Test Series: March, 2023

MOCK TEST PAPER –1

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

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

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

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

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

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

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

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

1,35,000
= ×100=6.75 %
20,00,000

2. Computation of EPS under three-financial plans.

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

Plan II: Debt – Equity Mix

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

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

Monthly Cash Budget for Six Months: April to September 2023

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

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

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

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

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

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

=√ 2,50,00,00,000 = ` 50,000

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

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

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

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

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

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

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

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

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

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