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CA IPCC : Sample / Mock Test Paper (with Model Answers) - COST ACCOUNTING & FINANCIAL MANAGEMENT Sep 2014

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Test Series: September, 2014 MOCK TEST PAPER 1 INTERMEDIATE (IPC): GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART I : COST ACCOUNTING Question No. 1 is compulsory. Attempt any five questions from the remaining six questions. Working notes should form part of the answer. Time Allowed 1 Hours 1. Maximum Marks 50 Answer the followings: (a) The Profit as per cost accounts of Venkatesh Pvt. Ltd., for the quarter ended 30th June, 2014 is Rs. 3,65,200. The following information is extracted from the books of Venkatesh Pvt. Ltd., for the quarter ended 30th June, 2014: (i) Stocks As per Cost Accounts (Rs.) As per Financial Accounts (Rs.) 52,800 21,200 55,600 22,300 56,000 18,600 18,000 54,200 17,500 16,000 Opening stocks: - Raw Material - Work in Progress Closing stocks: - Raw Material - Work in Progress - Finished Goods (ii) Directors fees Rs. 52,000, Interest expenses Rs. 9,600, Provision for doubtful debts Rs. 1,300 and dividend received Rs. 3,800 have been considered in the financial accounts only. (iii) Notional rent of Rs. 7,200 was charged only in the cost accounts. (iv) Research expenses written-off of Rs. 13,600 has not been charged in the cost accounts. (v) Other overheads for the quarter as per the financial accounts were Rs. 1,28,000 and as per the cost accounts, it was Rs. 1,30,400. You are required to prepare, a statement showing profit/ loss as per financial accounts. 1 (b) Kevin Ltd. produces a product C123 , the cost structure of product C123 is as follows: Amount per unit (Rs.) 1,650 925 315 2,890 Direct Material Direct Labour Variable overheads Total Variable cost Selling price of C123 is Rs. 3,400 per unit and quantity of sales is 55,000 units per annum. Total fixed cost per annum is Rs. 1,80,00,000. You are required to calculate: (i) Break-even sales in units. (ii) Margin of safety in units (iii) If the total variable cost increased by 10% and fixed cost increased by Rs. 20,00,000, how many additional units of C123 should be sold in order to obtain the present profit while selling price per unit remains unchanged. (2 x 5 Marks = 10 Marks) 2. From the following information for the month of July, 2014, prepare Process-III cost accounts. Opening WIP in Process-III Transfer from Process-II Transferred to warehouse Closing WIP of Process-III Units Scrapped Direct material added in Process-III Direct wages Production overheads 1,600 units at Rs. 24,000 55,400 units at Rs. 6,23,250 52,200 units 4,200 units 600 units Rs. 2,12,400 Rs. 96,420 Rs. 56,400 Degree of completion: Opening Stock Material Labour Overheads Closing Stock Scrap 80% 60% 60% 70% 50% 50% 100% 70% 70% The normal loss in the process was 5% of the production and scrap was sold @ Rs. 5 per unit. 2 (Students may treat material transferred from Process II as Material A and fresh material used in Process III as Material B) (8 Marks) 3. Swift Cabs Pvt. Ltd. is a New Delhi based cab renting company, provides cab facility on rent for cities Delhi, Agra and Jaipur to the tourists. To attract more tourists it has launched a new three days tour package for Delhi-Jaipur-Agra-Delhi. Following are the relevant information regarding the package: Distance between Delhi to Jaipur (Km.) Distance between Delhi to Agra (Km.) Distance between Agra to Jaipur (Km.) Price of diesel in Delhi Price of diesel in Jaipur Price of diesel in Agra Mileage of cab per litre of diesel (Km.) Chauffeur s salary Cost of the cab Expected life of the cab 274 242 238 Rs. 54 per litre Rs. 56 per litre Rs. 58 per litre 16 Rs. 12,000 per month Rs. 12,00,000 24,00,000 kms. Rs. 30,000 after every 50,000 