home sales = 1,20,00,000 + 60,00,000= 1,80,00,000
Apportionment of cash cost of COGS in proportion of equivalent home sales between Home and
Foreign Sales:
Home sales = 1,47,00,000 × 1 ,20 ,00 ,000 = 98,00,000

1 ,80 ,00 ,000
Foreign sales = 1,47,00,000 × 60 ,00 ,000 = 49,00,000

1 ,80 ,00 ,000
2. Projected Income Statement

Particulars `
Wages 36,00,000
Administration Expenses 12,00,000
Cash Cost of Goods Sold 1,47,00,000
Assumption: Administrative expenses is related to production.
PYQ 5
Day Ltd., a newly formed company has applied to the Private bank for the first time for financing its
working capital requirements.
The following information is available about the projection for the current year:
Estimated level of activity Completed units of production 31,200 units

Plus units of WIP 12,000
Raw material cost `40 per unit

Direct wages cost `15 per unit
Overhead (Inclusive Depreciation `10 per unit) `40 per unit
Selling price `130
Raw material in stock Average 30 days consumption

Work in progress stock Material 100% and conversion cost 50%
Finished goods stock 24,000 units
Credit allowed by suppliers 30 days
Credit allowed to purchasers 60 days
Direct wages (lag in payment) 15 days
Expected cash balance `2,00,000
Assume that production is carried on evenly throughout the year (360 days) and wages and
overhead accrue similarly. All sales are on credit basis.
4.18
You are required to calculate the Net Working Capital requirement on Cash Cost Basis.
[(10 Marks) May 2018]
Answer
Particulars `
(A) Current Assets:
Raw Materials Stock (17,28,000 × 30/360) 1,44,000
Work in progress 7,50,000
Finished goods 20,40,000
Debtors (6,12,000 × 60/360) 1,02,000
Cash 2,00,000
Total (A) 32,36,000
Creditors (17,28,000 + 1,44,000) × 30/360 1,56,000
Outstanding wages (5,58,000 × 15/360) 23,250
Total (B) 1,79,250
Projected Cost of Goods Sold

Particulars `
Raw Materials (31,200 × 40 + 12,000 × 40) 17,28,000
Direct Wages (31,200 × 15 + 12,000 × 7.5) 5,58,000
Overheads excluding Depreciation (31,200 × 30 + 12,000 × 15) 11,16,000
Cost Upto Factory 34,02,000
Less: Closing WIP 12,000 units × (40 + 7.50 + 15) (7,50,000)
Cost of Production (31,200 units) 26,52,000
Less: Closing FG 24,000 units × (40 + 15 + 30) (20,40,000)
Cost of Goods Sold (7,200 units) 6,12,000
PYQ 6
Following information has been extracted from the books of ABS Limited:
01.04.17 31.03.18
Raw Material 1,00,000 70,000
Work-in-process 1,40,000 2,00,000
Finished goods 2,30,000 2,70,000
Average Receivables 2,10,000
Average Payables 3,14,000
Purchases 15,70,000
Wages and overheads 17,50,000
Selling expenses 3,20,000
Sales 42,00,000
All purchases and sales are on credit basis. Company is willing to know:
(1) Net operating cycle period.
(2) Amount of working capital requirement (Assume 360 days in a year).
Answer
4.19
(1) Operating cycle = R+W+F+D–C

= 19 + 19 + 28 + 18 – 72 = 12 Days
Calculations:
(1 ,00 ,000 + 70 ,000 ) ÷ 2
= = 19 days
16 ,00 ,000 ÷ 360
Raw materials consumption = Opening RM + Purchases – Closing RM

= 1,00,000 + 15,70,000 – 70,000 = 16,00,000

(1 ,40 ,000 + 2,00 ,000 ) ÷ 2
= = 19 days
32 ,90 ,000 ÷ 360
Cost of Production = RM consumed + Wages and OH + Opening WIP

– Closing WIP
= 16,00,000 + 17,50,000 + 1,40,000 – 2,00,000
= 32,90,000
Average stock of FG
(2,30 ,000 + 2,70 ,000 )÷ 2
= = 28 days
32,50 ,000 ÷ 360
Cost of Goods Sold = Cost of Production + Opening FG – Closing FG

= 32,90,000 + 2,30,000 – 2,70,000 = 32,50,000
Average book debts

Debtors collection period =
Average credit sales per day
2,10 ,000
= = 18 days
42 ,00 ,000 ÷ 360
Average trade creditors

Credit period availed =
Average credit purchases per day
3,14 ,000
= = 72 days
15 ,70 ,000 ÷ 360
(2) Amount of working capital required:
Annual Cost of Sales

Working Capital = × Operating Cycle Period
360
35,70 ,000
= × 12 = `1,19,000
360
Cost of Sales = Cost of Goods Sold + Selling expenses

= 32,50,000 + 3,20,000 = 35,70,000
4.20
PYQ 7
Bita Limited manufactures a product used in the steel industry. The following information regarding the
company is given for your consideration:
(1) The cost structure for Bita Limited’s product is as follows:
Per Unit
Raw Material `80
Direct Labour `20
Overhead (including depreciation `20) `80
Total Cost `180
Profit `20
Selling Price `200
(2) Expected level of production 9,000 units per annum.

(3) Raw materials are expected to remain in stores for an average of two months before issue to
production.
(4) Work-in-progress (50% complete as to conversion cost) will approximately to ½ month’s
production.
(5) Finished goods remain in warehouse on an average for one month.
(6) Credit allowed by supplier is one month.
(7) Two month’s credit is normally allowed to debtors.
(8) A minimum cash balance of `67,500 is expected to be maintained.
(9) Cash sales are 75% less than the credit sales.
(10) Safety margin of 20% to cover unforeseen contingencies.
(11) The production pattern is assumed to be even during the year.
You are required to estimate the working capital requirement of Bita Limited.
[(10 Marks) May 2019]
Answer
Particulars `
(A) Current Assets:
Raw Materials (7,20,000 × 2/12) 1,20,000
Work-in-progress:
Materials (7,20,000 × 0.5/12 × 100%) 30,000
Labour and Overhead [(1,80,000 + 7,20,000) × 50%] × 0.5/12 18,750
Finished Goods (16,20,000 × 1/12) 1,35,000
Debtors (16,20,000 × 4/5 × 2/12) 2,16,000
Cash 67,500
Total (A) 5,87,250
Creditors (7,20,000 × 1/12) 60,000
Total (B) 60,000
Add : Safety margin @ 20% 1,05,450
4.21
Working Notes:
1. Projected Income Statement (Production of 9,000 units)
Particulars `
Raw Materials (9,000 × 80) 7,20,000
Direct Labour (9,000 × 20) 1,80,000
Overhead : in cash (9,000 × 60) 5,40,000
: Depreciation (9,000 × 20) 1,80,000 7,20,000
Profit (9,000 × 20) 1,80,000
Sales 18,00,000
2. Proportion between cash and credit sales:
Let Credit sales be x then cash sales will be 0.25 x (x – 75%)

Cash Sales : Credit Sales = x : .25x = 1 : .25 = 4:1
PYQ 8
PK Ltd. a manufacturing company, provides the following information:
Particulars `
Sales 1,08,00,000
Raw material consumed 27,00,000
Labour paid 21,60,000
Manufacturing overhead (including depreciation for the year `3,60,000) 32,40,000
Administrative and Selling overheads 10,80,000
Additional information:
(a) Receivables are allowed 3 months’ credit.
(b) Raw material supplier extends 3 months’ credit.
(c) Lag in payment of labour is 1 month.
(d) Manufacturing overheads are paid one month in arrear.
(e) Administrative and Selling overhead is paid 1 month advance.
(f) Inventory holding period of raw material and finished goods are of 3 months.
(g) Work-in-progress is Nil.
(h) PK Ltd. sells goods at cost plus 33⅓%.
(i) Cash balance `3,00,000.
(j) Safety margin 10%.
You are required to compute the working capital requirements of PK Ltd. on cash cost basis.
[(10 Marks) Nov 2020]
Answer
Particulars `
(A) Current Assets:
Raw Materials (27,00,000 × 3/12) 6,75,000
Finished Goods (77,40,000 × 3/12) 19,35,000
Debtors (88,20,000 × 3/12) 22,05,000
Cash balance 3,00,000
4.22
Prepaid Administrative and Selling overhead (10,80,000 × 1/12) 90,000

Total (A) 52,05,000
Creditors (27,00,000 × 3/12) 6,75,000
Outstanding labour (21,60,000 × 1/12) 1,80,000
Outstanding Manufacturing Expenses (28,80,000 × 1/12) 2,40,000
Total (B) 10,95,000
Add : Safety Margin @ 10% of 41,10,000 4,11,000
Working Notes:
Projected Income Statement (Cash Cost Basis)
Particulars `
Labour 21,60,000
Manufacturing overhead (32,40,000 – 3,60,000) 28,80,000
Administrative and Selling overhead 10,80,000
PYQ 9
X Ltd. has furnished following cost sheet of per unit cost;
Raw material cost `150

Direct labour cost `40
Overhead cost `60
Total Cost `250
Profit `50
Selling Price `300
The company keeps raw material in stock on an average for 2 months; work in progress on an average
for 3 months and finished goods in stock on an average 1 month. The credit allowed by suppliers is 1.5
months and company allows 2 months credit to its debtors. The lag in payment of wages is 1 month and
lag in payment of overhead expenses is 1.5 months. The company sells 25% of the output against cash
and maintain cash in hand at bank put together at `1,50,000. Production is carried on evenly throughout
the year and wages and overheads also similarly. Work in progress stock is 75% complete in all respects.
Prepare statement showing estimate of working capital requirement to finance an activity level of
15,000 units of production.
Answer
Particulars `
(A) Current Assets:
Raw materials (22,50,000 × 2/12) 3,75,000
Work in progress (37,50,000 × 75% × 3/12) 7,03,125
Finished goods (37,50,000 × 1/12) 3,12,500
4.23
Debtors (37,50,000 × 75% × 2/12) 4,68,750

Cash 1,50,000
Total (A) 20,09,375
Creditors (22,50,000 × 1.5/12) 2,81,250
Outstanding labour (6,00,000 × 1/12) 50,000
Outstanding overhead (9,00,000 × 1.5/12) 1,12,500
Total (B) 4,43,750
Working Notes:
Particulars `
Raw materials (15,000 × 150) 22,50,000
Direct Labour (15,000 × 40) 6,00,000
Overheads (15,000 × 60) 9,00,000
Total cost 37,50,000
Profit (15,000 × 50) 7,50,000
Sales (15,000 × 300) 45,00,000
BQ: 2, 5, 6, 7, 8, 9, 11
PYQ: 1, 2, 4, 7
4.24
CHAPTER 5 TREASURY AND CASH MANAGEMENT
CASH BUDGET FOR SHORT PERIOD
BQ 1
Prepare monthly cash budget for six months beginning from April 2023 on the basis of the following
information:
(a) Estimated monthly sales are as follows:

January `1,00,000 June `80,000
February `1,20,000 July `1,00,000
March `1,40,000 August `80,000
April `80,000 September `60,000
May `60,000 October `1,00,000
(b) Wages and salaries are estimated to be payable as follows:

April `9,000 July `10,000
May `8,000 August `9,000
June `10,000 September `9,000
(c) 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 debts losses.
(d) Purchase amount to 80% of sales and are made and paid for in the month preceding the sales.
(e) The firm has 10% debenture of `1,20,000. Interest on these has to be paid quarterly in January,
April and so on.
(f) The firm is to make an advance payment of tax of `5,000 in July 2023.
(g) The firm had a cash balance of `20,000 on April 1, 2023, which is the minimum desired level of cash
balance. Any cash surplus or deficit above or below this level is made up by temporary investment
or liquidation of temporary investment or temporary borrowing at the end of each month (interest
on these to be ignored).
Answer
Monthly Cash Budget for Six Months, April to September 2023
Particulars April May June July August Sept
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
Collection from debtors 1,08,000 76,000 52,000 60,000 76,000 68,000
Cash available (A) 1,44,000 1,08,000 88,000 1,00,000 1,12,000 1,00,000

Payment for 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 debentures 3,000 - - 3,000 - -
Tax payment - - - 5,000 - -
Total payments (B) 60,000 72,000 90,000 82,000 57,000 89,000
5.1
TREASURY AND CASH MANAGEMENT CHAPTER 5
Balance (A - B) 84,000 36,000 (2,000) 18,000 55,000 11,000

Less: Temporary Invest (64,000) (16,000) - - (35,000) -
Add: Liquidation of - - 22,000 2,000 - 9,000
Invest or borrowings
Closing balance 20,000 20,000 20,000 20,000 20,000 20,000
WN: Collection from debtors:

(` in Thousands)
Particulars Feb March April May June July August Sept
Sales 120 140 80 60 80 100 80 60
Credit sales 96 112 64 48 64 80 64 48
(80% of total sales)
Collections:
75% in one month 72 84 48 36 48 60 48
25% in two months 24 28 16 12 16 20
Total collection 108 76 52 60 76 68
BQ 2
Gold Stone Ltd. has given the following particulars. You are required to prepare a cash budget for three
months ended 31st December, 2023 and in Total.
Months Sales Materials Wages Overheads
August 40,000 20,400 7,600 3,800
September 42,000 20,000 7,600 4,200
October 46,000 19,600 8,000 4,600
November 50,000 20,000 8,400 4,800
December 60,000 21,600 9,000 5,000
(a) Credit terms are:
Sales: 10% Sales are on cash basis. 50% of the credit sales are collected next month and
the balance following months.
Creditors: Materials 2 months, Wages 1/5 month and Overheads 1/2 month
(b) Cash balance on 1st October, 2023 is expected to be `8,000
(c) A machinery will be installed in August, 2023 at a cost of `1,00,000 and the monthly instalment
of `5,000 is payable from October onwards.
(d) Dividend at 10% on preference share capital of `3,00,000 will be paid on 1st December, 2023.
(e) Advance to be received for sale of vehicle `20,000 in December.
(f) Income-tax (advance) to be paid in December `5,000.
Answer
Cash Budget
(From October to December)
Particulars October November December Total
Opening balance 8,000 11,780 18,360 8,000
Cash sales & Debtors collection 41,500 44,600 49,200 1,35,300
Advance against sale of vehicle - - 20,000 20,000
Total A 49,500 56,380 87,560 1,63,300
Payments to creditors (2 months credit) 20,400 20,000 19,600 60,000
Wages 7,920 8,320 8,880 25,120
Overheads 4,400 4,700 4,900 14,000
5.2
Preference dividend - - 30,000 30,000

Machine installments 5,000 5,000 5,000 15,000
Income tax - - 5,000 5,000
Total B 37,720 38,020 73,380 1,49,120
Closing balance (A - B) 11,780 18,360 14,180 14,180
Working Note 1: Cash Sales and Collection from Debtors:

Cash From Debtors Total
Month Sales
Sales 10% 50% 50% Collection
August 40,000 4,000 - - -
September 42,000 4,200 18,000 - -
October 46,000 4,600 18,900 18,000 41,500
November 50,000 5,000 20,700 18,900 44,600
December 60,000 6,000 22,500 20,700 49,200
Working Note 2: Payment of wages:

Payment Total Payment Total
Month Wages OH
4/5 1/5 Payment 50% 50% Payment
Septembe 7,600 6,080 - - 4,200 2,100 - -
r 8,000 6,400 1,520 7,920 4,600 2,300 2,100 4,400
October 8,400 6,720 1,600 8,320 4,800 2,400 2,300 4,700
November 9,000 7,200 1,680 8,880 5,000 2,500 2,400 4,900
Decembe
r
BQ 3
From the information and the assumption that the cash balance in hand on 1st January 2023 is
`72,500 prepare a cash budget.
Assume that 50% of total sales are cash sales. Assets are to be acquired in the months of February
and April. Therefore, provisions should be made for the payment of `8,000 and `25,000 for the same.
An application has been made to the bank for the grant of a loan of `30,000 and it is hoped that the loan
amount will be received in the month of May.
It is anticipated that a dividend of `35,000 will be paid in June. Debtors are allowed one month’s
credit. Creditors for materials purchased and overheads grant one month’s credit. Sales commission at
3% on sales is paid to the salesman each month.
Materials Salaries & Production Office &

Months Sales
Purchases Wages Overheads Selling OH
January 72,000 25,000 10,000 6,000 5,500
February 97,000 31,000 12,100 6,300 6,700
March 86,000 25,500 10,600 6,000 7,500
April 88,600 30,600 25,000 6,500 8,900
May 1,02,500 37,000 22,000 8,000 11,000
June 1,08,700 38,800 23,000 8,200 11,500
Answer
Monthly Cash Budget for Six Months, January to June 2023
Particulars Jan Feb March April May June Total
5.3
Opening balance 72,500 96,340 1,21,330 1,55,650 1,51,292 2,05,767 72,500

Receipts:
Cash sales 36,000 48,500 43,000 44,300 51,250 54,350 2,77,400
Collection debtors - 36,000 48,500 43,000 44,300 51,250 2,23,050
Bank Loan - - - - 30,000 - 30,000
Cash available (A) 1,08,500 1,80,840 2,12,830 2,42,950 2,76,842 3,11,367 6,02,950
Payments:
Payment purchases - 25,000 31,000 25,500 30,600 37,000 1,49,100
Salaries and wages 10,000 12,100 10,600 25,000 22,000 23,000 1,02,700
Production OH - 6,000 6,300 6,000 6,500 8,000 32,800
Selling and Office OH - 5,500 6,700 7,500 8,900 11,000 39,600
Sales commission 2,160 2,910 2,580 2,658 3,075 3,261 16,644
Purchase of Assets - 8,000 - 25,000 - - 33,000
Dividend paid - - - - - 35,000 35,000
Total payments (B) 12,160 59,510 57,180 91,658 71,075 1,17,261 4,08,844
Closing balance (A - B) 96,340 1,21,330 1,55,650 1,51,292 2,05,767 1,94,106 1,94,106
BQ 4
The following information relates to Zeta Limited, a publishing company:
The selling price of a book is `15, and sales are made on credit through a book club and invoiced on the
last day of the month. Variable costs of production per book are materials (`5), labour (`4), and
overhead (`2). The sales manager has forecasted the following volumes:
Month No. of Books
November 1,000
December 1,000
January 1,000
February 1,250
March 1,500
April 2,000
May 1,900
June 2,200
July 2,200
August 2,300
Customers are expected to pay as follows:

