CA INTERMEDIATE – TEST
FINANCIAL MANAGEMENT
Test No.: 01 Marks: 50 Marks
Topics: TVM, Leverage & Capital Structure Time: 1:30 Hours (Reading Time 10 mins Extra)
ANSWERS
Q.1.
(a) The value of equity share = the sum of: (i) PV of dividend payments during years 1 – 4 and (ii) PV of expected
market price at the end of year 4 based on growth rate of 5 per cent.
Year Dt = D0 (1 + g)t PV factor at 12% Total PV
(`) (`)
1 2 (1 + 0.14)1 = 2.28 0.893 2.036
2
2 2 (1 + 0.14) = 2.60 0.797 2.072
3
3 2 (1 + 0.14) = 2.96 0.712 2.108
4
4 2 (1 + 0.14) = 3.38 0.636 2.150
8.37
D5 Rs. 3.381 0.05
P4 = = = ` 50.71
k e g n 12% 5%
Gn = normal growth rate
PV or market price of the share at the end of year 4 = ` 50.71 x PV factor at 12 per cent at the end of year 4
(0.636) = ` 32.25.
P0 = ` 8.37 + ` 32.25 = ` 40.62
The market price of the share would be ` 40.62.
(b)
Computation of cash inflow per annum `
Net operating income per annum 13,60,000
Less: Tax @ 35% 4,76,000
Profit after tax 8,84,000
Add: Depreciation (`72,00,000 / 5 years) 14,40,000
Cash inflow 23,24,000
The IRR of the investment can be found as follows:
NPV = - ` 72,00,000 + ` 23,24,000 (PVAF5, r) = 0
` 72,00,000
or PVA F5 r (Cumulative factor) = = 3.09
` 23,24,000
Computation of Internal Rate of Return (IRR)
Discounting rate 15% 19%
Cumulative factor 3.35 3.06
Total NPV (`) 77,85,400 71,11,440
(`23,24,000 3.35) (`23,24,000 3.06)
Internal outlay (`) 72,00,000 72,00,000
Surplus (Deficit) (`) 5,85,400 (88,560)
NPV at LR
IRR = LR + (HR - LR)
NPV at LR - NPV at HR
5,85,400
= 15% + × (19% -15%)
5,85,400 - (-88,560)
= 15% + 3.47 = 18.47%
(c) (i) Total Assets = Fixed assets + Current Assets
= 3,00,000 + 1,50,000
= 4,50,000
Sales 8,40,000
Sales turnover = = = 1.87
total assets 4 ,50,000
(ii) EBIT = 10% of 8,40,000 = ` 84,000/-
84,000
Percent of EBIT on investment = x 100 = 18.67%
4 ,50,000
(d) D1 =`6
D2 = ` 6 (1.18) = ` 7.08
D3 = ` 6 (1.18)2 = ` 8.35
D4 = ` 6 (1.18)3 = ` 9.86
D5 = ` 9.86 (1.17) = ` 11.54
D6 = ` 9.86 (1.17) (1.16) = ` 13.38
D7 = ` 9.86 (1.17) (1.16) (1.15) = ` 15.39
D8 = ` 9.86 (1.17) (1.16) (1.15) (1.14) = ` 17.54
D1 D2 D3 D3 D4 D5 D6 D7 TV
P =
1 k e 1 k e 1 k e 1 k e 1 k e 1 k e 1 k e 1 k e 1 k e 7
2 3 3 4 5 6 7
D8 17.54
TV = = = ` 438.50
K e g 0.18 0.14
6.00 7.08 8.35 9.86 11 .54 13 .38 15 .39 438 .50
P =
1 0.18 1 0.18 1 0.18 1 0.18 1 0.18 1 0.18 1 0.18 1 0.18 7
2 3 4 5 6 7
= 6.00 x 0.847 + 7.08 x 0.718 + 8.35 x 0.609 + 9.86 x 0.516 + 11.54 x 0.437 + 13.38 x 0.370 + 15.39 x 0.314
+ 438.50 x 0.314 = ` 172.85
Since the Intrinsic Value of share is ` 172.85 while it is selling at ` 150 hence it is under- priced and better to
acquire it.
Q.2. ` lakhs
Preference Dividend 12% on 30 lakhs 3.60
Equity Dividend 15% on 100 lakhs = 15.00
Total Dividend 18.60
Total dividend payout Ratio (Equity & Preference) is 60%
Dividends
Dividend Payout ratio = 100
Earnings
Total Dividends 60% - 18.60 lakhs
Total Earnings 100% - ?
100%
18.60 = ` 31 lakhs earnings
60%
` lakhs
Total earnings, i.e., PAT 31.00
Tax at 50% 31.00
PBT 62.00
Interest on :
Debentures : 14% on 30 = 4.20
Loans 12% on 20 = 2.40
Banks OD 15% on 20 = 3.00 9.60
EBIT 71.60
EBIT should be ` 71.60 lakhs in order to achieve to meet the company’s commitments.