kilometres run. Rs. 50 for every 200 kilometres of completed journey Rs. 2,400 per month. Servicing cost Chauffeur s meal allowance Other set up and office cost Swift Cabs has made tie-up with fuel service centres at Agra, Jaipur and Delhi to fill diesel to its cabs on production of fuel passbook to the fuel centre. Company has a policy to get fuel filled up sufficient to reach next destination only. You are required to calculate the price inclusive of service tax @ 12.36% to be quoted for the package if company wants to earn profit of 25% on its net takings i.e. excluding service tax. (8 Marks) 4. August Furniture makes different varieties of office furniture. It makes 7 revolving chairs per hour by employing 5 skilled, 10 semiskilled and 20 unskilled workers. The standard wage rate is Rs. 24 per labour hour. During the last week workers worked for 56 hours and made 400 revolving chairs. 2% of the time paid was lost due to the abnormal reasons. The actual hourly rate paid to skilled, semiskilled and unskilled workers were Rs.30, Rs.24 and Rs.18 respectively. You are required to calculate (i) Labour Cost Variance (ii) Labour Rate Variance 3 (iii) Labour Efficiency Variance and (iv) Idle Time Variance. 5. (a) (i) (8 Marks) Discuss accounting treatment of idle capacity costs in cost accounting. (ii) List any four functional budgets prepared by a business organization. (b) Distinguish between job costing and process costing 6. (4 x 2 = 8 Marks) Panchal Group undertook a contract for Rs. 5,00,000 on 1st April 2013. On 31st March 2014 when the accounts were closed, the following details about the contract were gathered: Rs. 1,25,000 45,000 12,000 1,25,000 25,000 15,000 2,50,000 2,00,000 15,000 12,500 Materials purchased Wages paid General expenses Plant purchased Material in hand 31.3.2014 Wages accrued 31.3.2014 Work certified Cash received Work uncertified Depreciation of plant The contract contained an escalation clause, which read as follows: In the event of increase(s) of prices of materials and rates of wages by more than 5%, the contract price would be increased accordingly by 25% of the rise of the cost of materials and wages beyond 5% in each case. It was found that since the date of signing the agreement, the prices of materials and wage rates increased by 25%. The value of the work certified does not take into account the effect of the above clause. Prepare the contract account. The workings should form part of your answer. (8 Marks) 7. (a) Explain the treatment of over and under absorption of overheads in cost accounting. (b) Distinguish between fixed and flexible budget. 4 (4 x 2 =8 Marks) Test Series: September, 2014 MOCK TEST - I INTERMEDIATE (IPC) Group I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART II : FINANCIAL MANAGEMENT All questions are compulsory. Working notes should form part of the answer. Time Allowed 1 Hours 1. Maximum Marks 50 Answer the following questions, supporting the same with reasoning/working notes: (a) Mr. X wants to buy an ordinary annuity that will pay him Rs. 4,000 a year for the next 20 years. He expects annual interest rates will be 8 per cent over that time period. Calculate the maximum price he would be willing to pay for the annuity. (b) EOQ is the order quantity that minimizes total carrying costs over our planning horizon. Is the statement true or false? (c) If two projects are completely independent (or unrelated), what is the measure of correlation between them? (d) A firm s degree of operating leverage (DOL) depends primarily upon its sales variability. Is the statement true or false? (4 2 = 8 Marks) 2. (a) The following data applies to Alpha Limited (Rs. in crores): Rs. Cash and marketable securities Fixed Assets Sales Net income Current liabilities Current ratio DSO* ROE *Calculation is based on a 