One month after sale 40%
Two months after the sale 60%.
The company produces the books two months before they are sold and the creditors for
materials are paid two months after production. Variable overheads are paid in the month following
production and are expected to increase by 25% in April; 75% of wages are paid in the month of
production and 25% in the following month. A wage increase of 12.5% will take place on 1st March.
The company is going through a restructuring and will sell one of its freehold properties in May
for `25,000, but it is also planning to buy a new printing press in May for `10,000. Depreciation is
currently `1,000 per month, and will rise to `1,500 after the purchase of the new machine.
The company’s corporation tax (of `10,000) is due for payment in March. The company presently
has a cash balance at bank on 31st December 2023, of `1,500.
You are required to prepare a cash budget for the six months from January to June, 2023.
5.4
Answer
Monthly Cash Budget for Six Months, January to June 2023
Particulars Jan Feb March April May June
Opening balance 1,500 3,250 1,500 (11,912) (15,024) 576
Receipts:
Sales receipts 15,000 15,000 16,500 20,250 25,500 29,400
Sell of property - - - - 25,000 -
Cash available (A) 16,500 18,250 18,000 8,338 35,476 29,976
Payments:
Payment for purchases 5,000 6,250 7,500 10,000 9,500 11,000
Variable overheads 2,500 3,000 4,000 3,800 5,500 5,500
Wages 5,750 7,500 8,412 9,562 9,900 10,237
Printing press - - - - 10,000 -
Corporation tax - - 10,000 - - -
Total payments (B) 13,250 16,750 29,912 23,362 34,900 26,737
Closing balance (A - B) 3,250 1,500 (11,912) (15,024) 576 3,239
Working note:
Calculation of Sales receipts, payment for Purchases, Variable overheads and Wages:
Particulars Nov Dec Jan Feb March April May June
Forecast sales in units 1,000 1,000 1,000 1,250 1,500 2,000 1,900 2,200
1. Sales receipts:
Sales @ `15/unit 15,000 15,000 15,000 18,750 22,500 30,000 28,500 33,000
1 month 40% - 6,000 6,000 6,000 7,500 9,000 12,000 11,400
2 months 60% - - 9,000 9,000 9,000 11,250 13,500 18,000
- - 15,000 15,000 16,500 20,250 25,500 29,400
2. Pay for purchase:
Quantity produced 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300
(2 months before sales)
Materials cost @ `5 p.u. 5,000 6,250 7,500 10,000 9,500 11,000 11,000 11,500
Payment after 2 month - - 5,000 6,250 7,500 10,000 9,500 11,000
3. Pay for variable oh:

Variable OH @ `2 and 2,000 2,500 3,000 4,000 3,800 5,500 5,500 5,750
`2.50 p.u. from April
Payment next month - 2,000 2,500 3,000 4,000 3,800 5,500 5,500
4. Pay for wages:

Wages @ `4 and `4.50 4,000 5,000 6,000 8,000 8,550 9,900 9,900 10,350
p.u. from March
Same month 75% 3,000 3,750 4,500 6,000 6,412 7,425 7,425 7,762
Next month 25% - 1,000 1,250 1,500 2,000 2,137 2,475 2,475
- 4,750 5,750 7,500 8,412 9,562 9,900 10,237
BQ 5
Consider the balance sheet of Maya Limited as on 31st December, 2023:
5.5
[` in Thousand]
Equity & Liabilities ` Assets `
Equity shares capital 100 Net fixed assets 1,836
Retained earnings 1,439 Inventories 545
Long-term borrowings 450 Accounts receivables 530
Accounts payables 360 Cash and bank 50
Loan from banks 400
Other liabilities 212
2,961 2,961
The company has received a large order and anticipates the need to go to its bank to increase its
borrowings. As a result, it has to forecast its cash requirements for January, February and March, 2023.
Typically, the company collects 20 per cent of its sales in the month of sale, 70 per cent in the subsequent
month, and 10 per cent in the second month after the sale. All sales are credit sales.
Actual sales in November and December and projected sales for January through April are as
follows (in thousands):
Month ` Month ` Month `
November 500 January 600 March 650
December 600 February 1,000 April 750
Purchases of raw materials are made in the month prior to the sale and amounts to 60 per cent
of sales. It is paid in the subsequent month. Payments for these purchases occur in the month after the
purchase. Labour costs, including overtime, are expected to be `1,50,000 in January, `2,00,000 in
February, and `1,60,000 in March. Selling, administrative, taxes, and other cash expenses are expected
to be `1,00,000 per month for January through March.
On the basis of this information:

(a) Prepare a cash budget for the months of January, February, and March and determine the amount
of additional bank borrowings necessary to maintain a cash balance of `50,000 at all times.
(b) Prepare a proforma balance sheet for 31st March, 2024.
Answer
(a) Cash Budget
(From January to March) (` in Thousand)
Particulars January February March
Opening balance 50 50 50
Debtors Collection:
20% in month of sales 120 200 130
70% of sales in 1 Month 420 420 700
10% of sales in 2 Month 50 60 60
Total (A) 640 730 940
Payments to creditors 360 600 390
Labour cost 150 200 160
Selling, administrative, taxes and other cash exp. 100 100 100
Total (B) 610 900 650
Balance (A - B) 30 (170) 290
Add: Additional Borrowing/(Repayment) 20 220 (240)
Closing balance 50 50 50
5.6
(b) Proforma Balance Sheet, 31st March, 2024 [` in Thousand]

Equity & Liabilities ` Assets `
Equity shares capital 100 Net fixed assets 1,836
Retained earnings 1,529 Inventories 635
Long-term borrowings 450 Accounts receivables 620
Accounts payables 450 Cash and bank 50
Loan from banks 400
Other liabilities 212
3,141 3,141
Working notes:
Accounts receivable = Sales in March × 80% + Sales in February × 10%
= 6,50,000 × 80% + 10,00,000 × 10% = `6,20,000
Inventories = `5,45,000 + Total purchases from January to March − Total sales from
January to March × 60%
= `5,45,000 + (10,00,000 + 6,50,000 + 7,50,000) × 60% - (6,00,000 +
10,00,000 + 6,50,000) × 60% = `6,35,000
Accounts payable = Purchases in March

= `7,50,000 × 60% = `4,50,000
Retained earnings = `14,39,000 + Sales – Material Cost – Labour costs and Other expenses, all
for January to March
= `14,39,000 + (6,00,000 + 10,00,000 + 6,50,000) - (6,00,000 + 10,00,000 +
6,50,000) × 60% - (1,50,000 + 2,00,000 + 1,60,000) - (1,00,000 × 3 M)
= `14,39,000 + (`22,50,000 - `13,50,000 - `5,10,000 – `3,00,000)
= `15,29,000
BQ 6
Vivek and Company are manufactures of check valves which are sold at `50 each.
The cost data are:
(a) Variable manufacturing cost : `25 per unit.
(b) Variable selling expenses : `5 per unit.
(c) Fixed manufacturing cost paid in cash : `1,50,000 per month
Fixed selling expenses : `1,00,000 p.m. payable in cash
(d) Depreciation : `30,000 per month.
Other data:
(1) The company's policy is to hold at the end of each month an inventory of finished goods
representing targeted sales for next two months. Opening inventory on 1st January was 30,000
units.
(2) The raw material required each month is purchased in cash which is the included in variable
manufacturing cost of `25. No inventory of raw material is held.
(3) All sales are on credit. Collection is 50% in the same month and the balance in the following
month. The Debtors balance was `4,00,000 on 1st January.
5.7
(4) All manufacturing costs are paid in cash in the month of production.
(5) The company pays 80% of its variable selling expenses in the month of sale and the balance in
the following month. On 1st January the company owed `25,000 for December expenses.
(6) The minimum desired cash balance is `50,000 which is held on 1st January.
(7) The company borrows at the beginning of the month and repays at the end amount available in
excess of `50,000. Ignore interest.
(8) The sales budget is:
Month Units Month Units
January 15,000 February 20,000
March 25,000 April 27,000
May 30,000 June 30,000
Prepare cash budget of the company (i) for January, February and March; and (ii) in total.
Answer
Cash Budget of Vivek & Company for the period January to March
Particulars January February March Total
Opening Balance 50,000 50,000 50,000 50,000
Collection from debtors:
50% of current month 3,75,000 5,00,000 6,25,000 15,00,000
Previous period 4,00,000 3,75,000 5,00,000 12,75,000
Total A 8,25,000 9,25,000 11,75,000 28,25,000
Variable manufacturing cost @ `25 each 7,50,000 6,75,000 7,50,000 21,75,000
Fixed manufacturing cost
Fixed selling expenses 1,50,000 1,50,000 1,50,000 4,50,000
Variable selling expenses: 1,00,000 1,00,000 1,00,000 3,00,000
Current month 80% 60,000 80,000 1,00,000 2,40,000
Next month 20% 25,000 15,000 20,000 60,000
Total B 10,85,000 10,20,000 11,20,000 32,25,000
Balance (A - B) (2,60,000) (95,000) 55,000 (4,00,000)
Add: Borrowing 3,10,000 1,45,000 - 4,50,000
Less: Repayment - - (5,000) -
Closing balance 50,000 50,000 50,000 50,000
Working Notes: Calculation of units to be produced

Sales 15,000 20,000 25,000
Add: Closing stock (next two months requirements) 45,000 52,000 57,000
60,000 72,000 82,000
Less: Opening stock (30,000) (45,000) (52,000)
Production 30,000 27,000 30,000
BQ 7
From the following information relating to a departmental store, you are required to prepare for
the three months ending 31st March, 2023:
(a) Month-wise cash budget on receipts and payments basis; and

(b) Statement of Sources and uses of funds for the three months period.
5.8
It is anticipated that the working capital at 1st January, 2023 will be as follows:
Particulars ` in ‘000’s
Cash in hand and at bank 545
Short term investments 300
Debtors 2,570
Stock 1,300
Trade creditors 2,110
Other creditors 200
Dividends payable 485
Tax due 320
Plant 800
` in ‘000’s
Budgeted Profit Statement
January February March
Sales 2,100 1,800 1,700
Cost of sales 1,635 1,405 1,330
Gross Profit 465 395 370
Administrative, Selling and Distribution Expenses 315 270 255
Net Profit before tax 150 125 115
` in ‘000’s
Budgeted balances at the end of each months
31st Jan. 28th Feb. 31st March
Short term investments 700 - 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade creditors 2,000 1,950 1,900
Other creditors 200 200 200
Dividends payable 485 - -
Tax due 320 320 320
Plant (depreciation ignored) 800 1,600 1,550
Depreciation amount to `60,000 is included in the budgeted expenditure for each month.
Answer
(a) Cash Budget
(3 months ending 31st March, 2023)
` in ‘000’s
Particulars
Jan. Feb. March
Opening Cash Balances 545 315 65
Add: Receipts:
From Debtors 2,070 1,900 1,850
Sale of Investments - 700 -
Sale of Plant - - 50
Total (A) 2,615 2,915 1,965
Payments:
Creditors 1,645 1,355 1,280
Cash Expenses (Exp – 60,000 for depreciation) 255 210 195
Purchase of Plant - 800 -
Payment of dividend - 485 -
Purchase of Investments 400 - 200
Total (B) 2,300 2,850 1,675
Closing Cash Balance (A - B) 315 65 290
5.9
(b) Statement of Sources and uses of Funds (3 months ending 31st March, 2023)
Sources of Funds ` in ‘000’s
Funds from Operations:
Net profit (150 + 125 + 115) 390
Add: Depreciation (60 × 3) 180 570
Sale of Plant 50
Decrease in Working Capital (W.N.) 665
Total (A) 1,285
Uses of Funds ` in ‘000’s
Purchase of Plant 800
Dividend Payment 485
Total (B) 1,285
Working Note:
1. Calculation of receipts from debtors and payment to creditors:
` in ‘000’s
Workings
Jan’ 23 Feb’ 23 March’ 23
Opening balance of debtors 2,570 2,600 2,500
Add: Sales 2,100 1,800 1,700
Less: Closing balance of debtors (2,600) (2,500) (2,350)
Receipts from debtors 2,070 1,900 1,850
Cost of sales 1,635 1,405 1,330

Add: Closing stock 1,200 1,100 1,000
Less: Opening stock (1,300) (1,200) (1,100)
Purchases 1,535 1,305 1,230
Add: Opening balance of creditors 2,110 2,000 1,950
Less: Closing balance of creditors (2,000) (1,950) (1,900)
Payment to creditors 1,645 1,355 1,280
2. Statement of Changes in Working Capital

` in ‘000’s
Particulars
January’ 23 March’ 23
(A) Current Assets:
Cash in hand and at Bank 545 290
Short term Investments 300 200
Debtors 2,570 2,350
Stock 1,300 1,000
Total (A) 4,715 3,840

Trade Creditors 2,110 1,900
Other Creditors 200 200
Tax Due 320 320
Total (B) 2,630 2,420

Working Capital (A - B) 2,085 1,420
Decrease in Working Capital - (665)
5.10
CASH BUDGET FOR LONG PERIOD
BQ 8
You are given below the Profit & Loss Accounts for two years for a company:
Particulars Year 1 Year 2 Particulars Year 1 Year 2
To Opening stock 80,00,000 1,00,00,000 By Sales 8,00,00,000 10,00,00,000
To Raw materials 3,00,00,000 4,00,00,000 By Closing 1,00,00,000 1,50,00,000
To Stores 1,00,00,000 1,20,00,000 stock 10,00,000 10,00,000
To Man. exps 1,00,00,000 1,60,00,000 By Misc.
To Other expenses 1,00,00,000 1,00,00,000 Income
To Depreciation 1,00,00,000 1,00,00,000
To Net Profit 1,30,00,000 1,80,00,000
9,10,00,000 11,60,00,000 9,10,00,000 11,60,00,000
Sales are expected to be `12,00,00,000 in year 3.
As a result, other expenses will increase by `50,00,000 besides other charges. Only raw materials
are in stock. Assume sales and purchases are in cash terms and the closing stock is expected to go up by
the same amount as between year 1 and 2. You may assume that no dividend is being paid. The Company
can use 75% of the cash generated to service a loan.
Compute how much cash from operations will be available in year 3 for the purpose? Ignore
income tax.
Answer
Projected Profit and Loss Account for the year 3 (` in Lakhs)
Year 2 Year 3 Year 2 Year 3
Particulars Particulars
(Actual) (Projected) (Actual) (Projected)
To RM Consumed 350 420 By Sales 1,000 1,200
To Stores 120 144 By Misc. Income 10 10
To Man. Expenses 160 192
To Other Expenses 100 150
To Depreciation 100 100
To Net Profit 180 204
1,010 1,210 1,010 1,210
Cash Flow:
Particulars (` in Lakhs)
Net Profit 204
Add: Depreciation 100
304
Less: Cash required for increase in stock (50 Lakhs same as between year 1 & 2) (50)
Net Cash Inflow 254
Available for servicing the loan: 75% of `2,54,00,000 = `1,90,50,000
Note: The above also shows how a projected profit and loss account is prepared
Working Notes:
5.11
(a) Material consumed in year 2 = `350 Lakhs ÷ `1,000 lakhs = 35% of sales
Likely consumption in year 3 = `1,200 Lakhs × 35% = `420 Lakhs
(b) Stores are 12% of sales, as in year 2

(c) Manufacturing expenses are 16% of sales
CASH CYCLE & CASH TURNOVER
BQ 9
The following information is available in respect of Sai trading company:
1. On an average, debtors are collected after 45 days; inventories have an average holding period of
75 days and creditor’s payment period on an average is 30 days.
2. The firm spends a total of ` 120 lakhs annually at a constant rate.
3. It can earn 10 per cent on investments.
From the above information, you are required to Calculate:

(a) The cash cycle and cash turnover,
(b) Minimum amounts of cash to be maintained to meet payments as they become due,
(c) Savings by reducing the average inventory holding period by 30 days.
Answer
(a) Cash cycle = F+D–C
= 75 days + 45 days – 30 days
= 90 days (3 months)
Cash turnover = 12 months ÷ 3 months = 4 times
(b) Minimum operating cash = Total operating annual outlay ÷ Cash turnover
= `120 lakhs ÷ 4 times
= `30 lakhs
(c) Revised Cash cycle = F+D–C

= 45 days + 45 days – 30 days
= 60 days (2 months)
Revised Cash turnover = 12 months ÷ 2 months = 6 times
Revised Min. operating cash = Total operating annual outlay ÷ Cash turnover
= `120 lakhs ÷ 6 times
= `20 lakhs
Reduction in investments = `30 lakhs – `20 lakhs

= `10 lakhs
Savings = 0.10 × `10 lakhs

= `1 lakh
5.12
CLEAR & UNCLEARED FUNDS
BQ 10
Prachi Ltd is a manufacturing company producing and selling a range of cleaning products to wholesale
customers. It has three suppliers and two customers. Prachi Ltd relies on its cleared funds forecast to
manage its cash.
You are an accounting technician for the company and have been asked to prepare a cleared
funds forecast for the period Monday 7 August to Friday 11 August 2023 inclusive. You have been
provided with the following information:
(1) Receipts from customers:

