V Semester B.

Com Examination February/March 2024

(NEP Scheme)
Paper – 5.1 (DSC): Financial Management
Chief Examiner
Prof. Ramesh G K
Assistant Professor of Commerce
Govt. First Grade College, Gauribidanur

Time: 2 ½ Hours Max. Marks 60

Instruction: Answers should be written completely either in English or in Kannada

SECTION – A
Answer any 5 Sub-Questions. Each Question carries 2 marks (5 x 2 = 10)
(1)
a) If Mr. X deposits Rs. 50,000 on 01/01/2023 at 10% rate of interest, what will be
doubling period as per the rule of 72
72/rate of return -72/10 = 7.2 years
b) State the important areas of financial decisions.
Financing decisions, investment decisions and dividend decisions
c) What do you mean be operating leverage?
Operating leverage may be defined as the ability of a concern to use fixed operating
costs to magnify the effect of change in sales on its operating profits
d) What do you mean be post payback period profitability?
Earnings of a project after payback period is called post payback profitability.
e) What is payback period?
Payback period refers to the period within which the cost of the project is fully recovered.
Hence it states the number of years required to recover the original investment.
f) What is temporary working capital?
Temporary working capital is also called as fluctuating /varying working capital.
Temporary working capital refers to the amount of working capital, which goes on
fluctuating from time to time with changes in the volume of business activities.
g) What is Internal Rate of Return?
Internal rate of return is that rate at which the sum of discounted cash inflows equals the
sum of discounted cash outflows. In other words, it is the rate, which balances the total
present values of cash inflows & total present values of cash outflows to zero. In short, it
is the rate at which the NPV of the project is exactly zero
SECTION – B
Answer any 3 Questions. Each Question carries 4 marks (3 x 04 = 12)
(2) What are the Advantages of Adequate Working Capital?
The important advantages of adequate working capital are-
 Helps in getting easy financial assistance from banks and financial institutions.
 It helps to improve goodwill of the business organisation.
 It helps in smooth and uninterrupted flow of business operations.
 It helps to maintain good customer and supplier relationships.
 It helps to take advantage of favourable market conditions.
 It gives business organisation the strength to face the crisis effectively.
  Through smooth and uninterrupted flow of business operations, it improves the solvency
of business organizations.
 It improves the morale, efficiency, productivity of employees and reduces the waste and
absenteeism of employees.

(3) Explain the principles of sound financial plan

Principles of Sound Financial Plan
1. Principle of Simplicity states that, the financial plan should be easily understandable by a
layman about its contents and implementation along with all the stakeholders say investors,
creditors, employees, competitors and so on. Because, financial plan should not leads to
complications and suspicions and ambiguity. Hence the simplicity principle should be kept in
mind while preparing the financial plan.
2. Principle of foresight states that, the financial plan should be keeping in mind the present and
future requirements/needs of the organization; though it is too difficult to forecast the future
funds requirements due to change in business environment. Hence a plan which is prepared
with some foresight definitely helpful to the firm to meet its requirements.
3. According to the Principle of flexibility, the financial plan should incorporate the changing
requirements of the firm in its financial plan. There by the financial plan should be in a position
to serve the purpose of the organization.
4. According to the principle of Liquidity, the firm should incorporate the liquidity factor in its
structure, where sufficient / reasonable amount of current assets should be maintained to repay
then current liabilities. Because the liquidity ensures credit worthiness and goodwill to the firm.
5. According to the principle of Optimum Use, funds raised must be used optimally for the
purpose. Then only the financial plan serves it purpose. Hence financial plan should incorporate
neither excess funds nor deficit funds. It should have required/ optimum funds/balanced funds.
6. Principle of Economy states that, the financial funds should be raised at minimal cost. Hence
while formulating financial plan cost of procurement of capital funds should be kept in mind.
7. Principle of contingency and risk states that, sufficient provision should be provided for
contingencies and risk while formulating financial plan, because maximum utilization of funds
depends on how best we manage these future obstacles. Hence the financial plan should be with
the principle of provision for contingency and risk.