365 days year. 10.00 28.35 100.00 5.00 10.55 3.0 40.55 days 12% The company has no preference shares only equity shares, current liabilities, and long-term debt. The Institute of Chartered Accountants of India You are to calculate Alpha Limited s (i) Accounts receivable (A/R), (ii) Current assets, (iii) Total assets, (iv) ROA, (v) Common equity, and (vi) Long-term debt. If Alpha Limited s accounts receivable (A/R) = Rs. 11.10 crores. If the company could reduce its DSO from 40.55 days to 30.4 days while holding other things constant, how much cash would it generate? If this cash were used to buy back equity shares (at book value), thus reducing the amount of equity, how would this affect (i) the ROE, (ii) the ROA, and (iii) the total debt/total assets ratio? (b) You are a financial analyst for Beta Limited. The director of finance has asked you to analyse two proposed capital investments, Projects X and Y. Each project has a cost of Rs. 10,000, and the cost of capital for each project is 12 per cent. The project s expected net cash flows are as follows: Expected net cash flows Year Project Y Rs. Rs. 0 (10,000) (10,000) 1 6,500 3,500 2 3,000 3,500 3 3,000 3,500 4 (i) Project X 1,000 3,500 Calculate each project s payback period, net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR). (ii) Which project or projects should be accepted if they are independent? (iii) Which project should be accepted if they are mutually exclusive? (12 + 8= 20 Marks) 3. (a) There are two companies, Company A and B having Net Operating Income of Rs. 15,00,000 each. Company B is a levered company whereas company A is all equity company. Debt employed by Company B is of Rs. 7,00,000 @ 11%. The tax rate applicable to both the companies is 25%. Calculate: (i) Earnings available for equity and debt for both the companies. (ii) Present value of tax shield. The Institute of Chartered Accountants of India (b) A proforma cost sheet of a Company provides the following particulars: Amount per unit (Rs.) Raw materials cost Direct labour cost Overheads cost Total cost Profit Selling Price 100 37.50 75 212.50 37.50 250 The Company keeps raw material in stock, on an average for one month; work-inprogress, on an average for one week; and finished goods in stock, on an average for two weeks. The credit allowed by suppliers is three weeks and company allows four weeks credit to its debtors. The lag in payment of wages is one week and lag in payment of overhead expenses is two weeks. The Company sells one-fifth of the output against cash and maintains cash-in-hand and at bank put together at Rs.37,500. You are required to prepare a statement showing estimate of Working Capital needed to finance an activity level of 1,30,000 units of production. Assume that production is carried on evenly throughout the year, and wages and overheads accrue similarly. Work-in-progress stock is 80% complete in all respects. (For calculation purposes, four weeks has been considered equivalent to 1 month and 1 year is = 52 weeks) (6 + 8 = 14 Marks) 4. Answer the following: (a) Differentiate between the following: (i) Deep Discount Bonds and Zero Coupon Bonds (ii) Investment Decision and Financing Decision (b) Write a short note on Seed Capital Assistance. The Institute of Chartered Accountants of India (6 + 2 = 8 Marks) Test Series: September, 2014 MOCK TEST PAPER 1 INTERMEDIATE (IPC): GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART I : COST ACCOUNTING Suggested Answers/ Hints 1. (a) Statement of Profit/ loss as per Financial Accounts Amount (Rs.) Profit as per cost accounts Amount (Rs.) 3,65,200 Add: Dividend received 3,800 - Notional rent 7,200 - Other overheads (Rs.1,30,400 - Rs.1,28,000) 2,400 Less: Opening stock of Raw Materials (Rs. 55,600 - Rs.52,800) 13,400 2,800 - Opening stock of WIP (Rs.22,300 - Rs. 21,200) 1,100 - Closing stock of Raw Material (Rs. 56,000 - Rs. 54,200) 1,800 - Closing stock of WIP (Rs.18,600 - Rs. 17,500) 1,100 - Closing stock of finished goods (Rs. 18,000 - Rs. 16,000) 2,000 - Directors fees 52,000 - Interest expenses 9,600 - Prov. For doubtful debts 1,300 - Research expenses written off 13,600 Profit as per financial accounts (85,300) 2,93,300 (b) Workings (a) Contribution per unit = Selling price per unit Total variable cost = Rs.3,400 Rs.2,890 = Rs.510 (b) Profit = Total Contribution Total Fixed Cost = 55,000 units Rs.510 Rs.1,80,00,000 = Rs.2,80,50,000 Rs.1,80,00,000 = Rs.1,00,50,000 The Institute of Chartered Accountants of India (i) Break-even Sales in units = (ii) Total Fixed cost Rs.1,80,00,000 = = 35,294.12 or 35,294 units. Contribution per unit Rs.510 Margin of Safety in units = Sales units Break even sales in units = 55,000 35,294 = 19,706 units. OR = Rs. 1,00,50,000 Pr ofit = Rs. 510 Contributionper unit = 19,705.88 or 19,706 units. (iii) To maintain the same amount of profit, total contribution should be equal to Present profit + Total fixed Cost = Rs.1,00,50,000 + (Rs.1,80,00,000 + Rs.20,00,000) = Rs. 3,00,50,000. Revised contribution per unit = Rs.510 10% of Rs. 2,890 = Rs. 221 No. of units to be sold = = Rs. 3,00,50,000 Rs. 221 Re quiredcontribution Re visedcontributionper unit = 1,35,972.85 or 1,35,973 units Therefore, to maintain profit amount of Rs.1,00,50,000, Kevin Ltd. has to sell 80,973 (1,35,973 55,000) additional units of C123. 2. Statement of Equivalent Production Process III Input Details Units Output Particulars Opening 1,600 Work on Op. WIP WIP Process-II 55,400 Introduced & completed during Transfer the month Normal loss (5% of 52,800 units) Closing WIP Abnormal Gain 57,000 The Institute of Chartered Accountants of India Units 1,600 Equivalent Production Labour & Material-A Material-B Overhead % Units % Units % Units - 20 320 40 640 50,600 100 2,640 - 4,200 100 (2,040) 100 57,000 50,600 100 50,600 100 - - - 4,200 70 (2,040) 100 52,760 - 2,940 50 (2,040) 100 51,820 50,600 2,100 (2,040) 51,300 Working note: Production units = Opening units + Units transferred from Process-II Closing Units = 1,600 units + 55,400 units 4,200 units = 52,800 units Statement of Cost Cost (Rs.) Material A (Transferred from previous process) 6,23,250 Less: Scrap value of normal loss (2,640 units Rs. 5) (13,200) 6,10,050 Material B 2,12,400 Labour 96,420 Overheads 56,400 9,75,270 Equivalent Cost per units equivalent units (Rs.) 52,760 51,820 51,300 51,300 11.5627 4.0988 1.8795 1.0994 18.6404 Statement of apportionment of Process Cost Amount (Rs.) Opening WIP Material A Completed opening WIP Material B (320 units Rs. 4.0988) units-1600 Wages (640 units Rs. 1.8795) Overheads (640 units Rs. 1.0994) Amount (Rs.) 24,000 1311.62 1202.88 703.62 3,218.12 Introduced & Completed- 50,600 units Rs. 18.6404 50,600 units 9,43,204.24 Total cost of 52,200 finished goods units 9,70,422.36 Closing WIP units- 4,200 Material A (4,200 units Rs. 11.5627) 48,563.34 Material B (2,940 units Rs. 4.0988) 12,050.47 Wages (2,100 units Rs. 1.8795) 3,946.95 Overheads (2,100 units Rs. 1.0994) 2,308.74 66,869.50 Abnormal gain units- 2,040 (2,040 units Rs. 18.6404) The Institute of Chartered Accountants of India 38,026.42 Process III A/c Particulars Units To Balance b/d To Process II A/c To Direct material To Direct wages To Production overheads To Abnormal gain Amount (Rs.) 1,600 55,400 2,040 Particulars 24,000 By Normal loss 6,23,250 By Finished goods 2,12,400 By Closing WIP 96,420 56,400 Units Amount (Rs.) 2,640 52,200 13,200 9,70,422.36 4,200 66,874.06* 38,026.42 59,040 10,50,496.42 59,040 10,50,496.42 * Difference in figure due to rounding off has been adjusted with closing WIP 3. Calculation of Price of the Delhi-Jaipur-Agra-Delhi tour package