Customers Credit terms Payment method 7 Aug 2023 sales 7 July 2023 sales
W Ltd 1 Calendar month BACS `1,50,000 `1,30,000
X Ltd None Cheque `1,80,000 `1,60,000
(a) Receipt of money by BACS (Bankers' Automated Clearing Services) is instantaneous.
(b) X Ltd’s cheque will be paid into Prachi Ltd’s bank account on the same day as the sale is made and
will clear on the third day following this (excluding day of payment).
(2) Payments to suppliers:

Payment 7 Aug 2023 7 July 2023 7 June 2023
Supplier Credit terms
method Purchase purchases purchases
A Ltd 1 Calendar month BACS `65,000 `55,000 `45,000
B Ltd 2 Calendar months Cheque `85,000 `80,000 `75,000
C Ltd None Cheque `95,000 `90,000 `85,000
(a) Prachi Ltd has set up a standing order for `45,000 a month to pay for supplies from A Ltd. This will
leave Prachi’s bank account on 7 August. Every few months, an adjustment is made to reflect the
actual cost of supplies purchased (you do not need to make this adjustment).
(b) Prachi Ltd will send out, by post, cheques to B Ltd and C Ltd on 7 August. The amounts will leave
its bank account on the second day following this (excluding the day of posting).
(3) Wages and salaries:
July 2023 August 2023
Weekly wages `12,000 `13,000
Monthly salaries `56,000 `59,000
(a) Factory workers are paid cash wages (weekly). They will be paid one week’s wages, on 11 August,
for the last week’s work done in July (i.e. they work a week in hand).
(b) All the office workers are paid salaries (monthly) by BACS. Salaries for July will be paid on 7 August.
(4) Other miscellaneous payments:
(a) Every Monday morning, the petty cashier withdraws `200 from the company bank account for the
petty cash. The money leaves Prachi’s bank account straight away.
(b) The room cleaner is paid `30 from petty cash every Wednesday morning.
(c) Office stationery will be ordered by telephone on Tuesday 8 August to the value of `300. This is
paid for by company debit card. Such payments are generally seen to leave the company account
on the next working day.
5.13
(d) Five new softwares will be ordered over the Internet on 10 August at a total cost of `6,500. A
cheque will be sent out on the same day. The amount will leave Prachi Ltd’s bank account on the
second day following this (excluding the day of posting).
(5) Other information: The balance on Prachi’s bank account will be `200,000 on 7 August 2023. This
represents both the book balance and the cleared funds.
Prepare a cleared funds forecast for the period Monday 7 August to Friday 11 August 2023
inclusive using the information provided. Show clearly the uncleared funds float each day.
Answer
Clear Fund Forecast
7 Aug 23 8 Aug 23 9 Aug 23 10 Aug 23 11 Aug 23
Particulars
(Monday) (Tuesday) (Wednesday) (Thursday) (Friday)
Receipts:
W Ltd 1,30,000 - - - -
X Ltd - - - 1,80,000 -
Total A 1,30,000 - - 1,80,000 -
Payments:
A Ltd 45,000 - - - -
B Ltd - - 75,000 - -
C Ltd - - 95,000 - -
Wages - - - - 12,000
Salaries 56,000 - - - -
Petty Cash 200 - - - -
Stationery - - 300 - -
Total B 1,01,200 - 1,70,300 - 12,000
Cleared Excess Receipts (A - B) 28,800 - (1,70,300) 1,80,000 (12,000)
Add: Opening Cleared Balance 2,00,000 2,28,800 2,28,800 58,500 2,38,500
Closing Cleared Balance (C) 2,28,800 2,28,800 58,500 2,38,500 2,26,500
Uncleared Float:
Uncleared receipts 1,80,000 1,80,000 1,80,000 - -
Less: Uncleared Payments (1,70,000) (1,70,300) - (6,500) (6,500)
Uncleared Balance (D) 10,000 9,700 1,80,000 (6,500) (6,500)
Total Book Balance (C + D) 2,38,800 2,38,500 2,38,500 2,32,000 2,20,000
*1,70,000 = Cheque to B Ltd for `75,000 and Cheque to C Ltd for `95,000
WILLIAM J. BAUMOL’S EOQ MODEL (1952)
BQ 11
A firm maintains a separate account for cash disbursement. Total disbursement are `1,05,000 per
month or `12,60,000 per year. Administrative and transaction cost of transferring cash to disbursement
account is `20 per transfer. Marketable securities yield is 8% per annum.
Determine the optimum cash balance according to William J. Baumol model.
Answer
2UP 2 × 12,60 ,000 × 20
Optimal Cash Balance (C) = = = `25,100
S 0.08
5.14
PAST YEAR QUESTIONS
PYQ 1
Following information relates to ABC company for the year 2016:
(a) Projected sales (` in lakhs)

August September October November December
35 40 40 45 46
(b) Gross profit margin will be 20% on sale.
(c) 10% of projected sale will be cash sale. Out of credit sale of each month, 50% will be collected in
the next month and the balance will be collected during the second month following the month of
sale.
(d) Creditors will be paid in the first month following credit purchase. There will be credit purchase
only.
(e) Wages and salaries will be paid on the first day of the next month. The amount will be `3 lakhs
each month.
(f) Interim dividend of `2 lakhs will be paid in December 2016.
(g) Machinery costing `10 lakhs will be purchased in September 2016. Repayment by instalment of
`50,000 p.m. will start from October 2016.
(h) Administrative expenses of `1,00,000 per month will be paid in the month of their incurrence.
(i) Assume no minimum cash balance is required. Opening cash balance as on 01.10.2016 is estimated
at `10 lakhs.
You are required to prepare the monthly cash budget for the 3 month period (October 2016
to December 2016).
Answer
Cash Budget
(From Oct 2016 to December 2016)
Particulars October November December
Opening Balance 10,00,000 14,25,000 21,25,000
Cash Sales @ 10% of Sales 4,00,000 4,50,000 4,60,000
Debtors Collection:
50% of Credit Sales 1 Month 18,00,000 18,00,000 20,25,000
50% of Credit Sales 2 Month 15,75,000 18,00,000 18,00,000
Total A 47,75,000 54,75,000 64,10,000
Payments to creditors (1 Month Credit) 29,00,000 29,00,000 33,00,000

Purchase = Sales – GP - Wages (40L – 20% - 3L) (40L – 20% - 3L) (45L – 20% - 3L)
Wages & Salaries 3,00,000 3,00,000 3,00,000
Admin Expenses 1,00,000 1,00,000 1,00,000
Interim dividend - - 2,00,000
Machine installments 50,000 50,000 50,000
Total B 33,50,000 33,50,000 39,50,000
Closing Balance (A - B) 14,25,000 21,25,000 24,60,000
5.15
PYQ 2
VK Co. Ltd. has total cash disbursement amounting `22,50,000 in the year 2017 and maintains a
separate account for cash disbursements. Company has an administrative and transaction cost on
transferring cash to disbursement account `15 per transfer. The yield rate on marketable securities is
12% per annum.
Determine the optimum cash balance according to William J Baumol model.

Answer
2UP 2 ×22,50,000 ×15
Optimal transfer size = √
S
= √
0.12
= 23,717
PYQ 3
Slide Ltd is preparing a cash flow forecast for the three months period from January to the end of March.
The following sales volumes have been forecasted:
December January February March April
Sales (units) 1,800 1,875 1,950 2,100 2,250
Selling price per unit is `600. Sales are all on one month credit. Production of goods for sales takes place
one month before sales. Each unit produced requires two units of raw material costing `150 per unit.
No raw material inventory is held. Raw materials purchases are on one month credit. Variable overheads
and wages equal to `100 per unit are incurred during production and paid in the month of production.
The opening cash balance on 1st January is expected to be `35,000. A long term loan of `2,00,000 is
excepted to be received in the month of March. A machine costing `3,00,000 will be purchased in March.
(a) Prepare a cash budget for the months of January, February and March and calculate the cash
balance at the end of each month in the three month period.
(b) Calculate the forecast current ratio at the end of the three months period.
[(10 Marks) Nov 2019]
Answer
(a) Cash Budget
(for three months period January to March)
Opening Balance 35,000 3,57,500 6,87,500
Collection from debtors 10,80,000 11,25,000 11,70,000
Loan receivable - - 2,00,000
Total A 11,15,000 14,82,500 20,57,500
Payments to creditors 5,62,500 5,85,000 6,30,000
Variable overheads and wages 1,95,000 2,10,000 2,25,000
Purchase of machine - - 3,00,000
Total B 7,57,500 7,95,000 11,55,000
Closing Balance (A - B) 3,57,500 6,87,500 9,02,500
Working note:
Calculation of Collection from debtors, payment for Purchases, Variable overheads and Wages:
Particulars December January February March
Forecast sales in units 1,800 1,875 1,950 2,100
5.16
1. Sales receipts:
Sales @ `600 per unit 10,80,000 11,25,000 11,70,000 12,60,000
Collection from debtors - 10,80,000 11,25,000 11,70,000
2. Payment for purchase:

Quantity produced 1,875 1,950 2,100 2,250
(1 months before sales)
Materials cost @ `300 p.u. (150 × 2) 5,62,500 5,85,000 6,30,000 6,75,000
Payment after 1 month
- 5,62,500 5,85,000 6,30,000
3. Payment for variable OH and wages:
Quantity produced - 1,950 2,100 2,250
Variable OH and wages @ `100 per unit - 1,95,000 2,10,000 2,25,000
(b) Forecast Current Ratio:

Expected Current Assets
Forecast Current Ratio =
Expected Current Liabilities
Current Assets = Cash and bank balance + Sundry debtors + Stock of FG

= `9,02,500 + `12,60,000 + `9,00,000 = `30,62,500
Value of stock of Finished Goods = 2,250 units × [(2 units of raw material × `150) + `100]
= `9,00,000
Current Liabilities = Sundry creditors = `6,75,000
30,62,500
Forecast Current Ratio = 6,75,000
= 4.537 times
PYQ 4
A garment trader is preparing cash forecast for first three months of calendar year 2021. His estimated
sales for the forecasted periods are as below:
January (` ‘000) February (` ‘000) March (` ‘000)
Total sales 600 600 800
(i) The trader sells directly to public against cash payments and to other entities on credit. Credit
sales are expected to be four times the value of direct sales to public. He expects 15% customers
to pay in the month in which credit sales are made, 25% to pay in the next month and 58% to pay
in the next to next month. The outstanding balance is expected to be written off.
(ii) Purchase of goods are made in the month prior to sales and it amounts to 90% of sales and are
made on credit. Payments of these occur in the month after the purchase. No inventories of goods
held.
(iii) Cash balance as on 1st January, 2021 is `50,000.
(iv) Actual sales for the last two months of calendar year 2020 are as below:
November (` ‘000) December (` ‘000)
Total sales 640 880
You are required to prepare a monthly cash budget for the three months from January to
March, 2021.
[(5 Marks) Dec 2021]
5.17
Answer
Cash Budget (From January to March, 2021)
Opening Balance 50,000 1,74,960 3,55,280
Cash Sales & Debtors Collection 6,64,960 7,20,320 6,54,400
Total A 7,14,960 8,95,280 10,09,680
Payments to creditors (90% of sales) 5,40,000 5,40,000 7,20,000
Total B 5,40,000 5,40,000 7,20,000
Closing balance (A - B) 1,74,960 3,55,280 2,89,680
Working Note: Cash Sales and Collection from Debtors: (` ‘000)

Cash Sales Credit Sales From Debtors Total
Month Sales
20% 80% 15% 25% 58% Collection
November 640 128 512 76.8 - - -
December 880 176 704 105.6 128 - -
January 600 120 480 72 176 296.96 664.96
February 600 120 480 72 120 408.32 720.32
March 800 160 640 96 120 278.4 654.4
PYQ 5
K Ltd. has a Quarterly cash outflow of `9,00,000 arising uniformly during the Quarter. The company has
an Investment portfolio of Marketable Securities. It plans to meet the demands for cash by periodically
selling marketable securities. The marketable securities are generating a return of 12% p.a. Transaction
cost of converting investments to cash is `60. The company uses Baumol model to find out the optimal
transaction size for converting marketable securities into cash.
Consider 360 days in a year.

(a) Company’s average cash balance,
(b) Number of conversions each year and
(c) Time interval between two conversions. [(5 Marks) Nov 2022]
Answer
(a) Average cash balance = ½ of `60,000 = `30,000
Annual Cash Requirement 9,00,000 × 4
(b) Number of conversions p.a. = =
Optimal Transaction Size 60,000
= 60 conversions per annum
360 360
(c) Time interval btn two conversions = = = 6 Days
No.of Coversions 60
Working Note:
2UP 2  9 ,00 ,000  4  60

Optimal Cash Balance (C) = = = `60,000
S 0.12

BQ: 1, 4, 5, 7, 8, 10
PYQ: 3, 5
5.18
CHAPTER 6 RATIO ANALYSIS
INCOME STATEMENT & BALANCE SHEET
BQ 1
Equity share capital `1,00,000
The relevant ratios of the company are as follows:

Current debt to total debt .40
Total debt to owner's equity .60
Fixed assets to owner's equity .60
Total assets turnover 2 Times
Inventory turnover 8 Times
Complete the following balance sheet from the above information:
Balance Sheet
Current Debt - Inventory -
Long Term Debt - Cash -
Total Debt - Total Current Assets -
Equity Share Capital - Fixed Assets -
- -
Answer
Balance Sheet
Current Debt 24,000 Inventory 40,000
Long Term Debt 36,000 Cash 60,000
Total Debt 60,000 Total Current Assets 1,00,000
Equity Share Capital 1,00,000 Fixed Assets 60,000
1,60,000 1,60,000
Working Notes:
1. Total debt:
0.60 × Owners equity = 0.60 × `1,00,000 = `60,000
2. Current Debt:
Current debt to total debt = 0.40
Current debt = 0.40 × `60,000 = `24,000
3. Fixed assets:
0.60 × Owners equity = 0.60 × `1,00,000 = `60,000
4. Total of liability side:

Total debt + Owners equity = `60,000 + `1,00,000 = `1,60,000
6.1
RATIO ANALYSIS CHAPTER 6
5. Total assets consisting of fixed assets and current assets must be equal to `1,60,000 hence,
current assets should be `1,00,000.
6. Total assets turnover is 2 times:

Sales
= 2 times
Total Assets
Sales = `1,60,000 × 2 = `3,20,000
Inventory turnover is 8 times:

Sales
= 8 times
Inventory
Sales 3,20 ,000
Inventory = = = `40,000
8 8
7. Cash: = `1,00,000 – `40,000 = `60,000
BQ 2
Using the following information, Prepare this Balance sheet:
Long term debt to net worth 0.5
Total assets turnover 2.5
*Average collection period 18 days
Inventory turnover 9
Gross profit margin 10%
Acid test ratio 1 to 1
*Assume a 360 day year and all sales on credit

` `
Cash - Notes and payables 1,00,000
Account receivables - Long term debt -
Inventory - Common stock 1,00,000
Plant and equipment - Retained earnings 1,00,000
Total Assets - Total liabilities and equity -
Answer
Balance Sheet
` `
Cash 50,000 Notes and payables 1,00,000
Account receivables 50,000 Long term debt 1,00,000
Inventory 1,00,000 Common stock 1,00,000
Plant and equipment 2,00,000 Retained earnings 1,00,000
Total Assets 4,00,000 Total liabilities and equity 4,00,000
Working Notes:
1. Long term debt to net worth = Long term debt ÷ Net worth = 0.5
Long term debt = Net worth × 0.5
= `2,00,000 × 0.5 = `1,00,000
2. Total Assets Turnover = Sales ÷ Total Assets = 2.5

Sales = Total Assets × 0.5
6.2
= `4,00,000 × 2.5 = `10,00,000
3. Debtors = Credit Sales × Average collection period/360

= `10,00,000 × 18/360 = `50,000
4. Inventory turnover ratio = COGS ÷ Inventory = 9

Inventory = (`10,00,000 × 90%) ÷ 9 = `1,00,000
5. Acid test ratio = (CA – Inventory) ÷ CL = 1

= (CA – `1,00,000) ÷ `1,00,000 = 1
Current Assets = `2,00,000

Current Assets = Cash + Account receivables + Inventory
= Cash + `50,000 + `1,00,000 = `2,00,000
Cash = `50,000
BQ 3
Complete the following annual financial statements on the basis of ratios given below:
Profit and loss account for the year ended 31st March, 2023
Particulars ` Particulars `
To Cost of goods sold 6,00,000 By Sales 20,00,000
To Operating expenses -
To EBIT -
20,00,000 20,00,000
To Debenture interest 10,000 By EBIT -
To Income tax -
To Net profit -
- -
Balance Sheet as at 31st March, 2023

Net worth: Fixed assets -
Share capital - Current assets:
Reserve and surplus - Cash -
10% Debenture - Stock -
Sundry creditors 60,000 Debtors 35,000
- -
Net Profit to sales 5% Current Ratio 1.5 times

Return on net worth 20% Share capital to reserves 4:1
Rate of Income - tax 50% Inventory turnover 15 times
(based on cost of goods sold)
Answer
Profit and loss account for the year ended 31st March, 2023
To Cost of goods sold 6,00,000 By Sales 20,00,000
To Operating expenses 11,90,000
To EBIT 2,10,000
6.3
20,00,000 20,00,000
To Debenture interest 10,000 By EBIT 2,10,000
To Income tax 1,00,000
To Net profit 1,00,000
2,10,000 2,10,000

Net worth: Fixed assets 5,70,000
Share capital 4,00,000 Current assets:
Reserve and surplus 1,00,000 Cash 15,000
10% Debenture 1,00,000 Stock 40,000
Sundry creditors 60,000 Debtors 35,000
6,60,000 6,60,000
BQ 4
Using the following data, complete the Balance Sheet of X Ltd. as at 31.03.2023:
Gross profit 25% of Sales Gross profit `1,20,000