(4) A company is requiring a machine which requires an investment of Rs 3,20,000. The net
income before tax and deprecation is estimated as follows:
Year 1 2 3 4 5
Rs 1,60,000 80,000 1,08,000 1,12,000 96,000
Deprecation is to be charged on n straight line basis. The tax rate is 55%. Calculate Average Rate
of Return (ARR).

Particulars Amount
Total profit before depreciation and tax 5,56,000
Less: Total Depreciation 3,20,000
Total Profit before tax 2,36,000
Less: Tax at 55% 1,29,800
Total Profit after tax 1,06,200
Alternatively
Year PBDT Depreciation EBT Tax @ EAT
55%
1 1,60,000 64,000 96,000 52,800 43,200
2 80,000 64,000 16,000 8,800 7,200
3 1,08,000 64,000 44,000 24,200 19,800
4 1,12,000 64,000 48,000 26,400 21,600
5 96,000 64,000 32,000 17,600 14,400
Total EAT 1,06,200

Average investment = 3,20,000/2 = 1,60,000

Average EAT = 1,06,200/5 = 21,240
ARR = 21,240/1,60,000 x 100 = 13.275%

(5) Selling price per unit 120. Variable cost Rs 80. Fixed cost Rs 6,00,000. Interest Rs 2,00,000.
Number of units sold 30,000. Calculate Three Types of Leverages.
Particulars Amount
Sales (30,000 x120) 36,00,000
Less: Variable cost (30,000 x80) 24,00,000
Contribution 12,00,000
Less: Fixed Cost 6,00,000
EBIT 6,00,000
Less: Interest 2,00,000
EBT
4,00,000
Operating leverage = contribution/EBIT = 12,00,000/6,00,000 = 2 times.
Financial Leverage = EBIT/EBT = 6,00,000/4,00,000 = 1.5 times
Combined Leverage = OL x FL = 2 x 1.5 = 3 times OR = contribution/EBT =
12,00,000/4,00,000 = 3 times
(6) Calculate the future value at the end of five years of the following series of payments at
10% rate of interest. Rs 4,000 at the end of 1styear, Rs 5,000 at the end of 2nd year, Rs 6,000
at the end of 3rd year, Rs 7,000 at the end of 4th year, Rs 8,000 at the end of 5th year.
Year Amount No. of Compounding Future
Compoundings factors Vale
1 4,000 4 1.464 5,856
2 5,000 3 1.331 6,655
3 6,000 2 1.210 7,260
4 7,000 1 1.110 7,770
5 8,000 0 1.000 8,000
Total future value 35,541
 SECTION – C
Answer any 3 Questions. Each Question carries 10 marks (3 x 10 = 30)
(7) The management of Royal Industries has called for a statement showing the working capital to
finance a level of activity of 1,80,000 units of output for the year. The cost structure for the
company’s product for the above-mentioned activity level is detailed below.
Particulars Amount
per unit
(Rs.)
Raw material 20
Direct labour 05
Overheads (including Depn of Rs.
05 per unit) 15
Total cash cost 40
Profits 10
Selling price 50
Additional information:
1. Minimum desired cash balance is Rs. 20,000.
2. Raw materials are held in stock, on an average, for two months.
3. Work in progress (assume 50% completion stage) will approximately to half a month’s
production.
4. Finished goods remain in the ware house, on an average, for a month.
5. Suppliers of materials extend a month’s credit and debtors are provided two months’ credit;
cash sales are 25% of total sales.
6. There is a time lag in payment of wages of a month; and half a month in the case of
overheads.
From the above facts, you are required to prepare a statement showing working capital
requirements.
Solution:
Statement showing working capital requirements
Particulars Amount Amount
A. Current Assets
Cash in hand 20,000
Raw materials (1,80,000 x 20 x 2/12) 6,00,000
Work in progress
Raw materials (1,80,000 x 20 x 0.5/12) 1,50,000
Labour (1,80,000 x 05 x 0.5/12 x50/100) 18,750
Overheads (1,80,000 x 10 x 0.5/12 x 50/100) 37,500 2,06,250