Amount (Rs.) Particulars Diesel Cost (Working Note-2) Servicing Cost 2,635.00 Rs. 30,000 50,000kms 754kms. 452.40 Chauffeur s meal cost (three 200 km. completed journey Rs. 50) Other Allocable costs: Rs.12,00,000 Depreciation 24,00,000kms 754kms. Rs. 2,400 Other set-up and office cost 30days Rs. 12,000 Chauffeur s salary 30days 3days Total Cost Add: Profit (25% of net takings or 1/3rd of total cost) Add: Service Tax @12.36% Price of the package (inclusive of service tax) The Institute of Chartered Accountants of India 150.00 377.00 3days Amount (Rs.) 240.00 1,200.00 1,817.00 5,054.40 1,684.80 6,739.20 832.97 7,572.17 Working Notes (1) Total distance of journey From To Distance (in Km.) Delhi Jaipur Agra Jaipur Agra Delhi 274 238 242 754 Total Distance (2) Cost of Diesel III Price of diesel per litre (Rs.) IV Total diesel Cost (Rs.) V= (III 16 km) IV 274 238 242 54 56 58 924.75 833.00 877.25 2,635.00 From To Distance (in Km.) I II Delhi Jaipur Agra Jaipur Agra Delhi Total cost 4. Total labour hours required to make 7 revolving chairs = 5 skilled hours + 10 semi-skilled hours + 20 unskilled hours = 35 labour hours. Standard labour hours per unit = 35 = 5 labour hours 7 Standard labour hours for actual output = 400 units 5 = 2,000 hours Standard cost for actual output = 2,000 hours Rs. 24 = Rs.48,000 Actual hours paid and Idle hours Worker hours Idle time (hours) Actual hours worked Rate per hour (Rs.) Amount Paid (Rs.) Skilled 5 56 = 280 280 2% = 5.6 280 - 5.6 = 274.4 30 8,400 Semiskilled 10 56 = 560 560 2% = 11.2 560 -11.2 = 548.8 24 13,440 20 56 = 1,120 1,120 2% = 22.4 1,120-22.4 = 1,097.6 18 20,160 1,960 39.2 1,920.8 Unskilled Total Actual paid The Institute of Chartered Accountants of India 42,000 Calculation of Variances (i) Labour Cost Variance = Standard Cost for actual output Actual cost = Rs.48,000 - Rs.42,000 (ii) Labour Rate Variance Skilled worker = Rs.6,000 (F) = Actual hours paid ( Standard rate Actual rate) = 280 (24 30) = Rs.1,680 (A) Semi-skilled worker = 560 (24 24) = Nil Unskilled worker = Rs.6,720 (F) Rs.5,040 (F) = 1,120 (24 18) (iii) Labour Efficiency Variance = Std. Rate (Standard hours Actual hours worked) Skilled worker = 24 (5/7 400 274.4) = 24 (2,000/7 274.4) = Rs.271.54 (F) Semi-skilled worker = 24 (10/7 400 548.8) = 24 (4,000/7 548.8) Unskilled Worker = 24 (20/7 400 1,097.6) = 24 [8,000/7 1,097.6] (iv) Idle time Variance (a) (i) = Rs.1,086.17(F) Rs.1,900.80 (F) = Idle Time x Standard rate = 39.2 hours Rs.24 5. = Rs.543.09 (F) = Rs.940.80 (A) Treatment of Idle Capacity Cost (1) If idle capacity is due to unavoidable reasons such as repairs & maintenance, changeover of job etc., a supplementary overhead rate may be used to recover the idle capacity cost. In this case, the costs are charged to production capacity utilized. (2) If idle capacity cost is due to avoidable reasons such as faulty planning, power failure etc, the cost should be charged to Costing P&L A/c. (3) If idle capacity is due to seasonal factors, then the cost should be charged to cost of production by inflating overhead rates. (ii) The various commonly used Functional budgets are: Sales Budget Production Budget Direct Material Purchase Budget Direct Labour (Personnel) Budget The Institute of Chartered Accountants of India (b) The main points which distinguish Job Costing and Process Costing are as below: Job Costing Process Costing (i) A Job is carried out or a product The process of producing the product has is produced by specific orders. a continuous flow and the product produced is homogeneous. (ii) Costs are determined for each Costs are compiled on time basis i.e., for job. production of a given accounting period for each process or department. (iii) Each job is separate independent of other jobs. and Products lose their individual identity as they are