Q.3.
Financial Options
Option I Option II
75,000 equity share
Particulars 13% Long
@ ` 20 i.e. 15,00,000
term loan of
and 11% debenture
` 30,00,000
of ` 15,00,000
Earnings before interest and Tax (EBIT) 17.4 % on
40,02,000 40,02,000
(` 2,00,00,000 + ` 30,00,000)
Less: Interest on old debentures (` 2,70,000) and long
8,10,000 8,10,000
term loan
(` 54,00,000 @10% i.e. 5,40,000)
31,92,000 31,92,000
Less: Interest on long term loan (new) @ 13% on
3,90,000
` 30,00,000
Less: Interest on Debenture (new) @ 11% on ` 15,00,000 1,65,000
Earnings before tax 28,02,000 30,27,000
Less: Taxes @ 30% 8,40,600 9,08,100
Earnings for equity shareholders (EAT) 19,61,400 21,18,900
Number of Equity Shares 6,30,000 7,05,000
Earnings per Share (EPS) ` 3.113 ` 3.005
Price/ Earnings ratio 8.16 9.6
Market Price per Share (EPS x P/E Ratio) 25.40 28.85
So, Option II is better.
Working Notes:
1. Calculation of Present and future rate of Earnings:
Sources `
Equity Share Capital (6,30,000x 10) 63,00,000
100
Long term Loan (2,70,000 X ) 22,50,000
12
100 12
10% Debentures (3,60,000 X X ) 54,00,000
10 8
Undistributed Reserves and surplus 60,50,000
Total Capital 2,00,00,000
Earnings before interest and tax (EBIT) given 28,80,000
28,80,000
Rate of Present Earnings X 100 14.4%
2,00,00,000
New rate of earnings (14.4% + 3%) 17.4%
2. Calculation of Current PE Ratio
15,75,000
EPS = = 2.5
6,30,000
24
Price Earnings Ratio = = 9.6
2 .5
3. Calculation of future PE Ratio:
Option 1 Option 2
Debt Debt
100 100
Debt Equity Debt Equity
22,50,000 54,00,000 30,00,000 22,50,000 54,00,000 15,00,000
100 100
2,30,00,000 2,30,00,000
1,06,50,000 91,50,000
= 100 = 100
2,30,00,000 2,30,00,000
= 46.30 = 39.78
Price earnings ratio go down by 15% and will be
9.6 × 0.85 = 8.16
Q.4. Company A
EBIT
(i) Financial Leverage =
EBT i.e. EBIT Interest
EBIT
So, 3 =
EBIT ` 20,000
Or 3 (EBIT – ` 20,000) = EBIT
Or 2 EBIT = ` 60,000
Or EBIT = ` 30,000
Contributi on Contribution
(ii) Operating Leverage = Or, 5 =
EBIT ` 30,000
Or, Contribution = ` 1,50,000
Contributi on
Sales =
P/V Ratio (1 - var iable cos t ratio)
` 1,50,000
= = ` 3,75,000
40%
(iii) Fixed Cost = Contribution – EBIT
= ` 1,50,000 – 30,000
Or, Fixed cost = ` 1,20,000
Company B
EBIT
(i) Financial Leverage =
EBT i.e. EBIT - Interest
EBIT
So, 2 =
EBIT 1,00,000
Or, 2 (EBIT – ` 1,00,000) = EBIT
Or, 2 EBIT – ` 2,00,000 = EBIT
Or, EBIT = ` 2,00,000
Contributi on
(ii) Operating Leverage =
EBIT
Contribution
Or, 2 =
` 2,00,000
Or, Contribution = ` 4,00,000
Contributi on
Sales =
P/V Ratio (1 - var iable cos t ratio)
` 4 ,00,000
=
50%
= ` 8,00,000
(iii) Fixed Cost = Contribution – EBIT
= ` 4,00,000 - ` 2,00,000
Or Fixed cost = ` 2,00,000
Income Statements of Company A and Company B
Company A (`) Company B (`)
Sales 3,75,000 8,00,000
Less: Variable cost 2,25,000 4,00,000
Contribution 1,50,000 4,00,000
Less: Fixed Cost 1,20,000 2,00,000
Earnings before interest and tax (EBIT) 30,000 2,00,000
Less: Interest 20,000 1,00,000
Earnings before tax (EBT) 10,000 1,00,000
Less: Tax @ 30% 3,000 30,000
Earnings after tax (EAT) 7,000 70,000
Comment based on Leverage:
Comment based on leverage – Company B is better than company A of the following reasons:
• Capacity of Company B to meet interest liability is better than that of companies A (from EBIT/Interest
ratio)
30,000 2.00,000
[A = = 1.5, B = = 2]
20,000 1,00,000
• Company B has the least financial risk as the total risk (business and financial) of company B is lower
(combined leverage of Company A – 15 and Company B – 4)
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