Finished goods (1,80,000 x 35 x 1/12) 5,25,000
Debtors (1,80,000 x 35 x 2/12 x75/100) 7,87,500
Total Current Assets 21,38,750
B. Current Liabilities
Creditors (1,80,000 x 20 x 1/12) 3,00,000
Outstanding Labour (1,80,000 x 5 x 1/12) 75,000
Outstanding overheads (1,80,000 x 10 x .0.5/12) 75,000
Total current liabilities 4,50,000
Working capital requirements = (A-B) 16,88,750
(8) A firm cost of capital is 10% is considering two Projects X and Y the details of which are
Particulars Project X Project Y
Investment Rs 70,000 Rs 70,000
Estimated life 5 years 5 years
Cash inflow year 1 2 3 4 5 Total
Project X 10,000 20,000 30,000 45,000 60,000 1,65,000
Project Y 60,000 40,000 20,000 10,000 10,000 1,40,000
Compute the PBP, and NPV for the two Projects.
Year 1 2 3 4 5
PV Factors 0.909 0.826 0.751 0.683 0.621
at 10%
Solution. Computation of PBP
Cash inflows Cumulative cash inflows
Year Project X Project Y Project X Project Y
1 10,000 60,000 10,000 60,000
2 20,000 40,000 30,000 1,00,000
3 30,000 20,000 60,000 1,20,000
4 45,000 10,000 1,05,000 1,30,000
5 60,000 10,000 1,65,000 1,40,000
PBP for Project X = 3 + 10,000/45,000 = 3 + .0223 = 3.223 years
PBP for Project Y = 1 + 10,000/40,000 = 1 + 0.25 = 1.25 years
Computation of NPV
Cash inflows PV PV of cash inflows
Year Project X Project Y Factors Project X Project Y
1 10,000 60,000 0.909 9,090 54,540
2 20,000 40,000 0.826 16.520 33,040
3 30,000 20,000 0.751 22,530 15,020
4 45,000 10,000 0.683 30,735 6,830
5 60,000 10,000 0.621 37,260 6,210
Total of PV of cash inflows 1,16,135 1,15,640
Less: Initial Investment 70,000 70,000
NPV 46,135 45,640
(9) Sonu Ltd. company has on Equity Share Capital of Rs 10,00,000 divided into shares of Rs
100 each. It wishes to raise further Rs 6,00,000 for expansion plan. The company plans the
following financing schemes.
a) All Equity shares
b) Rs 4,00,000 in Equity shares and Rs 2,00,000 in 10% Debentures
c) All in 10% Debentures
The company has estimated EBIT at Rs 3,00,000 The corporate rate of tax is 50% calculate EPS
in each case. Give a comment as to which capital Structure is suitable.
Particulars Plan A Plan B Plan C
Earnings before interest and taxes (EBIT) 3,00,000 3,00,000 3,00,000
Less: Interest ----- 20,000 60,000
Earnings before tax 3,00,000 2,80,000 2,40,000
Less tax at 50% 1,50,000 1,40,000 1,20,000
Earnings after tax 1,50,000 1,40,000 1,20,000
Less: Preference dividend ----- ------ --------
Earnings available to ESHs 1,50,000 1,40,000 1,20,000
No of equity shares 16,000 14,000 10,000
Earnings per share 9.375 10.000 12.000
The company should go for Plan C as EPS is high in plan C
(10) Explain the objectives of financial Management.
Aims/Goals/Objectives of FM
Financial Management as a specialized discipline of basically has two-fold objectives.
Broadly speaking, the financial management discipline has dual objectives, namely
a. Profit Maximization
b. Wealth maximization
Meaning of Profit
The term profit is an operational concept, which signifies economic efficiency of firm's activities.
Here profitability refers to a situation where output exceeds input; that is the value created by the
use of resources is more than the total of the input resources.
In this sense, profit maximization would imply that, a firm should be guided by financial decision
making by one test that, select those assets projects and decisions which are profitable and reject
those which are not.