Shareholder’s equity `20,000 Credit Sales to total sales 80%
Total turnover to total assets 4 times Cost of sales to inventory 10 times
Average collection period 5 days Long-term debt ?
Current ratio 1.5 Sundry creditors `60,000
Assume 365 days in a year
Balance Sheet of as at 31.03.2023

Share capital - Cash -
Long term debt - Inventory -
Sundry creditors - Debtors -
Fixed assets -
- -
BQ 5
From the following information, prepare a summarised balance sheet as at March 31, 2023:
Stock Turnover ratio 6 Fixed assets turnover ratio 4

Capital turnover ratio 2 Gross profit 20%
Debt collection period 2 months Creditors payment period 73 days
Gross profit `60,000
Closing stock was `5,000 in excess of the opening stock.
Answer
Working Notes:
Gross Profit 60,000
1. Sales = =
GP Ratio 20%
= `3,00,000
6.4
COGS
2. Stock Velocity = = 6
Average Stock
COGS 2,40,000
Average Stock = =
6 6
= `40,000
Opening Stock  Clo sin g Stock

3. Average Stock =
2
40,000 × 2 = Opening Stock + Closing Stock
80,000 = (Closing – 5,000) + Closing Stock
Closing Stock = `42,500 [Opening Stock = Closing – 5,000]
Turnover
4. Capital Turnover Ratio = = 2
Capital
3,00,000
Capital = = `1,50,000
2
Sales
5. Fixed Assets Turnover = = 4
Fixed Assets
3,00,000
Fixed Assets = = `75,000
4
6. Debtors = Credit sales × Collection period

12
= 3,00,000 × 2 = `50,000
12
7. Creditors = Credit purchase × Payment period

12
= 2,45,000 × 73 = `49,000
365
Assuming all purchases to be credit purchases, the amount of credit purchase is determined as follows:
Cost of Goods Sold = Opening Stock + Purchases - Closing Stock

= 2,40,000
Purchase = COGS + Closing Stock – Opening Stock

= 2,40,000 + 42,500 - 37,500 = `2,45,000

Capital 1,50,000 Fixed assets 75,000
Sundry creditors 49,000 Current assets:
Stock 42,500
Debtors 50,000
Cash (b.f.) 31,500
1,99,000 1,99,000
6.5
BQ 6
From the following particulars prepare the balance sheet:
Current ratio 2 Working capital `4,00,000

Capital block to CA 3:2 Fixed assets to turnover 1:3
Sales cash/credit 1:2 Debentures/share capital 1:2
Stock velocity 2 months Creditors velocity 2 months
Debtors velocity 3 months Gross profit ratio 25%
Reserve 2 1/2% of sales Profit & Loss (Cr. balance) 10% of sales
Answer
Balance Sheet
Share Capital 6,00,000 Fixed assets 8,00,000
Reserves 60,000 Current assets:
Profit & Loss A/C 2,40,000 Stock 3,00,000
Debentures 3,00,000 Debtors 4,00,000
Sundry creditors 3,00,000 Cash 1,00,000
Other Current Liabilities 1,00,000
16,00,000 16,00,000
Working Notes:
(a) Working Capital = Current Assets – Current Liabilities
= 4,00,000 (i)
Current Assets
= 2
Current Liabilitie s
Current Assets = 2 Current Liabilities (ii)
CA – CL = 4,00,000
2 CL – CL = 4,00,000
Current Liabilities = `4,00,000
Current Assets = 2 × `4,00,000 = `8,00,000
(b) Capital Employed/Block = 8,00,000 × 3/2
Capital Employed = `12,00,000
(c) Total liabilities = 12,00,000 + 4,00,000 = Total Assets
Fixed Assets = 16,00,000 – 8,00,000 = `8,00,000
(d) Turnover/ Sales = 8,00,000 (FA) × 3
Sales = `24,00,000
Credit sales and cash sales `16,00,000 and `8,00,000 respectively.
(e) Debtors = 16,00,000 × 3/12 = `4,00,000
6.6
(f) Stock = COGS × 2/12

= 18,00,000 × 2/12 = `3,00,000
(g) Creditors = Credit purchase 2/12

= 18,00,000 × 2/12 = `3,00,000
[Credit purchase = COGS]
(h) Cash Balance = 8,00,000 - 7,00,000 = `1,00,000
(i) Reserves = 24,00,000 × 2.5% = `60,000
(j) Profit = 24,00,000 × 10% = `2,40,000
(k) Block or Fixed Capital = 12,00,000

Reserve and Profit = 3,00,000
Debentures and Share Capital = 9,00,000
Share Capital is `6,00,000 and Debentures are `3,00,000 respectively.
BQ 7
From the following information relating to Wise Limited you are required to prepare its
summarized Balance Sheet.
Current ratio 2.5 Acid test ratio 1.5

Gross profit to sales ratio 0.2 Sales to net fixed assets ratio 2.0
Sales to net worth ratio 1.5 Sales to debtors ratio 6.0
Reserves to capital ratio 1.0 Stock velocity (in months) 2
Net worth to long term loan 20 Paid up share capital `10 lakhs
Net WC to net worth ratio 0.3
Answer
Balance Sheet of ABC Ltd
Share Capital 10,00,000 Fixed assets 15,00,000
Reserves 10,00,000 Stock 4,00,000
Long term Loans 1,00,000 Debtors 5,00,000
Current Liabilities 4,00,000 Other Current Assets 1,00,000
25,00,000 25,00,000
BQ 8
From the following information and ratios, PREPARE the Balance sheet as at 31st March, 2023 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
6.7
Net profit Ratio 10%

Gross profit Ratio 40%
Operating expenses (excluding interest) `9 lakh
Long term loan interest 12%
Tax Nil
Answer
Income Statement of M/S Ganguly & Co.
Particulars `
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 of M/S Ganguly & Co.

Equity Share Capital 22,50,000 Fixed assets 62,50,000
Long term debt 50,00,000 Stock 10,00,000
Current Liabilities 5,00,000 Debtors 4,16,667
Other Current Assets 83,333
77,50,000 77,50,000
Working Notes:
1. Current Ratio = 3:1

CA = 3CL
WC = `10,00,000
CA – CL = `10,00,000
3CL – CL = `10,00,000
2CL = `10,00,000
CL = `5,00,000
CA = `15,00,000
2. Acid Test Ratio = CA – Stock / CL = 1:1

15,00,000 – Stock = 5,00,000
Stock = `10,00,000
3. Stock Turnover ratio (on sales)= 5

Sales = 5 × Avg stock
Sales = `50,00,000
4. Gross Profit = `50,00,000 × 40% = `20,00,000

Net profit (PBT) = `50,00,000 × 10% = `5,00,000
5. PBIT/PBT = 2.2
PBIT = 2.2 × `5,00,000
PBIT = `11,00,000
6.8
Interest = `11,00,000 – `5,00,000 = `6,00,000

Long term loan = `6,00,000 ÷ 0.12 = `50,00,000
6. Average collection period = 30 days

Receivables = (30/360) × `50,00,000 = `4,16,667
7. Fixed Assets Turnover Ratio = 0.8

`50,00,000/ Fixed Assets = 0.8
Fixed Assets = `62,50,000
BQ 9
From the following information, you are required to PREPARE a summarized Balance Sheet for Rudra
Ltd. for the year ended 31st March, 2023:
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%
Answer
Balance Sheet of M/S Ganguly & Co.
Capital 10,00,000 Fixed assets 30,00,000
Reserves 20,00,000 Current Assets:
Long Term Loan @ 10% 30,00,000 Stock 20,00,000
Current Liabilities: Debtors 20,00,000
Creditors 10,00,000 Cash 5,00,000
Outstanding Interest 3,00,000
Other CL 2,00,000
75,00,000 75,00,000
Working Notes: Let sales be x
1. Fixed Asset Turnover = 4 = x/Fixed Assets

Fixed Assets = x/4
2. Stock Turnover = 6 = x/Stock

Stock = x/6
3. Sales to net worth = 4 = x/Net worth

Net worth = x/4
4. Debt: Equity = 1:1
6.9
Long Term Loan/Net worth = 1/1

Long term loan = Net worth = x/4
5. Gross Profit to Cost = 20%

G P/ (Sales – G P) = 20%
GP
GP = 0.2 x – 0.2 GP
1.2 GP = 0.2 x
GP = 0.2 x/1.2
GP = x/6
Cost of Goods Sold = x – x/6 = 5/6 x
6. COGS to creditors = 10 : 1
COGS/Creditors = 10/1
5/6 x = 10 Ceditors
Creditors = x/12
7. Stock/Debtor = 1
Debtor = Stock = x/6
8. Current Ratio = 3:1

(Stock + Debtors + Cash)/CL = 3
x/6 + x/6 + 5,00,000 = 3 CL
x/3 + 5,00,000 = 3 CL
x/9 + 5,00,000/3 = CL
9. CA = 3CL = 3 (x/9 + `5,00,000/3)

CA = x/3 + 5,00,000
10. Net worth + Long Term Loan + CL = Fixed Asset + CA

x/4 + x/4 + x/9 + `5,00,000/3 = x/4 + x/3 + `5,00,000
x/4 + x/9 – x/3 = `5,00,000 – `5,00,000/3
(9x + 4x – 12x)/36 = `3,33,333.33
x = `3,33,333.33 × 36 = `1,20,00,000
11. Now, from above calculations, we get,
Fixed Asset = x/4 = `30,00,000
Stock = x/6 = `20,00,000
Debtor = x/6 = `20,00,000
Net Worth = x/4 = `30,00,000
Now, Capital to Reserve is 1 : 2
Capital = `10,00,000
Reserve = `20,00,000
Long Term Loan = x/4 = `30,00,000
6.10
Outstanding Interest = `30,00,000 × 10% = `3,00,000
Creditors = x/12 = `10,00,000
Current Liabilities = Creditors + Outstanding Interest + Other CL

x/9 + 5,00,000/3 = `10,00,000 + `3,00,000 + Other CL
`1,20,00,000/9 + 5,00,000/3 = `13,00,000 + Other CL
Other CL = `2,00,000
BQ 10
Following is the abridged Balance Sheet of Alpha Ltd:
Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Profit and Loss Account 17,000 Plant and Machineries 50,000
Current Liabilities 40,000 Less: Depreciation 15,000 35,000
1,15,000
Stock 21,000
Receivables 20,000
Bank 1,000 42,000
1,57,000 1,57,000
With the help of the additional information furnished below, you are required to prepare trading and
profit & loss account and a balance sheet as at 31st march, 2023:
(1) The company went in for reorganisation of capital structure, with share capital remaining the same
as follows:
Particulars %
Share capital 50%
Other shareholders funds 15%
5% Debentures 10%
Payables 25%
100%
Debentures were issued on 1st April, interest being paid annually on 31st March.
(2) Land and Buildings remained unchanged. Additional plant and machinery has been bought and a
further
`5,000 depreciation written off.
(The total fixed assets then constituted 60% of total fixed and current assets.)
(3) Working capital ratio was 8 : 5.
(4) Quick assets ratio was 1 : 1.
(5) The receivables (four-fifth of the quick assets) to sales ratio revealed a credit period of 2 months.
There were no cash sales.
(6) Return on net worth was 10%.
(7) Gross profit was at the rate of 15% of selling price.
(8) Stock turnover was eight times for the year.
(9) Ignore Taxation.
6.11
Answer
Projected Profit and Loss account for the year ended 31-03-2023
To Cost of Goods Sold 2,04,000 By Sales 2,40,000
To Gross profit (15% of `2,40,000) 36,000
2,40,000 2,40,000
To Administration and other 22,000 By Gross Profit 36,000
expenses (b.f.)
To Interest on Debenture 1,000
(5% on `20,000)
To Net Profit 13,000
36,000 36,000
Projected Balance Sheet as at 31st March, 2023

Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Other shareholders funds 30,000 Plant and Machineries 60,000
5% Debentures 20,000 Less: Depreciation 20,000 40,000
Payables 50,000 1,20,000
Stock 30,000
Receivables 40,000
Bank (b.f.) 10,000 80,000
2,00,000 2,00,000
Working Notes:
(1) Total Liabilities:

Share capital = 50% of total liabilities = `1,00,000
Total Liabilities = `1,00,000 ÷ 50% = `2,00,000
(2) Classification of total liabilities:

Particulars % (`)
Share capital 50% 1,00,000
Other shareholders funds 15% 30,000
5% Debentures 10% 20,000
Payables 25% 50,000
100% 2,00,000
(3) Fixed Assets:

Total liabilities = Total Assets = `2,00,000
Fixed Assets = 60% of total fixed assets and current assets
= `2,00,000 × 60% = `1,20,000
(4) Calculation of Historical cost of Plant & Machinery:

Particulars `
Total fixed assets 1,20,000
Less: Land and Buildings 80,000
Plant and Machinery (after providing depreciation) 40,000
6.12
Depreciation on Machinery up to 31.03.2018 15,000

Add: Further depreciation 5,000
20,000
Historical Cost of Plant and Machinery (40,000 + 20,000) 60,000
(5) Current Assets:

Current assets = Total assets – Fixed assets
= `2,00,000 – `1,20,000 = `80,000
(6) Calculation of Stock:

Current assets−Stock
Quick ratio = = 1
Current liabilities
80,000−Stock
= 50,000
= 1
Stock = `80,000 – `50,000 = `30,000
(7) Receivables:
Receivables = 4/5th of quick assets
= (`80,000 – `30,000) × 4/5 = `40,000
(8) Receivables turnover ratio:

Receivables
= Credit Sales
× 12 Months = 12 months
40,000
= × 12 Months = 2 months
Credit Sales
Credit sales = 40,000 × 12/2 = `2,40,000
(9) Return on net worth (net profit):

Net worth = `1,00,000 + `30,000 = `1,30,000
Net profit = `1,30,000 × 10% = `13,000
BQ 11
The following accounting information and financial ratios of PQR Ltd. relate to the year ended 31st
December, 2022:
Accounting Information:
Gross profit 15% of sales
Net profit 8% of sales
Raw material consumed 20% of works cost
Direct wages 10% of works cost
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of works cost
Debt collection period (All sales are on credit) 60 days
Financial Ratios:
Fixed assets to Sales 1:3
Fixed assets to Current assets 13 : 11
Current ratio 2:1
Long term loan to Current liabilities 2:1
Capital to Reserve and Surplus 1:4
If value of fixed assets as on 31st December, 2022 amounted to `26 lakhs, prepare a summarised profit
and loss account of the company for the year ended 31st december, 2022 and also the balance sheet as
6.13
on 31st december, 2022.
Answer
Profit and Loss account for the year ended 31.12.2022
To Direct Materials 13,26,000 By Sales 78,00,000
To Direct Wages 6,63,000
To Works Overheads (b.f.) 46,41,000
To Gross profit (15% of `78,00,000) 11,70,000
78,00,000 78,00,000
To Administration and Selling 5,46,000 By Gross Profit 11,70,000
expenses (b.f.)
To Net Profit (8% of `78,00,000) 6,24,000
11,70,000 11,70,000
Balance Sheet as at 31st December, 2022

Share Capital 3,00,000 Fixed Assets 26,00,000
Reserves and Surplus 12,00,000 Current Assets:
Long term loans 22,00,000 Raw Material Stock 3,31,500
Current Liabilities 11,00,000 Finished Goods Stock 3,97,800
Receivables 12,82,192
Cash 1,88,508
48,00,000 48,00,000
Working Notes:
(a) Calculation of Sales:

Fixed Assets
Sales
= 1/3 or Sales = 3 × `26,00,000
Sales = `78,00,000
(b) Calculation of Current Assets:

Fixed Assets
Current Assets
= 13/11 or CA = `26,00,000 × 11/13
(c) Calculation of Raw Material Consumption and Direct Wages:

Works Cost = Sales – Gross Profit
= 78,00,000 – 15% of Sales = `66,30,000
Raw Material Consumption = 20% of `66,30,000 = `13,26,000

Direct Wages = 10% of `66,30,000 = `6,63,000
(d) Calculation of Finished Goods Stock:

Finished Goods Stock = 6% of `66,30,000 = `3,97,800
(e) Calculation of Raw Material Stock:

Raw Material Stock = Raw Material Consumption × 3/12
= `13,26,000 × 3/12 = `3,31,500
6.14
(f) Calculation of Current Liabilities:

Current Assets
Current Ratio = Current Liabilities
= 2
Current Liabilities = `22,00,000 ÷ 2 = `11,00,000
(g) Calculation of Receivables:

ACP 60
Receivables = Credit Sales × 365 = `78,00,000 × 365
= `12,82,192
(h) Calculation of Long Term Loan:

Long Term Loan
Current Liabilities
= 2
Long Term Loan = 2 × `11,00,000 = `22,00,000
(i) Calculation of Cash Balance:

Current Assets = Cash + Stock + Receivables
Cash Balance = `22,00,000 – (`3,97,800 + `3,31,500 + `12,82,192)

= `1,88,508
(j) Calculation of Net Worth:

Total Liabilities = Total Assets (Fixed Assets + Current Assets)
= `22,00,000 + `26,00,000 = `48,00,000
Net Worth = Total Liabilities – Long Term Loan – Current Liabilities

= `48,00,000 - `22,00,000 - `11,00,000= `15,00,000
(k) Calculation of Capital, Reserve and Surplus:

Net Worth = Share Capital + Reserve and surplus
Capital to Reserve & Surplus = 1:4

Share Capital = `15,00,000 × 1/5 = `3,00,000
Reserve and Surplus = `15,00,000 × 4/5 = `12,00,000
BQ 12
The following figures and ratios are related to a company:
(a) Sales for the year (all credit) `90,00,000
(b) Gross profit ratio 35 percent
(c) Fixed assets turnover (basis on cost of goods sold) 1.5
(d) Stock turnover (basis on cost of goods sold) 6
(e) Liquid ratio 1.5 : 1
(f) Current ratio 2.5 : 1
(g) Debtors collection period 1 month
(h) Reserve and surplus to Share capital 1 : 1.5
(i) Capital gearing ratio 0.7875
(j) Fixed assets to net worth 1.3 : 1
You are required to prepare:
6.15
1. Balance Sheet of the company on the basis of above details.