manufactured in a continuous flow. (iv) Each job or order has a number The unit cost of process is an average and costs are collected against cost for the period. the same job number. (v) Costs are computed when a job is completed. The cost of a job may be determined by adding all costs against the job. Costs are calculated at the end of the cost period. The unit cost of a process may be computed by dividing the total cost for the period by the output of the process during that period. (vi) As production is not continuous and each job may be different, so more managerial attention is required for effective control. Process of production is usually standardized and is therefore, quite stable. Hence control here is comparatively easier. 6. Panchal Group Contract account for the year ended 31st March 2014 Dr. Cr. (Rs.) To Materials purchased To Wages paid Add: Wages accrued To General expenses 45,000 15,000 To Depreciation of plant To Notional profit c/d (Rs.) 1,25,000 60,000 12,000 12,500 86,900 2,96,400 The Institute of Chartered Accountants of India (Rs.) By Work-inprogress c/d Work certified Work uncertified Effect of escalation clause (Working note- 1) By Materials in hand c/d (Rs.) 2,50,000 15,000 6,400 2,71,400 25,000 2,96,400 To Profit and loss A/c (Working note- 2) To Work-in-progress c/d (Profit in reserve) 46,347 86,900 40,553 86,900 1.4.2014 To Work-in-progress b/d Work certified Work uncertified Effect of escalation clause To materials in hand b/d By Notional profit b/d 86,900 1.4.2014 By Work-inprogress b/d (profit in reserve) 2,50,000 15,000 6,400 40,553 2,71,400 25,000 Working notes (i) Ascertainment of effect of escalation clause: Total increase 25% (Rs.) Increase up to 5% (Rs.) Increase beyond 5% (Rs.) 20,000 4,000 16,000 12,000 2,400 9,600 32,000 6,400 25,600 Materials: Effect of increased price (Rs. 1,25,000 Rs. 25,000) 25 125 Wages: Effect of increased wage rates: 25 Rs. 60,000 125 Total increase Increase in value of work done (certified & uncertified) to date: 25% of Rs. 25,600 = Rs. 6,400 (ii) Profit to be transferred to the profit and loss account: Since the contract is 50% complete, two-third of the notional profit, reduced by the proportion of cash received to work certified, is to be transferred as below: = 2 Cash received Notional profit 3 Work certified The Institute of Chartered Accountants of India = 7. 2 3 Rs. 86,900 Rs.2,00,000 Rs. 2,50,000 = Rs. 46,347 (a) Treatment of over and under absorption of overheads are:(i) Writing off to costing P&L A/c: Small difference between the actual and absorbed amount should simply be transferred to costing P&L A/c, if difference is large then investigate the causes and after that abnormal loss shall be transferred to costing P&L A/c. (ii) Use of supplementary Rate: Under this method the balance of under and over absorbed overheads may be charged to cost of W.I.P., finished stock and cost of sales proportionately with the help of supplementary rate of overhead. (iii) Carry Forward to Subsequent Year: Difference should be carried forward in the expectation that next year the position will be automatically corrected. This would really mean that costing data of two years would be wrong. (b) Difference between Fixed and Flexible Budgets 1. 2. 3. 4. Fixed Budget It does not change with actual volume of activity achieved. Thus it is rigid It operates on one level of activity and under one set of conditions If the budgeted and actual activity levels differ significantly, then cost ascertainment and price fixation do not give a correct picture. Comparisons of actual and budgeted targets are meaningless particularly when there is difference between two levels. The Institute of Chartered Accountants of India Flexible Budget It can be re-casted on the basis of activity level to be achieved. Thus it is not rigid. It consists of various budgets for different level of activity. It facilitates the cost ascertainment and price fixation at different levels of activity. It provided meaningful basis of comparison of actual and budgeted targets. Test Series: September, 2014 MOCK TEST I INTERMEDIATE (IPC) GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART II : FINANCIAL MANAGEMENT SUGGESTED ANSWERS/HINTS 1. 