Significance of Profit maximization criterion:

The Profit maximization criterion serves as a basic criterion and the rationale behind this objective
is;
1. It is a simple guide to financial decision making.
2. Profit is a test of economic efficiency.
3. It provides a yardstick by which economic performance can be judged.
4. It leads to efficient allocation and uses of firm's economic resources to make profits.
5. It ensures economic welfare of society, since an individual who search for maximum profit
ability, it provides the famous invisible hand (profit) by which total economic welfare is
maximized.

Profit Maximization criticized as questioned:

In current financial literature, there is a general agreement that, Profit maximization is used in the
second sense; because it has been questioned and criticized on several grounds. The main technical
flaws of Profit maximization are;
1. The term Profit is Vague and Ambiguous concept.
2. It ignores timing of benefits.
3. It ignores the quality aspects of benefits.
1. Profit is Vague and Ambiguous concept
Profit has no precise connotation. It is amenable to different interpretations by different people. To
illustrate, profit may be, short term or long term; total or rate of profit; Profit before tax or Profit
after tax, return on investment or return on total assets or return on equity and so on. If profit is
taken to be the objective, the question arises, which of these variants of profits should a firm have
to maximize? Obviously, a loose expression like profit cannot form the basis of operational
criterion for financial management.
2. Profit ignores timing of benefits
This is another important technical objection to profit maximization, as a guide to financial
decision-making is that, it ignores the differences in the time patterns of the benefits received over
the working life of the asset, irrespective of when they were received. Normally the basic dictum
of financial planning is the earlier is the better principle' says that, the benefits received sooner are
more valuable than the benefits received later'. The reasons for the superiority of benefits received
now, over the benefits received later lies in the fact that, the former can be reinvested to earn a
return.
3. Profits ignore quality aspect of benefits
Profits ignore quality aspect of benefits associated with financial course of action. The term quality
here refers to the degree of certainty with which benefits can be expected. As a rule, the more
certain the expected return, the higher is the quality of the benefits. Conversely, the more
uncertain/fluctuating is the expected benefits; the lower is the quality of the benefits. An uncertain
and fluctuating return implies risk to the investors.
Risk is the chance that, actual outcome may differ from those expected. Our investors are risk
averters, who want to avoid or minimize risks. 1-lence, this risk concept makes profit maximization
objective as unsuitable as an operational criterion for financial management decisions, as it consider
only site of benefits and gives no weightage to the degree of uncertainty of the future benefits.

SHAREHOLDERS WEALTH MAXIMIZATION (SWM)

Shareholders Wealth Maximization is also known as Value Maximization or Net Present Value
(NPV) maximization states that, the value of the Asset or the value of a course of action or the
worth of the benefits associated with the precise estimation of the benefits actually derived and not
expected.

SWM concept is based on the concept of `cash-flows' generated by the asset rather than accounting
profit. SWM also considers the quality and quantity dimensions of the benefits measured in terms
of time value of money using an appropriate discount rate or interest rate or time preference rate or
capitalization rate. The worth of the streams of cash-flows with the value maximization criterion is
calculated by discounting its elements back to the present at a capitalization rate, that reflects both
time and risk preferences of the owners or suppliers of capital. in applying the value maximization
criterion, the term value is used in terms of worth to owners or shareholders.