2. The statement showing working capital requirement, if the company wants to make a provision for
contingencies @ 15% of net working capital.
Answer
(1) Balance Sheet
Reserve & Surplus 12,00,000 Stock 9,75,000
Debt 23,62,500 Debtors 7,50,000
Current Liabilities 9,75,000 Cash 7,12,500
63,37,500 63,37,500
(2) Statement of Working Capital Requirement

Particulars `
Current Assets: Stock 9,75,000
Debtors 7,50,000
Cash 7,12,500
24,37,500
Less: Current Liabilities (9,75,000)
Working Capital Before Provision 14,62,500
Add: Provision for Contingencies @ 15% of WC 2,19,375
Working Capital Including Provision 16,81,875
Working Notes:
a. Cost of Goods Sold = 90,00,000 - 35% = 58,50,000
COGS
b. Fixed Assets Turnover Ratio = = 1.5 times
Fixed Assets
58 ,50 ,000
Fixed Assets = = `39,00,000
1 .5
Fixed Assets
c. Fixed Assets to Net Worth = = 1.3 times
Net Worth
39 ,00 ,000
Net Worth = = `30,00,000
1 .3
Debt + Pr eference Debt + Nil

d. Capital Gearing = =
Equity 30 ,00 ,000
Debt = 0.7875 × `30,00,000 = `23,62,500
Assumption: Preference Share capital is zero.
e. Reserves & Surplus = 30,00,000 × 1/2.5 = `12,00,000
f. Share Capital = 30,00,000 × 1.5/2.5 = `18,00,000
COGS
g. Stock Turnover = = 6 times
Clo sin g Stock
6.16
58 ,50 ,000
Closing Stock = = `9,75,000
6
Sales × Collection Period

1
h. Debtors = = 90,00,000×
12 12
= `7,50,000
i. Stock = CL (Current ratio – Liquid ratio)

Current Liabilities = Stock ÷ (CR - LR)
= 9,75,000 ÷ (2.5 – 1.5) = `9,75,000
j. Current Ratio = CA ÷ CL = 2.5 times

Current Assets = 2.5 × 9,75,000 = `24,37,500
k. Cash in Hand = 24,37,500 – 9,75,000 - 7,50,000

= `7,12,500
BQ 13
Following information has been provided from the books of Laxmi Pvt. Ltd. for the year ending on 31 st
March, 2023:
Working capital `4,80,000
Bank overdraft `80,000
Fixed assets to proprietary ratio 0.75
Reserves and Surplus `3,20,000
Current ratio 2.5
Liquid ratio 1.5
You are required to prepare a summarised Balance Sheet as at 31st March, 2023 assuming
that there is no long term debt.
Answer
Balance Sheet
As at 31.03.2023
Reserves and Surplus 3,20,000 Stock 3,20,000
Bank Overdraft 80,000 Other Current Assets 4,80,000
Sundry creditors 2,40,000
22,40,000 22,40,000
Working Notes:
1. Current assets and Current liabilities computation:
CA
= 2.5
CL
CA = 2.5 CL
Working capital = CA – CL
4,80,000 = 2.5 CL – CL
CL = 3,20,000
CA = 3,20,000 × 2.5 = 8,00,000
6.17
2. Computation of stock:
Liquid Assets
Liquid ratio =
Current Liabilitie s
Current Assets - Stock
1.5 =
3,20,000
1.5 × 3,20,000 = 8,00,000 – Stock
Stock = 3,20,000
3. Computation of Proprietary fund, Fixed assets, Capital and Sundry Creditor
Fixed Assets
= 0.75
Proprietar y Fund
Fixed assets = 0.75 Proprietary fund
Net working capital = 0.25 Proprietary fund
4,80,000 = 0.25 Proprietary fund
4,80,000
Proprietary fund = = 19,20,000
0.25
Fixed assets = 0.75 Proprietary fund

= 0.75 × 19,20,000 = 14,40,000
Share Capital = Proprietary fund – R & S

= 19,20,000 – 3,20,000 = 16,00,000
Sundry creditors = CL - Bank overdraft

= 3,20,000 - 80,000 = 2,40,000
DU PONT ROI & ROE
BQ 14
Sales `20,00,000
Capital Employed `10,00,000
Operating Profit `3,00,000
Calculate Return on Capital Employed by applying Du Pont model.
Answer
Return on Capital Employed = Operating Profit Ratio × Capital Employed Turnover Ratio
= 15% × 2 times = 30%
Working Notes:
Operating Pr ofit 3 ,00 ,000
Operating Profit Ratio = × 100 = × 100
Sales 20 ,00 ,000
= 15%
Sales 20 ,00 ,000

Capital Employed Turnover Ratio = =
= 2 times
6.18
BQ 15
Net Profit Ratio 20%
Asset Turnover 1.2 times
Equity Multiplier 1.5 times
Calculate Return on Equity by applying Du Pont model.
Answer
Return on Equity (ROE) = Net Profit Ratio × Asset Turnover × Equity Multiplier
= 20% × 1.2 times × 1.5 times = 36%
MISCELLANEOUS
BQ 16
Manan Pvt. Ltd. gives you the following information relating to the year ending 31st March, 2023:
Current Ratio : 2.5 : 1

Debt-Equity Ratio : 1 : 1.5
Return on Total Assets (After Tax) : 15%
Total Assets Turnover Ratio : 2
Gross Profit Ratio : 20%
Stock Turnover Ratio : 7
Net Working Capital : `13,50,000
Fixed Assets : `30,00,000
1,80,000 Equity Shares of : `10 each
60,000, 9% Preference Shares of : `10 each
Opening Stock : `11,40,000

(a) Quick Ratio
(b) Fixed Assets Turnover Ratio
(c) Proprietary Ratio
(d) Earnings per Share
Answer
(a) Calculation of Quick Ratio
Quick Assets 9,90,000
Quick Ratio = Current Liabities
= 9,00,000
= 1.1 : 1
(b) Calculation of Fixed Assets Turnover Ratio

Sales 1,05,00,000
Fixed Assets Turnover Ratio = Fixed Assets
= 30,00,000
= 3.5
(c) Calculation of Proprietary Ratio

Proprietary Fund 28,50,000
Proprietary Ratio = Total Assets
= 52,50,000
= 0.54
(d) Calculation of Earnings per Equity Share (EPS)

PAT − Preference Share Dividend
Earnings per Equity Share (EPS) = Number of Equity Shares
6.19
7,87,500 −9% of 6,00,000

=
1,80,000
= `4.075
Workings Notes:
Current Assets
(i) Current Ratio = Current Liabilities
= 2.5
Current Assets = 2.5 Current Liabilities
Working Capital = Current Assets – Current Liabilities

13,50,000 = 2.5 Current Liabilities – Current Liabilities
Current Liabilities = 13,50,000 ÷ 1.5 = 9,00,000
Current Assets = 2.5 Current Liabilities

= 2.5 × 9,00,000 = 22,50,000
(ii) Sales = Total Assets Turnover × Total Assets

= 2 × (Fixed Assets + Current Assets)
2 × (30,00,000 + 22,50,000) = 1,05,00,000
(iii) Cost of Goods Sold = 80% of Sales

= 80% of 1,05,00,000 = 84,00,000

(iv) Average Stock = Stock Turnover Ratio
= 7
= 12,00,000
Closing Stock = (Average Stock × 2) – Opening Stock

= (12,00,000 × 2) – 11,40,000 = 12,60,000
Quick Assets = Current Assets – Closing Stock

= 22,50,000 – 12,60,000 = 9,90,000
Debt
Debt – Equity Ratio = Equity
= 1 : 1.5
1.5 Debt = Equity
Total Assets = Equity + Preference Share Capital + Debt + CL

52,50,000 = 1.5 Debt + 6,00,000 + Debt + 9,00,000= 2.5 Debt
Debt = 37,50,000 ÷ 2.5 = 15,00,000
Equity = 15,00,000 × 1.5 = 22,50,000

Proprietary Fund = Equity + Preference Share Capital
= 22,50,000 + 6,00,000 = 28,50,000
(v) Profit After Tax (PAT) = Total Assets × Return on Total Assets
= 52,50,000 × 15% = 7,87,500
BQ 17
The total sales (all credit) of a firm are `6,40,000. It has a gross profit margin of 15 per cent and a current
ratio of 2.5. The firm’s current liabilities are `96,000; inventories `48,000 and cash `16,000.
(a) Determine the average inventory to be carried by the firm, if an inventory turnover of 5 times is
expected? (assume a 360 day year).
(b) Determine the average collection period if the opening balance of debtors is intended to be of
`80,000? (assume a 360 day year).
6.20
Answer
Cost of goods sold 6,40,000 × 85%
(a) Inventory turnover = = = 5
Average inventory Average inventory
Average inventory = `5,44,000 ÷ 5 = `1,08,800
(b) Average collection period:

Current Ratio = Current Assets ÷ Current Liabilities = 2.5
2.5 = (Closing Debtors + Closing Inventories + Cash) ÷ CL
2.5 = Closing Debtors + `48,000 + `16,000) ÷ `96,000
Closing Debtors = `1,76,000
Average debtors = (80,000 + 1,76,000) ÷ 2 = `1,28,000
Average Receivables 1,28,000

Average coll. period = Annual Credit Sales
× 360 = 6,40,000
× 360 = 72 Days
BQ 18
The capital structure of Beta Limited is as follows:
Equity Share Capital of `10 each 8,00,000
9% Preference Share Capital of `10 each 3,00,000
11,00,000
Additional information: Profit (after tax at 35 per cent), `2,70,000; Depreciation, `60,000; Equity
dividend paid, 20 per cent; Market price of equity shares, `40.
You are required to compute the following, showing the necessary workings:
(a) Dividend yield on the equity shares.
(b) Cover for the preference and equity dividends.
(c) Earnings per shares.
(d) Price-earnings ratio.
Answer
(a) Dividend yield on the equity shares:
DPS 20% of 10
Dividend Yield = MPS
× 100 = 40
× 100 = 5%
(b) Dividend Coverage Ratio:

PAT 2,70,000
Preference = Preference Dividend
= 9% of 3,00,000
= 10 times
PAT−PD 2,70,000−27,000
Equity = Equity Dividend
= 20% of 8,00,000
= 1.52 times
(c) Earning Per Share:

PAT−PD 2,70,000−27,000
EPS = Number of Equity Shares
= 80,000
= `3.0375
(d) Price Earning Ratio:

MPS 40
PE Ratio = EPS
= 3.0375
= 13.17 times
6.21
BQ 19
X Co. has made plans for the next year. It is estimated that the company will employ total assets of
`8,00,000; 50 per cent of the assets being financed by borrowed capital at an interest cost of 8 per cent
per year. The direct costs for the year are estimated at `4,80,000 and all other operating expenses are
estimated at `80,000. The goods will be sold to customers at 150 per cent of the direct costs. Tax rate is
assumed to be 50 per cent.
You are required to calculate: (a) Operating profit margin (before tax), (b) Net profit margin
(after tax); (c) Return on assets (on operating profit after tax); (d) Asset turnover and (e) Return
on owners’ equity.
Answer
EBIT 1 ,60 ,000
(a) Operating Profit Margin= × 100 = × 100= 22.22%
Sales 7 ,20 ,000
EAT 64 ,000
(b) Net Profit Margin = × 100 = × 100= 8.89%
Sales 7 ,20 ,000
EBIT (1−t) 1,60,000 (1−.50)

(c) Return on Assets = Assets
= 8,00,000
= 10%
Sales 7 ,20 ,000

(d) Assets turnover = = = 0.9 times
EAT 64 ,000
(e) Return on Equity = × 100 = × 100= 16%
Equity Fund 4 ,00 ,000
The Net Profit is calculated as follows:

Particulars `
Sales Revenue (150% of `4,80,000) 7,20,000
Less: Direct Cost 4,80,000
Less: Other operating expenses 80,000
Operating Profit/EBIT 1,60,000
Less: Interest on 8% Debt (8,00,000 × 50% × 8%) 32,000
EBT 1,28,000
Less: Taxes @ 50% 64,000
EAT 64,000
BQ 20
Equity Share Capital 10,00,000 Goodwill 5,00,000
General Reserve 1,00,000 Plant and Machinery 6,00,000
Profit and Loss 4,00,000 Land and Building 7,00,000
16% Preference Share Capital 5,00,000 Furniture and Fixtures 1,00,000
12% Debenture 5,00,000 Stock in trade 6,00,000
Provision for Tax 1,76,000 Bills Receivable 30,000
Bills Payable 1,24,000 Debtors 1,50,000
Bank Overdraft 20,000 Bank 2,00,000
6.22
Creditors 80,000 Marketable Securities 20,000

29,00,000 29,00,000
Calculate (i) Current Ratio, (ii) Quick Ratio, (iii) Absolute Liquidity Ratio, (iv) Ratio of Inventory to
Working Capital, (v) Ratio of Current Assets to Fixed Assets, (vi) Debt to Equity Ratio, (vii)
Proprietary Ratio, (viii) Capital Gearing Ratio.
Answer
Current Assets 10 ,00 ,000
(i) Current Ratio = = = 2.5
Current Liabilitie s 4 ,00 ,000
Liquid Assets 4 ,00 ,000

(ii) Quick Ratio = = = 1
Cash and Cash Equivalent 2,20 ,000

(iii) Absolute Liquidity ratio = = = 0.55
Inventory 6 ,00 ,000

(iv) Inventory to WC = = = 1
Working Capital 6 ,00 ,000
Current Assets 10 ,00 ,000

(v) CA to Fixed Assets = = = .526
Fixed Assets 19 ,00 ,000
Long Term Debt 5 ,00 ,000

(vi) Debt to Equity Ratio = = = 0.33
Equity 15 ,00 ,000
Shareholde r' s Fund 20 ,00 ,000

(vii) Proprietary Ratio = = = 0.69
Debentures  Pr eference Share Capital

(viii) Capital Gearing Ratio =
Equity Shareholde r' s Fund
10 ,00 ,000
= = 0.67
15 ,00 ,000
BQ 21
In a meeting held at Solan towards the end of 2022, the Directors of M/s HPCL Ltd. have taken a decision
to diversify. At present HPCL Ltd. sells all finished goods from its own warehouse.
The company issued debentures on 01.01.2023 and purchased fixed assets on the same day. The
purchase prices have remained stable during the concerned period. Following information is provided
to you:
Income Statement
Particulars 2022 2023
Cash Sales 30,000 32,000
Credit Sales 2,70,000 3,00,000 3,42,000 3,74,000
Less: Cost of Goods Sold 2,36,000 2,98,000
Gross profit 64,000 76,000
Less: Operating Expenses:
6.23
Warehousing 13,000 14,000

Transport 6,000 10,000
Administrative 19,000 19,000
Selling 11,000 49,000 14,000 57,000
Net Profit 15,000 19,000
Balance Sheet
Fixed Assets (Net Block) - 30,000 - 40,000
Receivables 50,000 82,000
Cash at Bank 10,000 7,000
Stock 60,000 94,000
Total Current Assets (CA) 1,20,000 1,83,000
Payables 50,000 76,000
Total Current Liabilities (CL) 50,000 76,000
Working Capital (CA -CL) 70,000 1,07,000
Total Assets 1,00,000 1,47,000
Represented by:
Share Capital 75,000 75,000
Reserve and Surplus 25,000 42,000
Debentures - 30,000
1,00,000 1,47,000
You are required to calculate the following ratios for the years 2022 and 2023.
(1) Gross Profit Ratio
(2) Operating Expenses to Sales Ratio
(3) Operating Profit Ratio
(4) Capital Turnover ratio
(5) Stock Turnover ratio
(6) Net Profit to Net worth Ratio, and
(7) Receivables Collection Period.
Ratio relating to capital employed should be based on the capital at the end of the year. Give the reasons
for change in the ratios for 2 years. Assume opening stock of `40,000 for the year 2022. Ignore Taxation.
Answer
Computation of Ratios
(1) Gross Profit ratio
64 ,000 76 ,000
× 100 = 21.3% × 100 = 20.3%
Gross Profit ÷ Sales 3 ,00 ,000 3,74 ,000
(2) Operating Expenses to Sales

49 ,000 57 ,000
× 100 = 16.3% × 100 = 15.2%
Operating Expenses ÷ Sales 3,00 ,000 3 ,74 ,000
(3) Operating Profit Ratio

15 ,000 19 ,000
× 100 = 5% × 100 = 5.08%
Operating Profit ÷ Sales 3,00 ,000 3 ,74 ,000
6.24
(4) Capital Turnover Ratio

3,00 ,000 3,74 ,000
=3 = 2.54
Sales ÷ Capital employed 1 ,00 ,000 1 ,47 ,000
(5) Stock Turnover Ratio

2,36 ,000 2,98 ,000
= 4.72 = 3.87
COGS ÷ Average Stock 50 ,000 77 ,000
(6) Net profit to Net Worth

15 ,000 19 ,000
× 100 = 15% × 100 = 16.24%
Net Profit ÷ Net Worth 1 ,00 ,000 1 ,17 ,000
(7) Receivable Collection Period 50 ,000