2. (a) PVA = 4,000 (PVIF at 8% for 20 years) = 4,000 9.818 = Rs. 39,272. (b) False. EOQ is the order quantity that minimizes total carrying costs over our planning horizon. (c) Zero. (d) False. A firm s degree of operating leverage (DOL) depends primarily upon its closeness to its operating break-even point. (a) Alpha Limited s average sales per day was Rs. 100/365 = Rs. 0.274 crore. Its DSO was 40.55, so A/R = 40.55 (Rs. 0.274 crore) = Rs. 11.11 crores. Its new DSO of 30.4 would cause A/R = 30.4 (Rs. 0.274 crore) = Rs. 8.3 3 crores. The reduction in receivables would be Rs. 11.11 Rs. 8.33 crores= Rs. 2.78 crores, which would equal the amount of cash generated. (i) New equity = Old equity Shares bought back = Rs. 41.67 Rs. 2.78 = Rs. 38.89 crores. Thus, Net income New ROE = New equity = Rs. 5 Rs. 38.89 = 12.86% (versus old ROE of 12.0%). Net income (ii) New ROA = Total assets Reduction in A/R Rs. 5 = Rs. 60 Rs. 2.78 = 8.74% (versus old ROA of 8.33%). (iii) The old debt is the same as the new debt: Debt = Total claims Equity Rs. 60 Rs. 41.67 = Rs. 18.33 crores. The Institute of Chartered Accountants of India (b) (i) Old total assets = Rs. 60 crores. New total assets = Old total assets Reduction in A/R = Rs. 60 Rs. 2.78 = Rs. 57.22 crores. Therefore, Rs. 18.33 Debt = = 30.6%, Rs. 60 Old total assets While, New debt Rs. 18.33 = = 32.0%. New total assets Rs. 57.22 Payback Period Method The cumulative cash flows for each project are as follows: Year Cumulative Cash Flows Project X Project Y Rs. Rs. 0 (10,000) (10,000) 1 (3,500) (6,500) 2 (500) (3,000) 3 2,500 500 4 3,500 4,000 Rs. 500 Payback = 2 + = 2.17 years. x Rs. 3,000 Rs. 3,000 Payback = 2 + = 2.86 years. y Rs. 3,500 Net Present Value (NPV): Rs. 6,500 Rs. 3,000 Rs. 3,000 Rs. 1,000 NPV = Rs. 10,000 + + + + x (1.12)1 (1.12)2 (1.12)3 (1.12) 4 = Rs. 966.01. Rs. 3,500 Rs. 3,500 Rs. 3,500 Rs. 3,500 NPV = Rs. 10,000 + + + + y (1.12) 2 (1.12) 3 (1.12) 4 (1.12)1 = Rs. 630.72. The Institute of Chartered Accountants of India Internal Rate of Return (IRR) To solve for each project s IRR, find the discount rates that equate each NPV to zero: IRRx = 18.0%. IRRy = 15.0%. Modified Internal Rate of Return (MIRR) To obtain each project s MIRR, begin by finding each project s terminal value (TV) of cash inflows: TVx = Rs. 6,500(1.12)3 + Rs. 3,000 (1.12)2 + Rs. 3,000 (1.12)1 + Rs. 1,000 = Rs. 17,255.23. TVy = Rs. 3,500(1.12)3 + Rs. 3,500 (1.12)2 + Rs. 3,500 (1.12)1 + Rs. 3,500 = Rs. 16,727.65. Now, each project s MIRR is that discount rate that equates the PV of the TV to each project s cost, Rs. 10,000: MIRRx = 14.61%. MIRRy = 13.73%. (ii) The following table summarizes the project rankings by each method: Project that ranks higher Payback NPV X IRR X MIRR 3. X X Analysis: All methods rank Project X over Project Y. In addition, both projects are acceptable under the NPV, IRR, and MIRR criteria. Thus, both projects should be accepted if they are independent. (iii) If the projects are mutually exclusive, then the project with the higher NPV at k = 12%, or Project X would be accepted. (a) (i) Statement of Calculation of Earnings Available to Equity holders and Debt holders Company A Net operating income Less: Interest on Debt (11% of Rs. 7,00,000) Profit before taxes The Institute of Chartered Accountants of India B 15,00,000 15,00,000 77,000 15,00,000 14,23,000 Less: Tax @ 25% 3,75,000 3,55,750 Profit after tax/Earnings