Using Ezra Solomon's symbols & methods, NPV of a course of action is equal to;
W=V-C
Where, W = Net present worth
V = Gross present value.
C = Capital required to acquire- asset or to purchase a course of action (original
investment).
Wealth/ NPV is the difference between gross present worth (V) and the oripna investment I
required for achieving the benefits.
Advantages of Wealth Maximization
Wealth maximization as an operational criterion for management is most important and rational
from the following views:
1. Wealth maximization is a clear term since it takes in to account the time value of future benefits
to measure the future benefits of investment.
2. Wealth maximization takes into consideration the cash-flows instead of profit for measuring
the magnitude of returns i.e. NPV
3. Wealth maximization considers risk and uncertainty associated with future benefits through
discount rate.
4. Wealth is a visible concept by which the value of an organization is maximized.
5. Wealth maximization is a long-term objective for long run survival.
6. Wealth maximization shows true and fair picture of the organization.
Limitations of Wealth Maximization
The sound and clear concept of Wealth maximization is not out of criticisms; which are listed
below:
1. Wealth maximization objective is not descriptive, since this objective differs from one
organization to organization in its narration of wealth.
2. Wealth maximization objective leads to conflicting situation between the yardsticks of
management and stakeholders, since there are more possible areas of conflicts between them
with regard to the policies and procedures of the organization.
3. An ambiguity exists between the primary objective of Profit maximization and the secondary
objective of wealth maximization; since both the objectives are overlapping in nature.
4. There is a difficulty in the measurement of exact wealth, since it depends on anticipated future
cash flow benefits.
(11) Explain the factors determining working capital requirements of an organisation.
Factors determining Working Capital or Determinants of Working Capital
Number of factors affects/ leads to change in the quantum of working capital requirements of a
concern. The various such factors, which affect the working capital requirements of a concern, are:
1. Nature of Business
The nature of business is one of the important factors determining the working capital requirements
of a concern. Service rendering and public utility concerns business or industries 'like railways,
electricity supply companies require small amount of working capital. However, manufacturing
and trading concerns like steel industry, cement industry requires require large sums of working
capital.
2. Scale of Operations
Size of operations is also an important factor affecting the working capital requirements.
Large-size business organizations require large amount of working capital. Small size business
organizations require small amount of working capital.
3. Length of the Operating Cycle
The length of the operating cycle influences the size working capital. Longer the length of operating
cycle greater is the amount working capital. For example in case of ship building industry, aircraft-
manufacturing industries require more working capital. Shorter the length of operating cycle
smaller is the amount working capital.
4. Growth and Expansion of Business:
Growth and expansion of business also affects working capital requirements of a concern.
The growing & expanding business firms require relatively more amount of Working capital
compared to the firms, which are not growing and expanding.

5. Length of Manufacturing Process

Length of manufacturing process also influences the amount of working capital. Longer the
manufacturing process, the higher will be the amount of Working capital. ln trading concem, no
manufacturing process is involved so small amount of working capital is required.
6. Production Policies
Production policies are one of the factors affecting working capital requirements. For example,
capital-intensive industries require more fixed capital and small amount of working capital. The
labour-intensive industries require more working capital.
7. Rapidity of Turnover
The rapidity of turnover of inventories has influence on working capital requirements of a business
concern. If goods are sold quickly, it requires less Working capital. On the other hand, if turnover
is very low a concern requires more working capital. For example consumer goods industries
requires less working capital because of high rate of turnover. However, Jewellers industries
require more working capital because of low rate of turnover.
8. Seasonal Fluctuation in Demand
Seasonal fluctuation in demand also influences the amount of working capital. If the demand is
fluctuating, then amount of working required also varies. Cyclical factors also affect working
capital. During boom period, a concern requires more working capital. During the recessionary
period, a concern requires less working capital. If the demand is stable, less amount of working
capital is required. O11 the other hand, demand is highly fluctuating as in the case of readymade
dresses larger amount of working capital is required.
9. Reliability of Supply
The nature of supply of raw material decides the size of working capital. If there is, variation in
supply of raw materials, source of supply is not reliable, supply is irregular then large amount of
working capital is required to maintain more quantity of inventories. On other hand, if supply is
constant, regular and reliable small amount of working capital is enough.
10. Operating Efficiency
The operating efficiency of a firm affects its working capital requirements. High efficient
companies use its resources efficiently and require less working capital, On the other hand, a firm,
which does not enjoy operating efficiency, needs more working capital.
11. Credit Policy
The credit policy of a f`1rm determines its size of working capital requirements. When the firm
follows liberal credit policy and sells goods and services on credit, requires more working capital.
On the other hand, if the firm follows stricter credit policy, then the firm requires relatively small
amount of working capital.
12. Credit Facilities Enjoyed from Creditors
The credit facilities enjoyed from creditors will affect its size of working capital. A firm which
enjoys liberal credit facilities from its suppliers needs lesser working capital than a firm, which
does not enjoy liberal credit facilities from its suppliers.
13. Nature of Competition in the Market
Competitive conditions prevailing in the market influences the size of working capital of a business
concern. The firm facing stiff competition in the market has to provide liberal credit facilities to
their customers to retain them and to face the competition. ln addition, they require keeping large
quantity of inventories to meet customer’s orders in time, for these reasons, the firm requires large
amount of working capital. On the other hand, a monopoly firm needs small amount of working
capital.
14. Dividend Policy
Dividend policy also affects working capital requirements of a firm. A firm following liberal cash
dividend policy requires more working capital. On the other hand, a firm following strict dividend
policy requires small amount of working capital.