× 365 82 ,000
× 365
2,70 ,000 3 ,42 ,000
Average Receivables ÷ Average Daily = 67.6 days = 87.5 days
Credit Sales
Analysis: The decline in the Gross profit ratio could be either due to a reduction in the selling price or
increase in the direct expenses (since the purchase price has remained the same). In this case, cost of
goods sold have increased more than proportion of increment in sales & hence impacting gross profit
ratio.
Similarly, there is a decline in the ratio of operating expenses to sales. Further analysis reveals that in
comparison to increase in sales, there has a lesser proportionate increase in operating expenses. As a
result, even the operating profit ratio has remained the same approximately in spite of a decline in the
Gross profit ratio.
The company has not been able to deploy its capital efficiently. This is indicated by a decline in the
Capital turnover ratio from 3 to 2.54 times.
The decline in stock turnover ratio implies that the company has increased its investment in stock. Net
Profit to Net worth ratio has increased indicating that the company’s Net worth or Shareholders’ capital
is efficient in generating profits.
The increase in the Receivables collection period indicates that the company has become liberal in
extending credit on sales. There is a corresponding increase in the receivables also due to such credit
policy.
BQ 22
ABC Company sells plumbing fixtures on terms of 2/10, net 30. Its financial statements over the last 3
years are as follows:
Particulars 2020-21 2021-22 2022-23
Cash 30,000 20,000 5,000
Accounts receivable 2,00,000 2,60,000 2,90,000
Inventory 4,00,000 4,80,000 6,00,000
6,30,000 7,60,000 8,95,000
Net fixed assets 8,00,000 8,00,000 8,00,000
14,30,000 15,60,000 16,95,000
Account payable 2,30,000 3,00,000 3,80,000
Accruals 2,00,000 2,10,000 2,25,000
Bank loan, short term 1,00,000 1,00,000 1,40,000
6.25
5,30,000 6,10,000 7,45,000

Long term debt 3,00,000 3,00,000 3,00,000
Common stock 1,00,000 1,00,000 1,00,000
Retained earnings 5,00,000 5,50,000 5,50,000
14,30,000 15,60,000 16,95,000
Sales 40,00,000 43,00,000 38,00,000
Cost of goods sold 32,00,000 36,00,000 33,00,000
Net profit 3,00,000 2,00,000 1,00,000
Considering opening balance of Accounts Receivable and Inventory as 2,00,000 and

4,00,000 respectively as on 01.04.2020, Analyse the company’s financial condition and
performance over the last 3 years. Are there any problems?
Answer
Ratios 2020-21 2021-22 2022-23
Current Ratio 1.19 1.25 1.20
(Current Assets ÷ Current 6,30,000 7,60,000 8,95,000
( ) ( ) ( )
Liabilities) 5,30,000 6,10,000 7,45,000
Acid Test Ratio 0.43 0.46 0.40
(Quick Assets ÷ Current 2,30,000 2,80,000 2,95,000
( ) ( ) ( )
Liabilities) 5,30,000 6,10,000 7,45,000
Receivable Turnover Ratio 20 18.70 13.82
(Annual Credit Sales ÷ Average 40,00,000 43,00,000 38,00,000
( ) ( ) ( )
Receivables) 2,00,000 2,30,000 2,75,000
Average Collection Period 18.25 days 19.52 days 26.41 days
[(Average Receivables × 365) ÷ 2,00,000 2,30,000 2,75,000
( × 365) ( × 365) ( × 365)
Annual Credit Sales] 40,00,000 43,00,000 38,00,000
Inventory Turnover 8 8.18 6.11
(COGS ÷ Average Inventory) 32,00,000 36,00,000 33,00,000
( ) ( ) ( )
4,00,000 4,40,000 5,40,000
Total Debt To Net Worth 1.38 1.40 1.61
(*Total Debt ÷ Equity Fund) 8,30,000 9,10,000 10,45,000
( ) ( ) ( )
*Total Debt including CL 6,00,000 6,50,000 6,50,000
Long Term Debt To Total 0.33 0.32 0.32
Capitalization 3,00,000 3,00,000 3,00,000
( ) ( ) ( )
(Long Term Debt ÷ Long Term 9,00,000 9,50,000 9,50,000
Fund)
Gross Profit Margin 20% 16.28% 13.16%
[(Gross Profit ÷ Sales) × 100] 8,00,000 7,00,000 5,00,000
( × 100) ( × 100) ( × 100)
40,00,000 43,00,000 38,00,000
Net Profit Margin 7.50% 4.65% 2.63%
[(Net Profit ÷ Sales) × 100] 3,00,000 2,00,000 1,00,000
( × 100) ( × 100) ( × 100)
40,00,000 43,00,000 38,00,000
Asset Turnover 2.80 2.76 2.24
(Sales ÷ Total Assets) 40,00,000 43,00,000 38,00,000
( ) ( ) ( )
14,30,000 15,60,000 16,95,000
Return on Assets 20.98% 12.82% 5.90%
[(Net Profit ÷ Total Assets) × 3,00,000 2,00,000 1,00,000
( × 100) ( × 100) ( × 100)
100] 14,30,000 15,60,000 16,95,000
6.26
Analysis: 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, although the average collection period is still very reasonable relative
to the terms given. Inventory turnover is slowing as well, indicating a relative build-up in inventories.
The increase in receivables and inventories, coupled with the fact that net worth has increased very
little, has resulted in the total debt-to-net worth ratio increasing to what would have to be regarded on
an absolute basis as a high level.
Long-term debt to total capitalization has not changed relatively coupled with the fact that retained
earnings of only `50,000 is made in year 2021-22, and there is no issuance of new long-term debt in
year 2021-22 and 2022-23.
Both the gross profit and net profit margins have declined substantially. The relationship between the
two suggests that the company has incurred more relative expenses. The build-up in inventories and
receivables has resulted in a decline in the asset turnover ratio, and this, coupled with the decline in
profitability, has resulted in a sharp decrease in the return on assets ratio.
BQ 23
Following information are available for Navya Ltd. along with various ratio relevant to the particulars
industry it belongs to. Appraise your comments on strength and weakness of Navya Ltd. comparing its
ratios with the given industry norms.
Balance Sheet as at 31.03.2023

Equity Share Capital 48,00,000 Fixed Assets 24,20,000
10% Debentures 9,20,000 Cash 8,80,000
Sundry Creditors 6,60,000 Sundry Debtors 11,00,000
Bills Payable 8,80,000 Stock 33,00,000
Other Current Liabilities 4,40,000
77,00,000 77,00,000
Statement of Profitability for the year ended 31.03.2023

Particulars (`) (`)
Sales 1,10,00,000
Less: Cost of Goods Sold:
Materials 41,80,000
Wages 26,40,000
Factory Overheads 12,98,000 81,18,000
Less: Selling and Distribution Cost 11,00,000
Less: Administrative Cost 12,28,000 23,28,000
Earnings before Interest and Taxes (EBIT) 5,54,000
Less: Interest Charges 92,000
Earning before Tax (EBT) 4,62,000
Less: Taxes @ 50% 2,31,000
Net Profit (PAT) 2,31,000
Industry Norms
Ratio Norm
Current Ratio 2.5
6.27
Receivables Turnover Ratio 8.0

Inventory Turnover Ratio (based on Sales) 9.0
Total Assets Turnover Ratio 2.0
Net Profit Ratio 3.5%
Return on Total Assets (on EBIT) 7.0%
Return on Net worth (Based on Net profit) 10.5%
Total Debt/Total Assets 60.0%
Answer
Computation of Ratios
Ratios Navya Ltd. Industry Norms
1. Current Ratio 52,80,000/19,80,000 = 2.67 2.50
2. Receivables Turnover Ratio 1,10,00,000/11,00,000 = 10.00 8.00
3. Inventory Turnover Ratio 1,10,00,000/33,00,000 = 3.33 9.00

(based on Sales)
4. Total Assets Turnover Ratio 1,10,00,000/77,00,000 = 1.43 2.00
5. Net Profit Ratio 2,31,000/1,10,00,000 = 2.10% 3.50%
6. Return on Total Assets (on EBIT) 5,54,000/77,00,000 = 7.19% 7.00%
7. Return on Net worth

(Based on Net profit) 2,31,000/48,00,000 = 4.81% 10.50%
8. *Total Debt /Total Assets 29,00,000/77,00,000 = 37.66% 60.00%
*Total debt = Liabilities other than shareholder’s fund
Comments:
(1) The position of Navya Ltd. is better than the industry norm with respect to Current Ratio and
Receivables Turnover Ratio.
(2) However, the Inventory turnover ratio and Total Asset Turnover ratio is poor comparing to
industry norm indicating that company is inefficient to utilize its inventory and assets.
(3) The firm also has its net profit ratio and return on net worth ratio much lower than the industry
norm.
(4) Total debt to total assets ratio is lower that the industry standard which suggests that the firm is
less levered by debt and more by equity resulting in less risky company.
BQ 24
The Balance Sheets of A Ltd. and B Ltd. as on 31st March 2023 are as follows:
Particulars A Ltd B Ltd
Liabilities:
Share Capital 40,00,000 40,00,000
Reserve and surplus 32,30,000 25,00,000
Secured Loans 25,25,000 32,50,000
Current Liabilities and provisions:
6.28
Sundry Creditors 15,00,000 14,00,000

Outstanding Expenses 2,00,000 3,00,000
Provision for Tax 3,00,000 3,00,000
Proposed Dividend 6,00,000 -
Unclaimed Dividend 15,000 -
Assets: 1,23,70,000 1,17,50,000
Fixed Assets (Net) 80,00,000 50,00,000
Investments 15,00,000 -
Inventory at Cost 23,00,000 45,00,000
Sundry Debtors - 17,00,000
Cash & Bank 5,70,000 5,50,000
1,23,70,000 1,17,50,000
Additional information available:

(i) 75% of the Inventory in A Ltd. readily saleable at cost plus 20%,
(ii) 50% of Sundry Debtors of B Ltd. are due from C Ltd. which is not in a position to repay the amount
B Ltd. agreed to accept 15% debentures of C Ltd.
(iii) B Ltd. had also proposed 15% dividend but that was not shown in the accounts.
(iv) At the year end, B Ltd. sold investments amounting to `1,20,000 and repaid Sundry Creditors.
On the basis of the given Balance Sheet and the additional information, you are required to
evaluate liquidity of the companies. All working should form part of the answer.
Answer
Particulars A B
Current Assets and Liquid Assets:
Stock (23,00,000 × 75%) + 20% 20,70,000 -
Debtor (17,00,000 × 50%) - 8,50,000
Cash & Bank 5,70,000 5,50,000
Liquid Assets 26,40,000 14,00,000
Add: Stock (23,00,000 × 25%) 5,75,000 45,00,000
Total Current Assets 32,15,000 59,00,000
Current Liabilities:
Proposed Dividend 6,00,000 6,00,000
Creditor 15,00,000 15,20,000
Out Expenses 2,00,000 3,00,000
Provision for tax 3,00,000 3,00,000
Unclaimed Dividend 15,000 -
26,15,000 27,20,000
Evaluation of Liquidity
RATIO A B
CA 32 ,15 ,000 59 ,00 ,000
1. Current Ratio  = 1.23 = 2.17
CL 26 ,15 ,000 27 ,20 ,000
LA 26 ,40 ,000 14 ,00 ,000
2. Liquid Ratio  = 1.009 = .51
CL 26 ,15 ,000 27 ,20 ,000
6.29
PAST YEAR QUESTIONS
PYQ 1
NOOR Limited provides the following information for the year ending 31st March, 2014:
Equity Share Capital `25,00,000

Closing Stock `6,00,000
Stock Turnover Ratio 5 Times
Gross Profit Ratio 25%
Net Profit/Sale 20%
Net profit/Capital 1/
4
You are required to prepare Trading and Profit and Loss Account for the year ending 31st March,
2014.
Answer
Trading and Profit & Loss Account
(For the year ending 31st March, 2014)
To Opening Stock [WN (iv)] 3,37,500 By Sales [WN (ii)] 31,25,000
To Purchase and Conversion Cost 26,06,250 By Closing Stock 6,00,000
To Gross Profit [WN (iii)] 7,81,250
37,25,000 37,25,000
To Operating Expenses 1,56,250 By Gross Profit b/d 7,81,250
To Net Profit [WN (i)] 6,25,000
7,81,250 7,81,250
Working Notes:
(i) Calculation of Net Profit:
Net Pr ofit 1 Capital
= or Net Profit =
Capital 4 4
25,00 ,000
Net Profit = = `6,25,000
4
(ii) Calculation of Sales:

Net Pr ofit Net Pr ofit
= 20% or Sales =
Sales 20 %
6 ,25 ,000
Sales = = `31,25,000
20 %
(iii) Calculation of Gross Profit:

Gross Profit = 25% of Sales
= 25% of `31,25,000 = `7,81,250
(iv) Calculation of Opening Stock:
6.30
COGS
Stock Turnover Ratio = = 5 Times
Average Stock
COGS (Sales  25%)
Average Stock =
5
31 ,25,000  25%
= = `4,68,750
5

Average Stock =
2
Average Stock × 2 = Opening Stock + Closing Stock
4,68,750 × 2 = Opening Stock + 6,00,000
Opening Stock = 9,37,500 – 6,00,000 = `3,37,500
Note: All figures in Trading and Profit and Loss A/c are balancing figures except calculated in
working notes.
PYQ 2
SRS Ltd has furnished the following ratios and information relating to the year ended 31st
March,2015.
Sales `60,00,000
Return on Net Worth 25%
Rate of Income Tax 50%
Share Capital to Reserve 7: 3
Current Ratio 2
Net Profit to Sales (after tax) 6.25%
Inventory Turnover 12
(Based on cost of goods sold and closing stock)
Cost of Goods Sold `18,00,000
Interest on Debenture @ 15% `60,000
Sundry Debtors `2,00,000
Sundry Creditors `2,00,000

(a) Calculate the operating expenses for the year ended 31st March,2015.
(b) Prepare Balance Sheet as on 31st March,2015.
Answer
(a) Operating Expenses = Gross Profit - EBIT
= `42,00,000 – `8,10,000 = `33,90,000
Working:
Calculation of EBIT
Particulars `
Net Profit After Tax (EAT) 6.25% of `60,00,000 3,75,000
Add: Tax @ 50% (3,75,000 × 0.50/1-0.50) 3,75,000
Net Profit Before Tax (EBT) 7,50,000
6.31
Add: Interest 60,000

Earning Before Interest and Tax (EBIT) 8,10,000
(b) Balance Sheet

(As on 31.03.2015)
Share Capital 10,50,000 Fixed Assets (b.f.) 17,00,000
Reserves 4,50,000 Current Assets:
Debentures 4,00,000 Bank & Cash 50,000
Sundry Creditors 2,00,000 Inventory 1,50,000
Debtors 2,00,000
21,00,000 21,00,000
Working Notes:
PAT
(a) Return on Net Worth = × 100 = 25%
Net Worth
3 ,75 ,000
Net Worth = = 15,00,000
25 %
Net Worth = Share Capital + Reserve = 15,00,000
Share Capital to Reserve = 7:3
Share Capital = 15,00,000 × 7/10 = 10,50,000
Reserve = 15,00,000 × 3/10 = 4,50,000
Interest 60 ,000
(b) Debentures = =
Rate of Interest 15 %
= 4,00,000
COGS
(c) Inventory Turnover =
Clo sin g Stock
COGS 18 ,00 ,000
Closing Stock = =
= 1,50,000
CA
(d) Current Ratio = = 2 times
CL
Debtors  Clo sin g Stock  Cash
2 times =
Creditors
2 ,00 ,000  1 ,50 ,000  Cash
2 =
2 ,00 ,000
Cash and Bank = 4,00,000 – 3,50,000 = 50,000
PYQ 3
VRA Limited has provided the following information for the year ending 31st March, 2015:
Debt Equity Ratio 2:1

14% long term debt `50,00,000
6.32

Return on equity 50%
Income Tax Rate 35%
Capital Turnover Ratio 1.2 Times
Opening Stock `4,50,000
Closing Stock 8% of sales
You are required to prepare Trading and Profit and Loss Account for the year ending 31st
March, 2015.
Answer
(For the year ending 31st March, 2015)
To Opening Stock 4,50,000 By Sales 90,00,000
To Purchase & Conversion Cost (b.f.) 65,70,000 By Closing Stock (8% of 90 Lacs) 7,20,000
To Gross Profit c/d (30% of 90 Lacs) 27,00,000
97,20,000 97,20,000
To Operating Expenses (b.f.) 76,923 By Gross Profit b/d 27,00,000
To Interest on debt (14% of 50 Lacs) 7,00,000
To Income tax 6,73,077
To Net Profit 12,50,000
27,00,000 27,00,000
Working Notes:
(i) Calculation of Equity:
Debt
= 2:1
Equity
Equity = Debt ÷ 2
50,00,000 ÷ 2 = `25,00,000
(ii) Calculation of Net Profit After Tax(PAT):

PAT
Return on Equity = × 100 = 50%
Equity
Profit After Tax = 50% of 25,00,000 = `12,50,000
(iii) Calculation of Income Tax:

PAT
Income Tax = 35% of PBT = 35% of
1t
12,50 ,000
= 35% of = `6,73,077
1  .35
(iv) Calculation of Sales:

Sales Sales
Capital Turnover Ratio = =
Capital Equity  Debt
Sales
= 1.2 times
25 ,00 ,000  50 ,00 ,000
Sales = 75,00,000 × 1.2 = `90,00,000
6.33
PYQ 4
With the following ratios and further information given below prepare a Trading Account, Profit
and Loss Account and Balance Sheet of ABC Company.
Fixed Assets `40,00,000

Stock turnover ratio 10 times
Net Profit Ratio 20%
Net profit to capital 1/5
Capital to other liabilities 1/2
Fixed assets to capital 5/4
Fixed assets / Total current assets 5/7
Answer
To Opening Stock 80,000 By Sales 32,00,000
To Purchase & Conversion Cost (b.f.) 27,20,000 By Closing Stock 4,00,000
To Gross Profit c/d (25% of 32 Lacs) 8,00,000
36,00,000 36,00,000
To Operating Expenses (b.f.) 1,60,000 By Gross Profit b/d 8,00,000
8,00,000 8,00,000
Balance Sheet
Capital 32,00,000 Fixed Assets 40,00,000
Other Liabilities 64,00,000 Current Assets:
Stock 4,00,000
Other CA (b.f.) 56,00,000
96,00,000 52,00,000 96,00,000
Working Notes:
(i) Calculation of Capital:
Fixed Assets
= 5/4 or Capital = 40,00,000 × 4/5
Capital
= `32,00,000
(ii) Calculation of Other Liabilities:

Capital
= 1/2 or Other Liabilities = 32,00,000 × 2
Other Liabilitie s
= `64,00,000
(iii) Calculation of Current Assets:

Fixed Assets
= 5/7 or Current Assets = 40,00,000 × 7/5
Current Assets
= `56,00,000
6.34
(iv) Calculation of Net Profit:

Net Pr ofit
= 1/5 or Net Profit = 32,00,000 × 1/5
Capital
= `6,40,000
(v) Calculation of Sales:

Net Pr ofit
= 20% or Sales = 6,40,000 ÷ 20%
Sales
= `32,00,000
(vi) Calculation of Opening Stock:

COGS = 75% of Sales = 75% of 32,00,000 = 24,00,000
COGS
= 10 or Average Stock = 24,00,000 ÷ 10
Average Stock
= 2,40,000
Average stock = (Opening Stock + Closing Stock) ÷ 2 = 2,40,000
Opening Stock = (2,40,000 × 2) – 4,00,000 = `80,000
PYQ 5
The following figures and ratios pertains to ABG Company Limited for the year ending 31 st March,
2016:
Annual sales (credit) `50,00,000
Gross Profit ratio 28%
Fixed assets turnover ratio (based on COGS) 1.5
Stock turnover ratio (based on COGS) 6
Quick ratio 1:1
Current ratio 1.5
Debtors collection period 45 days
Reserve and surplus to Share capital 0.60 : 1
Capital gearing ratio 0.5
Fixed assets to net worth 1.2 : 1
You are required to prepare the Balance Sheet as at 31st March, 2016 based on the above
information. Assume 360 days in a year.
Answer
Balance Sheet
Reserve and Surplus 7,50,000 Current Assets:
Long Term Debts 10,00,000 Stock 6,00,000
Current Liabilities 12,00,000 Debtors 6,25,000
Cash (b.f.) 5,75,000 18,00,000
42,00,000 42,00,000
Working Notes:
6.35
(i) Cost of Goods Sold = Sales – Gross Profit (28% of Sales)

= `50,00,000 – `14,00,000 = `36,00,000
(ii) Closing Stock = Cost of Goods Sold/Stock Turnover

= `36,00,000/6 = `6,00,000
(iii) Fixed Assets = Cost of Goods Sold/Fixed Assets Turnover

= `36,00,000/1.5 = `24,00,000
(iv) Current Assets and Current Liabilities
Stock = (CR - LR) × CL

6,00,000 = (1.5 – 1) CL OR CL = `12,00,000
Current Assets = 12,00,000 × 1.5 = `18,00,000
(v) Debtors = Sales × Debtors Collection Period(days) /360 days

= `50,00,000 × 45/360 = `6,25,000
(vi) Net worth = Fixed Assets / 1.2

= `24,00,000/1.2 = `20,00,000
(vii) Reserves and Surplus and Share Capital

Reserves & Surplus and Share Capital = 0.6 + 1 = 1.6
Reserves and Surplus = `20,00,000 × 0.6/1.6 = `7,50,000
Share Capital = Net worth – Reserves and Surplus

= `20,00,000 – `7,50,000 = `12,50,000
(viii) Long- term Debts

Capital Gearing Ratio = Long-term Debts / Equity Shareholders’ Fund (Net worth)
Long-term Debts = `20,00,000 × 0.5 = `10,00,000
PYQ 6
The following information relate to Temer Ltd.:
Debtors velocity 3 months
Creditors velocity 2 months
Stock turnover ratio 1.5
Gross profit ratio 25%
Bills receivables `25,000
Bills payables `10,000
Gross profit `4,00,000
Fixed assets turnover ratio 4
Closing stock of the period is `10,000 above the opening stock.

Find out:
1. Sales and cost of goods sold
2. Sundry Debtors
3. Sundry Creditors
6.36
4. Closing Stock
5. Fixed Assets
Answer
1. Sales = Gross Profit ÷ Gross Profit Ratio
= `4,00,000 ÷ 25% = `16,00,000
Cost of goods sold = Sales - Gross Profit

= `16,00,000 - `4,00,000 = `12,00,000
2. Sundry debtors = Credit sales × 3/12 – Bills receivables

= `16,00,000 × 3/12 – `25,000 = `3,75,000
3. Sundry creditors = Credit Purchase × 2/12 – Bills payables

= `12,10,000 × 2/12 – `10,000 = `1,91,667
Credit purchase = COGS + Closing Stock – Opening Stock

= `12,00,000 + `10,000 = `12,10,000
4. Closing Stock:
Average Stock = COGS ÷ 1.5 = `12,00,000 ÷ 1.5 = `8,00,000

Average Stock =
2
8,00,000 × 2 = Opening Stock + Closing Stock
16,00,000 = (Closing – 10,000) + Closing Stock
Closing Stock = `8,05,000

[Opening Stock = Closing – 10,000]
5. Fixed Asset Turnover= COGS ÷ Fixed asset

Fixed Asset = 12,00,000 ÷ 4 = `3,00,000
Note: Alternatively Fixed Asset Turnover ratio can be calculated on the basis of sales.
PYQ 7
XY Ltd. provides the following information for the year ending 31st March, 2017:
Equity share capital `8,00,000

Stock turnover ratio 5 times
Net Profit/Sales 16%
Net profit/Capital 25%
You are required to prepare Trading and Profit & Loss account for the year ending 31st March,
2017.
6.37
Answer
To Opening Stock 2,50,000 By Sales 12,50,000
To Purchase & Conversion Cost (b.f.) 9,00,000 By Closing Stock 1,50,000
To Gross Profit (20% of 12,50,000) 2,50,000
14,00,000 14,00,000
To Operating Expenses (b.f.) 50,000 By Gross Profit b/d 2,50,000
2,50,000 2,50,000
Working Notes:
(i) Calculation of Net Profit:

Net Pr ofit
= 25% or Net Profit = 8,00,000 × 25%
Capital
= `2,00,000
(ii) Calculation of Sales:

Net Pr ofit
= 16% or Sales = 2,00,000 ÷ 16%
Sales
= `12,50,000
(iii) Calculation of Opening Stock:

COGS = 80% of Sales = 80% of 12,50,000 = 10,00,000
COGS
= 5 or Average Stock = 10,00,000 ÷ 5
Average Stock
= 2,00,000
Average stock = (Opening Stock + Closing Stock) ÷ 2 = 2,00,000
Opening Stock = (2,00,000 × 2) – 1,50,000 = `2,50,000
PYQ 8
Equity share capital G Ltd. has furnished the following information relating to the year ended 31 st
March, 2017 and 31st March, 2018:
Particulars 31st March, 2017 31st March, 2018
Share Capital 40,00,000 40,00,000
Reserve and Surplus 20,00,000 25,00,000
Long term loan 30,00,000 30,00,000
 Net profit ratio: 8%

 Gross profit ratio: 20%
 Long-term loan has been used to finance 40% of the fixed assets.
 Stock turnover with respect to cost of goods sold is 4.
 Debtors represent 90 days sales.
 The company holds cash equivalent to 1½ months cost of goods sold.
 Ignore taxation and assume 360 days in a year.
6.38
You are required to prepare Balance Sheet as on 31st March, 2018 in following format:
Share Capital - Fixed Assets -
Reserve and Surplus - Sundry Debtors -
Long-Term Loan - Closing Stock -
Sundry Creditors - Cash in hand -
Answer
Balance Sheet
Reserve and Surplus 25,00,000 Sundry Debtors 15,62,500
Long-Term Loan 30,00,000 Closing Stock 12,50,000
Sundry Creditors (b.f.) 14,37,500 Cash in hand 6,25,000
1,09,37,500 1,09,37,500
Working Notes:
(1) Net Profit = Change in Reserve and Surplus
= 25,00,000 – 20,00,000 = `5,00,000
(2) Sales:
Net Profit ratio = 8% of sales
∴ Sales = Net Profit ÷ Net profit ratio
= 5,00,000 ÷ 8% = `62,50,000
(3) Cost of Goods Sold = Sales – Gross Profit (20% of Sales)

= `62,50,000 – 20% of `62,50,000 = `50,00,000
(4) Fixed Assets = Long term loan ÷ 40%

= `30,00,000 ÷ 40% = `75,00,000
(5) Closing Stock = Cost of Goods Sold ÷ Stock Turnover

= `50,00,000 ÷ 4 = `12,50,000
(6) Debtors = Sales × Debtors Collection Period(days)/360 days

= `62,50,000 × 90/360 = `15,62,500
(7) Cash Equivalent = COGS × 1.5/12

= `50,00,000 × 1.5/12 = `6,25,000
PYQ 9
The accountant of Moon Ltd. has reported the following data:
Gross profit : `60,000

Gross profit margin : 20%
Total Assets Turnover : 0.30 : 1
Net Worth to Total Assets : 0.90 : 1
Liquid Assets to current liability : 1:1
6.39
Credit Sales to Total Sales : 0.80 : 1

Average Collection Period : 60 days
Days in a Year : 360 days
You are required to complete the following:
Balance Sheet of Moon Ltd.

Net Worth - Fixed Assets -
Current Liabilities - Debtors -
Stock -
Cash -
Total Liabilities - Total Assets -
Answer
Balance Sheet of Moon Ltd.
Net Worth 9,00,000 Fixed Assets 8,50,000
Current Liabilities (b.f.) 1,00,000 Debtors 40,000
Stock 50,000
Cash 60,000
Total Liabilities 10,00,000 Total Assets 10,00,000
Working Notes:
(1) Sales = Gross Profit ÷ Gross Profit ratio
= 60,000 ÷ 20% = `3,00,000
(2) Total Assets = Sales / Total Assets Turnover

= 3,00,000 ÷ .030 = `10,00,000
(3) Net worth = Total Assets × 0.90

= `10,00,000 × 0.90 = `9,00,000
(4) Current Assets = Current Liabilities × 1.50

= `1,00,000 × 1.50 = `1,50,000
(5) Fixed Assets = Total Assets - Current Assets

= `10,00,000 - `1,50,000 = `8,50,000
(6) Liquid Assets = Current Liabilities × 1

= `1,00,000 × 1 = `1,00,000
(7) Closing Stock = Current Assets – Liquid Assets

= `1,50,000 - `1,00,000 = `50,000
(8) Debtors = Credit Sales × Debtors Collection Period(days)/360 days

= `3,00,000 × .080 × 60/360 = `40,000
(9) Cash = Current Assets – Stock - Debtors

= `1,50,000 - 50,000 - `40,000 = `60,000
6.40
PYQ 10
A limited Company’s books reveals following information:
Net Income : `3,60,000

Shareholder’s Equity : `4,00,000
Assets Turnover : 2.5 times
Net Profit Margin : 12%
You are required to calculate ROE of the company based on the ‘DuPont model’.
Answer
Return on Equity = Net Profit Margin × Asset Turnover × Equity Multiplier
= 12% × 2.5 times × 3 times = 90%
Working Notes:
1. Sales:
Net profit Margin = Net Income ÷ Sales = 12%
Sales = `3,60,000 ÷ 12% = `30,00,000
2. Total Assest:
Asset Turnover = Sales ÷ Total Assets = 2.5 times
Total Assets = Sales ÷ 2.5 = 30,00,000 ÷ 2.5 = `12,00,000
3. Equity Multiplier = Total Assets ÷ Equity

= `12,00,000 ÷ `4,00,000 = 3 times
PYQ 11
The following is the information of XML Ltd. relate to the year ended 31-03-2018:
Gross profit 20% of sales
Net profit 10% of sales
Inventory holding period 3 months
Receivable holding period 3 months
Non-current assets to sales 1:4
Non-current assets to current assets 1:2
Current ratio 2:1
Non-current liabilities to current liabilities 1:1
Share capital to reserve and surplus 4:1
Non-current assets as on 31.03.2017 `50,00,000
Assume that:
(a) No change in Non-current assets during the year 2017-18.
(b) No depreciation charged on Non-current assets during the year 2017-18
(c) Ignoring tax
You are required to calculate cost of goods sold, Net profit, Inventory, receivables and cash for the
year ended on 31.03.2018.
Answer
6.41
(a) Net Profit = 10% of sales = 10% of `2,00,00,000 = `20,00,000
(b) Cost of Goods Sold = Sales – Gross Profit

= `2,00,00,000 – 20% = `1,60,00,000
(c) Inventory = COGS × 3/12 = `1,60,00,000 × 3/12 = `40,00,000
(d) Receivables = Sales × 3/12 = `2,00,00,000 × 3/12 = `50,00,000
(e) Cash = Current assets – Stock – receivables

= `1,00,00,000 - `40,00,000 - `50,00,000 = `10,00,000
Working:
Non current assets 50 ,00 ,000
1. = ½ or = ½
Current assets Current assets
So, Current assets = `50,00,000 × 2 = `1,00,00,000
Non current assets 50 ,00 ,000

2. = ¼ or = 1/4
Sales Sales
So, Sales = `50,00,000 × 4 = `2,00,00,000
PYQ 12
Following figures and ratios are related to a company Q Ltd.:
Sales for the year (all credit) : `30,00,000

Gross Profit Ratio : 25%
Fixed Assets Turnover (based on COGS) : 1.5
Stock turnover (based on COGS) : 6
Liquid Ratio : 1:1
Receivables (Debtors) Collection Period : 2 months
Reserve and Surplus to Share Capital : 0.6 : 1
Capital Gearing Ratio : 0.5
Fixed Assets to Net Worth : 1.20 : 1
You are required to calculate Closing Stock, Fixed Assets, Current Assets, Debtors and Net Worth.
Answer
(1) Closing Stock:
Stock Turnover = COGS ÷ Closing Stock
6 = (`30,00,000 – 25%) ÷ Closing Stock
Closing Stock = `3,75,000
(2) Fixed Assets:

Fixed Assets Turnover = COGS ÷ Fixed Assets
1.5 = (`30,00,000 – 25%) ÷ Fixed Assets
Fixed Assets = `15,00,000
(3) Current Assets:
6.42
Liquid Ratio = [CA – Stock (Non Liquid Assets)] ÷ Current

liabilities
1 = (CA - `3,75,000) ÷ Current liabilities
Current Liabilities = Current Assets - `3,75,000 …..Equation (i)
Current Ratio = Current Assets ÷ Current liabilities

1.5 Current Liabilities = Current Assets
1.5 (Current Assets - `3,75,000) = Current Assets
(4) Debtors:
Debtors = Credit Sales × Average collection Period/12
= `30,00,000 × 2/12 = `5,00,000
(5) Net Worth:

Fixed Assets to Net Worth = Fixed Assets ÷ Net Worth
1.20 = `15,00,000 ÷ Net Worth
Net Worth = `12,50,000
PYQ 13
Following information has been gathered from the books of Tram Ltd. The equity share of which is
trading in the stock market at `14.
Particulars Amount (`)
Equity Share Capital (Face Value `10 each) 10,00,000
10% Preference Shares 2,00,000
Reserves 8,00,000
Profit Before Interest and Tax for the year 4,00,000
Interest 60,000
Profit After Tax for the year 2,40,000
Calculate the following:

(a) Return on Capital Employed
(b) Earnings Per Share
(c) PE Ratio
Answer
EBIT 4,00,000
(a) Return on Capital Employed = Capital Employed
× 100 = 26,00,000
× 100
= 15.38%
PAT−PD 2,40,000−20,000
(b) Earnings Per Share (EPS) = Number of Shares
= 1,00,000
= `2.20
MPS 14
(c) Price Earning Ratio (PE) = EPS
= 2.20
= 6.36 times
Working Note:
Capital Employed = Equity Share Capital + Reserves + Preference Share Capital
+ Debentures
6.43
= `10,00,000 + `8,00,000 + `2,00,000 + `6,00,000

= `26,00,000
PYQ 14
Following information relates to RM Co. Ltd.
Total Assets employed `10,00,000

Direct Cost `5,50,000
Other Operating Cost `90,000
The goods will be sold to customers at 150 per cent of the direct costs. 50 per cent of the assets
being financed by borrowed capital at an interest cost of 8 per cent per year. Tax rate is assumed to be
30 per cent.
You are required to calculate: (a) Net profit margin; (b) Return on Assets; (c) Asset turnover
and (d) Return on owners’ equity.
Answer
EAT 1 ,01 ,500
(a) Net Profit Margin = × 100 = × 100 = 12.30%
Sales 8 ,25 ,000
EBIT (1−t) 1,85,000 (1−.30)

(b) Return on Assets = Assets
= 10,00,000
× 100 = 12.95%
Sales 8 ,25 ,000

(c) Assets turnover = = = 0.825 times
EAT 1 ,01 ,500

(d) Return on Equity = × 100 = × 100 = 20.30%
Equity Fund 5,00 ,000
The Net Profit is calculated as follows:

Particulars `
Sales Revenue (150% of `5,50,000) 8,25,000
Less: Other operating expenses 90,000
EBIT 1,85,000
Less: Interest on 8% Debt (10,00,000 × 50% × 8%) 40,000
EBT 1,45,000
Less: Taxes @ 30% 43,500
EAT 1,01,500
PYQ 15
From the following information, complete the Balance Sheet given below:
(a) Equity share capital `2,00,000
(b) Total debt to owner's equity 0.75
(c) Total assets turnover 2 Times
(d) Inventory turnover 8 Times
6.44
(e) Fixed assets to owner's equity .60