available to Equity holders 11,25,000 10,67,250 Total Earnings Available to Equity holders + Debt holders 11,25,000 10,67,250 + 77,000 = 11,44,250 (ii) As we can see that the earnings in case of Company B is more than the earnings of Company A because of tax shield available to shareholders of Company B due to the presence of Debt structure in Company B. The interest is deducted from EBIT without tax deduction at the corporate level; equity holders also get their income after tax deduction. Due to which income of both the investors increase to the extent of tax saving on the interest paid i.e. tax shield i.e. 25% 77,000 = 19,250 i.e. difference in the income of two Companies earnings i.e. 11,44,250 11,25,000 = Rs. 19,250. (b) Activity level: 1,30,000 units Statement showing Estimate of Working Capital Needs A. Investment in Inventory: Raw material inventory: 1 month 4 1,30,000 Rs. 100 52 10,00,000 * 1 WIP Inventory : 1 week 1,30,000 0.80 212.50 52 4,25,000 Finished goods inventory: 2 weeks 2 1,30,000 212.50 52 10,62,500 B. Investment in Debtors: 4 weeks at cost 4 4 1,30,000 212.50 5 52 17,00,000 C. Cash balance D. Investment in Current Assets (A + B + C) E. Current Liabilities: Creditors : 3 weeks 3 1,30,000 100 52 The Institute of Chartered Accountants of India 37,500 42,25,000 7,50,000 Deferred wages : 1 week 1 1,30,000 37.50 52 93,750 Deferred overheads : 2 weeks 2 1,30,000 75 52 3,75,000 12,18,750 Net Working Capital Needs 4. (a) 30,06,250 (i) Deep Discount Bonds and Zero Coupon Bonds : Deep Discount Bonds (DDBs) are in the form of zero interest bonds. These bonds are sold at a discounted value and on maturity face value is paid to the investors. In such bonds, there is no interest payout during lock-in period. IDBI was first to issue a Deep Discount Bonds (DDBs) in India in January 1992. The bond of a face value of Rs.1 lakh was sold for Rs. 2,700 with a maturity period of 25 years. A zero coupon bond (ZCB) does not carry any interest but it is sold by the issuing company at a discount. The difference between discounted value and maturing or face value represents the interest to be earned by the investor on such bonds. (ii) Investment Decision and Financing Decision: The investment of long term funds is made after a careful assessment of the various projects through capital budgeting and uncertainty analysis. However, only that investment proposal is to be accepted which is expected to yield at least so much return as is adequate to meet its cost of financing. This has an influence on the profitability of the company and ultimately on its wealth. Such types of decisions are known as investment decisions. On the other hand, Financing Decisions relate to raising of funds from various sources. Each source of funds involves different issues. The finance manager has to maintain a proper balance between long-term and short-term funds. With the total volume of long-term funds, he has to ensure a proper mix of loan funds and owner s funds. The optimum financing mix will increase return to equity shareholders and thus maximise their wealth. (b) Seed Capital Assistance: The seed capital assistance has been designed by IDBI for professionally or technically qualified entrepreneurs. All the projects eligible for financial assistance from IDBI, directly or indirectly through refinance are eligible under the scheme. The project cost should not exceed Rs. 2 crores and the maximum assistance under the project will be restricted to 50% of the required promoters contribution or Rs. 15 lacs whichever is lower. The seed capital assistance is interest free but carries a security charge of one percent per annum for the first five years and an increasing rate thereafter. The Institute of Chartered Accountants of India

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