SECTION – D
Answer the following question. It carries 8 marks (01 x 08 = 08)
(12) (a) Following is the data for X company for the financial year ended 31-03-2023.
Particulars X
% of Variable costs to sales 75%
Interest Expenses 6,000
Operating leverages 6:1
Financial leverages 4:1
Income tax rate 35%
Prepare Income Statement of the company.
ா஻ூ் ா஻ூ்
Financial Leverage = OR Financial Leverage =
ா஻் ா஻ூ்ିூ
ா஻ூ்
4= ா஻ூ்ି଺,଴଴଴
= 4EBIT – 24,000 = EBIT = 3EBIT = 24,000 EBIT = 8,000
஼௢௠௧௥௜௕௨௧௜௢௡ ஼௢௠௧௥௜௕௨௧௜௢௡
Combined Leverage = ா஻ூ்
=6= ଼,଴଴଴
= Contribution = 48,000
 Income statement

Particulars Amount
Sales (48,000/25 x 100) 1,92,000
Less: Variable cost (1,92,000 x 75%) 1,44,000
Contribution 48,000
Less: Fixed Cost 40,000
EBIT 8,000
Less: Interest 6,000
EBT
2,000
OR
(b) Using the following data, calculating the current operating cycle for XYZ Ltd.
(Rs. In ‘000’)
Sales 6,000
Cost of production 4,200
Purchases 1,200
Average raw material stock 160
Average work-in-progress 170
Average finished goods stock 360
Average creditors 180
Average debtors 700

Computation of Operating Cycle

Particulars No. of
Days
Raw material holding period
஺௩௘௥௔௚௘ ோ ெ ଵ଺଴ 49
RMHP = ோெ ஼௢௡௦௨௠௣௧௜௢௡ X 365 days = ଵଶ଴଴ X 365 days
Work in Progress Holding Period
஺௩௘௥௔௚௘ ௐூ௉ ଵ଻଴
WIPHP = ஼௢௦௧ ௢௙ ௉௥௢ௗ௨௖௧௜௢௡ X 365 days = ସଶ଴଴ X 365 days 15
Finished Goods holding period
FGHP =
஺௩௘௥௔௚௘ ி ீ
X 365 days =
ଷ଺଴
X 365 days 31
஼஼ைீௌ/௢௦௧ ௢௙ ௉௥௢ௗ௨௖௧௜௢௡ ସଶ଴଴
Debtors Collection period
஺௩௘௥௔௚௘ ஽௘௕௧௢௥௦ ଻଴଴
DCP = X 365 days = X 365 days 43
஼௥௘ௗ௜௧ ௌ௔௟௘௦ ଺଴଴଴
Gross Operating Cycle 138
Less: Creditors Payment Period
஺௩௘௥௔௚௘ ஼௥௘ௗ௜௧௢௥௦ ଵ଼଴ 55
CPP = X 365 days = X 365 days
஼௥௘ௗ௜௧ ௉௨௥௖௛௔௦௘௦ ଵଶ଴଴
Gross Operating Cycle 83