(f) Current debt to total debt .40
Balance Sheet
Equity Share Capital 2,00,000 Fixed Assets ?
Long Term Debt ? Current Assets:
Current Debt ? Inventory ?
Cash ?
[(5 Marks) Jan 2021]
Answer
Balance Sheet
Long Term Debt 90,000 Current Assets:
Current Debt 60,000 Inventory 87,500
Cash 1,42,500
3,50,000 3,50,000
Working Notes:
1. Total debt:
0.75 × Owners equity = 0.75 × `2,00,000 = `1,50,000
2. Current debt:
Current debt to total debt = 0.40
Current debt = 0.40 × `1,50,000 = `60,000
3. Long term debt:

Long term debt = Total debt – Current debt
= `1,50,000 - `60,000 = `90,000
4. Fixed assets:
0.60 × Owners equity = 0.60 × `2,00,000 = `1,20,000
5. Total of liability side:
Total debt + Owners equity = `1,50,000 + `2,00,000 = `3,50,000
6. Total assets consisting of fixed assets and current assets must be equal to `3,50,000 hence,
current assets should be `2,30,000.
7. Total assets turnover is 2 times:

Sales
= 2 times
Total Assets
Sales = `3,50,000 × 2 = `7,00,000
Inventory turnover is 8 times:

Sales
= 8 times
Inventory
6.45
Sales 7 ,00 ,000

Inventory = = = `87,500
8 8
8. Cash: = `2,30,000 – `87,500 = `1,42,500
PYQ 16
Masco Limited has furnished the following ratios and information relating to the year ended 31 st
March, 2021.
Sales `75,00,000
Return on Net Worth 25%
Rate of Income Tax 50%
Share Capital to Reserve 6:4
Current Ratio 2.5
Net Profit to Sales (after tax) 6.50%
Inventory Turnover (Based on cost of goods sold) 12
Cost of Goods Sold `22,50,000
Interest on Debenture `75,000
Receivables (includes Debtors `1,25,000) `2,00,000
Payables `2,50,000
Bank Overdraft `1,50,000

(a) Calculate the operating expenses for the year ended 31st March, 2021.
(b) Prepare Balance Sheet as on 31st March in the following format:
Share Capital Fixed Assets
Reserves and Surplus Current Assets:
15% Debentures Stock
Payables Receivables
Bank Overdraft Cash
[(10 Marks) July 2021]
Answer
(a) Operating Expenses = Gross Profit (Sales - COGS) - EBIT
= `52,50,000 (75,00,000 – 22,50,000) – `10,50,000 =`42,00,000
(b) Balance Sheet

Share Capital 11,70,000 Fixed Assets (b.f.) 18,50,000
Reserves and Surplus 7,80,000 Current Assets:
15% Debentures 5,00,000 Stock 1,87,500
Payables 2,50,000 Receivables 2,00,000
Bank Overdraft 1,50,000 Cash 6,12,500
28,50,000 28,50,000
Working notes:
1. Calculation of EBIT
Particulars `
6.46
Net Profit After Tax (EAT) 6.50% of `75,00,000 4,87,500

Add: Tax (4,87,500 × 0.50/1-0.50) 4,87,500
Net Profit Before Tax (EBT) 9,75,000
Add: Interest 75,000
Earnings Before Interest and Tax (EBIT) 10,50,000
PAT
2. Return on Net Worth = × 100 = 25%
Net Worth
Net Worth = 4,87,500 ÷ 25% = 19,50,000
Net Worth = Share Capital + Reserve = 19,50,000

Share Capital to Reserve = 6:4
Share Capital = 19,50,000 × 6/10 = 11,70,000

Reserve = 19,50,000 × 4/10 = 7,80,000
Interest
3. Debentures =
Rate of Interest
= 75,000 ÷ 15% = 5,00,000
COGS
4. Inventory Turnover =
Clo sin g Stock
COGS 22 ,50 ,000
Closing Stock = =
= 1,87,500
CA
5. Current Ratio =
CL
Re ceivables  Clo sin g Stock  Cash
2.5 times =
Payables  Bank Overdraft
2 ,00 ,000  1 ,87 ,500  Cash
2.5 =
2 ,50 ,000  1 ,50 ,000
Cash = 4,00,000 × 2.5 – 2,00,000 – 1,87,500 = 6,12,500
PYQ 17
Following are the data in respect of ABC Industries for the year ended 31st March, 2021:
Debt to Total assets ratio : 0.40
Long-term debts to equity ratio : 30%
Gross profit margin on sales : 20%
Accounts receivables period : 36 days
Quick ratio : 0.9
Inventory holding period : 55 days
Cost of goods sold : `64,00,000
Balance Sheet
Equity Share Capital 20,00,000 Fixed Assets
Reserves & surplus Inventory
6.47
Long-term debts Accounts receivables

Accounts payable Cash
Total 50,00,000 Total
Complete the Balance Sheet of ABC Industries as on 31st March, 2021. All calculations should
be in nearest rupee. Assume 360 days in a year.
[(10 Marks) Dec 2021]
Answer
Balance Sheet
Reserves & surplus 10,00,000 Inventory 9,77,778
Long-term debts 9,00,000 Accounts receivables 8,00,000
Accounts payable 11,00,000 Cash 1,90,000
Total 50,00,000 Total 50,00,000
Working Notes:
1. Inventory = COGS × Inventory holding period
360
= `64,00,000 × 55/360 = `9,77,778
2. Sales = COGS ÷ COGS ratio

= `64,00,000 ÷ 80% (100 – G.P. ratio) = `80,00,000
3. Debtors = Sales × Account receivable s period

360
= `80,00,000 × 36/360 = `8,00,000
4. Debt:
Debt ( Long  term debt  Accounts payables )
Debt to Total asset = = 40%
Total Asset
Debt = 40% of Total Assets
= `50,00,000 × 40% = `20,00,000
Note: In debt we are considering total debt i.e. Long-term debt and Accounts payables.
5. Equity Fund = Equity Share Capital + Reserve and surplus

= Total Liabilities – Debt (Long term debt + Account payable)
= `50,00,000 – `20,00,000 = `30,00,000
Reserve and surplus = Equity fund – Equity share capital

= `30,00,000 – `20,00,000 = `10,00,000
6. Long-term debt:
Long  term debt
Long-term debt to equity= = 30%
Equity
Long-term debt = 30% of Equity

= 30% of `30,00,000 = `9,00,000
6.48
Accounts payables = Debt – Long-term debt

= `20,00,000 – `9,00,000 = `11,00,000
Current assets  Inventorie s

7. Quick Ratio = = 0.9
Current liabilitie s
Current assets – `9,77,778 = 0.9 × `11,00,000
Current Assets = `9,90,000 + `9,77,778 = `19,67,778
Cash = Current assets – Inventories – Accounts receivables

= `19,67,778 - `9,77,778 - `8,00,000 = `1,90,000
8. Fixed assets = Total assets – Current assets

= `50,00,000 – `19,67,778 = `30,32,222
PYQ 18
Following are the information and ratios are given for W limited for the year ended 31 st March,
2022:
Equity Share Capital of `10 each : `10 Lakhs
Reserves & Surplus to Shareholder’s Fund : 0.50
Sales/ Shareholders’ Fund : 1.50
Current Ratio : 2.50
Debtors Turnover Ratio : 6.00
Stock Velocity : 2 Months
Gross profit Ratio : 20%
Net Working Capital Turnover Ratio : 2.50

(1) Shareholders’ Fund
(2) Stock
(3) Debtors
(4) Current Liabilities
(5) Cash Balance
Answer
(1) Shareholders’ Fund = Equity Share Capital + Reserve and Surplus
= `10 Lakhs + 0.50 Shareholders’ Fund
0.50 Shareholders’ Fund = `10 Lakhs
Shareholders’ Fund = `10 Lakhs ÷ 0.50 = `20,00,000

Reserve and Surplus
= 0.50 or Reserve & Surplus = .5 Shareholders’ Fund
Shareholders′ Fund
(2) Stock = COGS × Stock velocity/12

= `24,00,000 × 2/12 = `4,00,000
Sales
Shareholders′ Fund
= 1.50 or Sales = 1.5 Shareholder Fund
Sales = 1.50 × `20,00,000 = `30,00,000
6.49
COGS = Sales – Gross Profit

= `30,00,000 – 20% = `24,00,000
(3) Debtors = Annual Credit Sales ÷ Debtors Turnover Ratio

= `30,00,000 ÷ 6 = `5,00,000

Current Ratio = CA ÷ CL = 2.50
Current Asset = 2.50 CL
Sales
Net Working Capital
= 2.50
Net Working Capital = Sales ÷ 2.50 = `30,00,000 ÷ 2.50
= `12,00,000
CA – CL = `12,00,000
2.5 CL – CL = `12,00,000
Current Liabilities = `12,00,000 ÷ 1.5 = `8,00,000
(5) Cash Balance = Current Asset – Debtors – Stock

= `20,00,000 - `5,00,000 - `4,00,000
= `11,00,000
Current Asset = 2.5 CL

= 2.5 × 8,00,000 = `20,00,000
PYQ 19
The following figure are related to the trading activities of M Ltd.
Total assets - `10,00,000

Debt to total assets - 50%
Interest cost - 10% per year
Direct Cost - 10 times of the interest cost
Operating Exp. - `1,00,000
The goods are sold to customers at a margin of 50% on the direct cost Tax Rate is 30%.

(a) Net profit margin
(b) Net operating profit margin
(c) Return on assets
(d) Return on owner’s equity
Answer
EAT 70 ,000
(a) Net Profit Margin = × 100 = × 100 = 9.33%
Sales 7 ,50 ,000
EBIT 1 ,50 ,000

(b) Net Operating Profit Margin = × 100 = × 100 = 20%
Sales 7 ,50 ,000
6.50
EBIT (1−t) 1,50,000 (1−.30)

(c) Return on Assets = Assets
= 10,00,000
= 10.5%
EAT 70 ,000
(d) Return on Equity = ×100= × 100 = 14%
Equity Fund 5 ,00 ,000
Working Notes:
(1) Debt = 50% of `10,00,000 = `5,00,000
(2) Interest = 10% of `5,00,000 = `50,000
(3) Direct cost = 10 times of `50,000 = `5,00,000
(4) Sales = Direct cost + 50% = `5,00,000 + 50% = `7,50,000
(5) Equity Fund = Total Assets – Debt = `10,00,000 - `5,00,000= `5,00,000
(6) The Net Profit is calculated as follows:
Particulars `
Sales Revenue 7,50,000
Less: Operating expenses 1,00,000
Operating Profit/EBIT 1,50,000
EBT 1,00,000
Less: Taxes @ 30% 30,000
EAT 70,000
PYQ 20
Following information and ratios are given in respect of AQUA Ltd. for the 10 year ended 31st March,
2023:
Current ratio 4.0
Acid test ratio 2.5
Inventory turnover ratio (based on sales) 6
Average collection period (days) 70
Earnings per share `3.5
Current liabilities `3,10,000
Total assets turnover ratio (based on sales) 0.96
Cash ratio 0.43
Proprietary ratio 0.48
Total equity dividend `1,75,000
Equity dividend coverage ratio 1.60
Assume 360 days in a year.
You are required to complete Balance Sheet as on 31st March, 2023.
6.51

Equity share capital XXX Fixed assets XXX
(`10 per share) Inventory XXX
Reserve & surplus XXX Debtors XXX
Long-term debt (b.f.) XXX Loans & advances XXX
Current liabilities 3,10,000 Cash & bank XXX
XXX XXX
[(10 Marks) May 23]
Answer
Equity share capital 8,00,000 Fixed assets 16,66,250
(`10 per share) Inventory 4,65,000
Reserve & surplus 5,95,000 Debtors 5,42,500
Long-term debt (b.f.) 12,01,250 Loans & advances 99,200
Current liabilities 3,10,000 Cash & bank 1,33,300
29,06,250 29,06,250
Working Notes:
CA
a. Current Ratio = = 4 times
CL
Current Assets = 4 × 3,10,000 = `12,40,000
CA  Stock 12 ,40 ,000  Stock

b. Acid test ratio = = = 2.5 times
CL 3 ,10 ,000
Inventory = `4,65,000
Cash & bank Cash & bank

c. Cash ratio = = = 0.43
CL 3 ,10 ,000
Cash & bank = `1,33,300
Sales Sales
d. Inventory turnover = = = 6
Inventory 4 ,65 ,000
Sales = `27,90,000
e. Debtors = Credit Sales × 70/360

= 27,90,000 × 70/360 = `5,42,500
f. Loans & advances = CA – Debtors – Inventory – Cash and Bank

= 12,40,000 – 5,42,500 – 4,65,000 – 1,33,300 = `99,200
Sales 27 ,90 ,000

g. Total assets turnover = = = 0.96
Total assets Total assets
Total assets = `29,06,250
h. Fixed assets = Total assets – Current assets

= 29,06,250 – 12,40,000 = `16,66,250
6.52
Pr op . fund Pr op . fund
i. Proprietary ratio = = = 0.48
Total assets 29 ,06 ,250
Proprietor’s fund = 0.48 × 29,06,250 = `13,95,000
EAT
j. Equity dividend coverage=
Equity Dividend
EAT
1.6 =
1 ,75 ,000
EAT = 1.6 × 1,75,000 = `2,80,000
EAT 2,80 ,000

k. Number of Equity shares= = = 80,000
EPS 3 .5
l. Equity share capital = 80,000 shares × `10 = `8,00,000

Reserves & surplus = 13,95,000 – 8,00,000 = `5,95,000
PYQ 21
You are available with following information of Brave Ltd:
Debtor’s velocity 3 months

Stock velocity 6 months
Creditor’s velocity 2 months
Gross profit ratio 20%
The gross profit for the year ended 31st March, 2023 was `10,00,000. Stock for the same period was
`40,000 more than what it was at the beginning of the year. Bills receivable were `1,20,000.
From the above information. You are required to calculate:

(a) Sales
(b) Sundry debtors
(c) Closing stock
[(5 Marks) Nov 23]
Answer
(a) Sales = Gross Profit ÷ G.P. Ratio
= 10,00,000 ÷ 20% = `50,00,000
(b) Sundry debtors = (Sales × Debtors velocity/12) – Bills receivables

= (50,00,000 × 3/12) – 1,20,000 = `11,30,000
(c) Average stock = COGS × Stock velocity/12

= 40,00,000 × 6/12 = 20,00,000
Closing Stock = Average Stock + ½ of 40,000

= 20,00,000 + 20,000 = `20,20,000

BQ: 5, 6, 9, 10, 11, 12, 13, 19, 21, 24
PYQ: 2, 4, 5, 10, 15, 17, 20
6.53

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CA INTERMEDIATE

This book is dedicated to my Mother

‘MRS. RAMAN ARORA’

ABOUT THE AUTHOR

For any suggestion please mail me at canamitarora@gmail.com

A word to the students

“Work hard in class, be attentive and grab the concepts

ALL THE BEST

0 INTRODUCTION 0.1 – 0.3 –

1 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.1 – 1.23 5 – 10

2 LEVERAGES 2.1 – 2.39 5 – 10

3 MANAGEMENT OF RECEIVABLES & PAYABLES 3.1 – 3.21 5 – 10

4 MANAGEMENT OF WORKING CAPITAL 4.1 – 4.24 5 – 10

5 TREASURY & CASH MANAGEMENT 5.1 – 5.18 5

6 RATIO ANALYSIS 6.1 – 6.53 5 – 10

7 CAPITAL BUDGETING/INVESTMENT DECISION 7.1 – 7.62 10

8 COST OF CAPITAL 8.1 – 8.37 5 – 10

9 CAPITAL STRUCTURE 9.1 – 9.18 5 – 10

10 DIVIDEND DECISIONS 10.1 – 10.23 5

INCOME STATEMENT & BALANCE SHEET

2. Study Pattern and Books:

4. Financial Management Decisions:

5. Considerations in Case of Financing Decision:

6. Objectives of Financial Management:

7. Economic Value Added: ROI – Cost of Capital (KC)

CHAPTER 1 CAPITAL STRUCTURE – EBIT & EPS ANALYSIS

EARNING PER SHARE (EPS) AND MARKET PRICE OF SHARE (MPS)

Calculate EPS under all three alternatives.

Which form of financing should the company choose?

alternative to finance the project.

You are required to ascertain the probable price on the share.

1. Calculation of capital employed before expansion plan:

Equity share capital (30,000 shares × `10) `3,00,000

2. Return on Capital Employed (ROCE):

EBIT 2,80 ,000

3. Debt Ratio if `4,00,000 is raised as debt:

8 ,00 ,000 ( 4 ,00 ,000 + 4 ,00 ,000 )

4. Debt Equity Ratio if `4,00,000 is raised as Equity:

5. Number of Equity Shares to be issued in Plan 2:

Find out the probable price of share if:

(Note: Retained earnings of the company is `1.2 crore)

1. Calculation of capital employed before expansion plan:

Equity share capital (8,00,000 shares × `10) `80,00,000

2. Return on Capital Employed (ROCE):

EBIT 52 ,00 ,000

3. Debt Equity Ratio if `40,00,000 is raised as Debt:

1 ,40 ,00 ,000 (1 ,00 ,00 ,000 + 40 ,00 ,000 )

4. Debt Equity Ratio if `40,00,000 is raised as Equity:

1 ,00 ,00 ,000

5. Number of Equity Shares to be issued in Plan 2:

Calculate the indifference point between two alternative methods of financing.

Calculation of point of Indifference:

EBIT = 3 × (EBIT – 72,00,000)

EBIT  NIL  1  0.50  = EBIT  15 ,00 ,000  1  0.50 

EBIT  I1  T  = EBIT  I1  T 

EBIT  3,60 ,000  1  0.40  = EBIT  8 ,40 ,000  1  0.40 

You are required to determine for each plan:

Proposal A Financial B.E.P. = No Fixed Financial Cost = Zero